Greenwashing fears dampen global interest in Japan's inaugural transition bonds

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International investors showed tepid interest in Japan's first sovereign transition bond sale, possibly due to concerns that the country's decarbonization financing tool is not sufficiently green.

The Japanese government in February issued a total of about ¥1.6 trillion of yen-denominated transition bonds — about ¥800 billion each for the five- and 10-year debt — becoming the world's first sovereign to issue bonds of this type. The issuance was the kickoff of the country's plan to sell ¥20 trillion worth of transition bonds over the next decade.

Transition bonds are typically used by heavy polluters to fund projects aimed at reducing their environmental impact or emissions.

"It received very little interest in the implications of transition bonds despite the large planned amount," said Edward Bourlet, a senior research analyst at CLSA. "The main challenges for transition bonds for overseas investors seem to be what is regarded as green by overseas taxonomies — transition bonds are broader in their remit — and Japan's low yields."

A start

Still, Japan's first sovereign transition bonds are a "start" and the nation has the potential to become Asia's energy transition finance hub, Bourlet said, adding, that transition bonds would appear more suited to Asia's transition needs. "To this end, it's important for foreign investors to get involved," he said.

Japan, which relies heavily on carbon-intensive businesses such as steelmaking, is pushing for this relatively new product designed to finance a transition to a net-zero goal. The world's third-biggest economy aims to become a hub for transition finance, which is different to commonly accepted definitions of green bonds that are specifically used to finance green projects such as renewable energy.

In the Asia-Pacific region, China issues two separate categories of green bonds — one aligned with international standards and another to local definitions. In recent years, the world's biggest greenhouse gas emitter has leaned more toward standards that are more in line with international practices to make its bonds more attractive to global investors.

Greenwashing concerns

Transition bonds could raise greenwashing concerns among European investors as "they think it as either green or not green," said Takahide Kiuchi, executive economist at Nomura Research Institute. "They only think of it in two ways."

The market for transition bonds is not big even in Japan. Non-sovereign issuers sold ¥236 billion of transition bonds in 2023, compared with ¥421.2 billion in 2022, according to data from the Japan Securities Dealers Association. Issuance of green bonds nearly doubled to ¥2.281 trillion in 2023, from ¥1.085 trillion in the previous year, data show.

The bid-cover ratio of the five-year sovereign transition bonds auctioned Feb. 27 was 3.39×, lower than the 3.44× for the recently issued regular government bonds with the same maturity. The ratio of the 10-year transition bonds sold Feb. 14 was 2.9×, compared with 3.65× for a regular Japanese government bonds of a similar tenure, according to analysts. Most of the sovereign transition bonds were purchased by domestic brokerages, they said.

Kiuchi said that the lower bid-to-cover ratios mean "a lack of strong investor demand." The executive further said that transition bonds are "not well recognized" overseas … particularly in Europe, the leader of the global green bonds market.

Investor roadshows

Japan hosted investor roadshows in major green bond markets — the UK, France, Germany and the US — to attract international buyers for its sovereign transition bond sale, according to a Finance Ministry spokesperson who declined to be named.

"We went to those countries because there are many ESG [environmental, social and governance] opinion leaders there and we wanted to expand our investor base for the transition bonds," the spokesman said. "We were able to gain the understanding from them on the transition bonds to some extent, but there were some 'dark green' investors who would rather stick with green bonds," he added.

Proceeds from the sovereign transition bonds issued in February will be used for a wide range of projects, such as exploring hydrogen-used technologies for steelmaking and fuel-cell batteries, and promoting production of clean-energy powered automobiles, according to the government. The broader list of eligible programs for the decarbonization includes developing a next-generation nuclear reactor, carbon-capture technologies and decarbonizing ships.

Low liquidity

Japan's sovereign transition bonds will also face the challenge of low liquidity, potentially making them less attractive to international investors. The planned issuances of transition bonds over the next decade would make just 2% of the total Japanese sovereign bonds. The market for regular government bonds surpassed ¥1,100 trillion in 2023, according to Bank of Japan data.

The Bank of Japan owned ¥336.6 trillion worth of the 10-year transition bonds as of Feb. 29, according to data from the central bank. That is about 40% of the total amount of about ¥800 billion of the debt sold Feb. 14.

"That would distort the market mechanism and reduce the liquidity further," said Haruyasu Kato, a fund manager at Asset Management One. "Investors wouldn't buy them [transition bonds] just for ESG."