Finance for a just transition

Actions are required at the strategic and operational level to mobilize financial support for a just transition

The need to anticipate and address the socioeconomic repercussions accompanying the transition to low-emission and climate resilient pathways is increasingly acknowledged. The concept of a just transition has, therefore, gained momentum and is widely discussed in key international forums such as the G20 and the United Nations Climate Change Conference (COP 27). The Paris Agreement preamble, for instance, cites "the imperatives of a just transition of the workforce and the creation of decent work and quality jobs in accordance with nationally defined development priorities".

To operationalize the "just" element of the transition is particularly pertinent to emerging markets and developing countries (EMDCs), where climate change can aggravate existing challenges of poverty, inequality, unemployment and inadequate social protection, among other things. In the meantime, to achieve a just transition may unveil opportunities that contribute to a much broader development agenda through climate actions.

A key difficulty in achieving a just transition — a transition process that not only delivers decarbonization but also ensures employment stability and social equity — lies in the question of who pays for it. Theoretically, it is the responsibility of governments to provide social security (e.g., unemployment insurance and job training programs, and subsidies for the ultra-low-income population) as a cushion for dislocation of the job market during the process of transition. However, in many countries, especially EMDCs, their fiscal capacity is already constrained and there are simply no extra fiscal resources to address unemployment and other social stresses resulting from the net zero transformation of carbon-intensive industries such as coal-fired power generation, steel, cement and petrochemicals.

It is therefore imperative that a wider range of financial sector players, including institutional investors, banks, and multilateral development institutions, be involved in financing the just transition, given the asset base they manage. Over the past years, they have been active in financing many "pure green" or near "pure green" projects (e.g., renewables and electric vehicles) according to green or sustainable finance taxonomies such as those adopted by China and the European Union. Nevertheless, most financial institutions have stayed away from financing transition activities undertaken by carbon intensive companies, largely due to the lack of a clear definition of and disclosure requirement for transition activities, which could lead to "transition-washing" and fear of being accused of "transition-washing".

To address these barriers that have constrained the willingness of the financial sector to participate in transition finance, the G20 Sustainable Finance Working Group has released the G20 Transition Finance Framework — a document endorsed by the G20 leaders in Bali, Indonesia, on Nov 16. This document sets out 22 principles for establishing a policy framework for transition finance, including how to incorporate the "just" element into financial transactions to support a just transition.

As outlined by the G20 Transition Finance Framework (as part of the 2022 G20 Sustainable Finance Report), a just transition should be encompassed as one of the essential pillars in the continuous configuration of the transition finance framework. The framework "encourages fund raisers to assess and mitigate potential impacts of their transition plans or other strategies. In setting the eligibility criteria and reporting framework for transition activities, authorities or financial institutions, consistent with domestic mandates and local laws and regulations, should encourage the fund raiser (the company) to assess the potential socioeconomical implications of its transition plan and to be transparent about the implications of the measures taken to mitigate negative impacts or highlight potential net positive impacts.

To implement the G20 Transition Finance Framework, especially its guidance on incorporating the "just" element, we believe that the following actions are required:

First, a dedicated set of social indicator matrices should be developed to help measure the progress made in implementing the "just" element of transition plans. A few existing practices might enlighten indicator designs. The EU's Just Transition Mechanism, for instance, proposes to include "jobs created in supported entities" as a key performance indicator. To give another example, South Africa's Just Energy Transition Investment Plan suggests three core indicators, namely "number of coal workers transitioned", "number of workers in all priority sectors reskilled, upskilled and/or retained" and "number of youth positioned for the new energy economy".

To start with, a list of high-level social indicators could be formulated to guide the assessment of transition-induced impacts on employment and human capital development, including those pertaining to job access (the number of people retained or accessing alternative job opportunities, for example), and training (number of people trained for reskilling/upskilling).Tracking these could be further disaggregated at the project level by breakdowns into gender, age and income group, as per project specifics. In addition to input-based indicators, outcome-based indicators (such as annual salary increases, satisfaction with employment) might also be developed in an attempt to capture the quality of the transition.

Second, financial incentives could be further promoted to reinforce the just transition efforts of high-emitting companies, including those dedicated to ensuring social stability and equity. On this front, the rapid deployment of transition finance instruments, such as sustainability-linked loans (SLLs) and bonds, may provide timely opportunities. Take SLLs as an example. A step-down of 5 to 10 percent of the initial margin is commonly observed in the market if a transition target is fulfilled. Such pricing incentives are, however, considered modest at best, compared to the sustainability actions anticipated or being seriously conducted by the fund raisers.

It is important for financial institutions to realize that it could be in their best interests to offer incentives for borrowers to meet targets, particularly the social ones, as mismanaged targets could result in greater operational consequences, (such as social grievances and unrest resulting from insufficient employee placement) and reputational risks to borrowers, which in turn could pose higher risks of loan defaults. Financial losses, once realized, could be more substantial for financial institutions than that provided as incentives.

Third, to further stimulate the undertakings of financial institutions and others as proposed above, it is crucial to engage capable third parties in monitoring the use of transition finance and for the social implications of the transition activities to be disclosed. Second Opinion Providers, for instance, could help verify the rationality and adequacy of sustainability-linked financing arrangements for high-emitting companies, paying special attention to whether socioeconomic considerations are properly incorporated in target setting, tracking and disclosure. Disclosure requirements should also be put in place to ensure that companies using "transition finance" report the just social commitments they make, the actions (reskilling and retraining programs) undertaken, and the deliverables against their commitments.

Zheng Yuan is a climate specialist at the New Development Bank. Ma Jun is the president at the Institute of Finance and Sustainability and co-chair of G20 Sustainable Finance Working Group. The views of the article are entirely those of the authors and do not represent the New Development Bank. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn.