Guest post by: Michael Horvath, Sustainability Leader, and Geoffroy Marcassoli, Sustainability Assurance Leader, at PwC Luxembourg 

In the years following the Paris Agreement, transition finance has gradually but forcefully emerged as a key concept within the wider sustainable finance universe, as asset managers and investors alike sought to channel capital to drive real-economy decarbonisation changes rather than simply divesting from high-emitting sectors. However, during those years, it quickly transpired that distinguishing genuine transition exposure from greenwashing was a central challenge.

The European Commission has recently unveiled the long-awaited proposal for a revamped Sustainable Finance Disclosure Regulation (‘SFDR 2.0’) which formally introduces a transition product category (Article 7). This regulatory clarity allows financial market participants to have exposure to companies that are not yet sustainable but are expected to become so.

Indeed, the SFDR 2.0 proposal raises the stake. By defining transition as a distinct investment objective, it signals that financial products adopting the label must be matched by measurable investment behaviour. These strategies operate in a grey zone, holding issuers whose current environmental performance may be weak but projected to improve.

The key question for the asset management industry is how can investors reliably separate genuine transition impact from relabelling?

Where relabelling risk emerges

Relabelling risk arises when the narrative of transition evolves faster than the underlying investment process. One common feature is heavy reliance on internal ESG assessments. Proprietary scoring models can provide useful signals, but when they dominate issuer analysis without external benchmarking or methodological transparency, they create confidence without verifiability. Investors may be told an issuer is “on track,” even though the assumptions and data underlying that assessment remain opaque.

This risk is reflected by ESMA’s recent analysis which showed that 64% of funds changed their names when the guidelines on the use of ESG and sustainability terms in fund names came into force, and 56% updated their investment policies, most commonly by introducing fossil fuel exclusions. Notably, only a third of the funds that changed names also revised their underlying policies, illustrating that name changes alone did not reflect substantive investment strategy adjustments. This highlights how quickly labels can change without corresponding portfolio action, leaving investors exposed to superficial claims.

Indeed, engagement practices present another potential gap. Transition exposure is often justified through active ownership, including dialogue and collaborative initiatives. Yet engagement without defined milestones, time-bound targets, or escalation mechanisms risks becoming an indefinite holding rationale.

A further disconnect appears between portfolio-level metrics and issuer-level action. Funds often highlight declining carbon intensity or improved aggregate ESG scores. While these metrics suggest directional change, they do not necessarily demonstrate that companies are reallocating capital in line with transition pathways. Portfolios can decarbonise on paper while the underlying business models remain largely intact, creating the risk that the label reflects optics more than real-world change.

What distinguishes transition from relabelling

For investors, the critical test is whether the transition label alters investment behaviour. Credible transition strategies share identifiable operational features. Interim targets should be measurable and time bound. Issuer-level indicators, including capital expenditure alignment and operational decarbonisation, should feed directly into investment decisions. Governance structures should monitor progress alongside financial performance, ensuring oversight is both active and accountable.

Indeed, consequences are essential, where issuers fail to meet milestones. Escalation of engagement, voting action, position reduction, or eventual exit should be defined and enforceable. Quantifiable exclusions also matter: claims to avoid the most harmful activities must be transparent, with thresholds and residual exposure clearly monitored.

The SFDR 2.0 proposal reinforces this principle by requiring transition products to invest at least 70% of their assets in investments that meet a clear, measurable transition objective, with the remainder not undermining that objective. This quantitative threshold ensures that labels reflect substantive portfolio alignment rather than narrative alone, leaving less room for relabelling or superficial adjustments.

Evidence as the new currency

The implications for investors are profound. Regulatory scrutiny of sustainability claims is increasing, raising reputational and conduct risks where labels cannot be substantiated. Asset owners are sharpening due diligence, looking beyond policies toward evidence of implementation. Mistaking relabelling for genuine transition exposure can create financial risk, especially where high-emitting assets face abrupt repricing.

In sustainable finance, credibility increasingly depends on measurable outcomes. Strategies that can demonstrate how transition considerations influence capital allocation, engagement, and issuer-level action are viewed as more robust than those relying on narrative alone. Transparency in assumptions, consistent measurement frameworks, and enforceable escalation mechanisms are essential, while portfolio-level metrics must align with real-world change and internal ESG ratings should be validated externally where possible.

Aligning labels with investment reality

Transition finance was conceived to align capital with decarbonisation and real-economy change. For that promise to hold, labels must correspond to observable investment behaviour rather than aspiration alone. Good intentions, while important, are no substitute for verifiable proof. Investors need to see that capital is flowing in ways that actively support transition pathways, that issuers are meeting milestones, and that governance mechanisms enforce accountability when progress falters.

The formal introduction of the transition product category in the SFDR 2.0 proposal represents a pivotal moment. By codifying transition as a distinct investment objective, the proposal strengthens the link between strategy names and actual portfolio behaviour.

Avoiding relabelling risk now requires rigorous internal and external verification. ESG assessments must be transparent, engagement measurable, exclusions quantifiable, and portfolio-level metrics aligned with issuer-level action. Where assumptions are forward-looking, uncertainty must be explicitly disclosed. Only strategies that meet these standards – combining governance, data, and enforceable consequences – can claim genuine transition impact.

The growth of transition finance means that only strategies with verifiable terms, evidence-backed labels will earn investor trust. Their credibility will guide capital allocation and ultimately shape the path to net-zero.