A small manufacturer that intends to switch to decarbonized equipment sits down at a bank counter. The officer asks which equipment, by when, and down to what level of emissions. Are there criteria to verify the answers, and a procedure to check years later whether those answers were actually kept, behind that counter? Transition finance is not decided by the number of agreements signed, it depends on whether these two things are in place.
Since NH Financial Group carried out the first such deal, business agreements and dedicated support products from banks have followed one after another. The channel for funding companies moving toward decarbonization is widening. The function of screening who qualifies to pass through that channel has not grown as much.
Transition finance without screening criteria and a post-loan management system ends as a repackaging of existing corporate credit with a green mark added.
Transition finance is the concept of funding a business that is moving from brown to green. A business already classified as green falls outside its scope. That is what makes screening difficult.
The fact that current emissions are high is not in itself a disqualification, and instead the question is whether the reduction pathway is credible. If the base year and units of the reduction target, the interim review point, and the treatment of a shortfall are not written into the loan agreement, screening amounts to transcribing a declaration.
The counterargument is strong. In the early stage, growing the market comes first, and setting strict criteria excludes the mid-sized and small companies that actually need the funding. In practice, the firms with staff able to design a reduction pathway on paper are concentrated among large corporations. This point is valid.
But the answer should not be to lower the criteria, it should be to build the criteria on their behalf. If standard reduction pathways by industry and verification forms are supplied by the public sector, companies gain the language to pass screening without paying for consulting. Remove the criteria and the money flows but no reductions remain. The losses then fall on the banks that discover the bad loans years later, and on the credibility of the term transition finance itself.
Post-loan management is the weaker link. A loan is assessed once at execution and that is the end of it, but reductions occur over 5 or 10 years. Without a linkage mechanism that periodically collects emissions performance after execution, compares it with the target, and adjusts the interest rate or the limit when a deviation is confirmed, the name transition is valid only on the day of execution.
The number of agreements and product launches looks set to keep rising. Only when it begins to be disclosed how often credit classified as transition finance is reviewed after execution, and how cases falling short of targets are handled, can the substance of this market be gauged. Whether the review cycle and the criteria for handling shortfalls are disclosed is the point to watch.
