Understanding Climate Transition Finance

The transition to net zero greenhouse gas emissions is one of the most pressing challenges of our time. To meet the Paris Agreement's temperature goals, it is crucial to make financial flows consistent with a pathway toward low greenhouse gas emissions. Climate transition finance could be a vital tool supporting high-emitting sectors in their journey to net zero. However, to ensure its continued development and effectiveness, we must address the risk of widespread transition-washing.

What is Climate Transition Finance?

Transition finance refers to funding provided to high-emitting businesses and sectors to facilitate their transition to net zero emissions. Unlike green finance, which typically supports low- or zero-emission projects, transition finance includes sectors that are not inherently green but are on the path to becoming greener over time. This distinction is vital as estimates suggest that over 90% of the global economy consists of carbon-intensive sectors.

Why is Transition Finance Important?

The potential of transition finance lies in its inclusivity and its potential to incentivise net zero corporate transitions across high-emitting sectors based on the terms and conditions on which such financing is provided. For firms earnestly implementing credible net zero transition plans, labelled transition finance markets should theoretically be capable of reflecting mitigated transition risks in a cheaper cost of capital, supported by high investor demand for sustainable financial products. Effective labelled transition finance markets could, in other words, prove vital to facilitating and incentivising the real economy’s climate transition. .

Guardrails to Prevent Transition-Washing

For policymakers seeking to protect the integrity of labelled transition finance and mitigate the risk of transition-washing, we recommend six policy guardrails:

1. Prepare National (Or Regional) Paris-Aligned Emissions Reduction Pathways: National or regional emissions reduction pathways should be developed on a sectoral basis to provide a clear and scientifically robust benchmark regarding the required pace of decarbonisation for corporate transition plans in different geographies, taking into account local economic circumstances.

2. Set (or Approve) Robust Classification Standards: criteria demarcating credible transition activities and technologies must be scientifically validated to ensure transition strategies align with Paris Agreement goals.

3. Build Market Capacity for External Verification: Strengthening the market for independent verification of transition finance instruments and the transition plans and strategies that underpin them is crucial to maintain credibility of labelled transition finance markets as a whole.

4. Implement Targeted Financial Regulation: Regulations should carve out and set mandatory threshold requirements for particular voluntary-use transition finance labels, ensuring that only firms with credible, science-based transition strategies can access these labels.

5. Empower Financial Regulators: Financial regulators should be given the authority and resources to penalize transition-washing effectively.

6. Implement Systemic Reforms: Policymakers should implement  reforms that can simultaneously drive a whole of economy net zero transition and simultaneously help to scale up labelled transition finance, for example mandating the implementation of Paris-aligned transition strategies at large firms.

 Labelled climate transition finance has the potential to be a game-changer in our fight against climate change. By ensuring high standards and preventing transition-washing, we can harness its full potential to drive the global economy toward a sustainable, net-zero future.

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