Transition Finance: Connotation, Framework, and Future Prospects

Abstract

The latest IPCC assessment report highlights that climate change has caused widespread adverse impacts and economic losses to nature and humans. Governments and private-sector firms around the world have committed to reducing carbon emissions with the goal of limiting global warming to 1.5 degrees. As of 2022, over 130 countries and regions, representing 91% of global GDP and 83% of global greenhouse gas emissions, have made a net-zero commitment. In this context, “transition finance” is gaining traction among governments and market participants.

The concept of transition finance has recently emerged, and there is no internationally unified standard definition. This paper posits that transition finance refers to the financial services required to support the orderly transition of the real economy towards the net-zero goal. From a functional perspective, transition finance can serve as an expansion and extension of green finance, focusing on supporting carbon-intensive enterprises that have clear plans for reducing carbon emissions. The essence of transition finance lies in a series of capital market instruments with specific functions aimed at promoting the low-carbon transition of the real economy. These instruments can help enterprises manage their transition risks to maintain future competitiveness.

Based on existing initiatives and market practices, this paper explores the fundamental principles of transition finance development and analyzes the positioning and roles of various stakeholders, including the government, enterprises, and financial sectors. In addition, by comparing the main global transition finance approaches and summarizing the common requirements for developing transition finance, the basic content of the five-point transition financial framework was established. First, develop a transition financial support catalog or principles to clarify transition goals; second, develop necessary transition plans that are aligned with internal strategy; third, develop appropriate transition financial instruments; fourth, carry out transition-related information disclosure and assessment; fifth, enforce transition-related policy incentives. This paper explains the basic meaning, necessity of existence, main content included, and current practices in major countries or regions for each item.

Overall, the development of transition finance has just begun, and there are still many challenges. These include the lack of unified transitional standards, an imperfect information disclosure system, and the difficulty in managing transition risks. In the future, the government can enhance the coordination and binding force of the top-level policy system, unify and improve the definition standards of transition finance. The market and regulators can focus on stimulating the vitality of transition finance and enhancing the ability to address risks associated with transition finance. Furthermore, academia and research institutions should actively engage in theoretical innovation regarding transition finance.