While Japan positions itself as a leader in the upscaling of the global transitional finance market, several headwinds threaten to offset the appeal of this market in gaining wide public support. 

After closing the world’s first sovereign transitional finance deal in February 2024, the Japanese government fuelled the momentum by four more transitional bonds in less than eight months, bringing the total issuance in the year to 89 trillion yen ( US$580 billion ).

These transactions come as part of the ambitious push in the Japanese government’s 150-trillion-yen Green Transformation ( GX ) financing programme planned over a 10-year period starting from 2023.

Proceeds from the programme are predominantly allocated to research and development, including 256 billion yen ringfenced for hydrogen energy in the iron and steel sector and 331.6 billion yen targeting battery storage development.

The country has remained at the forefront of the global transitional finance market by working to decarbonize the manufacturing-reliant sector of its economy. And, while the amount of transition finance issuance from Japan, according to data from Nomura, accounted for 68% of global issuance, this market faces financing challenges, particularly in gleaning support from key investors.

Interest in transition finance is hindered by the fact that it involves financing in the hard-to-abate sectors, such as those of oil refining, airlines and shipping. As transition finance sits between grey investment and fully green assets, investors are often cautious about whether the use of proceeds are qualified as green or sustainable. Worse still, investing in transition finance may increase the total financed emission in their investment portfolio.

In the European Union, transition finance, says Takahide Kiuchi, executive economist at Nomura Research Institute, faces harsh criticism under a rigid framework of “either green or not green”. 

“[GX bonds have] received very little interest within the transition bond space despite the large amount of issuance planned,” adds Edward Bourlet, a senior research analyst at CLSA. “The main challenges for transition bonds faced by overseas investors seems to be determining what is regarded as green by overseas taxonomies – transition bonds are broader in their remit – and Japan’s low yields.”

Tepid sentiment on Japan’s transition finance, according to S&P Global, is also reflected in the 2.9 times oversubscription of the first sovereign transition bond, compared with the average of 3.65 times for other regular government bond issuances. Although a second issuance saw improved demand of 3.44 times oversubscription, it still remains below that of a regular issuance of the same tenor arranged at that time.

The latest GX bond issuance in January more than halved the size to 350 billion yen from the 800 billion yen involved in the programme’s first issuance. The programme is seeing an urgent need to broaden its investor base as government entities, including the Bank of Japan and the Government Pension Investment Fund, hold more than half of the outstanding GX bonds.

To help investors gain familiarity with the GX bond programme and the notion of transition finance, Nomura suggests, the Japanese government should enhance the transparency of this kind of financing, which can be achieved through aligning taxonomies with other countries. Other solutions include increasing international engagement paired with more education.

The government is also making notable headway in bringing the GX bond programme to the global stage. Recently, the GX Acceleration Agency added big names from international climate groups to GX bonds’ Global Advisory Council, including CEOs from the International Capital Market Association, Climate Bond Initiatives and the Carbon Disclosure Project.