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Defining green investments has been at the heart of EU legislative efforts in the sustainable finance space. What has been missing until now are the equally important policies and tools to channel finance towards companies and activities that intend to transition to a green or low-carbon economy. Given its importance, transition finance as an approach is gaining traction internationally.

Transition plans are emerging as a key tool for directing capital flows toward companies seeking to transition to climate neutrality. As there are no universally accepted principles for transition plans, Europe finds itself at a defining moment to determine how they should be developed in its sustainable finance regulations. This will require clear guidelines and definitions to ensure transition plans are effective, avoid transition-washing and support businesses to finance their transition.

What a transition plan is

The UK has been quicker to move on mandatory transition plans for companies. The recently established Transition Plan Task Force (TPT) that E3G co-leads the Secretariat of aims to provide recommendations for these standards to the UK regulatory processes. A key goal of the TPT is to improve the market understanding of what good practice transition plans look like. As the first step for this work, it launched a public Call for Evidence in May.

The upcoming challenge for EU legislators will thus be to set up the right framework for transition finance and define the guiding principles of businesses’ transition plans. Moreover, it is critical to avoid overlaps and ensure coherence across the various EU regulations and policy instruments such as taxonomies, green bond and sustainability reporting standards. But what is already happening at the EU level?

Transition plans in EU legislation

The EU is still in the initial stages of crafting its requirements for transition plans. Different EU legislative files that are currently being developed already hint toward including them. The scope and level of detail with which these plans are spelt put, however, vary significantly across legislative initiatives:

1. The Corporate Sustainability Reporting Directive (CSRD) requirescompanies to disclose their transition plans to ensure their strategy is compatible with the transition to a sustainable economy and the Paris Agreement goal. In the ongoing negotiations, co-legislators are considering including the entire value chain of reporting entities.
2. The recently proposed Corporate Sustainability Due Diligence Directive (CSDDD) includes a requirement for aligning business models with a sustainable economy and limiting global warming to 1.5°C. Consistency between the CSRD and CSDDD will be important, given common areas between the two.
3. In the ongoing reform of the European Emissions Trading Systems (ETS), so-called “decarbonisation plans” were introduced by the European Parliament. According to the proposed amendment, companies that seek to keep receiving free emissions allowances will need to publish such plans from 2025 onwards and include measures to reach climate-neutrality by 2050.
4. In addition, in the final negotiation stages of the European Green Bond Standard (EUGBS), legislators are considering whether transition plans should only be used by companies with a credible transition pathway in line with the Paris Agreement.

What does a good transition plan look like?

As these policy developments highlight, transition plans will be embedded in various EU legislation. For such transition plans to mobilise finance effectively, they must be consistent and comparable across various sectors of the EU economy. For this to happen, robust overarching principles need to be established, as well as credible EU standards alongside guidance on specific metrics and targets. Such principles should include:

1. Alignment with an economy-wide transition to climate neutrality, ideally compatible with a 1.5°C low or no-overshoot scenario by 2050.
2. Focus on concrete actions which emphasise near, medium, and long-term goals and are backed by clear governance mechanisms to assess progress and explain how these actions are in line with the transition to climate neutrality.
3. Enable periodic reporting and verification in a transparent manner through the adoption of quantifiable and timebound key performance indicators, with a defined stakeholder feedback mechanism.

A key challenge before the EU now is getting the transition finance legislation right to avoid transition-washing and to support European businesses on their transition path. It is imperative to create the right enabling market and regulatory environment to both incentivise the financial sector to allocate capital in a smart way and incentivise the real economy to revamp its overall strategy.