Holistic thinking can provide more opportunities for funding
RENEWED TARGETS
Annual funding target to developing nations now set for 2023 following COP26 talks in Glasgow
INVESTMENT DEFINITIONS
There is some confusion as to what finance can be classed as development funding or aid
KEY QUOTE
Climate action is very much something that is part of the development process—whether it’s mitigation or adaptation
The level of assistance for developing countries is a perennial sticking point at the UN climate talks (COP). At the troubled 2009 talks in Copenhagen, developed countries—those historically responsible for the levels of greenhouse gas (GHG) emissions—pledged to mobilise $100 billion annually by 2020 in finance for climate change mitigation and adaptation measures in these emerging markets. This was meant to be additional finance to that already pledged and encompass both public and private capital. But this goal was missed. Instead, the UK government—in its role as president of the 2020 climate talks, which were delayed until 2021 owing to the Covid-19 pandemic—published a plan to meet this goal instead by 2023. “Countries like Germany, Sweden, Japan pay their fair share and then some, of the $100 billion, and they come in with the best of intentions to meaningfully support climate action in developing countries,” says Sarah Colenbrander, director of the climate and sustainability programme at the Overseas Development Institute (ODI) a think tank. Colenbrander co-authored a 2021 report analysing governments’ contributions to climate finance. “The US, Australia and Canada just don’t—they don’t meet the aid target of 0.7% of gross national income and now they don’t pay their fair share of climate finance either,” she adds. Colenbrander says the classifications of developed and developing countries in the UN climate change framework is outdated. “[It] is grossly misrepresentative and the result is that climate laggards in the developed world are able to hide behind the skirts of progressive developed countries, whose efforts to build trust and boost ambition are consequently undermined.” While acknowledging that there is no singular agreed “good” definition of climate finance, often what is provided by high-income donor nations goes via development corporations, says Jens Sedemund, from the OECD Development Assistance Committee’s Financing for Sustainable Development Division. “Climate action is very much, at the end day, something that is part of the development process—whether it’s mitigation or adaptation, it’s invariably integrated into the developing context.” This means the $100 billion goal takes the form of development finance. And while the focus is often on infrastructure financing, this only represents one priority area for climate action. Support is also needed to build capacity‚ such as administrative frameworks, regulatory frameworks—in recipient countries so that the projects supported can be actualised and beneficial, such as supporting the development of a grid which is based on renewable energy.
AID OR FINANCE Aid and climate finance are two different things, yet it can be hard to disentangle, says Colenbrander. “There are certain arenas where it easy to work out what is climate finance and what isn’t,” she says, citing the incremental cost of a renewable energy technology versus the fossil fuel alternative the country had previously planned to use. “But something like a sewer, or pipe water, or health services, or all-weather roads, or emergency services—all are absolutely fundamental to reducing people’s susceptibility to climate hazards and enhancing their adaptive capacity,” she says. “Yet because of the reporting structures that are put in place and the divisions between some of these communities, what we’re seeing are efforts to disentangle adaptation finance and aid. The result is that triple-wins across both of these areas are being missed.” Promising signs emerged from the 2021 Glasgow climate talks, to shift to a more holistic approach, says Colenbrander, namely the South Africa Just Energy Transitions Partnership and the Task Force on Access to Climate Finance. Both initiatives address different gaps, with the former bringing concessional finance to level the playing field for renewable energy in South Africa and support coal workers’ reskilling, a model which could be rolled out to other high-emitting nations such as India, Indonesia and Kazakhstan. Meanwhile, the Task Force is focused on five developing countries (Bangladesh, Fiji, Jamaica, Rwanda and Uganda) and will see the use of donor assistance to help reduce costs for project funding requests and pooling resources to finance whole packages, rather than individual projects. “These programmatic approaches to tackle key bottlenecks show the direction that climate finance architecture should be going,” adds Colenbrander, noting that the Climate Investment Funds, a $10.5 billion multinational funding programme, has also employed this approach to much success. One option would be for the Task Force to look at the target countries’ Nationally Determined Contributions (NDCs) under the Paris Agreement and turn them into investment plans. “The idea of the Task Force is that it should be taking the direction of travel of the NDCs, which are country-owned, and support those countries to turn that into a pipeline of measures that they need. Not just infrastructure projects, but the ecosystem you need around that, whether that is capacity building for the civil service, financial sector deepening and strengthening, and financing then as a whole at concessional rates,” she says. “If that works, then a number of countries would be on board for similar efforts and the international community could overcome some of the distrust that is constraining climate action.” Still, even smarter use of public funds, will not be enough. “Donor countries can do more and have to do more,” Sedemund says. “Even if you scale up lots of international development finance, you have a financing gap that you won’t be able to fill unless you really succeed in scaling up private finance.” “In terms of the real scaling up, it’s a seven-fold increase between current spending and spending that you [need to] reach by 2030 to be in line with the objectives of the Paris Agreement—particularly in emerging countries,” he adds. “There’s still trillions [of dollars] per annum of gap,” says Christopher Bredholt of Moody’s Investors Services’, a credit ratings business, even with multilateral development banks and finance institutions. “They are significant players, but the real gap is in bringing that private finance,” he adds.
PRIVATE CHALLENGE This is especially true in the energy sector, according to Sedemund, including energy infrastructure and supporting a transition away from fossil fuels to sustainable energy, as well as the twin challenges of meeting the energy growth needs that accompanies development. “The encouraging aspect is that, with costs coming down, it’s increasingly the least expensive option to add renewable energy to your existing system, but it’s not always the easiest option,” he adds, citing factors such as grid infrastructure as a barrier and financing, due to high up-front capital costs. This can present another hurdle, particularly for small developing countries which do not have a deep financial sector and instead rely on international markets but are then exposed to added costs, such as higher interest rates. Bredholt also sees country risk as a challenge, in terms of access to capital markets, as well as institutional capacity shortfalls in recipient nations, such as on permitting. Public assistance can help build that capacity, while the private sector could address the financing gaps. One other solution comes via GET.invest, an EU-backed technical assistance platform which helps match financiers and investors with projects and companies. Focused on small- and medium-scale sustainable energy across sub-Saharan Africa, the Caribbean and the Pacific region, it supports project developers in target countries in accessing finance. “I’ve talked to a lot of financiers over the years, and they often ask, ‘where are the bankable projects?’” says Michael Franz from GET.invest. “But the other thing the financiers say is that the proposals they get are not really where they should be, in order to quickly work with them. As a result there is a lot of money circulating but deploying too slowly.” Some of this is due to inadequate regulatory frameworks or due to a mismatch in the type of finance and project or country. Some of the delay is because companies or project proponents “don’t speak the right language” for investors—which is where GET.invest steps in to help the projects and companies “become bankable”. However, Franz notes that there is little private finance available. “Many of the instruments we are talking about are capitalised by development banks,” he says. “We are still at the place in the curve where we go from innovation to scale,” says Franz. “In the early days, that’s not necessarily where fully private finance would sit. That’s also why programmes like GET.invest exist—our role is to help get these markets going so that they can then stand on their own two feet.”
UNLOCK CAPITAL Changes to the financial space could help get over this hurdle and unlock more capital. “There is a grotesque overabundance of late-stage big-ticket debt capital at the expense of pretty much all other types of finance,” Franz says. “If that doesn’t change, we won’t make much progress. But that will require work by donors and financiers. It’s important to appreciate that the way most banks and investment funds are organised is about scale and low transaction costs. However, there are simply not enough of these investees and it also favours a centralised market structure, which should only be a part of the picture. We need healthy, decentralised and vibrant energy markets.” Indeed, high costs were also flagged by Bredholt as a challenge. “If you’re looking at a number of relatively small, disparate economies, investors looking project-by-project are going to incur a lot of time and a lot of due diligence costs, so it might not be really efficient,” says Bredholt. “There’s a lot of calls from, say, the Net-Zero Asset Owner Alliance to get funds, or other types of structures, that could allow them to deploy capital at scale—at a sort of critical mass rather than picking and choosing lots of disparate projects,” Bredholt adds. The Net-Zero Asset Owner Alliance is a UN-convened group of pension funds and insurance companies committed to decarbonising their portfolios.
COST SPREAD One option is to develop alternative financing pathways, such as debt securitisation. Bredholt cites Bayfront Infrastructure Management, a Singapore-based investment plaform. Here, the firm pools project and infrastructure loans from across Asia Pacific then sells tranches of these to institutional investors, grouped according to different risk profiles. “There needs to be the underlying pool of loans,” he says, which may take a few years to put together. But it then frees up capital for the banks which issued the original loans to support further projects. “Once one or two of these things are [operating], investors will then understand how it works and get more comfortable with how it’s done.” The use of insurance and catastrophe bonds is freeing up capital for investment, says Charlie Langdale, from insurance broker Howden. “People have worked out that funding events after a disaster has happened is a really poor way of dealing with a disaster,” he says, as it is too slow to disperse and can be uncertain. Having insurance for such events allows money to reach people immediately to help with evacuations or provide food and clean water.
CARBON PRICE Another route is the use of carbon markets, which is something the Australian government is exploring via its Indo-Pacific Carbon Offsets Scheme (IPCOS). This A$104 million programme will use public funding to leverage private investments in partner countries, including supporting the creation of carbon accounting frameworks, national climate policy frameworks, and a pipeline of projects which either reduce, avoid or sequester emissions. “It’s really looking at setting up an amount of money that can be used to create a facility… to de-risk investments in some pilot projects and hopefully create a sustainable facility for investment in emissions reduction activities,” says Emily Gerrard of Comhar Group, an Australian advisory firm. Article 6 of the Paris Agreement also enables private sector investment in other countries to reduce GHG emissions, both via the creation of tradeable credits via investments in projects to reduce GHG emissions and also via non-market-based approaches, says Gerrard. “We need to be careful that we’re not shuffling resources between buckets. We need to ensure we actually add to it,” she adds. “The size of the problem and the size of the solutions and the amount of money that is required to address climate change are all huge and there is an acknowledgement that the private sector needs to be engaged and mobilised. Article 6 is a key part of that but it needs to be done very carefully,” Gerrard says, with the public sector continuing to do and add to what it is already doing then topped up by the private sector. •
TEXT Katie Kouchakji
ILLUSTRATION Hvass&Hannibal and Liana Mihailova PHOTO Frederico Beccari