Amid increasingly stringent global climate policies and rising carbon emissions, coupled with the heavy dependence of many emerging economies on high-carbon industries, understanding how different environmental regulations affect the development of transition finance is crucial for balancing economic growth and deep decarbonisation. Using China’s carbon emissions trading pilots and low-carbon city pilots as representative cases, this study systematically examines how market-driven environmental regulatory strategies (MERS) and government-led environmental regulatory strategies (GERS) affect the development level of transition finance (DLTF), how their joint implementation within an environmental hybrid governance framework (EHGF) reshapes these relationships, and the underlying mechanisms and spatial spillover effects. Drawing on the G20 Sustainable Finance Report 2022, we construct a city-level DLTF index covering both the ‘investment’ and ‘benefits’ dimensions and employ a multi-period difference-in-differences model with panel data for 243 prefecture-level cities from 2009 to 2021. The results show that the joint implementation of the MERS (coefficient=0.016) and GERS (coefficient=0.006) within the EHGF framework raises the estimated coefficient of DLTF to 0.018, and all the core coefficients are significant at the 1% level. This indicates that the governance synergy generated by hybrid regulation clearly outperforms any single policy instrument. Mechanism tests suggest that MERS promotes transition finance primarily by strengthening environmental incentives, fostering green innovation, and improving resource allocation, whereas GERS exerts a more pronounced influence through green innovation and resource allocation. Spatial econometric analysis further reveals that MERS generate significant positive spillover effects on neighbouring cities, whereas the impact of GERS is more localised within administrative boundaries. Overall, these findings indicate that scientifically combining market-driven and government-led environmental regulatory tools and aligning them with the development trajectory of transition finance is a key governance strategy for supporting the orderly transition of high-carbon sectors and advancing long-term carbon reduction goals and sustainable economic transformation.
In the global fight against climate change, carbon emissions have continued to rise at an average annual growth rate of 10 % in recent years, despite numerous policies and measures implemented by the international community. Among major emitters, China, the United States, and India have exhibited exponential increases in emissions (Fig. 1). This persistent upward trend exposes a fundamental governance dilemma: existing policy instruments are frequently deployed yet deliver limited effects, whereas more systemic hybrid governance solutions remain underexplored.
Against this backdrop, the G20 Sustainable Finance Report 2022 explicitly elevates transition finance to a core component of the global sustainable finance agenda, emphasising its potential to bridge the gap between macro-level climate ambitions and the actual financing needs of high-carbon economies (Barkat et al., 2024; Dhahri et al., 2024; Suhrab et al., 2024). Within the G20 framework, transition finance is positioned as an innovative financial instrument that combines policy and market attributes. It is expected to accelerate the green transformation of financial systems by providing credible decarbonisation pathways for high-carbon industries, thereby helping emerging economies balance economic growth and environmental protection. Beyond the G20, regulatory practices in major jurisdictions have pushed transition finance from a conceptual proposition towards an institutionalised framework. In 2021, Japan’s Financial Services Agency issued the Basic Guidelines on Climate Transition Finance, defining transition finance for the first time as an independent category within the national policy system. Subsequently, the European Union, Singapore, Canada and other economies have released transition finance taxonomies and guidance documents, gradually forming an international consensus focused on measurable emission-reduction targets, transparent disclosure of transition pathways, and supportive financial mechanisms. Collectively, these institutional developments indicate that transition finance is no longer just a vague extension of green finance. It is gradually becoming a key pillar within the global green finance system, with its distinct connotation and clearly defined boundaries. Transition finance (Lin et al., 2024; Suhrab et al., 2024) seeks to support sectors and firms that do not yet fully meet ‘green’ standards but possess clear low-carbon transition potential, such as steel, coal-fired power, building materials, and agriculture. This is achieved by directing financial resources and policy guidance towards their efforts in energy conservation, carbon reduction, technological upgrades, and structural adjustment. Unlike green finance, transition finance focuses on the dynamic process through which firms move from ‘high carbon’ to ‘low carbon’, rather than solely on the final ‘green’ status of projects or assets. Its core objective is to achieve carbon emission reductions and industrial upgrades, while emphasising phasing, path-dependence, and goal alignment in capital allocation. In essence, transition finance uses financial instruments to provide an appropriate transition period and funding support for industries that are ‘not yet green but becoming greener’, preventing traditional industries from experiencing funding disruptions or severe contraction during the low-carbon transition. Thus, transition finance and green finance are not mutually exclusive or competing concepts; instead, they function as complementary components within the green finance system. Green finance primarily channels funds towards already-green activities, whereas transition finance designs and supports verifiable decarbonisation pathways for hard-to-abate sectors. This transition-oriented financial approach simultaneously safeguards economic stability and advances environmental governance, representing an important financial innovation for achieving global net-zero targets.
Moreover, the persistent difficulty in identifying solutions that reconcile emission reductions with economic development arises not only from the limited diversity of financial instruments but also from existing governance models that are overly simplified or fragmented. These models lack a hybrid governance perspective that can systematically coordinate multiple financial policy instruments, limiting transition finance from fully realising its problem-solving potential (Leonardo et al., 2025; Ziegert & Sotirov, 2024). Traditional single-policy governance models are prone to resource scarcity, policy rigidity, and inefficiency, making them ill-suited to addressing complex global challenges (Khan et al., 2026). By contrast, a hybrid governance framework can overcome these limitations and demonstrate more flexible, comprehensive, and effective outcomes through multi-stakeholder collaboration, policy coordination, resource allocation, and market participation. China provides a particularly illustrative context to observe the interaction between transition finance and hybrid environmental governance. As the world’s largest developing country and a major carbon emitter, China has introduced a series of environmental regulatory policies at different stages in an effort to maximise combined economic, environmental, and social benefits (Ge et al., 2024; Qi et al., 2021; Shao et al., 2023). Among them, the carbon emissions trading pilots and the low-carbon city pilots are two representative institutional arrangements that reflect market-driven and government-led environmental regulatory models, respectively (Ren et al., 2024; Zhou & Qi, 2022). In practice, these policies inevitably overlap, interact, and occasionally collide while promoting green transformation of the financial system, thereby generating complex cross-policy synergies and frictions. Evaluating environmental regulation effects from a single-policy perspective risks overlooking these interaction mechanisms, potentially underestimating the institutional dividends that a well-designed hybrid regulatory framework could unlock for the development of transition finance.
Motivated by these considerations, this study is guided by a set of closely related research questions: Is there a synergistic effect between market-driven and government-led policies? Can hybrid governance play a significant role in environmental governance? More importantly, can the integration of a hybrid governance framework for environmental regulation with transition finance overcome the bottlenecks of balancing economic growth and environmental protection, ultimately addressing the pressing global risk of rising carbon emissions?
Although the literature on green finance and environmental regulation is well-developed, a significant gap remains in understanding how different types of environmental regulatory tools promote the transition of financial markets towards sustainability by enhancing the level of transition finance development. To address this gap, the study makes the following contributions.
First, it constructs a city-level Transition Finance Development Index grounded in the ‘highest-level principles’ proposed in the G20 Sustainable Finance Report 2022, covering both investment and benefit dimensions. It provides a systematic and operable measurement framework that resolves the long-standing challenge of quantitatively assessing transition finance within the green finance system. Second, it treats the staggered implementation of China’s carbon emissions trading pilots and low-carbon city pilots as a quasi-natural experiment. Using a multi-period difference-in-differences (DID) design combined with mediation analysis, it rigorously identifies and compares the causal effects and transmission mechanisms of market-driven and government-led environmental regulatory strategies on transition finance development. Third, it embeds these dual pilot policies in an environmental hybrid governance perspective and further incorporates spatial econometric analysis to uncover heterogeneous and spillover effects across different types of cities. This approach demonstrates when and how hybrid regulatory arrangements can outperform single-instrument governance in promoting the green transformation of financial markets.
Literature reviewTransition finance, a crucial tool for advancing the shift to a low-carbon economy, has garnered significant attention in the context of global climate change and sustainable development. However, its development depends not only on market forces but also on effective government governance to ensure that funds are directed towards carbon-intensive industries for their green transition while minimising greenwashing and associated financial risks. Existing research has focused on the following key areas.
Historical progression of transition financeThe development of transition finance reflects the global urgency to address climate change and promote the transition to a low-carbon economy. Its development can be broadly divided into three stages:
Initial Phase (2000–2010): The rise of green finance marked the beginning of financial support for directly green industries such as renewable energy and environmental protection projects. However, these efforts were insufficient to cover the transformation of high-carbon industries (Wang & Gao, 2024).
Growth Phase (2010–2020): The 2015 Paris Agreement, which established carbon neutrality targets, marked a turning point. Scholars and policymakers worldwide began to introduce the concept of ‘transition finance’ (Anantharajah & Setyowati, 2022). Subsequently, countries explored various policy frameworks and practices, such as the 2019 policy recommendations by the UK’s financial market regulators to support the green transformation of high-carbon industries (James & Quaglia, 2019). Emerging economies, including China, also incorporated transition finance into their national environmental policies to drive industrial transformation.
Development Phase (2020–present): Transition finance has gradually become a key component of climate finance. The 2022 G20 Sustainable Finance Report introduced high-level principles specifically for transition finance, aiming to foster global low-carbon transitions through financial innovation, policy support, and international collaboration. The report also emphasised increasing social participation and integrating corporate environmental, social, and governance (ESG) indicators to support broader green development across environmental, social, and economic dimensions (Kafle et al., 2022).
The existing literature offers a broad overview of transition finance but overlooks several key aspects. Although green finance has focused on renewable energy and environmental protection, it often neglects the challenges of financing the transition of high-carbon industries, which are critical for achieving global climate goals. Additionally, although the Paris Agreement helped formalise transition finance, research treats it as a uniform policy across regions, ignoring the distinct approaches of developed and emerging economies, which limits the applicability of findings. Furthermore, although the 2022 G20 report highlights the importance of ESG integration and social participation, it lacks a comprehensive framework that connects policy interventions, financial instruments, and their wider socioeconomic impacts. In particular, much of the existing work remains at a descriptive level, tracing the chronological evolution of concepts and instruments but shying away from a sharper analytical question: Under what concrete regulatory and institutional conditions can transition finance genuinely ease the decarbonisation constraints of high-carbon industries rather than simply rebranding conventional finance as ‘green’?
Innovative extension of green finance through transition financeTransition finance and green finance are core components of the green finance system. They share a common normative orientation of promoting coordinated realisation of economic development and environmental protection, but differ in capital allocation logic, policy functions, and implementation pathways (Y. Su et al., 2024). Thus, transition finance is best understood as a functional extension of and structural complement to green finance, rather than a simple relabelling. A systematic comparison of the two helps clarify the unique role of transition finance (Table 1).
Comparing Transition Finance and Green Finance.
Green Finance is generally defined as a set of financial activities that support projects and industries with clear, direct environmental benefits, such as clean energy, renewable energy, energy-efficient buildings, pollution control, and ecological restoration (Razi et al., 2024). Its operating principle is predominantly result-oriented: projects typically need to demonstrate verifiable environmental performance at the time of financing (Meng et al., 2024). Since the issuance of the Guidelines for Establishing the Green Financial System in 2016, China has developed a relatively mature green finance framework, including green credit, green bonds, and green funds (Meng et al., 2024). Existing studies show that these instruments guide capital into low-carbon sectors, internalise environmental externalities, promote industrial upgrading, and mitigate environment-related risks in the financial system (Babic, 2024).
By contrast, Transition Finance refers to financial activities that support sectors and firms that are not yet aligned with green standards but have clear and credible decarbonisation potential. These include high-carbon and energy-intensive industries such as steel, coal-fired power, building materials, and agriculture (Fuest & Meier, 2023). Transition finance is process-oriented: financing is linked to measurable emission-reduction pathways, interim targets, and technology upgrades, rather than requiring projects to be ‘green’ at the outset. It mainly describes financial instruments and arrangements that facilitate the orderly transition of high-carbon industries from ‘high carbon’ to ‘low carbon’. International frameworks in Japan, Singapore, and the European Union emphasise forward-looking transition plans and transparent disclosure to ensure that funds are genuinely used to support decarbonisation. In China, the China Transition Finance Taxonomy (Draft for Comments) issued by the People’s Bank of China in 2023 marks an important step towards systematising transition finance, with core principles such as decarbonisation-oriented, measurable pathways, and transparent targets (Ren et al., 2024).
Overall, the literature suggests that green finance mainly serves emerging green sectors and functions as ‘incremental finance’, whereas transition finance targets the decarbonisation of traditional high-carbon industries and functions as ‘adjustment finance’ for the existing economic structure (Kafle et al., 2022; X. Su et al., 2024). Placed within a unified Green Finance System, the two jointly form a support pattern covering both ‘already green’ and ‘in transition’ activities, providing a complete financial toolkit for achieving long-term climate and development goals. This also implies that green finance and transition finance cannot be understood in isolation from the regulatory context in which they operate. Although we know much about how green finance and transition finance operate in theory, far less is known about how specific governance arrangements activate, distort, or mute their roles in real-world low-carbon transitions. This calls for calling for closer attention to how government environmental governance shapes the evolution of transition finance.
Role of government-led environmental governance in transition financeGovernment-led governance strategies and environmental regulatory policies are core mechanisms to ensure the effective implementation of transition finance. Effective governance is a prerequisite for the efficient operation of financial instruments (Haase & Sassen, 2024; Olumekor & Oke, 2024). The government focuses on how capital allocation in green finance can truly promote low-carbon transition through targeted interventions (Chen et al., 2024; Wang & Gao, 2024), ensuring sustained governance benefits rather than just short-term economic growth. This underscores the critical importance of high-quality regulatory frameworks and institutional governance strategies in promoting transition finance (Sun et al., 2024; Zhao et al., 2024). Furthermore, environmental regulatory policies not only set clear standards for the green transition of enterprises but also reduce negative environmental externalities through market-based mechanisms (Jiang et al., 2024; Meng et al., 2024). Specifically, carbon trading pilot policies have enhanced enterprise productivity (Zhang et al., 2025) and technological innovation (Zhang et al., 2025), increasing the financing demand for transition finance and promoting environmental development through carbon reduction and emission control. Electric vehicle pilot policies have garnered more green financial support and achieved CO2 emissions reduction by improving the energy consumption structure (Cheng & Xiong, 2024). Low-carbon city pilot policies have facilitated industrial upgrading through increased support for scientific research financing (Zhao et al., 2025), improving the effectiveness of environmental regulation. Combined with innovation-driven city pilot policies, these measures deliver even better results (Jiang et al., 2023). Although the above environmental regulatory policies each have their strengths, existing literature still focuses on identifying the effects of individual policies on sustainable finance and green development. Although some studies have explored the potential of policy synergy, they generally address it as a random combination of policies, lacking a higher-level perspective based on governance frameworks. Consequently, the system-wide, complementary potential of policy systems remains underutilised. Most studies still evaluate environmental policies one by one. They treat policy overlays as ad hoc or incidental combinations, rather than as deliberate configurations within a higher-order governance architecture. Therefore, the overall coherence and complementary potential of policy portfolios in steering transition finance have been under-theorised and rarely subjected to systematic empirical testing.
Challenges in the development of transition financeThe challenges facing transition finance can be broken down progressively into three key areas: policy effectiveness, policy overlay effects, and the lack of a systemically complementary governance framework. First, the issue of policy precision remains prominent. Although transition finance tools are central to driving the low-carbon economy transition, a mismatch often exists between financial policies and broader economic goals. This results in funds being directed towards high-carbon industries or short-term, high-return projects that do not align with long-term green development (De Groote et al., 2024; Filippini et al., 2024; Fuest & Meier, 2023). This indicates that policies with single objectives cannot be affected by deep governance, highlighting the need for more precise policy designs to ensure that funds are directed towards low-carbon transition areas (Rashid et al., 2023). Second, the unstructured combination of policy overlays is a significant issue. Although most studies focus on the primary effects of individual policies, only few have addressed the overlay effects of policies. The overlay effects are often only briefly mentioned or treated as random combinations, and systematic analysis of the effects of multiple policy overlays is lacking (Jiang et al., 2023). Consequently, the interactions between different policies have not been fully explored. Finally, the lack of a systemically complementary hybrid governance framework exacerbates these issues. Existing research often neglects the deeper economic and managerial considerations required to establish a comprehensive and complementary policy framework. This ‘skill without strategy’ situation (Liu et al., 2024) leads to the random combination of policy measures, which struggles to address the global complexities of transition finance and fails to create a holistic solution, thereby hindering the achievement of more inclusive and sustainable development goals. Although the literature extensively discusses the challenges facing transition finance, it has yet to deeply explore how to establish a systematic governance framework that integrates economic, financial, and managerial perspectives to effectively coordinate multiple policy forces in promoting the development of transition finance. Thus, the current debate on the challenges of transition finance is often rich in conceptual diagnoses but poor in operational metrics and causal evidence, especially in terms of how multiple policies can be orchestrated within a hybrid governance framework. This study aims to fill this gap by proposing more precise policy designs and a comprehensive governance framework, thereby fostering sustainable, integrated development across the financial, economic, and environmental domains.
In summary, research indicates that government-led governance plays a crucial role in advancing transition finance and promoting social sustainability. However, significant gaps remain in the literature. First, most studies fail to address the financing constraints faced by high-carbon enterprises during their sustainable transition (Tennant et al., 2024). Carbon-intensive industries are vital components of the economic structure in emerging economies. These industries cannot sacrifice economic growth solely to meet environmental requirements. Addressing the challenges faced by these industries is critical for achieving the sustainable transformation of global financial markets, which is precisely where transition finance should focus its efforts. Second, from the perspective of a comprehensive governance framework, empirical research on policy coordination, complementary effects, and underlying mechanisms is still scarce (Wu et al., 2024). By introducing a hybrid governance framework, this study systematically explores the governance strategies and pathways for transition finance development, expanding research on sustainable development. Furthermore, research on transition finance has mainly relied on qualitative analysis, with limited quantitative assessments and scientific evaluations. To address this gap, this study constructs a comprehensive indicator system based on the G20 Sustainable Finance Report 2022, encompassing 37 indicators to accurately measure the development level of transition finance (DLTF). By jointly addressing the conceptual, measurement, and governance deficiencies identified above, this study moves beyond the dominant single-policy and single-tool perspectives in the transition finance literature. It provides new theoretical foundations and practical insights for future policy design and empirical research.
Policies and hypothesesThe concept of ‘hybrid governance’ was originally developed in institutional and organisational economics to describe governance arrangements that combine market-based contracting with hierarchical coordination (Williamson, 2002). It was later extended to the analysis of private-sector governance (Makadok & Coff, 2009). Within Williamson’s transaction cost framework, markets, hierarchies, and hybrids are viewed as alternative governance structures that differ in their handling of uncertainty, asset specificity, and contractual incompleteness: markets offer flexibility but weak control, hierarchies provide strong control at higher organisational costs, and hybrids balance adaptability with coordination by selectively combining both elements. In public administration and environmental governance, hybrid governance coordinate state regulation, market mechanisms, and societal participation to address complex problems that neither markets nor hierarchies can solve alone. Similarly, within the ‘governance toolbox’ of most governments exists a latent form of hybrid governance designed to coordinate multiple policy instruments that cannot achieve satisfactory outcomes in isolation, thereby improving overall governance performance. Building on this literature, we conceptualise market-driven environmental regulatory strategies (MERS) and government-led environmental regulatory strategies (GERS) as ideal-type instruments that together constitute an environmental hybrid governance framework (EHGF) that combines ‘market regulation’ with ‘macro control’. From the perspective of transition finance, such a framework is expected not only to aggregate the direct effects of MERS and GERS but also to generate additional governance benefits through cross-policy complementarities. It also offers a coherent governance logic for understanding analytical pathways and research hypotheses developed in this study. In particular, MERS (carbon trading pilot policies) and GERS (low-carbon city pilot policies) have shown significant potential in China for maximising the benefits of transition finance.
Policy backgroundMERS is represented by China’s carbon trading pilot policy. This pilot policy is divided into two batches, 2013 and 2016, to explore carbon market mechanisms and promote the transition to a low-carbon economy. The first batch (2013) included Beijing, Tianjin, Shanghai, Chongqing, some cities in Hubei Province, and parts of Guangdong Province. The second batch (2016) added several cities in Fujian Province. This policy aims to control carbon emissions through market-based mechanisms and effectively allocate resources to support sustainable development. In promoting green finance, the carbon trading market guides capital flow towards low-carbon projects, fostering the development of green bonds, funds, and other financial instruments, and facilitating the deep integration of the financial system with the green economy.
By contrast, China’s low-carbon city pilot policy, which exemplifies GERS, promotes energy structure optimisation and carbon emissions reduction through measures such as carbon emission monitoring in specific cities and government incentives. The first batch of pilot cities (2010) included Guangdong, Hubei, Liaoning, Shaanxi, Yunnan provinces, and eight cities such as Shenzhen and Xiamen. The second batch (2012) was gradually expanded to more provinces and cities, including Chongqing, Tianjin, and Ningbo. The third batch (2017) further included cities like Nanjing, Hefei, and Changsha. As a government-driven initiative, the low-carbon city pilot policy has proven effective in enhancing the role of transition finance and successfully driving the transformation and upgrading of low-carbon technologies, industries, and sustainable finance (Fig. 2).
Research hypothesesDirect mechanisms of EHGF empowering transition finance
As a key policy tool within MERS, carbon trading pilot policies have made significant achievements in promoting the innovation of sustainable financial instruments and optimising the financial market. First, the carbon trading market has increased capital flows through price mechanisms, diversified financial products, and improved risk management systems, providing companies with tools to hedge carbon risks (Li & Xing, 2024; Man et al., 2024), helping them manage financial assets related to carbon emissions better. Second, the carbon market has directed capital towards projects with higher environmental and social benefits, improving the efficiency of capital use while fostering the development of green credit, sustainable investments, and low-carbon funds. This has created a positive feedback loop between financial markets and the low-carbon economy (Peng & Bai, 2021). The transparency and regulatory framework of the carbon trading market have further enhanced its effectiveness. The government’s clear disclosure requirements for carbon emissions (Frankovic & Kolb, 2024) have increased market transparency, enabling financial institutions to assess firms’ environmental risks more accurately. This transparency not only improves market efficiency but also reduces information asymmetry, providing institutional support for the stable development of financial markets (Pires Tiberto et al., 2020). Overall, MERS facilitated the transformation of financial markets in a greener and more sustainable direction through mechanisms such as green financial innovations, optimised resource allocation, and enhanced information disclosure. These governance policies provide crucial financial support for achieving low-carbon economic and sustainable development goals. Therefore, this study proposes the following hypothesis:
H1a: MERS contribute to the transition of financial markets in a greener and more sustainable direction.
The low-carbon city pilot policy, with its successful track record, has been expanded to several cities and has driven widespread adoption through three phases of implementation in recent years. As a quintessential example of GERS, it has effectively facilitated the sustainable transformation of financial markets. First, the policy has established clear low-carbon development goals and pathways through strong government guidance, creating a stable policy environment (Liu et al., 2024). The clarity and continuity of these policies provide development directions and investment expectations for financial markets, motivating financial institutions to develop and promote financial products related to the low-carbon economy, thereby promoting the steady growth of the sustainable finance market (Deng et al., 2024). Second, the government has significantly reduced the risks and costs associated with green investment through financial incentives and subsidies, further directing financial resources towards the low-carbon sector and attracting businesses and financial institutions to invest in low-carbon projects. These incentives enhance the economic viability of low-carbon projects, increase the enthusiasm of financial institutions for green investments, and accelerate the development of transition finance (Chen & Majeed, 2024). Additionally, the implementation of the low-carbon city pilot policy has spurred institutional innovation and financial reform (Zhou et al., 2024). The policy has established green funds, set green financial standards, and strengthened information disclosure requirements, providing institutional support for the development of green financial products. It has also improved market transparency and credibility of financial products, enhancing the stability and sustainability of the financial market. Overall, GERS have demonstrated the government’s key role in advancing low-carbon economies and sustainable finance through policy guidance, financial incentives, and institutional innovation. Therefore, this study proposes the following hypothesis:
H1b: GERS contribute to the transition of financial markets in a greener and more sustainable direction.
Although the carbon trading and low-carbon city pilot policies are well-intentioned, they each have certain limitations in their practical implementation. The carbon trading pilot policy faces issues with the market mechanism and inadequate regulation (Jing et al., 2024; Zou et al., 2023). In some regions, the carbon market exhibits significant price volatility and lacks liquidity, failing to attract enough market participants and reducing resource allocation efficiency. Additionally, the allocation of carbon emission allowances remains complex, with some enterprises failing to optimise their carbon emissions according to market mechanisms. Instead, they resort to grey market practices such as purchasing additional carbon allowances, which undermines the effectiveness of the market mechanism. Similarly, the low-carbon city pilot policy is overly reliant on local governments, resulting in insufficient flexibility and autonomy for enterprises (Li & Yan, 2024; Pan & Cao, 2024). This has led to inconsistent policy outcomes across different cities, with enterprises in some regions becoming overly dependent on government subsidies, which diminishes the long-term market-driven incentives.
Therefore, this study proposes EHGF to address the shortcomings of single-pilot policies (Fig. 3). Unlike tactical single-pilot policies, this framework combines MERS and GERS, integrating the strengths of market regulation and macro-control to complement each other’s weaknesses (Franco et al., 2024; Koehne & Ivory, 2024). It ensures coordinated and complementary policies across time and space, forming a systematic governance strategy at the strategic level, thus unlocking greater potential for transition finance. The government can play a guiding and incentivising role through macro-control through the synergistic effect of the hybrid governance framework, ensuring the achievement of low-carbon development goals (F. Zhou et al., 2024; Zhu et al., 2024), while the market mechanism directs funds towards green projects through price signals. Simultaneously, the framework can create systemic linkages across different levels and sectors, optimising resource allocation and promoting low-carbon investments across regions and sectors (Hou et al., 2024), thereby enhancing the economy’s green transformation capacity. In summary, the EHGF overcomes the limitations of single policies and provides a more comprehensive and long-term solution for sustainable economic and environmental development. Accordingly, this study proposes the following hypothesis:
H1c: Synergies associated with the EHGF have a stronger effect on promoting the transition of financial markets in a greener and more sustainable direction than any single environmental regulatory strategy.
Indirect mechanisms of MERS and GERS empowering transition financeSustainable finance theory aims to explore how financial markets and financial instruments can drive the achievement of ESG goals (Boiral et al., 2024; Luo et al., 2022; Shi & Zhang, 2024). The theory posits that the realisation of comprehensive benefits depends not only on the financial instruments but also on a conducive market environment. Financial markets are complex social systems involving multiple stakeholders, including governments, enterprises, and financial institutions. Therefore, achieving sustainable finance goals requires collaboration among these stakeholders to create a synergistic chain. Specifically, enterprises are encouraged to engage in green innovation under the guidance of government environmental policies, which, in turn, attracts more financial capital into green sectors, ultimately driving the development of sustainable finance (Chu et al., 2024; Xu & Lin, 2024).
- (1)
Strengthening environmental incentives. MERS enhance environmental incentives through price signals, increasing the costs faced by high-emission enterprises and motivating them to reduce these costs through environmental protection measures and green investments. Financial markets respond to this incentive mechanism by increasingly supporting enterprises with high environmental compliance and performance, leading to a flow of capital towards green enterprises. This reinforcement of market incentives drives the environmental orientation and sustainability of financial markets (Toșa et al., 2024). Similarly, GERS directly increase the economic costs of polluting behaviours through policy tools such as environmental taxes, pollution fines, and green credit incentives, while simultaneously lowering the barriers to green investment (Li et al., 2024). These policy measures not only encourage corporate compliance with environmental regulations but also attract more social capital to green financial products, such as green bonds and environmental liability insurance, further promoting the green transformation of financial markets.
- (2)
Promoting green innovation. By applying market mechanisms, MERS incentivise enterprises to reduce emissions and costs through technological innovation when confronted with carbon cost pressures (Wang et al., 2024). The financial market shows increasing investment interest in these innovative enterprises, further encouraging the research, development, and application of green technologies through capital support. This innovation-driven market mechanism facilitates the diffusion and industrialisation of green technologies, deepening the financial market’s involvement in green technology sectors (Ma & Lin, 2024). Meanwhile, GERS promote R&D investment and technological breakthroughs in green technologies by enterprises and research institutions through policy directives, such as R&D subsidies, technological standards, and innovation incentives (Huang et al., 2019). These policy-driven innovation activities motivate financial institutions to invest more capital in green technology and environmental protection projects, thereby fostering a technology-driven green transformation of financial markets (Tan et al., 2024).
- (3)
Optimising resource allocation. MERS internalise the external costs of carbon emissions by establishing a carbon price. Faced with the costs of carbon emissions, firms tend to reduce high-carbon production activities and invest in low-carbon technologies and green industries instead (Yang et al., 2024). This market-driven optimisation of resource allocation redirects capital towards environment-friendly enterprises and projects, thereby greening the resource allocation within financial markets. By contrast, GERS directly guides resource allocation through policy interventions, channelling resources towards industries and technologies that meet environmental requirements (Cheng & Yang, 2024). This government-led optimisation corrects market failures and ensures the flow of resources in ways that contribute to achieving sustainable development, thus providing a solid foundation for the green transformation of financial markets (Zhao et al., 2024).
Building on the above discussion, we expect MERS to activate all three transmission channels, but with different relative strengths. Market‐driven instruments rely on price signals and competitive pressures. Thus, they are suitable for strengthening firms’ environmental incentives, nudging them to internalise carbon costs and adjust their behaviour. Simultaneously, they create strong pressures for firms to engage in green innovation and adopt cleaner technologies by linking compliance costs and financial performance to market expectations. Most importantly, market‐based instruments help reallocate capital and production factors away from high‐carbon activities towards more efficient, low‐carbon uses across sectors and regions by attaching a price to carbon and other environmental externalities. Accordingly, we propose the following hypotheses:
H2a: MERS promote the transition of financial markets in a greener and more sustainable direction by strengthening price‐based environmental incentives for firms.
H2b: MERS promote the transition of financial markets in a greener and more sustainable direction by fostering green innovation in high‐carbon industries.
H2c: MERS primarily promote the transition of financial markets in a greener and more sustainable direction by improving the efficiency of resource allocation across sectors and regions.
By contrast, GERS operate mainly through planning, regulatory mandates, and public financial support, exhibiting a different mechanism profile. First, GERS reshape firms’ payoff structures and risk perceptions by setting binding emission targets, performance assessment indicators, and strict compliance requirements, thereby exerting direct pressure on polluters and strengthening environmental incentives even in regions with less developed market mechanisms. Second, government-led strategies typically bundle environmental regulation with targeted subsidies, tax relief, dedicated funds, and public R&D programmes, which lower the cost of experimentation and adoption of low-carbon technologies. This makes them particularly powerful in stimulating green innovation within regulated industries and regions. Third, GERS can guide the reallocation of capital and labour towards strategic low-carbon sectors and regions through spatially differentiated planning instruments. The use of instruments such as functional zoning, industrial layout policies, and place-based low-carbon pilot programmes aids in correcting market failures and overcoming coordination problems that pure price signals may not resolve. The multi-batch low-carbon city pilot in China is a prominent example. It has encouraged local governments and firms to reorient investment portfolios, upgrade industrial structures, and expand transition-related financial products by combining mandatory targets with fiscal and institutional support. These features suggest that GERS is especially effective in promoting transition finance through green innovation and resource allocation channels, while still influencing firms’ environmental incentives via regulatory pressure. Accordingly, we propose the following hypotheses:
H3a: GERS promote the transition of financial markets in a greener and more sustainable direction by enhancing environmental incentives through regulatory standards and performance assessments.
H3b: GERS primarily promote the transition of financial markets in a greener and more sustainable direction by strengthening green innovation via planning, regulation, and public support.
H3c: GERS also promote the transition of financial markets in a greener and more sustainable direction by guiding resource allocation towards low‐carbon activities via administrative instruments.
MethodVariables and dataExplained variableBased on the definition of transitional finance from The G20 Sustainable Finance Report 2022 and the High-Level Principles, this study constructs an indicator system to assess the DLTF from two dimensions: investment and efficiency (Table 2). The system includes 6 primary indicators, 19 secondary indicators, and 37 tertiary indicators. Additionally, the entropy value method is employed to calculate the comprehensive score of transition finance development, which serves as the explained variable (Polzin et al., 2021; Semieniuk et al., 2021).
- (1)
Investment dimension.The G20 Sustainable Finance Report 2022 highlights the need for broad investments to support climate transition, including expanding sustainable financial markets and improving the accessibility of financial instruments. Consequently, this dimension evaluates the types of investments and their objectives, encompassing 3 primary indicators, 13 secondary indicators, and 20 tertiary indicators: the level of greening investments, high-tech investments, and efficient investments.
- (2)
Benefits dimension.The G20 Sustainable Finance Report 2022 emphasises the need for transitional finance to promote fair and orderly transition activities while mitigating negative impacts on employment, sustainable development, energy security, and price stability. This dimension assesses the overall benefits of transitional finance, including environmental, social, and economic benefits, with 3 primary, 6 secondary, and 17 tertiary indicators.
System of indicators for the DLTF.
This study constructs two dummy variables as the core explanatory variables based on the carbon trading pilot policy (2013, 2016) and the low carbon city pilot policy (2010, 2012, 2017) (Wang et al., 2023; Zhou & Qi, 2022). According to the model demand of multi-period DID, the dummy variables are treated as follows. The first is the dummy variable of carbon trading pilot city (tcdid). If a city is a carbon trading pilot city in that year, the observed value of the variable in that year and thereafter will be 1; otherwise it will be 0. The second is the dummy variable of a low-carbon pilot city (lcdid). If a city is a low-carbon pilot city in that year, the observed value of the variable in that year and thereafter will be 1, and 0 otherwise.
Mechanism variablesBased on the previous analysis, this study selects mechanism variables from three channels – environmental incentives, green innovation, and resource allocation – to study the mechanism of environmental regulatory instruments on the level of transition financial development, to form a comprehensive theoretical framework system. Specific mechanism variables are as follows: environmental incentives (smech) (Zhu & Jiang, 2024) play a significant role in promoting the construction of a low-carbon environment in the region; hence, this study takes regional energy conservation and environmental protection expenditures as a measure of environmental incentives. Green innovation (gmech) is measured using green patent authorisation, referring to the study on green innovation and financial technology by Huang and Ma (2024). Drawing on the study on human resource allocation and green governance by Liu et al. (2024) and the definition of brown industries in the G20 Sustainable Finance Report 2022, resource allocation (rmech) is measured by the data of brown industries’ employees (electricity, construction, extractive industries, manufacturing industries).
Control variablesThe control variables selected in this study cover economic, market, and social aspects, which play a key role in promoting or hindering transition finance development (Frankovic & Kolb, 2024; Man et al., 2024; Zhang et al., 2025; Zhou et al., 2024).
- (1)
Economic development factors: the degree of financial development (findev) and per capita disposable income of urban residents (incban). This reflects the maturity of the financial market and the consumption capacity of residents, which directly affects the supply and demand of funds for transition finance.
- (2)
Marketisation factors: the level of marketisation (marklev), the scale of marketisation (marksiz), and the degree of market openness (markope). This reflects the development of the market economy; a higher level of marketisation and openness promotes innovative financial instruments and international green finance experience.
- (3)
Social structure factors: urbanisation level (curban) and human capital stock (humcap). This represents the urbanisation process and high-quality labour force, which promote popularity and further development of transition finance services. Considering these control variables together can effectively eliminate the interference of external factors and accurately identify the impact of environmental regulation on the development of transition finance.
The pairwise correlation matrix shows that the explained variable, policy dummies, and main control variables are positively and significantly correlated, and no pair of variables exhibits excessively high correlations, suggesting that multicollinearity is not a serious concern. Detailed descriptive statistics are shown in Table 3.
Descriptive statistics results of variables.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
The research sample consists of balanced panel data of 243 prefecture-level cities in China over the period 2009–2021. To ensure comparability of the sample, the data of municipalities are excluded, as municipalities are provincial-level administrative units, and their economic, environmental, and social development levels are significantly different from those of other prefectural-level cities, which are not directly comparable. Data sources include China Urban Statistical Yearbook, China Energy Statistical Yearbook, China Science and Technology Statistical Yearbook, China Financial Yearbook, statistical yearbooks of prefectural-level cities, and official websites of authoritative organisations such as the People’s Bank of China, the National Bureau of Statistics, and the Ministry of Science and Technology. Data on carbon emissions are from the CEADs database, and the digital financial index is quoted from the Digital Inclusive Finance Database released by Peking University. Missing individual data were supplemented using interpolation.
Model specificationThis study considers market-driven carbon trading and government-led low-carbon city pilot policies as exogenous events, treating them as a quasi-natural experiment. The evaluation of these policy events is typically conducted using the DID model. Given the staggered implementation timelines of both pilot policies, this study employs a multi-period DID model to examine the impact of the pilot policies on the DLTF.
The multi-period DID model is more suitable than the traditional DID model for evaluating policies implemented in multiple stages. It captures the dynamic effects of policies, analysing both short-term impacts and long-term outcomes, while fully utilising multi-period data to improve estimation efficiency and accuracy. Additionally, the model controls for time trend differences between groups, reducing biases caused by unobserved factors. This approach is particularly applicable to the multi-stage policy context of the carbon trading pilot and low-carbon city pilot examined in this study, providing more precise and reliable policy effect evaluations:
where fin denotes the level of transition finance development; did denotes a dummy variable constructed by a multi-period double-difference model.Xitdenotes group of control variables.γidenotes time fixed effect,ϑtdenotes city fixed effect, and εi,t denotes random disturbance term.
To investigate the mechanism of environmental regulation on the level of transition finance development, the study follows (Bullock et al., 2010; Hou & Shi, 2024) and tests it using a mediated effects model (Equations (1)–(3)):
whereMedi,tdenotes the mediating variable and the rest of the variables retain the same meaning as in Equation (1).ResultsDirect mechanism testBenchmark regression results
The regression results in Table 4, Columns (1)–(4), verify the significant impact of the carbon trading and low-carbon city pilot policies on the development of transition finance, demonstrating that these two environmental policies effectively represent MERS and GERS within the EHGF. The specific results are as follows: in Column (1), the carbon emissions trading pilot policy shows a significant positive effect on transition finance development without control variables, and this effect remains significant after adding control variables in Column (2). Similarly, in Column (3), the low-carbon city pilot policy demonstrates a significant positive effect on transition finance development without control variables, and this effect remains significant after adding control variables in Column (4). These findings validate H1a and H1b.
Benchmark regression results.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors. Same below.
Furthermore, this study reconstructs the sample by first excluding cities without any pilot programs. Cities that simultaneously implemented carbon trading and low-carbon city policies are categorised as the experimental group for environmental hybrid governance, whereas cities that implemented only one of the policies are treated as the control group. This approach evaluates whether the environmental hybrid governance strategy has a better synergistic effect than the single-pilot policies. The results in Columns (5) and (6) show that regardless of whether control variables are included, the hybrid governance strategy has a significant positive effect on improving transition finance development, validating H1c.
Identification hypothesis testing(1) Parallel trend test
The double difference model needs to satisfy the parallel trend assumption, that is, the trend in the level of transition finance development in pilot and non-pilot regions must be non-differentiated before the implementation of the environmental regulation policy. Therefore, this study adopted the event study method to conduct the parallel trend test, expressed by the following formula:
where α denotes Di,tk set of dummy variables that equal 1 when a policy shock occurs in the region of prefecture i in year t and after, and 0 before it occurs. The rest of the variables have the same meaning as in Equations (4) – (6). In the regression analysis specific to the parallel trend test, this study takes k= -1, that is, 1 year before policy implementation, as the base period, so the dummy variable Di,t−1 is not included in Equations (4) – (6). Finally, the coefficient of αk can be tested to assess whether the parallel trend test is satisfied.
Plotting time trends for market-led environmental regulation and government-led environmental regulation demonstrated that the control group will have a significantly higher level of transition finance development than other treatment groups after the policy is implemented (Fig. 4, Figs. 4-2, 4-3, 5-1, 5-2).
(2) Placebo test
. Parallel trend test (Hybrid governance)
Note: The horizontal axis reports event time relative to the first year in which a city enters the corresponding pilot, ‘current’ denotes the first treatment year, negative values (e.g. −8, −7, −6, …, −2) indicate years before the pilot starts, and positive values (1, 2, …, 11) indicate years after the pilot starts. As the policies are implemented in multiple waves, each point represents the average effect across cities at the same relative time and does not correspond to a single calendar year.
Time-placebo test: To account for potential differences between the experimental and control groups due to time factors, this study performs a time-placebo test, following the results of the parallel trend test. The policy implementation time is advanced by one or two years to construct a hypothetical policy shock, and Equation (1) is re-estimated. The regression results are presented in Fig. 5. The placebo test results indicate that the impact of the two policies on the development of transition finance is not significant, suggesting no significant time-trend differences between the policy and control groups.
Space-placebo test. An individual placebo test was conducted to verify the robustness of the carbon trading and low-carbon city pilot policies on transition finance development. As shown in Fig. 5, the results indicate that the policies’ effects on the adaptability of urban green development are not significant in years when the policies were either not implemented or did not have an impact. This suggests that the observed effects are attributable to policy implementation rather than other unobserved factors or time trends.
Endogeneity and robustness(1) Propensity Score Matching
This study uses the Propensity Score Matching (PSM) method to construct the sample for the endogeneity test. After PSM, the distribution of variables between the control group and the experimental group becomes more balanced, with the bias ratio less than 10 % and no significant difference in the mean results between the control and experimental groups. As shown in Tables 5–7, the empirical results from the PSM-DID using kernel matching and nearest-neighbour matching techniques indicate that the pilot carbon trading policy, pilot low-carbon city policy, and EHGF all enhance the level of transition finance development.
(2) Excluding the interference of parallel policies
Endogeneity and robustness test for market-led environmental regulation.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
Endogeneity and robustness test for government-led environmental regulation.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
Endogeneity and robustness test for EHGF.
Note: ⁎⁎⁎, **, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
To exclude the influence of other parallel policies on the research results, this study takes the atmospheric governance policy (2013, 2018) as a parallel interference policy and adds it to the group of control variables. The regression results are shown in Column (3) of Table 5–7, and the results remain robust.
Indirect mechanism testMERS: carbon trading pilot policy(1) Strengthening Environmental Protection Incentives
As shown in the regression results in Columns 1, 2, and 3 of Table 8, the carbon emissions trading pilot policy has a significant positive effect on transition finance development (coefficient: 0.016, significance level: 1 %). Additionally, it has a significant positive effect on the mediating variable, environmental protection incentives (coefficient: 1.366, significance level: 10 %), which, in turn, positively affect transition finance development (coefficient: 0.001, significance level: 1 %). This indicates that the carbon emissions trading pilot policy directly promotes transition finance development and amplifies its impact through the mediating effect of environmental protection incentives.
(2) Promoting Green Innovation
Mechanism test results for market-led environmental regulation.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
The regression results in Columns 4 and 5 of Table 8 demonstrate that the carbon emissions trading pilot policy has a significant positive impact on green innovation when it is used as the mediating variable (coefficient: 5.558, significance level: 1 %). Green innovation, in turn, significantly promotes transition finance development (coefficient: 0.002, significance level: 1 %). This suggests that the carbon emissions trading pilot policy enhances transition finance development by fostering green innovation.
(3) Optimising Resource Allocation
The regression results in Columns 6 and 7 of Table 8 show that the carbon emissions trading pilot policy has a significant positive effect on resource allocation when it is used as the mediating variable (coefficient: 8.648, significance level: 1 %). Resource allocation also positively influences transition finance development (coefficient: 0.001, significance level: 1 %). This suggests that the carbon emissions trading pilot policy further promotes transition finance development by optimising resource allocation.
GERS: low-carbon city pilot policy(1) Strengthening Environmental Incentives
The regression results in Columns 1, 2, and 3 of Table 9 indicate that the low-carbon city pilot policy has a significant positive impact on transition finance development (coefficient: 0.006, significance level: 1 %). However, the policy does not significantly affect environmental incentives (coefficient: 0.175). Despite this, environmental incentives still exert a significant positive influence on transition finance (coefficient: 0.001, significance level: 1 %). This suggests that the low-carbon city pilot policy directly promotes transition finance, whereas the environmental incentive mechanism, though not significantly affected, still positively contributes to the development of transition finance.
(2) Promoting Green Innovation
Mechanism test results for government-led environmental regulation.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
The regression results in Columns 4 and 5 of Table 9 demonstrate that the low-carbon city pilot policy has a significant positive impact on green innovation when it is used as the mediating variable (coefficient: 2.449, significance level: 1 %). Green innovation, in turn, significantly promotes transition finance development (coefficient: 0.002, significance level: 1 %). This suggests that the low-carbon city pilot policy enhances the development of transition finance by fostering green innovation.
(3) Optimising Resource Allocation
According to the regression results in Columns 6 and 7 of Table 9, the low-carbon city pilot policy has a significant positive effect on resource allocation when it is used as the mediating variable (coefficient: 2.779, significance level: 1 %). Resource allocation also significantly promotes transition finance development (coefficient: 0.001, significance level: 1 %). This implies that the low-carbon city pilot policy further contributes to the development of transition finance by optimising resource allocation.
Spatial heterogeneity analysisOld industrial bases versus non-old industrial basesThe heterogeneity analysis results in Columns 1 and 2 of Table 10 show that the impact of the carbon emissions trading pilot policy on transition finance development differs between old and non-old industrial bases. In old industrial bases, the policy has a significant positive effect on transition finance development, with a regression coefficient of 0.003 and a significance level of 5 % (p < 0.05). In non-old industrial bases, the positive effect is even more pronounced, with a regression coefficient of 0.018 and a significance level of 1 % (p < 0.01). Similarly, the low-carbon city pilot policy’s effect on transition finance development varies significantly between old and non-old industrial bases. As shown in Columns 1 and 2 of Table 11, the low-carbon city pilot policy has a significant positive impact on old industrial bases (coefficient: 0.002, significance level: 1 %), whereas its effect is stronger in non-old industrial bases (coefficient: 0.007, significance level: 1 %). This indicates the varying role of environmental regulatory policies in promoting transition finance development across regions with differing industrial intensities.
Heterogeneity test for market-led environmental regulation.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
Heterogeneity test for government-led environmental regulation.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
The heterogeneity analysis results in Columns 3 and 4 of Table 10 demonstrate that the effect of the carbon emissions trading pilot policy on transition finance development differs between environmentally focused protection cities and non-focused cities. In environmentally focused cities, the policy has a significant positive impact on transition finance development (coefficient: 0.031, significance level: 1 %), whereas, in non-focused cities, the positive impact is still significant but weaker, with a regression coefficient of 0.005 and a significance level of 1 %. Similarly, the heterogeneity analysis results in Columns 3 and 4 of Table 11 demonstrate that the effect of the low-carbon city pilot policy on transition finance development differs between these city types. In environmentally focused cities, the policy has a significant positive effect (coefficient: 0.010, significance level: 1 %), but in non-focused cities, the policy’s effect is not significant. This suggests that environmental regulation policies play a stronger role in promoting transition finance development in environmentally focused cities, whereas their impact is more limited in non-focused cities.
Spatial spillover effects analysisSpatial correlation effect testThis study conducts both global and local spatial autocorrelation tests to determine whether transition finance development exhibits spatial dependence across Chinese cities. The global Moran’s I index (Table 12), calculated for each year from 2009 to 2021, consistently shows significant positive values, indicating strong spatial clustering effects. These results imply that cities with similar levels of transition finance development are geographically proximate, rather than randomly distributed. Further verification is provided by the local Moran’s I index maps for 2012, 2015, 2018, and 2021. As illustrated in Fig. 6, most cities are concentrated in ‘High-High’ and ‘Low-Low’ clusters, particularly in the eastern coastal and western inland regions, respectively. This spatial pattern suggests the presence of localised spillover effects, where cities benefit from or are constrained by the transition finance performance of their neighbouring areas.
Spatial correlation effect test.
Importantly, this clustering pattern aligns with the spatial heterogeneity characteristics observed in the previous section. Cities identified as old industrial bases or environmentally focused protection areas exhibit significantly different spatial responses to policy interventions. These findings further justify the use of spatial econometric models to investigate the spatial spillover effects of differentiated environmental regulatory strategies on transition finance development.
Spatial spillover effect testThis study employs the spatial Durbin model (SDM) and performs likelihood ratio (LR) tests to evaluate the spatial spillover effects of different environmental regulatory strategies on transition finance development and confirm model suitability. As shown in Table 13, LR statistics indicate that the SDM significantly outperforms both the SAR and SEM models for both policy types, confirming the appropriateness of SDM in capturing both direct and indirect effects. The empirical results reveal a clear divergence in spatial dynamics between the two regulatory types. For the market-driven carbon trading policy (tcdid), the indirect effect (0.016) and total effect (0.020) are statistically significant, whereas the direct effect (0.003) is not. This suggests that carbon trading exerts its impact primarily through inter-city spillovers, potentially via capital reallocation, institutional imitation, or green finance diffusion across regions. By contrast, the government-led low-carbon city policy (lcdid) demonstrates a significant direct effect (0.005) and total effect (0.006), but the indirect effect (0.001) does not. This indicates that the policy effect is more localised, likely attributable to administrative control and locally implemented environmental mandates.
Spatial Spillover Effect Test.
Note: ⁎⁎⁎, ⁎⁎, and * indicate statistical significance at the 1 %, 5 %, and 10 % levels, respectively, and values in parentheses are robust standard errors.
These findings demonstrate the structural differentiation in spatial impact between market-based and command-and-control strategies within hybrid environmental regulation. Market mechanisms tend to foster broader regional interaction and diffusion, whereas administrative tools are more confined in scope but directly effective at the local level.
DiscussionImpact effectsIn the previous section, we presented empirical results that support many of the hypotheses discussed in Section 3. However, further discussion is needed to explore their applicability, impacts, and underlying causes.
Direct effects: MERS, GERS, and EHGF on DLTFThis study finds that both MERS and GERS contribute to the transition of financial markets in a greener and more sustainable trajectory, and these findings remain robust across various sensitivity tests. Generally, MERS are more effective in highly capitalised countries or regions, where financial market mechanisms are more developed (Lang et al., 2024), and firms can quickly adapt to policy requirements and address environmental regulatory challenges through market-based instruments (Sheenan et al., 2024; Wijethunga et al., 2024). By contrast, GERS rely more on policy interventions and institutional frameworks to direct financial resources towards low-carbon and environmentally friendly industries through mandatory standards, tax incentives, and other policy measures (Qamruzzaman, 2024). These instruments are particularly suited for less economically developed regions, where market mechanisms are underdeveloped, making it difficult for the market alone to drive rapid green transitions (Zhao et al., 2024).
Mechanism effects: environmental incentives, green innovation, and resource allocationThe study reveals that MERS promote transition finance by strengthening environmental incentives, fostering green innovation, and optimising resource allocation. The key advantage of MERS lies in their flexibility and efficient transmission of market signals (Bossaerts et al., 2024; Xu et al., 2024). These regulatory instruments can swiftly communicate green demand to financial markets and corporate decision-makers, prompting firms to reallocate investments and prioritise green technologies and low-carbon projects. This flexibility is particularly important in competitive markets, where financial institutions and companies can independently select the most economically efficient green projects based on market price signals and profit expectations (Liu et al., 2023), thereby improving capital allocation efficiency. However, GERS are less effective at optimising resource allocation and primarily promote transition finance through green innovation and strengthened environmental incentives. Owing to their mandatory nature, which depends on policy directives and financial support (Wang et al., 2024), these instruments can effectively promote innovation and incentives but may cause inefficiencies in resource allocation or rent-seeking during implementation (Zhang et al., 2024). In summary, MERS and GERS complement each other in their transmission mechanisms. MERS excel in optimising resource allocation and responding to market demand, whereas GERS are more effective in providing policy guidance and incentivising innovation, particularly in the early stages of green financial market development.
Heterogeneous effects: old industrial bases and environmentally focused citiesThe study also finds that cities in old industrial bases exhibit more complex responses to environmental regulation owing to their industrial structure and historical background. MERS can effectively drive transformation and financial development in these cities by optimising market resource allocation and facilitating technological upgrading (Zhang et al., 2024). GERS also play a significant role in these cities, owing to their long-standing reliance on government intervention and policy support (Adefeso & Muraina, 2024; Ahmad & Satrovic, 2023). By contrast, non-old industrial base cities, with their more flexible industrial structures, respond more quickly to market signals and can adjust financial resource allocation faster to meet green development goals. Consequently, MERS are more effective in these cities, whereas the role of GERS is more limited, likely because of the rigidity of policy implementation and its lack of alignment with market adaptability (Felgenhauer & Webster, 2013). Similarly, both MERS and GERS have significantly affected the development of transition finance in environmentally focused cities, which have a first-mover advantage in environmental policy and green development, as well as more robust policy systems. These cities can leverage both market and government forces to advance green finance. However, MERS have a more prominent role in non-environmentally focused cities, where market mechanisms promote green finance, and GERS have less impact owing to insufficient policy support or limited implementation (Jackson, 2024; Woode, 2024).
LimitationsAlthough this study provides significant theoretical insights and practical contributions regarding the direct role, indirect mechanisms, and heterogeneous effects of environmental regulatory instruments in promoting transition finance, its limitations warrant further exploration in future research.
Sample applicability issues. This study primarily relies on urban panel data from China, and although broadly representative, its applicability may be limited in other countries or regions. Different countries or regions exhibit varying levels of economic development, market maturity, and policy implementation environments, which may influence the effectiveness of MERS and GERS. Future research could extend the analysis to an international context through cross-country comparative studies, exploring the applicability of environmental regulatory instruments in promoting transition finance under different institutional frameworks and testing the global relevance and variability of these instruments.
Measurement and variable selection. The city-level DLTF index constructed in this study is based on the ‘highest-level principles’ of transition finance in the G20 Sustainable Finance Report 2022 and covers both investment and benefits dimensions. However, the measurement system has several limitations. The set of control variables and mediating variables, although motivated by existing theories, is not exhaustive. Other factors such as local government governance capacity, firms’ policy sensitivity, and households’ or investors’ acceptance of transition-related financial products may also play important roles but are not explicitly modelled. Additionally, the DLTF index does not yet incorporate a disclosure dimension based on textual analysis. With the rapid development of large language models, future work could construct transition finance disclosure indicators by applying advanced text-mining techniques to corporate reports, bond prospectuses, and policy documents, and integrate them into the measurement framework. Some conceptually important indicators, such as more detailed measures of transition bonds or the carbon intensity of the coal-fired power industry, could not be included due to data availability and consistency constraints. Subsequent studies could refine the indicator system as higher-quality and more granular data become accessible.
Heterogeneity. Although this study examines the heterogeneous effects across old industrial bases, non-old industrial bases, environmentally focused cities, and non-environmentally focused cities, it does not delve into heterogeneity at the industry level. Different industrial sectors may respond differently to environmental regulatory instruments. For instance, heavily polluting industries may rely more on GERS, whereas innovation-driven sectors may favour MERS. Future research could refine the analysis by focusing on industry-level heterogeneity, further exploring how industry characteristics shape the impact of environmental regulations on transition finance.
Conclusion and implicationsConclusionUsing panel data from 243 Chinese cities between 2009 and 2021, this study evaluates the effects of MERS and GERS on the promotion of transition finance development through a multi-period DID approach. The study constructs and measures the level of transition finance development at the city level in China and conducts various robustness tests to confirm these effects. Additionally, an integrated governance framework is introduced, encompassing environmental incentives, green innovation, and resource allocation, which are explored as mechanisms for promoting transition finance development. Finally, the study analyses the heterogeneous effects of MERS and GERS on transition finance development.
ImplicationsBased on the empirical results and the preceding discussion, this study offers a series of policy recommendations and managerial insights. These recommendations provide both theoretical foundation and practical guidance for promoting the green transformation of financial markets, while also offering valuable management insights for policymakers.
- (1)
Improving the flexibility of market mechanisms. To further optimise resource allocation and promote the development of transition finance, policymakers should focus on enhancing market flexibility (Fei et al., 2024) and reducing resource mismatches caused by government intervention (Wen et al., 2024). In particular, regulation and incentives for the green financial market should be strengthened in non-environmentally focused cities. This includes reducing the risk of green investment by establishing comprehensive green standards and encouraging independent innovation by financial institutions (Du et al., 2023). Additionally, the government can provide incentives through public policies to reduce the uncertainty of green financial investments, fostering more active participation in the green transition by market players.
- (2)
Strengthening policy continuity and coordination. To achieve long-term transition finance development, the government must ensure policy continuity and stability. Frequent changes in short-term policies can undermine trust among market participants, weakening incentives to invest in green finance (Antelo et al., 2023). Therefore, governments should enhance coordination between different levels of policy to ensure the complementary roles of MERS and GERS (J. Zhao et al., 2024). This is especially important in balancing environmental protection and economic development, ensuring the effective implementation of transition finance policies in the long term.
- (3)
Strengthening international experience and cooperation. Although the empirical results of this study are primarily based on the Chinese context, its findings have international relevance. Many developed countries have achieved rapid financial market development through MERS, while some developing countries rely more on GERS to promote green transitions (Gu et al., 2022). In the future, international policy cooperation and experience sharing will be critical for advancing global green finance (Wang et al., 2022). For old industrial bases and key environmental cities, cross-border cooperation should be encouraged to facilitate the adoption of advanced green technologies and financial models, fostering synergistic development among countries within the framework of the global Sustainable Development Goals.
This research received no external funding.
CRediT authorship contribution statementBing Ran: Writing – original draft, Software, Data curation. Bing Zhou: Writing – review & editing, Supervision. Bowen Yin: Methodology, Investigation.
The authors declare no conflict of interest.
Resource-Based view: G20; O13; O38
