Recent Discussions on Transition Finance in Japan

This article will discuss a paper titled “Addressing the Challenges of Financed Emissions”, which was issued by a working group launched by several Japanese ministries and globally operating financial institutions, and which focuses on the role of financial institutions in accelerating decarbonisation. It will also explain the “Japan Climate Transition Bond Framework”.

In February 2023, the Japanese government formulated the Basic Policy for the Realisation of GX (Green Transformation) and enacted the GX Promotion Law in July 2023. Since then, the GX Implementation Council within the government has been continuing to meet to promote GX.

In regard to transition finance provided by financial institutions for transition in industries where decarbonisation is difficult (known as “hard-to-abate industries”), in June 2023, the Financial Services Agency (FSA), the Ministry of Economy, Trade, and Industry (METI), and the Ministry of the Environment (MOE) released the “Transition Finance Follow-up Guidance” as guidance for financial institutions.

Based on this guidance, in October 2023, the Japan Public and Private Working Group on Financed Emissions to Promote Transition Finance, which was launched by the MOE, the METI, and the FSA together with ten globally operating private financial institutions, released a paper titled “Addressing the Challenges of Financed Emissions” (the “Report”).

The Report summarises the roles that financial institutions are expected to play in the transition to carbon neutrality and in the disclosure of financed emissions to achieve that carbon neutrality. As well as ensuring that the financing of innovation and the transition toward decarbonisation of hard-to-abate industry is appropriately evaluated and promoted. The Report presents two types of solutions to the issue of financed emissions: (i) methods for calculating and disclosing financed emissions, and (ii) methods for disclosing multiple indicators other than financed emissions.

In order for the initiatives of financial institutions, including transition finance, to be properly evaluated, it would be useful to devise calculation and disclosure methods that take the current financed emissions issues into account. The Task Force on Climate-Related Financial Disclosures (TCFD) has already recommended the disclosure of carbon intensity and weighted average carbon intensity (WACI) (financed emissions in intensity) in terms of physical and economic intensity, following the disclosure financed emissions in absolute terms. In addition, the calculation and disclosure of financed emissions related to transition finance is a possible option.

By disclosing the entirety of the financed emissions and then showing the financed emissions related to transition finance as a breakdown of those financed emissions, it will be possible to appeal to stakeholders more clearly for the transition finance initiatives of the financial institution. For example, even if the financed emissions of the entire portfolio increase due to an increase in transition finance, with the separate disclosure of the transition finance portion, the increase in financed emissions can be explained as the result of investments in hard-to-abate industries and other sectors to support the decarbonisation of the real economy.

By dividing financed emissions into the emissions share of projects eligible for earmarked transition finance and the emissions share of other projects, the contribution of financial institutions that have supported decarbonising investments through transition finance can be reflected more precisely in financed emissions than in the current methods used to account for financed emissions.

Apart from innovation in the calculation and disclosure of financed emissions, another way to describe the decarbonisation efforts of financial institutions is to use multiple indicators. While financed emissions are an excellent indicator for comparing and continuously monitoring the net zero efforts of financial institutions, it is not easy to evaluate various efforts over a medium-term investment based on financed emissions alone, which captures only fragments of a single point in time. Therefore, it is important to use the following other indicators in addition to financed emissions to properly evaluate the efforts of financial institutions.

Indicators related to efforts to promote decarbonisation of the real economy, such as:

Indicators related to the ability of financial institutions to implement measures related to decarbonisation support. Indicators of the degree of progress and implementation of plans developed by financial institutions can be a useful guide to the extent of their involvement in decarbonisation. The following indicators can be listed.

In response to the Basic Policy for the Realisation of GX, the Japanese government has decided to issue GX Economy Transition Bonds amounting to JPY20 trillion over ten years starting in 2023. This is the world’s first transition bond issued by a national government. A liaison conference called the “Government-Related Ministries and Agencies Liaison Conference on GX Economy Transition Bond Issuance” (the “Liaison Conference”) was launched by the Cabinet Secretariat, the FSA, the Ministry of Finance, the METI and the MOE to develop a framework specifying the use of funds from the bonds and to obtain third-party certification. The Liaison Conference formulated a framework titled “Japan Climate Transition Bond Framework” for the issuance of the GX transition bonds in November 2023. Under this framework, the GX transition bonds have received certification from external evaluation agencies that the bonds meet international standards. A summary of the framework is provided below.

Based on the government’s GX Promotion Strategy, the procured funds will be used for projects that help achieve international commitments of carbon neutrality in 2050 and a 46% reduction in greenhouse gases in 2030 (compared to fiscal year 2013), which are consistent with the Paris Agreement.

The four basic conditions for selecting the use of procured funds are:

The funds will be used for projects that meet these four criteria.

In particular, specific uses are stipulated within the following broad categories: energy efficiency, renewable energy, low-carbon and decarbonised energy, clean transportation, environmentally friendly industrial goods, environmentally friendly production technologies and processes, sustainable management of living natural resources and land use, and the circular economy.

The procured funds will be allocated to eligible projects and will be managed to ensure that the funds are used for the purposes presented in the Framework. METI will use an internal management system to track and control the procured funds on an annual basis to ensure that the procured funds match the actual expenditure.

In the reporting to be conducted after the implementation of fundraising based on the Framework, fund appropriation reporting (reporting items: (i) amount appropriated, (ii) balance of unappropriated funds, and (iii) estimated amount or percentage of the portion of funds raised that was appropriated in the fiscal year prior to the time of issuance) and impact reporting (reporting items: (i) CO2 emission reductions and other environmental improvement effects, (ii) outline of major projects, (iii) appropriation amount, (iv) number of adopted projects, (v) examples of introduction, and (vi) progress in R&D and capital investment) will be conducted.

A revision the Framework will be considered at least in the next five years, depending on the development of Japan’s GX promotion strategy and the progress of eligible projects.