Transition plans as a supervisory tool

The Bank of England (BoE) recently published its climate transition plan, detailing its targets and strategy to reach net zero greenhouse gas (GHG) emissions for its physical operations. This is a significant milestone from the central bank, where its own operations rather than its supervisory expectations are thrown into the spotlight. The FCA and Payments Systems Regulator subsequently published their joint transition plan, all of which have highlighted the challenges of preparing such plans and the reasons they are necessary.

The BoE transition plan follows the recent publication of a stocktake by the Network for Greening the Financial System (NGFS) — the group of central banks and supervisors committed to sharing best practices on climate and environmental risk management in the financial sector — of financial institutions' (FIs) transition plans in key jurisdictions. The report explores the relevance and extent to which these transition plans relate to micro-prudential authorities' roles and mandates, and whether they should be considered within the supervisory toolkit and overall prudential framework. 

In this article KPMG in the UK considers how transition plan disclosures are currently reflected in UK and EU regulatory requirements. We also look at the key findings from the NGFS survey and how they could influence future developments.

In a speech¹ at the Guildhall on 27 June, BoE COO Ben Stimson described transition plans as `fundamental to the framework, alongside climate related financial disclosures and product labels, to facilitate transition. They help firms to set their strategic approach to transition. They provide forward looking information that enables stakeholders, such as shareholders, to steward companies. And they allocate capital to support real economy to decarbonise and manage risks'. 

A climate transition plan should set out how a company will adapt as the world transitions toward a low-carbon economy. It should include:

• High-level ambitions to mitigate climate risks, including GHG reduction targets;
• Actionable steps the company plans to take to achieve those targets, including how those actions will be financed; and 
• Governance and reporting frameworks to support the delivery of the plan.
  

The NGFS stocktake notes that transition plans have the potential to show the real economy's pathway to a net-zero future and that FIs' plans can be an important part of the wider transition finance framework. However, requirements for transition plans and their disclosure vary greatly across jurisdictions. Although climate transition plans were recommended by the TCFD in 2021, approaches remain inconsistent and the NGFS points to growing focus on (i) the need for credible and comparable plans, (ii) how firms will deliver on them and (iii) accountability mechanisms.

Guidance and formal requirements around transition plans are emerging slowly. 

GFANZ: In 2022, the Glasgow Financial Alliance for Net Zero (GFANZ) published a Net-zero Transition Plan (NZTP) framework for the financial sector. This was designed to enable a financial institution `to demonstrate, and stakeholders to judge, the credibility of its plan to accelerate and scale clean energy and transition-related finance to levels consistent with limiting global warming to 1.5 degrees C'. Some firms have already begun to develop transition plans on a voluntary basis under this framework.

FCA, PRA and BoE: As already mentioned, the TCFD recommendations include the disclosure of transition plans. In the UK, the FCA has mandated TCFD-aligned disclosures for listed companies, asset managers and regulated asset owners via PS21/23 and PS21/24,the first of which were due earlier in 2023. The PRA's SS3/19 also supports the adoption of TCFD recommendations by all PRA-regulated banks and insurers: it expects regulated firms to `take into account the benefits of disclosures' but has stopped short of setting a formal requirement to disclose transition plans. Additionally, the BoE has been clear that banks and insurers should take action to address the financial risks they face from climate change. Whilst there is no specific BoE requirement to publish transition plans, the comment on publication of its plan that `it is only right that we hold up a mirror to ourselves to ensure we meet the standards we expect of others' sent a strong message to supervised firms. 

TPT: The UK Transition Plan Taskforce (TPT), established by HM Treasury to develop a `gold standard' for transition plans, has consulted on a Disclosure Framework and Implementation Guidance with final publication expected in autumn 2023. The FCA is then expected to set mandates for firms to disclose their plans or explain why they have not done so (for more on the TPT see our article here.)

CSRD: In the EU, the Corporate Sustainability Reporting Directive (CSRD) will require disclosure of transition plans to ensure that companies' business models and strategies are compatible with the goals of the Paris Agreement and the EU's 2050 climate neutrality target. The CSRD will be phased in over several years, with disclosures required from: 

— 2025 from companies already captured by the Non-Financial Reporting Directive (NFRD)

— 2026 for large EU companies

— 2027 for listed SMEs in the EU

— 2029 for large non-EU companies with a branch or subsidiary in the EU. 

CSDDD: The European Commission's proposed Corporate Sustainability Due Diligence Directive (CSDDD) could also require large companies to adopt transition plans — though this remains subject to negotiation (see here for a summary of the proposals).

CRR3 / CRD6: From a prudential perspective, the EU's proposed amendments to the Capital Requirements Regulation (CRR3) and Capital Requirements Directive (CRD6) would require banks to have in place plans and quantifiable targets to address the short, medium and long-term risks of transition — and these would be monitored by national competent authorities. 

ISSB: The International Sustainability Standards Board (ISSB) global standards — IFRS S1 (general sustainability) and IFRS S2 (climate), both finalised in June 2023 and to be adopted by local regulators — require transition plans to include information on the assumptions and dependencies that companies use in their planning. See here for more information on ISSB transition plan disclosures, and here for wider information on the ISSB's work.

The NGFS report focuses on how transition plans could be added to the micro-prudential supervisory toolkit. The six key findings are that: 

1) There are multiple definitions of transition plans, reflecting their use for different purposes.

2) There is merit in distinguishing transition planning (transition strategy) from a transition plan (transparency to a specific audience).

3) Existing frameworks speak to a mix of objectives, audiences and concerns for transition plans but predominantly relate to climate-related corporate disclosures.

4) Transition plans could be a useful source of information for micro-prudential authorities to develop a forward-looking view of whether the risks resulting from an institution's transition strategy are commensurate with its risk management framework. 

5) There are some common elements to all transition plans which are relevant to assessing safety and soundness.

6) The role of micro-prudential authorities needs to be situated in the context of other financial and non-financial regulators rather than existing in isolation. 

The NGFS notes that there are multiple definitions and use cases for transition plans. It highlights the distinction between `strategic' and `risk-focused' plans.  

Many FIs are developing transition plans for disclosure that fall within the `strategy' bucket, i.e. plans aimed mainly at external audiences that set out how their strategy will help achieve targets such as Paris-aligned goals and the transition to net zero. The GFANZ and UK TPT guidance supports this type of plan.   

Risk-focused transition plans, however, mainly consider how firms will manage the financial risks associated with transition, identifying exposure to and impact of transition risks and how these are managed. These plans are usually intended not for public disclosure but for internal or regulatory purposes — similar to the analysis an insurer would include in its ORSA, or a bank in its ICAAP. With the NGFS's focus on micro-prudential supervision, it is these plans that will be of most interest to its network when assessing how firms manage their transition.

The current requirements for transition plans and their disclosure vary by jurisdiction and by regulator, and we know that further guidance and regulation are yet to come from numerous sources such as the TPT and the FCA to name a few. 

The focus to date from regulators and within industry has been on how transition plans outline firms' strategies and actions to reach their emissions reduction targets. However, the NGFS stocktake has highlighted the additional prudential importance of firms' plans and it is actively considering how supervisors could use these plans in their framework. That could either be by forming judgements about overall risk management and governance based on a firm's disclosed `strategic' transition plan, or by using `risk-based' plans to gain comparable insights on firms' financial exposures. The thinking on the latter example is nascent, but the NGFS has called for greater coordination on this subject and so firms can expect further developments here. 

There is also a potential role for regulators and/or central banks at a macro-prudential level, to facilitate the aggregation of analysis from individual FI transition plans. This aggregate analysis could provide regulators and governments with a systemic view of the assumptions being made by firms across the financial system, track how implementation is progressing against high level targets, and identify system-wide gaps in the transition path to net zero. However, before this can happen in a meaningful and decision-useful way, there will need to be consistency in approach and execution across and within jurisdictions. 

Therefore, beyond the existing work that firms are doing to prepare their transition plans, there are no new actions for them to complete yet. But, it is worth being aware of the activities at supervisory level about the possible prudential uses of their plans — and they should not be surprised if prudential regulators show increased interest in their transition plans.