Michael Horvath, Sustainability Leader, and Geoffroy Marcassoli, Sustainability Assurance Leader, PwC Luxembourg, argue that SFDR 2.0 offers investors genuine opportunities for real-world impact.
The sustainable finance landscape is undergoing changes and challenges driven by political and economic realities in the US as well as in Europe. The complexity introduced in the European sustainability framework is certainly not helping matters. The recent unravelling of the Net Zero Banking Alliance and announcements by major credit institutions of rollbacks on net zero commitments being prominent examples of how these changes and challenges are trickling down.
In the European Union, while the sustainability omnibus package issued earlier this year is expected to water down the scopes of landmark rules such as the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD), the momentum to reform the framework covering the financial sector has not stalled. Indeed, the European Commission is expected to issue a revamped version of the Sustainable Finance Disclosure Regulation (SFDR) by the end of the year – and the asset management industry is anxiously awaiting to see what will come out.
With three major frameworks under revision at the same time, policymakers are faced with a monumental task of balancing political interest groups and aligning between the frameworks amidst rapidly deteriorating planetary boundaries.
Given that the ‘SFDR 2.0’ is widely expected to reflect elements of a briefing note published by the Platform on Sustainable Finance in December 2024, it will likely bring forth a formal labelling system that includes a ‘transition finance’ label – not a completely new concept as the term ‘transition’ came up extensively in guidelines issued by the European Securities and Markets Authority on funds’ names using ESG or sustainability-related terms. Irrespective of Taxonomy-compliant activities, all other activities or practices may very well be one way or another in a state of transition. Why should this new prospective label matter to asset managers? And what are the pitfalls and potential opportunities that lie ahead in this revamped framework?
Transition finance: a primer
Between the signing of the Paris Agreement in December 2015 and the early 2020s, sustainable finance experienced a proverbial moment in the sun, particularly in Europe. Policymakers and lawmakers rushed to launch ambitious action plans, strategies, regulations and policies to promote sustainability. ‘ESG’ became a household term used by financial and non-financial companies. Numerous net zero alliances were established. Banks, insurance companies and asset managers rushed to outcompete one another with ambitious net zero targets.
Then, as SFDR and its ‘Articles 6, 8 and 9’ quasi-labels proved to be too complex to implement and disclose meaningful contributions to ESG factors, reality set in, particularly when it comes to supporting so-called ‘hard-to-abate’ sectors in their decarbonisation efforts. The framework – including for most parts the EU Taxonomy – does not recognise the value of incrementally transitioning a company from a sustainability point of view, and how that may create value along the way. Indeed, it became clear for financial institutions that emissions-heavy sectors that are essential for everyday life – such as steel, cement and aviation – cannot simply be excluded from portfolios or financing activities.
‘Transition finance’ thus emerged as a key, if slightly nebulous, component of sustainable finance. In a nutshell, it entails providing financing to emissions-heavy companies in a way that requires them to reduce their emissions through a clear, science-based and empirically-verifiable framework. The term gained much traction at COP28 in Dubai.
The challenges of transition finance
Despite its promise and necessity, transition finance faces several significant hurdles.
For starters, there are significant greenwashing and accountability risks, as without robust regulatory frameworks and accountability mechanisms, transition finance can become a tool for greenwashing. For instance, a bank might finance an emissions-heavy company’s renewable energy projects, only for that company to use the freed-up capital to extend the life of its fossil fuel assets. This potential misallocation of capital undermines net zero goals at a time when we can ill afford to do so.
Indeed, while the International Capital Market Association (ICMA) has developed a useful and comprehensive guidance through its Climate Transition Finance Handbook – and while several large financial institutions have issued their own transition finance frameworks – the current lack of widely-accepted clear definitions and standards related exacerbate the greenwashing and capital misallocation risks. This policy-regulatory uncertainty, coupled with a lack of accurate data and the multi-faceted complexities involved in overseeing and monitoring enterprise-wise decarbonisation efforts, make transition finance a potentially problematic pathway for financial institutions to adopt, especially for those with strong sustainability credentials.
Further, limiting ‘transition finance’ to hard-to-abate sectors and environmental considerations, seems to again exclude certain sectors from having access to financing to help transition their products and services to a better – potentially less harmful – state over time. This is also where firms need to distinguish between regulatory requirements and ethics- or belief-based ESG exclusions that limit their transition finance framework from the outset – and this is before we start addressing the elephant in the room: defence spending.
Upcoming clarity and opportunities for asset managers
Despite these challenges, the ongoing SFDR review and the potential introduction of a transition finance label present significant opportunities for asset managers.
In theory, clear labels for transition finance can provide recognition for financial products that are credibly on a decarbonisation trajectory or are reducing the negative impact of their products for their consumers, offering investors greater confidence and helping to channel capital towards genuine transition efforts.
Indeed, an SFDR-based clear transition finance category for investment funds would allow asset managers to invest in relevant fixed-income instruments (e.g., green bonds, sustainability-linked bonds) and companies that are on a credible transition pathway, even if they do not yet meet (all) strict sustainability thresholds. This can greatly enhance accountability, especially when paired with robust third-party sustainability assurance.
Moreover, transition finance-labelled funds would help asset managers differentiate their products by expanding the investable universe and supporting real-world environmental or social impacts by improving practices, services and products. By investing in transition finance-focused assets, asset managers can play a pivotal role in driving the development and deployment of new climate technologies, retrofitting infrastructure, and transforming supply chains. After all, transition requires innovation which in turn creates value – this is where asset managers that understand sustainability as a core input into their investment decisions want to differentiate going forward.
As the European Commission moves forward with its SFDR review, the integration of a broad transition finance label could be a substantial step forward for sustainable finance – which might also require a rebranding, as it indicates an end-state and not the journey of improving sustainability. By providing clarity, accountability, and market recognition, such a label would empower asset managers to support the transition of the global economy in different sustainability dimensions, turning transition finance from a buzzword into a powerful tool for real-world impact.
Michael Horvath, Sustainability Leader, and Geoffroy Marcassoli, Sustainability Assurance Leader, PwC Luxembourg, argue that SFDR 2.0 offers investors genuine opportunities for real-world impact.
The sustainable finance landscape is undergoing changes and challenges driven by political and economic realities in the US as well as in Europe. The complexity introduced in the European sustainability framework is certainly not helping matters. The recent unravelling of the Net Zero Banking Alliance and announcements by major credit institutions of rollbacks on net zero commitments being prominent examples of how these changes and challenges are trickling down.
In the European Union, while the sustainability omnibus package issued earlier this year is expected to water down the scopes of landmark rules such as the Corporate Sustainability Reporting Directive (CSRD) and the Corporate Sustainability Due Diligence Directive (CSDDD), the momentum to reform the framework covering the financial sector has not stalled. Indeed, the European Commission is expected to issue a revamped version of the Sustainable Finance Disclosure Regulation (SFDR) by the end of the year – and the asset management industry is anxiously awaiting to see what will come out.
With three major frameworks under revision at the same time, policymakers are faced with a monumental task of balancing political interest groups and aligning between the frameworks amidst rapidly deteriorating planetary boundaries.
Given that the ‘SFDR 2.0’ is widely expected to reflect elements of a briefing note published by the Platform on Sustainable Finance in December 2024, it will likely bring forth a formal labelling system that includes a ‘transition finance’ label – not a completely new concept as the term ‘transition’ came up extensively in guidelines issued by the European Securities and Markets Authority on funds’ names using ESG or sustainability-related terms. Irrespective of Taxonomy-compliant activities, all other activities or practices may very well be one way or another in a state of transition. Why should this new prospective label matter to asset managers? And what are the pitfalls and potential opportunities that lie ahead in this revamped framework?
Transition finance: a primer
Between the signing of the Paris Agreement in December 2015 and the early 2020s, sustainable finance experienced a proverbial moment in the sun, particularly in Europe. Policymakers and lawmakers rushed to launch ambitious action plans, strategies, regulations and policies to promote sustainability. ‘ESG’ became a household term used by financial and non-financial companies. Numerous net zero alliances were established. Banks, insurance companies and asset managers rushed to outcompete one another with ambitious net zero targets.
Then, as SFDR and its ‘Articles 6, 8 and 9’ quasi-labels proved to be too complex to implement and disclose meaningful contributions to ESG factors, reality set in, particularly when it comes to supporting so-called ‘hard-to-abate’ sectors in their decarbonisation efforts. The framework – including for most parts the EU Taxonomy – does not recognise the value of incrementally transitioning a company from a sustainability point of view, and how that may create value along the way. Indeed, it became clear for financial institutions that emissions-heavy sectors that are essential for everyday life – such as steel, cement and aviation – cannot simply be excluded from portfolios or financing activities.
‘Transition finance’ thus emerged as a key, if slightly nebulous, component of sustainable finance. In a nutshell, it entails providing financing to emissions-heavy companies in a way that requires them to reduce their emissions through a clear, science-based and empirically-verifiable framework. The term gained much traction at COP28 in Dubai.
The challenges of transition finance
Despite its promise and necessity, transition finance faces several significant hurdles.
For starters, there are significant greenwashing and accountability risks, as without robust regulatory frameworks and accountability mechanisms, transition finance can become a tool for greenwashing. For instance, a bank might finance an emissions-heavy company’s renewable energy projects, only for that company to use the freed-up capital to extend the life of its fossil fuel assets. This potential misallocation of capital undermines net zero goals at a time when we can ill afford to do so.
Indeed, while the International Capital Market Association (ICMA) has developed a useful and comprehensive guidance through its Climate Transition Finance Handbook – and while several large financial institutions have issued their own transition finance frameworks – the current lack of widely-accepted clear definitions and standards related exacerbate the greenwashing and capital misallocation risks. This policy-regulatory uncertainty, coupled with a lack of accurate data and the multi-faceted complexities involved in overseeing and monitoring enterprise-wise decarbonisation efforts, make transition finance a potentially problematic pathway for financial institutions to adopt, especially for those with strong sustainability credentials.
Further, limiting ‘transition finance’ to hard-to-abate sectors and environmental considerations, seems to again exclude certain sectors from having access to financing to help transition their products and services to a better – potentially less harmful – state over time. This is also where firms need to distinguish between regulatory requirements and ethics- or belief-based ESG exclusions that limit their transition finance framework from the outset – and this is before we start addressing the elephant in the room: defence spending.
Upcoming clarity and opportunities for asset managers
Despite these challenges, the ongoing SFDR review and the potential introduction of a transition finance label present significant opportunities for asset managers.
In theory, clear labels for transition finance can provide recognition for financial products that are credibly on a decarbonisation trajectory or are reducing the negative impact of their products for their consumers, offering investors greater confidence and helping to channel capital towards genuine transition efforts.
Indeed, an SFDR-based clear transition finance category for investment funds would allow asset managers to invest in relevant fixed-income instruments (e.g., green bonds, sustainability-linked bonds) and companies that are on a credible transition pathway, even if they do not yet meet (all) strict sustainability thresholds. This can greatly enhance accountability, especially when paired with robust third-party sustainability assurance.
Moreover, transition finance-labelled funds would help asset managers differentiate their products by expanding the investable universe and supporting real-world environmental or social impacts by improving practices, services and products. By investing in transition finance-focused assets, asset managers can play a pivotal role in driving the development and deployment of new climate technologies, retrofitting infrastructure, and transforming supply chains. After all, transition requires innovation which in turn creates value – this is where asset managers that understand sustainability as a core input into their investment decisions want to differentiate going forward.
As the European Commission moves forward with its SFDR review, the integration of a broad transition finance label could be a substantial step forward for sustainable finance – which might also require a rebranding, as it indicates an end-state and not the journey of improving sustainability. By providing clarity, accountability, and market recognition, such a label would empower asset managers to support the transition of the global economy in different sustainability dimensions, turning transition finance from a buzzword into a powerful tool for real-world impact.
Share via:
Recommended for you