Transition Finance
Transition finance is the financing of decarbonisation in emissions-intensive or hard-to-abate activities, as opposed to green finance, which finances assets that are already low-carbon. The exam tests whether you can judge credibility rather than label.
Instruments and their mechanics
Green bonds follow the ICMA Green Bond Principles: use of proceeds, project evaluation and selection, management of proceeds, and reporting. Sustainability-linked bonds carry KPIs and sustainability performance targets, with a coupon step-up typically around 25 basis points; sustainability-linked loans use a margin ratchet with the same logic. The ICMA Climate Transition Finance Handbook sets the credibility test: an issuer-level transition strategy aligned to science, business model environmental materiality, implementation transparency, and governance.
Taxonomies and policy
EU Taxonomy alignment needs substantial contribution, do no significant harm and minimum safeguards; transitional activities must be at best-in-class emissions and must not lock in carbon-intensive assets. ASEAN uses a traffic-light framework; China maintains its own green bond catalogue. On policy, the EU ETS cap declines annually and free allocation is being phased out for CBAM sectors; the CBAM definitive regime starts in 2026; the US Inflation Reduction Act works through subsidies rather than a carbon price; Just Energy Transition Partnerships package concessional and multilateral capital for coal-dependent economies.
Carbon markets
Article 6.2 produces internationally transferred mitigation outcomes; Article 6.4 creates a central mechanism. Voluntary market integrity is anchored on the ICVCM Core Carbon Principles: additionality, permanence, robust measurement reporting and verification, no double counting, sustainable development benefits, and governance.
Worked example
A cement producer issues a sustainability-linked bond with an SPT to cut Scope 1 intensity from 0.62 to 0.52 tCO2 per tonne of cement by 2030. Annualised, that is roughly 2.9% a year, against a science-aligned 1.5°C benchmark near 4.2% a year - the target fails ambition. The 25 bp step-up on a 500m issue costs about 1.25m a year, small against the abatement capex, so the incentive is weak. Two credibility failures: ambition and consequence.
Traps
Confusing taxonomy eligibility with alignment; counting refinancing of existing green assets as new transition capital; accepting an SPT already achieved at issuance; ignoring double counting of ITMOs; labelling gas as transitional without a dated sunset.