FINANCE FINANCE EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT Mobilizing Finance for the Just Energy Transition in the European Union Pietro Calice and Dimitri G. Demekas © 2023 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. Equitable Growth, Finance, and Institutions Policy Notes (EFI Policy Notes) are prepared under the direction of the EFI Vice President. EFI Policy Notes analyze topical issues of importance to policy makers in emerging market and developing economies. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development of the World Bank and its affiliated organizations or those of the Executive Directors of the World Bank or the governments they represent. Contents Acknowledgments 1 Abbreviations 2 Executive Summary 4 1. Introduction 7 2. Key Concepts and Challenges for the Financial Industry 11 3. Toward an Enabling Framework for Just Transition Finance 15 4. Case Study: The EU Just Transition Framework 19 Hierarchy of priorities 20 Fiscal transfer 20 Financial flows enablers 22 5. Key Takeaways 29 References 32 Acknowledgments This policy note was prepared by a team, led by Pietro Calice (EECF1), that was composed of Stefano Battiston, Dimitri G. Demekas, Victor Duggan, and Irene Monasterolo (consultants, EECF1). The team is grateful to Lalita Moorty (EECDR), Ilias Skamnelos (EECFI), and Gallina Andronova Vincelette (ECCEU) for their guidance. The team also gratefully acknowledges comments and input received by Katarzyna Szwarc (Ministry of Finance, Poland) as well as Reena Badiani-Magnusson (EECDR); Julie Biau and Steven Jouy (ECCEU); Pablo Salas Bravo (CELCE); Rome Chavapricha and Philip Lam (IPGFG); François Lesage and Martijn Regelink (EFNFS); Aaron Levine and Fiona Stewart (EFNLT); Rachel Mok (EAEF1); Rachel Perks and Michael Stanley (IEEXI); and Marc Sadler (SCADR). Hanna Chang (EFIOS) and Barbara Rice (consultant) provided editorial support while Martha Sofia Mora Alvarez (ECAVM) provided administrative support. PHOTO CREDITS Cover: Scott Wallace / World Bank Page 4: Jutta Benzenberg / World Bank Page 6: Curt Carnemark / World Bank Page 9: Flore de Préneuf / World Bank Page 10: Dominic Chavez / World Bank Page 14: Dana Smillie / World Bank Page 18: John Hogg / World Bank Page 28: Arne Hoel / World Bank MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 1 Abbreviations APLMA Asia Pacific Loan Market Association CDSB Climate Disclosure Standards Board CMU Capital Markets Union (EU) COP Conference of the Parties (UN) CRD Capital Requirements Directive CRR Capital Requirements Regulation CSDD Corporate Sustainability Due Diligence (EU) CSRD Corporate Sustainability Reporting Diligence EBA European Banking Authority ECB European Central Bank EFAMA European Fund and Asset Management Association EFI Equitable Growth, Finance, and Institutions ESG environmental, social, and governance EU European Union GHG greenhouse gas JTF Just Transition Fund (EU) JTM Just Transition Mechanism (EU) IFRS International Financial Reporting Standards ILO International Labour Organization ISSB International Sustainability Standards Board KPIs key performance indicators LMA Loan Market Association LSTA Loan Syndications and Trading Association 2 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION MDB multilateral development bank MNE multinational enterprises NFRD Non-Financial Reporting Directive (EU) NGFS Network for Greening the Financial System OAM Ostrum Asset Management OECD Organisation for Economic Co-operation and Development ORC operational risk capital PSF Platform on Sustainable Finance RBC responsible business conduct SASB Sustainability Accounting Standards Board (IFRS Foundation) SBPs Social Bond Principles SDGs Sustainable Development Goals SLBPs Sustainability-Linked Bond Principles SLLPs Sustainability-Linked Loan Principles (LMA, LSTA, and APLMA) SLPs Social Loan Principles (LMA, LSTA, and APLMA) SMEs small and medium enterprises SREP Supervisory Review and Evaluation Process SSSL Social, Sustainability, and Sustainability-Linked TCFD Task Force on Financial Disclosures TJTPs Territorial Just Transition Plans UN United Nations UNGPs UN Guiding Principles on Business and Human Rights WBG World Bank Group MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 3 >>> Executive Summary Minimizing the adverse social and economic consequences of the energy transition is an important social aspiration. It is the essence of the “just transition,” the connective tissue that binds together climate goals with social outcomes centered around jobs. As with the energy transition itself, this requires mobilizing financial resources at a scale far exceeding the capacity of the public sector. Private finance is therefore key for achieving that goal. Several private sector initiatives and financial innovations originally developed for climate finance could provide templates and pathways for just transition finance. However, just transition finance faces unique conceptual and operational challenges. Since the just transition reflects social values of fairness, it is hard to define a just transition project or financial product and to measure its impact. The latter also depends on the choice of the target group for the remediation effort and on the time horizon, which is likely to be longer than that for most financial decisions. Therefore, market mechanisms alone cannot fully incorporate just transition considerations in finance. An overarching policy framework that provides guidance and aligns incentives is needed. This policy note proposes the first iteration of a just by the transition; and several initiatives that promote transition policy framework built around three interrelated better disclosure, improved risk management, and capital and mutually reinforcing pillars. These include: (i) a system mobilization to crowd in private investment for the just for determining a hierarchy of priorities for activities, sectors, transition. However, some gaps remain. or groups that are to be compensated for the negative The assessment provides seven key takeaways for impacts they suffer from the transition to a low-carbon consideration by competent authorities to strengthen economy or supported because they contribute directly to a further the EU just transition policy framework going more equitable sharing of the costs and opportunities from forward. These are: (i) narrowing the scope of the framework the transition; (ii) a fiscal transfer mechanism to allocate by focusing on social support and/or land restoration, public funds consistent with these priorities; and (iii) financial while encouraging private sector funding for economic flows enablers, a set of instruments or policy interventions to revitalization projects; (ii) enhancing data collection on social facilitate private financial flows to activities or projects that impact assessment to better understand the negative effects are deemed to contribute to a more just transition. of climate transition initiatives and prevent “social washing”; The framework is applied to the European Union (EU) (iii) embedding just transition considerations in sustainability to preliminarily gauge any residual barriers that can regulations by including relevant indicators and metrics; hinder private capital mobilization at scale for the just (iv) providing guidance on assessing just transition-related transition. The EU is more advanced than other major risks for financial firms in prioritized regions and sectors; jurisdictions in putting a just transition policy framework in (v) clarifying supervisory expectations for financial firms place, representing an interesting case study to test the regarding just transition-related litigation and liability risk; validity and applicability of the proposed framework. The (vi) encouraging the development of financial instruments for emerging EU framework incorporates key components of the just transition; and (vii) maximizing the role of multilateral all three pillars: a set of rules for determining just transition development banks in de-risking just transition projects, priorities delegated, within certain parameters, to member especially in member countries with limited resources and states; a pool of grants to support the regions most affected capacity. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 5 1. 6 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION >>> Introduction There is increasing recognition that the successful transition to a net-zero economy will be contingent on addressing its social and economic consequences. In this context, the “just energy transition” has become the main concept and strategy tool for managing the transformation toward a net-zero economy in a way that is fair and leaves no one behind. Ensuring that the transition to a low-carbon economy corresponds to social norms of fairness is both a moral imperative and a political imperative to win support for climate action and address possible opposition.1 The concept of just transition does not apply only to the energy transition. It also refers to mitigating the distributional impact of any transition to a new technological or economic paradigm. Concerns about the impact of digitalization and artificial intelligence, for example, have also generated calls to ensure a just transition (Stocker 2021, 4:03; Buhovskaya 2017; TUAC 2019). A labor-driven concept of the just energy transition aligned with its original meaning is needed in order to operationalize it. Although jobs remain an important element, the just energy transition concept is today considerably broader, encompassing wider issues of justice and equity raised by the prospect of the energy transition (for example, poverty eradication, social inclusion, and inequality). As a result, just energy transition is increasingly understood and used in many different ways, with the danger of being hollowed out and overstretched. This complicates the operationalization of the just energy transition, calling for a pragmatic interpretation that builds on the original meaning. This is essentially based on the idea that workers and communities whose livelihoods will be lost because of an intentional shift away from high carbon activities and sectors should receive support from the state. From this narrower perspective, the just energy transition requires that the transition out of carbon-intensive sectors and activities be accompanied by measures to minimize the impact on workers and communities in the regions that are negatively affected. Despite the broader environmental benefits, the transition to a low-carbon economy will inevitably cause stranded assets, lost jobs, and sizable shifts in income and wealth across regions and economic sectors. When a coal mine closes or a car plant shifts to electric vehicles, for example, carbon emissions are reduced, but employees and their families lose wages and benefits, the local 1 Evidence suggests that perceived fairness is one of the strongest predictors of both support for climate action and behavior change. See, for example, Drews and van den Bergh (2016). MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 7 economy suffers from lower spending, and local governments Drawing on three background papers, this policy note lose tax revenue.2 In this context, the just energy transition first attempts to conceptualize a just transition policy would essentially involve developing new sources of framework for mobilizing private capital.3 In the absence employment and growth to prevent or mitigate the localized of relevant literature and experience, the result is necessarily dislocations resulting from declining industries (for example, suggestive and based on simplifying assumptions. While coal and lignite mining and crude petroleum and natural gas just energy transition finance shares many features with extraction) or transforming industries (for example, basic sustainable finance, important operational differences reflect materials and automotive). This includes active regional the unique purposes and goals of the just energy transition restructuring practices with industrial policy and regional project. These have to do with the political choices required development initiatives. to identify the target groups eligible for remediation and the need to integrate private capital with public resources to As with the energy transition itself, a key challenge for fund noncommercially viable activities (for example, income the just energy transition is mobilizing sufficient financial compensation and land restoration). Narrowly focusing on resources. To be sure, both tasks require efforts across a finance only without considering these essential elements is wide range of human activities, including science, technology, an enterprise doomed to fail. Nonetheless, the experience economic investment, social mobilization, and political action. and knowledge of enabling frameworks for climate (and But both also involve a massive reallocation of financial flows sustainable) finance offer important insights to the process as well as the mobilization of additional financial resources of developing a policy framework for facilitating the funding at a scale far exceeding the capacity of the public sector. of just energy transition activities. From this perspective, this Private finance is therefore key for achieving both goals. policy note assumes that mobilizing private capital for the just However, just transition finance is distinct from climate finance energy transition can be achieved in the context of evolving for it is focused on societal and developmental goals for environment, social, and governance (ESG) approaches. those negatively impacted by climate action. In other words, while climate finance relates to funding the decarbonization This policy note then critically evaluates the conceptual of the economy, just transition finance is about financing framework for mobilizing just transition finance using the the “management of the socioeconomic consequences” of EU as a case study. The EU is more advanced than other decarbonizing activities (Lowitt 2021). jurisdictions in putting in place a comprehensive just transition policy framework, representing a natural candidate for Mobilizing private finance for the just energy transition evaluating the proposed framework’s validity and applicability. requires an enabling policy framework. The distinct feature The just energy transition is a defining principle of the of private capital mobilization for the just energy transition is European Green Deal, the EU’s growth strategy to net zero. a place-based investment approach aiming to support the This emphasizes that the transition to a climate neutral and economic diversification and reconversion of the territories circular economy must be just and inclusive, where no person impacted. Examples include the backing of productive is left behind. One of the key instruments for delivering the just investments in small and medium enterprises (SMEs), the energy transition in the EU is the Just Transition Mechanism creation of new firms, and research and innovation. The (JTM), set up as part of the European Green Deal Investment nature of the just energy transition and the conceptual and Plan—the investment pillar of the European Green Deal. measurement obstacles it faces mean that market forces alone are not sufficient to generate the required resources in the The assessment provides key takeaways for strengthening necessary scale. An overarching policy framework to provide further the EU policy framework with the specific focus clarity and a sense of social priorities, as well as adequate on measures to mobilize private capital in support of the public funding and the right set of incentives, is needed. just energy transition. The proposed measures are focused 2 These effects can be very long-lasting. For example, 40 years after the abrupt decline of the coal mining industry in the United Kingdom, regions that were once economic powerhouses still bear the scars of the upheaval that comes with rapid structural change (Beatty, Fothergill, and Gore 2019). 3 The three background papers prepared for this policy note cover the following topics: just transition issues for financial regulators; challenges and opportunities for just transition finance in the European Union; and potential just transition risks in bank portfolios in Poland (Battiston, Calice, and Monasterolo, forthcoming; Demekas and Calice, forthcoming; Duggan, forthcoming). 8 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION on enhancing the mobilization of finance for the just energy and Poland, have benefited from this support.5 This policy transition, not for broader social or environmental goals. note highlights the relevance of declining and transforming More specifically, the measures are intended to facilitate the industries impacted by the energy transition other than the mobilization of finance in support of regional development coal sector and discusses options for financing place-based initiatives and industrial transitions, not of compensation and economic diversification and industrial restructuring beyond employment measures for affected workers or land restoration.4 social protection and land and plant repurposing. While the focus of this policy note is on the EU, it also highlights Following this introduction, the paper is organized in preliminary lessons learned for other regions and countries that four sections. Section II presents key concepts and provides wish to operationalize the just energy transition agenda. an overview of the challenges that the financial industry faces This policy note complements and extends ongoing in developing just transition finance markets and instruments. efforts by the World Bank Group (WBG) to support EU Section III introduces the key elements of a policy framework member countries transitioning away from coal. Based on for mobilizing private capital in support of the just transition. lessons learned from decades of transition experience, the Section IV assesses the framework in the context of the EU WBG has built an approach that supports national, regional, just transition policy framework. Section V concludes with key and local authorities worldwide developing clear roadmaps takeaways for strengthening further the EU framework, with a focusing on governance structures, the welfare of people and focus on measures that can help mobilize private capital. For communities, and the remediation and repurposing of former simplicity, in the remainder of this policy note the term “just mining lands and coal-fired power plants (Stanley et al. 2018). transition” will refer to the just energy transition as narrowly Several EU member countries, such as Bulgaria, Greece, defined herein. 4 For a review of emerging financial mechanisms that aim to leverage private finance for compensation and coal plan retirement, see Calhoun et al. 2021. 5 For more information, see the World Bank’s website at https://www.worldbank.org/en/topic/extractiveindustries/justtransition. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 9 2. 10 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION >>> Key Concepts and Challenges for the Financial Industry Originated in the North American labor movement in the 1990s, the concept of just transition was formally articulated by the International Labour Organization (ILO) and has gained political momentum since then. Just transition was an early trade union demand for managing the transformation toward a net-zero carbon economy and this approach has now become a mainstream policy tool referred to by international institutions and treaties. y The ILO defined a just transition as “greening the economy in a way that is as fair and inclusive as possible to everyone concerned, creating decent work opportunities, and leaving no one behind” and published guidelines in 2015 (ILO 2015).6 y The concept of the just transition was formally incorporated in the Paris Agreement in 2015, where it is stated that governments should take into account “the imperatives of a just transition in the workforce and the creation of decent work and quality jobs in accordance with nationally defined priorities.”7 y It was reinforced in 2018 at the 24th Conference of the Parties of the Climate Change Convention (COP24) through the Solidarity and Just Transition Silesia Declaration; at COP25 in 2019 through the initiative Climate Action for Jobs; at COP26 in 2021 through the Declaration on Supporting the Conditions for a Just Transition Internationally, signed by the governments of 17 countries plus the EU; and most recently, at COP27 in 2022 through the Sharm el-Sheikh Implementation Plan, which put the imperative of a just transition at the core of the global climate agenda. From the original meaning, the concept of just transition has developed in too broad and general terms, requiring a pragmatic interpretation to operationalize it. To discuss it meaningfully, and crucially to operationalize the concept, it is important to return to the original interpretations of what just transition means in practice, clarifying upfront intended outcomes (“what”) and process (“how”) (Galgóczi 2019). The outcomes, as articulated in international treaties, should be to minimize employment disruptions in the regions most affected by the energy transition. The process should be based on a managed transition that deals with the 6 For more information, see the website of the ILO at https://www.ilo.org/global/topics/green-jobs/WCMS_824102/lang--en/ index.htm. 7 For more information, see p. 1 of “Paris Agreement to the United Nations Framework Convention on Climate Change, Dec. 12, 2015, T.I.A.S. No. 16-1104.” MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 11 social impact of climate policies, for example, how the energy cases, regional development initiatives aimed at diversifying transition affects different income groups and what forms of the economy and creating new job opportunities will be compensation should apply. It should also deal with managing needed, requiring significant investment to avoid lock-ins and the economic impact. This aspect implies focusing not only stranded assets. on employees whose jobs are being lost or fundamentally With public finance insufficient, mobilizing private capital transformed during the energy transition, but also on all those at scale will be key to deliver the just transition. Like stakeholders whose livelihood depends on those activities (for with the energy transition itself, it is generally accepted that example, households, SMEs, and local authorities). the scale of the just transition financing challenges will be An operational focus on jobs implies identifying sectors greater than what the public sector alone can fund. Therefore, and territories for which the energy transition has the any public sector contribution will need to be supported in most negative social and economic impacts. From a significantly higher amounts by the private financial sector. sectoral perspective, there will be winners and losers in the Financial firms are coming under pressure from energy transition. Mining of coal and lignite and the extraction different directions to take into account just transition of crude petroleum and natural gas are the sectors that will considerations in their business practices. These include: experience the largest contraction in jobs (“declining sectors”), while steel, cement, chemicals, and car manufacturing sectors y High-level political declarations or commitments, such will have to be heavily transformed to be a part of low-carbon as the Paris Agreement and the United Nations (UN) economy (“transforming sectors”).8 A key issue is that these Sustainable Development Goals (SDGs), in particular declining or transforming sectors tend to be geographically SDG 8 (decent work and economic growth), SDG 10 concentrated within countries. Regions that are heavily reliant (reduced inequalities), and SDG 7 (affordable and clean on these sectors for economic growth and employment will energy), are closely related to the concept of just transition. be disproportionately negatively affected by the transition. The UN Guiding Principles (UNGPs) on Business and They will suffer heavier job losses and lose key drivers of Human Rights9 and the OECD Guidelines for Multinational their economic growth as well as industries that might be an Enterprises on Responsible Business Conduct,10 which important part of their regional cultural identity. Therefore, in its most recent version explicitly refers to the just the just transition has a strong sectoral and geographical transition, provide a set of high-level norms for conducting connotation. business and creating societal expectations that financial firms—especially global ones—should consider in light As the nature and magnitude of the challenge differ across of the broader social and human impact of their business sectors, different policy responses are required. The social decisions. impact of the transition to climate neutrality is primarily linked to job losses, the need for reskilling or upskilling workers, and y Pressures to take into account just transition considerations workers’ mobility. This will have direct consequences for the in business decisions may also arise internally in financial livelihoods of households and families as well as social exclusion firms from activist shareholders and investors. During the and important gender implications. This calls for active labor last two decades or so, there has been a gradual increase market and social protection policies, primarily funded by the in investor and shareholder interest in ESG issues. While fiscal purse. The economic impact of the transition will play the focus has so far been on climate issues, the just out differently between declining and transforming sectors. transition may attract increasing attention in the future. The latter is associated with closure of mines and extraction sites, loss of assets, and decommissioning of fossil fuel-fired y Concern about emerging “social risk” may also be adding power plants, with structural changes in related value chains. to the pressure on financial firms to incorporate just The former is mostly related to deep greenhouse gas (GHG) transition considerations in their risk management. Social emissions reduction, which will require changes in production risk is the risk of a negative financial impact on a financial patterns and the deployment of new technologies. In both firm if the latter does not take into account the employment 8 For example, see Griffin et al. 2019. 9 The UNGPs are based on the concept of do no harm that stresses the states’ “responsibility to protect” and the corporate “responsibility to respect” human rights (United Nations 2011). 10 The guidelines of the Organisation for Economic Co-operation and Development (OECD) provide standards of “responsible conduct” for multinational firms that include observance of the UNGPs. The most recent update of the guidelines, approved in June 2023, make explicit reference to the need to “to assess and address social impacts in the context of their environmental management and due diligence activities and to take action to prevent and mitigate such adverse impacts both in their transition away from environmentally harmful practices, as well as towards greener industries or practices” (OECD 2023, 36). 12 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION or social impacts of its business decisions; for example, y Associated with the measurement challenge is the issue withdrawing bank financing from coal mining or fossil fuel- of disclosures that may be needed to enable investors, based energy generation without considering the loss of market participants, and potentially regulators to assess jobs and incomes in the local communities. the contribution of individual projects or investments to the just transition. y Finally, in emerging markets and developing economies, where multilateral development banks (MDBs) are major y The focus on the impact of climate transition projects on sources of funding, domestic financial institutions may be local economies and communities is another challenge. pushed to internalize just transition considerations in their Financial transactions typically involve the supplier(s) of a business practices. This dynamic is already evident in financial service (such as funding, risk coverage, or maturity relation to climate-related commitments. transformation) and a single client (such as an individual or corporate borrower, a client purchasing insurance, However, responding to these pressures and incorporating or an entity issuing equity or debt). Depending on the just transition considerations into financial decisions run chosen target group, taking into account just transition against unique conceptual and measurement challenges. considerations potentially expands the set of stakeholders y The most fundamental challenge is defining what whose interests might need to be taken into account constitutes a just transition project and selecting a target beyond the parties directly involved in the transaction. population or locality for the remediation effort. Even when These challenges hamper the spontaneous bottom-up adopting an original interpretation of what just transition growth of just transition finance in the private sector means in practice, that is, one focused on jobs, the concept calling for an enabling framework. Private financial markets still remains framed in very broad and vague terms (for have an essential role to play in reallocating capital in support example, “decent work” and “quality jobs”). Given that all of the just transition. However, their primary role is to reflect economic activities have socially beneficial effects, such the underlying conditions of the real economy. Thus, it would as job creation, almost anything could be considered a just be unrealistic to expect them to induce a just transition in the transition project. Moreover, the magnitude of the impact absence of adequate environmental and social policy making would depend on the time horizon over which one expects in the real economy (Claessens, Tarashev, and Borio 2022). the effects to materialize. While this principle is valid for the energy transition in general, y A related challenge is the absence of tested indicators to it is all the more important for the just energy transition. This quantify and measure the effects of the energy transition, is because mobilizing private finance for the energy transition especially since some are qualitative and reflect abstract requires addressing market failures, whereas leveraging social norms of justice. This becomes a major hindrance private investment for the just transition essentially involves when there are trade-offs between conflicting objectives finding ways to multiply the limited fiscal resources for a (or between objectives applying to different time frames) public policy objective. Both climate finance and just transition that require balancing one against another and arriving at finance need an enabling framework, but the goals and tools an estimate of net impact. The dearth of reliable indicators for each are very different. Therefore, the government has a of impact creates scope for social washing—the practice of pivotal role to play in signaling to the private sector the desired making misleading or exaggerated statements about the action and outcomes related to funding the just transition. An positive social impact of certain economic activities—which overarching policy framework that provides clarity and a sense could undermine the credibility of just transition initiatives of social priorities as well as adequate public funding and the (Marsh 2020). right set of incentives, is needed. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 13 3. 14 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION >>> Toward an Enabling Framework for Just Transition Finance With the exception of the EU, no policy makers in any major jurisdiction have made a systematic attempt to develop an enabling environment for just transition finance. Most national policy initiatives have so far been narrowly targeted to coal mining or fossil fuel-based energy generation and used mainly fiscal instruments to rectify the impacts.11 They do not include any policy dimension specific to the financial sector and do not involve financial policy or regulation. As such, although they provide a signal of government intentions and priorities, they are not directly relevant to just transition finance. In truth, research and experience on interventions to mobilize and deploy just transition finance remain nascent and highly embryonic. No body of evidence exists to inform policy choices or assess the effectiveness of different approaches to support such finance flows. Any attempt to design a policy framework should be seen as an experimental iterative process. The knowledge and experience of building an enabling environment for climate finance could provide templates and pathways for just transition finance. To facilitate just transition finance flows, an enabling environment must be created in the same way as it has been and continues to be for climate finance. This entails, among others, defining what constitutes a just transition project, which metrics to be used and how to measure them, what information to disclose and report, as well as taxonomies, labeling, and standards. In particular, first iterations of developing a conducive policy framework for just transition finance can be situated within current understandings of ESG approaches. However, it would be a mistake to see just transition finance simply as an extension of climate finance (table 1). There is a fundamental difference between the energy transition and the just energy transition. The former is science-based. The extent to which an investment or activity contributes to decarbonization can, in principle, be assessed on the basis of objective, measurable criteria, notably the reduction in GHG emissions (although in practice this assessment can be complicated due to methodological or data issues). Assessing the extent to which an investment or an activity contributes to a just energy transition, on the other hand, is a subjective undertaking, involving fundamental choices of the target group for the remediation effort and on the time horizon—which is likely to be longer than that for most financial decisions. No objective yardsticks exist for making these judgments. Therefore, any enabling environment for just transition finance should be part of a broader, internally consistent just transition policy framework. 11 For a review of country studies, see Briggs and Mey 2020; OECD 2021; European Commission 2021; Presidential Climate Commission 2022; and The Presidency of South Africa 2022. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 15 Since it reflects social norms of fairness or justice, the context-dependent and vary across countries and over time just transition is fundamentally a political project, not (McCauley and Heffron 2018). The transition to a low-carbon one that can—or should—be delegated to regulatory economy is a long process of technological, economic, and agencies. These norms include procedural justice to ensure a social change that will involve costs and trade-offs. Ensuring transparent and inclusive decision-making process for energy the consequences of the transition are consistent with social transition policies; distributive justice to share fairly the costs norms of fairness should be mediated through the political and opportunities of the transition; and restorative justice process. Establishing a just transition policy framework is, to ensure that past, present, and future negative impacts therefore, the responsibility of governments. of the transition are properly rectified. These norms are TABLE 1 - Differences between climate finance and just transition finance CLIMATE FINANCE JUST TRANSITION FINANCE Global taxonomies in place that help identify Definition No agreed definition and no taxonomy. qualifying investments. Management of social and economic Goal Transition to a low-carbon or net-zero economy. implications of climate transition actions. Mandatory and voluntary environment, social, No consensus on indicators, measurement, Measurement and governance disclosures; or disclosure requirements. globally converging principles and toolkits. Project Typically, big infrastructure projects, with high Often local or regional projects, community- characteristics replicability; new value chain development. level infrastructure, and smaller ticket prices. Well-established, formal, often listed Often nontraditional participants with limited Parties to the companies, medium and large enterprises with or no commercial or technology track records transaction solid commercial and technology track records. and limited financial literacy. Highly constrained skills base, high technical High level of skills; limited (if any) need Project skills assistance requirement, and input early in for technical assistance. project process. Business Traditional. Novel. models Source: Adapted from Lowitt (2021). 16 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION As a first iteration, a just transition finance policy framework y Mobilization. This includes removing any legal or regulatory should have three interrelated and mutually reinforcing pillars. obstacles to the development of innovative financial instruments that support the just transition; finding ways to 1. Hierarchy of priorities. A system for determining a broadly increase the private returns of just transition investments accepted and relatively stable hierarchy of economic or projects, notably through public-private partnerships— activities, sectors, and target groups that is prioritized for (i) including with MDBs—to de-risk investments; and compensation for the negative impacts they suffer from the supporting the development of investable projects by transition to a low-carbon economy, reflecting restorative the private sector in the areas negatively affected by the justice considerations; and (ii) financial support because climate transition. they contribute directly to a more equitable sharing of the costs and opportunities from the transition, reflecting Policy interventions in all three pillars should be distributive justice. coherent and coordinated. Initiatives under the third pillar (financial flows enablers), such as efforts to improve the data 2. Fiscal transfer. A mechanism to allocate public funds in and information infrastructure, identify investable projects, a time-consistent manner in line with the economic and establish de-risking mechanisms, or mobilize MDB financing, social priorities. As the experience with just transition must focus on the priority sectors or groups identified under policy initiatives thus far shows, their time horizon extends the first pillar (hierarchy of priorities) and complement any well beyond the budget cycle and even the electoral cycle. support measure under the second pillar (fiscal transfer). To be effective and credible, a just transition finance policy Uncoordinated initiatives with conflicting priorities across the framework would need to incorporate safeguards to ensure three pillars are not only likely to be less effective, but also that the necessary public resources would be available for risk undermining the political support for the just transition the duration of the just transition programs. project. For the same reasons, a policy framework that 3. Financial flows enablers. A set of instruments or policy narrowly focuses on financial enablers only—the third pillar— interventions to facilitate private financial flows to activities is doomed to fail. or projects that are deemed to contribute to a more just Policy makers should be aware of the risks and transition, which would also ideally incorporate procedural unintended consequences of their actions. This justice considerations. Since different jurisdictions have awareness is particularly important for central banks and different needs, degrees of financial development, financial regulators that will face increasing pressure to take institutional arrangements, and political and regulatory on additional responsibilities for ensuring the just transition. traditions, there is no general formula. The policy However, the tools at their disposal are not necessarily interventions should be tailored to the characteristics of effective for this purpose, and attempting to use them to each individual jurisdiction. promote the just transition would pose difficult operational Interventions under the third pillar fall into three broad trade-offs with their other policy goals. In addition, since the categories reflecting the channels through which financial just transition is not part of their legal mandate, adopting it markets can deliver on the just transition.12 as a goal risks undermining their independence. Ultimately, the biggest risk is lack of policy coordination. If central banks y Reporting. This encompasses initiatives and policies that and financial regulators move ahead on their own to support classify sustainable activities and encourage and facilitate the just transition—a fundamentally political goal—without the collection and dissemination of information regarding a framework and a clear sense of priorities provided by the the employment or social impact of climate transition government, their efforts would not only prove fruitless, but policies (and, more broadly, economic activities). To be could also trigger a backlash, potentially compromising their effective, these policies require the availability of data on ability to achieve their other policy goals. employment and social impact. y Risk management. This involves identifying and encouraging financial firms to integrate just transition- related risks into their business decisions. However, given the nature of the just transition, these risks are very hard to define and measure. 12 For example, see Carney 2021 and NGFS 2021. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 17 4. 18 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION >>> Case Study: The EU Just Transition Framework The EU is more advanced than other major jurisdictions in putting in place a policy framework for the just transition. The just transition is a defining principle of the European Green Deal, EU’s growth strategy, which emphasizes the transition to a climate neutral and circular economy must be just and inclusive, paying attention to the regions, industries, and workers most affected (European Commission 2019a). Although it is still work in progress, the emerging framework is the most comprehensive to date. It incorporates a system for determining just transition priorities delegated to national governments; a mechanism for funding projects that combines fiscal resources with blended finance instruments; and several initiatives that, directly or indirectly, contribute to better disclosure, improved risk management, and capital mobilization for the just transition. One of the key instruments for delivering a just transition in the EU is the JTM. It was set up as part of the European Green Deal Investment Plan—the investment pillar of the European Green Deal—to deliver on the ambition of leaving no one behind (European Commission 2019b). It aims to support those regions most affected by the energy transition through financing and technical assistance. Specifically, it seeks to ensure the retraining of workers directly affected by the foreseeable cessation of high-carbon-emitting activities and to enable the economic revitalization of territories impacted. By doing so, the JTM is by design meant to crowd in private capital. It is complemented by policies and initiatives that, while not directly related to the just transition agenda, may in practice be instrumental to achieving its objectives. Can the emerging EU policy framework effectively contribute to mobilizing private capital for the just transition? While this is fundamentally an empirical question, it may be helpful to assess EU initiatives in relation to the three pillars of the just transition policy framework presented in section III, that is: (i) a system for determining a hierarchy of economic activities, sectors, and target groups that are prioritized; (ii) a mechanism to allocate public funds in a time- consistent manner in line with the economic and social priorities; and (iii) a set of instruments or policy interventions to facilitate private financial flows to activities or projects that are deemed to contribute to a more just transition. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 19 HI E R ARC HY OF PRIORIT IES The system for determining just transition priorities in the agenda. A key challenge includes the very broad scope of EU is delegated, within certain parameters, to member activities that can be supported, spanning social support, states through national Territorial Just Transition Plans economic revitalization, and land restoration.13 It could (TJTPs). A key legal instrument in the EU just transition policy complicate the prioritization of projects. Another challenge is framework is Regulation (EU) 2021/1056 establishing the Just that not all member states have aligned their climate transition Transition Fund (EU 2021). It identifies both the target group targets with the EU’s goal to phase out coal by 2030, including (citizens and companies) and the activities and projects that some of the largest potential recipients of support under the can be supported (social support, economic revitalization, and JTM. The criteria for determining the most vulnerable regions land restoration). Crucially, it delegates to member states the in each country are largely qualitative. Eligible sectors are identification of the territories most negatively affected by the loosely defined as declining sectors (those “expected to social and economic effects of the climate transition. This is cease or significantly scale down their activities related to done through TJTPs, which outline for each of the territories the transition”) and transforming sectors (those “expected to identified the specific actions to be undertaken on the basis of undergo a transformation of their activities, processes and a template to ensure alignment with their national energy and outputs”). While the final list of eligible target groups was climate plans and with the EU climate neutrality goal. determined by budget constraints and political negotiations, it will have an impact on which regions and sectors are The current hierarchy of priorities is very ambitious, which prioritized over others. might affect the implementation of the just transition F I S CAL TR A NSFER The key fiscal transfer mechanism of the EU just transition Fiscal resources may be spread too thinly given the policy framework is the Just Transition Fund (JTF). With objectives of the just transition agenda. While budget an overall budget of €19.2 over the period 2021–27, the JTF is constraints are binding, as is the 7-year horizon of the EU the primary budgetary tool to support the just transition in the budgetary cycle, there is a sense that the size of the JTF may EU. It aims to provide primarily grants, among other things, to be too small given its wide scope and ambition. In truth, in the support workers to develop skills and competences for the job absence of objectively difficult estimates of the funding needs market of the future and help SMEs, start-ups, and incubators for the just transition, it is hard to substantiate this statement. create new economic opportunities in the regions affected. However, a summary comparative analysis with just transition The JTF is implemented under shared management rules, policies implemented in other jurisdictions shows that providing which implies close cooperation with national, regional, and an adequate amount of social support (for example, retraining local authorities. The allocation criteria are based on industrial workers) to the most affected citizens will already absorb emissions in regions with high carbon intensities, employment most, if not all, of the funds devoted to the JTF (Cameron in industry and in coal and lignite mining, production of et al. 2020). This is all the more evident when one contrasts peat and oil shale, and the level of economic development. JTF-eligible territories with other potential regions “at risk” Member states that have not yet committed to implementing proxied by the relative share of employment in sectors that are the objective of achieving climate neutrality by 2050 will only expected to decline and in sectors that will have to transform be awarded 50 percent of their planned allocation. They are (figure 1). The relatively small size of the JTM strengthens the expected to co-finance projects under the JTF, with a share case for mobilizing private capital at scale. between 15 percent and 50 percent depending on the region in which the projects are located. Finally, member states can complement their JTF allocation with the resources allocated under the European Regional Development Fund and the European Social Fund Plus. 13 The issue of the broad scope of the JTF had been raised after the European Commission unveiled its proposal for the JTM in January 2020. It was maintained in the final package, though JTF resources were increased from the initial proposal (Cameron et al. 2020). 20 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION FIGURE 1 - Regional exposures to declining and transforming industries a. Territories eligible for the JTF b. Employment in sectors expected to decline Share of total emplyment in sectors expected to decline ˂0.1 0.1 – 0.5 0.5 – 1 1–2 ˃2 c. Employment in sectors expected to transform d. Employment in automotive manufacturing Share of total emplyment Share of total emplyment in sectors expected to transform in automotive sector ˂0.1 0 – 0.1 0.1 – 1 0.1 – 1 1 – 2.5 1 – 2.5 2.5 – 5 2.5 – 5 ˃5 5 – 100 Engine manufacturing plants Sources: Cameron et al. 2020; EPRS 2021. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 21 F I N ANCI AL FLOWS ENABL E RS REPORTING three broad objectives: decent work, adequate living standards and well-being for end-users, and inclusive and Efforts to incorporate social impact considerations sustainable communities (PSF 2022). The proposed social directly in regulations have so far suffered setbacks. taxonomy would classify economic activities based on their “substantial contribution” to each of these objectives while y In early 2022, the European Commission adopted a “doing no significant harm” to any other and would identify proposal for a Corporate Sustainability Due Diligence certain activities as always “socially harmful.” The report Directive (CSDD). The aim of the CSDD is to foster outlined three different types of substantial contribution: sustainable and responsible corporate behavior and to maximizing positive impact, minimizing negative impact, anchor human rights and environmental considerations in and enabling other activities to provide social benefits. company operations and corporate governance (European At the same time, the report acknowledged several Commission 2022). The proposed rules, which would apply challenges: (i) distinguishing the substantial contribution to large EU-based companies (that is, 500 or more of an economic activity to these three objectives from employees or more than €150 million in global turnover), the inherent social benefits generated by all economic would require businesses to identify and prevent or mitigate activities is conceptually hard and context-dependent; activities, such as child labor, worker exploitation, or (ii) quantifying this contribution is even harder; (iii) some damage to natural ecosystems, in their supply chains types of “significant contribution” are best assessed at the inside or outside Europe. Victims of damage would be product or activity level, while others can only be assessed empowered to take legal action if abuses were uncovered at the entity level; and (iv) to assess impacts, the proposed that had not been reported by businesses. During taxonomy would have to define target populations negotiations at the European Council, however, some (such as youth, farmers, and the unemployed) or target member countries objected to financial firms being included geographies, which would introduce an additional layer of in these rules on the grounds that they do not have supply complexity and political negotiation. In addition, given the chains in the same sense as companies producing physical political sensitivities, the proposal shied away from naming goods.14 This objection was criticized by campaigners who socially harmful activities. More broadly, the proposal left claimed that it would allow large banks and fund managers unclear how to reconcile national legislation and political to continue financing fossil fuel or mining projects without traditions (for instance, regarding the role of trade unions) scrutinizing the environmental damage or social issues in member states with an EU-wide social taxonomy. they might cause. However, a recent position by the Unlike an environmental taxonomy, which is at least partly European Parliament voted on June 1, 2023, which among science-based, a social taxonomy would reflect social others introduced a new requirement for companies to norms and political preferences, which vary significantly adopt and implement climate transition plans, extends the across member states. Likely reflecting these pitfalls, the coverage to financial services providers, such as asset European Commission appears to have shelved the PSF managers and other investors, while the European proposal for the near future (Ainger and Arons 2022). Council’s position left the decision to include these companies up to member states. However, the combination of the EU’s sustainability taxonomy and corporate disclosure requirements could y The European Commission asked the Platform on be seen as moving toward a more expansive definition Sustainable Finance (PSF), an advisory body established of sustainability that might include just transition under the Taxonomy Regulation, to prepare a proposal considerations. It should be stressed, however, that this is a for a possible social taxonomy. The PSF report laid out matter of interpretation not yet tested in practice. 14 The desire to attract financial business from the United Kingdom post-Brexit may have played a role in this decision (Hancock 2022). 22 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION y In response to the shortcomings of the multiple and These initiatives come on top of international efforts inconsistent voluntary taxonomies developed internationally, to harmonize sustainability disclosure rules that may the EU to date is one of only two major jurisdictions to have eventually include explicit just transition considerations. introduced a statutory ESG taxonomy; the other is China. At COP26, the International Financial Reporting Standards It is the Framework to Facilitate Sustainable Investment— (IFRS) Foundation announced the formation of an International the so-called Taxonomy Regulation, Regulation (EU) Sustainability Standards Board (ISSB). It is meant to build on 2020/852—that establishes an EU-wide classification the work of existing investor-focused reporting initiatives— system intended to identify which economic activities including the Climate Disclosure Standards Board (CDSB), the can be considered environmentally sustainable. Under Task Force on Financial Disclosures, the IFRS Foundation’s this regulation, to qualify as environmentally sustainable, Integrated Reporting Framework and Sustainability Accounting an activity must make a substantial contribution to at Standards Board (SASB) Standards (commonly called SASB least one of six environmental objectives while doing Standards), and the World Economic Forum’s Stakeholder “no significant harm” to any other and meeting certain Capitalism Metrics—to become the global standard-setter “minimum standards.” These standards explicitly include for sustainability disclosures for financial markets (IFRS the UNGPs and the guidelines of the Organisation for Foundation 2021). Economic Co-operation and Development (OECD) for In March 2022, the ISSB launched a public consultation multinational enterprises (MNE) on responsible business on a set of proposed standards on general sustainability- conduct (RBC). Although the Taxonomy Regulation does related disclosure requirements and climate-related not explicitly mention the just transition, this could arguably disclosure requirements, following which it will finalize provide an entry point for just transition considerations to and endorse them. Importantly, in December 2022, the ISSB be taken into account in the classifications. decided to explore incremental enhancements to the Climate- y In a separate initiative in 2019, the European Commission related Disclosures Standard (IFRS S2), including those issued nonbinding guidelines to help EU-based companies relating to the just transition. As the Group of 20 has welcomed comply with the Non-Financial Reporting Directive (NFRD) this initiative, the ISSB looks likely to yield eventually a broadly 2014/95/EU. These guidelines incorporate the principle of accepted disclosure standard. “double materiality,” which requires companies to disclose through climate transition plans not only how ESG factors RISK MANAGEMENT impact their economic and financial activities (“outside-in”), but also how their activities impact ESG factors, which Just transition-related risks can be potentially material could, in turn, become financially material (“inside-out”). for EU financial firms (box 1). However, given the nature This inside-out perspective could be seen as an indirect of the just transition, these risks are very hard to define and way to require companies, including financial firms, to measure. Arguably, just transition-related risks fall under the start considering the social impact of their climate-related broader category of social risk, as defined above. Of the three activities. channels through which social risk could translate into losses for financial firms,15 only reputational risk and operational risk y Building on these guidelines in 2022, the EU introduced related to litigation and liability risks are potentially relevant, the Corporate Sustainability Reporting Directive (CSRD). especially in the EU where “soft law” standards such as the The CSRD expands the scope of the NFRD to all listed UNGPs or the OECD’s guidelines for MNEs on RBC are companies, including SMEs, and introduces mandatory codified into “hard law” (like the Taxonomy Regulation). EU sustainability reporting standards for ESG aspects that are being worked out by the European Financial It should be noted, however, that the effects of liability Reporting Advisory Group. The CSRD also further clarifies and litigation risks are ambiguous. They may incentivize the obligation to report according to the double materiality greater compliance with these commitments and norms or, perspective. The rules introduced by the NFRD remain in conversely, dissuade financial firms from subscribing to them force until companies have to apply the new rules of the (Morris, Bryan, and Walker 2022). These challenges related CSRD. to identification and quantification may help explain why 15 These channels include social inequality, political pressures to delay or dilute the transition, and litigation and liability risks. See discussions in Wood 2016; Cort, Park, and Nascimento 2022; Robins 2020; Monnin and Robins 2022; and Clifford Chance 2021. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 23 > > > BOX 1 - Potential just transition-related risks in the portfolios of Polish banks The just transition poses significant challenges for European Union (EU) member states, especially those with economies heavily reliant on fossil fuels and high-carbon activities. Poland serves as an example, as a significant part of its economy is exposed to climate transition risk compared to other EU countries. Declining sectors in Poland, such as coal mining and fossil fuel-based energy production, need to shrink to align with the national energy transition goals, potentially leading to the realization of carbon stranded assets. On the other hand, transforming activities, like the manufacturing of electric vehicles and low-carbon cement, require technological advancements. The concentration of declining and transforming activities in specific geographical areas introduces economic and financial risks for Polish banks that have invested in these sectors. The exposure of Polish banks to districts that are beneficiaries of Just Transition Fund (JTF) support represented 11.4 percent of total credit to the economy as of 2022Q3. Less than one-fourth of this, or 2.7 percent of total credit to the economy, was allocated to high-carbon sectors and activities, while outstanding credit to coal mining activities accounted for only 0.1 percent of the total (particularly concentrated in the district of Katowice, Silesia). At the same time, aggregate exposure of Polish banks to high-carbon sectors and activities in just transition- relevant districts (that is, those where the fraction of credit to high-carbon sector and activities is in the top quartile of the regional distribution) currently not included in the TJTPs, accounted for 13.8 of total credit. Credit to high- carbon sectors and activities located in those districts amounted to 4.7 percent of the total, which is higher than the corresponding figure for districts that are beneficiaries of JTF support. However, credit to activities in coal mining located in these districts was almost absent. These figures are illustrative only and may overestimate exposure to just transition-related risks, given that they include exposure to high-carbon sectors and activities that may not be relevant in the spatial dimension (that is, in terms of concentration of economic activity and employment at the district level) which is a key attribute of the just transition. In addition, these exposures are aggregated at the level of the banking sector, while the risk of individual banks may differ. Source: Battiston, Calice, and Monasterolo, forthcoming-a. EU financial regulatory authorities so far have held off on well as litigation and liability risks. While it is far from a “just hardwiring just transition-related risks in regulation and limited transition regulation,” this step could be seen as an indirect themselves to raising awareness among financial firms of the way to introduce just transition considerations in banks’ risk potential employment or social impact of their decisions and management. issuing guidance to that effect. Things may change in the future, with the EU setting out The European Central Bank (ECB) may be cautiously binding requirements for how EU financial institutions moving toward reflecting just transition elements in its manage ESG risks. The legislative process around the supervisory guidance. Like some other major central banks, EU Banking Package is now entering its final stages. While the ECB has issued supervisory expectations on climate- the primary aim of the package is to implement the Basel related and environmental risks for banks (ECB 2020). One III framework, the proposals for revisions to the Capital of them (expectation 7.5), advises banks to take into account Requirements Directive (CRD) and Capital Requirements the OECD guidelines for MNEs on RBC in their due diligence Regulation (CRR), known collectively as CRD6/CRR3, assessment of clients in order to reduce reputational as include ESG provisions not present in the Basel III text that 24 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION change the nature of ESG risk management for EU banks, firms may be able to leverage existing processes and including for social risk. It might also extend to just transition capabilities, but they will need to ensure that, as for climate considerations, though this is mostly speculative at this stage. risks, they are developing the internal expertise and data gathering capabilities to include broader ESG risks in their y CRD6 is expected to introduce new mandatory requirements risk identification, measurement, and mitigation processes. for banks to develop transition plans. These are already embedded in several pieces of EU legislation, namely the CSDD and the CSRD, but are neither mandatory nor MOBILIZATION enforceable. Under the proposed framework, financial The need for financing climate transition-related— supervisors will receive new powers to assess and monitor and, more broadly, sustainability-related—projects has the implementation of banks’ transition plans as a part of spurred the development of several innovative capital the Supervisory Review and Evaluation Process (SREP). market instruments. Most of them are debt instruments, y CRD6 revisions introduce explicit rules on the management some of which could be adapted for financing just transition and supervision of ESG risks. While these are broadly projects. While the size of this market is still relatively small, in line with recommendations set out by the European it is growing rapidly. Global issuance of sustainable debt Banking Authority (EBA) in a 2021 report (EBA 2021), the instruments exceeded US$1 trillion in 2021 (compared to details will be included in forthcoming guidelines for risk global bond issuance in the same year of more than US$9 management, internal stress testing, and the integration trillion) before falling slightly to US$0.9 trillion in 2022 reflecting of ESG risks into the SREP that the EBA is planning to the headwinds facing the global fixed income market (Michetti issue by end-2023. The EBA’s guidelines are likely to be et al. 2023). The EU accounted for more than 40 percent broadly consistent with existing ECB guidelines and Basel of the overall market. Over half of these sustainable debt Committee on Banking Supervision principles. Financial instruments are green bonds (figure 2). FIGURE 2 - Sustainable debt market 1200 Green Social Sustainability 1000 SLB Transition 800 USD Billions 600 400 200 0 <2015 2016 2017 2018 2019 2020 2021 2022 Source: Michetti et al. (2023, 4). MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 25 Social, sustainability, and sustainability-linked (SSSL) y In some cases, KPIs were already achieved (for example, bonds, where the EU is a dominant player, may be well through the selection of backdated indicators by the suited for just transition purposes. However, experience issuer), and the benefits of issuing SSSL bonds were so far has revealed obstacles that limit the scope for scaling limited, leading to accusations of social washing. these instruments. y Last but not least, their impressive growth notwithstanding, y Given the greater flexibility on the use of proceeds compared all sustainability-related and social instruments have a short to traditional green bonds, SSSL bonds can be attractive to track record. Green bonds—the oldest of the sustainable issuers. They can also be attractive to investors, as they bond labels—have existed since 2007, and the rest have provide greater choice of sectors than green bonds. At the histories that stretch back little more than 5 years. These same time, SSSL bonds require issuers to document the instruments are, therefore, children of the post-financial achievement of the desired environmental, sustainability, crisis world, in which yields were extremely low. It remains or social impact through Key Performance Indicators to be seen how they will perform in an environment of (KPIs). The clarity, verifiability, and robustness of KPIs are persistently higher interest rates. thus critical. Given the multitude of different dimensions A different emerging approach to introducing just of impact, KPIs need to be painstakingly designed and transition considerations in financial markets is to set negotiated for every deal. This is often the biggest hurdle up investment vehicles that screen the underlying assets for issuers of and investors in SSSL bonds. In the case of sustainability-linked bonds, in particular, the penalty based on their just transition impact. Box 2 outlines two for failure to achieve KPIs in terms of stepped-up coupon examples. By allowing investors to differentiate between bonds payments is often too modest relative to the issuer’s total based on their just transition characteristics, this approach— which could in theory also be extended to equity instruments— cost of borrowing, reducing the incentive to achieve them aims to increase financial flows toward companies that in their and, therefore, the potential benefits of the instrument. > > > BOX 2 - Just transition-focused private investment fundss The Just Transition for Climate fund, launched by Amundi in 2021 with about CHF 425 million of assets under management, is based on the Bloomberg Barclays Euro Aggregate Corporate index, which includes more than 3,100 European corporate bonds. It aims to maintain a carbon footprint that is 20 percent lower than this benchmark. At the same time, bonds should have an environment, social, and governance rating and a just transition rating that are higher than or equal to E, with A being the highest and G the lowest. Amundi’s just transition score looks at the different social aspects involved in the transition to a low-carbon economy, such as impact on employees, consumers, and local communities. In addition, the fund has a dedicated engagement policy that involves the managers sending an annual letter to companies to encourage them to produce transition plans. The Global Sustainable Transition Bond fund, launched by Ostrum Asset Management (OAM) in September 2022, invests in sovereign or corporate fixed-income instruments that finance projects in renewable energy, green buildings, clean mobility, inclusive development (healthcare, education, decent housing), or ecosystem preservation (circular economy, sustainable use of resources, biodiversity). They must meet three criteria: (i) reducing the issuer’s carbon footprint, (ii) promoting positive social impact, and (iii) protecting ecosystems and local economies. Adherence to these criteria is assessed by OAM at the level of both the issuer and the individual instrument by a proprietary methodology which, OAM claims, allows for a “better assessment of risks and long-term value for our clients.” Sources: Amundi Asset Management 2021; Kirakosian 2021; Leguilloux 2022; EFAMA 2022. 26 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION transition plans are factoring in the employment and social improved risk management practices can support private impact of their activities as well as incentivize more issuers to capital mobilization for the just transition. However, indirect do so. The lack of agreed metrics, however, means that the public finance measures and other forms of support are social impact or just transition rating of each asset or issuer is needed to significantly increase financial flows. The JTM assessed solely by the companies’ in-house analysts on the already includes a set of incentives to that end. basis of proprietary methodologies. As with the various ESG y A dedicated just transition scheme under the InvestEU ratings, the lack of transparency, verifiability, and auditability Program is expected to mobilize up to €10 billion to €15 are inevitable pitfalls of this approach. billion of mostly private investments. The scheme provides There has been less innovation in banking, where a budgetary guarantee across the four policy windows of just transition-related initiatives are still largely at the the InvestEU Program, while an InvestEU Advisory Hub concept stage. These initiatives are voluntary, led mainly acts as a central entry point for advisory support requests. by trade associations, international organizations, or non- Eligible projects are those located in the territories having governmental organizations, and follow in the wake of similar an approved TJTP or projects that benefit those regions, earlier initiatives in climate finance. It is not clear how much provided they are key to the transition of those territories. traction they have had in actual business practice. Two such For instance, infrastructure projects that improve the initiatives, focused specifically on banking, are characteristic connectivity of the just transition regions may be covered. examples. y A public sector loan facility combining €1.5 billion of grants y The Loan Syndications and Trading Association (LSTA), from the EU budget with €10 billion of loans from the together with the Loan Markets Association (LMA) and European Investment Bank, aims to mobilize €18.5 billion the Asia Pacific Loan Markets Association (APLMA), of public investment in energy and transport infrastructure, published a set of voluntary high-level principles for district heating networks, and energy efficiency measures, social loans—the Social Loan Principles (SLPs)—and including renovation of buildings and social infrastructure. the Sustainability-Linked Loan Principles (SLLPs) for These can function as catalyzers for private investment. sustainability-linked loans. They build on the International y The Just Transition Platform, which consists of a single Capital Market Association’s Social Bond Principles access point and help desk, assists member countries (SBPs) and Sustainability-Linked Bond Principles (SLBPs), and affected regions with the just transition. It provides respectively. Like the SBPs and SLBPs, the SLPs and comprehensive technical and advisory support. Authorities SLLPs provide only a high-level framework for social and beneficiaries can access it to find all they need to know and sustainability-linked loans (APLMA, LMA, and LSTA about the funds, including opportunities, relevant regulatory 2023a,b). These principles could provide a template for updates, and sector-specific initiatives. The platform also developing a framework for just transition lending, but it is actively promotes the exchange of best practices among all not clear how widely they are used by banks. stakeholders involved, including through regular physical y The ILO and the Grantham Research Institute for Climate and virtual gatherings. Change and the Environment, which is part of the London MDBs could be more actively leveraged, especially in School of Economics and Political Science, developed Central and Eastern Europe. Support for the just transition a Just Transition Finance Tool for banking and investing is an important priority for many MDBs. In 2021, at the margin (ILO and Grantham Research Institute for Climate of COP26, MDBs issued a joint statement outlining their Change and the Environment 2022). This tool provides commitment to the just transition based on five high-level generic recommendations to banks and asset managers principles (Multilateral Development Banks 2021). The on how to embed the just transition in broad corporate strategies, internal governance, product design, and client principles aim to help guide MDBs’ support for a just transition management. At best, it can be seen as an awareness- and to ensure consistency, credibility, and transparency in their raising pamphlet rather than an operational guidance efforts. Especially in member states with limited resources and document for banks. capacity, MDBs could provide long-term financing bundled with technical support, helping de-risk private investments. They These market developments, which have not been could also support innovative transactions and kickstart new connected with the EU’s just transition framework, are markets. Finally, MDBs could help support the development of not sufficient to mobilize capital at the scale needed. a pipeline of investable projects. Taxonomies, disclosures, and reporting initiatives as well as MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 27 5. 28 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION >>> Key Takeaways An enabling framework is a necessary condition for mobilizing private capital for the just transition. For that to happen, the concept of just transition needs to be interpreted pragmatically in order to operationalize it. This implies a focus on jobs in the regions and industries most affected by the energy transition. Yet it may still be hard to define a just transition project or financial product and to measure its impact. The latter critically depends on the choice of the target group for the remediation effort and on the time horizon. Market mechanisms alone cannot fully incorporate just transition considerations in finance, and an overarching policy framework that provides guidance and aligns incentives is needed. The just transition is essentially a political project. Only sovereign governments have the authority and accountability to put in place a just transition policy framework. This policy note proposes the first iteration of a just transition policy framework centered around three interrelated and mutually reinforcing pillars. y Hierarchy of priorities. A system for determining a hierarchy of priorities for sectors, territories, and social groups that are to be remedied for the negative impacts they suffer from the transition to a low-carbon economy or supported because they contribute directly to a more equitable sharing of the costs and opportunities from the transition. y Fiscal transfer. A mechanism to allocate public funds in a time-consistent manner in line with these priorities. y Financial flows enablers. A set of instruments or policy interventions that promote better disclosure, improved risk management, and capital mobilization to facilitate private financial flows to activities or projects that are deemed to contribute to a more just transition. The EU is more advanced than other major jurisdictions in putting a just transition policy framework in place, but some gaps remain. Assessed against the proposed just transition policy framework, the EU framework presents the following features: y The EU has a clear system to identify territories most negatively affected by the social and economic effects of the climate transition delegated to member states and built around national TJTPs. This allows for tailored actions based on national energy and climate plans. Yet, challenges remain in prioritizing projects because of the broad scope of activities that can be supported and the loose criteria for identifying vulnerable regions and sectors. MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION 29 y There is a clear fiscal transfer mechanism, the JTF, to fund could also be given to defining more objectively regions at just transition projects primarily through grants. Allocation risk and classifying eligible economic sectors according to criteria based on industrial emissions and employment in the Statistical Classification of Economic Activities in the specific sectors ensure targeted support. However, the European Community, commonly referred to as NACE. It JTF’s size may be insufficient given its wide scope and should be noted, however, that a delicate balance is to be objectives, leaving uncovered many regions at risk of struck between narrowing the focus of the JTF to increase serious socioeconomic disruption. its effectiveness on the one hand, and maintaining discretion for national governments in selecting projects y The EU has taken steps to incorporate social impact for inclusion in their TJTPs on the other hand. considerations into regulations. Efforts to create a social taxonomy have faced challenges and have been y Enhancing data collection for social impact temporarily shelved, but the existing sustainability assessment. In contrast to the climate impact of economic Taxonomy Regulation as well as the NFRD and the CSRD activities, which can be quantified by measuring GHG go some way toward indirectly reflecting the social and emissions, measuring their social impact faces significant human impact of the energy transition in classifications and conceptual and analytical difficulties because many of the required disclosures. dimensions of interest are qualitative. Nevertheless, there is room for improvement in the collection and dissemination y The ECB’s supervisory guidance could be seen as requiring of data covering at least certain aspects of social impact, banks to incorporate some aspects of the just transition— notably employment and gender. This could help over time through the OECD guidelines for MNEs on RBC—in their provide greater visibility and a better understanding of the risk management. Forthcoming legislation, namely the negative social and economic effects of climate transition Banking Package, can be a game changer in integrating initiatives and the associated need for remedial action. just transition considerations in financial decision-making. It could also help minimize the risk of social washing by y The EU framework includes blended finance instruments issuers and asset managers. Although data and information that can crowd in private investors and a technical infrastructure is the responsibility of national governments, assistance program that can help with project preparation. consistent standards and guidelines could be developed at However, especially in member countries with limited the EU level. resources and capacity, MDBs could play a more active y Embedding just transition considerations in and complementary role to leverage private finance at sustainability regulations. In the absence of a social scale. taxonomy—which is neither a necessary nor a sufficient The assessment provides key takeaways for consideration condition for the development of just transition finance— by competent authorities to strengthen further the EU emerging sustainability taxonomies and disclosures just transition policy framework going forward. These and reporting standards can bridge the gap. However, focus specifically on measures to enhance the mobilization of they have a much wider aim than the just transition, that finance for the just transition, not for broader environmental or is, to encourage, through the dissemination of better social goals, assuming a binding budget constraint. information, the flow of financial resources toward activities that promote (or do no harm to) certain social goods, such y Narrowing the scope of the JTF for maximum as human rights, environmental sustainability, or quality effectiveness. The JTF’s broad scope is deliberate, of life. While these social goods may be compatible with given the vastly different needs and opportunities for the goal of the just transition, they are much broader and just transition projects across member countries and not specifically targeted to groups or regions impacted by regions. This, however, combined with its relatively small climate transition policies. Attention could, therefore, be size, justifies an old criticism that fiscal resources may given to introducing just transition considerations in the be spread too thinly to make a difference. Therefore, sustainability standards and anchoring them in relevant consideration could be given to narrowing the scope of indicators and metrics (for example, percentages of net eligible activities to social support and/or land restoration. jobs created, workers receiving a living wage, or women This would also signal that economic revitalization projects in the workforce). should be funded by the private sector. Consideration 30 MOBILIZING FINANCE FOR THE JUST ENERGY TRANSITION IN THE EUROPEAN UNION y Providing guidance on assessing just transition- y Encouraging the development of financial instruments related risks. Competent authorities have a role to play for the just transition. This may involve, for example, in sensitizing financial firms to the longer-term social assisting in the definition and compilation of data related impact of their business decisions. Even though this may to social impact; providing training to build skills in the not translate into a quantifiable risk, increased awareness financial industry in the areas of social impact assessment among financial firm managers of these qualitative aspects and measurement, client engagement, and so forth; can minimize reputational risks, potentially leading to encouraging governance changes in financial firms that greater business resilience. Regulators follow a similar help embed a business culture that is more sensitive to the approach in the case of climate-related risks. Even though just transition agenda; establishing regulatory sandboxes, the scenario-based models used to estimate these risks if appropriate, for innovative instruments; or disseminating are not reliable or accurate enough to gauge financial best practices for the design of SSSL bonds. In addition, firms’ capital adequacy or to set capital requirements, policy initiatives unrelated to the just transition, notably they can still be useful by allowing them to envisage long- the Capital Markets Union (CMU) Action Plan, could be term adjustments that may be necessary to their business leveraged from the perspective of developing financial models. In that regard, consideration could be given to instruments for the just transition. For example, certain developing methodologies for assessing potential just elements of the CMU action plan, such as the European transition-related risks in financial firms’ portfolios in line Single Access Point for EU corporates, reforms to the with prioritized regions and sectors. regulatory framework for long-term investment funds, and initiatives to remove tax and other obstacles to cross- y Clarifying supervisory expectations for financial firms. country investments, could be reassessed with a view to Competent authorities could sensitize financial firms to just maximizing their potential contribution to just transition transition-related litigation and liability risk—which is part finance. of operational risk—and provide guidance for calculating operational risk capital (ORC) requirements. It should be y Maximizing the role of MDBs in de-risking just noted, however, that this task is far from straightforward. transition projects. Some just transition projects may Unlike other types of litigation and liability risks, where yield a positive economic return in addition to having social awards to plaintiffs are related to quantifiable economic and environmental benefits, but the risk-return profile losses, plaintiffs’ claims for violations of social norms of may still be insufficiently attractive to private investors. In fairness are essentially arbitrary. And if these claims are such cases, MDBs can play a far greater role in de-risking successful, any court-mandated compensation would just transition investments, complementing available be entirely at the discretion of the court. This makes instruments and mechanisms. MDBs can provide support just transition-related litigation and liability risk and through the creation of blended financing structures to alter the associated ORC requirements extremely hard to the risk-return profile for the just transition, for example, estimate, yet efforts could be made toward developing an by agreeing to be first to endure losses in just transition appropriate assessment methodology. This could also help funding vehicles and securitizations. MDBs can provide financial firms prepare for the forthcoming requirements on technical assistance to help develop projects, improve ESG risk management and supervision that are part of the national and local governments’ institutional capacity, Banking Package. and build the local currency bond markets (including municipal bond markets) to broaden the set of domestic investors. 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