The Paris Agreement resulted in a global commitment from both developing and developed nations to limit global temperature from increasing more than 1.5°C above pre-industrial levels.[1] Achieving this goal requires halving global greenhouse gas (GHG) emissions by 2030 and reaching net zero by 2050, otherwise our chances of preserving a livable planet will be dramatically reduced. In this sense, transitioning to net zero has become a global commitment and a challenge, as it comprises every aspect of the way we produce, consume, and live. Even though there is still a long way to go, some progress has been made: as of June 2024, 107 countries, which are responsible for around 80% of global GHG emissions, have adopted net zero pledges, resulting in new regulations and national policies.[2] Moreover, a growing number of economic players are actively participating in this global effort, as evidenced by the increasing membership in international initiatives focused on achieving net-zero goals. For instance, Race to Zero —the world’s largest coalition of non-state actors committed to halving global emissions by 2030— now boasts over 14,000 members, including more than 9,000 companies and 600 financial institutions.[3]
Governments’ net zero agendas increasingly emphasize transparency and accountability among economic actors.[4] Many now require financial institutions and companies to disclose climate risks, opportunities, strategies, and publish net zero transition plans.[5] For example, in the UK, by 2026, the Welsh Government will require all procurement tenders over £5m to have a carbon reduction plan as a pre-requisite.[6] In addition, the UK became the first G20 country to require disclosure of climate-related financial information on a mandatory basis (applicable to traded companies, banks and insurers, as well as private companies with over 500 employees and £500 million in turnover).[7] In addition, as part of transition plan requirements in the European Union, the Corporate Sustainability Due Diligence Directive (CSDDD) sets out an obligation for large companies to adopt and implement a transition plan for climate change mitigation.[8] This creates a ripple effect (see Figure 1): as governments and regulators introduce new regulations, financial institutions adopt their own net zero targets and strategies, influencing decision-making and affecting companies seeking financing. In turn, these companies develop net zero transition plans, impacting their suppliers and extending accountability across the value chain.
Figure 1. Ripple Effect
This blog aims to bring clarity into the different aspects of transition plans and their importance for both the companies that elaborate them, and the financial institutions supporting them. Specifically, this blog focuses on the key components of credible net zero transition plans, which are critical for financial institutions assessing client alignment with their net zero targets.
The Strategic Role of Financial Institutions in Corporate Net Zero Planning
The establishment of net zero commitments involves changes in a financial institution’s strategy, as it influences decision-making, and in turn, asset allocation.[9] To align with net zero transition plans, financial institutions may implement additional criteria in their client screening process, modifying the terms of their financial products and services to include the consideration of climate-related Key Performance Indicators (KPIs), as well as offering assistance and engagement with clients and portfolio companies in developing credible transition plans.[10] These modifications will have significant implications for companies from all sectors whose progress and commitments on net zero will play a crucial role in their access to financial products and services, especially for companies from hard-to-abate sectors (i.e., steel, cement, and petrochemicals).
In this sense, financial institutions play a vital role in shaping a company’s transition plan —a set of goals, actions and accountability mechanisms that align a company’s activities with the path to net zero.[11] Through their financing strategy, financial institutions can incentivize or discourage certain practices in order to contribute to a low carbon economy. More importantly, companies seeking access to capital and financial products and services that will finance its transition, must demonstrate their commitment to net zero through a credible net zero transition plan, as this will provide financial institutions the information needed to make financing decisions. Furthermore, developing a credible transition plan can serve as a reporting mechanism for financial institutions that want to assess the credibility of a company’s climate objectives, which increases a company’s transparency and credibility, and reduces its risks of greenwashing.[12]
Defining a Credible Net Zero Transition Plan
As defined per Carbon Disclosure Project (CDP), a credible net zero transition plan is a “time-bound action plan that outlines how a company will achieve its strategy to pivot its existing assets, operations, and entire business model towards a trajectory” aligned with the goals of the Paris Agreement of limiting global warming to 1.5°C.[13] As such, credible net zero transition plans enable companies to disclose their commitments and progress on its path to net zero, and fortify its image to investors and financial institutions.
Key Components of a Credible Transition Plan
When building a credible net zero transition plan, companies should have in mind CDP’s six guiding principles. A credible net zero transition plan should be: i) accountable, ii) internally coherent, iii) forward-looking, iv) time-bound and quantitative, v) flexible and responsive, and vi) complete.[14] This means that a net zero transition plan should set decarbonization goals for the short- and long-term towards 2050, with quantitative KPIs with defined timeframes, and accompanied with accountability mechanisms to monitor and disclose the company’s progress.
In addition, to comply with regulatory requirements and financial institutions’ net zero transition goals, when preparing their net zero transition plans, companies should incorporate the following elements into their plans:
Figure 2. Key Components of a Credible Climate Transition Plan[15]
Reaching net zero by 2050 is becoming a common commitment and challenge for companies from different economic sectors, it requires collective efforts to enhance more transparency and accountability. A credible net zero transition plan represents an effective tool for companies that want to demonstrate progress and real commitment in constructing a more sustainable and livable future. Implementing such transition plans also offers companies a way to reduce their climate transition risks and benefit from new opportunities, aligning with financial institutions’ own net zero strategies and supporting the company’s long-term growth.
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Natalia Velázquez is an Associate at HPL, graduated with a Bachelor’s Degree in International Relations from the Instituto Tecnológico Autónomo de México (ITAM). In HPL, she has supported 19 consultancy projects related to sustainable finance research, market guidance development, and the preparation and structuring of thematic bonds for development banks, commercial banks, and corporates in LAC. Natalia has also contributed to the execution of sustainable finance studies for multilateral development banks and international organizations.
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References
[1] United Nations (2015). Paris Agreement. Available here.
[2] United Nations (2024). For a livable climate: Net-zero commitments must be backed by credible action. Available here. Accessed 08.11.24.
[3] Race to Zero (2024). Race to Zero. Available here.
[4] Teneo (2024). Net Zero Transition Planning: From Apprehension to Opportunity. Available here.
[5] GFANZ (2022). Expectations for Real-economy Transition Plans. Available here.
[6] Department for Energy Security & Net Zero (2023). Net Zero Government Initiative UK Roadmap to Net Zero Government Emissions. Available here.
[7] GOV.UK (2021). Press Release – UK to enshrine mandatory climate disclosures for largest companies in law. Available here.
[8] CSDDD (n.d.). The Corporate Sustainability Due Diligence Directive (CSDDD) – Directive (EU) 2024/1760. Available here.
Also see: EFRAG (2024). Implementation Guidance [draft] Transition Plan for Climate Change Mitigation. Available here.
[9] GFANZ (2022). Expectations for Real-economy Transition Plans. Available here.
[10] Ibid.
[11] Ibid.
[12] OECD (2022). OECD Guidance on Transition Finance. Ensuring Credibility of Corporate Climate Transition Plans. Available here.
[13] CDP (2024). CDP Technical Note: Reporting on Climate Transition Plans. Available here.
[14] Ibid.
[15] Ibid.