Developments in the arena of climate finance have offered one of the few success stories for international climate politics in recent times.
Fast Start Finance began to flow from 2010, and have an impact. The climate finance paradigm is now shifting, and the international community is facing a set of new challenges.
Valuable lessons from the Fast Start Finance period, which we set out in our IIEA policy brief, can be used to understand and ultimately met these challenges.
A dramatic upswing in the level of funding is required by 2020 to “mobilise” US $100 billion annually.
Public funds, which have been the focus of Fast Start Finance, will not be sufficient, particularly as many developed countries enter a period of deleveraging. Indeed the UN estimates that up to 85% of funding will have to come from the private sector.
The global climate does not care where low carbon and climate resilient investment comes from – be it public or private sources.
The Copenhagen Accord paves the way for a prominent role for the private sector.
Everything from public funds, associated leveraged private investments, carbon offset market funds, multilateral development bank assistance, investment loan guarantees, concessional loans, foreign direct investment, institutional investor funding and equity investment should be on the table.
Below I outline nine key and interrelated challenges faced by developing countries within this context.
The current scale of financial flows is not sufficient to meet commitments, nor has a trajectory for scaling up financial transfers been agreed. The 2012 Doha COP merely “encourages” developed countries to keep climate finance flows to at least the average level of their Fast Start Finance between 2013 and 2015. Individual countries such as the UK and Germany made commitments to this effect, though they are in a minority. Agreeing a pathway to meeting 2020 commitments is therefore a priority. These issues can only be addressed by a concerted political process at international level.
2. CATALYSING PRIVATE SECTOR INVESTMENTS
It is clear that commitments cannot be met without galvanising investment from the private sector.
Given the rapid scale-up in funding required, scarce exchequer resources should arguably be used in a more targeted manner. A much greater focus needs to rest on leveraging private sector funding, rather than fully funding investments from the public purse. Enhanced involvement of the private sector through the more direct integration of private sector expertise in designing and implementing policies at national and international level, and best practice exchange, is required.
Greater focus might be placed on optimising “leverage ratios” associated with public funding (something that some multilateral development banks do well). Partnerships between the public and private sectors might also focus on “lighthouse” projects with transformative or demonstration effects – in the long term these are the types of projects that can catalyse long term and substantial transformation.
3. DE-RISKING PRIVATE SECTOR INVESTMENT
Mitigating risk for the private sector is a key aspect to leveraging increased levels of private sector investment. Low carbon and climate resilient investment projects in developing countries have typically been constrained by policy and regulatory uncertainty, leading to high risk premiums.
A weak environmental policy backdrop and the lack of a uniform and sufficiently high carbon price distort the payback on clean versus polluting infrastructure projects. Other barriers to investment include lack of familiarity, limited information and knowledge, and limited expertise on green infrastructure. Public-private collaborations which have successfully “crowded in” private investment include: loan guarantees; policy insurance to cover investors in case of policy change; partial risk guarantee or other funds; and Special Purpose Investment Vehicles which can partner development banks and private equity.
4. TARGETING INSTITUTIONAL INVESTORS
The enormous and increasing amount of funds under management by institutional investors makes this a potentially key area to be targeted if 2020 commitments are to be met. According to HSBC less than 1% of current bond issuances are “strongly aligned” with the climate economy, so there is a great pool of investment capital available which is not being tapped.
Institutional investors do not invest in individual projects, but rather in aggregated investment classes with a low risk profile and a track record. Many renewable projects have attributes which suit the long-term investment horizons of these investors.
There is no one-size-fits-all solution to attracting institutional investors, as they are as heterogeneous as potential recipient countries. Developed countries can generally help to “engineer investment grade offerings” through listening to and understanding the needs of institutional investors – such as those outlined by the Climate Bonds Initiative – and by engaging in de-risking initiatives such as those outlined above, and by promoting establishment of green financial institutions.
5. MONITORING, REPORTING AND VERIFICATION
In order to ascertain if objectives are met within a much more complex and multifaceted climate finance paradigm, a far more comprehensive approach is required. Donors and Multilateral Development Banks are making efforts to improve tracking and reporting of flows of finance to developing countries, and an increasing body of evidence of best practice is emerging.
The Rio markers already provide an approximate way of quantifying public funding to address climate change. However, detailed, accurate, and comparable information on finance is lacking.
Reporting to the UNFCCC is lacking in several respects. Tracking private flows of finance remains particularly incomplete and highly challenging.
There is therefore considerable room for the development of more formalised definitions, guidelines, conventions and rules for private finance flows, how they should be counted to meet commitments, and how their net contribution is to be calculated. Furthermore, more comprehensive ex ante assessment of environmental integrity and effectiveness of funding is also necessary.
6. GREATER FOCUS ON FINANCE FOR ADAPTATION
In reality mitigation and adaptation activities are qualitatively different enough to suggest far more differentiation between funding for these activities. Adaptation funding is closely aligned to ODA, and is largely funded from public sources. On the other hand, low carbon energy infrastructure investments can turn a profit and are generally far more likely to be attractive to the private sector. This pattern is evident in the Fast Start Finance period.
There may be a case for a greater differentiation between financing for adaptation and mitigation, and perhaps defining unique targets for each. Clearer methodologies are also required for determining if ODA is “new and additional”.
Finally, many developed economies have development assistance partner countries, and these pre-existing linkages should be leveraged to encourage greater levels of private sector investment in recipient countries. On the other hand, climate finance needs to find its way to the most needy, and cannot just serve geopolitical priorities or the needs of the private sector. These objectives require careful balancing.
7. DEFINING A ROLE FOR THE GREEN CLIMATE FUND (GCF)
The establishment of the GCF is an important development. While the GCF Board has been appointed, no funds have been committed, nor have any commitments been made to the on-going early and adequate replenishment process.
Questions around how much finance will pass through the GCF remain unanswered. There is a political challenge to overcome developed countries’ reluctance to commit financial contributions to financing instruments under the UNFCCC framework.
A prominent or central role for the GCF could arguably help: ensure that funds are allocated equitably and efficiently between recipients; ensure a fair balance between adaptation and mitigation; monitor the effectiveness of various approaches; and evaluate and determine best practice. The GCF could also ensure that spending is optimised and transaction costs minimised.
A key question is whether the GCF sees itself as a sort of umbrella for other funding initiatives in the area; or as a competitor to these existing initiatives? The former role would arguable represent a more significant contribution to the international climate finance regime, although a hybrid institution combining both functionalities is perhaps also possible.
Conditionality is an unpopular word when associated with overseas development aid. Nevertheless climate finance can and should be used to encourage more fundamental changes in these countries, otherwise it may find itself pushing against a locked door. It can be used to enhance enabling environments in many developing countries, recognising that national policy, and regulatory and governance frameworks play a crucial role in reducing investment barriers and using climate finance effectively. Differentiated access to carbon finance could be used to encourage appropriate modifications to regulatory frameworks; for example the removal of fossil fuels.
9. EXPLORING INNOVATIVE SOURCES OF FINANCE
There are several potentially innovative sources of funding which could be used to achieve commitments, many of which have been set out in an analysis by the UN. The template for how these innovative sources could be mobilised is perhaps provided by the Clean Development Mechanism (CDM), where 2% of certified emission reduction units issued for most Clean Development Mechanism projects go to the Adaptation Fund.
In the case of the EU Emissions Trading Scheme Directive 2009/29/EC, 50% of the revenue from auctioned permits can be used to fund global energy efficiency and renewables promotion, adaptation or avoided deforestation. The disbursement of revenues remains in the hands of EU Member States, and some will inevitably be opposed to any form of hypothecation.
The aviation and maritime industries are also expected to make some contribution to climate finance. The International Civil Aviation Organisation (ICAO), however, has questioned why it should be singled out as a contributor of climate finance, and has argued that revenues from any instrument covering aviation (such as emissions trading) should be applied in the first instance to mitigating the environmental impact of aircraft engine emissions (rather than climate finance).
Other options which might also be explored further include an international financial transactions tax, revenues from implementing border taxes on imports of GHG-intensive products, or redeployment of fossil fuel subsidies in developed countries.
All options face similar political barriers. Difficulties and challenges notwithstanding, it is unlikely that the 2020 commitment can be met without harnessing some of these options for mobilising innovative and new sources of finance.
JosephCurtin is Senior Research Associate with the Institute of International and European Affairs. He has worked for the OECD, NESC (an advisory body to the Irish Prime Minister), and the Sustainable Energy Authority of Ireland, on climate and energy policy-related issues. The policy brief upon which this article is based was drafted as part of the IIEA Environment Nexus project