Transition Finance

Transition finance has been in the spotlight recently, following the spectacular growth in recent years of green and sustainability linked loans and bonds which has slowed down from its initial boom. Whereas green and sustainability (linked) principles and guidelines were and continue to be developed by the Loan Markets Association (LMA) and the International Capital Market Association (ICMA) respectively, transition finance principles are on their own trajectory.

Not every borrower or issuer is able to commit to green and sustainability (linked) principles in its financing options, in particular (but not exclusively) in hard to abate and high emitting sectors. Nor is every borrower or issuer willing to do so, especially where accusations of “greenwashing” and climate litigation risk loom from investors, regulatory and supervisory authorities and other stakeholders. A better option for such borrowers or issuers may be transition finance instruments.

The Climate Transition Finance Handbook

Current practice in relation to transition finance is focused on the Climate Transition Finance Handbook (Guidance or Issuers) published by Climate Transition Finance. The Climate Transition Finance Handbook sets out that transition finance instruments may consist of “use of proceeds” provisions, as do green bonds or sustainability bonds, or may stipulate that proceeds are for “general corporate purposes”, as do sustainability-linked instruments currently.

The Handbook focusses on four key elements. Fist, an issuer’s climate transition strategy and governance must provide that the proceeds of its financing should be directed towards enabling the reduction of the Issuer’s GHG emissions reduction strategy in line with the Paris Agreement goals. There is an option for independent review.

Second, the business model of the issuer should focus on environmental materiality: the climate transition strategy should be relevant to the environmentally material parts of the issuer’s business model such that it should affect its core business or redirect it to diversification into new low-carbon business activities. There is an option for external review to provide comfort.

Third, the issuer’s climate transition strategy and targets are to be ‘science based’, meaning that the issuer’s climate transition strategy should be quantitatively measurable, be aligned with, benchmarked or include references to recognised third party, science-based trajectories where they exist, be publicly disclosed and supported by independent assurance or verification.

Fourth, the issuer should apply transparency in the implementation of its strategies and business model. An offering of bonds should be transparent as to how funds will be allocated, including where possible, details on the underlying investment programme (including capex and R&D).

Transition finance bonds

ICMA published its Green Enabling Projects Guidance document. The document makes clear that Green Enabling Projects are not themselves explicitly considered green, but such projects remain critical to the enabling of green projects. The Green Enabling Projects Guidance seeks to provide guidance for such Green Enabling Projects encompassing both the induced and avoided emissions dimensions, as well as the management of related environmental and social risks. 

The ICMA guidance assists issuers in selecting Green Enabling Projects. In order to be eligible the project must meet certain criteria, including (i) requirements in relation to the implementation of the green project value chain, (ii) the project constituting a necessary part of the net zero scenario and medium to long-term transition plan of the issuer, (iii) the project avoiding causing any carbon lock-in effects. (iv) the project should provide a clear, quantifiable and environmental benefit and (v) the project should manage identified environmental and social impacts and risks. 

Transition finance loans

The LMA is developing Transition Loan Principles. The new principles would follow in Q4 2024 but are now expected in H1 2025. 

If you have any questions regarding the above, please contact Niek Groenendijk or Marieke Driessen of our Stibbe Financial Markets team.