By Ira Poensgen

In recent years we have seen a tidal wave of companies announce climate targets, most often in the form of commitments to reduce their greenhouse gas emissions. According to data collected by Net Zero Tracker, over 50% of the world’s 2,000 largest companies (covering a total of USD27 trillion in revenue) have set targets to reduce their emissions to net zero. This signals a momentous step change in private sector climate ambitions.

However, establishing the integrity of these commitments is often difficult. Most firms provide limited information about what steps, if any, they are taking today, to meet tomorrow’s targets.

Developing and disclosing transition plans are critical next steps in the corporate climate journey. Such plans can serve a myriad of different purposes.

The Value of the Transition Planning Process

First and foremost, transition planning can be an immensely valuable exercise for the firm itself. For many companies, particularly those embedded in global supply chains, climate change poses a complex and multifaceted challenge. Firms have to grapple with pressures to rapidly decarbonise their own operations and value chain, in a context where the entire economy around them is transitioning in tandem. At the same time, they also need to respond to the increasingly severe physical impacts of the changing climate.

Responding to these challenges requires firms to answer fundamental questions about what role they want to play in tomorrow’s economy, and what steps they need to take now to get there.

The process of transition planning allows companies to develop robust answers to these questions. This will invariably need to be a conversation that is led from the very top of the organisation, with scrutiny and oversight from the board. But it will also require input and involvement from across the firm, including strategy, finance, research and development and human resources functions. This creates an opportunity to build a cross-company vision of the direction of travel and develop a blueprint for delivery.

Ultimately, a transition plan will help senior management teams manage the transformation of their firm and ensure that they are well positioned to weather climate-related risks, capture opportunities and protect and generate value over the long term.

Why Disclosures Matter to Investors

In addition, investors and lenders are increasingly interested in understanding how their clients and portfolio firms are preparing for, and contributing to, the transition.

This is predominantly driven by a growing understanding that climate-related risks are material in the here and now.

The chronic and acute physical impacts are undeniable. According to data from the Copernicus Climate Change Service, the period from January to October was the hottest on record, with global mean surface temperatures being a hefty 1.7ºC warmer than estimated pre-industrial averages.

The impacts are being felt around the world. Just this year, we have witnessed:

  • the continuation of a severe three-year drought disrupting agricultural production and water access in Syria, Iraq and Iran;
  • devastating floods across the Mediterranean region which has led to over 3,900 casualties in Libya alone;
  • a prolonged heatwave across Argentina, Brazil, Paraguay and Bolivia that has caused major wildfires; and
  • extreme wildfires in Canada that caused at least 17 direct fatalities, led to the evacuation of over 150,000 people, caused major air pollution across Canada and the United States, and burnt over 13 million hectares of land.

According to analysis by the World Weather Attribution initiative, all of these would have been significantly less likely and less intense without human-induced climate change.

In addition, the transition risks faced by companies are also growing. Policymakers around the world are introducing climate policies with significant impacts on private markets. Prominent examples include the US Inflation Reduction Act as well as the European Union’s Corporate Sustainability Reporting Directive and Carbon Border Adjustment Mechanism. Similarly, data from the London School of Economics and Political Science’s Grantham Research Institute on Climate Change and the Environment show that the number of companies targeted in climate litigation cases has been steadily increasing for years.

To make informed lending, underwriting and investment decisions, financial institutions need to understand which firms are taking the necessary steps today to respond to these risks.

Transition plans provide this missing layer of information, helping investors identify those who are supporting stated ambitions with concrete action.

Investors are starting to recognise this, and are asking their clients and portfolio companies for improved disclosures. For example, Norges Bank Investment Management, the Norwegian sovereign wealth fund which manages assets worth USD1.4 trillion, updated its expectations to companies this year, calling on investee firms to develop credible transition plans.

Helping Transition Finance Scale with Integrity

Thirdly, these plans are crucial for allowing transition finance to scale with integrity.

To successfully tackle climate change, we need to overcome a major investment gap. The Intergovernmental Panel on Climate Change estimates that we need a three- to six-fold increase in annual mitigation investments in the run up to 2030 to reach the goals of the Paris Agreement. This is supported by modelling from Bloomberg New Energy Finance, which estimates that an average 4:1 ratio of investment in low carbon versus fossil energy supply will be required by 2030 to support limiting global warming to 1.5ºC. 

This hurdle is particularly acute in emerging and developing economies which need to expand access to affordable energy, cater for growing domestic energy demand, whilst simultaneously reducing the carbon intensity of their energy systems.

According to analysis conducted by the International Energy Agency, meeting climate and sustainable development goals in emerging markets require annual investments in clean energy systems to more than triple to between USD2.2 trillion and USD2.8 trillion by the early 2030s (around USD200 billion to 240 billion of which are needed across Southeast Asia). An estimated 60% of this financing will need to come from the private sector.

Many leading financial institutions have publicly committed to supporting this transition. However, it is currently often challenging for investors to assess whether investing in a given company or asset will support business-as-usual practices or contribute to the required progress. In order to effectively allocate capital, they need to understand not only where a company or asset is today, but where it plans to be tomorrow.

Transition plans can help investors identify which firms are backing up ambitious targets, with concrete action and mechanisms for accountability. This will enable them to direct capital to companies and assets that are making meaningful contributions to the transition, and away from those that aren’t.

Transition plans can also act as reference points in transition finance products and instruments. For example, the metrics and targets in a transition plan could be used as key performance indicators in sustainability-linked bonds, strengthening the incentives for delivery.

Global Momentum is Growing

Private actors around the world have started to recognise the benefits of transition planning. It therefore isn’t surprising that we are seeing an increasing number of firms pressing ahead and publishing their first plans.

At the same time, the global political and regulatory momentum behind transition planning is accelerating.

In May 2023, G7 leaders highlighted the need for companies to underpin Paris-aligned, net-zero commitments with credible transition plans. In September, the G20 Sustainable Finance Working Group released a report that similarly calls on financial institutions and corporations to develop and disclose such plans.

In June 2023, the International Sustainability Standards Board (ISSB) released its two inaugural standards, IFRS S1 and S2, which are intended to serve as the global baseline for sustainability- and climate-related reporting globally. The climate-related disclosure standards include several provisions which relate to transition planning.

Increasingly, individual jurisdictions are also pressing ahead with increased expectations on transition planning. For example:

+ The UK Government announced in 2021 that it would move to make the publication of transition plans mandatory across the economy. To support delivery, it set up the Transition Plan Taskforce (TPT), which brings together leaders from across finance, corporates, civil society, academia, government and regulators to develop a ‘gold standard’ for good practice transition plans. The TPT launched its Disclosure Framework in October 2023, which is expected to inform future listing requirements in the UK.

+ The European Union has implemented the Corporate Sustainability Reporting Directive, which requires firms to report in line with the European Sustainability Reporting Standards. This includes requirements to disclose transition plans for climate mitigation.

+ In the United States, the Securities and Exchange Commission has proposed a draft rule that would require public firms to disclose plans where they have adopted them voluntarily. The Treasury has also released voluntary principles for net-zero financing and investment, which emphasise that financial institutions should ensure that their net-zero commitments are accompanied by robust net-zero transition plans.

+ In Singapore, the Monetary Authority of Singapore has recently released consultation papers outlining transition planning guidelines for banks, insurers and asset managers.

+ The Australian government has launched a consultation on a new Sustainable Finance Strategy which lists credible net-zero transition planning as a central priority.

Transition plans are also under consideration as a tool in many multilateral regulatory forums, including the International Organization of Securities Commissions, Financial Stability Board, Basel Committee on Banking Supervision, Network for Greening the Financial System, International Association of Insurance Supervisors, Coalition of Finance Ministers for Climate Action and International Platform on Sustainable Finance.

Overall, transition plans are poised to play a crucial role in tomorrow’s sustainable finance infrastructure.

Emerging Body of Guidance Can Help You Get Started

Developing a transition plan is a complex exercise. But there is an increasing body of guidance that can help preparers get started.

In 2022, the Glasgow Financial Alliance for Net Zero developed recommendations and guidance for transition planning by financial institutions, and published a guide for real-economy companies, outlining what information financial institutions find relevant in their decision-making.

The work by the TPT complements these recommendations by setting out a sector-neutral Disclosure Framework for best-practice transition plan disclosures. It is accompanied by a whole suite of guidance which can support preparers in their transition planning journey.

Central to the TPT’s work is the idea that a credible transition plan requires firms to take a strategic and rounded approach. To avoid unintended consequences, entities need to not only think about how they will decarbonise their own operations and value chains, but also how they will respond to climate-related risks and opportunities and, crucially, contribute to the economy-wide transition towards net-zero and climate resilience.

This will help avoid strategies of ’paper decarbonisation’ which rely on the transfer of high-emitting assets to others who may be less well-placed to support their managed phase-out.

Recognising the importance of building international coherence in emerging norms, the TPT’s work is designed to be consistent with, and build on, the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) and the climate-related disclosure Standard issued by the ISSB. It also draws on the work of GFANZ, ensuring the two initiatives lock together to form an integrated approach to transition planning.

Get Going and Learn Over Time

Uncertainties are a fundamental part of transition planning and companies should be prepared to not have all the answers from the start. Some gaps, such as reliable Scope 3 emissions data, are likely to close over time as emissions reporting is mainstreamed. Others, such as uncertainties about future technological developments or policies, are a more permanent feature of forward-looking planning.

Given what we know about the urgency of climate action, however, this cannot be a cause for delay. Companies should start developing ambitious plans on the basis of what they know now, communicate not only their ambitions but also the strategies, assumptions and dependencies on which these rest, and build on that over time.

Ira Poensgen is the Technical Lead of the Transition Plan Taskforce Secretariat. She is also the Deputy Policy Lead at the Oxford Sustainable Finance Group and Deputy Head of Policy at the Centre for Greening Finance and Investment.