Transition Finance Resource Hub

Transition finance is an emerging concept with various views on its precise scope, purpose, and credibility. Some see it as any financing that broadly supports the transition to net-zero emissions, while others define it as financing that specifically facilitates the decarbonization of high-emitting counterparties (e.g., corporates, sovereigns, projects) and/or sectors, particularly those that do not have readily available low- or zero-emitting technologies or solutions. However it is defined, transition finance is gaining momentum and various organizations have put forth frameworks to steer the market towards greater convergence. 

RMI has commonly used the latter definition, including in our open letter, A Global Call to Action on Transition Finance at COP28, which was supported by 10 other NGOs. There, transition finance is described as enabling decarbonization of high-emitting entities and/or hard-to-abate sectors where a credible pathway to 1.5°C-aligned decarbonization exists. 

Reaching net-zero emissions by 2050 and keeping global average temperatures within 1.5ºC of pre-industrial levels are critical to avoid the worst consequences of climate change. To achieve this, the global economy must undergo rapid transformation. Financial markets can play an important role in providing financial products and services that facilitate real economy emissions reductions and scale low-carbon solutions.  

The economy-wide climate transition will offer abundant financing and investment opportunities. The IEA estimates global clean energy investment must rise to about $4.5 trillion per year by 2030 to meet 1.5°C goals. Outside of the energy sector, Citi estimates decarbonization could require up to $1.6 trillion per year in the aviation, shipping, road freight, steel, and cement sectors.   

Providing transition finance is one way in which financial institutions can enable net zero, especially through the decarbonization of high-emitting counterparties and assets to align with a 1.5°C future. This type of financing and investment may be particularly important for supporting activities that may not otherwise be eligible for other types of sustainable or green finance due to current high emissions. With the correct guardrails in place, transition finance has the potential to support a rapid and just transition.  

Transition finance can raise concerns about continued financing of high-emitting counterparties and activities due to its complex and forward-looking nature. Two related concepts include “greenwashing” — providing misleading information, labeling, or communication about the environmental benefits of an activity or company — and “transition-washing” — where transition finance is provided to activities or entities that lack credible plans to decarbonize at the pace required to achieve a global 1.5°C target. 

Robust guardrails, credibility assessments, and outcome tracking will be needed to reduce these risks and ensure that capital is allocated in support of climate goals and does not simply perpetuate business-as-usual activity. While there is growing momentum and convergence on transition finance in the market, there is currently a lack of consensus on precisely what those guardrails, assessments, and measurements should entail. At a high level, however, a few suggested principles to support credibility are listed below.   

Credible transition finance should be:  

• Predicated on the existence of a credible strategy for the counterparty to decarbonize over time, in line with relevant sector and regional science-based pathways, where available. This could be featured in a transition plan or demonstrated through engagement, disclosures, targets, capex plans, and commitments. The strategy should include credible plans and business strategy to phase out misaligned activities, as well as scaling up climate-aligned activities. 
• Tracked via annual monitoring and evaluation, with regular reporting of transition activities and outcomes from agreed baselines. This could include incentives or penalties if transition milestones and/or KPIs are met or missed, with transparency on expectations set out at initial engagement. 
• Designed to avoid carbon lock-in. Consideration should be given to the lifetime of the activities and time horizons to ensure that this is not business-as-usual financing that extends the lifetime of high-emitting assets and technologies beyond scenario time horizons or incentivizes new investment in misaligned technologies.  

• Allocated with attention to a just transition, which is critical to ensure that negative consequences of transitional activities are minimized and co-benefits are generated where possible. This should include consideration of social and economic equity and inclusion.  

To date, transition finance has largely been issued in the form of debt financing; a report published in February 2024 by the International Capital Market Association (ICMA) estimates that $119 billion of green, sustainability, and sustainability-linked bonds have been allocated to transition finance in the hard-to-abate industries and fossil fuel sector. However, equity investments in transition-enabling counterparties will likely become more common as we navigate the crucial decade for climate action. Private equity, venture capital, and asset managers are likely to see growing demand for transition finance. For example, funds from investors such as Brookfield and BlackRock have highlighted momentum for equity financing in supporting the transition and emerging technologies. We also expect the adaptation of other financial instruments and asset classes, including insurance, real estate and infrastructure investments, and public equity products such as transition-related ETFs and indices. The unique attributes of each asset class can support transition in slightly different ways and for different purposes, and necessitate further, tailored guidance on how to ensure credibility for each. 

Measuring the total volume of transition finance in the market 

Transition finance and associated emissions reduction benefits are challenging to quantify. The lack of standardized labeling for transition finance makes it difficult to accurately calculate the global volume of transition finance issuance in the market. While there is growing convergence in the space, some financial institutions are developing their own taxonomies to label and report on transition finance that could lead to accusations of greenwashing based on the subjective credibility of what activities and assumptions are included. Convergence on standards will be needed to help reduce this barrier to comparable quantification, and a better understanding of today’s volume of transition finance will clarify the current net-zero financing gap.

Measuring the emissions benefit attributable to transition finance 

The impact of transition finance is also difficult to quantify. By its nature, transition finance aims to support future decarbonization of companies or assets; the emissions reductions are not necessarily known at the time of finance issuance and may be difficult to estimate. Ex-post quantification of emissions reductions is similarly difficult due to a lack of metrics to do so.  

Financed emissions, a common and important metric used by financial institutions to quantify, report, and track the emissions associated with their lending and investment activity, are backward-looking and therefore do not tell the whole story of future impact enabled by transition financing. Transition finance may also increase reported financed emissions in the near term, as financial institutions provide decarbonization finance to high-emitting companies and activities with credible transition strategies. As such, this measurement — and other similar backward-looking metrics such as green/fossil financing ratios — does not provide a sufficiently nuanced understanding of the potential impact of transition finance. Ongoing work to develop additional, complementary metrics, such as those based on forward-looking capex data and/or tailored to specific sectors, is crucial to accurately incentivize, assess, and account for transition finance.