This article is sponsored by Wells Fargo.
If you walk into a bar in your local financial district to strike up a conversation around transition finance, you could be lonely in short order. However, if you stumble into a group of climate professionals and do the same, you’re in for a long and likely contentious evening. While the climate crew has passion and a shared goal, their disagreements on the topic might slow down their progress. On a broad scale, these debates could delay investments in greenhouse gas emission reductions across the economy and make it harder for the rest of the crowd at the bar to join in.
It may not be the hottest topic across the whole financial sector, but climate transition finance is a growing one. Unlike financing for cleantech companies or solar projects, transition finance is focused on traditional businesses that need financing to decarbonize their high-emitting activities, or technologies considered "imperfect" but necessary to transition from today’s economy to one that has zero GHG emissions.
This includes a steel factory that wants to supply the EV manufacturers expanding in the United States but needs to reduce its own carbon footprint to be competitive. That steel factory will need capital to invest in new solutions, perhaps replacing blast furnaces with direct reduced iron or electric arc furnaces, or maybe pursuing carbon capture.
Transition finance can be hard to categorize. It could be financing for transmission lines that are directly connected to a wind energy project, but also lines that carry electrons from clean and fossil fuel sources all mixed together. Sometimes referred to as "brown to green" financing, transition finance is envisioned as a way to bring traditional companies, such as legacy energy generation and heavy industry operations, onto a sustainability-oriented path and therefore help them to more effectively reduce overall economy-wide emissions. Transition finance products and services — whether general corporate finance, transition bonds and loans, sustainability-linked loans or other — are a growing opportunity not only for companies looking to finance their solutions but for the capital markets in general.
The desire for standards
To avoid a Wild West, anything-goes approach to transition finance, it’s necessary to create standards in the form of transition finance frameworks. Consistency and comparability across transactions, as well as clarity in how the financed activities support lower or net-zero emissions, are important to mitigate greenwashing risk and ineffective outcomes. Having standards supports overall trust in and stable performance of the capital markets that finance the transition.
This desire for standards has ushered in the great framework buildout. It seems everyone, from industry groups to nongovernmental organizations and even the financial institutions themselves, are all working on frameworks. As envisioned in our evening out at the pub with climate professionals, there are a lot of opinions. Each framework struggles with the right approach, the specific definitions and the correct taxonomy. How do you categorize and measure EV battery manufacturing and nuclear power generation, given current supply chains and evolving technologies? And even while talented climate finance professionals work hard to get the frameworks right, equally talented engineers and entrepreneurs are bringing new technologies to the market. It seems prudent to leave more than a few available rows on the framework’s associated spreadsheet. But have we stopped to think about what the frameworks will really give us? Is the time-consuming process of creating detail-ridden transition frameworks really the answer we need to quickly mobilize investment towards a low-carbon, sustainable future?
The urgency of climate change demands immediate action, and the current preference for frameworks could delay the financing needed to move forward. Fortunately, there are alternatives to waiting for the perfect framework, and they are already in play.
Transition finance in action
As with most viable market opportunities, where there is a need, the financing is already flowing, even without a widely accepted framework. As noted by GreenBiz earlier this year, several financia
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