Transition finance will accelerate decarbonization in China. Here’s how

The 2022 United Nations Climate Change Conference at Sharm el-Sheikh (COP27) has made it crystal clear: climate pledges will not hold without concrete and concerted actions and the provision of climate finance is crucial for a net-zero transition. According to the latest Emissions Gap Report, the global low-carbon transformation requires an investment of at least $4-6 trillion per year.

Decarbonizing the industrial sectors is crucial for the transition to net zero. Hard-to-abate sectors – including materials industries such as aluminium, steel, cement and concrete, chemicals and transport industries such as road freight, shipping and aviation – account for around 30%-40% of carbon dioxide emissions globally. These economic activities are referred to as “hard to abate” because reducing emissions in these sectors is constrained by the availability of economically feasible technologies and bankable projects, which comes down to financing.

Sustainable finance has been promoted for several decades globally and great progress has been made in many countries. Global green financing on environmentally friendly projects worldwide has grown over 100 times in the past decade, swelling from $5.2 billion in 2012 to $540.6 billion in 2021. However, as a crucial enabler for climate action and a green transition, the current regime of sustainable finance needs to support the transition of carbon-intensive industries noted above. Transition finance should be called on to address this problem.

The G20 Sustainable Finance Working Group defines transition finance as “financial services supporting the whole-of-economy transition, in the context of the Sustainable Development Goals (SDGs), towards lower and net-zero emissions and climate resilience, in a way aligned with the goals of the Paris Agreement.”

Compared to sustainable finance or green finance that mobilizes capital for “green” projects, transition finance aims to mobilize financing for the transition of carbon-intensive “brown” sectors.

Take the steel and aviation industries, for example. In September 2022, six multinational banks launched the Sustainable STEEL Principles, a climate-aligned finance agreement for the steel sector, which is the turnkey solution to measure and disclose the alignment of steel lending portfolios with 1.5°C climate targets. Meanwhile, the aviation industry is accelerating commercialized solutions to expedite the use of sustainable aviation fuel (SAF) after International Civil Aviation Organization announced the historical goal of net-zero transition by 2050.

As the world’s largest emitter, China currently emits one-third of the global total greenhouse gas emissions. However, it has committed to peaking carbon emissions before 2030 and achieving carbon neutrality before 2060. This vision is no small task because China is still a developing country with growing urbanization and a relatively young industrial infrastructure. That means there will be more lock-in emissions if new growth is ill-equipped with low-carbon technologies.

Hard-to-abate sectors take the lion’s share of China’s total carbon emissions. For example, the steel sector accounted for 17%, cement and concrete 13% and chemicals 13%. The industrial processes of these sectors depend very much on fossil fuels and electricity used by these sectors largely comes from coal, accounting for about 58% of China’s total power generation. This high proportionality makes the transition journey an even more challenging one.

For the past decade, China has been championing a “green finance revolution” and has done a great deal in utilizing green finance to increase renewables. China was one of the first countries in the world to issue a green bond project catalogue; it recently developed its own Green Bond Principles; and it worked with the EU to develop the Common Ground Taxonomy. With over $380 billion in investment in renewables in 2021, China is leading the world.

Despite all these advances, one big problem remains to be solved, which is how to decarbonize emission-intensive sectors. Under the current green finance regime, financial institutions are not encouraged to invest in or make loans to companies in these sectors, even when projects are designed to reduce emissions. Without financial support, however, these sectors won’t be able to scale up the use of cutting-edge low-carbon technologies.

Leaders of the G20 approved the transition finance framework in Bali. It outlines five pillars for the development of transition finance – transition activities and investments identification, information reporting, financial instruments, policy measures and just transition. Based on our experience developing green finance in China, we can convene and catalyze collective actions in several areas.

As a co-chair country of the G20 Sustainable Finance Working Group, China has already taken steps on transition finance. The People’s Bank of China is leading the development of a transition finance taxonomy.

Some pilot zones for green finance reform and innovation are taking local initiatives to develop their locality- and industry-specific taxonomies. For example, the City of Huzhou launched its regional transition finance roadmap in February this year.

Conventional business models and financial instruments are inadequate to mobilize financing to support the deployment of cutting-edge technologies in the hard-to-abate sectors. To achieve that goal, we need to create policy incentives for investors and redesign the supply chain and transaction modalities.

The First Movers Coalition, a global initiative of the World Economic Forum, leverages collective purchasing power from companies to send a clear demand signal to the supply side to scale up critical emerging technologies essential for the net-zero transition. Our initiative Mobilizing Investment for Clean Energy in Emerging Economies, launched the Coal-to-Renewables Toolkit in 2022, which promotes best practices through case studies on coal-to-renewables repurposing from technology and financing perspectives.

An eco-system of transition finance not only requires standards and instruments but also needs capacity building for companies to learn how to make good use of the standards and instruments. These capacity-building activities should cover how to develop corporate-level decarbonization roadmaps, account for and verify greenhouse gases, leverage carbon markets for corporate emission reductions and utilize innovative financing models and financial instruments (such as sustainability-linked bonds) to finance the deployment of new technology, etc.

Fighting climate change is a collective endeavour; no country or institution can do it alone. The Forum works with stakeholders across borders, sectors and industries to foster collective actions.

For example, the Mission Possible Partnership is an alliance between the Forum and other global institutions with a mandate to decarbonize the hard-to-abate sectors. Finally, the Carbon Neutrality Alliance to convene climate leaders and catalyze collective actions to decarbonize industries and transport in China is currently being launched.

Vital contributions to this article also came from Wen Zhang, Materials Sector Lead, China Climate Action, World Economic Forum; Wei Xu, Mobility Sector Lead, China Climate Action, World Economic Forum; and Vee Li, Energy Sector Lead, China Climate Action, World Economic Forum.