Transition plan stocktaking from the NGFS
Around 42% of micro-prudential authorities worldwide have already started or plan to engage with financial institutions on transition plans, says a recent report from the NGFS. Are current transition plans relevant and usable for micro-prudential policies? How does that fall into their mandate (i.e., supervising the safety and soundness of individual financial institutions)? The report benchmarks 16 transition plans guidelines or frameworks, notably the ones requested in 4 jurisdictions (e.g., Singapore, etc.). The NGFS highlights transition plans discrepant definitions, scopes and heterogeneous use. However, they are becoming a “must have” across jurisdictions worldwide, with nuances between “disclose or explain” and mandatory disclosure, or even mandatory setting of a transition plan.
What we learnt from the NGFS paper:
Definitions and use-cases
- There is an interest in distinguishing “transition plan” from “transition planning”: the latter corresponds to an internal process for a company to develop its transition strategy and deliver on targets, while “transition plan” would be – amongst others – the external facing output for specific audiences (incl. investors).
- Strategy-focused transition plans and risk-focused transition plans coexist, reflecting different use-cases and disclosure status. The first ones are more intended to provide transparency to external audiences, including shareholders and investors, on a firm’s strategic approach to meet specific climate commitments or targets. Conversely, risk-focused plans are primarily focused on how institutions will manage the financial risks associated with the transition to a low carbon economy, and are less publicly disclosed.
The specific situation of financial institutions
- There are diverging expectations around transition plans from diverse audiences: regulators to oversee financial stability, governing authorities to incentizive climate outcomes, and corporates to steer their transition and communicate on it. In this regard, financial institutions’ transition plans, as intermediaries, are more complex to develop.
- Against this backdrop, financial institutions play a dual role in transition planning: they do not operate in isolation and are both “users” and “preparers” of transition plans.
Strategy vs. risks
- Transition plans are today predominantly associated to climate-related disclosures. It is unclear whether risk exposure and risk management are part of such disclosure. It seems that most of the information made available in transition plans relate to strategy planning. The NGFS considers that current transition plans barely or unreliably help for risk management and supervisory needs. However, there are a few attempts. For instance, the Philippines, mentioned in the NGFS stock-take, have mandated transition plans for banks, and are assessed by Philippine micro-prudential authorities. In some instances, transition plans may even serve as an exemption or derogatory clause to financial pressure against (the financing of) brownish actors (past and dismissed amendments on CRR3 to lift capital overweight for fossil fuel lending in case of transition plan existence).
Voluntary disclosure, comply or explain, or obligations
- The EU has adopted a comply or explain approach, as in the UK SDRs, meaning that in case the company does not have a transition plan, it must explain why. In the U.S future rules on climate-related disclosure however, the disclosure is only required if the company has developed one.
- The mandatory adoption of transition plans seems to gain attractivity in some cases. The currently debated CS3D in the EU will force companies to implement a climate transition plan, to the point that directors’ bonuses would be linked to their achievement. Still in the EU, the inclusion of transition planning as a mandatory requirement within financial institutions’ risk management framework is being debated under the 3rd Capital Requirement Regulation negotiations.
Credibility and information materiality
- There is no single or mandatory method or approach to elaborate transition plans, but credibility is a key concern, usually assessed through items like business strategy, risk management, metrics, and governance. Companies are increasingly required to disclose material and “useful” information: for instance, the EU CSRD requires corporate to disclose “where relevant, [their] exposure to coal-, oil- and gas-related activities” as part of their Paris Agreement-aligned transition plan.
Sustainable finance products
- Climate-related disclosure, and transition plans as part of it, plays a role of antechamber of sustainable finance approaches and instruments. The existence, ambition and credibility of transition plans are key concerns for investors, being true eligibility requirement for Sustainable Finance Products. For instance, the recently adopted European Green Bond Standard will require companies to explain how the proceeds are helping to achieve their transition plans.
The foreseen momentum and implementation chapter following this reflection phase – not forecast before years though – must be subject to scrutiny with anticipated transition planning “washing”, economic costs, and stakeholders’ over-responsibilities (especially verifiers or third-party assessors).
Overall, the NGFS paper remains quite undecided on how micro-prudential authorities should request and/or leverage transition plans within their mandate. A lot of questions are still pending: is it about requiring, using, or enforcing a transition plan? Must transition plans become formal? Are transition plans reflecting risks differentials arising from climate risks? How can a financial institution articulate its role as a user of transition from corporates and as a preparer of its own transition plan? After this first stock-take report, the NGFS will continue digging into this topic and try to recommend coordinated way of tackling transition plans within prudential frameworks (Phase 2).
 Basel Committee on Banking Supervision (2022), CDP (2021), Climate Action 100+ (2022), Climate Policy Initiative (2022), Climate Safe Lending Framework / UN PRI (2021), European Sustainability Reporting Standards (2021), Financial Stability Board (2022), GFANZ (2022), INSPIRE-GRI (2022), International Sustainability Standard Board (2022), Investor Group Climate Change (2022), SBTi (2022), Securities Exchange Commission (2022), TCFD (2021), UK Transition Plan Taskforce (2022), UNEP-FI (2021).