Quoted: Sustainable Financing – Shifting Towards The Transition

Sustainable Financing - shifting towards the transition

1. Introduction

In the European Union's (EU) policy context, sustainable finance is understood as finance to support economic growth while reducing pressures on the environment to help reach the climate and environmental objectives of the European Green Deal,1 taking into account social and governance aspects.2 Sustainable finance is about financing both what is already environment-friendly today (green or sustainability-linked finance) and what is transitioning to environment-friendly performance levels over time (Transition Finance). Transition Finance is any form of financial support that helps decarbonise high-emitting activities or enables the decarbonisation of other economic activities.3 Standards have been developed for green and sustainability-linked finance for European financial markets (para. 3). No such standards have been developed for Transition Finance yet, which is seen by COP284 as lagging behind.5 However, the Loan Market Association (LMA)6 published the Guide to Transition Loans by the end of 2025.7 This guide builds upon existing LMA documentation for green and sustainable lending.

In this Quoted we advocate for the importance of Transition Finance in addition to green and sustainability-linked finance. The main question addressed in this Quoted is how Europe should accommodate Transition Finance (see conclusion in para. 6). We will answer this question based on the following topics:

1. A high-level overview of the relevant EU regulatory framework for sustainable finance: Sustainable Finance Disclosure Regulation (SFDR),8 Corporate Sustainability Reporting Directive (CSRD),9 EU Taxonomy regulation (EU Taxonomy),10 Directive on Corporate Sustainability Due Diligence (CSDDD)11 and the Omnibus Simplification Package12 (para. 2)
2. Types of sustainable finance and, to the extent applicable, LMA principles:13 green loans, sustainability-linked loans (SLLs) and transition loans (para. 3)
3. Reasons for Europe to focus on Transition Finance (para. 4)
4. Suitability of the current regulatory framework for Transition Finance and suggestions on how to shift towards Transition Finance (para. 5).

2. EU Regulatory Framework

General

The EU's sustainable finance agenda is underpinned by a suite of interrelated regulations: SFDR, CSRD, EU Taxonomy and CSDDD. Together, they are designed to reorient capital flows towards sustainability objectives. These instruments work by enhancing transparency; standardising environmental, social or governance (ESG) data; and reshaping how lenders and investors allocate capital.

The SFDR and CSRD establish a mandatory disclosure framework. While the CSRD ensures that companies disclose ESG data, the SFDR ensures that financial market participants (FMPs) and financial advisers (FAs) use those data to make informed decisions about sustainable investments. Disclosures pursuant to the CSRD provide sustainability data that FMPs and FAs need to meet their obligations under the SFDR. Both frameworks rely on the EU Taxonomy to define what qualifies as a sustainable economic activity.

The EU Taxonomy provides a unified classification system for environmentally sustainable economic activities. The CSDDD introduces binding due diligence obligations, compelling in-scope companies (large companies and their value chains) to proactively manage human rights and environmental risks, with the objective of improving businesses' resilience and attractiveness to sustainability-focused investors. Further, the CSDDD provides the substantive obligations that companies must report on under the CSRD and ensures that companies implement the due diligence processes that SFDR disclosures are meant to reflect. Finally, the Omnibus Simplification Package targets to make sustainability reporting and due diligence frameworks more efficient, pragmatic and proportionate.

Together, the aforementioned regulatory instruments, by mandating ESG disclosures (SFDR and CSRD), defining sustainable activities (EU Taxonomy), mandating corporate due diligence (CSDDD) and streamlining implementation (Omnibus Simplification Package), create a framework that (in theory) enhances transparency, aligns capital with sustainability goals and embeds ESG considerations into lending and investment decisions, in the hope that this will accelerate the EU's broader transition towards a net-zero economy.

SFDR

The SFDR lays down harmonised disclosure and transparency rules for FMPs and FAs on sustainability risks and on how to integrate ESG factors into their investment decisions, financial advice and overall product-related sustainability ambitions.14 The objective of the SFDR is to limit the risk of greenwashing, where financial products are marketed as sustainable or climate friendly, or where FMPs make sustainability-related claims that are not supported in practice.15

Under the SFDR, FMPs16 must publish sustainability information about their products and services. The SFDR, therefore, applies to a wide range of products with an investment component. Also, under the SFDR, FAs are obliged to fulfil certain transparency obligations regarding sustainability characteristics when advising on such products. FMPs must disclose sustainability information on their website, in pre-contractual documents and in periodic reports. This information is required at both entity level (e.g. policies on integrating sustainability risks and considerations of adverse impacts) and product level (e.g. how a financial product addresses ESG objectives). Pursuant to Article 2 of the SFDR, at entity level the FMP must make transparent how it deals with sustainability in a generic sense (known as 'complying or explaining'). Products and the required disclosure level are often classified on whether they promote ESG characteristics or pursue a sustainability objective.

The SFDR was originally designed as a disclosure regime to improve transparency on how sustainability risks are integrated into investment decisions. In practice, it has been widely used as a product-labelling system. Pursuant to the SFDR at product level, every provider must clearly state the sustainability characteristics of the product.17 This is where the product in practice gets the label 'dark green',18 'light green'19 or 'grey'.20 This labelling results in inconsistent application and greenwashing concerns.21 Therefore, the SFDR was revised. On 20 November 2025, the European Commission published its legislative proposal for the amendment of the SFDR ('SFDR 2.0').22 The key revisions are follows:

1. Introduction of defined product categories instead of previous disclosure-based approach: (i) transition category (new Article 7) – at least 70% of investments must meet a measurable transition objective, (ii) ESG-basics category (new Article 8) – at least 70% of investments must integrate sustainability factors and (iii) Sustainable category (new Article 9) – at least 70% of investments must meet a clear and measurable sustainability objective. Each category has specific requirements and exclusions, particularly regarding fossil fuels, tobacco and controversial weapons;
2. Deletion of definition of "sustainable investments" and instead the focus is on whether products meet the criteria for one of the three new categories, using sustainabilityrelated indicators and thresholds;
3. Reduction of the burden for FMPs by deleting principal adverse impacts (PAI) disclosure requirements: (i) entity-level disclosures under previous Article 4 (PAI) and Article 5 (remuneration policies) have been deleted, (ii) financial advisors and portfolio managers are now excluded from the scope of SFDR 2.0 and (iii) product-level PAI disclosures remain for product in the transition and sustainable categories but entity level reporting is longer required; and
4. Certain grandfathering and transition provisions are included – closed-ended products established before its application date may choose not to apply the new rules. Other existing products must comply with the new categories, website and reporting provisions within 12 months from SFDR 2.0's application date.23

Footnotes

1 'A European Green Deal – Striving to be the First Climate-Neutral Continent', available at: The European Green Deal – European Commission.

2 https://finance.ec.europa.eu/sustainable-finance/overview-sustainable-finance_en .

3 W. Mak and A. Vinelli, 'Navigating Transition Finance: An Action List', CFA Institute 2024, available at: https://www.cfainstitute.org/sites/default/files/-/media/documents/article/industry-research/transition-finance.pdf . Also see: Overview of sustainable finance – European Commission.

4 COP28 stands for The 2023 United Nations Climate Change Conference.

5 K. Leung, 'Beyond COP28: Financial Institutions Should Adopt Nuanced Transition Finance Frameworks to Support Net Zero', Institute for Energy Economics and Financial Analysis (13 February 2024), and para. 9 of: https://www.cop28.com/en/climate_finance_framework .

6 See www.lma.eu.com.

7 Loan Market Association, Guide to Transition Loans, 16 October 2025, http://www.lma.com/documents.

8 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector, Official Journal of the European Union.

9 Directive (EU) 2022/2464 of the European Parliament and of the Council of 14 December 2022 amending Regulation (EU) No 537/2014, Directive 2004/109/EC, Directive 2006/43/EC and Directive 2013/34/EU, as regards corporate sustainability reporting, Official Journal of the European Union.

10 Regulation (Eu) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment and amending Regulation (EU) 2019/2088, Official Journal of the European Union.

11 Directive (Eu) 2024/1760 of the European Parliament and of the Council of 13 June 2024 on corporate sustainability due diligence and amending Directive (EU) 2019/1937 and Regulation (EU) 2023/2859, Official Journal of the European Union.

12 Proposal for a Directive of the European Parliament and of the Council amending Directives 2006/43/EC, 2013/34/EU, (EU) 2022/2464 and (EU) 2024/1760 as regards certain corporate sustainability reporting and due diligence requirements.

13 International Capital Market Association (ICMA), 'Green and Sustainability Bond Principles', available at: Green-Bond-Principles-GBP-June-2025.pdf, and Sustainability-Linked-Bond-Principles-June-2024.pdf.

14 Recital 17 of the Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector, Official Journal of the European Union.

15 Summary of the Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability‐related disclosures in the financial services sector, Summaries of EU Legislation.

16 FMP stands for Financial Market Participant, as defined in Regulation 2019/2088 (SFDR). FMPs include fund managers, investment firms, insurers, pension funds and banks that offer asset management services (Art. 2(1) SFDR).

17 Art. 6-10 Regulation SFDR.

18 Art. 9 SFDR. A 'dark green' has the following key requirements: (i) the product must aim to make sustainable investments, as defined in Art. 2(17) SFDR (Investments in economic activities that contribute to an environmental or social objective, provided they do not significantly harm any other objectives and follow good governance practices); (ii) the product must demonstrate that its investments do not significantly harm other environmental or social objectives (Art. 2(17) SFDR); (iii) in pre-contractual documents, on the website and in periodic reports, providers of the product must comply with the disclosure requirements (Art. 6(1) and (3) SFDR); (iv) if a product claims to be a dark green product, the provider must describe the likely impacts of sustainability risks on the returns of the financial products (Art. 6(1) sub b SFDR); and (v) if product intends to make environmentally sustainable investments, it must disclose the extent to which these investments are aligned with the EU Taxonomy.

19 Art. 8(1) SFDR. A 'light green' has the following characteristics: (i) the product promotes environmental and/or social characteristics, and that the investee companies have good governance practices in place (Art. 8(1) SFDR)); (ii) in pre-contractual documents, on the website and in periodic reports, providers of the product must be transparent on how ESG characteristics are achieved (Art. 8(1) 11 and 13 SFDR); (iii) light green products may include investments that qualify as sustainable investments (Art. 8(1) and 2(17) SFDR), but this is not mandatory; and (iv) if the product includes environmentally sustainable investments, it must state to what extent those investments are aligned with the Taxonomy.

20 Art. 6 SFDR. A 'grey' product does not promote environmental or social characteristics (light green) and does not have a sustainable investment objective (dark green). It has the following characteristics: (i) the product is neutral with respect to sustainability and (ii) even if the product does not have an ESG focus, pre-contractual documentation must include basic disclosures about how sustainability risks are integrated into investment decisions, or if they are not considered relevant, an explanation why not (comply or explain).

21 'The EU Sustainable Finance Disclosure Regulation 2.0 – 10 Questions', February 2025, available at: esg-briefing--sfdr-20-february-2025.pdf.

22 'Commission simplifies transparency rules for sustainable financial products, 20 November 2025, available at: Commission simplifies transparency rules for sustainable financial products - Finance.

23 The application date of SFDR 2.0 is not fixed yet. According to the official proposal, once SFDR 2.0 is formally adopted through the EU legislative process, it will apply 18 months after its entry into force.

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