UK Transition Finance Market Review (TFMR): Scaling Transition Finance

TFMR sets out a blueprint for the UK to take the opportunities posed by the net-zero transition

On 17 October 2024, the report and recommendations of the Transition Finance Market Review (TFMR) were published. The TFMR sets out the critical components of a market-based blueprint for the UK government to meet its commitments under the Paris Agreement and its Nationally Determined Contributions.  All the while taking advantage of the growth and investment opportunities afforded by net-zero transition for UK businesses and financial institutions.

The TFMR lays out plans for a move away from ‘pure green play’ finance by recommending enabling policies which incentivise and reward investment in transition activities: including investment in high emitting assets and activities with emphasis on decarbonisation. It advises the development of ‘clear and robust sectoral decarbonisation pathways’ to align financial decisions with UK policy on net-zero transition.  The recently published Invest 2035: The UK’s Modern Industrial Strategy embraces the opportunities afforded from the net-zero transition for growth and prosperity in the UK, aligning the UK’s industrial strategy with a sustainable future.

Time is short – the opportunities need to be seized now

We note the very short timeframe given for adoption of the recommendations in the TFMR (six months to three years) – time is of the essence if the opportunity is to be seized ahead of other countries and markets.

Blended finance will be key (amongst other things)

For the financial sector, one of the critical components covered in Chapter 3 is the scaling of finance for transition activities with a particular emphasis on blended finance, both in the UK and emerging markets and developing economies.  Policy and regulatory levers and other tools, such as innovation clusters, repayable/convertible grants, blended finance, subsidies, guarantees and technical assistance, should all be employed to scale transition finance.  Notably, insurance is also an important part of the transition to net zero providing products which address risk protection gaps and which enable scaling of investment by de-risking transactions.

Below, we highlight some of the recommendations from each of the chapters.

Chapter 1 – Defining the scope of transition finance

Feedback to the TFMR’s Call for Evidence showed that market participants did not agree on a definition of transition finance or whether it should be applied to a limited number of hard-to-abate sectors or more widely in the economy.  The TFMR responded by:

• creating a simple, flexible and dynamic ‘Transition Finance Classification System (TFCS)’ which is not a full taxonomy and is for illustrative purposes.  The classification system does not focus on particular sectors or industries but is applied to the entire economy; and
• setting out high level Financial Sector Guidelines for Credible Transition Finance (the Guidelines).  The Guidelines can be used in conjunction with the TFCS to inform credible financial institution transition finance frameworks.  It is intended to provide high level principles which can be further developed by the Transition Finance Council and trade associations or industry-led initiatives.       

The TFMR does address considerations beyond emissions, such as nature, adaptation and just transition but concludes that in the near term the ‘whole-of-economy approach to emissions reduction remains the primary objective of transition finance’.  But government, markets and civil society need to consider how non-emission elements should be integrated into decision-making.

Chapter 2 – Pathways and Policy

Creating an environment of policy security is key to building the transition finance markets in the UK.  The TFMR therefore sets out targeted recommendations for UK policymakers to create this certainty, these include the Government:

• working with industry to consider the most appropriate structure of its net-zero policy framework;
• creating sector decarbonisation pathways;
• ensuring the demand-side of the market is developed as well as the supply-side;
• reinstating the Net Zero Council and communicating effectively with industry and financial institutions especially about policy, regulatory and funding initiatives; and
• considering:
  • the practical policy barriers to the roll out of key technologies and the decarbonisation of key sectors in a systematic way; and
  • policies and measures which can be achieved at macro-level (including at G20- and UN-level), including taxes, subsidies and carbon pricing to ensure that all levers push towards decarbonisation.

Chapter 3 – Scaling finance for transition activities

We have written before about the importance of blended finance to incentivise private sector investment in sustainable finance. And the TFMR agrees.  It emphasises the need for the Government to adjust Public Finance Institution (PFI) mandates to support high risk, emerging transition activities that the market cannot finance independently, including concessional terms and/or the ability to blend with grants.

In connection with this the TFMR also recommends:

• rationalising and streamlining various government funding and blended finance structures and ensuring adequate expertise and economies of scale;
• creating a single, user-friendly gateway for the private sector to engage; and
• creating a database of structured finance solutions across PFIs to replicate successful models and require disclosure of high-level structure information as a condition of PFI support.

In addition, the TFMR recommends establishing a Transition Finance Lab, based at the Green Finance Institute, run by the private sector but funded by the Government.  The Transition Finance Lab would prioritise the sectors and technologies signalled by the Government and should develop and pilot finance structures, including aggregation, funds, securitisation and insurance solutions.  The scope of the Transition Finance Lab should include developing solutions in emerging markets and developing economies.

Not to be left out, the TFMR also recommends that insurers should adapt and develop new insurance solutions for transition activities to address risk protection gaps, collaborate on the structured finance structures developed by the Transition Finance Lab, whilst evolving strategies and practices in support of the transition.  Brokers and (re)insurers should work with the Government and the City of London Corporation to promote the role of the UK’s insurance market in domestic and global transition finance.

Chapter 4 – Scaling finance for transitioning entities

The TFMR recognises that activity-level transition finance is currently available but the market needs to develop to provide entity-level transition finance.  Clear and credible corporate transition plans are crucial to achieving this change. 

It is not a surprise that transition plans form an important part of the transition strategy set out in the TFMR.  The Transition Plan Taskforce and the EU Corporate Sustainability Due Diligence Directive have both underlined their importance in helping to manage the risks and opportunities of the transition as well as monitoring overall effectiveness at a business, investment and country level.  Over time, transition plans should be made public, become more sophisticated and disclose related capital expenditure, operational expenditure and revenue.  

Financial institutions’ capital allocation and pricing decisions will be driven by the clarity and credibility of transition plans.  This information will drive stewardship and engagement from financial institutions as they strive to meet their own targets and transition plans over time.

The TFMR also suggests support for the Loan Market Association’s (LMA’s) development of a transition finance use-of-proceeds label which the LMA has announced it is developing and which is expected to be released in 2025 and also recommends a time limited incentive to support SMEs to uptake of green labelled finance.

Chapter 5 – Scaling transition finance with credibility and integrity

The TFMR recognised that stakeholders were broadly consistent on factors relevant to integrity and credibility and the resulting greenwashing concerns.  They noted that the expectations of the market included (i) demonstrating real economy alignment with a pathway or benchmark, such as alignment with the Paris Agreement; (ii) having governance processes in place for oversight of delivery of the activity or strategy; (iii) application of recognised standards and methodologies; and (iv) disclosure of progress against agreed metrics.  

So the TFMR has recommended regular engagement between regulators (Bank of England and FCA), the Climate Change Committee (CCC), the Department for Energy Security and Net Zero (DESNZ) and the North Sea Transition Authority.  New workstreams should consider appropriate metrics for inclusion in financial instruments, including existing metrics (ISSB, TPT etc) and close engagement with the Climate Financial Risk Forum.  Other recommendations include engagement across the market and with European regulatory authorities to support opportunities for convergence, where possible.  

The TFMR recommends that there is market engagement and collaboration to develop the UK Sustainability Improvers label under the Sustainability Disclosure Requirements (SDR) and that the Government issues its awaited consultation on the UK Green Taxonomy which HM Treasury did on 14 November 2024.

Chapter 6 – Scaling finance in Emerging Markets and Developing Economies (EMDEs)

Transition of the UK to net-zero alone is not enough.  So the TFMR sets out recommendations in connection with advocacy, supporting and developing finance for EMDEs, including providing technical assistance.  The UK government should maximise its levers to leverage private money into EMDE transactions.

Chapter 7 – Delivering on the ambitions of the Review

The TFMR discusses the three key supporting factors which are needed to support the global transition: communication, capacity and governance, including the establishment of the Transition Finance Council within the City of London Corporation which will act as a thought leadership hub and provide governance for the delivery of the recommendations.

What are the roles of the Transition Finance Council, the Net Zero Council and the Transition Finance Lab?

Takeaways

The TFMR conceives of a market shift to embrace the transition to net zero as part of the UK Industrial Strategy 2035 and recognises that the transition to net zero provides opportunities for business and the economy.  

Three organisations exist to support the transition to net zero the Transition Finance Council, the Net Zero Council and the Transition Finance Lab.  Together they are designed to break down the silos which exist between different sectors and business and government.  These organisations will provide much needed coordination within the wider economic and geopolitical landscape.  And they will capture the views and opinions of the public and private sector as well as academic and other sectors.

Next steps

The FCA welcomed the publication of the TFMR’s report and recognised the challenges and complexities around structuring transition finance for firms and the opportunities for long-term investment in the UK economy.  We also understand from press statements that the TFMR’s policy recommendations will be adopted by the UK’s National Wealth Fund which is already tasked with using blended finance and similar tools to increase the impact of transactions.

The TFMR primarily deals with tackling climate change by focusing on net zero transition and until recently much of the guidance has been in relation to carbon emission reduction and mitigation.  But the UK Chancellor, Rachel Reeves, recently highlighted the importance of nature and the materiality of nature-related financial risks in a new remit letter to the Bank of England’s Financial Policy Committee, bringing nature further up the agenda.  

In addition, in October 2024, at COP 16 on Biodiversity, the Taskforce on Nature-related Financial Disclosures (TNFD) published a discussion paper on nature transition plans which provides guidance on developing and disclosing a transition plan covering all aspect of nature apart from climate change and greenhouse gas emissions as drivers of nature loss.  Almost simultaneously, the Glasgow Financial Alliance for Net Zero (GFANZ) published a consultation paper aiming to provide financial institutions with guidance on incorporating nature-related levers in their net zero transition plans, thus dove-tailing with the TNFD discussion paper.  Looking to the future, we can expect to see a lot more focus on including nature in the climate change debate as an important tool amongst many in reaching net zero.

Our global Sustainable Finance & Investment group brings together a multidisciplinary global team that provides clients with best-in-market support.  We are following the development of transition finance in the UK and globally closely so please get in touch if you would like to discuss.

This note is intended to be a general guide and covers questions of law and practice. It does not constitute legal advice.  

Authored by Emily Julier and Bryony Widdup.