Transition plans need to be mandatory to be effective, say experts

Transition plans have been touted as one of the key tools financial firms can use to move towards a greener economy. Experts say they are the next step after net-zero commitments and targets. But just how useful they can be may depend on what is included, and whether they are mandated or voluntary.

Climate transition plans are time-sensitive action plans outlining what steps a company will take to make its business strategy and operations align with a 1.5°C goal. They usually include detailed, future-oriented actions which work towards longer-term goals, such as reducing company emissions or lowering investments in fossil fuels.

While net-zero commitments are usually about reducing emissions, transition plans tend to have more specific metrics, said Anderson Lee, a research associate at the World Resources Institute. So instead of just publishing a broad number of how much sustainable finance they have mobilised, banks are becoming more specific about the areas and categories, which can help stakeholders see how and where financial institutions are performing.

But one of the key issues of transition plans is standardisation is lacking across jurisdictions, so comparability is lost, Lee said.

Being able to compare on an “apples-to-apples basis” would be helpful but difficult to do, “because a lot of the assumptions, details, or even disclosures, they vary a lot from bank to bank”.

Many transition plans focus on the disclosure aspect and do not address how to assess the credibility of such plans from a holistic perspective, said Romain Poivet, climate and energy engagement lead at the World Benchmarking Alliance.

He says transition plans should have a triple consistency: be in line with the Paris Agreement; consistent with its sector and the area in which the company operates; and feasible within its proposed timeline.

But for the financial sector it’s a bit more complicated, as they play more of an indirect role in the transition. They can work to make sure that the loans and investments they make are in line with the Paris Agreement and that those companies’ transition plans are reliable, in the same way that banks today will look at financial statements of a business before offering a loan.

“The role of financial institutions is a bit more of a supporting role for the transition of their counterparties,” Poivet said.

Mandatory vs voluntary transition plans

While transition plans will be mandatory in the EU under the capital requirement directive, financial regulators are still hashing out the details of what will be required.

And not every jurisdiction is in favour of making them mandatory. In October, finance ministers and central bank governors from the G20 welcomed “voluntary and nonbinding” transition plans but fell short of asking for such disclosures to be mandatory.

But experts say transition plans should be mandatory, as research has found that voluntary climate commitments are not always effective.

Mats Marquardt, a development economist at the New Climate Institute, said the connection between a financial institution and the companies and assets they lend to is very complex. While banks can have an impact through divestment, exclusion and, to some extent, engagement, “the ability of financial institutions to really influence emissive assets all the way on the other side of the spectrum is very limited”.

In a paper published by the institute in 2023, Marquardt and his colleagues analysed the net-zero targets of financial institutions and found that even for banks that have set ambitious goals, “there is very little happening”.

This was true not only for the banks’ portfolios but also, as far as they could assess, there was very little impact on the real economy. A separate report from the World Resources Institute looking at bank net-zero commitments had similar findings, namely that no plans would actually achieve net-zero emissions.

“Is it really the right approach to rely on voluntary net-zero targets that are so difficult to set, that rely on such complex methodological questions and require so much data that we currently don’t have?” Marquardt asked.

Making transition plans part of financial reporting

Many companies see transition plans as a reporting exercise when they should instead be seen as a tool to steer the company in the same way that financial reporting is used, Poivet said.

“You don’t do financial reporting just to please the stakeholders who ask companies to report financial reports; you do financial reports because it’s also helping you to have your forward-looking perspective,” he said.

Companies, including financial institutions, are being asked to move away from their current business model, so there tends to be a bit of pushback against transition plans. This is why Poivet argues that it is important to push for mandatory transition plans at an international level and even for national transition plans.

“There are not enough carrots to make sure that companies will transition toward a low-carbon world,” he said.

But more importantly, countries need to put the tools in place to allow companies to implement their transition plans. If countries do not have the supporting infrastructure, then companies should not be blamed for not doing anything, he said.

Some companies may make net-zero goals, which can sometimes be detailed in transition plans. But such goals are not as effective as some companies claim and can even lead to greenwashing.

Transition plans for financial institutions should not only be mandatory but should also be linked to the compensation of bank executives, said Lee from the World Resources Institute.

Tying transition plans to remuneration is an “important lever, leverage for setting [them], incentivising senior leadership, and then that translates into overarching policies for the institution” as “compensation is a big driver of behaviour,” he said.

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