A deeper understanding of your clients' transition plans can create commercial benefits

By assessing the credibility of your clients’ climate resilience and decarbonisation plans and then supporting their transition with appropriate financial products, you can meet your firm’s own net zero commitments and better navigate the risks and opportunities that lie ahead.

Jim Fitzgerald, expert in Energy and Resources, explains how banks need to move fast to differentiate themselves to reach net zero targets.

Like most banks, your firm has probably already committed to reaching net zero by 2050, if not earlier. Now, you should be considering what operational changes you’ll need to make to achieve these ambitious targets. Meeting your climate commitments will mean focusing on clients that understand how climate change will impact their business, have realistic prospects of significantly decarbonising their operations and have already published a credible transition plan (CTP) showing how they’re going to achieve their goals within a specified timeframe. 

CTPs are extremely important, because unless a client’s transition plan is credible, they’re unlikely to meet their decarbonisation goals on time. Despite the immense value of CTPs, research suggests that only 44% of companies with net zero targets have backed up these commitments by publishing a transition plan. This raises serious concerns about whether these organisations can meet their climate goals.  

In this article, we explain why a structured evaluation of transition plans is so important. And we’ll share our insights into the capabilities and processes to identify the financing opportunities needed to accelerate the transition to a low-carbon economy.  

Why do you need to assess your clients’ transition plans?

Recently, regulators have required banks to conduct climate stress tests based on a static balance sheet. These exercises have highlighted how vulnerable the banking system is to transition and physical risk. And they’ve helped banks understand the impact of climate-related financial risk on their current balance sheets and lending portfolios. However, to manage and mitigate those risks, banks must also understand how their exposure to climate risk could change over time. 

The extent to which your firm is exposed to climate risk is intrinsically linked to your lending portfolio. Naturally, you’ll look to reduce this exposure — the easiest way being to shift from high-emitting to low-emitting clients. But this won’t help decarbonise the real economy. What’s more, you could risk reputational damage if your company isn’t seen to be playing its part in the fight against climate change. And if you turn your back on high-emitting clients that need investment to successfully transition to and thrive in a low-carbon economy, or if you don’t apply climate-focused due diligence when making new lending decisions, you could miss the opportunity to profit from the clean energy investment boom. 

The largest part of your firm’s carbon footprint comes from your clients: the greenhouse gases emitted by the activities and energy consumption of the companies and households to which you provide financial products and services. This means that your net zero trajectory hinges on your clients’ capacity to decarbonise. To identify climate risks within your portfolio, you need to work out which of your clients don’t have a realistic plan to decarbonise, and which ones hold assets that are highly exposed to transition and physical risks. Moreover, most clients will require additional funding to execute their transition plans. This means you should engage with their specific transition paths so you can craft sustainable finance solutions to enable them to achieve their goals. Ultimately, this will help you meet your own net zero commitments. 

Hitting your targets won’t be easy, as annual greenhouse gas emissions are continuing to increase year-on-year. This has resulted in a sharp decline in the carbon budget – the maximum amount of carbon humanity can emit while avoiding the most devastating consequences of climate change. Consequently, averting disaster will require even greater annual emission reductions, for which we’ll need even more powerful technological and infrastructural innovations. As these innovations disrupt different sectors, companies in the real economy will need to assess the impact on their operations and decide how to respond. The impact varies not just between industries, but also by country, since each will follow its specific decarbonisation path, and advanced economies need to reach net zero ahead of emerging markets and developing economies. This means you should work to better understand your clients’ forward-looking decarbonisation plans, so you can better ascertain their future expected emissions, and look at how they compare to their peers in the same sector and geography. 

An increased focus on transition planning within the real economy is urgently needed. But it will require lenders to determine which clients have formulated realistic plans with clear funding requirements, and which need further support to anticipate how climate change will impact their business. Assessing the credibility of transition plans can’t be just another task tagged onto the busy schedules of risk teams and relationship managers. Since the decarbonisation of your clients’ operations is the foundation on which your firm’s net zero commitments are built, your assessment of their plans must be consistent, systematic, transparent and thorough. Any weakness in the assessment process could jeopardise your ability to meet your net zero targets and your published commitments, so you could be accused of greenwashing.

Firms are grappling with three key issues when assessing transition plans

1. Adopting or developing an appropriate assessment framework 

To assess transition plans consistently and systematically, your firm needs to apply an established and comprehensive evaluation framework. It should cover a wide range of different company types and industries, tackle sector-specific climate-related challenges, and address technological and operational opportunities. Unfortunately, there isn’t a universally agreed approach to assessing the credibility of transition plans. This creates uncertainty and mixed messages for clients when banks make financing decisions based on their transition credibility assessments.

Whether your firm is tailoring an existing framework or defining its own, a specific organisational structure is needed to ensure transparency and integrity. Regardless of how this structure in incorporated within your company’s operations, it should follow three core principles: 

• It should have appropriate policies and controls that define a robust governance structure.
• There needs to be transparency when carrying out due diligence on your clients’ plans against your chosen assessment framework. This includes deep analysis of transition goals, decarbonisation pathways, and also the identification of technology dependencies and risks.
• Finally, engagement with your clients is critical. Assessing their transition plans shouldn’t be just an extra step in the credit approval process. Instead, it should be a continuous evaluation of the company’s progress, done collaboratively as part of the ongoing conversation. 

Your firm needs to have in-depth conversations with clients about sector decarbonisation pathways, technological opportunities and climate impact, then use these insights to inform decisions. This requires a step-change in the capabilities of your front-line teams and their supporting functions throughout the organisation.

2. Enhancing business functions with the required sector-based capability

There are many nuances between sectors and geographies, which increases the complexity of assessing transition plans. These subtleties can be addressed, and better financing decisions made, when teams have the right tools and data. In addition, front-office teams need sector-specific training so they can have meaningful conversations with their clients about the challenges arising from climate change and identify commercial opportunities to sell appropriate sustainable finance products.

It's not realistic or efficient to expect your front-line teams to take on the brunt of work to build up this capability. The insights used to assess your clients’ transition plans and decarbonisation targets need to be available throughout the organisation to inform strategy, risk management and financial planning. Banks looking to become market leaders in climate and build long-term relationships with clients should embed this capability across the entire organisation with clear responsibilities for gathering, collating and sharing climate data and maintaining an up-to-date and well-researched view of a transition plans.  

On-the-job training and mentoring are key to achieving this step-change in capability. As your teams get up and running, they’ll generate fresh data and insights, and use new tools and reports when engaging with clients. They’ll need rest of the organisation (from front-office to back office) to be net zero aligned to support customer engagement based on CTPs – for example:  product pricing, risk appetite and transfer pricing, etc. You should enhance your firm’s data infrastructure, policies, procedures and operating models to allow your front-line teams and supporting functions to operate effectively. 

3. Establish the right infrastructure, processes and policies within your support functions

You risk making ill-informed financing decisions if your net zero targets aren’t embedded across your entire organisation. As we’ve highlighted in this article, your ability to meet your climate commitments depends mostly on your clients’ current emissions and their ability to effectively transition to a low-carbon economy. If your clients’ climate goals aren’t in line with your own, you may not be able to meet your commitments. 

To reach net zero, all teams – and in particular the risk management function – must look at transition plan assessments when evaluating lending decisions. To do so, they’ll need new data, frameworks and key performance indicators, as well as a sound understanding of the physical and transition risks and opportunities your clients face.

You’ll need a strategic change programme to integrate client transition credibility assessment  into your operations, risk modelling and financial planning in a way that feeds and strengthens your firm’s net zero commitments. 

Incorporating your clients’ transition plans into your business processes requires strategic vision

New infrastructure, specific expertise and a shift in organisational culture must be at the heart of your approach to making lending decisions. 

Even though trends are emerging around frameworks, capability  and operationalisation, there’s no one-size-fits-all approach to achieving net zero. The solution you put in place will need to use your organisation’s strengths and competitive advantages, so it’ll be specific to your firm. 

To learn more about how Baringa can help you engage with your clients and assess the credibility of their transition plans, please contact Jim Fitzgerald, Guillaume Nerzic or Kate Henderson.