A swap-based framework for managing energy transition risks

The sustainable energy transition represents a transformative shift in how energy is produced, distributed, and consumed – moving away from fossil fuels toward renewable energy sources. This shift is essential for achieving global decarbonization goals but presents significant challenges for businesses. As firms are compelled to adapt to this evolving regulatory and economic landscape, they become increasingly exposed to transition-related financial risks and uncertainties. This exposure is particularly pronounced for small and medium-sized enterprises (SMEs), which often lack the financial and strategic capacity to manage such transformation effectively, placing their valuations and long-term competitiveness at risk. To facilitate SMEs' transition process, we propose a novel financial tool, termed Transition Risk Impact Swap (TRIS), that leverages the conceptual framework of equity swaps, the use of conventional and sustainability-linked indices as proxies for corporate greenness, and flexible customisation, to enable the hedging of climate transition costs and uncertainty based on SMEs' transition performance. Proposed under both floating-for-floating and fixed-for-floating structures, TRIS allows for positive upfront payments and mitigating basis risk through linkage to observable market indicators, while also offering the flexibility to achieve a zero initial value through appropriately defined spreads, enhancing its marketability. The economic viability and risk-mitigating potential of the TRIS are quantitatively assessed through Historical Bootstrap and Monte Carlo simulations using European market data from STOXX and MSCI index series. The proposed financial instrument offers a scalable mechanism to strategically support firms in initiating or accelerating their climate transition by enhancing financial flexibility, reducing reliance on traditional funding channels, and mitigating the risk of long-term marginalisation or market exclusion.