Why do we need an EU transition finance framework?
In order to truly drive climate change mitigation, it is essential that all economic sectors become greener.A sole focus on “dark green” financing will not be enough to reach our climate goals. This applies in particular to sectors such as steel, cement and aluminium. But especially in those sectors, greenhouse gasses emitted as part of industry processes are considered “hard to abate”, as the businesses in question either do not (yet) have the technology required or because the costs are (still) very high.
We in the European Union should therefore be putting a lot more emphasis on how to support and provide financing for transition activities and efforts. This is precisely where transition finance comes in, as it focuses on promoting activities that are moving towards more sustainability. At the same time, transition finance provides a comprehensive overview of economic sectors as a whole.
The transition finance approach can be viewed in sharp contrast to a static evaluation of activities that are already sustainable, as exhibited by, for example, the EU taxonomy.While the EU taxonomy may indeed have the potential to stimulate markets to provide green financing, its binary nature (green vs. not green), the fact that it does not cover all economic activities and the restrictive definition of transition activities mean that the sustainability standard is inadequate when it comes to financing the transition.
The solution: the creation of an independent, principle-based transition finance framework, designed to reach as many businesses as possible. It would provide all businesses with information on where they stand on the path to a sustainable transformation, furnishing them with motivation to improve their sustainability metrics. It would also allow them to adjust their business models in accordance with their sector in order to operationalise steps towards more sustainability.
What is the state of transition finance within the European Union?
The European Commission published a “Recommendation on facilitating finance for the transition to a sustainable economy” on 27 June 2023. The Recommendation refers to basic transition finance principles and use of relevant financing instruments. However, it remains to be seen how this Recommendation will be viewed by market participants and whether it will be sufficient in practice. We believe that the general guidelines provided by the European Commission are a useful first step, but it is likely that there will be a need for additional guidelines, for example focusing on transition pathways for specific sectors.
German private banks release position paper
The Association of German Banks has therefore worked with our members to develop important principles for a more comprehensive framework for transition finance. We have published these principles in a position paper, which can be accessed at the following link. The key points in the paper have been summarised as a call to action below:
Scope:
The scope of application should go above and beyond the EU taxonomy
Transition activities carried out by businesses should be examined on a corporate level and on the level of the activity itself
Benchmarks:
The comparison could, for example, be carried out using global, science-based sectoral transition pathways
These transition pathways should be developed as soon as possible by governments in collaboration with industrial actors and experts
Transition plans:
Businesses transition efforts should be documented in transition plans
These plans should ideally be designed with high levels of commonality and standardisation
Financing:
Financing should be considered transition financing if (1) the business proves, using a transition plan, that its activities are already in line with relevant sectoral transition paths or (2) shows that it will take suitable steps promptly
Reporting:
Businesses should provide yearly external reports on their transition plans in the interests of transparency
Transition finance should not be included in mandatory reporting requirements for banks, but best-practice guidance would be welcome
