What is transition finance, which is frequently mentioned at COP28, and how is it evolving?

Transition finance is the next frontier of sustainable finance.

Green and low-carbon transformation and high-quality development require massive financial guarantees to stimulate the endogenous power of the market. Climate investment and financing is one of the key topics of the 28th United Nations Climate Change Conference (COP28), and relevant parties have held a number of side meetings and discussions on issues related to finance and climate change. At present, green finance is in full swing, and transition finance has become a new focus. What is the difference between green finance and transition finance, and how should transition finance develop? Focusing on related issues, a reporter from China Environment News interviewed Zhang Lijun, PwC China's Regional Economic and Financial Business Leader.

What is Transition Finance?

Promoting the orderly decarbonization of high-carbon industries has supplemented the shortcomings of green finance

Both green finance and transition finance are sustainable finance. In recent years, green finance has been frequently mentioned and is more well-known, but the concept of transition finance was proposed relatively late.

What is Transition Finance?

It is understood that this concept was first proposed by the Organization for Economic Co-operation and Development (OECD) in 2019. According to the OECD, transition finance refers to the financial activities that provide financing to economic agents as they transition to the Sustainable Development Goals.

"Generally speaking, green finance refers to the flow of funds to engage in zero-carbon and near-zero-carbon green environmental protection technology fields to support 'pure green' economic activities, such as photovoltaics, wind power, new energy vehicle energy storage and other industrial fields. Zhang Lijun told reporters, "Transition finance is in the face of high-emission industries, the flow of funds from high carbon to low-carbon process, such as cement, steel, chemical and other high-carbon, difficult to reduce emissions of industries are not fully covered by green finance, and it is impossible to transform into a green industry all at once, in the process of low-carbon transformation also needs a lot of financial support, this is the meaning of the existence of transition finance." ”

"The emergence of transition finance has supplemented the shortcomings of green finance to a certain extent, but the inevitability of developing transition finance is more reflected in China's energy structure and industrial structure. First of all, China's energy structure has the characteristics of 'rich coal, poor oil and low gas', and energy security is very important for a fast-growing country. Secondly, China is still in the process of industrialization and urbanization, steel, cement, chemical and other industries are needed in the current stage of development, so they need transition finance to support them in energy conservation and emission reduction, unlike developed countries where all kinds of infrastructure are in place, and the industrial structure is dominated by the service industry, which can directly eliminate these high-carbon industries. From the perspective of industrial structure, transition finance is not only a new market, but also has more important significance, and high-carbon industries need financial support for their orderly transformation to reduce carbon emissions. Zhang Lijun said.

How can transition finance keep pace with the development of green finance?

  China has policy support, and top-level design and standards are gradually improving

China attaches great importance to the development of green finance. We have continuously improved the green financial system, and carried out active exploration and practice in green loans, green bonds, climate investment and financing, etc. According to public data, as of the end of the third quarter of 2023, China's green loan balance was 28.58 trillion yuan, ranking first in the world, and the balance of the domestic green bond market was 1.98 trillion yuan, ranking second in the world.

With the rapid development of green finance, how can transition finance keep up with the pace?

The system construction and design of the top level are gradually improving. Previously, the People's Bank of China issued the "Promoting the Effective Connection between Green Finance and Transition Finance" to further strengthen the top-level design of financial support for green and low-carbon development. The paper mentions that transition finance focuses on serving industries and projects with significant carbon emission reduction benefits, providing reasonable and necessary financial support for low-carbon transformation in areas with high emissions or difficult to reduce emissions, and it is necessary to summarize and refine effective practices and beneficial models for the development of green finance and apply them to the field of transition finance.

In this regard, Zhang Lijun further said, "The People's Bank of China has taken the lead in drafting transition finance standards for four industries: coal power, steel, building materials, and agriculture, which will provide a very clear and accurate direction for promoting transition finance identification, financial support, and financial product innovation." Previously, the People's Bank of China set up a special re-loan to support the clean and efficient use of coal, and in the future, as the standard definition becomes clearer, there will be more monetary policy tools to encourage financial institutions to devote themselves to transition finance innovation. ”

China also has its own standards and experience on how to define the industry itself. "When financial institutions provide financial support for the low-carbon transition of high-carbon emission industries, they need relevant standards for reference, and the improvement of carbon accounting standards provides support for the quantitative evaluation of transition finance. In fields such as cement, steel, transportation, and construction, there must be clear standards for what technologies and processes need to be adopted in the process of transition finance. China is also currently developing a set of standards to facilitate the flow of money to these areas. Zhang Lijun told reporters.

What are the keys to driving transition finance practices?

It is necessary to build a data support system that can be monitored, reported and verified

China's financial system is dominated by commercial banks, and commercial banks must play their role. The traditional economic industries are constantly adjusting, and commercial banks are also looking for new growth opportunities. In this process, commercial banks will face some challenges.

"The essence of finance is to pursue a balance between risk and investment returns, and the return on funds allocated to unit risk is the highest. The traditional financial system does not measure climate-related environmental risks. On the return side, there is no price for positive externalities of carbon emissions. Regardless of whether it is green finance or transition finance, on the basis of normal financial returns, if the carbon reduction part is monetized and then included in the return, the return on capital will inevitably be different; Zhang Lijun said, but at present, these calculations have not been established, and a large amount of normative data must be relied on.

Traditional finance uses hard collateral, which is not applicable to green finance, especially transition finance. For commercial banks, it is necessary to have an in-depth understanding of the technology and industry-related environmental performance of relevant sub-sectors in emerging fields, combined with standardized data, such as carbon factor database and carbon footprint data products, so that commercial banks can have a full and objective assessment when granting credit.

The design of a set of transition standards and supporting measures is the key to promoting the practice of transition finance, and the establishment of standards and supporting measures requires a large amount of data support.

Zhang Lijun made suggestions based on his own experience, "It is necessary to establish a set of MRV (verification, reporting, accounting) system, further promote the integration of carbon scenarios and data elements, accelerate the construction of scientific and accurate green benefit accounting and measurement methodology, effectively monitor the environmental benefits of green subjects and green projects, and establish and improve carbon emission data collection, carbon accounting, The carbon account management and evaluation system allows the data exchange and the carbon emission exchange to be connected, and fully supports the establishment of its own database in each vertical industry. ”

The underlying logic of sustainable development is to ensure that it is not only green, energy secure, but also affordable. "The work of building data cannot be done by a single bank, it is not capable, and the cost is high, and the state needs to promote the establishment and implementation of it at the overall level. Zhang Lijun said, "China has always been at the forefront of the circulation of data elements, and the country is also promoting and accelerating the construction of a basic data support system to provide a guarantee for the development of sustainable finance." ”