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June 15, 2023

Sovereign SLB: an option for Japan’s transition

Japan is looking to finance its decarbonisation program with transition bonds. AFII suggests sovereign SLBs instead.

Japan has recently announced a significant borrowing programme (GX transition bonds), specifically to support its energy transition. The proposed framework designates proceeds for investment in specific technologies, including hydrogen/ammonia co-firing. Anthropocene Fixed Income Institute (AFII) analyses the Japanese transition bond framework, and suggests an alternative-Sustainability-Linked Bonds (SLB), where proceeds are unrestricted and coupon payments linked to transition outcomes.

Using an SLB to finance the Japanese energy transition offers three key benefits:

▪ There are questions being raised about the carbon reduction and cost of hydrogen/ammonia co-firing as a transition technology. Issuing an SLB rather than a bond with a fixed use-of-proceeds would give the Japanese government the option to allocate capital to a variety of technologies without locking in choices today. It is a more flexible instrument than the proposed GX transition bonds, which bet today on specific technologies that may prove uneconomical in future.

▪ SLB financing focuses on outcomes rather than investment. This can reassure Japan’s partners of its long-term goal of decarbonisation. Performance targets linked to an ambitious reduction in carbon emissions would provide a strong message about Japan’s determination to tackle the sources of climate change. It would also allow commitments to be made beyond the term of a political cycle, as subsequent changes in policy could resultin increased financing costs.

▪ Transition bonds are not a widely used product; an SLB format could appeal to a broader range of investors. Use-of-Proceeds (UoP) transition bonds, where funding isused only for specific eligible investments that are not for traditional green projects, have so far found little interest from international investors. An SLB format could attract more interest from global investors, as it can be aligned to international standards. This could create lower funding costs, and more credibility on the global stage for Japan’s transition.