The transition finance communique, published by the EU Commission as part of its sustainable finance package published 13 June, sent a clear message: transition finance will be crucial for Europe to achieve its green goals.
Transition finance is required to invest in cleaning up economic activities that are not currently green, to support innovation and infrastructure that will enable these activities to achieve climate neutrality, and in some cases to finance the phase-out of activities that cannot become sustainable. To access transition finance for green goals, entities should disclose a credible transition plan with steps to reach climate neutrality by 2050.
As well as extending the EU’s vision for financing the transition, the communique can be seen as a snapshot of the various EU private finance tools directly leveraging transition finance. What will be the impact on the EU economy?
A good assessment of transition tools, but no clarity on their intersections with climate risk
Although a very welcome first analysis, bringing coherence across a specific set of policy instruments, this exercise will not add value to the EU transition unless further regulatory steps are taken. The transition potential of capital expenditure plans under the EU taxonomy is well described, but crucially there is no mention of taxonomy extension to include “amber” activities.
The communique brought more coherence to existing EU regulations, for example, how to use climate benchmarks as a tool to transpose sectoral targets into entity ones, or how to raise transition finance via green loans, bonds and equity financing. However, the communique does not clarify the next steps for the creation of a transition bond standards. It also does not cover legislation currently under revision that will be crucial for the transition, such as the Sustainable Finance Disclosure Regulation (SFDR). The language on the alignment between transition planning and climate risk is very welcomed, but also here key EU files currently under discussion, like the Capital Requirement Regulation and Directive (CRR/CRD), are regrettably not mentioned.
Further alignment between transition plans and the EU prudential framework will ensure the same plan for the overall purpose of transitioning while risk mitigating this process. The ideal outcome – establishing one transition plan for many users – should be a goal for the European Supervisory Authorities (ESAs). When further defining what climate risks for banks and insurers mean, ESAs should encourage entities to produce future-proofed transition plans, going beyond target-setting alone and considering climate risk management.
Transition in CSDDD, competitiveness, and public funding
Another important directive for transition planning is not mentioned since it is still under negotiation. The Corporate Sustainability Due Diligence Directive (CSDDD) would represent a crucial step forward for mandatory requirements on implementing transition plans. We expect a final CSDDD text around March 2024. Unfortunately, its ambition is being challenged on many fronts.
A value chain and systemic approach, as seen with the CSDDD, is a unique opportunity for functioning entity transition planning in the EU, which would finally shift from reporting to impact on environmental action. But ambitious transition planning is also a synonym for more competitiveness. A recent study showed that between 2015 and 2020, companies with science-based transition plans saw a positive association with their financial performance, implying a positive relation between decarbonisation efforts and financial results over time.
The EU is the only actor that can provide a competitive environment, with predictable investment cycles and clearly directed public (and consequently private) funds. Many private investors are demanding this. A watered down CSDDD would be bad news for the overall competitiveness of the European market. Such a market, and the physical world around it, will become less predictable in the future. Entities will need to assess their impact on the environment (CSDDD), and consequently their risks related to it (CRR/CRD). Transition planning will serve to mitigate these greater environmental and financial risks while also supporting the competitiveness of European industry.
Moreover, transition planning will be strategic not only for risk mitigation, but also for identifying sectoral funding gaps and new investment cases for transitional activities, and mobilising finance to achieve climate neutrality. Intrinsic bottlenecks in the real economy’s transition do exist. To overcome them, understanding how to allocate new (and scarce) EU public money will be key as will recognising differing sectoral starting points.
To unleash the potential of transition finance, the EU Commission, together with the major EU public finance providers (EIB, national public banks, etc.), should create dedicated programs where next sectorial steps are discussed and decided together with companies, commercial banks and insurers across different EU member states. Setting an overall direction for Europe’s economic transition in a multistakeholder setting is the much-needed context in which transition finance tools must sit.
