Transition finance market review findings welcomed by UK financial firms

This independent transition finance market review (TMFR) (133 pages / 27.6 MB), commissioned by the UK Treasury and department for energy security and net zero, sets out a comprehensive roadmap to scale high-integrity transition finance markets. The goal is to support both UK and global decarbonisation and net zero ambitions.

James Hay, sustainable finance expert at Pinsent Masons, said: “The findings should be well received by industry as the TFMR has sought to tackle some of the difficult issues faced by sustainability regulation which often focuses too narrowly on green finance, thereby side-stepping the challenges associated with transitioning high emitting sectors and companies. In particular, the TMFR has been bold enough to highlight potential trade-offs and accept that there might be varying speeds of decarbonisation through what it refers to as ‘common but differentiated responsibilities’.”

The TFMR’s findings are organised around three pillars underpinned by proper communication, capacity building and governance: establishing clarity and credibility, scaling finance for transition activities, and scaling finance for transitioning entities.

Hayden Morgan, sustainable finance expert at Pinsent Masons, said: “Transition finance presents one of the biggest opportunities for financial services firms to support clients with new financial products and services. At the same time, it also presents significant challenges and risks, in terms of aligning commercial strategies, and avoiding greenwashing risk.”

The report’s recommendations are structured around addressing five barriers. These include lack of long-term regulatory and policy certainty with regard to real economy transition and mismatch in the risk-return profile required by capital providers and the investible opportunities. The report also sets out recommendations regarding the difficulties in assessing whether financing a particular activity or entity will have a decarbonisation impact as well as the limited provision for transition activities and strategies in the UK’s sustainable finance regulatory regime. Additionally, the risk of actual greenwashing and risk of greenwashing allegations and reputational damage are addressed.

The report’s recommendations are addressed to the government, businesses and financial services firms over various timeframes and represent the continuation of other recent initiatives such as the UK Transition Plan Taskforce (TPT) - although the TFMR has developed new work as part of its review.

Morgan said: “The TFMR provides good practice market reference, especially in relation to the ‘Transition Finance Classification System’ and the ‘Guidelines for Credible Transition Finance’. These recommendations, supported by the public policy levers identified, will be well received, especially by financial services firms seeking to support their clients in real world decarbonisation.”

There is also a recognition that the current regulatory focus for financial services firms on “financed emissions” may not be a useful future indicator of progress or performance, as in order to support clients with their own transition, lenders and investors will need to align with sector-wide transition pathways, which will result in higher financed emissions, in the short to medium term. 

Although there is much to welcome in the TFMR report, there are two areas to critique, according to the experts.

The first is the recommendation to develop transition finance metrics. “While metrics are useful to quantify progress towards targets, their simple nature can easily distract from the harder work that needs to go into determining transition strategy and setting action plans – a pitfall encountered by a number of firms in recent years who set interim net zero targets without a sufficient plan to achieve them who are now rowing back on these commitments,” said Hay.

The second is the establishment of a transition finance bureaucracy to oversee delivery of the report’s recommendations.

Hay said: “While the government certainly has a role to play in developing transition finance in the UK, it should be careful not to stifle the private sector with rules but instead should focus on providing sufficient clarity without being heavy-handed and should leverage its ability to de-risk and incentivise transition activities to scale transition finance rather than crowd-out and obstruct.”

In order to continue to access finance, align with stakeholders’ expectations, and prepare for forthcoming regulatory requirements, companies across most sectors will need to develop credible transition plans, the experts urge. At present the findings are no more than recommendations and it will be up to government ministers and regulators to decide what policy measures to adopt and how quickly.

Mark Ferguson, public policy expert at Pinsent Masons, said: “However, businesses may wish to take note of the warm reception of the review’s recommendations by ministers and the restatement that the government is currently ‘developing our approach to mandate UK registered financial institutions and large companies to implement credible transition plans’. Those businesses with an interest in how the TFMR recommendations are implemented should now take time to consider their next steps. Financial institutions, in particular, should consider that the FCA has indicated that it is keen to hear from firms as it undertakes further work on this issue.”

The TFMR will inform regulators, including the Financial Conduct Authority in its own market consultation, in fulfilment of this commitment.