If FIs are to successfully navigate the complexities of transition finance and maximize the associated opportunities, they need to embed the right mechanisms and processes into their operating model and activities.
That will require ongoing, iterative effort over many years, including instilling a culture of continuous improvement. Firms are at varying levels of maturity, so best practice will vary — especially across regions. For now, once net-zero-aligned targets are set, focus should be on these actions:
- Target real-economy transition: setting targets and metrics that prioritize real-world decarbonization, and monitoring progress against these to minimize the risk of divestment and increase portfolio decarbonization.
- Set the right incentives: using internal levers such as capital allocation and adjusted risk appetite to create the right set of incentives for client-facing staff and decision-makers, helping to deliver on net-zero transition.
- Develop greater specialization: recruiting specialized talent and training existing staff will help firms develop their transition finance capabilities, as well as improve their understanding of emerging technologies and the evolving policy landscape.
- Improve data for decision-making: overcoming the continuing obstacles of data quality and availability will depend on making the right investments. A data strategy with a clear roadmap for improving data quality at sector, client and activity levels is key. Investment in internal processes will also be needed if firms are to be able to track progress and inform their investment and lending decisions.
- Innovate new products: creating in-house transition finance frameworks based on best-in-class industry guidance and placing robust controls around the scaling up of products such as transition funds and bonds will enable FIs to finance the transition while minimizing greenwashing risks.
The right government policies can be a huge accelerator of transition technologies. The US’ Inflation Reduction Act (IRA) is a prime example, deploying up to US$379b in federal funding for green technology and clean energy projects. Meanwhile, the UK government plans to commit £20b in funding to the early development of carbon capture, usage and storage (CCUS) technology over the next 20 years, as well as developing new business models and carbon pricing mechanisms alongside the private sector.
Governments and regulators, in consultation with the private sector, can also accelerate transition finance by clarifying sector pathways and improving the coverage and consistency of taxonomies. In our view, key framework improvements to prioritize over the next two to three years are:
- Evolution of industry and voluntary standards and frameworks: for FIs this would include the SBTi’s FINZ standard and Glasgow Financial Alliance for Net Zero (GFANZ) guidance providing a clearer view of portfolio alignment and associated transition criteria and metrics.
- Comparable categories and coverage: more consistent categorization of economic activities between different taxonomies would be valuable, especially for global FIs that operate across multiple regions. For instance, the Canadian Sustainable Finance Action Council (SFAC) 9 and the Australian Sustainable Finance Institute have published their own roadmaps for categorizing transition activities.
- Greater interoperability of disclosure: enhanced interoperability across key disclosure standards such as the International Sustainability Standards Board (ISSB) and European Financial Reporting Advisory Group (EFRAG) would make it easier for FIs to manage the volume of compliance – for example, by reducing the need for multiple interpretations, and by making it easier to align metrics and KPIs in a way that incentivizes growth.
- Transition planning guidance: there needs to be a concerted effort across jurisdictions to move toward the mandatory disclosure of high-quality transition plans. A hugely positive step is the UK’s Transition Plan Taskforce (TPT), which provides a gold standard framework for a strategic, rounded approach to transition planning and takes into account related considerations such as nature and just transition.
- Enhanced collaboration: collaboration between FIs, trade bodies, policymakers and regulators will be critical to building momentum behind transition finance, especially when it comes to establishing shared standards, agreed parameters and greater cross-border interoperability.
- A global taxonomy: in an ideal world, there would be a standard global transition-specific taxonomy. A myriad of factors, including the diversity of different countries’ economies, make this especially challenging. In the next few years, it would be more realistic to focus on transition disclosures, industry and voluntary standards and frameworks, and mechanisms for interoperability.
Success is dependent on a range of factors, including strong political leadership and policies, consistent definitions and regulations across jurisdictions, supportive industry frameworks and FIs’ own capabilities and investments. FIs therefore need to optimize factors within their own control. These include mobilizing transition finance through the right structures and incentives, engaging closely with clients, and collaborating with peers, regulators and other stakeholders to improve industry frameworks, policies and practice.