Guardrails to address greenwashing of climate transition finance

ClientEarth has released "Guardrails to address greenwashing of climate transition finance", a paper that sets out clear guidelines for policymakers to plug the global regulatory gap in climate transition financing and tackle the rise of greenwashing in the market.

The paper is the first in-depth analysis of ‘transition-washing’, or greenwashing, in labelled transition finance. It recommends practical policy measures to raise market standards and ensure capital flows to companies that are genuinely transitioning, so that policymakers can unlock the potential of labelled transition finance in the race to net zero.

Labelled transition finance debt instruments – such as sustainability-linked bonds and Japanese labelled transition bonds – hold immense potential for funding the shift to sustainability in high-emitting industries and decarbonising the global economy.

However, transition-washing – defined as providing transition finance to entities not genuinely transitioning to align with the Paris Agreement – is eroding investor confidence, stalling market growth and threatening to derail global climate goals by misallocating capital.

This paper has identified the absence of clear policy guardrails as a key factor enabling the proliferation of transition-washing.

The paper emphasises the need for countries to establish differentiated standards for climate leaders as a way to foster a more inclusive and globally coordinated transition, preventing energy poverty and unemployment and ensuring no one is left behind.

Alex Lombos, lawyer at ClientEarth and lead author of the report, said: "It’s clear that the climate transition finance market cannot be left to police itself. Robust standards are absolutely necessary to urgently restore integrity and stop funds flowing to companies that are failing to transition.

“Our recommendations for an effective policy response to transition-washing in labelled transition finance debt markets, particularly bond markets, offer a practical solution. We show how a strong regulatory framework could fast-track the climate transition by creating and incentivising use of a new playing field for climate leaders in high emitting sectors.”

Risks to investors and market integrity

Transition-washing exposes investors to financial losses and reputational damage. Without strong regulation to maintain robust standards, investor confidence collapses, stalling the flow of funds for a clean transition. Even with confidence, greenwashing can lead to capital going to the wrong places, jeopardising global climate goals under the Paris Agreement.

ClientEarth's paper proposes six policy guardrails to address these risks and restore credibility. These guardrails complement existing market tools with regulatory reforms, and may also help policymakers address transition-washing in other market areas such as loan, equity, and fund markets.

"These guardrails aim to create policy frameworks blending the need for a robust transition finance rulebook with the pragmatism required by the complexity of climate transition finance," added Lombos. "Without such frameworks, transition finance will not catalyse a Paris-aligned net zero transition in the real economy." 

POLICY GUARDRAILS

The paper outlines six key policy guardrails for policymakers to consider:

1. Preparation of  national or regional Paris-aligned emissions reduction pathways to guide corporate transition strategies.
2. Development of scientifically robust classification standards for carbon-intensive activities and technologies.
3. Building capacity in the market for external verification of transition finance instruments.
4. Implementing targeted financial regulation with mandatory threshold requirements for credible use of protected transition finance labels.
5. Empowerment of financial regulators to penalise transition-washing practices effectively.
6. Implementing systemic reforms to scale up transition finance flows, both labelled and unlabelled.

With these tools, robust regulation could create and incentivise the use of a new playing field for climate leaders capable of driving the wider net zero transition.

The position paper also adds that effective regulatory frameworks can empower investors, as these frameworks can help them identify financial centres where labelled transition bonds are likely impactful and less exposed to transition-washing risks. In addition, jurisdictional labels, such as a "UK Sustainability-Linked 1.5°C Bond," could gain greater trust in the sustainable investment market, assuming the UK's regulatory framework is viewed as more ambitious and credible.

Note:

Transition finance is generally understood to mean finance provided to high-emitting economic businesses, sectors and sovereigns for the purposes of their transitions to net zero. It is distinguishable from green finance, which is generally regarded as being for discrete low- or zero-emitting economic activities and projects.