Scaling Transition Finance with Lessons from Environmental Markets

Channelling trillions of dollars of “transition finance” towards cleaner energy, circular supply chains and more efficient infrastructure requires a rewiring of loan and risk management markets.

Many similar challenges have already been addressed in environmental markets, offering valuable lessons and advanced technology for the transition economy.

Transition Finance

Consensus is emerging on Transition Finance being defined as financing hard to abate sectors to meet the Paris Agreement temperature goal. The Glasgow Financial Alliance for Net Zero (GFANZ) characterises transition finance as enabling “an orderly reduction in emissions for carbon-intensive activities.”¹

Many businesses in hard to abate sectors see benefits in preparing for a decarbonised economy due to stricter regulations, investor demands for greenhouse gas (GHG) disclosures and changing consumer preferences. Trade flows are being affected too; for example, manufacturers of carbon intensive goods entering the EU face new emission thresholds and direct tax via the Carbon Border Adjustment Mechanism (CBAM).

Missing these signals results in transition risks, and as recently highlighted by the European Central Bank, transition risks result in elevated credit and litigation risks for financial institutions. So transition finance can be seen as a way for all parties to mitigate risk. Reducing the cost of capital for a borrower when GHG emissions are reduced can improve the underlying performance by reducing exposure to transition risk (Tandon, 2021²).

Although Transition Finance benefits are clear, its structure is still debated due to its complexity. Transitioning, by definition, implies supply chain asset-level changes, more amenable to lifecycle analysis than to the point in time proceeds or corporate level metrics used in sustainable finance. However, solutions are in sight, precipitated by the imminence of CBAM-style regulations affecting trade flows for specific commodities, and by environmental market experiences offering guidance.

“While there is no single definition of transition finance across the market, Standard Chartered has defined transition finance as any financial service provided to clients to support them in aligning their business or operations towards the 1.5 degree trajectory. Historically, one of the main challenges in this area has been that new-low carbon technologies are not sufficiently established in the market. But we’re starting to see the innovation needed across technology and digital to encourage the transition, and the development of the supporting transition finance structures required behind this.” - Nicolas Decaillet, Managing Director, Energy and Infrastructure at Standard Chartered Bank

Scaling Transition Finance with Lessons from Environmental Markets

Channelling trillions of dollars of “transition finance” towards cleaner energy, circular supply chains and more efficient infrastructure requires a rewiring of loan and risk management markets.

Transition Finance

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