%20(13).png)
WeeFin takes a closer look at the regulatory landscape and the reference frameworks available for assessing issuers' transition plans.
Our analysis will be structured around 6 key areas of focus. And to get an expert view, we interviewed Romane Delevoie and Vincent Kiefer fromADEME, and co-founders of the the Assessing low Carbon emission Transition (ACT) initiative, and Luc Olivier, manager of a climate and biodiversity fund at LFDE.
The International Monetary Fund estimates that an additional annual investment of €3,740 billion, on top of the €830 billion already needed, will be required globally between now and 2030 to achieve the Paris Agreement targets by 2050.
To achieve this ambitious 2050 target, the United Nations Climate Action has identified five key strategies to accelerate the transition to renewable energies. One of these calls for a tripling of investment in the low-carbon energy sector, highlighting the essential role played by the financial sector in the ecological transition.
The need to take a long-term view in order to promote the transition is supported by Luc Olivier :
Companies that innovate in the field of clean technologies and renewable energy are likely to be well positioned to face future challenges.
To guide these financial flows, it will be necessary to provide stakeholders with common and clear definitions. This is why the European taxonomy has defined an "asset in transition" as an investment that meets the following three conditions :<br>
However, this concept of transition must also include the social aspect, notably through the principle of a just transition, associated with equitable transformation for all stakeholders. So, despite a desire to provide a common language for this term, there is no single definition to date that can help stakeholders.
That said, ESG regulations and initiatives appear determined to integrate this notion into their texts through mechanisms such as the SRI Label, SDR, TCFD and the CSRD. They encourage companies to reassess their strategies and their investment portfolios, integrating the transition aspect at different levels of the entity. So, even if the regulatory framework relating to transition remains vague, it is starting to become clearer. Both Romane and Vincent agree, and also highlight the objective of unifying the different regulations so that they "speak the same language", thus facilitating understanding and actions required by the different players in the market.
To date, each regulation and initiative has highlighted the notion of transition in different ways. For some, this takes the form of quantitative constraints such as a minimum investment in assets in transition, while for others it involves transparency requirements regarding the construction of transition plans. In order to understand the methods of integrating transition within these guidelines, WeeFin has put together the following summary table:
%20(1500%20x%20850%20px)%20(3).png)
Systematic inclusion of the notion of transition in future regulations?
As this is a key issue for achieving the international objectives of carbon neutrality, it is highly probable that transition will be included in each new European financial regulation. For example, the proposal to overhaul the European SFDR regulation, which is currently being assessed, also includes a transition reporting element via the inclusion of a question on the decarbonisation objectives of the financial product.
However, although these texts refer to transition via quantitative and/or reporting requirements, they do not provide a specific methodology for building a strategy linked to this notion. Rather they recommend the use of existing reference frameworks, such as the ACT initiative or the TPT (Transition Plan Task Force).
As pointed out by Romane and Vincent, representatives of the ACT initiative, (to which LFDE is actively contributing within the working groups) :
Financial players, whether small, medium or large, currently lack transition plans. This is mainly due to the difficulty in fully grasping the associated implications.
To meet the requirements set out above, financial players need to implement transition-related strategies in the management of their financial products. These can be associated with different approaches, such as engagement through dialogue and voting, or exclusion / stock selection.
To do this, financial players can rely on existing reference frameworks, such as :
The ACT initiative has developed several modules:
It is vital to analyse the climate objectives promoted by an entity. This is because, as the representatives of the ACT initiative explain, "sometimes the objectives set are not ambitious enough, or although they have been achieved, they may not be sufficiently binding". To enable investors to integrate the transition into their investment process, the World Benchmark Alliance has published indices presenting the ACT scores for several industries. This is to highlight the positioning of a large number of companies in the same sector in relation to their transition and contribution to a low-carbon economy.
Practical example of using Zerolytics :
The SBTi assesses the emissions reduction targets of companies and financial players. Once a company has committed to defining an emissions reduction target, it has 2 years to develop. It must then be validated by the initiative. If the target(s) are approved, companies can announce their objectives and publicly communicate the strategies for achieving them. It is important that companies respect the 2-year deadline. More than 200 companies have recently had their net-zero commitments withdrawn by the initiative, either because they failed to meet the deadline for setting net-zero emission targets, or because subsequently they decided not to use the SBTi.
Practical example of using Zerolytics :
The ZerloLytics model analyses net zero transition plans and focuses on how companies allocate their capital expenditure.
This assessment measures companies' readiness and progress towards net zero by quantifying the gap between current emissions and the reductions needed to meet their climate goals. The analysis provides an overview of the investments and actions required to achieve net zero, and the impact on revenues, profits and CapEx allocations.
Practical example of using Zerolytics :
Avoid greenwashing! In addition to complying with regulations, it is essential to implement a robust and transparent decarbonisation strategy in order to avoid any greenwashing practices. Thus, to identify transition plans that are inconsistent with their stated objectives, Reclaim Finance published a report in January 2024 highlighting several indicators to identify potential "red flags" in transition plans. For example, an entity promoting a transition plan without integrating a formal escalation process into its commitment policy could potentially be accused of using greenwashing in its communications. It should be noted that this process is specific to each financial entity.
Luc Olivier explains the process at LFDE. When an alert is triggered on a portfolio, an escalation process is initiated, commencing with the identification of the main contributors to the deviation from defined objectives.
The fund management team then adjusts the portfolio weightings, which may simply be as a result of market movements or changes in the portfolio composition. Each modification is examined on a case-by-case basis. The escalation process should include a defined timeframe with the option to disinvest if previously confirmed commitments are not met.
In addition to these methods, it is common for asset management companies to use internal methodologies. Luc Olivier highlights the methodology utilised by LFDE: "Given the limitations of the data available (which is often imperfect and does not allow for a precise selection of issuers), we established a qualitative internal method called Climate and Biodiversity Maturity, developed with the help of the consultancy firm ICARE, comprising a checklist for systematically assessing companies on different aspects of sustainability and ecological transition. The checklist includes an analysis of companies' past and present carbon trajectories, the coherence of their transition plan, governance (including the existence of management committees dedicated to climate issues), and the quality of disclosure of information relating to climate and biodiversity".
These methodologies can be built using the previously highlighted frameworks (ACT, SBTi, Zerolytics) and in particular the Reclaim Finance checklist, based on the recommendations from the United Nations High-Level Expert Group (HLEG). This checklist defines the minimum criteria for a transition plan to be considered robust, and consists of a 5-stage analysis. This list also assesses the completeness and relevance of existing public reference frameworks of transition plans. In this way, a financial player can define its own transition plan assessment criteria based on the Reclaim Finance methodology.
Temperature alignment involves projecting one or more scenarios over a time horizon, and can be used to measure an asset's level of transition towards the Paris Agreement's 1.5°C target. By assigning a temperature alignment value, investors can directly compare the climate performance of different companies or sectors and orient their investments according to the temperature results. For more information on the alignment methodology, please consult this article.
This is one of the metrics that La Financière De l'Échiquier uses to ensure that its Climate & Biodiversity Fund is well aligned with a trajectory below 2°C. Luc Olivier, manager of this fund, emphasises the importance of updating this data daily and implementing controls to monitor the performance.. This makes it possible to monitor and take the necessary action if alerts are raised, such as rebalancing or even divestment if commitments are not met.
By connecting to several data providers, the ESG Connect platform enables financial institutions to monitor and control the temperature alignment of their portfolios. In this way, ESG Connect enables them to anticipate the financial climate risks of companies and ensure that the temperature results of portfolios are consistent with the stated environmental ambitions. In addition to a tool offering all these functions, clients can also utilise the expertise available at WeeFin to analyse and improve their transition plans.
.gif){kind=spacer}
