Report on Transition Finance by the Expert Committee on Climate Finance

Report on Transition Finance By Expert Committee on Climate FinanceTable of Contents 1. Abbreviations and Acronyms ______________________________________________ i 2. Letter from Chair to Chairperson, IFSCA __________________________________ iv 3. Committee Formation ____________________________________________________ v 4. Approach of the Committee _____________________________________________ vii 5. Acknowledgment ______________________________________________________ viii 6. Executive Summary ______________________________________________________ 1 7. Context __________________________________________________________________ 2 8. Deliberations and Recommendations _____________________________________ 5 8.1 Pillar 1 – Scope and Definition of Transition Finance _______________________________ 5 Recommendations _________________________________________________________________ 12 8.2 Pillar 2 – Policy and Regulation __________________________________________________ 15 Recommendations _________________________________________________________________ 18 8.3 Pillar 3 – Financial Mechanisms (Structures) and Financial Instruments ___________ 22 Recommendations _________________________________________________________________ 23 9. Appendixes _____________________________________________________________ 281. Abbreviations and Acronyms Abbreviations Definition ADB Asian Development Bank AIF Alternate Investment Fund ASEAN Association of Southeast Asian Nations AUM Asset Under Management BRSR Business Responsibility and Sustainability Reporting CBI Climate Bond Initiative CCFD Carbon Contract for Difference CCUS Carbon Capture, Utilisation and Storage CEEW Council on Energy, Environment and Water CEO Chief Executive officer CGM credit guarantee mechanism CGTSME Credit Guarantee Fund Trust for Micro and Small Enterprises CO2 Carbon dioxide CPI Climate Policy Initiative CSR Corporate Social Responsibility DBS Development Bank of Singapore DFI Development Financial Institution ECA Export Credit Agencies ECB External Commercial Borrowings EMDEs Emerging Markets and Developing Economies ESCO Energy Service Company ESG Environmental, Social and Governance EU European Union EY Ernst and Young FCDO Foreign, Commonwealth & Development Office FCRA Foreign Contribution Regulation Act FI Financial Institutions FLDG First Loss Default Guarantee GBP British pound sterling GCF General Collateral Financing iAbbreviations Definition GFANZ Glasgow Financial Alliance for Net-Zero GGEF Green Growth Equity Fund GHG Greenhouse gases GIFT Gujrat International Financial Tech-city Green, Social, Sustainable, Sustainability-linked and transition GSS+ labelled ICM Indian Carbon Market ICMA International Capital Markets Association IEA International Energy Agency IFC International Finance Corporation IFSC International Financial services centres IFSCA International Financial services centres Authority INR Indian Rupee IPCC Intergovernmental Panel on Climate Change IRDAI Insurance Regulatory and Development Authority IREDA Indian Renewable Energy Development Agency ISDA International Swaps and Derivative Association IT Information Technology JSW Jindal Steel Works KPI Key Performance Indicators LC Letter of credit LMA Loan Market Association MAS Monetary Authority of Singapore MD Managing Directors MDB Multilateral development banks MLI Member lending institutions MOEFCC Ministry of Environment, Forest and Climate Change of India MoF Ministry of Finance MW Megawatt NCGTC National Credit Guarantee Trustee Company NIIF National Investment and Infrastructure Fund NSE IFSC National Stock Exchange- International Financial Service Centre iiAbbreviations Definition NZE Net Zero Emissions OECD Organisation for Economic Cooperation and Development PCG Partial Credit Guarantee PE Private Equity PPF Project Preparatory Facility PRI Principles for Responsible Investment PRSF Partial Risk Sharing Facility RBI Reserve Bank of India RD&D Research, Development and Demonstration RE Renewable Energy SDF Steel Development Fund SDGs Sustainable Development Goals SEBI Securities and Exchange Board of India SLB Sustainability-Linked Bonds SLD Sustainability- Linked Derivative SLL Sustainability-linked Loans SME Small and Medium Enterprises TA Technical Assistance TPI Transition Pathway Initiative TRL Technology readiness level TSC Technical Screening Criteria UK United Kingdom UN United Nations UNFCCC United Nations Framework Convention on Climate Change US United States USD United States Dollar USICEF US-India Clean Energy Finance VC Venture capital VGF Viability Gap Funding WTE Waste to Energy iii2. Letter from Chair to Chairperson, IFSCA India stands at a critical juncture with the challenging task of mobilizing climate finance estimated over USD 10 trillion by 2070 to achieve its net-zero ambitions and at the same time ensure economic growth and well-being of its citizens. Therefore, India needs to convert the challenge of low carbon/net zero transition into an opportunity for green growth. As the world grapples with the climate crisis and recognizes the seriousness of the threat, there is an urgent need for coordinated action to mobilize substantial international financial resources for climate investments in India. IFSCA constituted an Expert Committee on Climate Finance with a focus on low carbon transition sector and activities and also for developing IFSC-GIFT City into a global climate hub for the region. This report on Transition Finance with inputs from the Expert Committee is a timely and pivotal contribution which underscores the need for aligning financial flows with the objectives of the Paris Agreement and other global climate commitments. As we endeavour to limit global temperature rise to 1.5 degrees Celsius, the mobilization of transition finance becomes not just a strategic imperative but a moral responsibility and ensuring a sustainable future for generations to come. The report captures the recommendations by the Expert Committee under its three pillars: 1. Scope and definition of Transition Finance, 2. Policy and Regulation, 3. Financial Mechanisms and Instruments. The report emphasizes the role of transition finance in driving investments towards hard-to-abate sectors which are crucial for economic growth, and facing technical and economic challenges in decarbonization. By exploring global best practices and regulatory landscapes, the report offers strategic recommendations by the Expert Committee to enhance the role of GIFT-IFSC as a conduit for attracting international capital, crucial not only for India's climate objectives but also for furthering sustainable development in India and the region. I commend the contributors for their comprehensive analysis and recommendations presented in this report. The Expert Committee hopes that this report serves as a catalyst for informed dialogue and drives action among policymakers, financial institutions, and stakeholders across the globe, as we collectively strive towards a resilient, low-carbon future. Dr. Dhruba Purkayastha Chairperson, Climate Finance Committee, IFSCA Director, Council on Energy Environment and Water (CEEW) 01 July 2024 iv3. Committee Formation As per the sixth assessment report from the Intergovernmental Panel on Climate Change (IPCC), climate change “has caused widespread adverse impacts and related losses and damages to nature and people,” and that projected “mid- and long-term impacts are up to multiple times higher than currently observed.” To mitigate the impact of climate change, it is essential to limit the global temperature rise to 1.5 degree Celsius. In order to limit the average global temperature, there is a need to implement decarbonization measures that can bring substantial reductions in emission intensity across geographies and sectors, particularly, energy intensive and hard-to-abate sectors. As per the report submitted by the UN High-Level Climate Action Champions, USD125 trillion of climate investment is needed by 2050 to meet net zero target. According to a report by the Council on Energy, Environment and Water (CEEW) India would need to mobilise investments worth over USD10 trillion to achieve its net-zero commitments. The Green, Social, Sustainable, Sustainability-linked and transition labeled (GSS+) debt securities have seen incredible growth in recent years. According to Climate Bond Initiative (CBI) report, as on Q3, 2023, cumulative listing of GSS+ bonds stood at USD 4.3tn. However, the mobilization of funds towards climate actions has been restricted to certain sectors which are already at near-zero or low carbon emissions. The need of the hour is to cover all sectors, especially hard-to-abate sectors. This gap is currently not being met with the existing GSS+ labelled bonds. In this context, transition finance instruments such as transition bonds, transition loans etc. have emerged as an alternative to fill this financing gap. Taking into consideration the critical need for transition finance, the development of such financing instruments being at a nascent stage, and lack of globally recognized framework, IFSCA has constituted an Expert Committee on Climate Finance with special focus on transition. Terms of References of the Committee i. To assess the trends in climate financing across the world, identify best practices and assess requirement of climate Finance with special focus on transition in India by 2047. ii. To recommend a regulatory framework for transition finance instruments utilizing the IFSCA draft framework as a starting point. iii. To recommend policy measures by Government of India in order to promote transition finance from GIFT IFSC, including legal, taxation, regulatory etc. iv. To advise IFSCA on the approach to developing a reliable and cost-effective ecosystem for transition finance meeting needs of Indian industry. v. To provide a roadmap and timelines for IFSCA to develop climate finance ecosystem and instruments at GIFT IFSC. vvi. To recommend policies and regulations for establishment of GIFT-IFSC as the global hub for climate financing, as deemed fit by the committee. Committee Members Sr. Name Designation Capacity No 1 Mr. Dhruba Director - Growth and Institutional Chair Purkayastha Advancement, CEEW 2 Mr. Shalabh South Asia Head of Operations & Climate, IFC Member Tandon (World Bank Group) 3 Mr. Prabodha Chief Sustainability Officer, JSW Group Member Acharya 4 Mr. Gaurav Bhagat MD & Head of Financial Institutions, South Member Asia, MUFG 5 Mr. Gagan Sidhu Director, CEEW-Centre for Energy Finance Member 6 Mr. Piyush Jha Head, Climate and Sustainable Finance, Tata Member Steel Limited 7 Ms. Neha Kumar Head, South Asia Programme, Climate Bonds Member Initiative 8 Ms. Roopa Satish Country Head, Sustainable Banking & CSR, Member IndusInd Bank 9 Mr. Ajay Sirikonda Partner, EY Member 10 Mr. V MD & CEO, NSE IFSC Limited Member Balasubramaniam 11 Mr. Saurabh Head Treasury, Ultra Tech Cement Member Chakravarty 12 Mr. Hemal Mehta CFO, Edelweiss Alternative Asset Advisors ltd Member 13 Mr. Jagjeet Sareen Partner, Global Climate Practice, Dalberg Member Advisors 14 Mr. Abhilash General Manager, IFSCA Member Secretary Mulakala vi4. Approach of the Committee The Committee was tasked with the overall aim of expanding offerings – both in terms of instruments and sectors in which investments can flow. It had to keep in mind that IFSCA also caters to foreign investors which could be through Indian Banking, Financial services, and Insurance (BFSI) entities. With this mandate, the overall work and the committee were structured into 3 sub-groups: a) Scope and Definition, b) Policy and Regulation, and c) Financial Instruments The first component is the scope and definition aspect since this will allow guardrails to be put in place and also give confidence to investors. The second component helps build a regulatory framework that IFSCA can implement, and also provides policy recommendations to GoI on how transition finance can be mobilized through IFSC more efficiently and effectively. The third component comprising market and institutional interventions, not only looks at the development of new products – on both assets and liabilities – but also at ways of designing pilot transactions, thereby giving banks and FIs more confidence in adopting the new product offerings. The objectives of each of the above sub-groups are: a) Scope and Definition - Establish scope and definition for transition finance. b) Policy and Regulation - Provide policy and regulatory recommendations feeding into a regulatory framework document. c) Financial Instruments - Identify market and institutional interventions required. vii5. Acknowledgment The Committee wishes to express its profound gratitude to Mr. K. Rajaraman, Chairperson of IFSCA, for establishing the expert committee on Climate Finance. His vision has provided an exceptional platform for members to engage in thorough discussions and formulate actionable recommendations for developing a regulatory framework on transition finance in GIFT IFSC. We are deeply appreciative of Mr. Pradeep Ramakrishnan, Executive Director of IFSCA, for his exemplary leadership of this initiative. Mr. Ramakrishnan’s unwavering support was crucial to the successful functioning of the committee throughout our deliberations. Our sincere thanks go to Ms. Neha Khanna for her invaluable contributions. Her support to the committee chair was pivotal in ensuring the seamless operation and progress of our work. The committee also recognizes the significant support provided by Mr. Rajesh Kumar Miglani, Ms. Aditi Bhatia, Ms. Esha Sar, Ms. Upasana Handa, Mr. Dharmesh Tejani, Mr. Subahoo Chordia, Mr. Mayank Thukral, Mr. Rawson Gonsalves, and Mr. Dishant Rathee. Their insights and assistance were invaluable to our efforts. Lastly, we extend our heartfelt appreciation to the entire IFSCA Sustainable Finance team, including Mr. Abhilash Mulakala (GM), Mr. Chintan Panchal (Manager), and Mr. Abhineet Panwar (AM). Their coordination and extensive support were instrumental in the finalization of our recommendations. viiiDhruba Purkayastha Gagan Sidhu Neha Kumar Piyush Jha Roopa Satish Ajay Sirikonda V Balasubramaniam Prabodha Acharya Hemal Mehta Jagjeet Sareen ix6. Executive Summary The world requires a staggering USD 125 trillion in climate investments by 2050 to achieve net-zero emissions. India's share of this challenge is equally significant, with estimates suggesting the country needs over USD 10 trillion by 2070 to meet its climate goals and net-zero commitments. Domestic finance is crucial for India's climate action. A 2022 report by the Climate Policy Initiative ("Landscape of Green Finance in India 2022") found that domestic sources accounted for the majority of green finance in India, at 87% and 83% in fiscal years 2019 and 2020, respectively. While international sources are increasing (from 13% in FY 2019 to 17% in FY 2020), they are still insufficient to meet India's net-zero target. Therefore, greater participation from international finance is essential. In this context, GIFT-IFSC is uniquely positioned to play a key role. It can act as a channel for foreign capital, not only for India's net-zero goals, but also for other developing countries. The market for GSS+ labelled bonds and loans has seen growth, but its impact has been limited to already green or net-zero emission sectors. To address this gap, "transition labelled instruments" are emerging across the world. However, there's currently no universally agreed-upon definition of "transition finance." Various regulatory bodies, standard-setting organizations, and institutions around the world have developed their own versions for financing transition. Given GIFT-IFSC's role as a gateway connecting India to the global economy, a key challenge is creating an enabling framework for "transition finance" in a way that attracts international investors while also considering India's socio-economic realities. By analysing existing global definitions and best practices, the report has analysed areas of convergence and common parameters. The report proposes various alternative approaches for IFSCA to consider, aiming to support India's journey towards net-zero emissions by 2070. The report has also delved into policy and regulatory levers in order to increase the mobilization of transition finance through financial instruments through GIFT-IFSC. Beyond defining the scope, definition, policy and regulations for transition finance, the report addresses financial structures and instruments to mobilize these investments. It recognises the need for innovation not just in debt and equity instruments, but also in risk mitigation tools like insurance and guarantees. Additionally, the report recommends various tools to support the capture and standardization of information, which is crucial for effective transition finance. The committee's comprehensive recommendations aim to create a robust ecosystem for transition finance at GIFT-IFSC. This ecosystem will not only facilitate capital mobilization for India's net-zero goals, but also serve as a springboard for other developing economies on their journeys towards sustainability. 17. Context The Paris Agreement calls for making finance flows consistent with pathways towards low greenhouse gas emissions. To limit the average global temperature, increase to 1.5 degree Celsius, there is a need to implement decarbonizing measures and strategies that can bring about substantial reduction in emissions intensity across geographies and sectors, particularly, in energy intensive and hard-to-abate sectors such as steel and cement. To achieve this, a directed and simultaneously inclusive approach is necessary for financing the global low-carbon economic transition, that also addresses the concerns of Emerging Markets and Developing Economies (EMDEs). It is estimated that capital investment of approximately USD 3.5 trillion per year is required by 2050 to shift to a global net-zero economy and avert the apparently inevitable climate catastrophe1. India would need cumulative investments of over USD 10 trillion by 2070 to achieve its net-zero ambitions2. Given that the tracked finance flows to climate mitigation account for approximately 25% of the total climate investments required3 in India, it can be inferred that the transition to net-zero will require a significant increase in climate investments -- not only toward cleaner energy and transport, but also to hard-to-abate sectors like industries and buildings, with a focus on reduction in carbon emissions. While financing cleaner technologies is relatively easier and well-defined as ‘green’, financing transition to low-carbon emissions in hard-to-abate sectors is much harder and does not have a well-defined approach. If India is to achieve its net-zero target, finance flows toward decarbonization of hard-to-abate sectors is critical. Finding solutions would require deploying and scaling up new and innovative technologies, often called transition technologies. However, financing such technologies is currently limited and constrained by a lack of clear definition and taxonomy. Transition finance, which is inclusive of sectors and geographies, has emerged to fill this gap. Emissions abatement in industrial sectors will rely on a combination of best-available technologies -- energy efficiency, renewable energy, alternative fuels, etc. -- during this decade, and breakthrough technologies such as green hydrogen, carbon capture, direct electrification, etc., post-2030 (discussed later in this report). Unlike the power and transport sectors where green technologies such as solar PV/wind and battery energy storage can shift the sectors to low/near-zero carbon emissions, industrial sectors will likely undergo a gradual transition. Utilization of the best available and commercially viable technologies is needed to keep the cumulative emissions (‘area under the curve’) to a minimum, while also investing in commercial-scale demonstrations and scaling up of breakthrough technologies until they are ready for market-based financing. Investments are needed in technologies that can lower emissions intensity of the sector, though these may not be green/near-zero emissions and are therefore 1Report on “Achieving A Transition Finance Framework in The EU” by E3G 2 https://www.ceew.in/cef/publications/investment-sizing-india-s-2070-net-zero-target 3 https://www.climatebonds.net/files/reports/cbi_susdebtsum_q32023_01e.pdf 2incompatible with net-zero/climate neutrality targets. Most of these technologies are Capex and Opex heavy and require massive investments. Public capital alone is not sufficient to meet the demand for financing the transition in industrial sectors, and much larger sources of private capital must step in. Transition finance is emerging as an important category of finance that can enable private finance to flow towards ‘transition activities’ that are otherwise not a part of green finance markets. Transition finance instruments can help trigger entity-wide transformations and reduce the exposure to transition risks. Public capital alone is not sufficient to meet the demand for financing the transition in industrial sectors and much larger sources of private capital must step in. Mobilization of capital, both domestic and international, is needed. International Financial Services Centres (IFSCs), therefore, have an integral role to play since they can be the conduits for international capital to flow. Examples of Transition Finance initiatives As Per the Organisation for Economic Cooperation and Development (OECD), transition finance can be defined as finance deployed or raised by economic agents to implement their net-zero transition, in line with the temperature goal of the Paris Agreement and based on the credible climate transition plans with measurable results. OECD has defined transition finance as a financing approach that 'focuses on the dynamic process of becoming sustainable, rather than providing a point-in-time assessment of what is already sustainable, to provide solutions for a whole-of economy decarbonisation.' Contrary to green finance, transition finance intends to allocate capital to companies and activities that are not 'green’ but are in the process of 'becoming green', or in the process of reducing emissions (and therefore, lowering their exposure to transition risks), emphasizing both inclusiveness and environmental integrity to avoid greenwashing4. According to Climate Bonds Initiative (CBI), the 'transition' label can be used for eligible investments that are making substantial contributions to halving global emissions levels by 2030 and reaching net-zero by 2050, but do not have a long-term role to play {i.e. beyond 2050), and the activities that will have a long term role to play but at present, their long term pathway to net zero goals is not certain. Under Article 10 (2) of the European Union Taxonomy Regulation, transition activity is defined thus: '..an economic activity for which there is no technologically and economically feasible low-carbon alternative shall qualify as contributing substantially to climate change mitigation where it supports the transition to a climate-neutral economy consistent with a pathway to limit the temperature increase to 1.5 degrees C 4https://www.climatebonds.net/files/reports/cbi_slb_report_2024_04d.pdf 3above pre-industrial levels, including by phasing out greenhouse gas emissions, in particular emissions from solid fossil fuels, and where that activity: a) has greenhouse gas emission levels that correspond to the best performance in the sector or industry; b) does not hamper the development and deployment of low-carbon alternatives; and c) does not lead to a lock-in of carbon-intensive assets, considering the economic lifetime of those assets.' As per Japan’s Ministry of Economy, Trade and Industry, transition to net-zero should comprise a transition phase where all sectors maximize efforts to decarbonize as much as possible through process efficiencies -- typically energy efficiency, fuel switching, material circularity, etc. The aim is to reduce emissions until technologies like carbon capture and storage become economically viable. According to International Capital Markets Association (ICMA)5, a ‘transition’ label applied to a debt financing instrument should serve to communicate the implementation of an issuer’s corporate strategy to transform the business model in a way which effectively addresses climate-related risks and contributes to alignment with the goals of the Paris Agreement. According to the Asian Development Bank6, ‘Transition finance is a concept where financial services are provided to high carbon-emitting industries – such as coal-fired power generation, steel, cement, chemical, paper making, aviation and construction – to fund the transition to decarbonization.' According to G20 Sustainable Finance Working Group, Transition Finance7 is defined 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.' The Climate Finance committee set up by IFSCA believes that the ADB and G20 approaches reflect the economic realities of India much better than the EU’s approach, given India’s economic development scenario and income levels. It may be useful to note that while some definitions lend themselves to 'green', and others to 'sustainable’, there is a lack of clarity on how finance can be qualified for transition activities. 5 https://www.icmagroup.org/assets/documents/Regulatory/Green-Bonds/Climate-Transition-Finance- Handbook-December-2020-091220.pdf 6 https://blogs.adb.org/blog/transition-finance-critical-address-climate-change 7 https://g20sfwg.org/wp-content/uploads/2022/10/2022-G20-Sustainable-Finance-Report-2.pdf 4Clarifying Green and Transition Finance For transition finance to become mainstream as a class of directed financing, a definition and clear understanding of boundary conditions is the first step. Currently, there is a lack of global consensus on the definition and framework for transition finance. As a result, the market for transition finance is currently small and there is ambiguity on the role of Financial Institutions (FIs) in financing transition activities. Guidance on transition finance exists only in a few places like the EU and Japan. A few independent organizations have developed their own frameworks and guidance principles (described above and tabulated in Appendix 2: Definitions and Guardrails). However, it is important for these principles to define ‘transition activities’ and differentiate between transition finance and green finance. Table 1 below highlights this difference. In addition, transition finance frameworks for FIs should consider which technologies are to be deemed ‘best-available technologies’; sector-specific benchmarks and targets to be used as reference for ‘transition pathways’; and global alignment while accounting for country-level and industry constraints. These and other policy and regulatory aspects have been discussed, and recommendations are presented in the following section. Table 1: Difference between green and transition finance Green Finance Transition Finance Reducing emissions for hard-to-abate Financing zero/near- sectors or sectors that are important for zero-emissions emissions reductions in other sectors (as Definition technologies that are enablers). In most cases, these activities aligned with the Paris are not Paris Aligned but are important due Agreement to the lack of suitable ‘green’ alternatives. Steel, Cement, Shipping, Aviation, Heavy- Examples Solar PV, Wind duty transport, etc. 8. Deliberations and Recommendations 8.1 Pillar 1 – Scope and Definition of Transition Finance This aims to provide clarity to entities seeking to raise capital for financing transition activities and projects/businesses, and to provide confidence to investors and lenders. The following trends and imperatives provide valuable background and justification for the recommendations that have been put forth. Global initiatives: Various efforts are underway in multiple jurisdictions by governments and regulators, by international standard-setting bodies and coalitions, as well as 5individual institutions, that draw from existing mandates and/or voluntary standards, to match the scope of their operations. Their initiatives on transition finance come in many different forms, including guidelines, frameworks, guidance, taxonomies, handbooks, and white papers. The sub-group on Scope and Definitions mapped ten significant initiatives to arrive at specific recommendations for IFSCA. The list of evaluated frameworks is in Table 2. Domestic initiatives: Capital market regulator SEBI, issued guidelines that expanded the scope of green debt securities to include transition bonds and plans, that also need environmental and social risk assessment pertaining to the investment and impact reporting. A granular classification system to screen activities, however, remains to be developed to guide the flow of thematic international (and local) capital for such activities at scale. The Ministry of Finance (MoF) set up a Sustainable Finance Task Force in 2021. The terms of reference of the Task Force include defining the framework for sustainable finance in India, establishing the pillars for a sustainable finance roadmap, suggesting draft taxonomy of sustainable activities and a framework of risk assessment by the financial sector. Rapidly evolving theme: Transition finance, both in concept and practice, is only a few years old, and is rapidly evolving. Hence, it is desirable to align with globally recognized good practices, investor expectations, and account for any Indian context-specific particularities, such as the 2070 pathway to net-zero emissions. It is also important to recognize that enormous capital will need to be mobilized to front-load investments in the current decade for an orderly transition. Specifically, India would require investments of over USD 10 trillion to achieve net-zero by 2070, at an average rate of about USD 200 billion per year (CEEW, 2021). Investor expectations: Preferences of international (and domestic) investors point to the need and opportunity to finance transition in hard-to-abate sectors. International investors point out that national frameworks and taxonomies are welcome for their signalling effect on the market and leadership. However, for international investors, the opportunity cost accruing from the additional effort of translating the differences in different taxonomies and standards is perceived as high, and they would likely fill this gap with some existing international framework or taxonomy. Market integrity: Integrity is central to the growth of the market and for the smooth flow of transition finance. This is emphasized by international investors (and by regulators worldwide), implying the need for a robust assurance system8 through external verification when thematic capital is raised using a label. The 'transition finance' label, for transition bonds/loans (Use of Proceeds) and sustainability-linked bonds/loans (outcome linked), while lucrative to issuers and witnessing a huge potential for growth, is also subject to heightened investor scrutiny for transparency, measurable progress, and accountability from companies embracing transition finance. Deal flows: Trends relating to growth in the cumulative volume of green, social, sustainability, and sustainability-linked (GSS+) debt, show global tally at USD 4.2 trillion 8 International standards such as Climate Bonds have established a process for external verification, which is widely used and can be adopted or recognized by IFSCA to avoid duplication. 6in 2023 (Climate Bonds Initiative, 2023), with 67% dominated by green bonds; social bonds at 16%; sustainability bonds at 14%; Sustainability-Linked Bonds (SLBs) at 3%; and transition bonds making up 0.3%9. High investor scrutiny for SLBs may have disincentivized issuers and investors alike. SLBs have been facing considerable scrutiny due to lack of credibility owing to linkages with greenwashing as a result of inadequate structural and calibration features, and weak underlying transition plans. Transition plans are being increasingly asked for by investors and regulators to check if they include all material sources of emissions and reinforce the issuers’ commitment through credible financial planning10. Figure 1: Issuance of GSS+ Labelled bonds Table 2: Transition finance initiatives evaluated Nature of Name of Entity Title Release Entity Jurisdiction/ Association of Transition Finance Guidance October 2023 Regulator Southeast Asian Nations (ASEAN) European Union EU Taxonomy regulation June 2020 (EU) Taxonomy delegated July 2021 regulation for Technical Screening Criteria (TSC) Japan Basic Guidelines on Climate May 2021 Transition Finance Technology Roadmaps (Iron & October 2021 Steel) 9 https://www.climatebonds.net/files/reports/cbi_susdebtsum_q32023_01e.pdf 10 https://www.climatebonds.net/files/reports/cbi_slb_report_2024_04d.pdf 7Nature of Name of Entity Title Release Entity Monetary Singapore-Asia Taxonomy for December Authority of Sustainable Finance 2023 Singapore (MAS) Standard Climate Bonds White Paper - Financing September Setter/ Initiative (CBI) Credible Transitions 2020 Coalition Discussion Paper on Transition September Finance for Transforming 2022 Companies CBI has sector criteria available for energy, transport, buildings, etc. available here Glasgow Financial Institution Net-zero November Financial Transition Plans: 2020 Alliance for Net- Fundamentals, Zero (GFANZ) Recommendations, and Guidance International Climate Transition Finance September Capital Markets Handbook: Guidance for 2023 Association Issuers (ICMA) Institution Barclays Transition Finance Framework February 2024 DBS Sustainable & Transition March 2022 Finance Framework & Taxonomy Standard Transition Finance Framework 2021 Chartered A detailed matrix elaborating on the approach taken by each of the ten entities under the three categories (jurisdictions/regulators, standard setters/coalitions, and institutions) towards transition finance, is provided in Appendices 1, 2 and 3. Findings Areas of convergence and common parameters: The wide range of entities and initiatives on transition finance notwithstanding, their respective approaches to it feature several areas of convergence. Specifically, many seek to approach transition finance from the perspective of common parameters such as industry/sector; activity/process; transition trajectory; and test for general corporate finance and instruments. Table 3 summarizes the approaches of various entities with regard to these parameters. 8Table 3: Parameters-specific approach taken by evaluated entities Parameters Approach Industry/Sector • Listed directly (without going through labelling/traffic light) - 1 Jurisdiction/Regulator (Japan) - 2 Institutions (Barclays, Standard Chartered) • Arrived at via a labelling/traffic light system. - 2 Jurisdictions/Regulators (EU, MAS) - 1 Standard Setter/Coalition (CBI) - 1 Institution (DBS) • Labelling system exists but does not arrive at specific industry/sector. - 1 Jurisdiction (ASEAN) - 1 Standard Setter/Coalition (GFANZ) • No guidance - 1 Standard Setter/Coalition (ICMA) Activity/Process • Listed directly. - 2 Institutions (Barclays, Standard Chartered) • Arrived at via a taxonomy/technology roadmap. - 4 Jurisdictions/Regulators (ASEAN, EU, Japan, MAS) - 1 Standard Setter/Coalition (CBI) - 1 Institution (DBS) • No guidance - 2 Standard Setters/Coalitions (GFANZ, ICMA) Trajectory • Aligned with Paris Agreement (1.5°C) - 2 Jurisdictions/Regulators (EU, Japan) - 2 Standard Setters/Coalitions (CBI, GFANZ) - 1 Institution (Standard Chartered) • Aligned with Paris Agreement (1.5°C or 2.0°C) - 1 Jurisdictions/Regulators (ASEAN) - 1 Standard Setter/Coalition (ICMA) - 1 Institution (DBS) • Aligned with 2.0°C but transitioning towards 1.5°C by specified target year - 1 Jurisdiction/Regulator (MAS) • Provides choices to select alignment with regional or national scenarios, in addition to Paris Agreement 1.5°C - 1 institution (Barclays) Test for General • Specific percentage of revenues (90%) traceable to specified Corporate activities Finance - 2 Institutions (Barclays, Standard Chartered) • Qualitative framework - 1 Institution (DBS) • No guidance - 4 Jurisdictions/Regulators (ASEAN, EU, Japan, MAS) 9Parameters Approach - 3 Standard Setters/Coalitions (GZANZ, CBI, ICMA) Instruments • All financial instruments - 1 Jurisdiction/Regulator (ASEAN) - 1 Institution (DBS) • Use of proceeds & SLB - 1 Jurisdiction/Regulator (Japan) - 2 Standard Setter/Coalition (CBI, ICMA) • Exclusions for SLB++ - 1 Institution (Barclays) • No guidance - 2 Jurisdictions/Regulator (EU, MAS) - 1 Standard Setter/Coalition (GZANZ) • 1 Institution (Standard Chartered) Rapid decarbonization of the economy would entail decarbonization of sectors, which would in turn happen through decarbonization of economic entities. This would entail adoption of cleantech/emissions reduction technologies, supply chain disclosures and emissions reductions. etc). At each of these levels, a set of tools will be needed -- such as frameworks/regulations and trajectories at the level of sectors; financial instruments and transition plans; entity-level assessments; and financial instruments such as the use of proceeds and taxonomies at the level of activities and measures. Mitigation focus: The priority mandate for the sub-group concerned emissions reduction. This is not to say that adaptation or social aspects are less important for transition, but they are to be mostly used as environmental and social 'safeguards’. From a more high-level perspective transition finance initiatives should aim to incorporate, principles of ambition, inclusivity, and flexibility with a credible transition plan: • Ambition: Aiming high means aligning activities with a science-aligned pathway with targets that get the entity to net-zero by 2050 or earlier, and/or respective countries net-zero trajectory consistent with Paris goals. • Inclusivity allows all sectors and activities to participate; and • Flexibility means utilizing financial instruments -- other than bonds and loans-- for financing transition. Table 4 gives a list of options for IFSCA for each parameter. 10Table 4: Parameters-specific approach options for IFSCA Parameters Approach Options for IFSCA Industry/Sector • Option 1: List directly without going through labelling/traffic light system - 15 sectors listed in India’s Third National Communication to UNFCC which account for 91% of emissions. - Sectors which eventually come into the fold of the Indian Carbon Market (ICM) • Option 2: Arrive via labelling/traffic light system - Adapt existing global or regional system to suit Indian needs. - Nudge appropriate authorities (MoF/SEBI) to create bespoke for India Activity/Process • Option 1: Recognize established jurisdictional taxonomies/global standards as an interim measure until India’s own taxonomy is released - ASEAN - EU - Japan (technology roadmap) - MAS - CBI - ICMA • Option 2: Adopt Indian taxonomy - Nudge appropriate authorities (MoF/SEBI) to create bespoke for India • Option 3: Adopt activities that feature on India’s whitelist for Article 6.2 - While activities themselves are mentioned, granularity with respect to their technology specifications is presently lacking. Trajectory • Option 1: Align with Paris Agreement 1.5°C - EU (Note that most - Japan taxonomies - Or others such as IEA, IPCC RCP 1.9 and RCP 2.6 have emissions thresholds • Option 2: Align with Paris Agreement 1.5°C or well below 2.0°C stapled to the - ASEAN various activities listed in them, which • Option 3: Adopt a quantitative approach and implement are in turn Industry/Sector-specific trajectories aligned with the - Nudge appropriate authorities (Niti Aayog, MOEFCC, line trajectories they ministries) to create bespoke for each industry/sector are targeting) 11Parameters Approach Options for IFSCA Test for General • Option 1: Specify Corporate - Percentage based that represents significant contribution to Finance emissions reduction - Qualitative (where required) - Transition plan with clear milestones and financial plan • Option 2: Do not specify (leads to misallocation of capital and greenwashing) - Majority of entities evaluated (8 out of 10) do not give guidance, and the 2 that do, are institutions Instruments • Option 1: All financial instruments • Option 2: Specify exclusions In light of the above, following are the recommendations for IFSCA for each parameter, along with a brief rationale for the same. Recommendations 1 Approach for transition finance on various parameter Recommendation for Parameter Rationale IFSCA Industry/ • List directly without • Use 15 sectors listed on page going through 74 of India’s Third National Sector labelling/traffic light Communication to UNFCC system that account for >90% of emissions. • Labelling/traffic light can be an onerous exercise, whereas sources of emissions-- which is where transition needs to happen--- are already documented. • Japan, which has been the most successful jurisdiction for transition bonds also lists the industry/sectors directly without going through a labelling/traffic light system. 12Activity/Proc • Allow use of well- • As India does not yet have a ess recognized and robust taxonomy in place, taxonomy/technology passporting roadmaps taxonomies/technology roadmaps from elsewhere would be an efficient way to kick-start transition finance flows. • In doing so, any robust and widely recognized good practice taxonomy/technology roadmap may be allowed to be used. • When India introduces its own taxonomy, it will be added to the list of allowed taxonomies, without removing the previously allowed ones. Trajectory • Allow alignment with • Per IPCC at a global level, a either Paris Agreement 2.0° trajectory would require (Note that 1.5°C or well below reaching net-zero by around most 2.0°C 2070, which is also India’s taxonomies stated net-zero target year. have • By also introducing optionality emissions to align with 1.5°C rather than thresholds only 2.0°C, a greater number stapled to the of activities under 1.5° C various aligned activities taxonomies/technology listed in roadmaps (e.g., EU & Japan) them, which become available for are in turn financing to entities with aligned with higher ambition. the trajectories they are targeting) Test for • Specify Specify rationale: General • Specifying would be Corporate particularly relevant for those Finance institutions which do not have general corporate finance tests of their own. • This would also be valuable for bond issuances. 13• In the case of institutions with their own general corporate finance tests they may be allowed to use either their own or the test that the framework will specify. • To make explicit the transition plan with clearly defined milestones against science- aligned trajectory for accountability and transparency. 2 Universally prevalent systems of assurance should be used for third party verification to reduce chances of greenwashing. 3 A detailed taxonomy for transition finance for India may need to be pursued by the MoF and/or SEBI; currently this lies outside the scope of IFSCA. Another aspect to be considered is the linking of instruments as either result-based or use of proceed, or both. An example of instruments for each of the options is in Table 5. Table 5: Difference between result based/KPI linked and instruments Results-Based (Sustainability-Linked Use of Proceeds (Green Bonds) Bonds/Loans) Type of KPI-linked Use of proceeds finance Use of Proceeds are debt instruments where the issuer Usually finances entity-level promises to the investors that all transition activities to the raised funds will only go to Scope sustainable practices. May specified climate-related include several sustainability programs or assets, such as indicators as part of KPIs. renewable energy plants or climate mitigation funding programs. ICMA Sustainability-Linked ICMA Green Bond Principles Standards Bond Principles (SLBP) (GBP) Benchmarking against sectoral Due diligence Company-level transition plans transition pathways and targets. 148.2 Pillar 2 – Policy and Regulation Stimulating the Demand for Transition Finance There exist significant barriers to the decarbonization of industrial and other hard-to- abate sectors such as shipping and aviation, that can result in potential locking-in of investments in carbon-intensive assets. Several ‘transition-stage’ technologies, which are expected to play an important role in decarbonizing these sectors, are between Technology Readiness Levels (TRL) 5 – 9 (early demonstration to early commercial operations). Technologies that are commercially available in India (mainly RE, energy efficiency, and material circularity), and have substantial mitigation potential, remain severely under-used despite having favourable economics. There are several underlying barriers to financing and adoption of low-carbon technologies, including technology performance risk; unproven business models; high upfront investment costs; internationally competitive markets; policy and regulatory uncertainty; lack of appropriate incentives; lack of supporting infrastructure; limited technical capabilities and resources to finance a profitable transition through technological improvements and innovation; and limited access to suitable financing and financial services owing to a lack of tailored solutions. These underlying barriers translate into real and perceived investment risks, causing a mismatch between a project's investment risk-return profile and the expectations of private investors, resulting in high cost of financing and under-investment in climate- positive activities. Diffusion of breakthrough technologies cannot be left to market forces alone. Financial sector policies, regulations, and guidelines/frameworks to unlock the supply of transition finance, need to be complemented with targeted interventions focused on the real sector, that address the barriers to financing; improve the risk-return profile of investments; and thereby stimulate the demand for transition finance. The speed and scale of a low-carbon transition would require the government to play a key role in correcting multiple market failures (environmental externalities, information asymmetry, coordination failures), and in creating new markets for low-carbon technologies. Effective and well-designed ‘green’ sectoral policies can level the playing field between low-carbon and conventional technologies, incentivize early adopters of low-carbon solutions, reduce investment risks (by reducing cost of capital), and create markets for green products, in turn creating a demand for transition finance to flow into these sectors. Such policy frameworks would need to target (and balance) multiple outcomes – output, competitiveness, and decarbonization – and could use a mix of financial, market-based, and regulatory instruments to achieve these objectives. Table 6 describes various types of policy instruments that can be used to this effect. 15Table 6: Real sector policy instruments to stimulate demand for transition finance Category Instrument Definition Instrument Type Long-term Developing, supporting, and decarbonization implementing policies, targets and including targets and Others sectoral strategic plans, that guide pathways policy development Research, Development Public RD&D Public grant funding for RD&D Fiscal and financial and funding Demonstratio Incentives for private sector Private RD&D n (RD&D) and spending on RD&D, like tax Fiscal and financial incentives Supporting credits Investments Public expenditure to develop Public supporting infrastructure, investments in such as pipelines and storage Fiscal and financial supporting facilities, enabling private infrastructure investments in low-carbon technologies. Tax on fossil fuels or carbon Carbon pricing - dioxide emissions intended Fiscal and financial tax to reduce the emission of carbon dioxide. Carbon pricing - Policies introducing tradable cap and trade carbon/GHG emission Technology market with permits based on fixed Market-based Push tradable allowances per sector and (Supply-Side certificates producer Interventions) Policy that levies a carbon Carbon border price on imports to prevent adjustment (as a carbon leakage, generally Market-based complementary applied together with a policy measure) domestic carbon price. Public direct Policies aimed at setting up investment in low-carbon production low-carbon facilities through direct Fiscal and financial production investments by State-Owned facilities Enterprises Capital subsidies, consumer Viability Gap grants or rebates as one-time Funding / Capex payments to cover a Fiscal and financial subsidies percentage of the capital cost of an investment 16Category Instrument Definition Instrument Type Policies offering a long-term agreement/regulation remunerating the sale of Opex subsidies Fiscal and financial fuel/feedstock/electricity at a fixed price which is typically above standard market levels Subsidized Policies providing subsidized investment loans financing to project Fiscal and financial and loan developers, and credit guarantees guarantees to investors Policies allowing for full or partial deduction from income tax obligations for investments / or that provide Investment / the investor or owner of Production tax qualifying asset with an Fiscal and financial credits annual income tax credit based on the amount of fuel/feedstock/electricity generated during the relevant year. Price support for low-carbon materials either through Green public direct procurement at green Fiscal and financial procurement premium or through contract- for-differences (CfDs) for public infrastructure projects Standards on emissions Regulations on use of low- performance of carbon materials (such as end-products Demand Pull steel/cement) in end-use Regulation that use low- (Demand-Side sectors like automotive, carbon materials Interventions) shipping, and manufacturing. (embedded carbon) Standards on use Regulations on use of of by-products captured CO2 in high-value Regulation (ex: captured markets CO2) Accreditation of products in Labelling of green line with specific end-use Regulation environmental/emission products standards to advertise 17Category Instrument Definition Instrument Type environmental quality or characteristics of the product Internationally aligned Interoperability/g definitions on varying degrees lobally accepted of 'green materials'" to standards for Regulation standardize production green and low- processes and support carbon materials investment disclosures Recommendations Having identified potential ways to increase the mobilization of transition finance through financial instrument issuances through the IFSC, our recommendations, aimed at policy and regulatory levers that could be used and/or may be required, are as follows: 1. Taxonomy compliance for transition finance – Providing a reliable investment opportunity for international investors where they can trust in the compliance of underlying instruments with global standards (or having an IFSC Taxonomy), could be useful for issuing transition finance instruments through the IFSC. Given that investors would come from various jurisdictions, it is recommended that IFSCA allows the compliance of transition finance products with the taxonomies of key jurisdictions, wherever the issuances are directed, till MoF, GoI issues its own Green Finance (including transition finance) taxonomy. IFCSA could provide adequate assurance to investors, preferably through third- party assurance providers. IFSCA could also consider laying out the following compliance requirements, and state the incentives for the issuance of transition finance instruments from IFSC: a. Transition finance instruments should comply with at least one of the key taxonomies recognized in leading markets. To start with, IFSCA can recognize the taxonomies detailed in Appendix 2: Definitions and Guardrails. b. Issuers should comply with necessary compliance requirements for individual taxonomies, file compliance reports, and third-party assurance reports with IFSCA. 2. Tax Incentives should be provided to reduce the cost of transition finance for borrowers/investee companies investing through GIFT-IFSC till 2030, such as waiver of withholding tax for foreign investors/reduction of the withholding tax to 4%. 183. External Commercial Borrowings (ECB) in Automatic Route - Allow the raising of funds via transition finance instruments in automatic route in ECB. Box 1: ECB Automatic Route ECB refers to commercial loans, in the form of bank loans; buyers’ credit; suppliers’ credit; securitized instruments (e.g., floating rate notes and fixed rate bonds); availed from non-resident lenders with a minimum average maturity of 3 years. ECB can be accessed from two routes: (i) Automatic Route, and (ii) Approval Route. ECB for investment in real sector comes under Automatic Route and do not require RBI / Government approval. Automatic Route: Corporates registered under the Companies Act, except financial intermediaries, are eligible to raise ECB from internationally recognized sources such as international banks; international capital markets; multilateral financial institutions; export credit agencies; suppliers of equipment; foreign collaborators; and foreign equity holders. The maximum amount of ECB that can be raised by a corporate is USD 500 million or equivalent during a financial year. ECB can be raised only for investment in new projects and modernization/expansion of existing production units in the real sector - industrial sector (SMEs) and infrastructure sector - in India. Current challenges: There are restrictions on end-use. For example, restrictions do not allow investments to go into projects such as Smart Cities or in the areas of water supply. Apart from end-use restrictions, the current requirements around minimum maturity time are also not conducive for investments in required sectors via the ECB route. At present, the minimum maturity period is 3 years which does not allow for short-term investing. The idea here is that since there is always an option to make short-term investments even in long-term projects in the domestic scenario, the same flexibility could be afforded to international investors. Further, there is also an element of pricing, where the current regulations put a cap on the spread. Ideally, the longer the tenure, the higher the pricing. However, with the cap, longer tenure investments become less appealing to investors since they are unable to get the required return. 4. Encourage setting up of Green FinTech in the GIFT-IFSC (with suitable tax incentives) that can offer services to debt raising companies and international investors and catalyze the market. This initiative could cover Fintech applications including: a. Support for disclosures pertaining to transition finance, with specialization in specific industries. b. ESG/ transition finance data providers c. ESG registries to record and maintain provenance of data and reports. d. Third-party assurance services for transition financing instruments 5. Blended Finance Mechanisms –Blended finance mechanisms allow for risk sharing and crowding in commercial finance to improve the acceptability of transition finance instruments. Policy interventions like the following would have a positive impact on the adoption of transition finance instruments: 19a. Encourage public sector entities like National Credit Guarantee Trustee Company (NCGTC) to set up credit guarantee funds for transition finance instruments offered by Indian companies. Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTSME) could also set up a separate entity to be used for loans given by banks from IFSC based branches. b. Encourage public sector entities like Indian Renewable Energy Development Agency (IREDA), Power Finance Corporation to set up transition finance funds, specifically credit funds, and invest in high-risk tranches of transition finance instruments, which can help improve the uptake of transition finance instruments. c. Use of Philanthropic and CSR Funds– Currently, Corporate CSR funds cannot be invested for profit. Regulatory relaxations should be given to provide such funds for high-risk activities like development of new green technologies, implementation of projects involving newer/untested green technologies, performance incentives. See Box 2 below for clarification on what qualifies as ‘Blended Finance’. 6. Enhanced disclosures – While the above measures are geared to improve the cost of transition finance and improve supply, certain measures are needed to improve the demand for transition finance. a. ESG disclosures by corporate entities: SEBI Business Responsibility & Sustainability Reporting (BRSR) guidelines are an important step forward to improve ESG disclosures of listed corporates and nudge these companies to embark on the path of decarbonization. If the BRSR disclosure requirements are expanded to cover the disclosures of net-zero targets and decarbonization roadmap of the listed entities, it will significantly influence the demand for transition finance. b. Climate risk disclosures by financial entities: The RBI draft paper on climate risk disclosures for banks will increase the demand for transition finance by real economy corporate entities, as banks define their net-zero targets and look to reduce their financed emissions. The MoF can encourage the Insurance regulator and the Pension regulator to expand similar climate risk disclosures for their regulated entities which will further increase the demand for transition finance and accelerate the decarbonization of India 20Box 2: What Qualifies as Blended Finance? Blended finance—the strategic use of development and other concessional finance to mobilize commercial finance for sustainable development—could play more of a role in scaling transition finance in India, as well as in financing for overall sustainable development; but is yet to realize even a small fraction of the potential it presents. Blended Equity The nature of impact investing in India is quite close to that of commercial financial investments, with a focus on later-stage investments and an expectation of significant returns. Blended equity presents an opportunity to finance smaller and emerging companies in niche climate change segments that have the potential to scale over the next few years. Each category of investor is driven by a typical risk, return, and impact profile; thus, capital needs to be mixed from a range of investors while providing differentiated risk-return for a given impact. Therefore, there is a need to pool investors and structure innovative financial mechanisms (e.g., a blended fund) that allow different risk, return, and impact requirements to be met with different classes of shares. Concessional equity will increase the risk-adjusted return rate for private investors, allowing the fund to invest in climate change businesses with a high economic rate of return and relatively lower internal rate of return, in which private sector financial investors would not have invested independently. This concessional contribution could be like a first-loss catalytic contribution (Junior equity), or a capped return structure. Example: Green Growth Equity Fund (GGEF) was established with anchor investment from India’s National Investment and Infrastructure Fund (NIIF) and Foreign, Commonwealth & Development Office (FCDO), Government of UK. GGEF invests in scalable operating companies and platforms across clean energy sectors. NIIF and the UK Government have committed GBP 120 million each into the Fund. Blended Debt The perceived risk of early-stage technologies acts as a major barrier to accessing affordable debt financing from traditional lenders. There is a necessity for blended finance mechanisms/structures to facilitate debt financing at affordable interest rates. One such mechanism is an inverted subordinate debt structure where the concessional funder’s debt contribution is subordinate to senior loans and is priced lower than senior loans, getting the second charge on assets. An inverted/subordinated debt can be structured as an on-lending facility that can increase the availability of debt from local FIs, improve access to financing, and help build local lending capacity. DFIs can on-lend concessional capital via credit lines to local FIs, who then blend it with their own higher-cost funds to provide loans to end-users at lower-than-market rate. Another blended finance instrument is Partial Credit Guarantee (FLDG/PCG) which can be structured as a credit guarantee mechanism (CGM). A CGM would work as a bilateral loss- sharing agreement between the credit guarantee fund and lending institutions (banks/FIs), supporting the lending institutions in case of delay in debt servicing, and also reimbursing them for a portion of any losses incurred due to payment default. Philanthropies could provide concessional capital to the CGM Fund. Member lending institutions (MLIs) (empaneled lenders) would avail guarantees for their loan portfolios in exchange for a guarantee fee. 218.3 Pillar 3 – Financial Mechanisms (Structures) and Financial Instruments While transition finance is a relatively new concept, green finance has been around for quite some time. Transition finance addresses the same need to reduce emissions from economic activities but does not necessarily need them to be absolute/near-zero emissions. While designing financial instruments or attempting innovation in financial instruments, it is important to first look at basic aspects, such as ‘what is a financial instrument?’. Financial instruments essentially remain the same, aligned with the basic theoretic capital stack of a firm /business ranging from pure equity to pure debt along the line of risk and return, as explained in the following graphic. Capital stack is a spectrum from equity to debt with reducing returns in line with reduced risk and has various intermediate instruments in between. Some hybrid instruments are possible such as those that combine fixed income and variable returns. Financial instruments across the capital stack would have to align/comply with the definitions and guardrails laid out in Pillar 1 – Scope and Definition. Figure 2: Types of financing instruments Reducing Risk; Reducing Return Private vs Quasi vs Common Local vs Corporat Sub/Mez Senior listed preferred Equity Hard e vs Bonds ze Loans Loans equity equity Currency Project debt debt Equity Debt Capital stack is used via different mechanisms. Typically, financial mechanisms are institutional approaches defined by financial regulators in India – the RBI, IRDAI and SEBI. Examples of existing and novel financial mechanisms (also called structures) include a) Securitization b) Blended Finance c) Alternative Investment Funds d) Guarantees/Risk Sharing Mechanisms e) Carbon finance mechanisms, etc. Each mechanism uses one or multiple financial instruments which are: equity, (even Junior Equity), senior debt, subordinate debt, preference shares, hybrid instruments, guarantees, etc. An indicative list of structures and mechanisms is presented in Figure 3. The ones in dark red are for financing and the lighter ones are de-risking mechanisms. Figure 3: Financing and de-risking mechanisms and structures 22New and innovative financial mechanisms that could support scaling transition finance, may include a range of traditional debt and equity instruments, and risk mitigation instruments like insurance and guarantees. Some novel instruments that already exist in the market include transition bonds, sustainability-linked bonds, and loans among others. Recommendations Following financial instrument that can be enabled in GIFT-IFSC to mobilize transition finance. 1. Equity and debt instruments Transitio Convertible Sustainability- Sustainability n Bonds/ Transition Linked Equity/AIF - Linked Transitio Bonds/ Derivative Bond/Loan n Loans Loans (SLD) Debt instruments with option to convert into equity at a predetermin A derivative ed level. transaction This Equity/ Debt with Key instrument Quasi- instruments Performance offers Equity/ Nature of with interest Indicators Debt flexibility to Convertibl Instrument rate linked to (KPIs) built into investors e predetermine contractual seeking the instrumen d outcome arrangements safety of t of SLD bonds but transactions. with the potential to convert to stocks in favorable market conditions. Banks/FI Banks/FIs, s, Private Funds, AIF Subscriber FIs, Funds Private Investors etc. Investors etc. etc 23Transitio Convertible Sustainability- Sustainability n Bonds/ Transition Linked Equity/AIF - Linked Transitio Bonds/ Derivative Bond/Loan n Loans Loans (SLD) Investmen t into Reducing capex for carbon General Reducing low- emission corporate carbon carbon/ s purpose with Incentivize ESG Purpose emissions energy- intensity outcome performance. intensity of efficient of linked to SDG operations technologi operatio 13 es with ns specified outcomes Issuers Transition can plan adhere to Issuers can /pathway internati adhere to to be put in onal international Methodolo place. International standard standards set gy/ Third- Swaps and s set by by Framewor party by Derivative organizat organizations k to be verificatio Association ions like like LMA, adopted n may be (ISDA) LMA, ICMA, and prescribed ICMA, CBI, among at overall and CBI, others. company among level others 2. Blended Finance Instruments for equity and debt structure. Tables 7 and 8 provide details of how blended finance can be used for equity and debt structures, respectively11. Table 7: Blended finance for equity investments Structure I (Capped upside Structure II (Junior equity) return) Anchor Investment with a capped Contribution as catalytic first- Foundations’ return, thereby passing the loss capital, thereby providing contribution downside protection to other 11 https://www.climatepolicyinitiative.org/blended-finance-for-climate-investment-in-india-equity-debt/ 24Structure I (Capped upside Structure II (Junior equity) return) potential upside to other investors. It is also termed as the investors. Junior equity structure. Investor’s returns Possible returns will be high. Returns would be lower as the Upside incentive for upside is shared proportionately investors. with foundations’ contribution. Capital protection Investments from anchor Investors capital would be foundations and other protected at least to an extent of investors will be exposed anchor foundations’ contribution equally to any downside risk by way of first-loss protection. (capital erosion). Table 8: Blended finance for debt investments Structure I (Inverted Structure II (FLDG/PCG) subordinate debt) Anchor Subordinate to senior loans Contribution as catalytic first- Foundations’ but priced lower than senior loss capital, thereby providing contribution loans. Gets second charge on downside protection to other assets. lenders. Commercial Usual risk-priced interest Usual risk-priced loans, but lender rates. interest rates are likely to be lower. Capital On default recovery, waterfall Commercial lenders’ capital is protection pays off senior debt first and protected to the extent of the commercial lenders have the default guarantee. (For India we first charge on collateral. found that FLDG does not work so just PCG is better). 3. Trade Finance Transitioning to a low-carbon economy essentially involves technologies that come in the form of hard physical assets. In some instances, importing such technologies may become a necessity, while in others, India can play an important role as an exporter of certain technologies. In this context, trade finance, which encompasses products such as LCs, bank guarantees, factoring, purchase order finance, among others, can also emerge as an important transition finance product category. As with the case of any other financial product category, the guidance on industry, activity and trajectory would ultimately be an important factor in determining which technologies would be eligible for availing trade finance under the transition finance classification. 254. Export Credit Agencies (ECAs) can leverage their position as public capital providers to serve as anchor investors. ECAs, which have so long played a limited role in financing transition efforts, can finance transition activities of SMEs and corporates through the provision of transition loans, guarantees and insurance products. Following a precedent from global renewables investments, MDBs could provide project financing through an ECA. ECAs would be required to play a role in closing the investment gap and providing credit enhancements to unlock private debt financing. Significant lending for non-recourse projects or projects with non- investment grade counterparties is unlikely without a vast majority of debt (i.e., 80% and upwards) being covered by guarantees, that can be provided by ECAs. Insurers could also have a higher likelihood of providing credit, political and performance risk insurance for investments in new technologies, when working under the preferred creditor umbrellas of ECAs. 5. Carbon credits Carbon credit is a tradable instrument used to monetize the value of carbon emissions. Usually, one credit is measured in one ton of carbon dioxide or the equivalent in other greenhouse gases. Carbon credits are the basis for cap-and- trade-based regulated carbon markets, where entities in a given sector and jurisdiction are given an emissions allowance (cap) and are allowed to trade credits to promote economic efficiency in emissions reduction. Carbon credits can be used to structure hybrid instruments and mechanisms. Two such examples – Carbon Contract for Difference (CCfD) and an innovative Results- Based Carbon Transition Bonds are described in the Box 3 below. Apart from innovation in instruments and mechanisms, tools that support, capture and standardization of information would also be required. For example, a carbon rating could be used as a standardized measure of the emissions intensity of financed activities. Strong disclosures and tools like carbon rating play an important role in enabling innovation in instruments and structures. This is to ensure that all institutions use standardized approaches toward emissions management, since emissions reduction remains one of the key objectives of transition finance 26Box 3: Examples of Innovative Carbon-based Instruments 1. Car bon Contract for Difference (CCfD) B reakthrough technologies required to decarbonize industrial sectors can have substantial incremental production costs compared with conventional technologies, a significant barrier to adoption. Moreover, market uncertainties can lead to revenue uncertainty, directly impacting a project’s access to finance; financing structure and costs; cost of c arbon abatement; and ultimately, financial viability. A Carbon Contracts for Difference ( CCfD) mechanism can be used to address this barrier. A project-based CCfD is a bilateral contract between a government/government-owned entity and a low-carbon project, where the latter would receive payments equal to the difference in the carbon price that is r equired to make the project viable (the strike price), and the price of carbon in the market. I f the price of carbon in the market is higher than the strike price, then the project pays back the difference to the government/ government-owned entity. A CCfD is both a policy and a financial instrument that covers the incremental cost of low- carbon production and de-risks investments by addressing market uncertainties (volatility in carbon price). Key benefits of CCfDs include revenue stability, enhanced bankability, i mproved financing conditions, and lowering of carbon abatement costs. 2. Results-Based Carbon Transition Bonds This hybrid instrument is an alternative to transition bonds, where a part of the coupon r epayment to the investor is in the form of carbon credits generated from the carbon e missions abated during the life of the project, while the remainder is financial returns. The amount of repayment in the form of carbon credits would be computed by multiplying the volume of carbon emissions avoided (against a baseline) and the price of carbon, and t he same would be amortized across the tenure of the bond. The carbon returns would t hen be deducted from the coupon rate to determine the financial returns. This instrument would enable flow of results-based financing towards transition activities (the ability of the project to make carbon-based repayments would be contingent upon its meeting carbon mitigation targets); while reducing the cost of financing for beneficiaries. This instrument classifies as a ‘use-of-proceeds’ instrument, where financing must be utilized only for decarbonization activities. 279. Appendixes Appendix 1: Evolution of Transition Finance Definitions Organizations Definitions Sources Transition TPI analyses whether a company’s practice is aligned with the goal of https://www.lse.ac.uk/Research/research- Pathway limiting global warming to 1.5°C. Companies are assessed both on their impact-case-studies/2021/transition- Initiative (TPI) carbon governance and management practices -- a precursor to climate pathway-initiative, 2017 action, and their greenhouse gas emissions pathways -- the ultimate output and what matters to the planet. EU taxonomy Within the EU Taxonomy, 'transition finance' refers to investments EU Taxonomy, Jun 2020, Taxonomy aimed at facilitating the transition to a more sustainable economy. This delegated regulation for Technical includes investments in activities and projects that contribute to Screening Criteria (TSC), Jul 2021 reducing greenhouse gas emissions, increasing resource efficiency, or promoting the adoption of clean and sustainable technologies. CBI Climate Bond Initiative (CBI) defines transition finance as the White Paper Financing Credible investment required to reduce GHG emissions to levels 'commensurate Transitions, Sep 2020, Discussion with meeting the goals of the Paris Agreement' (Anna Creed, 2020). Transition Finance for Transforming Companies, Sep 2022 ADB Transition finance is a concept where financial services are provided to Transition Finance is Critical to Address high carbon-emitting industries – such as coal-fired power generation, Climate Change, ADB, 2022 steel, cement, chemical, paper making, aviation and construction – to fund their transition to decarbonization. OECD OECD limits the scope of transition finance to hard-to-abate sectors Transition Finance: Investigating the State and argues to concentrate the financing of 'economic activities that are of Play - A Stocktake of Emerging 28Organizations Definitions Sources emissions-intensive, do not currently have a viable green substitute Approaches and Financial Instruments, (technologically, economically or both), but are important for socio- OECD, 2022 economic development'. ICMA International Capital Market Association (ICMA) defines transition Climate Transition Finance Handbook: finance as 'investments that effectively address climate-related risks Guidance for Issuers, Sep 2023 and contribute to alignment with the goals of the Paris Agreement” (ICMA, 2020). 29Appendix 2: Definitions and Guardrails Jurisdictions/Regulators Test for General Industry/Sector Activity/Process Trajectory Corporate Instruments Finance ASEAN • 3 labels to identify • Proposes reference to • All of below Na • All financial transitioning entities. taxonomies to identify • 1.5°C/2.0°C instruments - 1.5° C aligned/aligning. activities/processes. aligned (Transition - 2.0°C aligned/aligning • Cites following • Science-based Finance - Progressing examples of model or Guidance, Oct taxonomies: ASEAN, country/industry 2023) Singapore, Thailand, body led Indonesia, Malaysia, commitment Philippines EU • 6 environmental objective • Multiple processes • All of below Na Na labels allocate economic listed for each of 28 sub- • 1.5°C aligned activities to 9 sectors. sectors with emissions • Do not hamper (EU Taxonomy, • 5 (out of 9) qualify as thresholds (aligned with development and Jun 2020, transitional 1.5°C) deployment of Taxonomy • Energy, construction & • For example, for iron & low- carbon delegated real estate, information & steel 6 listed, including alternatives regulation for communication, electric arc furnace • Do not lead to Technical manufacturing (cement, lock-in of carbon Screening iron & steel etc), transport intensive assets Criteria (TSC), (with 28 sub-sectors • Science based Jul 2021) listed) Japan • 9 listed • Proposes technology • All of below Na • Use of • Iron & steel, chemicals, roadmaps for each of • 1.5°C/2.0°C proceeds 30Test for General Industry/Sector Activity/Process Trajectory Corporate Instruments Finance (Basic electricity, gas, oil, the 9 listed industries aligned instruments Guidelines on cement, paper & pulp, with emissions • Science-based, (bonds or Transition shipping, aviation thresholds (aligned with including targets loans) Climate 1.5°C) and pathways • Sustainability- Finance, May • For example, for iron & Linked 2021, steel: 14 technologies Bonds/Loans supplemented with 25 activities by 9 sector specific roadmaps) MAS • 3 labels to classify all • Multiple processes • Any one of below Na • Na economic activities listed for each of 40 sub- • Moving towards - Green (sustainable) sectors (under the 8 green transition (Singapore-Asia - Amber (transition) industries/sectors that pathway (1.5°C) in Taxonomy for - Red (ineligible) come under the Amber a defined time Sustainable • 8 listed under Amber label), with thresholds frame Finance, Dec • Energy, transport, aligned with 1.5 degrees • Facilitating 2023) construction, industry C for each significant (iron & steel, cement), • For example, for iron & emissions agri & forestry, CCUS, IT, steel: 3 listed, including reductions with a waste/circular economy blast furnace prescribed sunset (with 40 sub-sectors) date Note: The analysis in the above table is based on the authors interpretation and review of the various initiatives evaluated. In order to facilitate a like for like comparison, terminology used to evaluate the various parameters may differ in certain instances from the original documentation. 31Standard Setters/Coalitions Industry/Sector Trajectory Test for Instruments Activity/Process General Corporate Finance CBI • 4 labels to classify economic activities by • Netzero by 2050 (in line Transition • Entity Level entities/activities with 1.5°C trajectory) plan, - Equity (White Paper - Near-zero (emissions) • Science-based credible investments Financing Credible - Pathway to Zero • Offset don’t count: but targets and - General Transitions, Sep - Interim should count upstream metrics purpose 2020, Discussion - Stranded scope 3 emissions debt Transition Finance • For entities: Transition label applicable to • Technology viability (over - SLBs/SLLs for Transforming - Pathway to Zero economic • Activities Level Companies, Sep - Interim competitiveness) - Use of 2022) • For activities: Transition label applicable to • Action not pledge: backed proceeds - Pathway to Zero by operating metrics bonds/loans - Interim - Stranded GFANZ • Specifies 4 financing strategies that facilitate • In line with achieving net- Na Na real economic transition zero by 2050 (Financial - Climate Solutions • 1.5°C aligned Institution Net-zero - Aligned • Foundation, Transition Plans: - Aligning implementation strategy, Fundamentals, - Managed Phaseout engagement strategy, Recommendations, • But does not go into specifying metrics, and targets and Guidance, Nov business/activities 2020) ICMA Na • 1.5°C/2.0°C aligned Na • Use of proceed • Business model instruments 32Industry/Sector Trajectory Test for Instruments Activity/Process General Corporate Finance (Climate Transition environmental materiality • General Finance Handbook: • Climate transition purpose Guidance for strategy and targets to be sustainability- Issuers, Sep 2023) science-based: aligned linked with the Paris Agreement instruments • Implementation (SLBs) transparency, including annual disclosure of capex and opex plans Note: The analysis in the above table is based on the authors interpretation and review of the various initiatives evaluated. In order to facilitate a like for like comparison, terminology used to evaluate the various parameters may differ in certain instances from the original documentation. Institutions Industry Activity/Process Trajectory Test for General Instruments Corporate Finance Barclays • 11 listed • 110+ listed • Any one of below • 90% of • Exclusions: • Agri, cement, • Examples include • 1.5°C /no overshoot company M&A, SLB, chemicals, energy, Carbon Capture, benchmark global revenues AUM, in ESG (Transition Finance power & utility, real Utilization and scenarios such as derived from funds, Framework, Feb estate, metals, Storage (CCUS), IEA NZE, IPCC, and transition Trading/market 2024) mining, aviation, WTE, low carbon PRI framework making, Liquid ground transport, fuels • Regional or national activities securities shipping scenario pathways financing, • Regional sustainable derivatives 33Industry Activity/Process Trajectory Test for General Instruments Corporate Finance and transition finance taxonomies (e.g. EU) DBS • 3 labels to classify • 40+ listed • All of below • Divestitures, • All financial economic activities • Examples include • 1.5°C/2.0°C aligned diversification instruments of industries pumped storage, • Enables the wider or (Sustainable & - Green bio-gas, CCUS application or decarbonization Transition Finance - Transition integration of less towards lower Framework & - UN SDG carbon-intensive exposure to Taxonomy, Mar • 11 listed under options carbon intensity 2022) transition or emissions • Automotive, metals reductions & mining, food & agri, O&G, chemicals, power, infrastructure, shipping, aviation, telecom, logistics Standard • 8 listed • 75+ listed • All of below • 90% of • Asset as well as Chartered • Iron & steel, • Examples include • 1.5°C aligned company entity-based railways, agri, CCUS, low emission • Avoid lock-in of revenues financing aviation, cement, fuels, material carbon-intensive derived from (Transition Finance aluminium, efficiency asset transition Framework, 2021) shipping, other framework activities Note: The analysis in the above table is based on the authors interpretation and review of the various initiatives evaluated. In order to facilitate a like for like comparison, terminology used to evaluate the various parameters may differ in certain instances from the original documentation. 34Appendix 3: Financial Mechanisms and Instruments Mechanism Instrument Type Source Description Applicable existing examples RD&D Grant Finan Public, RD&D Funds (primarily grants) support low-carbon Ministry of Steel (MoS) has set up Funding cing Private technology development during concept, prototype, Steel Development Fund (SDF) to and early demonstration stages. fund up to INR 150 crore per year for R&D in the steel sector. Venture Equity Finan Public, VC/PE firms provide early-stage risk capital A total of USUSD 53.7 billion of Capital (VC) cing Private (primarily equity) to companies, mostly start-ups, VC/PE capital was invested in and Private that are not listed on the public stock exchange. This climate-tech start-ups in 2021. Equity (PE) source of capital is not for steel companies Temasek, Breakthrough Energy themselves, rather, for startups that innovate and Ventures, and Future Ventures have develop new low-carbon technologies. been major investors of this capital. Viability Gap Subsidy Finan Public Viability gap funding or capex grants is the financial During 2015-17, GoI launched VGF Funding cing support provided by the government to projects that scheme for solar projects, covering (VGF) are not commercially viable but are justified up to 30% of the project cost, or INR because of their overall economic and development 2.5 crore per MW. impact. Project Grant, Equity Finan Public PPF/ TA facilities provide grant funding to US India Clean Energy Finance Preparatory / cing, decarbonization projects to defray the costs related (USICEF): a USUSD 20 million Technical De- to project preparatory activities and enable the facility that supports projects in Assistance riskin projects to become investment ready. distributed solar space and helps Facility g them scale into viable projects. Developmen Equity Finan Public, Development equity funds support early-stage IFC Infra Ventures: a USD150 million t Equity cing Private ventures by providing project development global infrastructure project assistance and early-stage risk capital, to scale and development fund that combines 35raise debt financing, at which stage, the capital will early-stage risk capital and project be converted into an equity position in the project. development support. Blended Concession Finan Public, Blended finance structures blend concessional Tata Cleantech – GCF credit line: a Equity, Debt al equity, cing Private capital from lenders and investors to lower the USUSD 200 million blended debt debt overall cost of capital for projects faced with financing facility for solar rooftop unviability at commercial rates. segment. Carbon Carbon Finan Public, Carbon finance is an innovative financial International Voluntary Carbon Finance credits cing Private intervention that allows the flow of capital from Markets: allow carbon emitters to emissions- intensive projects to projects that abate help offset their emissions by emissions, through the trading of carbon credits. purchasing carbon credits generated by low-carbon projects. Contract for Subsidy Finan Public A project-based CfD is a bilateral contract between - Difference cing, the government/government-owned entity and a (CfD) De- low-carbon project that covers the incremental cost riskin of production compared with conventional g technology. The low-carbon project would receive payments equal to the difference in the levelized cost of production, using a low-carbon technology versus the 'market price' of steel produced using conventional technologies. A CfD can also apply to carbon price. Sustainabilit Debt Finan Private SLBs are bonds where the proceeds of issuance are Ultratech Cement raised USUSD y-Linked cing not defined, and the borrower can use the funding 400 million through India’s first SLB Bonds as they see fit while committing to achieve defined issuance. JSW Steel raised USUSD 1 (SLBs) sustainability targets within a given timeframe. The billion through SLBs. characteristics of these bonds, like coupon rate, changes, based on performance of the defined targets. 36Transition Debt Finan Private Financing intended for economic activities that are - Finance cing emissions-intensive, do not have a viable green (loans/bond (near-zero emissions) substitute but are important s) for socio-economic development. The use of proceeds of transition finance instruments is defined. The borrower must use the proceeds towards transition activities. Credit Guarantee De- Public, Credit guarantees would work as a bilateral Partial Risk Sharing Facility (PRSF): a Guarantees riskin private agreement between the guarantor (sovereign or FI) USUSD 43 million facility under g and lending institutions (banks/ FIs) for risk-sharing which partial credit guarantees are in case of delay/default in debt servicing, wherein provided to cover a share of default the guarantor reimburses the lending institution/s risk faced by FIs in extending loans for a portion of the losses incurred due to payment to energy efficiency projects default by the borrower. implemented through Energy Service Company (ESCOs). Credit Guarantee De- Public, Credit enhancement mechanisms support - Enhanceme riskin Private decarbonization projects in accessing capital nt g markets through issuance of credit-enhanced bonds to domestic and international investors. The facility would lower the cost of credit enhancement and unlock the flow of capital from the bond market. Credit Insurance De- Private Credit insurance is a risk management tool that All general insurance companies Insurance riskin covers the insured against the risk of outstanding have a credit insurance product for g receivables. trading companies. 37