Legal Issues in Sustainable Finance for 2026: Transition Finance and Green Bond Practice

2026-02-02

✅ Key Takeaways

📉 GSS bond issuance decreased 30% YoY in 2025, but legal frameworks significantly evolved: ICMA/LMA released critical guidelines in November 2025, clarifying legal requirements for transition finance
⚖️ Transition finance faces a critical juncture in 2026: Whether it can establish itself as a private sector-led funding scheme depends on contract practices, KPI design, and disclosure obligations
🌊 Adaptation finance and blue bonds emerge as new legal frontiers: Tokyo Metropolitan Government issued the world’s first CBI-certified resilience bond, positioning physical climate risk response as a key funding theme
🔍 Green bond “greenwashing” risks materialize: With greenium disappearing and market maturation, companies shift from cost reduction to prioritizing credibility and legal risk management

Table of Contents

Introduction

As the year draws to a close, this post explains the legal trends in the sustainable finance market for 2026 and the practical issues companies will face.

The global market for GSS bonds (Green, Social, Sustainability bonds, etc.) in 2025 is expected to end the year at roughly 30% lower than the previous year.
If we look only at the decline in issuance volumes, many may be concerned that the market is stagnating.

However, 2025 was also a major turning point, marked by new rulemaking and experimentation. In particular, in November, the International Capital Market Association (ICMA) published the Climate Transition Bond Guidelines (CTBG), and around the same time the Loan Market Association (LMA) released the Transition Loans Guide.

With these international guidelines now in place, transition finance—long described as “high in ambition but lacking consensus”—can be seen as finally entering the implementation phase.

This article organizes the key legal issues that corporate CFOs, corporate planning teams, sustainability teams, and legal departments should understand in 2026, from a practical perspective.

Current state of the sustainable finance market and a review of 2025

Contraction of the GSS bond market and structural drivers

The global GSS bond market in 2025 produced a harsh outcome: a decline of about 30% year-on-year.
Multiple structural factors appear to be contributing to this trend.

First, heightened geopolitical risk.
In 2025, “defense spending” became part of the market debate in Europe, while geopolitical risk also became a major theme in East Asia. As energy security is increasingly prioritized over decarbonization goals, corporate financing strategies are shifting.

Second, the disappearance of the “greenium” (the phenomenon whereby green bonds, etc. can be issued at lower rates than conventional bonds).
In Japan as well, it was reported that the greenium disappeared in a green bond jointly issued by local governments in March 2025 (see: Bloomberg JP article).
As the market matures, the economic incentive to issue green bonds weakens, and companies may find them less attractive as a funding tool.

Key developments in 2025

At the same time, 2025 saw major progress in the development of the legal and market framework.

ICMA: Publication of the “Climate Transition Bond Guidelines”
In November 2025, ICMA published the Climate Transition Bond Guidelines (CTBG).
These guidelines provide issuance-level guidance for transition bonds as an emerging financing tool aimed at achieving the goals of the Paris Agreement.

ICMA also updated the Climate Transition Finance Handbook, clarifying how companies can operationalize transition strategies at the corporate level.

LMA: Publication of the “Transition Loans Guide”
Also in October 2025, LMA—together with APLMA and LSTA—published the Transition Loans Guide.
This helped establish a practical framework for transition finance not only in bond markets but also in loan markets.

Tokyo Metropolitan Government: Issuance of a resilience bond
In October 2025, the Tokyo Metropolitan Government issued a resilience bond overseas—the world’s first to receive certification from the Climate Bonds Initiative (CBI).
This financing, themed around adaptation to the physical risks of climate change, breaks new ground beyond mitigation-focused green bonds.

Key 2026 trends and legal risks

Transition finance: Explaining the ICMA/LMA guidelines

What is transition finance?

Transition finance is a mechanism that supports funding for companies and projects that are currently carbon-intensive but have credible long-term decarbonization strategies toward carbon neutrality.
Whereas traditional green bonds target “projects already environmentally beneficial,” transition finance focuses on “companies that will decarbonize going forward.”

For example, in industries with inherently high CO₂ emissions—such as steel, chemicals, and shipping—transition finance can support plans such as hydrogen-based steelmaking, switching marine fuels, and electrifying manufacturing processes.

Legal requirements in the ICMA guidelines

The Climate Transition Bond Guidelines (CTBG) published by ICMA in November 2025 require transition bond issuers to satisfy four core elements:

Issuer transition strategy and entity-level governance

Establish a company-wide long-term decarbonization strategy
Put governance in place at the board level
Set science-based targets (e.g., SBTs)

Environmental materiality in the business model

Identify climate risks and opportunities in the business model
Align with sector-specific transition pathways

Science-based transition strategy and targets

Set a reduction pathway aligned with the Paris Agreement (1.5°C goal)
Define quantitative interim targets and milestones

Implementation transparency

Disclose the use of proceeds
Measure KPIs (Key Performance Indicators) and provide regular progress reporting

While these requirements are not legally binding, they are increasingly becoming international market practice.
If a company fails to meet them, it risks losing investor confidence, facing higher funding costs, and in the worst case being criticized for “greenwashing.”

Practical significance of the LMA loan guide

The LMA’s Transition Loans Guide provides practical guidance for transition finance in loan markets.
Unlike bonds, loans are largely negotiated bilaterally, and contractual terms are shaped through lender–borrower negotiation.

The guide highlights the following points as particularly important:

How to set KPIs: Practical approaches to defining environmental performance metrics the borrower must achieve
Treatment if KPIs are not met: Designing interest rate adjustment clauses (step-up provisions)
Need for third-party verification: Standards for when external KPI verification should be required

In Japan, for example, in November 2025, Sumitomo Mitsui Banking Corporation implemented a transition loan for Mazda, and further growth in such transactions is expected.

Legal issues companies will face

When using transition finance, companies should examine the following legal issues.

Scope of disclosure obligations
How detailed the disclosure of a transition strategy should be is a difficult question.
More detail can build investor trust, but also carries the risk of revealing technological strategy to competitors.

In Japan, the Financial Services Agency has required sustainability disclosures in annual securities reports since 2023, aligned with TCFD recommendations.
Ensuring consistency between transition finance frameworks and TCFD disclosure is also a key issue.

Legal responsibility if KPIs are not achieved
Transition bonds and loans often adopt sustainability-linked structures in which interest rates change depending on KPI performance.
Step-up clauses apply if KPIs are not met, but designing appropriate force majeure or relief provisions—e.g., for regulatory changes or supply chain disruptions—remains a practical challenge.

Greenwashing litigation risk
In Europe and the US, lawsuits are increasing where investors or consumers allege exaggerated environmental claims.
Because transition finance targets companies that are “still carbon-intensive today,” it may carry higher greenwashing risk than green bonds.

Companies should implement legal and practical measures to ensure credibility, including science-based targets, third-party verification, and rigorous periodic reporting.

Green bonds: Greenwashing risk

Disappearance of the greenium and market maturation

The green bond market is now more than a decade old and has entered a mature phase.
However, global CO₂ emissions continue to rise, and there is growing skepticism about how much green bonds have contributed to real environmental improvement.

In 2025, the disappearance of the greenium—previously observed in overseas markets—was reported.
In Japan as well, the greenium disappeared in local government bonds, weakening the economic rationale for issuance and prompting some municipalities to reconsider issuing green bonds.

Increase in greenwashing litigation

As the market matures, investor scrutiny is intensifying.
When environmental claims do not match reality, the risk of legal liability for “greenwashing” increases.

In Europe, disclosure regulations regarding the environmental performance of financial products (SFDR) have been strengthened, and the allocation of green bond proceeds is subject to stricter review.

In Japan, the Financial Services Agency established a “Sustainable Finance Expert Panel” in 2024 and is advancing discussions to improve the reliability of disclosures for green bonds and related instruments.
Companies should build transparent disclosure frameworks consistent with the Green Bond Principles (GBP), including: identifying eligible use of proceeds, obtaining external reviews (second opinions), and publishing regular impact reports.

Legal measures companies should take

To avoid greenwashing risk, the following legal measures are recommended:

Use external reviews
Consider obtaining second opinions or certifications from third-party organizations.
Representative providers include CBI, Sustainalytics, and Moody’s ESG Solutions.

Strictly manage use of proceeds
Strengthen internal governance to track whether proceeds are actually allocated to eligible projects.
Examples include establishing a dedicated team to manage proceeds post-issuance and performing periodic internal audits.

Publish impact reports regularly
Market practice generally expects at least annual impact reporting after issuance, disclosing detailed allocations and environmental outcomes (e.g., CO₂ reductions).

Legal requirements for adaptation finance

The difficulty of achieving the Paris Agreement “1.5°C target” and the growing importance of adaptation

Achieving the Paris Agreement’s “1.5°C target” is becoming extremely difficult in practical terms.
According to UNEP’s Emissions Gap Report 2024, continuing current policies could lead to a projected 3.1°C increase in average global temperature by the end of the century.

In this context, “adaptation” to physical climate risks—floods, droughts, heatwaves, and other impacts—has become a key management issue for companies as well.
Adaptation finance refers to funding for infrastructure and technology that improve resilience against such impacts.

Legal significance of Tokyo’s resilience bond

In October 2025, Tokyo issued the world’s first CBI-certified resilience bond in overseas markets.
Proceeds are allocated to measures addressing flood risk, such as constructing rainwater storage facilities and strengthening sewer networks.

To obtain CBI certification, the bond must comply with the Climate Bonds Resilience Taxonomy (CBRT), an international classification standard published by CBI in August 2025 that clarifies definitions for adaptation and resilience projects.

Legal issues in corporate use of adaptation finance

Companies considering adaptation finance should examine the following legal issues:

Definition and scope of “adaptation projects”
What qualifies as an “adaptation project” is not always clear.
For example, is strengthening cooling systems in data centers adaptation to rising temperatures—or simply part of a business continuity plan (BCP)?

CBRT defines adaptation projects as “activities that improve resilience to the physical impacts of climate change,” but determining eligibility in specific cases requires expert judgment.

Boundary with mitigation measures
Adaptation differs conceptually from mitigation (CO₂ reduction), but the two can overlap.
For example, improving building insulation reduces energy use (mitigation) while also supporting adaptation to heatwaves.

Whether funding should be raised under a green bond framework or an adaptation finance framework depends on strategic considerations.

Difficulty of impact measurement
Measuring the effects of adaptation projects is often harder than measuring mitigation outcomes.
CO₂ reductions can be quantified, but “how much flood risk was reduced” can be difficult to express numerically.

In Japan, some major life insurers have already underwritten local bonds dedicated to adaptation projects, and market practice is likely to develop further.

Contract practice for blue bonds

What are blue bonds?

Blue bonds are bonds used to finance projects related to ocean conservation and water resource management.
Eligible projects may include preventing marine pollution, sustainable fisheries, establishing marine protected areas, and improving water infrastructure.

In 2025, blue bonds for the Thames Tideway Tunnel project in the UK drew attention.
The project aims to build a “super sewer” to divert untreated sewage flowing into the River Thames, financed in part through blue bond proceeds.

The importance of water finance

Water-related risks are becoming increasingly important management issues for companies.
They affect energy and food security, securing cooling water for data centers, and more.

With the intensification of extreme weather due to climate change, water-related disasters such as floods and droughts are increasing.
Companies need to integrate water risk management into corporate strategy to strengthen business resilience.

Key contract practice issues

In blue bond contracting, the following points are particularly important:

Defining eligible use of proceeds
Blue bond proceeds must be limited to projects related to “water” or “oceans.”
However, what qualifies as a “water-related project” is not always obvious.

For example:
Does an agricultural water-efficiency project qualify?
Does upgrading wastewater treatment equipment at a factory qualify?
These determinations often require reference to international criteria (e.g., CBI Water Infrastructure Criteria).

Measuring environmental impact
Impact reporting for blue bonds is expected to quantify improvements such as water quality and marine ecosystem outcomes.
But scientifically measuring these effects can be technically challenging.

Ensuring scalability
The blue bond market remains small compared to the green bond market.
Smaller deal sizes may be less attractive to large institutional investors.

For the market to mature, larger and more standardized deals, well-established evaluation frameworks, and more active secondary markets will likely be necessary.

Legal checkpoints companies should understand

Contract structures in sustainable finance

When using sustainable finance, companies should understand the following contract structures:

Use-of-proceeds structure

Typical for green bonds and blue bonds, where proceeds are limited to specified projects.
Tracking and reporting on allocations are essential.

Sustainability-linked structure

Typical for Sustainability-Linked Bonds (SLBs) and Sustainability-Linked Loans (SLLs), where interest rates vary depending on achievement of corporate-level ESG KPIs.
KPI design and verification are critical.

Hybrid structures

Structures combining elements of both also exist.
For example, transition bonds may require both: (i) allocating funds to specific projects (use-of-proceeds) and (ii) achieving corporate-level CO₂ reduction targets (sustainability-linked).

Practical issues in KPI design and measurement

In sustainability-linked finance, KPI setting is often the most important contractual negotiation point.

Principles for KPI design

Under ICMA’s Sustainability-Linked Bond Principles (SLBP), KPIs are expected to meet the following requirements:

Relevance: Relevant to the company’s core business
Measurability: Quantitatively measurable
Ambition: Challenging for the company
Verifiability: Capable of third-party verification

Clause design when KPIs are not achieved

Typical provisions include:

Interest step-up: Interest increases by around 0.1–0.3% if KPIs are not met
Charitable donation: A set amount is donated to environmental organizations if KPIs are not met
Early redemption rights: Investors receive a right to demand early redemption

Disclosure and reporting obligations

Sustainable finance typically involves ongoing disclosure and reporting obligations after issuance.

Contents of annual reporting

Allocation status: Which projects received the raised funds
Environmental impact: Quantitative outcomes (e.g., CO₂ reductions, reduced water use)
KPI performance: Progress against KPIs (for sustainability-linked structures)

Third-party verification

Many investors require not only self-reported figures but also external verification.
Typical verifiers include audit firms, ESG rating agencies, and specialized consulting firms.

Conclusion

The sustainable finance market in 2026 is likely to be a year that demands qualitative deepening rather than quantitative growth.

Transition finance has finally entered the implementation phase following the ICMA/LMA guideline releases in late 2025.
Companies must address legal and practical challenges, including setting science-based reduction targets, building robust and transparent disclosure frameworks, and refining KPI design.

As the green bond market matures and the greenium disappears, companies are increasingly shifting from prioritizing lower funding costs to prioritizing credibility.
To avoid greenwashing risk, external reviews, strict use-of-proceeds management, and regular impact reporting are essential.

Adaptation finance and blue bonds are expected to attract further attention as responses to climate physical risk and water risk.
Tokyo’s resilience bond issuance may serve as an international precedent influencing other municipalities and companies.

CFOs, corporate planning teams, sustainability teams, and legal departments should consider these trends when designing the most appropriate financing strategy.
Sustainable finance is not merely a funding tool—it is closely tied to long-term corporate growth strategy.