DBS sets up to pursue transition finance

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??This week: DBS Bank has rolled out the first major update to its transition finance framework in three years, clarifying and enlarging the scope of activities and assets that fall under the framework.

With its sustainable finance portfolio expanding by 27 per cent to S$89 billion in 2024, DBS could be setting up a potential new growth engine from supporting the decarbonisation of high-emitting sectors. However, the complexities of transition finance could necessitate changes to the way that the bank reports its financed emissions.

In very simplistic terms, transition finance is funding that helps brown become more green, and it represents the next step in the evolution of sustainable finance.

From green to brown-to-green

A paper by the Net-Zero Banking Alliance (NZBA) and Oliver Wyman explains that evolution. In the early days of sustainable finance, banks began by simply setting targets for the amount of sustainable finance they would provide. But these targets were primarily focused on “green” finance, and they weren’t based on what was required for sustainable outcomes.

Sustainable finance then shifted to portfolio alignment with decarbonisation pathways and expanded to products like sustainability-linked financing. The focus on portfolio emissions enabled assessments of whether the banks were doing enough. However, measuring progress based on portfolio emissions incentivises banks to finance already green entities and activities, while discouraging them from engaging with high emitters to get them to decarbonise. Such a situation could delay the phasing out of high-emission assets, especially those with long lifespans like coal-fired power plants.

The sustainable finance industry has therefore been trying to develop transition finance, which seeks to support the decarbonisation of existing entities and activities.

Assembling the framework

But transition finance has the potential to be abused for greenwashing. You’re financing something that’s brown on the expectation that the money will be used to become more green, but if you’re not careful that money could be used to stay brown for longer. These risks make it essential for financiers to ensure that transition plans are credible and that the financing doesn’t lead to a “lock-in” of high emissions.

The NZBA-Oliver Wyman paper raised the example of a hypothetical coal-fired power plant operating in a competitive market against renewable and gas competitors. Even though early retirement of coal plants would normally fall under most transition eligibility lists, in such a scenario financing a managed phase-out of this coal plant could lock in the plant’s emissions for longer than necessary. If the banks finance the plant’s lower-emitting competitors instead, it might even hasten the shutting down of the coal plant.

The latest refinements to the DBS framework provide significantly more details about how the framework protects against these situations.

The new version shows how DBS decides what is eligible for a “transition” label. If an activity is being financed, it needs to fall within the bank’s eligibility taxonomy. An entity obtaining sustainability-linked financing needs to have a transition plan and the financing instrument’s sustainability targets need to be linked to the transition plan. Any financing with the transition label also has to comply with the bank’s responsible financing standard and pass assessment, credit approval and labelling checks.

The eligibility taxonomy for transition has also been widened to now include Infrastructure adaptation and resilience, and to include “enabling” activities. An enabling activity is one that is deemed to be necessary for the development or implementation of an eligible activity’s value chain but doesn’t directly contribute to emissions reduction. Examples include supplying materials for the electric vehicle industry, or the production of batteries that can be used for storage of renewable energy.

The taxonomy further allows for financing that supports the development of an entity’s transition plan.

DBS has also set minimum expectations for clients’ transition plans to be credible enough to qualify for financing. Those expectations include allowing for guardrail measures – such as ringfencing use of proceeds – if the credibility of the transition plans has not yet been independently verified. Such an option seeks to avoid delaying transition efforts.

Seeking potential

Updating the framework to make it more robust and credible has strategic value for the bank.

As evident in the new eligible activities that DBS has added to its framework, transition opens a new world of potential business for sustainable finance. DBS can more aggressively pursue those opportunities with less concern about being accused of greenwashing. It could be good for the bottom line.

The timing of the update also comes as pieces have begun to fall into place that could accelerate progress in transition finance.

In response to queries, Shilpa Gulrajani, DBS head of sustainability for the institutional banking group, says that sustainable finance taxonomies by Singapore and the Association of Southeast Asian Nations have “amber” categories for transition activities. Rating agencies have developed climate transition assessments that can help investors discern the strength of different transition plans.

“Transition finance is still at a nascent stage in Asia. Notwithstanding this, transition financing instruments continue to gain traction in Asia,” she says.

Long story

If DBS succeeds in growing its transition finance business, it might face the other challenge of transition finance, which is how to report outcomes.

The current norm of reporting financed emissions may not work well with transition finance, because lending to brown entities raises the portfolio’s emissions in the short term, even though the positive impact only takes place over the long term. This could lead DBS to miss interim targets on financed emissions.

The dominant industry view is that the current way of reporting portfolio emissions doesn’t quite work for transition finance because future emissions reductions are not captured under the existing methodologies. However, because transition finance as a distinct class is still a developing field, how to report transition finance impact is still a work in progress.

NZBA-Oliver Wyman describe three classes of metrics that might be used:

• Activity performance indicators: These show how much sustainable finance has been provided, with splits to show how much is labelled transition.
• Output performance indicators: These show emissions reductions attributable to the financing. However, these metrics can be highly controversial due to the complexities of trying to determine reduction and attribution. The Glasgow Financial Alliance for Net Zero (GFANZ) has proposed calculating “expected emissions reduction”, but that idea has been criticised because of the high risk of greenwashing in determining a baseline from which to measure reductions. Another suggestion is to report “committed emissions reduction” that measures borrowers’ commitments attributable to financing, but this would require clear ringfencing of proceeds as well as borrowers to have clear transition targets.
• Aggregate indicators: These show accumulated outputs of activities and deliverables, such as the expected financed emissions reduction by target deadlines from financing carried out during the reporting period. However, these are exposed to the same problems of the other metrics, even if the granularity is not reported.

Regardless of what emerges as an industry standard, the report authors stressed the need to maintain the primacy of traditional and well-established methodologies for reporting portfolio emissions, and to be transparent about material contextual factors.

??Top ESG reads:

1. Hong Kong and Singapore are the only two out of nine major Asian markets that have yet to quantify and communicate climate impacts or vulnerabilities across specific sectors, says the Asian Investor Group on Climate Change.
2. Singapore will launch a request for proposal later this year for the procurement of carbon credits, and commit S$62.5 million to develop a test-bedding facility for low-carbon solutions.
3. Malaysian lawmakers passed legislation on carbon capture, utilisation and storage as part of a goal to become a global leader in the technology.
4. The US has withdrawn commitments worth over US$3 billion to programmes in Thailand and Vietnam aimed at the early retirement of coal power plants.
5. More than two dozen foreign and domestic investors are warning Vietnamese leaders that retroactive changes to subsidies for renewable power could put more than US$13 billion of investments at risk.

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