Transition Finance Gets a Harmonised Framework: LMA Issues Guide to Transition Loans

The Loan Market Association (LMA) has released a comprehensive “Guide to Transition Loans,” which includes an exposure draft of the Transition Loan Principles (the Guide). This development is a significant step toward a common, cross‑jurisdictional framework that clarifies what constitutes credible transition financing in the loan market and provides practical guardrails for both entity‑level and asset/project‑level transactions.https://www.lma.eu.com/application/files/8017/6121/0645/Guide_to_Transition_Loans_-_16_October_2025.pdf.

For borrowers and lenders active in hard‑to‑abate sectors, the Guide is intended to expand access to capital for real‑economy decarbonisation by de‑risking execution, sharpening expectation‑setting, and reducing greenwashing risk.

The Guide was released in collaboration with the Asia Pacific Loan Market Association (APLMA) and the Loan Syndications and Trading Association (LSTA). This Client Alert summarizes the Guide’s provisions, highlights market trends, and provides key takeaways for market participants.

What Is Transition Finance?

Transition finance is distinct from green finance, which typically funds activities that are already low carbon. Conversely, Transition finance is designed to enable real‑economy decarbonisation, particularly in high‑emitting and hard‑to‑abate sectors, by funding credible, science‑aligned pathways to net zero that avoid carbon lock‑in and deliver measurable emissions reductions at either the entity level (via transition‑themed SLLs) or the asset/project level (via use‑of‑proceeds transition loans).

The Guide’s formalisation of transition finance as a distinct category for loans may be advantageous for infrastructure projects and corporate refinancings in developing and middle-income countries and/or for sectors such as power, chemicals, mining and metals, and aviation

Transition finance occupies a middle ground and has historically been crowded out by green finance on one side and conventional finance structures on the other side. The Guide’s formalisation of transition finance as a distinct category for loans may be advantageous for infrastructure projects and corporate refinancings in developing and middle-income countries and/or for sectors such as power, chemicals, mining and metals, and aviation.

What the Guide Does

The Guide is designed to provide market participants with a common language and practical tools to finance decarbonisation in sectors that fall outside traditional “green” categories. It distinguishes “financing the transition” (being all forms of financing relating to decarbonisation) from “labelled transition finance” (a subset of the broader decarbonisation effort including labelled instruments such as transition loans) and focuses on the latter at the transaction level.

The Guide sets out two complementary avenues for transition finance in the loan market:

1. General corporate financing, typically via SSLs, calibrated around science‑based key performance indicators (KPIs) and sustainability performance targets (SPTs) that track the borrower’s material Scope 1, 2, and 3 emissions, or robust proxy metrics where tracking Scope 3 emissions is not feasible.
2. Use‑of‑proceeds transition loans, to fund specific assets, operations, or investments that materially reduce emissions along a credible pathway but sit outside established green categories. Transition loans can fund entire transition projects or specific components (whether existing or new projects) that are essential to a broader decarbonisation strategy. These components may include capital expenditure, operational expenditure, research and development costs, or phase‑out (including decommissioning) costs.

At the heart of the Guide’s framework is an emphasis on credibility and contextualisation. Credible transition finance should (i) align with Paris Agreement-compatible objectives, (ii) avoid carbon lock‑in (i.e., continued use of fossil fuel infrastructure despite the availability of low-emission alternatives), (iii) be benchmarked against science‑based pathways, and (iv) incorporate safeguards against significant harm to biodiversity, ecosystems, land and water use, and pollution levels.

The Guide recognises that pathways vary by sector and region, and accommodates pragmatic, time‑bound interim steps where lower‑carbon alternatives are not yet technically or economically feasible.

The Exposure Draft Transition Loan Principles

The exposure draft of the Transition Loan Principles introduces five core components that mirror familiar green loan concepts while tailoring eligibility and safeguards to transition activities. These include:

1. Entity-level transition strategy: Borrowers should present a credible enterprise‑wide transition strategy. Ideally, this should take the form of a published plan or, at minimum, a robust set of indicators that show alignment to science‑based pathways and demonstrate how financed projects contribute to their overarching decarbonisation goals.
2. Use of proceeds: Proceeds must be exclusively applied to eligible transition projects that are on a credible pathway to net zero and deliver quantifiable, material emissions reductions within a defined timeframe; this can include whole projects or components thereof.
3. Project evaluation and selection: Borrowers should articulate clear criteria and governance for (i) selecting projects; (ii) demonstrating alignment with recognised sectoral pathways, technology roadmaps and relevant policy frameworks; (iii) the absence of feasible lower‑carbon alternatives; and (iv) robust management of environmental and social risks, including carbon lock‑in.
4. Management of proceeds: Net proceeds (or an equivalent amount) should be credited to a dedicated account or otherwise tracked through formal internal processes to ensure transparency, with disclosure of any temporary placement of unallocated funds.
5. Reporting: Borrowers should provide at least annual updates on allocations and impacts. These updates should include a list of (i) financed projects; (ii) amounts allocated and expected or achieved emissions reductions using clear methodologies; and (iii) forward‑looking indicators, where feasible. External review is encouraged where appropriate to support credibility.

Market Update: Transition Loans and Related Structures

Market momentum for transition‑themed lending continues to build, particularly for borrowers in hard‑to‑abate sectors that seek to align financing with decarbonisation programs that are not strictly green. Several trends are shaping execution:

1. Borrowers are increasingly using hybrid structures, which combine sustainability‑linked features at the entity level with ring‑fenced transition use‑of‑proceeds tranches, to align incentives with near‑ and medium‑term transition milestones.
2. Lenders are intensifying diligence around entity‑level credibility, transition plans, governance, interim targets, and capex alignment before agreeing to transition labels, even where proceeds are dedicated to specific projects.
3. External review expectations are rising, with market participants pushing for pathway‑based eligibility rationales and transparency around key assumptions, dependencies, and just transition considerations.
4. The global policy and disclosure backdrop is maturing. IFRS S2, Transition Plan Taskforce (TPT) guidance, and emerging regional taxonomies are providing clearer reference points for target‑setting, KPI selection, and impact reporting.
5. Pricing dynamics continue to be driven less by “label premia” and more by borrower‑specific credibility factors, sustainability‑linked mechanics, and the quality of data and verification arrangements.

Case Study: Japan

Japan’s recent experience underscores the power of clear and credible transition finance architecture, particularly when paired with sovereign support. Anchored in Japan’s Green Transformation Strategy (the GX Strategy), the Japanese government’s inaugural sovereign Climate Transition Bond catalysed a record year for transition issuance and channelled proceeds into practical pathways for hard-to-abate sectors to decarbonise, demonstrating how use-of-proceeds instruments can support entity-wide climate transition strategies.

The GX Strategy’s emphasis on distinguishing green from transition finance, together with sectoral roadmaps and disclosure expectations aligned to international practice, has given investors confidence that capital is advancing real-economy decarbonisation rather than prolonging status quo activity. Sovereign signalling has been reinforced by institutional backing across ministries and agencies, creating a coherent policy-finance ecosystem that crowds in private capital. Together, these elements offer a compelling demonstration that with appropriate guidelines and robust sovereign and institutional support, transition finance can scale, mobilise diversified demand, and deliver investable pipelines for economy-wide transformation.https://www.environmental-finance.com/content/analysis/japan-the-case-for-transition-bonds.html.

Practical Implications for Borrowers and Lenders

We anticipate that with the release of the Guide, sponsors and borrowers in the project financing sector, particularly those involved in transition projects like carbon capture, usage, and storage (CCUS) or liquefied natural gas (LNG), will increasingly consider labelling their project finance loans as transition loans. Previously, the absence of an established framework and market consensus deterred many from adopting this label, despite the availability of third-party providers ready to assess the suitability of such labelling and frameworks that closely aligned with the Green Loan Principles. Moving forward, the Guide is expected to address these concerns, providing clarity and encouraging broader adoption of the transition loan label in the market.

For borrowers, the Guide provides a roadmap to structure credible transition financing aligned to corporate strategy, whether via SLLs focused on outcome‑based KPIs or via project‑level instruments to fund decarbonisation tools, phase‑outs, or enabling capital expenditure, operational expenditure and research and development costs of transition-compatible projects.

For lenders, the Guide offers a robust framework to diligence eligibility, mitigate lock‑in and greenwashing risk, and calibrate reporting and verification obligations. In both cases, there is now a clear framework, but the expectation is clear: Transition loans should be supported by science‑based pathways, context‑appropriate feasibility assessments, and transparent reporting of impacts.

Key Takeaways

• Transition finance is now a defined category in the loan market. The Guide clarifies how to structure both entity‑level SLLs and use‑of‑proceeds transition loans to finance credible decarbonisation outside traditional green categories.
• Credibility starts at the entity level. A published transition plan or, at minimum, multiple indicators evidencing alignment with science‑based pathways is foundational; projects should not be assessed in isolation. Just like green loans, second-party opinions from third-party corporate service providers will be important for lenders to ensure alignment of transition-labelled loans with the Guide and to demonstrate credibility.https://www.sustainablefitch.com/corporate-finance/sustainable-fitch-second-party-opinions-to-support-new-transition-loan-principles-30-10-2025.
• The exposure draft Transition Loan Principles mirror the green loan framework. Expect five core components — strategy, use of proceeds, selection, management of proceeds, and reporting — applied with transition‑specific eligibility and safeguards.
• Project eligibility requires a pathway and a purpose. Use‑of‑proceeds loans should fund activities with quantifiable emissions reductions on a defined timeline, aligned with sectoral roadmaps and regional taxonomies.
• Avoiding carbon lock‑in is crucial. Interim investments must be time‑bound, pathway‑consistent, and justified by local technology and economic constraints, with decommissioning or phase‑out plans where relevant.
• Just transition considerations matter. Environmental and social risk management should be integrated into project evaluation to ensure climate gains do not undermine other sustainability objectives.
• Reporting and verification are central to market integrity. Annual allocation and impact reporting, with transparent methodologies and, where appropriate, external reviews, will be expected.
• Hybrid structures are gaining traction. Combining entity‑level incentives with ring‑fenced transition tranches can better align financing with credible decarbonisation pathways and investment plans.
• Global reference frameworks are converging. The Guide encourages alignment with IFRS S2, TPT, and regional taxonomies, helping parties substantiate eligibility and reduce execution risk and declassification.

Next Steps

With a harmonised framework now established, we expect that borrowers and lenders will increasingly bring credible transition‑labelled financings to market, particularly in hard‑to‑abate sectors. Latham & Watkins will continue to review developments in the transition finance space, including updates to the Guide and exposure draft Transition Loan Principles.