Green is not enough: The need to scale up transition finance

Sustainability-related investments have grown rapidly over the past decade. Initially anchored in global climate commitments such as the 2015 Paris Agreement and net-zero targets, investors mainly focused on directing capital toward explicitly ‘green’ investments that have a limited negative impact on the environment, such as those providing products and services needed to mitigate climate change. 

This was reinforced by regulatory frameworks such as the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy, which together created a strong incentive to finance assets already aligned with a low-carbon economy.

However, the elephant in the room is that this approach ignores the need to provide finance to companies and sectors which are essential to the transition but not yet aligned – particularly high-emitting and hard-to-abate industries – to help them reduce their emissions.

The result is that even though sustainable investing has grown hugely in popularity and investment portfolios have been decarbonising, real-world emissions are still rising.

The urgent need for more transition finance

There is growing recognition that current approaches are insufficient. For example, institutions such as the International Energy Agency have made it clear that going green is not enough. While many investors have been able to reduce their financed emissions and their exposure to coal, global greenhouse gas emissions continue to rise, and it is painfully clear the world is not doing enough to reach the Paris Agreement’s goals. 

Hard-to-abate sectors such as steel, cement and heavy transport are underrepresented in responsible investment strategies, even though they are most in need of transition funding. This raises a fundamental question: are investors truly contributing to decarbonisation, or simply reallocating carbon-intensive assets elsewhere? 

Meanwhile, the global energy transition remains highly uneven. Diverging regional approaches – particularly between Europe and other parts of the world – highlight fragmentation in the world’s climate ambitions. In reality, the transition is not yet replacing existing systems but rather adding new layers of clean energy on top of existing fossil-based infrastructure, without sufficiently phasing out existing supply.

Actions by the most emissions-intensive sectors, companies and countries are crucial to put the world on a more sustainable pathway. But projects that could deliver meaningful reductions in environmental footprints often do not receive sufficient financial support. 

Currently, finance is chiefly directed to various green assets and activities – most prominently renewable power. While vital, these investments alone cannot deliver all the changes needed to cut global emissions, especially in areas where clean technologies are not yet commercially available or cost competitive. 

This is where transition finance comes in. It can help emission-intensive countries, companies and sectors shift towards sustainable practices aligned with long-term climate and development goals. With its focus on sectors where emissions are hard to abate and on emerging market and developing economies, transition finance can play a vital, complementary role to green finance.

Regulators are responding but more needs to be done

Transition-focused guidelines are emerging, reflecting the need to address these shortcomings. For example, the Net Zero Investment Framework¹ classifies companies based on their climate ambition and transition alignment. Such approaches enable investors to differentiate between transition leaders, improvers, and laggards, helping them decide where to allocate capital.

Building on these guidelines, BNP Paribas Asset Management has developed a proprietary framework designed to assess the robustness and credibility of investee companies' transition plans. This innovative tool provides analysts and portfolio managers with a structured approach to evaluate how well companies are prepared for their transition to more sustainable practices. 

Furthermore, the framework is employed at the asset manager level in the target setting and in the ongoing monitoring processes. Overall, this approach enhances BNPP AM’s ability to integrate climate considerations into its investment processes in a rigorous and systematic manner.

Meanwhile, the Climate Transition Bond Guidelines² help issuers in high-emitting sectors secure financing to enable them to reduce their emissions. As one of the coordinators of the International Capital Markets Association’s Climate Transition Bond working group, BNPP AM has advocated for the transition label to become a standalone label – primarily to protect the integrity of green bonds, but also to make it easier for hard-to-abate issuers to tap into the sustainable finance market. 

It is also vital that issuers of transition bonds provide useful metrics in clear impact reporting. One of the most important measures is the project-level carbon footprint, which provides clarity on how much emissions have been reduced because of a project. Avoided emissions, by contrast, is a forward-looking metric that may never be achieved. Our clients have made it clear that they need details about carbon footprints and other relevant metrics to persuade them to invest in such instruments.

Regulators responding to traction for transition-related investment strategies but more is needed

The anticipated update of SFDR 2.0 – particularly the introduction of so-called Article 7 – could play a pivotal role in scaling transition finance. 

Article 7 is expected to support the transition to a low-carbon economy by improving transparency about the real-world impacts of investments, helping investors identify companies that need financing to decarbonise. 

By highlighting adverse impacts alongside transition efforts, investors can better assess which companies are credible candidates for improvement. This will hopefully result in more targeted funding for emissions reduction, support for innovation and help to bridge the financing gap for hard-to-abate sectors. 

It would also be likely to encourage the development of transition-focused investment strategies and drive increased issuance of transition-labelled instruments. However, with the exact details still unclear, it is vital that Article 7 does not exclude too many investments as it must provide enough scope for investors to allocate to all the hard-to-abate sectors in need of funding to reduce their emissions.

Before the SFDR update, regulators in other jurisdictions issued transition-enabler labels. In the UK, the Sustainability Disclosure Requirements introduced an ‘Improver’ label, which focuses on financing companies that demonstrate environmental improvements over time. BNPP AM adopted this label for five fixed income and equity funds, with the goal of supporting the transition toward a decarbonised economy.

The next stage: From green to transition finance

The sustainable finance market is at a turning point. While considerable progress has been made in mobilising capital toward green activities, this alone will not be enough to achieve the world’s climate goals.

Transition finance must now move to the fore. We believe this should involve:

• Expanding the scope of sustainable finance to include hard-to-abate sectors 
• Implementing robust standards and enforcing transparency to ensure market integrity 
• Aligning global regulatory frameworks to support transition-focused strategies 
• Shifting investor focus from portfolio decarbonisation to making a real-world impact 
• Ensuring there is consistency between the loan and bond markets so that both can effectively support issuers’ transition strategies

At the same time, investors must remain vigilant to the risks associated with transition finance. For example, poorly designed or weakly governed transition strategies could lead to carbon lock-in, whereby capital continues to support emissions-intensive assets without any credible pathways to decarbonisation. 

This could also expose investors to increased reputational risk, particularly at a time of heightened scrutiny from regulators, clients and broader society.

Ultimately, minimising global temperature increases will depend not only on financing what is already green, but on helping everything that is not yet green to transition. Investors, regulators and the finance community all have a big role to play in achieving this ambition. 

For investors, transition finance also represents an opportunity to move beyond exclusion-based strategies and start financing real-world decarbonisation.