European Commission Recommendation on facilitating finance for the transition to a sustainable economy

As part of the 13 June 2023 package, the European Commission stated that its aim is to “ensure the EU sustainable finance framework continues to support companies and the financial sector, while encouraging the private funding of transition projects and technologies.” Although the EU's legal framework does not define the concept of transition finance, transition finance should be understood as the financing of climate and environmental performance improvements to transition towards a sustainable economy, at a pace which is compatible with the climate and environmental objectives of the EU, whilst ensuring the competitiveness of the EU economy. As part of the package, the European Commission therefore set out its recommendations on facilitating finance for the transition to a sustainable economy.

The EU has identified that it will need to invest circa EUR 700 billion more each year from 2021 to 2030 than it did from 2011 to 2020 to decarbonise its economy, achieve its environmental objectives and those of the proposed Net Zero Industry Act.

The recommendation aims to provide insight as to how companies can use the various tools of the EU sustainable finance framework on a voluntary basis, to channel the investments into the transition and manage their risks stemming from climate change and environmental degradation. The objective is to facilitate transition finance, not only for companies that have strong sustainability records already, but also for those that are at different starting points, with credible plans or targets to improve their sustainability performance. It is for undertakings that want to become sustainable but cannot shift in one step to a fully environment-friendly, climate-neutral performance model. Undertakings might have different starting points in the transition to sustainability, depending on various factors, such as the sectors and geographies in which they are active. It also acknowledges that small and medium-sized enterprises face specific challenges that need to be addressed.

The Commission notes that investors and asset owners, and financial intermediaries, can contribute to the financing of the transition by reflecting transition funding objectives in their lending or investment strategy. This may be an opportunity to engage with clients and investee undertakings on transition objectives, including through specific financing solutions and portfolio level targets. Transition planning can help undertakings convert the environmental and climate ambitions into actions, minimise the strategic and financial risks associated with the transition, identify business opportunities, and provide clarity on their business strategy which can attract new investors and business partners.

Financial intermediaries

Providing transition finance to the real economy enables the financial sector to fulfil its financing function during the transition and reduces transition risk over time. Financial intermediaries and investors can contribute to the transition by offering specific transition-related financing solutions that are linked to climate or environmental targets set by undertakings. The recommendations including the following good practice for financial intermediaries:

1. When setting transition targets and designing transition finance approaches for portfolios and investment or lending strategies, financial intermediaries can:

a) consider the recommendations to undertakings on determining transition finance needs and target setting;

b) make sure that the transition finance approach helps the transition and decarbonisation of the real economy, takes into account the different starting points of undertakings, applies the principle of proportionality (in particular to SMEs), and includes relevant climate and environmental safeguards, in line with the definition of transition finance in this Recommendation;

c) translate the transition finance approach into specific targets related to climate or environmental objectives, for all asset classes, and covering all types of finance and all economic sectors that are relevant for the transition; and

d) consider advice and engagement as important parts of the transition finance strategy.

2. To operationalise investment strategies with transition finance approaches and identify undertakings and projects that meet the transition targets, financial intermediaries and investors can:

a) use information provided by undertakings to determine transition targets and transition finance needs, including transition plans and corporate reporting;

b) use the decarbonisation methodologies required under the EU climate benchmarks such as clear decarbonisation targets by undertakings and restricting new investments in potentially stranded assets;

c) use the Taxonomy framework and criteria to identify investments that are eligible and could become Taxonomy-aligned, where necessary through interim steps according to a timetable that is compatible with the transition. For example, where necessary, consider as a first step to finance transition steps beyond performance levels defined by the do-no-significant-harm criteria and a second step to align with substantial contribution criteria, clarified in an activity-based transition plan; and

d) use disclosures and prospectuses that accompany the issuance of green-, transition- and sustainability-linked bonds or equity.

3. When engaging with clients and investee undertakings, the following aspects could be discussed:

a) material sustainability impacts, risks and opportunities, and how climate and environmental impacts and risks are addressed;

b) how the contribution to a climate or environmental objective is determined and what the time horizons for the lending or investments are;

c) the underlying transition pathways, to ensure that the lending or investment strategy is compatible with the transition;

d) whether or how the principle of ‘do no significant harm’ as defined in Article 17 of Regulation (EU) 2020/852 is applied and how adverse impacts are dealt with; and

e) how sustainability performance and the transition targets and plans of undertakings will be taken into account, including in assessing the risk of stranded assets, and transition risks and physical risks more broadly.

4. Green or other sustainability loans.

• Financial intermediaries are beginning to offer such loans and might offer competitive interest rates when the envisaged environmental performance underlying the loans helps to reduce transition risks or allows for lower refinancing rates for the financial intermediary.
• Investments in performance improvements at the level of undertakings could be financed through a sustainability-linked loan with science-based, time-bound climate or environmental performance targets serving as safeguards, and where interest rates are linked to achieving the planned sustainability performance targets, avoiding lock in effects.
• Articulating the purpose and specific goal through transition targets related to the criteria of the Taxonomy could encourage the take-up of loans dedicated to the transition.

5. Green or other sustainability bonds.

• To raise transition finance for a specific purpose, issuers could consider issuing bonds that demonstrate the use of proceeds for transition purposes.
• While international green bond standards exist and could be used to raise transition finance, undertakings could also consider using the European Green Bond Standard for issuing green bonds to finance economic activities that will become Taxonomy aligned in 5 (exceptionally 10) years.
• They should be linked to sound sustainability performance targets.

Small and medium-sized enterprises

• Small and medium-sized enterprises (SMEs) might need to finance their transition, and where this is the case, they could benefit from obtaining transition finance by providing key sustainability information.
• However, due to their size and more limited resources, this can be difficult and costly.
• SMEs might need the support of their financing partners, suppliers and customers in their value chain when considering their transition finance needs and accessing transition finance in practice.