A five-point agenda for financing NDCs

By Sean Kidney?

I’m in Washington DC today, at the US Treasury for a roundtable on corporate transition finance convened by Secretary Janet Yellen. As I walked past the White House this morning my mind was caught up by NDCs – climate action plans that every country has agreed to submit to the UN in the coming year under the Paris Agreement – and how they could be reconceived around emerging opportunities. The world economy is changing, driven by action by the four largest economies in the world – and the USA’s steps have little risk of being unravelled because they are creating so many jobs in Republican States.??

Just on energy, the world’s largest green hydrogen plant is being built in Kansas; the world’s biggest solar plant (3.5GW) has come online in China; Japan has launched the GX Promotion Organisation with a JPY1tn yen investment programme; over 40% cars bought in China this year will be electric; and an increasing share of sustainable aviation fuel will be mandated in the EU from 2025.ii,iii,iv??

The question for governments is how to end up as a winner in the new economy.??

As the world economy shifts to green, it changes the dynamics of designing NDCs. The extraordinary growth in demand for things like the mineral resources for green industry means governments can now make climate action an economic opportunity for their country. ??

NDCs can now be reconceived as transition opportunity plans (TOPs).?

A transition opportunity plan can help governments secure better terms on their debt.?

It’s not just that changes to the global economy are resulting in the development of new opportunities and different development pathways.?

It’s also that climate impacts are starting to hit, with sovereign credit ratings already suffering as a result.v Transition and stranded asset risks are also impacting ratings.vi Preparing well for those impacts will improve economic outcomes and reduce default risks.?

Many sovereign green bond issuers have already seen higher demand and reduced interest rates for labelled deals. Such pricing benefits have also been obtained by entities using sustainability-linked debt to finance corporate transition plans; countries can deploy exactly the same tactics.?

Approaches will vary between nations, not just between developed and emerging economies. Each country will need to take a specific tailored approach. However, there are some common principles for all.?

Climate Bonds has designed a five-point plan to help governments to achieve this: ?

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1. Develop a transition opportunities plan?

A transition opportunities plan (TOP) is an economic development plan explaining how government will respond to climate risks and take advantage of new opportunities.??

Transition planning is often only thought of in terms of emissions reductions. However, the point of a TOP is to ensure resilience to the changes occurring in the global economy. Investors are increasing pressure on governments to issue national transition plans to help them identify opportunities and mitigate risks in their portfolios.vii?

A TOP will boost economic development, create jobs, and encompass emissions reductions (and growth of low-carbon activities), climate resilience, just transition measures, and biodiversity protection. A TOP should:viii?

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Set credible targets to excite the market.

• As well as 2030 and 2050 climate mitigation targets, set resilience and just transition targets, with a process for regular review.??

Create a policy roadmap to deliver on opportunities.

• A vision of how the government will deliver the transition plan in its own operations and policies.??
• An assessment of the impact of decarbonisation, the feasibility of implementation, and the interdependencies of the transition actions and policies to develop a clear timeline for operationalisation. ?
• A capacity building plan for relevant government departments to ensure swift action on the policy roadmap. ?

Identify a pipeline of investment opportunities.?

• Financial targets based on an assessment of financing needs for the TOP, with detailed costing for shorter-term actions and policies, and an estimated timeline.?
• Identification of investment opportunities and sources of capital: public, private, and international, see steps 3–5.

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2. Prioritise urban development plans that build resilience, productivity and jobs?

Cities are experiencing increasingly frequent and severe climate change impacts, including floods, wildfire smoke, extreme heat, and sea-level rise. Rapid urbanisation, particularly in emerging markets, underscores the urgent need for investment in both mitigation and adaptation efforts. ??

Cities are responsible for 70% of global emissions (IPCC), and according to the Green Climate Fund, 70% of climate solutions are implemented at the local level (GCF). There is a significant opportunity to enhance urban resilience, improve quality of life, and position cities for inclusive growth.??

Transition plans will need to be aligned with and interact with urban economic plans to ensure we have productive cities that can create wealth, liveable for the population and resilient to withstand climate hazards.??

Resilient and prosperous cities will require aggressive enabling policies, including on buildings policy (energy efficiency, clean heating and cooling) and planning laws (green spaces and nature-based solutions (NbS)).ix An urban development plan is the starting point for transformative and creative urban planning.??

They should encompass all actors that impact urbanisation, including ensuring reliable access to insurance to safeguard resilience to climate shocks.??

Urban development plans should include financing plans, aligned with those of the TOP. These will provide private investors with long term clarity and security on urban planning. Financing strategies will likely include:?

• Green municipal bonds, facilitated by legislative changes where necessary to allow autonomous borrowing.?

• Innovative approaches such as land-value capture and integration of NbS to lower the cost of infrastructure development. ?

• Preferential regulatory treatment for green mortgages and mortgage-backed securities.x?

Alignment between NDCs, TOPs and all other development strategies provides clarity and assurance to investors. Cities with existing development strategies, can update plans to ensure alignment with a TOP.xi?

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3.?Make plans attractive to long term private capital?xii?

Private finance is crucial to achieving transition objectives. Domestic and international sources of private capital can be leveraged to finance the transition and spur the required economic growth. ?

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This requires:??

• An enabling policy environment that tilts investment decisions towards transition objectives.?

• Policy certainty: clear and consistent policymaking to enable long-term investment planning.?

• Targeted de-risking support where investments are new and risks cannot be managed through other policies.?

The investment opportunities and financial needs assessment of the TOP can be used to inform policy selection.? Investors have called for NDCs to be accompanied by financing strategies to enable them to identify long term investment opportunities.?

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4.?Use public sector capital efficiently?

There is limited public resource available to finance the transition. Therefore, it should be targeted at the transition expenditures which are the least attractive to private investors. Government spending, development bank balance sheets, sovereign wealth funds, etc. can all be tilted to prioritise green investments.

Resilience of public financing can be improved through local currency borrowing. Strong investor appetite for local currency sovereign green bonds in India and Mexico demonstrate the viability of this. In addition, measures to prevent overborrowing and keep costs of servicing debt lower could be deployed, such as modular development and borrowing for infrastructure development. ?

Public sector capital should prioritise crowding in of private investment wherever possible. This crowding-in can be achieved in multiple ways:??

• risk-sharing instruments, such as pooled and blended funds. This should be standardised for maximum impact.?

• enabling infrastructure investments (grids, rail, etc.), and??

• tilting government expenditure to provide demand for low-carbon products, transforming industries such as cement and steel where public demand accounts for 40% and 25% of global demand.?

?In addition, governments can work to capture international public sector capital. For resilience investments in particular, blended finance can use international concessionary capital to lower cost of capital.?

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5.?Commit to plans with sovereign issuance ??

Sovereign green, social, sustainability, and sustainability-linked bond (SLB) (collectively GSS+) issuance is a proven and powerful tool for a government to secure long-term, low-cost capital to finance its transition while also sending a powerful signal of its climate commitments. ??

The national TOP can be used in the development of the sovereign green bond framework. In particular, best practice in SLBs?is to align key performance indicators (KPIs) with the ambition set out in transition plans to ensure materiality and impact. Use of Proceeds (UoP) bonds can also be strengthened by aligning with TOPs to ensure funds raised are effectively directed towards projects that support the transition plan.?

Rooting bond frameworks in TOPs provides assurance on:??

• The alignment of the bond with the policy framework. Currently, sovereign bonds are often excluded from investors’ net zero strategies, partially due to flaws in policy frameworks.xii?

• The contribution of the bond to the country’s progress towards decarbonisation. Sovereign bond investors are calling for granular information on decarbonisation strategies beyond NDCs that improves understanding of transition risk exposure.???

• Achievability of the Sustainability Performance Targets in the case of SLBs. ?

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Increasing proportion of debt issued against the green bond framework is also a powerful indication of commitment to green. Alignment of the framework with the TOP should make this easier. Proportions of green debt vary widely across the world. Among the 53 issuers of aligned sovereign GSS+ debt captured by Climate Bonds at the end of Q1 2024, Chile’s GSS+ sovereign deals accounted for 46% of its total liabilities, France was at 18%, while the UK was at just 2%. ??

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There is unmet investor demand for sovereign green and transition deals The USD4.7tn GSS+ bond market is evidence of this. Demand for green sovereign bonds far outstrips supply with the January 2024 French green bond over 12x oversubscribed, receiving a record EUR98bn bids.xiii India’s debut sovereign bond, issued in local currency, received a 6bp greenium. Japan’s government Certified the first government transition bond, based on its Green Transformation (GX) Plan and also obtained a greenium.xiv ?

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Capital is moving at scale towards the green and resilient transition. Now is the time to develop the plans to capture these opportunities and deliver robust and resilient economic growth.??

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i?New Analysis of National Climate Plans: Insufficient Progress Made, COP28 Must Set Stage for Immediate Action | UNFCCC(link is external) ?

ii?World’s largest solar plant goes online in China –?pv?magazine International ( pv-magazine.com )(link is external) ?

iii?Trends in electric cars – Global EV Outlook 2024 – Analysis - IEA(link is external) ?

iv?ReFuelEU?Aviation -?European?Commission ( europa.eu )(link is external) ?

v?eprints.soas.ac.uk/26038/(link is external) ?

vi?fitchratings.com/research/sovereigns/climate-change-strandedassets-are-long-term-risk-for-some-sovereigns-15-02-2021(link is external) ?

vii?Transition planning for a greener economy - Aviva Investors(link is external) ?

viii?Informed by climate bonds’?5?Hallmarks?for transition plans,?guidance_to_assess_transition_plans.pdf ( climatebonds.net ) ?

ix?https://www.fema.gov/sites/default/files/documents/fema_riskmap-nature-based-solutions-guide_2021.pdf(link is external) ??

x?Programmes to support the green housing market?continue on?tighter terms ( mnb.hu )(link is external) ?

xi?IIGCC_Making?NDCs investable - the investor perspective_June2024.pdf(link is external) ?

xii?Sovereign Bonds and Country Pathways discussion paper ( iigcc.org )(link is external) ?

xiii?16 January 2024: Launch of the new Green OAT 3.00% 25 June 2049 for an amount of €8 billion |?Agence?France Trésor ( aft.gouv.fr )(link is external) ?

xiv?Japan will issue $11bn Climate Transition Bond, Certified under the Climate Bonds Standard | Climate Bonds Initiative ?Blog