Paving the way for a greener tomorrow

Transition finance is not as clear-cut as green finance, writes Sarah Kemmitt, lead, secretariat, United Nations Environment Programme Finance Initiative.

If we are to limit global warming to 1.5 degrees, we need every economic sector to adjust to a pathway of emissions reductions; a transition that involves shifting to new technologies and solutions. This requires urgent and considerable investment. The International Energy Agency projects that clean energy investment must increase to around $4tn annually, with McKinsey also estimating that $9.2tn is needed annually for a net-zero transition over the next 30 years.

At the Net-Zero Banking Alliance, our members are focused on acting as change agents in the global economy – providing this much-needed transition finance and expertise to their real-economy clients.

Members of the NZBA have each chosen to commit to transitioning their lending and investment activities to net-zero emissions by 2050, in alignment with the 1.5-degree ambition of the Paris agreement. This is not about it being ‘the right thing to do’. Limiting global heating to 1.5 degrees is necessary to secure a liveable future for all. It is also a bank’s fiduciary duty to act in the interest of their investors and clients.

Actioning this means  engaging proactively with their client base to encourage lower-emitting business development, supporting capacity building and accurately evaluating and mitigating climate-related risks.

Transition finance can be broadly defined as financing that supports and enables a global transition towards a 1.5 degree-aligned economy. A client may be providing a climate solution or be already aligned to a 1.5-degree pathway, or they may be a carbon-intensive company which is gradually transitioning towards net zero and requires capital to do so. This approach means that financing for projects and initiatives that meaningfully advance a borrower’s net-zero journey qualifies as transition finance – so long as the borrower has a credible 1.5 degree transition plan.

But there is no universal solution here. Given different starting points, geographic contexts, economic structures and growth potentials, no two countries or firms will have identical pathways or capital requirements. Therefore, it is critical that our member banks work with clients to clearly articulate their net-zero goals and transition plans.

To this end, the Alliance seeks to support banks with effective practices and frameworks for near-term action. In October 2022, an Alliance working group published the NZBA Transition Finance Guide, which offers concrete steps banks can take in developing and pursuing transition finance planning. And in November 2022, the Glasgow Financial Alliance for Net Zero (for which NZBA is a partner) finalised its recommendations for transition planning for financial institutions.

 Transition finance is not as clear-cut as green finance, giving rise to the risk that banks helping clients align to 1.5 degrees are accused of doing ‘business as usual’. Therefore, to avoid accusations of greenwashing, financial institutions must be clear on how they are supporting their clients’ transition.

Banks must partner with others in financing the transition in emerging economies and developing countries. There is a growing financing gap, which private finance is largely not able to fill. Partnerships with development finance institutions will be crucial to bring that investment within banks’ risk appetite through a range of structured vehicles. There is also work to do in removing barriers to investment and creating a conducive policy environment that facilitates the growth of the pipeline of bankable projects.

While banks recognise and are committed to fulfilling their roles in reaching net zero, it is crucial that policymakers, regulators and governments address remaining gaps to enable and support the transition. Businesses of all sizes require certainty from both policymakers and financiers to make business decisions which, in the context of transitioning towards low-carbon economies, are often well beyond the scope of normal business planning.

NZBA members have sent a clear signal and policymakers will need to respond with clear measures that level the playing field and incentivise real-economy companies to pursue a lower-emitting future.

Banks in the NZBA are already in the process of taking action, not considering whether they should take action. [AC1]