Transition finance vs green finance: what is the difference?

A bank’s sustainable finance team is regularly asked the same question by relationship managers: this client is not green, but it is trying to change, so can we label the deal? The honest answer depends on which kind of label is meant. Green finance and transition finance overlap, but they answer different questions, and confusing them is one of the quickest routes to a greenwashing allegation.

Green finance: where the money goes#

Green bonds and green loans are use-of-proceeds instruments. The ICMA Green Bond Principles, updated as of June 2025, rest on four core components: the use of proceeds, the process for project evaluation and selection, the management of proceeds, and reporting, with key recommendations on green bond frameworks and external reviews.

The Green Loan Principles, published by the loan market associations and last updated in March 2025, follow the same logic for loans.

The question is about the asset or the project. A company with a high-emitting core business can, in principle, issue a green bond for a renewable energy project, because the label describes what the proceeds finance, not the whole company.

The reverse is also true. A company with a credible decarbonisation strategy may finance much of it through activities that a green definition does not cover, such as efficiency upgrades to existing high-emitting assets. Under a use-of-proceeds test those projects may not qualify, even though they reduce emissions.

This is the gap transition finance is meant to fill, and it is also why the two approaches are not competitors: a single client may carry a green bond for one project, a sustainability-linked loan tied to its emissions targets and a transition facility for assets that sit between the two, each tested on its own terms.

Transition finance: who is being financed#

Transition finance starts from the other end. It is aimed at companies, often in hard-to-abate sectors, that need capital to move from where they are to a lower-emission business model, and whose projects may not meet a green definition. Because the projects alone cannot prove the case, the test moves to the issuer or borrower and its strategy.

The ICMA Climate Transition Finance Handbook, first published in December 2020, updated in 2023 and again in November 2025, sets out four elements for that test:

1. The issuer’s climate transition strategy and governance.
2. Business model environmental materiality.
3. A climate transition strategy and targets that are science-based.
4. Implementation transparency.

The Handbook applies to both use-of-proceeds and sustainability-linked instruments. In November 2025 ICMA also published Climate Transition Bond Guidelines, introducing a standalone Climate Transition Bond label for projects, and the OECD Guidance on Transition Finance, published in 2022, sets out ten elements of a credible corporate transition plan.

Green finance can be tested project by project, but transition finance also has to be tested against a plan, because the whole company is what is meant to change.

Sustainability-linked structures: KPIs and targets#

Many transition deals do not use a use-of-proceeds label at all. A sustainability-linked bond or loan can be used for general purposes, and its terms change if the borrower meets, or misses, sustainability performance targets.

The ICMA Sustainability-Linked Bond Principles, in their June 2024 edition, have five core components: selection of key performance indicators, calibration of sustainability performance targets, bond characteristics, reporting and verification. The credibility of the deal rests on whether the KPI is material to the business and whether the target is ambitious compared with what would have happened anyway.

Disclosure: IFRS S2 and transition plans#

Where a company reports under IFRS S2 Climate-related Disclosures, issued by the ISSB in June 2023, it must disclose any climate-related transition plan it has, including key assumptions and dependencies. IFRS S2 does not require a company to have a transition plan.

In June 2025 the IFRS Foundation published guidance on transition plan disclosures that does not change those requirements. For a lender, these disclosures, where available, are a starting point for testing a client’s plan, not a substitute for the test.

Where banks go wrong#

• Labelling a transition deal green because one component of it is green, while the rest of the plan is unexamined.
• Accepting a transition plan because it is well written, without testing targets, capital expenditure and governance behind it.
• Agreeing sustainability-linked KPIs that are easy to meet or immaterial to the borrower’s emissions.
• Ignoring carbon lock-in: financing assets that will keep emissions high for decades under a transition label.
• Monitoring at origination only, so that a missed target or a changed plan goes unnoticed during the life of the loan.

What good looks like#

1. Decide first which question the deal answers: where the money goes, who is being financed, or what performance is promised.
2. For transition deals, test the client’s plan against the four elements of the ICMA Handbook and record the conclusion.
3. For sustainability-linked deals, challenge the materiality of each KPI and the ambition of each target before terms are agreed.
4. Align the label, the documentation and the external review so that each says the same thing.
5. Monitor during the life of the facility and report honestly when targets are missed.

Transition Finance for Banks gives corporate, credit and ESG teams two days on testing client transition plans and financing decisions in high-emitting sectors. Green, Social & Sustainability-Linked Finance: Loans, Bonds and Sukuk covers the labelled instruments in depth, and the ESG and Climate Risk Stress Testing Masterclass covers how climate risk reaches the bank’s own balance sheet.