Sustainable finance

The risks associated with climate change and nature degradation are becoming more acute and the need for the sustainability transition more urgent. To address this, in 2025 we expect EU and UK policymakers to continue to steer sustainability-linked innovation, investment and resilience through a combination of measures, including through regulation. What will be different this year is that policymakers will shift their focus towards industrial strategy and fiscal policy as they position the sustainability transition to drive economic growth and competitiveness. 

For FS firms, the focus on industry and the economy, and greater clarity on national transition plans and sector decarbonisation pathways, should support demand for sustainable finance. Policymakers are also taking measures to increase public sector financing and address regulatory barriers to the provision of private sector financing. In turn, policymakers expect the FS sector to play a significant role in financing the sustainability transition.

Juxtaposed with this trend, policy action supporting the transition faces strong political headwinds and fiscal constraints domestically and internationally. Whilst we expect policymakers to make progress, their actions will be constrained. Most notably, we will see them take steps to reduce the burden of regulation at the same time as the measures referred to above to strengthen the sustainability drive are introduced.

Compliance and risk management also remain important themes. As the risks to businesses and society from environmental change increase, regulators and supervisors will continue to raise standards and extend expectations to ensure the transparency and soundness of sustainable assets and investments, and resilience to environmental-related financial and greenwashing risks.

In the face of uncertainty on the timing and content of new regulations and policies, firms can consider scenarios to identify no- or low-regret actions to take now, rather than wait for certainty to emerge. These steps include scaling the enterprise data environment to support future disclosure integrity and high quality, data driven decision making. This activity needs to be led by the Board to ensure all functions and business areas are aligned. 

Corporate sustainability reporting: only the end of the beginning
 

On paper, 2025 should be a milestone year for the implementation of the Corporate Sustainability Reporting Directive (CSRD), with larger firms reporting for the first time. But the attention of policymakers in the EU has shifted to reducing the reporting burden. As we start the year, it is uncertain what action the European Commission will ultimately take. How to define or quantify the reporting burden has not been agreed. And it is unclear how the Omnibus legislation to address the reporting burden across CSRD, the Corporate Sustainability Due Diligence Directive (CSDDD) and the EU Taxonomy, which the Commission President committed to in a speech in November to the European Parliament, will be progressed. Currently the only public indication from the Commission is that an ‘Omnibus simplification package’ will be prepared by the time of its College meeting on 26 February 2025.

In any event, we do not currently expect to see a proposal for paring back the core components of CSRD. We come to this conclusion in part because of the practical and political challenges of reopening negotiations on primary legislation, and also because we have not seen in the debate so far a strong desire to re-think the basic premise of requiring sustainability reporting – although we recognise that the political positioning on this topic is volatile. It is more likely that the Commission will identify ways to make the task of reporting less onerous for firms, including through streamlining and reducing duplication of requirements. That could be achieved, for example, by introducing a simpler regime for mid-sized companies, reconsidering sector-specific standards or revisiting the thresholds for companies in scope. Reporting requirements across different pieces of legislation could also be streamlined, or the transition from limited to reasonable assurance might be delayed.

Firms already reporting in 2025 and 2026 would anyway be advised to continue with their current CSRD implementation plans as requirements will not change immediately (if at all), and data and systems, internal controls and governance frameworks typically need to be developed further, including to accommodate sector-specific guidance, and to support improved data quality and assurance. However, smaller companies and third-country groups could consider what flexibility can be built into implementation roadmaps and reporting systems to anticipate potential future changes to requirements.

All firms should consider the opportunity to utilise data used to meet CSRD requirements to ensure sustainability is fully considered in business strategy and planning. Firms operating in the EU should also prioritise planning for the application of CSDDD (from July 2027) – at least, unless or until it is clear the mooted Omnibus legislation will postpone the implementation date for CSDDD. CSRD and CSDDD are connected through data needs and reporting requirements. Firms can start by mapping value chains and performing a gap analysis against the requirements, to inform an implementation plan.

Around 30 jurisdictions have consulted on sustainability-related disclosures since the publication of the International Sustainability Standards Board’s (ISSB) sustainability disclosure standards in June 2023. This year, the ISSB will continue to extend its standards, including through work on nature and human capital. The GHG Protocol is also likely to be refreshed this year, which is widely referenced in the standards for measuring emissions. 

In the UK, the Government is expected to create the Sustainability Reporting Standards by endorsing the ISSB sustainability disclosure standards during Q1. We expect it to adopt the international standards with minimal changes. Following a consultation and finalisation of the requirements, reporting is likely to begin for the first wave of firms (likely larger, listed companies) in 2027, based on FY2026 data. Given the complexity of the reporting requirements, firms that expect they might need to report in 2027 should start planning this year based on the ISSB standards. The Government will also consider whether to develop a UK green taxonomy, but since the outcome is so uncertain (it is not known if the Government will ultimately issue a green taxonomy, and if it does what approach it will take) there is little firms can do to prepare specifically for any rules in advance of a proposals, beyond any investment already being made to develop their sustainability reporting capabilities.

Financing the sustainability transition: addressing barriers to scaling finance
 

There is a pressing need to scale finance to support the sustainability transition. At the Conference of the Parties 29 (COP), the provision of public sector financing for developing countries was one of the main topics of discussion. Developed countries need urgently to increase investment in their own adaptation and resilience. One estimate puts the additional investment required to deliver the UK net zero transition at GBP £50 bn annually every year into the 2030s (from around £GBP 10 bn in 2020).

For FS firms, in the past uncertainty about the path of the sustainability transition, lack of demand for financing, and access to blended finance, and regulation have impeded lending. This year, several of those obstacles will begin to be addressed. If successful, the measures taken could in combination lead to a step change in the overall investment risk. For example, in the UK:

• Enabling sector policies. An industrial strategy, national transition plan and sector decarbonisation pathways will bring greater clarity to the assessment of investments, and should drive demand for financing.
• Availability of public finance and incentives. The National Wealth Fund and Great British Energy will increase risk sharing between the public and private sectors. Targeted grants, taxes and incentives (including a carbon tax from 2027) will further enhance the economic case for some investments.
• Coordinated government action. A Transition Finance Council will oversee the implementation of recommendations made by the Transition Finance Market Review (TFMR) to enhance the UK as a hub for transition finance. 

One specific aspect the TFMR considered was potential regulatory barriers to transition finance, including the capital treatment of transition exposures, the capacity of supervisors to assess the riskiness of transition exposures (and supervisors’ risk appetite) and the role of supervisors in supporting development of market-leading practices. The Financial Conduct Authority (FCA) subsequently said it would consider how best to embed the TFMR’s findings in its policymaking and supervisory work. The UK Government has also now inserted into the remits it sets for the microprudential and macroprudential regulators, a direction to support sustainable finance and the transition to net zero. In the near term, we expect the Bank of England (BoE) and FCA to increase capacity and capabilities to enable them to do so.

Some of the initiatives highlighted here are likely to be effective in the shorter term whilst others will take longer to crystallise, but all should improve the assessment of the commercial viability of sustainability-linked financing. FS firms will need to take a broad view across their business of the different measures, to understand in full the implications and consider what new opportunities might be created. They should also consider where to engage proactively with the development of policies.

Another consideration for FS firms in determining their strategy for providing transition finance is the extent to which they need to help existing customers transition to be able to meet their own net zero commitments. FS firms will in future likely need to disclose credible transition plans aligned with a 1.5°C climate-warming scenario (for EU firms, this is the result of CSDDD; for UK firms, it is likely as the Government is consulting on proposals this year having originally committed to the change in its pre-election manifesto). Since the latest scientific projections indicate a high likelihood that the world will breach the 1.5°C temperature threshold by 2030, it is increasingly hard for FS firms to set a credible transition strategy based on that benchmark. As they assess the credibility of their transition plans, firms should also consider how greater clarity on sector specific and economy-wide transition strategies will help investors and other stakeholders to assess and benchmark an individual firms’ progress.

Voluntary carbon markets have been a key area of discussion over the past year, including at COP29 which reached agreement on a new international carbon market. The UK Government also launched its integrity principles for voluntary carbon and nature markets. There is an ongoing debate about the extent to which carbon offsets should be used for the transition in hard-to-abate sectors. There is anyway little practically for FS firms to respond to in the near term. We expect the focus this year to be on further policy development. Challenges around integrity and transparency will also likely continue to slow carbon market growth.

Managing environmental-related risks: no time to pause
 

As climate change and nature degradation continue, the probability of environmental-related risk is increasing. The impact when risks crystallise is also rising because of the increasing severity of environmental-related events and because sustainability-linked activities account for an increasing share of firms’ businesses. The weakening of the political impetus globally to tackle climate change and nature degradation, including because of heightened geopolitical risk, is increasing transition risks as governments delay acting.

We expect the requirements supervisors set for how firms manage financial- and non-financial risks in climate will evolve this year rather than radically change. But firms should bear in mind that supervisors still have significant latitude to increase the intensity of supervision and to raise expectations within existing frameworks. When the BoE updates its supervisory guidance on managing the financial risks from climate change, it will provide examples of leading practices that may spur some firms to decide they need to improve their capabilities. For the European Central Bank (ECB), after the end-2024 deadline for banks to be fully aligned with its expectations for climate-related and environmental risks passes, we expect it to hold Boards and senior management teams to account, assigning remediation work and raising the prospect of periodic penalty payments for non-compliance.

An evolution of requirements still means change. The BoE has said that it will consider how scenarios for future stress tests could start to incorporate specific risks that are expected to be caused or exacerbated by climate change, and the UK Climate Financial Risk Forum plans to continue its work to support the development of firms’ risk management capabilities, including in relation to transition finance and adaptation. (Whilst the BoE and FCA will work internally this year to explore risks related to adaptation, we do not expect to see any recommendations to FS firms until later in the year at the earliest.) Also, supervisory work on “top-down” governance, incentives and accountability for data issues (discussed in the Banking sector chapter) will include climate and other sustainability data. For EU banks, the European Banking Authority's (EBA) guidelines on ESG risk management (finalised in January) introduced a requirement for firms to use portfolio alignment methodologies as a portfolio-level risk management tool.

Greenwashing risk and litigation risk are becoming more prominent. Supervisors in both jurisdictions have spoken about the fact that they are actively examining greenwashing risk in their supervisory work and have reminded firms that they have a number of tools that can be used that fall short of public sanctions. The clear implication is that firms should not assume that controlling greenwashing risk is anything other than a high priority. All FS firms should also consider their exposure to litigation and reputational risks from greenwashing that go beyond Sustainability Disclosure Requirements (SDR) or Sustainable Finance Disclosure Regulation (SFDR), including because of new disclosures they will make under CSRD. Unsatisfactory progress against transition commitments could also lead to reputational and (ultimately) litigation risk.

FS firms need to continue this year to develop robust risk, controls and monitoring frameworks at sufficient pace to keep up with the evolution of risks and standards. Firms should develop a roadmap for doing this that considers all the drivers – regulatory and supervisory, as well as internal and strategic considerations, and market practice.

We do not expect any fundamental change this year to minimum capital requirements to take account of climate risk (a now long-standing topic for the FS sector). The European Insurance and Occupational Pensions Authority (EIOPA) did publish a report last year on the prudential treatment of sustainability risks with Solvency II, recommending that the European Commission considers introducing additional capital requirements for fossil fuel assets. And in 2023, the EBA recommended enhancements to the bank Pillar 1 framework to capture environmental and social risks. But the resulting adjustments remain difficult to make in practice, and we have not seen any indication that policymakers are ready to introduce changes.

The focus of supervisors will continue to be on climate. There was an explosion in the discussion of nature risk during COP16, and the ECB continues to push the banks it supervises to develop their capabilities to assess and manage nature risk. We do not expect this to be sufficient though to elevate nature to the same level of attention as climate in 2025. But the increased activity should prompt firms that have not done so already to assess their nature risk exposure and to develop a strategy for embedding nature in their risk management and transition planning.

Conclusion
 

In 2025, the opportunities and risks for FS firms from sustainable finance will grow as policymakers take steps to accelerate the mobilisation of private and public financing for the sustainability transition, and as physical and transition risks increase. Firms cannot afford to wait for certainty to emerge. Firms can proactively plan using scenarios to identify low-regret actions to take. Amongst the steps they take now, scaling the enterprise data environment to support future disclosure integrity and high quality, data -driven decision making is a key investment, alongside enhancing governance and controls over sustainability information.

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