Green Financing: The Key to Japan’s Post-COVID Recovery?

In October 2020, Japan’s ambitious pledge to achieve a carbon neutral society by 2050 garnered widespread praise after years of the nation failing to upgrade carbon reduction goals in line with the 2015 Paris Climate Agreement. This marked the first time a Japanese prime minister has made climate change a top policy priority, but the government’s new decarbonization agenda also attracted criticism for lacking a comprehensive roadmap on how to achieve its goals, which are set 30 years from now. 

Japan had previously made firm emission reduction commitments until 2011, when the Fukushima Nuclear Disaster prompted the shutdown of all nuclear power plants nationwide and threw Japan’s carbon-reduction roadmap into total disarray, with the expansion of fossil fuels in lieu of nuclear energy. In 2019 Japan was accused of being “addicted to coal” by UN Secretary General Antonio Guterras after settling on low climate ambitions and vague timeframes inconsistent with limiting global warming to 1.5 degrees celsius by the end of the century.  

Since announcing the pledge to go carbon neutral, the Suga administration has unveiled a green growth strategy centered around technological innovation in the renewable energy sector. As the world’s fifth largest emitter of carbon dioxide, the government announced plans to boost the renewable energy mix to between 50 to 60 percent by 2050, up from its current target of 22 to 24 percent by 2030. The plan was prompted in part by a rise in the share of renewable energy in the first half of 2020, which grew to 23.1 percent after a dip in fossil fuel consumption as a result of the slowdown in economic activity. 

While Japan has set an ambitious decarbonization agenda it still lacks a comprehensive plan on how to achieve those targets

An economic downturn is a double edged sword in terms of environmental problems. A fall in consumption results in a fall in pollution while also cutting investments in green energy and projects with environmental benefits. Both are short term impacts but regardless, falling oil prices, uncertainty and a decline in company profits threatens to make the development of renewable energy less competitive. 

Under the new green growth strategy the government has put aside $19.2 billion in new funding and tax incentives to foster a much needed technological breakthrough to reduce battery costs. Improving rechargeable battery capacity is crucial if Japan plans to convert solar and wind energy into a stable energy supply. Meanwhile, Japan has pinned its hopes on offshore wind power as the golden ticket to reducing Japan’s greenhouse gas emissions by 2050. Currently Japan operates four offshore wind farms which generate 20 megawatts but wind power capacity is set to expand from an initial target of 10 gigawatts by early 2030 to as high as 45 gigawatts in early 2040 – which would make Japan the world’s third largest generator of wind power. Japan’s aggressive new wind power energy goals will be supported by government funded surveys of wind movements and seabeds in the effort to encourage private sector investment and competition in the budding sector.

Finance forms the backbone of infrastructure development and a transition towards a low carbon economy will need a huge amount of investment by public and private sectors. But green projects face financial challenges as they are small, under-insured, under-guaranteed and carry the risk of default. Green infrastructure is an emerging sector and is essentially undiscovered terrain. As a result, green projects tend to offer a lower rate of return since it requires long term investment to assemble new technologies from scratch, which takes time to make a profit. This makes low carbon projects less appealing in contrast to fossil fuel projects and clashes with traditional banks who carry reserves from deposits that are held for only the short to medium term.

Finance forms the backbone of a low carbon economy but green projects face financial challenges as these emerging sectors are essentially undiscovered terrain

Despite private sector interest in climate related projects meeting emissions targets requires innovation in capital markets. Green bonds are used exclusively to finance clean energy and environment projects and they are rising in popularity as a tool to open up investment flows from the non-bank financial sector. Insurance companies, pension funds and fintech companies are gaining recognition as the glue that fills the green investment gap between public and private sectors. In order to fight climate change on a global level, financial institutions must be enticed to participate in a new class of securities such as green bonds.

With even the wealthiest countries lacking effective crisis management tools to contain the spread of coronavirus, the pandemic is seen as a precursor to the impending climate crisis. Lessons from the 2008 Global Financial Crisis showed that long term investment is needed beyond an economic stimulus package. Analysts predict a green bond frenzy ahead. In September the number of green bonds issued globally peaked at $50 billion following a dip during the beginning of the COVID-19 pandemic which accrued in total $200 billion in 2020. The EU’s pandemic recovery package made history as the world’s largest long term green economic stimulus devoting 750 billion euros ($826.3 billion) towards combating climate change. The EU has taken the lead in pledging a 55 percent emissions cut by 2030 and 225 billion euros ($267 billion) in green bonds which is the equivalent of all securities sold globally last year. 

Japan’s bond market represents 12 percent of the global market share and in 2019 the market for green bonds expanded 24 times over a five year period. In Japan several financial institutions have issued green bonds. In June chemical company Asahi Kasei issued green bonds for hydroelectric power generation as well as Toyota Motor Credit in February, Asahi Group Holdings in October and Mitsubishi Heavy Industries to promote wind power generation in November. Yet these markets remain underdeveloped and green bonds represent a fraction of the overall debt market reaching a total issuance record of $1 trillion in a $100 trillion market.

Green bonds represent a fraction of the debt market, reaching a total issuance record of $1 trillion in a $100 trillion market

Green investment driven entirely by public funds is unrealistic but as many countries set carbon neutral goals, a growing number of investors want to know how their money is being managed. The only difference between bonds and their green counterparts is the green label. But in the last decade there have been incidents of ‘greenwashing’ in which some green bonds have posed as environmentally friendly projects in name only. The risk of greenwashing has investors looking beyond green bond labels towards institutional compatibility with green project values. More investment is expected to bring down yields and push up prices, reducing the cost burden on borrowers but this depends on promoting the integrity of the burgeoning green bond market. 

Currently the way bond issuers define green and the environmental scope for green bonds lack consistency. The widely recognized and non-binding Green Bond Principles (GBPs) is a global initiative that was launched in 2014 by the International Capital Market Association (ICMA) in an effort to clarify an approach for issuing green bonds and facilitate transparency on project selection and provide accessible information about the risks and rate of return. The separation between green investors and regular investors is not clear cut but a green rating system on a firm level that ranks large carbon emitting firms on their Environment Social and Government (ESG) assets could serve as an incentive to reduce investors’ carbon footprint.  

Japan’s Ministry of Environment also issued good practice green bond guidelines in 2017, tailored to the Japanese green bond market. It not only represents a tick of approval and the go-ahead for financial institutions to consider diversifying their bond portfolio but also aims to develop a green bond market that prevents greenwashing and upholds market integrity. The 2017 guidelines are largely principle-based and do not contain strict eligibility criteria or thresholds. The 2020 revised version was expanded to include not just green bonds but also green loans in which financing conditions are reviewed in line with the progress of the borrower on pre-determined Sustainability Performance Targets (SPTs). In addition, the Tokyo Stock Exchange released a handbook to help publicly listed firms identify, track and disclose ESG assets. 

The Bank of Japan (BOJ) also has a role to play in scaling up investments for environmentally friendly projects. But the BOJ is reluctant to take on green bonds, having spent seven years failing to achieve its main inflation target of two percent. There are growing calls for the BOJ to draw up guidelines that incorporate climate risk integration and ESG factors which would give a nod of approval to private banks to take the leap into the green bond and sustainable finance market. 

A massive shift in the allocation of finance capital is needed to meet Japan’s target of raising the share of renewable energy to between 50 and 60 percent. In theory, green bonds are an effective financial instrument but more practical examples and safeguards are needed to help classify environmentally sustainable economic activities and eligible green projects. This would give financial institutions the reassurance needed to steer investment toward climate adaptation projects by the private sector. 

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Thisanka Siripala is a Sri Lankan-Australian translator and broadcast journalist based in Tokyo. She specializes in Japan focused business, tech and social issues and is passionate about documenting Japan in depth for English speaking audiences.

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