Japan sold the world's first sovereign transition bond on Wednesday, taking an alternative path to net zero compared with many other countries, but the auction was not as strong as expected.
The finance ministry auctioned ¥800bn (US$5.3bn) of 10-year climate transition bonds. The Dutch auction stopped at 0.74%, on a compound yield basis, just 0.5bp lower than where the regular 10-year benchmark bond had traded before the bidding deadline. The coupon was set at 0.7%.
The greenium was a lot smaller than many expected. Sources said the transition bond had not traded in the grey market, but the yield had been quoted 4.6bp–6.6bp lower than the 10-year benchmark in the days before the auction. The pricing benefit in the end was even smaller than the 2bp greenium typically observed in Japan's municipal bond market.
The bid-to-cover ratio was 2.90, a lot lower than the average of 4.17 for traditional 10-year auctions last year.
"We are happy that the greenium was reasonable," said a source at a Japanese life insurer. "It is tough for life insurers to buy a 10-year bond and would have been even tougher if the greenium was 2bp." The source said he would not have invested if the greenium had been 4bp–6bp.
A dealer at a Japanese securities firm echoed these sentiments, saying he was actually glad the auction was relatively weak. "All our clients sighed when the auction results came out, but I told them we made a good start for [the transition bond programme]," he said. "I think this level of greenium would bring in many more investors."
Jarek Olszowka, international head of sustainable finance at Nomura, said the existence of a greenium was nonetheless notable. "I think it’s good there is a greenium – even a smaller one – as you have to remember that Japan is still in negative rates and prices [bonds] very tightly so every basis point or even half a point is important for this type of issuance," he said.
The government plans to raise an additional ¥800bn from an auction of five-year transition bonds on February 27. In the fiscal year ending on March 31, only five and 10-year transition bonds will be sold, but the sovereign will also look at tenors of two and 20 years in following years.
Two non-life insurers and at least seven Japanese lifers, including Japan Post Insurance, said they had bought the bond. The aforementioned dealer said he also saw orders from central cooperatives and pension funds, but that each order was small.
It is uncertain how many overseas investors bought the bonds, but the auction took place in Tokyo hours, making it hard for them to participate.
"I think there are some buyers in Europe and America," Olszowka said. "ESG-driven funds can also buy Japan's transition bond and many would prefer to do that rather than buy a conventional JGB because this is about decarbonising hard to abate sectors and providing so much transparency and additional reporting."
The transition bond closed its first day at 0.729%, versus 0.75% for the conventional 10-year bond. The following day, it closed at 0.69%, with the greenium widening in secondary to 3.1bp as some investors switched from the traditional 10-year to the transition bond.
Whole-economy plan
Japan intends to sell ¥20trn of climate transition bonds in the next 10 years under its green transformation programme, which it hopes will help generate ¥150trn of private and public investments to facilitate the country's targets of reducing emissions by 46% by 2030 from 2013 levels and reaching carbon neutrality by 2050, as well as growing the economy. It expects the pioneering bonds will also serve as a catalyst for transition initiatives in Japan and throughout Asia.
The government plans to use 55% of the proceeds from this month's offerings to support research and development of innovative technologies and 45% for subsidies to projects including batteries, clean energy vehicles and home insulation.
"The issuance will be used to invest in technologies where expected emission reductions or economic viability are unclear, affirming Japan's intention to pursue an alternative path to net zero than in other developed economies and regional Asian peers," Nneka Chike-Obi, head of APAC ESG ratings and research at Sustainable Fitch, said in a note.
The government formulated a transition bond framework in November and obtained second-party opinions from Japanese ratings agency JCR and Norway's DNV about the alignment of its framework with international standards.
"I think the positive comment is that finally we are witnessing an attempt to decarbonise hard to abate and polluting sectors at a very large scale," Olszowka said. "It's trying hard to achieve impact in a very hard and complex area."
The government said more than 1,500 market participants from over 700 entities attended the seminars it held for Japanese investors. It also visited about 40 investors in Europe and the US in January and February.
A banker who went to Europe with government officials said the roadshows were productive as the investors he met understood the reasons behind Japan's transition framework and why the country's approach is different to elsewhere.
"Some countries cannot shut down coal-fired [power plants] right away, but transition finance will open the way for those countries," said Toshiaki Otani, head of capital markets in Japan at BNP Paribas. "Green bonds have been only issued by 'environmentally straight-A students' . . . but Japan believes transition is needed for the sectors that were not in the spotlight and for Asia in order to achieve net zero."
Ammonia co-firing
Otani said his team received many tough questions during the roadshows, in particular about Japan's plans for ammonia co-firing and nuclear power.
Ammonia co-firing, which replaces some of the coal used in coal-fired power plants with ammonia, is seen as one of the key technologies for Japan to reduce emissions, and the country has included facilitating the introduction of hydrogen and ammonia as one of the eligibility criteria under its transition bond framework.
However, many environmentalists are not keen on ammonia co-firing (because it makes a minimal reduction in carbon emissions and most ammonia is made using hydrogen produced by fossil fuels) and ammonia co-firing is not included in the use of the proceeds for the first round of Japan's transition bonds.
"The bond strictly delineates its use of proceeds, excluding any allocation towards gas-fired power generation or operational activities involving ammonia co-firing in coal-fired plants," pointed out the Climate Bonds Initiative, which has certified the bond under its Climate Bonds Standard, indicating that it aligns with global standards.
Government officials denied that ammonia co-firing was intentionally excluded from the use of proceeds in order for the inaugural sale to go smoothly, saying that ammonia co-firing and the related technologies have already been funded via other programmes.
Other labelled bonds
Anthropocene Fixed Income Institute, a non-profit research organisation, recommended Japan issue complementary sustainability-linked bonds alongside its transition bond to lower its cost of capital, attract global investors and progress towards net zero.
However, this is apparently not the plan. A finance ministry official said that issuing additional bonds under a different label might lower market liquidity.
To keep the transition bond liquid, the ministry will discuss whether to conduct tap offerings in the future, but there is one hurdle to overcome.
"We did specify the use of proceeds for the ¥1.6trn issuance, so that I think will make it difficult to reopen," said the official. Future transition bonds may have different uses of proceeds. "ESG investors told us the more specific use of proceeds the better, but JGB investors told us the more liquid the better."
(Additional reporting by Azumi Kuboki and Tessa Walsh)
Updated story: adds banker quotes