The UK government began a consultation on transition finance on Thursday, asking for market input as it seeks ways to make the UK "the best place in the world to raise transition capital".
The Transition Finance Market Review will build on the UK's Transition Plan Taskforce, launched at COP 26 in 2021, which aims to set a "gold standard" for companies' climate transition plan disclosure.
“There is an opportunity to look at how the financial services sector, the real economy, public institutions and the government can come together to find new ways of financing or ways of removing some current frictions in a relatively structured way,” said Vanessa Havard-Williams, who is heading the TFMR as well as being a member of the TPT and co-chair of its oil and gas sector guidance working group.
The investment required to meet climate targets has been estimated as at least an additional $4tr-$5tr a year globally by the 2030s, according to the Review.
Transition finance is growing in prominence, including in the labelled bond market, and regulators and governments around the world are increasingly looking to set out official guidance.
The Review will consider how the TPT's disclosure framework and other standards can support the credibility and integrity of transition finance, protecting users from greenwashing accusations.
The TPT is so far the most detailed, specific and structured framework for corporate transition plans globally, market participants say. It was designed to be consistent with the International Sustainability Standards Board (ISSB) and draws on the Glasgow Financial Alliance for Net Zero (GFanz) transition planning framework.
“The [UK] disclosure framework is very well structured, which makes it relatively easy to use,” said Havard-Williams. “Developing a transition plan requires plenty of ambition, and I think it's a usable, corporate-friendly framework.”
From voluntary to mandatory
A shift from voluntary to compulsory transition plan disclosure could come as early as this year, after the UK committed to this at COP 26 to enforce transition plan disclosure. An increasing number of firms are publishing voluntary transition plans and investors are calling for more credible plans.
The UK's Review is its latest effort to engage with the market to create a usable transition framework that dovetails with existing sustainable finance frameworks.
“Importantly, having developed a voluntary framework, we're looking to engage with any countries or standard setters who are moving to implement mandatory requirements,” said Alice Carr, executive director for public policy and Just Energy Partnerships at GFanz. “It's been a key focus for us in the UK to work closely with the UK TPT as they build out a disclosure framework for transition planning.”
The TPT recommends that companies report transition plans annually, with a wider refresh every three years.
“Firms are increasingly deploying the framework on a voluntary basis, and in turn, they are turning to their clients and asking whether they have a transition plan, and [questioning] what pathways they are on,” said Carr.
"It's encouraging that firms are still making these commitments, because it's actually really difficult as a financial institution to support transition — you can't deliver it just through your own actions, you're essentially saying that you're going to work to support the transition of the real economy."
Large financial institutions have an incentive to engage with transition finance, said Carr, as they will be backing something that can bring growth, new technology and competitiveness.
UK firms with transition plans in place are generally happy to disclose them, but they are not currently obliged to have such plans. That is set to change.
“The [Financial Conduct Authority] will consult later this year on its regulation,” said Kate Levick, associate director at think tank E3G and co-head of the TPT secretariat.
The UK government also made a commitment last March in relation to its 2023 Green Finance Strategy to consult on introducing requirements for transition plan disclosures for all listed companies and large private firms.
Bringing private companies into the field of transition plan disclosure requirement “would take the scope of regulations out of just what the FCA is able to cover, so that would require some legislation as well, and we're still awaiting the consultation for this,” said Levick.
In August 2023, the FCA said it would consult on introducing disclosure requirements in the FCA Handbook, aligned with the TPT framework for listed companies.
“We need transition planning, it's not generally required globally at this time, but we could do with a common global baseline for transition planning that allows global financial institutions and global corporates to allocate finance and attract the financing that they need,” said Carr.
The UK is not the only country developing legislation for transition plans. Once the EU Corporate Sustainability Reporting Directive comes into force, some UK firms will have to start disclosing plans according to either UK or EU law.
“The UK is not an island — in terms of firms operating in the UK, some of them are already going to be in scope for the EU CSRD, for example, and they're going to have to be publishing transition plans, irrespective,” said Levick. “So this is very much a trend that's coming through, and requirements are slowly but surely starting to come through on firms to do this.”
The TPT is beginning to prove itself internationally as a usable and effective framework.
“[My impression is that ] the UK TPT framework has proved popular around the world, people have been interested in it and engaged in relation to it — it is already influential beyond the UK,” said Havard-Williams. “We're not the only country that has strong financial markets — others are also thinking about these issues, and obviously there's a degree of cross-fertilising of ideas, which is a healthy thing."
International and regulatory dispersion
As more countries create transition finance guidelines, the risk of regulatory fragmentation grows.
Between the UK's TPT, the International Financial Reporting Standards (IFRS) and European Sustainability Reporting Standards (ESRS), transition plan guidance varies in specificity, detail and structure.
“A lot of this is happening at different levels, there is a risk of dispersion,” said a sustainable finance regulation expert.
The exact definition of transition finance varies between frameworks and countries, which has generated scepticism.
“Whether you have a taxonomy, or broad guidance, or high level framework, a credible transition plan is at the core of being able to finance this area,” said Sean Kidney, chief executive of the Climate Bonds Initiative.
A lack of detailed information from corporates on their climate transition planning was a major obstacle preventing investors from identifying companies to finance their net zero targets, Kidney said. Lack of comparability with other sustainable finance frameworks was another.
The International Capital Market Association has identified three main uses of the term 'transition': an economy-wide transition, meant to transition an entire economy towards Paris alignment; a climate transition, transitioning a specific sector or industry; and a hard to abate transition, focused on the challenges in decarbonising high emitting sectors.
“We really do need to converge on globally consistent definitions of transition finance,” said Carr. "If we all have different ones, that's going to be problematic."
But coming up with a clear definition will be different from how regulators have approached green finance taxonomies, which tend to identify activities and decide whether they're green or not. The transition is dynamic and the way in which the regulator assesses whether a company or strategy is transitional will be fundamentally different.
But a few definitions are emerging — such as economy-wide transition, climate transition, and hard to abate transition. “Don’t wait for perfection, just get started with the transition plans, particularly in an environment now where it's voluntary and you can experiment,” said Levick.
ICMA has said the UK TPT is sufficiently explicit that corporates can get started implementing it now. Given its usability, coming up with a globally agreed definition is second priority to implementing the existing definitions.
Havard-Williams said: "Transition finance is an area where definitions are in different places, and getting to a single, globally accepted transition finance definition seems like a challenging exercise, and may not be the most productive use of time.”