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 financial institutions are developing and deploying products specifically branded for transition finance. Leaning into existing product lines, such as green bonds and sustainability-linked loans, for transition purposes could raise the profile of transition financing. It could also broaden the application of the existing products and assets, without needing to build new ones and navigate associated approval and process gauntlets.
Moreover, it is reasonable to believe that there is a significant amount of transition finance already occurring through general-purpose corporate finance. For example, a pipeline operator may invest the proceeds of a corporate lending facility in new solutions to monitor and reduce methane leaks. A legacy auto manufacturer may use a general corporate bond to finance the construction of a new EV manufacturing facility. These products or transactions aren’t labeled as “transition,” but the activity is in support of the transition to a lower-carbon economy.
The transition finance products are growing, while standardized frameworks are still pending. In addition, some transition financing is hidden in general-purpose financing. Does it mean that we’re moving towards the goal behind the framework process? Should we prioritize deploying transition finance through all available channels and products, or should we focus on being able to measure and track transition finance volumes to support its monitoring and managing? With these questions, we’ve now joined the ongoing debate among climate professionals.
Bring in the bankers
As with most either/or debates in addressing the climate challenge, there is no easy answer. The unsatisfying reality is that we need rapid deployment of transition finance and standards to track and monitor that activity as soon as reasonably possible. There is value in finding a way to support them both. In the case of transition finance, increasing training and climate awareness among bankers can do just that. Building a critical mass of informed bankers and relationship managers can help not only with tracking and reporting, which can help cultivate better frameworks — the enhanced client engagement also helps business leaders more easily recognize the scale of the business opportunity.
The selling point for the additional training will ultimately come down to the business opportunity, which is significant. A recent report estimates that between $5 trillion and $7 trillion per year globally through 2050 is needed to achieve net-zero GHG emissions by 2050. As regulatory requirements and technological advancement put pressure on market levers, bankers are the ones in place to help meet it.
The bankers and relationship managers in general-purpose financing can be the driving force moving this forward. Training increases the knowledge, the knowledge informs the dealmaking, and the dealmaking grows the business, which increases the desire to be informed. This is the kind of positive feedback loop that can work in favor of addressing climate change. If the goal is climate action, it is critical that capital flows not only to more green activity but also to where the emissions are today. There is no time to waste: Bring in the bankers.