The London Stock Exchange Group launches a dedicated “Transition Bond Segment”

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Mid-February the London Stock Exchange Group (LSEG) announced the expansion of its Sustainable Bond Market by creating a so-called Transition Bond Sub-Segment, which is not defined by a format per se (it can be Use-of-Proceeds and General Corporate Purpose Instruments alike). The LSEG is the first exchange to establish a “transition overlay” to its existing market components (see table 2 on Stock Exchanges’ Sustainable Finance Instruments Segments). A specific body of transition criteria presented below delineates this layer of analysis.

Composition of the Sustainable Bond Market Segment         

The Sustainable Bond Market (SBM) is a market component within the Debt Capital Market (“Bonds”) segment [1] of the LSEG exclusively listing sustainable finance debt securities. The SBM currently lists bonds from 23 countries worth more than £56bn. The Transition Bond Segment, which remains unsolicited for the time being, is a sub-segment within the SBM alongside the Use-of-Proceeds and General Corporate Purpose segments. An investor can thus distinguish between the different sustainable debt instruments listed on the LSE and efficiently single out transition bonds.

A Dedicated Transition Bond Segment

Transition bonds can be both Use-of-Proceeds and General Corporate Purpose formats considers the LSEG. It has specified that, in essence, transition bonds can be either sustainability-linked or green bonds with specific added criteria aimed at ensuring the transition of high-emitting companies; it is an additional layer or attribute. Table 1 details the structure of the SBM.

 

Table 1. Structure of the London Stock Exchange Group’s Sustainable Bond Market

Source: London Stock Exchange Group, Sustainable Bond Market (SBM) Factsheet - available here

*These companies generate more than 90% of their revenue from green activities: the underlying methodology is the Green Revenues taxonomy developed by FTSE Russell (available here). As of now, 78 bonds corresponding to the Green Revenue Segment are listed. They are issued by the EBRD, Pennon Group, Severn Trent Plc, Tesco, and United Utilities Water Finance Plc.

In order for a debt instrument to be included in the transition bond segment, the issuer is expected to comply with the following requirements set out by the LSEG:

Table 2. Analysis of the four requirements needed to solicit entrance in the transition bond segment

LSEG Transition Bond Requirements

Our opinion on the proposed criteria

A credible transition framework (not necessarily a bond issuance framework), prepared in accordance with the guidelines set out in the ICMA Climate Transition Finance Handbook, or as measured by well-recognized market frameworks such as the Transition Pathway Initiative (TPI).

Maintaining a substantial, sound and “science-based” [2] transition scenario is one of the core recommendations of the ICMA Climate Transition Finance Handbook. There are currently discussions about the methodologies testing the science-based feature of these transition scenarios (ACT, SBTi, TPI) and issuers are free to choose among various methodologies. Criteria are clear in theory. One wonders who will carry the assessment within the LSEG and what are the minimum requirements, for instance, what is necessary in terms of level of “management quality” when using TPI as a reference.    

 

A confirmation of effective disclosure practices aligned with the principles outlined by Task Force on Climate-Related Financial Disclosures (TCFD) or a well-recognized standard within a reasonable timeframe (within 18 months from admission of securities, or by the following annual reporting period)

 

This requirement is mandatory to verify the credibility and effectiveness of the transition strategy. In fact, the ICMA emphasizes the importance of a quality disclosure specific to climate-related data in order for the climate transition strategy of the issuer to be credible. The TCFD is recommended as a recognized reporting framework but other frameworks are allowed (TPI or ACT).

A confirmation of public commitment to Paris Agreement goals, including approved targets to achieve net zero emissions by 2050

The ICMA’s handbook does not involve a strict requirement for entities to be on a 2°C scenario - even though the ICMA notes that the design of the transition scenario should be “guided by the objective of limiting global temperature increases ideally to 1.5°C and, at the very least, to well below 2°C”. Consequently, the LSEG seems to set the thermometer lower than 2°C/set the bar higher/. However, the way this commitment is approved is not specified but one believes SBTi or ACT or verifiers might be solicited.

A reporting of the transition performance annually on an ongoing basis.

It is essential to assess progress and required for green and sustainability-linked bonds that are two of the forms a transition bond can potentially take.


These requirements are essentially safeguards allowing the LSEG to identify transition bonds. Nonetheless, it is unclear whether a dedicated verifying body or team is set to be in charge of guaranteeing the criteria are fulfilled. Further the LSEG has noted that it if these criteria are not met, but supporting materials are provided, it reserves the right to include bonds in this segment on a discretionary and case-by-case basis.

 

The rationale behind transition bonds

According to the LSEG,  transition bonds are a type of sustainable debt finance instruments serving low-carbon transition efforts and are particularly relevant for high-emitting sectors. Highly emitting companies have historically not been able to tap into dedicated / delineated sustainable finance opportunities (i.e. beyond ESG integration or some Indexes). Emphasizing the transition efforts of high emitting companies through sui generis/ad hoc filters, segments or approaches, could help such companies preserving their access to capital in the context of investors’ portfolios transition strategies (defensive approach), or even attract additional capital from investors poised to be activist from a climate change mitigation standpoint (offensive approach).

As of now, there is no agreed definition on the exact meaning of transition and transition bonds (see our transition tightrope webpage). The criteria proposed by the LSEG have some virtue as they reuse existing standards. However, temperature scenario alignment and disclosure are far from sufficient and most of the criteria required in situ and case-by-case analysis.

 

Table 2. Stock exchange with green, social or sustainable segments

Name of the Stock Exchange

Type of dedicated section

Launch date

Oslo Stock Exchange

Green Bonds

January 2015

Stockholm Stock Exchange

Sustainable Bonds

June 2015

London Stock Exchange

Sustainable Bond markets

July 2015

Shanghai Stock Exchange

Green Bonds

March 2016

Mexico Stock Exchange

Green Bonds

August 2016

Luxembourg Stock Exchange

Luxembourg Green Exchange

September 2016

Borsa Italiana

Green & Social Bonds

March 2017

Taipei Exchange

Green Bonds

May 2017

Johannesburg

Green Bonds

October 2017

Japan Exchange Group

Green & Social Bonds

January 2018

Vienna Exchange

Green & Social Bonds

March 2018

Nasdaq Helsinki

Sustainable Bonds

May 2018

Nasdaq Copenhague

Sustainable Bonds

May 2018

Nasdaq Baltic

Sustainable Bonds

May 2018

Swiss Stock Exchange

Green & Sustainability Bonds

July 2018

The International Stock Exchange

Green Bonds

November 2018

Frankfurt Stock Exchange

Green Bonds

November 2018

Santiago Stock Exchange

Green & Social Bonds

July 2019

Moscow Exchange

Sustainable Bonds

August 2019

Euronext

Green Bonds

November 2019

Hong Kong Exchange

Sustainable & Green Exchange

June 2020

Singapore Stock Exchange

Green, Social & Sustainability Bonds

 TBA

Source: Climate Bonds Initiative, Green Bond Segments on Stock Exchanges – available here.

 

[1] Approximately 12,000 debt securities are listed on the London Stock Exchange.

[2] ICMA, Climate Transition Finance Handbook (December 2020) – available here