Guardrails to Address Greenwashing of Climate Transition Finance

Transitioning to net zero greenhouse gas emissions is more urgent than ever. As policymakers and the private sector increasingly recognise the critical role of climate transition finance, ensuring the integrity of this market becomes paramount.

This paper addresses the pressing issue of transition-washing and proposes six essential policy guardrails to enhance market integrity and scale up transition finance.

Importance of Climate Transition Finance

Climate transition finance is crucial for aligning financial flows with emissions reduction pathways consistent with the Paris Agreement. This form of finance is vital for carbon-intensive sectors, which make up over 90% of the global economy. When properly implemented, it can facilitate and incentivize the real economy's transition to net zero, mitigating the worst impacts of climate change.

Need for Robust Regulation

Together, these guardrails seek to demonstrate the opportunity to create, and outline the critical ingredients of, policy frameworks that can blend the apparent need for a robust transition finance rulebook with a pragmatism that the complexity and changeable nature of climate transition finance requires. Without these, transition finance is unlikely to play its part in catalysing and accelerating a Paris-aligned net zero transition in the real economy.

Potential of Well-Designed Regulation

Well-designed financial regulation could have a positive enabling effect on labelled transition finance. Mandatory rules can create a level playing field for climate leaders by establishing a regulatory perimeter around protected transition finance labels, effectively excluding firms not making an earnest attempt to meet their net zero commitments. If this perimeter guarantees integrity and mitigates transition-washing risks, it could inject vital market confidence into these labels. This confidence could result in a cheaper cost of capital for compliant issuers, thus helping to create a vanguard of corporate climate leaders capable of driving the global net zero transition.

Competitive Edge in Transition Finance

As countries vie for leadership in the transition finance space, robust policy frameworks, including actual regulation, will be essential for becoming a leading transition financial centre. Effective regulatory frameworks can demarcate financial centres where labelled transition finance, particularly in the bond markets, is likely to be impactful and less exposed to transition-washing risks. For instance, a "Singapore Sustainability-Linked 1.5°C Bond" could offer issuers a cheaper cost of financing than equivalent non-Singaporean instruments, provided that investors perceive Singapore's transition finance regulatory framework as being more ambitious and credible than its competitors.

Tailoring Benchmarks for Developing Economies

In the design of policy and regulatory frameworks, developed economy financial centres should actively seek ways to set different benchmarks for climate leaders in developing economies. Recognising the unique challenges and opportunities in different regions can help create more inclusive and effective transition finance markets, driving global progress towards net zero.

Recommended Policy Guardrails

1. Prepare National or Regional Paris-Aligned Emissions Reduction Pathways: Develop scientifically robust pathways to guide emissions reductions, taking into account local circumstances whilst maintaining scientific credibility.
2. Develop Classification Standards for Carbon-Intensive Activities: Establish standards, such as transition taxonomies, to clearly define which transition activities and technologies are aligned with Paris goals and will remain so over time, helping to mitigate carbon lock-in risks.
3. Build Capacity for External Verification: Enhance the market's ability to assess the credibility of transition finance instruments through robust external verification processes.
4. Implement Targeted Financial Regulation: Introduce mandatory threshold requirements for the use of protected labels in transition finance, ensuring that only genuinely transitioning firms can access these labels.
5. Empower Financial Regulators: Provide regulators with the authority and resources to penalise transition-washing in labelled transition finance markets..
6. Implement Systemic Reforms: Implement whole of economy reforms that can scale up both labelled and unlabelled transition finance simultaneously, encouraging more comprehensive and effective corporate transition strategies.

By implementing these guardrails, we can ensure that transition finance, and labelled transition finance in particular, fulfils its potential in mitigating climate change.

You can download the full paper here to explore these recommendations in detail and join us in advocating for stronger, more effective climate finance policies.