Executive Summary
To support a global net-zero transition, all sectors of the economy, and especially high-emitting ones, need to rapidly decarbonise. To help fund their decarbonisation process, the concept of transition finance has been gaining traction over the past years, complementing existing green finance efforts by governments, donors, and Multilateral Development Banks (MDBs), to make private finance flow to more sustainable activities.
Transition finance focuses on raising and providing funds to decarbonise high-emitting economic activities and industries that currently do not have a fully feasible zero- or near-zero emission alternative. An increasing number of jurisdictions are beginning to put forward elements of transition finance policy frameworks, such as transition taxonomies and requirements on company transition plans.
Given this focus, a key question in transition finance is how to ensure the alignment of eligible investments with the temperature goal of the Paris Agreement. The debate largely focuses on investments involving fossil fuels, such as assets using unabated fossil fuels in energy-intensive industry sectors, and lending to companies with fossil fuel assets.
These investments bear a high risk of ‘carbon lock-in’. Carbon lock-in occurs when fossil fuel infrastructure or assets (existing or new) continue to be used, despite the possibility of substituting them with low-emission alternatives, thereby delaying or preventing the transition to such alternatives. To prevent carbon lock-in to the extent possible, and ensure the environmental integrity of transition finance, relevant investments must be carefully selected and carried out with appropriate safeguards in place.
Existing approaches and policy frameworks for transition finance emphasise the need to avoid carbon lock-in, but largely do not set clear guidance or criteria on how to do so. In the absence of consensus on how to avoid lock-in, finance may be directed to projects that do not have sufficient safeguards in place to ensure alignment with the temperature goal of the Paris Agreement. Similarly, corporates seeking transition financing may fear accusations of greenwashing.
The concept of carbon lock-in is a recurring theme in discussions around policy and financing for climate change mitigation. Existing public and private finance and investment frameworks and tools reflect to varying degrees the growing importance of carbon lock-in risk. However, as the window of opportunity to stay within the Paris temperature goal is closing, the issue of lock-in risk and questions on how best to mitigate it will need to take centre stage.
Building on the OECD Guidance on Transition Finance: Ensuring Credibility of Corporate Climate Transition Plans, this report provides an analysis and overview of relevant mechanisms to prevent carbon lock-in, taking inspiration from both private and public finance and investment frameworks and tools. It presents key findings and good practices to support policymakers in developing comprehensive and credible transition finance definitions and frameworks, as well as standards for relevant financial instruments, that can effectively reduce carbon lock-in. Key findings include:
Transition finance definitions can be strengthened by providing clarity on how to assess feasibility as part of eligibility criteria, and by taking a long-term approach in the assessment.
National sectoral emissions pathways can guide technology roadmaps, robust transition taxonomy criteria, and similar tools, as well as allowing companies to develop credible net-zero plans and targets.
Sunset clauses for use of fossil fuels can reduce carbon lock-in risk for assets where a fuel switch is planned to ensure alignment of the asset with the Paris temperature goal.
For assets where a fuel switch is needed to achieve alignment with the Paris temperature goal, flanking measures that ensure the switch happens in a timely manner can contribute to preventing carbon lock-in.
The development of standards and policy frameworks for sustainability-linked instruments is necessary to address emerging loopholes which increase the risk of lock-in of related investments.
These key findings are relevant to policymakers and regulators who have developed or are considering developing transition finance policies (for example, taxonomies, roadmaps, or guidance), standards for green, transition and sustainability-linked debt, frameworks for corporate transition plans, or broader climate-related disclosure frameworks. In collecting good practices that are relevant to each part of the transition finance ecosystem (definitions, asset-level requirements, entity-level tools and guidance, standards, and frameworks for relevant financial instruments), the report aims to support policymakers and regulators in developing holistic and robust transition finance policy frameworks.