BOJ Meeting on the Third Market Functioning Survey concerning Climate Change

Yesterday, the Bank of Japan held a meeting on the results of the third Market Functioning Survey concerning Climate Change. As is customary, the Bank led with explanatory material, followed by a Q&A session.

1. Recent Trends in Climate Change Finance

1.1. ESG Bond Market

• The outstanding amount and issuance amount of ESG bonds related to climate change have reached record highs in the Japanese corporate bond market.
• While the number of issuers of ESG bonds has also been increasing, the pace is slower compared to the growth in outstanding amount.
• Looking at the issuance by type in 2023, green bonds continue to be the dominant type. While large-scale issuance cases were observed, there were variations among types, with a decrease in the issuance of transition bonds, which had significantly increased in 2022.

1.2. Transition Finance

• There are concerns that the “green” scope of “green finance” is excessively limited to projects that can achieve net-zero emissions in the short term, making it difficult for carbon-intensive industries to secure necessary funding.
• “Transition finance” has been proposed as a framework to provide funding to sectors that face challenges in immediately decarbonizing. Both public and private sector initiatives are underway, including the issuance of transition bonds by private entities and the world’s first sovereign transition bond issuance in February 2024.
• International discussions on transition finance are also expanding. The 2022 G20 Sustainable Finance Report highlights two main approaches: (1) incorporating transition elements into the existing taxonomy and (2) establishing high-level guidelines. Furthermore, an ICMA report (2024) recognizes Japan as a frontrunner in issuing transition bonds by both the public and private sectors, drawing global attention to Japan’s initiatives.

1.3. Disclosure of Climate-Related Information

• Disclosure of climate-related information has primarily been based on the TCFD recommendations, which are voluntary.
• In June 2023, the ISSB standards, which include Scope 3 disclosure and promote international comparability, were finalized.
• In Japan, discussions are underway to incorporate domestic standards based on the ISSB standards into mandatory disclosure.

2. Outline of the “Survey on Market Functioning Related to Climate Change”

2.1. Objective of the Survey

• To continuously grasp the views of a wide range of market participants, including investors, financial institutions, and corporations, regarding the current state and challenges for the improvement of climate change-related market functions in Japan.

2.2. Background

• July 2021: Publication of “The Bank of Japan’s Approaches to Addressing Climate Change”.
• April 2022: Commencement of the First Survey (Survey results published: August 5).
• October 2022: Large-scale briefing session on the First Survey results (Approximately 150 participants).
• February 2023: Commencement of the Second Survey (Survey results published: July 7).
• August 2023: Large-scale briefing session on the Second Survey results (Approximately 150 participants).
• February 2024: Commencement of the Third Survey (Survey period: February 15 — March 29).

2.3. Survey Items

Reflection of Climate-Related Risks and Opportunities in Financial Asset Prices:

• Degree of reflection of climate-related risks and opportunities in stock and corporate bond prices.
• Factors that are not reflected as risks or opportunities.
• Challenges for promoting reflection.

Current Status of ESG Bond Market Related to Climate Change:

• Issuance and investment performance in the past and in the past year.
• Reasons for issuing or investing, and for not issuing or investing.
• Supply and demand for ESG bonds, supply and demand compared to general corporate bonds, and differences in issuance conditions (interest rates, lot sizes, maturities).

Future of the ESG Bond Market and Challenges:

• Stance on climate change finance in the medium to long term (until around 2030).
• Stance on transition finance and challenges in smoothly promoting it.
• Challenges related to information disclosure (questions were revised in light of the progress towards the incorporation of domestic standards into mandatory disclosure).
• Challenges for market expansion.

3. Key Findings of the Third Survey

3.1. Reflection of Climate-Related Risks and Opportunities in Financial Asset Prices

• Slightly more than 50% of respondents believe that climate-related risks and opportunities are reflected in stock prices, and slightly more than 40% believe they are reflected in corporate bond prices. However, only a few percent believe that these factors are fully reflected.
• The most commonly cited factor that is not reflected in prices is “physical risks” (more than half of respondents), followed by “transition risks” and “climate-related opportunities.” More respondents believe that these factors are not reflected in corporate bond prices than in stock prices.
• Compared to the previous survey (based on responses from entities that responded to both surveys), the incorporation of climate-related risks and opportunities into corporate bond prices has progressed somewhat.
• The most frequently cited factors necessary for further reflecting climate-related risks and opportunities in prices were “expansion and standardization of information disclosure,” “increase in issuers and investors who prioritize climate-related risks and opportunities,” and “improvement in the transparency of ESG assessments.” Compared to the previous survey, the percentage of respondents citing “improvement in the transparency of ESG assessments” decreased slightly.

3.2. Current Status of the ESG Bond Market Related to Climate Change

• The percentage of respondents with experience in issuing or investing in ESG bonds increased slightly compared to the previous survey. However, the proportion of entities with issuance experience remains low compared to those with investment experience, mainly concentrated in financial institutions.
• The most common reasons for not issuing ESG bonds were “lack of funding needs” and “lack of suitable projects.” This suggests that industries with well-established environmental certification for buildings, such as the real estate sector, may find it easier to structure projects and utilize ESG bonds. Additionally, many respondents cited that “domestic alternative financing methods offer more favorable conditions.”
• Regarding the issuance conditions of ESG bonds compared to general corporate bonds, more than half of respondents stated that ESG bonds offer advantages, primarily in terms of interest rates. However, a considerable number of respondents (over 40%) did not perceive any advantages.
• Regarding the supply and demand for ESG bonds, slightly less than 70% of respondents answered that the market is “generally balanced.” The percentage of respondents who answered “somewhat tight to tight” was higher among financial institutions compared to non-financial corporations. Compared to the previous survey (based on responses from entities that responded to both surveys), the percentage of respondents who answered “somewhat tight to tight” decreased slightly across all industries.

3.3. Future of the ESG Bond Market and Challenges

• Regarding the stance on climate change finance in the medium to long term (until around 2030), more than 50% of non-financial corporations and more than 70% of carbon-intensive industries responded that they are “expecting a significant increase in funding needs for climate change initiatives and are considering specific financing methods.” The most frequently selected financing methods were “loans” and “internal funds,” followed by “ESG bonds” (selected by more than 50% of respondents, with nearly half of them being entities without prior ESG bond issuance experience).
• As for the stance of investors (financial institutions) on bond investments in the medium to long term, nearly 60% responded that they “plan to make bond investments.” The most common specific bond investment policy was to “increase ESG bond investments” (approximately 60% of respondents). Approximately 20% of respondents answered that they would “reduce bond investments through negative screening.”
• Regarding the type of ESG bonds, more than 40% of non-financial corporations and more than 50% of financial institutions selected “green bonds” as the type they prioritize. Other types of ESG bonds were also selected by 30–40% of respondents. Both issuers and investors frequently chose to “respond flexibly (depending on the issuance/investment environment)” regarding the specific type of ESG bonds they would focus on.
• Regarding transition finance, while more than 60% of non-financial corporations answered that their policy is “undecided,” nearly 40% of carbon-intensive industries responded that they “plan to utilize it,” indicating progress in their considerations.
• The most frequently cited reasons for utilizing transition finance were “to gain understanding from stakeholders that emission reductions require the use of realistically available technologies” and “because it is a carbon-intensive business model and green finance alone cannot meet the necessary funding.”
• Among financial institutions, while approximately 30% responded that they “have a policy of actively engaging in transition finance,” nearly 30% answered that they are “not currently actively engaged” or “do not plan to engage.” The proportion of life insurance and non-life insurance companies that are “actively engaged” was relatively high.
• The most frequently cited reason for not actively engaging in transition finance at present was “difficulty in assessing risk and return.” Other commonly cited reasons included “concerns about greenwashing” and “insufficient information for making investment decisions such as transition plans.”
• Regarding the factors deemed important for smoothly promoting transition finance, the most common response was “deepening international understanding,” followed by “policy incentives.” Investors who responded that they “have a policy of actively engaging in transition finance” more frequently pointed out the “need to review the targets and calculation methods for financed emissions through international initiatives” compared to other respondents.

3.4. Challenges for the ESG Bond Market

• The challenges for expanding the ESG bond market continued to be “expanding the base of issuers and investors who prioritize climate-related risks and opportunities” and “expanding and standardizing information disclosure,” as well as “improving the transparency of ESG assessments.”
• In the open-ended questions regarding information disclosure, respondents cited various practical challenges encountered in preparing disclosures, including opinions on the scope, level, and provider of third-party assurance, as well as comments on the target entities, timing of implementation, and challenges in simultaneous disclosure of financial and climate-related information, considering the progress made towards incorporating domestic standards into mandatory disclosure.

3.5. Voices from Market Participants on Other Issues and Evaluations (Open-Ended Questions, Excluding Information Disclosure)

Expanding the Base of Issuers and Investors Who Prioritize Climate-Related Risks and Opportunities:

• Appreciation for the increasing number of ESG bond issuances and issuers.
• Highlighting the growing importance of investor engagement in facilitating smooth financing.

Transition Finance:

• Importance of transition finance in ensuring Japan’s competitiveness while addressing climate change.
• Deepening understanding of the concept of transition through various public and private initiatives, including the issuance of sovereign transition bonds.
• Future challenges include developing frameworks to incentivize investors, such as assessment methodologies for financed emissions, and promoting international understanding and rule-setting for international standards.

Other Overseas Trends:

• Concerns about the high cost of complying with overseas disclosure regulations due to extraterritorial application.
• Monitoring the trend of financial institutions in the US and other countries divesting from ESG investments and environmental agreements.

Conclusion

The survey results highlight the progress in the market for climate change-related finance, including the increase in both the issuance and investment of ESG bonds and the growing interest in transition finance. However, challenges remain, such as the need for further expansion of information disclosure, improvement of assessment methodologies, and international harmonization of standards. The Bank of Japan will continue to contribute to the development of a sound market for climate change-related finance by deepening the understanding of market participants through information dissemination and dialogue based on the survey results.

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