Transition Finance Unlocked: How Capital Can Accelerate Real-World Sustainable Change

To align with the Paris Agreement and limit global warming to below 1.5 degrees Celsius, financial institutions are recognising that decarbonisation cannot rely solely on green investments. While clean technologies such as renewables and electric vehicles are essential, they address only part of the emissions landscape. Over 30 percent of global greenhouse gas emissions originate from hard-to-abate sectors such as steel, cement, chemicals, oil, and gas, industries that remain critical to economic infrastructure and long-term portfolio exposure.¹

For investors, this presents both a systemic risk and a strategic opportunity. Without credible transition pathways, these sectors may face rising regulatory, reputational, and stranded asset risks. At the same time, enabling their decarbonisation through transition finance can unlock value by supporting the emergence of climate-resilient business models and technologies. This is where transition finance becomes a powerful tool, not only to close the emissions gap but also to position capital for long-term real-economy impact.

Transition finance refers to financial capital directed at helping high-emitting sectors reduce emissions and transform their operations over time. Unlike green finance, which supports projects already deemed sustainable, transition finance recognises that many companies need to evolve from their current state toward credible science-aligned decarbonisation pathways.

Transition finance aims to deliver real-economy impact. It is particularly relevant in sectors where the decarbonisation journey will be long, capital-intensive, and dependent on technologies that are not yet commercially viable.

According to the International Energy Agency, over 50 percent of the emissions reductions needed by 2050 will rely on technologies still in development. Without targeted capital flows and financial innovation, sectors such as shipping, aviation, and heavy industry may remain locked into high-emissions trajectories creating long-term transition risks and missed climate opportunities.

Despite growing climate commitments, global emissions continue to rise. Current climate finance flows remain heavily concentrated in low-emission sectors, largely through green bonds and ESG-linked equity. This concentration risks reinforcing a narrow definition of sustainable investing and leaves high-emitting sectors behind.

Transition finance addresses this gap by directing capital toward carbon-intensive industries that must decarbonise for net-zero targets to be met. It broadens the scope of sustainable capital allocation by enabling real-world emissions reductions, not just portfolio rebalancing or exclusions.

Importantly, transition finance also supports a just and inclusive transition. Sectors like coal, steel, and oil remain significant regional employers. Financing projects such as retrofitting, fuel switching, or carbon capture not only reduces emissions but also helps safeguard jobs and communities that might otherwise face abrupt economic displacement.

While definitions are still evolving, a growing set of market and regulatory principles are beginning to shape the boundaries of transition finance. For capital to be considered transition-aligned, investments typically need to demonstrate a credible science-based decarbonisation pathway, alignment with frameworks such as the Science Based Targets initiative or GFANZ, and time-bound implementation plans with measurable progress.

Unlike green finance, which supports already sustainable activities, transition finance facilitates the shift from high-emission to low-emission operations. Examples include:

• Retrofitting cement plants to reduce clinker content
• Deploying ammonia or biofuels in maritime transport
• Installing carbon capture and storage in industrial gas processing
• Reducing methane emissions in upstream oil operations

Several international taxonomies are beginning to define such activities, including the EU Platform on Sustainable Finance, Japan’s Basic Guidelines for Transition Finance, and the ASEAN taxonomy. However, the lack of harmonisation remains a challenge for global investors.

Financial innovation is expanding the transition finance toolkit. Key instruments include:

• Transition Bonds: Debt instruments tied to a clear transition strategy pioneered by Japan in sectors such as energy and steel.
• Sustainability-Linked Loans: Loans with interest rates linked to achieving specific decarbonisation key performance indicators
• Blended Finance: Public or philanthropic capital de-risks investments in emerging markets, attracting private sector funding
• Guarantees and Concessional Finance: Offered by Multilateral Development Banks to absorb early-stage risk and mobilise institutional capital
• Credit Rating Integration: Credit rating agencies are beginning to factor corporate transition plans into credit assessments influencing the cost of capital

As transition finance gains traction, maintaining integrity is critical. Without robust guardrails, the risk of greenwashing, overstating the climate benefit of financial products, can undermine trust and market confidence.

To ensure credibility, transition finance must be aligned with 1.5 degrees Celsius pathways using sector-specific science-based roadmaps, grounded in time-bound targets rather than vague long-term aspirations, and backed by strong governance particularly on disclosures, monitoring, and course correction.

Frameworks such as the GFANZ Transition Finance Framework, the Task Force on Climate-related Financial Disclosures, and the Task Force on Nature-related Financial Disclosures offer tools to assess and report progress. Third-party assurance is increasingly becoming a baseline expectation, especially for institutional investors seeking to mitigate reputational and compliance risks.

• Early-mover advantage: Institutions that build capabilities in transition financing can gain access to underserved sectors and influence future standards
• New investment pipelines: Transition finance fills a gap in ESG portfolios by offering measurable real-economy impact
• Policy alignment: Regulatory and policy frameworks such as the EU Green Deal, India’s draft Sustainable Finance Taxonomy, and global initiatives like the Net-Zero Banking Alliance and Net-Zero Asset Owner Alliance reflect increasing regulatory momentum to support transition-aligned capital flows

Many carbon-intensive sectors such as cement, steel, shipping, and aviation lack consistent, transparent emissions disclosures. Scope 1 and 2 data are often incomplete and Scope 3 emissions are rarely reported or poorly estimated. Additionally, companies may not publish sector-specific transition pathways, capital expenditure plans, or technology deployment roadmaps.

This limits investors’ ability to assess transition readiness, price risks accurately, and structure credible financing instruments. The absence of harmonised metrics also makes cross-sector and cross-border comparisons difficult, creating uncertainty in portfolio decision-making.

Transition projects are frequently perceived as high risk for several reasons:

• Technology risk: Many decarbonisation solutions like green hydrogen, carbon capture and storage, and zero-emission fuels are not yet commercially viable at scale
• Policy risk: Regulatory signals may be unclear, delayed, or subject to reversal depending on political cycles. For instance, inconsistent carbon pricing or a lack of industrial transition roadmaps can undermine investment confidence
• Stranded asset risk: Financial institutions fear that supporting high-emission assets even with a transition plan may expose them to future regulatory penalties or market devaluation if targets are not met

Structuring effective transition-linked financial products requires advanced capabilities:

• Sectoral expertise: Each industry has different decarbonisation levers and timelines. Without this understanding, setting meaningful key performance indicators or assessing transition credibility becomes challenging
• Verification and monitoring: Institutions must establish systems for ongoing performance assessment often requiring third-party verification and independent audits. Without this, products may lack credibility and fail to meet regulatory or investor expectations

To unlock the full potential of transition finance, financial institutions should consider:

• Integrating transition into ESG strategy not as a separate pillar but as a key driver of sustainable value creation
• Developing sector-specific transition policies as each sector has distinct pathways, risks, and capital needs
• Engaging proactively with clients to support portfolio companies in co-developing credible, science-aligned transition plans
• Building internal capacity by training teams on taxonomies, risk tools, and structuring instruments tailored to transition scenarios
• Innovating financial products from indexed transition bonds to insurance-wrapped loans new structures can improve scalability and impact

Transition finance is not an optional tool it is central to achieving net-zero in the real economy. Financial institutions are no longer just allocators of capital they are active enablers of decarbonisation.

By financing the greening of heavy-emitting sectors not just the already green they play a pivotal role in systemic transformation. The urgency is clear the instruments exist and the mandate is growing.

As the saying goes where finance flows change follows. The transition is underway. Now is the time to scale it responsibly.

• The road to a sustainable industrial revolution
• https://www.iea.org/reports/net-zero-roadmap-a-global-pathway-to-keep-the-15-0c-goal-in-reach/executive-summary
• How transition finance can ‘bring the bad guys in’
• Open AccessArticle Assessing the Role of Climate Transition Bonds in Advancing Green Transformations in Japan