Tackling Transition-Washing in Climate Finance

As the world grapples with the urgent need to reduce greenhouse gas emissions, climate transition finance has emerged as a crucial mechanism to fund the shift to a low-carbon economy. However, the effectiveness of this tool is threatened by transition-washing, where funds are misallocated to entities that do not genuinely aim to achieve net zero emissions in accordance with a Paris-Agreement-aligned timeframe. Addressing this issue is vital to maintaining (and developing) the credibility and impact of transition finance. 

What is Transition-Washing?

Transition-washing occurs when claims, acts or omissions (including in the context of financial instruments) create an impression that an entity is transitioning its economic or business activities to a state of net zero greenhouse gas emissions to a greater extent or more rapidly than it actually is. This practice undermines the market's ability to allocate capital effectively, leading to a misallocation of resources likely to delay or obstruct the achievement of the Paris Agreement temperature goals.

Root Causes of Transition-Washing

Several factors contribute to the prevalence of transition-washing in labelled transition bond finance:

• Lack of Robust Emissions Reduction Pathways: There is a shortage of scientifically robust, Paris-aligned pathways for carbon-intensive sectors tailored to particular geographies and sectors.

• Benchmarking Gap: Firms are not required to benchmark their transition strategies against specific Paris-aligned standards or pathways as part of the process of issuing instruments bearing transition finance labels.

• Counterproductive Incentives: Due to a split in investor / stakeholder preferences, firms are financially and reputationally incentivised to raise labelled transition finance, even where they are not transitioning their whole business in accordance with a Paris-aligned transition strategy..

• Low Quality External Verification: External verification practices have failed to check the proliferation of low quality transition finance instruments.

Recommendations to Address Transition-Washing

To combat transition-washing, the following policy guardrails are recommended:

1. Paris-Aligned Pathways: Develop and enforce national or regional emissions reduction pathways that are aligned with the Paris Agreement.

2. Classification Standards: Establish scientifically rigorous standards for carbon-intensive activities to ensure consistency with global climate goals.

3. External Verification: Enhance the capacity and credibility of external verifiers to provide independent assessments of transition plans.

4. Financial Regulation: Introduce mandatory regulations for transition finance labels, ensuring only firms with credible, science-based strategies can use these labels.

5. Regulatory Penalties: Empower financial regulators to impose penalties on firms that engage in transition-washing, ensuring accountability and integrity in the market.

6. Systemic Reforms: Implement broader reforms to mandate Paris-alignment for large firms and progressively restrict market access to those with credible transition plans.

By addressing the root causes of transition-washing and implementing robust policy guardrails, we can ensure that climate transition finance achieves its intended impact. This will not only restore investor confidence but also accelerate the global transition to a sustainable, net-zero future.

Find out more and download the report here.