Transition finance used to be shunned by financiers, especially those in Europe, who have made net zero pledges. But the tide is slowly turning.
“Over the last 12 months or so, there has been a change in sentiment towards transition finance,” said Eric Lim, chief sustainability officer of Southeast Asia’s third-largest bank UOB, referring to the emerging asset class which, unlike green finance, is used to help brown sectors become greener over time.
“We had a reality check, particularly in Europe, that green is not enough. You need to be able to chart out high-quality transition plans from carbon-intensive economic models to net zero models.”
Lim observed that institutional investors in Europe who engage with the Singapore-based lender have become increasingly open to transition-type financial assets in the form of bonds, loans, and equity-related financial instruments. But the key thing to note, Lim said, is these transition assets need to be of “high-quality.”
This is prompting Asia’s regulators to grow “more confident in leading the charge on transition plans and transition finance,” said Lim.
He cited the Monetary Authority of Singapore (MAS)’s work on managed coal phase-out with the global climate finance coalition Glasgow Financial Alliance for Net Zero (GFANZ) as progress, as well as the recent launch of the MAS’s transition planning guidelines for financial institutions – which experts have lauded as one of the most comprehensive for the sector thus far.
UOB, following in the footsteps of its regional competitor DBS, published its Transition Finance Framework last September, to support its clients in hard-to-abate sectors to pivot away from fossil fuels and other carbon-intensive business operations.
The framework enables UOB to finance carbon capture, utilisation and storage (CCUS) technologies, carbon offsets and the adoption of low-carbon fuels for the transportation and logistics industry.
As of the end of September 2023, UOB has provided S$38 billion (US$28.6 billion) in sustainable financing, surpassing its S$30 billion (US$22.5 billion) target roughly two years ahead of schedule.
Despite the growing interest in transition finance projects globally, Lim noted that many still fail to meet the “double criteria” of “high-quality” and “bankability” or commercial viability, which he added is where companies need greater national, sectoral and regulatory clarity on credible transition pathways.
Even if a company could articulate an investment plan to generate green or transition assets, it might be “shooting [itself] in the foot from a commercial standpoint” if coherent sectoral and national guidance do not exist, according to Lim.
Eco-Business sat down with Lim to speak more about how the bank strikes a careful balance between potential short-term increases in financed emissions while financing transition activities, as well as the regulatory signals needed to give financial institutions the confidence to scale up transition finance in Asia.
What are some key trends you’re seeing in the market, and what are their implications for transition finance in Asia?
While we see a growing awareness within the real economy of the need to transition, companies are still struggling to confidently put together high-quality transition plans. It’s not a willingness issue, but more about ensuring these plans are high-quality and executable. There is still a lack of sectoral and regulatory clarity on what national pathways look like.
If a company is not getting strong regulatory signals from the government, it makes it much harder for them to articulate a transition pathway without ending up with stranded green or transition assets [which are assets that may lose value or become obsolete as the world transitions to a more sustainable economy]. Suppose their investment plan generates new low-carbon economy assets, but the sectoral or national ecosystem isn’t ready to maximise the commercial value of those assets. In that case, they might be shooting themselves in the foot from a commercial standpoint.
For example, practitioners talk about the energy transition pathway in three big chunks: the energy supply, or how to wind down fossil fuels and grow renewable, hydrogen or possibly even nuclear capacity; the transmission distribution and storage bit in between; and the energy demand management on the downstream side.
Many energy transition plans focus on the supply side, but not enough attention is paid to the transmission distribution and storage, and demand management side. As a result, real economy companies might put a lot of capital expenditure into creating the supply and then realise there is not enough demand downstream because incentives are still in place to subsidise fossil fuels, or the infrastructure isn’t in place to ensure that the supply reaches the end user in an economically viable way. That complexity makes a lot of real economy clients hang back out of concern.
Are real economy companies held back by the fear of moving too fast, ahead of what the state’s direction is?
That’s right. This is why we advocate for each ecosystem player to understand the “levers” that sit within their control. For a national government or a regulator, it’s helping them understand that the real economy wants to move, but they need to make certain policy changes.
A classic example in point: the Bank of Thailand has told Thai incorporated banks that by the end of 2024, they need to have at least one sector with a net zero target. Now, this is the first time a banking regulator within the region has told their banks that they need net zero targets. We can tell you the moment you start to set net zero targets, it fundamentally changes the fabric of how banks think about business.
Once public commitments have been made to regulators, investors and the general market, product capabilities must be brought to the table, bankers need to be trained, and the bank has to ensure its risk management is up to snuff. It fundamentally starts to change how banks engage with the real economy. It makes the business of net zero the business of banking.
What are the “levers” that you can pull as a bank?
The MAS transition planning guidelines are important because the structural levers are the ones that create the largest change.
The first important structural change is that the regulator essentially stands in front of the banking system to encourage banks to move towards net zero, while steering them away from portfolio managing their way to net zero. So as a bank, we have to move towards net zero but we can’t simply divest my way towards net zero. So being stuck between a rock and a hard place means a bank has to engage.
What the MAS has done is structurally help the entire Singapore banking industry to legitimise our conversations with the real economy on a level playing field, and to push for transition plans, roadmaps and investment plans towards a low-carbon economy. This is a massive structural shift as there’s no more arbitrage. So you will likely have the same conversation when you go to any bank.
Secondly, there are greater regulatory expectations on the banks to invest in their capabilities. After guidelines are implemented and regulators ask for an inspection, they might request for a bank’s credit acceptance guidelines to be improved or deem clients’ transition plans to be low-quality.
Regulators are recommending greater involvement in financing transition activities, which may increase financed emissions in the short term. How is UOB navigating this?
Our board asked us the same question. This is where, again, the transition planning guidelines from the MAS become very important. It sets the ambition, but it also sets the expectation that banks should help clients transition.
Say we have a client that has a strong, credible transition roadmap and investment plan, but their baseline emissions right now are higher. When we do increase our exposure to them we make it very clear to senior management how we will help them.
We hold ourselves accountable to the board and to our regulator to perform emissions attribution analysis [used by investors to understand how much of an investee’s greenhouse gas emissions are attributed to an investment] at that level. Then we’ll explain to the market the reasons behind our actions.
What’s the difference between high-quality and bankability? And what is considered a high-quality transition plan?
When we say “high-quality” credible transition pathways, we are referring to trajectories aligned with the Paris Agreement, or limiting temperature rise to 1.5°C compared to pre-industrial times and achieving net zero carbon emissions by 2050.
Of course, different countries might have different net zero goals, such as Indonesia, which aims to be net zero by 2060 as part of its national plan. If you are an Indonesian company with a transition plan working towards net zero by 2060, it is still considered credible since it is aligned with the country’s national ambition, despite it being different from Paris Agreement goals.
The second component of a high-quality transition plan is the ability to articulate how companies can change their business model to deliver on that plan. For instance, they need to be able to say, “Today, my business model has this much in oil and gas. But by 2030, I want to have 15 per cent of my business in renewables and 15 per cent of my research and development in hydrogen. Meanwhile, I’m going to be utilising carbon capture technology.” They need to come up with a business transformation plan that has numbers behind it.
In critiquing bankability, both banks and investors look at a company’s plan and decide whether their investments are commercially and financially viable. It is our role as a bank to underwrite credit, or assess the creditworthiness of borrowers.
If the numbers don’t add up, then we deem their capital plans as not financeable or bankable.
You mentioned carbon capture. Is there a white list of decarbonisation technologies that UOB views as credible in its transition plans?
We recognise the fact that fossil fuels still need to be a part of the base energy load for some time in the transition towards net zero. CCUS should be responsibly used to capture, sequester or utilise carbon, but only for the time being.
We cannot support CCUS if it is used as an excuse to delay mitigation and a transition to renewable sources of energy. So if someone comes to us and says they will rely on CCUS technology while maintaining a coal-fired power plant for another 10 years, we will advise against this.
Who are the main clients using UOB’s transition finance framework?
The reality is that most clients would rather opt for a sustainability-linked loan (SLL) [a type of loan that is structured such that the interest rates borrowers pay are based on their achievement of sustainability performance targets] even if they have a high-quality transition plan in place.
This is because there are still sustainability performance targets that allow them to access sustainable financing but in a way that protects their reputation. Due to the scepticism that still surrounds transition assets and transition finance, companies are very reluctant to publish transition plans, believing that they will quickly be criticised.
So when we talk to them about publishing their transition plans, there is still some reluctance to do so. They would rather use SLLs and we need to change that; we need to legitimise the concept of transition roadmaps, pathways and finance to speed up progress.
Have you witnessed a similar transformation in the financial system previously that could serve as a model for making sustainable finance the norm?
In 10 years, sustainable finance will be conventional finance. Non-sustainable assets, companies, and business models will be viewed as “non-conventional,” attract less capital, and come with higher financing costs.
Transition finance will eventually legitimately become part of sustainable finance, and the moment we can unlock high-quality transition finance, it will throw into sharp contrast companies that do not have a transition plan.
This is because a transition plan is a business strategy and commercial viability plan for a low-carbon future. Companies without such a plan may soon appear commercially uncompetitive to banks, shareholders and investors compared to their competitors.
The European Banking Authority (EBA) also recently announced requirements for banks to start incorporating ESG considerations into their risk-weighted asset calculations. In a bank, we call that regulatory capital, which is the blood that flows through our veins. The moment the central bank requires banks to consider sustainability when calculating the amount of capital they must hold to reflect the risk profile of their assets, it completely changes how banks make investments.
It’s early days, but these things manifest over time. Once we have the right technologies, ecosystems and frameworks in place for companies to leverage, we will see sustainable finance becoming a norm much quicker.