Credible transition plans are in short supply, and that’s a problem for Net Zero financial institutions

Financial institutions’ credibility on Net Zero is largely outside of their direct control because of the importance of their customers’ own transition plans. However, they don’t need to remain passive and could benefit by offering incentives to customers who go beyond minimum requirements for the development and disclosure of transition plans.

• Just 81 companies — 0.4% of all those who make climate reports to CDP — had transition plans and disclosed enough information to demonstrate those plans were credible
• Despite making more disclosures overall than companies from other sectors, financial institutions’ credibility remains dependent on the credibility of their customers’ transition plans
• Offering ESG-linked financing to support company transition plans, particularly relating to financial planning for future investments, could improve credibility and increase opportunities to provide additional financing in the future

A new report by CDP shows that just 81 companies among the more than 18,600 who use the climate disclosure framework developed by CDP both had a transition plan and provided enough detail in their disclosures to give investors enough information to assess the plans’ credibility — a rate of just 0.4%. For the 662 financial institutions who report using the CDP framework, just two, or 0.3%, met the disclosure threshold on all indicators.

CDP released the statistics in a report grouping companies into categories relating to the adequacy of their disclosures, focusing on the 4,100 companies with transition plans. Within the companies that had transition plans, about 40% of those plans were public and offered a way for stakeholders to provide comment.

The disclosure gaps will evolve over time, and the low number of companies reporting on all metrics in 2022 did decrease compared to 2021 as a result of CDP raising the level of disclosure it considered adequate. Companies have also been releasing transition plans at an accelerating rate, with increased prioritization of climate issues for investors, banks and regulators.

The news wasn’t entirely bad because a substantial number of companies (more than 2,300) made sufficient disclosures on at least two-thirds of the indicators tracked by CDP, although not all of those companies had transition plans in place. Within financial services, 35% of companies that reported to CDP met the same threshold of disclosure for at least two-thirds of indicators, significantly higher than the overall average.

The CDP report also breaks down the categories of what types of indicators were more or less likely to be adopted by companies. For example, among the most common indicators that were reported are those relating to governance structures, identification of risks & opportunities, and scenario analysis. The least reported indicators related to financial planning for the transition, specific science-based targets, value chain emissions, and all scope emissions with third-party verification.

For financial institutions, developing credible transition plans is hard for many reasons. Firstly, they have to anticipate how their own business plans will be affected by the transition. That means factoring in the changes in structure for the wider economy, which may impact different financial institutions in different ways depending on their financing exposures.

However, beyond financial institutions’ own decision-making about how the transition will impact the economy as a whole, it will also require the financial institution to understand how the companies will respond to potential disruptions. This will include reviewing their customers’ own transition plans to review how well prepared they are to manage transition-related risks.

The current status of transition plans among the many companies who report against CDP’s framework shows the difficulty that financial institutions will have in creating credible transition plans of their own. They may be able to anticipate some of the broad macroeconomic changes that companies will have to navigate, and they may also be able to factor sector-specific risks into their financing decisions, including pricing. But they will still be left facing substantial blind-spots on whether their customers’ transition plans are ambitious enough, and whether they are credible.

This is where the different categories of indicator measurement frequency may be useful. Financial institutions will be able to work with customers that report information on a majority of the indicators to fill in gaps in the transition plan disclosures, driven by the likelihood and severity of potential risks. However, for companies reporting just a few or some of the indicators in sufficient detail, there may be too many companies and too widely disbursed risks for a financial institution to use its engagement with customers to address the gaps.

The rise in number of companies with transition plans will elevate further the number of those with only a few indicators for financial institutions to assess credibility. This will multiply the risks for banks by exceeding their ability to evaluate transition plan credibility, which will have the impact of reducing the value for companies that follow up a Net Zero commitment with a credible transition plan.

Although there are regulatory mandates behind many transition plans, the ability to demonstrate immediate value from better designed and implemented transition plans will be important. In the absence of this type of incentive, there may be more of an incentive to view the plans as a box-ticking compliance exercise rather than an important tool for business strategy in a highly dynamic environment. And regardless of whether companies are driven to invest in transition planning or just do the minimum to satisfy regulatory obligations, the transition risks remain.

This is important beyond the financial sector’s own considerations for their ability to assess customer risk and for customers to mitigate that risk. Financial institutions are not passive actors in the process and they can factor the strength of a transition plan into their decisions, including looking to find opportunities and incentives to support customers’ investments in transition planning.

One of the major gaps for many companies is financial planning around their transitions. If financial institutions are able to better assess customers’ risk from transition based on the clarity of their investment needs to deal with the transition, then they could benefit by offering ESG-linked financing to customers with gaps in their transition plans to manage the risk and cultivate opportunities for financing transition-related activities directly.

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