While developed countries have pledged to mobilize substantial climate finance for developing countries, the sums needed are so large that domestic spending by developing countries may also have to increase. Given the fiscal limitations in many developing countries, private financing – including from private capital markets – must be called on to contribute, and sound public policy and targeted use of public funds will be vital to unlocking those flows. The public sector's role broadly involves i) setting up incentive frameworks to mobilize climate finance from the private sector; ii) undertaking transformative investments that fill critical gaps in the development of low-carbon climate-resilient markets.
What are the key policy instruments?
There are various instruments available to raise climate finance. Governments can rely on national and international public finance, or mobilize private finance. This thematic area focuses on international public finance and private finance.
International public finance has various sources:
- UNFCCC: several funds operate under the UNFCCC umbrella. The two largest are the Green Climate Fund (GCF) and the Global Environmental Facility (GEF), with a budget of $10.3 and $4.43 billion respectively for the period 2014-2018. While GCF finances both adaptation and mitigation projects, GEF is dedicated largely to mitigation.
- Non-UNFCCC: outside the UNFCCC umbrella funds exist that provide finance for mitigation and adaptation projects. For instance, the UN REDD Programme provides funding to reduce emissions from deforestation and forest degradation in developing countries.
- Development banks: banks at the multilateral, regional, and national level contribute to financing climate-related projects. Within this framework, the $ 8 billion Climate Investment Funds play a crucial role in fostering climate change mitigation and adaptation projects. In 2017, climate financing from the main Multilateral Development Banks alone has reached $35.2 billion. The World Bank Group’s climate-relevant financing for fiscal year 2018 reached $20.5 billion.
Financing modalities vary, two modes that are can have a crucial role in climate policy are the following:
- Result-based climate finance (RBCF): climate funds are disbursed to the recipient only if pre-established results are achieved, as verified by an independent agent. This financing mode can be well suited to support structural changes to achieve long-term results and to align the interests of the donor with those of the recipient. In 2015, more than 74 RBCF project had already been implemented in various developing countries.
- Development policy lending: under these projects, funds are disbursed to the general budget to support a macroeconomic policy reform, e.g., implementing an emissions trading scheme. Disbursements are rather quick and can target policy change at the economy-wide or sectoral level. Disbursements can take the form of loans, credits, and grants.
Mobilizing private finance, governments have various instruments to mobilize private finance. Key examples include:
- Carbon markets: carbon markets can be a crucial driver of mitigation efforts. Well-designed carbon markets can reduce mitigation costs by concentrating abatements where they are less costly.
- Green bonds: green bonds are regular bonds used to finance green projects. While delivering an extra “green” benefit to society, green bonds can be advantageous to emitters because they provide a return of image. Public institutions can foster the use of green bonds, for instance, by providing guidelines or by issuing green bonds themselves. Governments’ efforts can also help in promoting international investments in local green bonds.
- Environmental risk analysis: Financial risks from climate change are often overlooked in current investments decision. Governments can support business practices that are more attentive towards these risks and thus steer private capital investments towards more climate-resilient investments.
- Public-private partnerships (PPP): PPP can be used to leverage private investments in green projects by reducing the risks bore by private entities.
- Risk-sharing instruments: governments can support the diffusion of climate-related risk-sharing instruments, such as climate insurance.
- Green banking: Governments can promote green banking, i.e., banking that delivers environmental benefits at the domestic or global level. For instance, governments can issue guidelines to support the private sector in redirecting their operations towards greener investments.
What are the challenges and opportunities ahead?
Access to international public finance presents various challenges.
- Governments may lack the capacity to access international public finance. The funding environment is complex, scattered, and quickly evolving. The plethora of alternative financing options may be unknown to national authorities, and even when known, it can be challenging to identify the best funding opportunities for a particular project/policy reform. Budget constraints may limit access to funding, for instance, if new and specialized expertise is needed for preparing funding applications.
- There is a risk that international climate finance is used sub-optimally. Since international climate finance is accessible by authorities operating at a different level of governance, there is the risk that uncoordinated use of international climate finance impairs the development of synergies in climate action. Finance ministries are well positioned to issue guidance to line ministries and coordinate action on the use of international climate finance to maximize its impact.
- Mobilizing private finance is also challenging. For instance, unclear and inconsistent policy signals toward low-carbon growth create uncertainty for investors, such as when carbon pricing and fuel subsidies are contemporaneous. Risks also exist that international climate finance crowds out rather than reward domestic policy action and that public climate finance substitutes, rather than complement or stimulate, private-sector investments, particularly in adaptation.
What are good practices and what can be learned from them?
As climate finance flows increase, good practice is emerging on how to best access and mobilize it.
Access to international public finance:
- Increasing direct access capacity: governments that want to access directly international public finance often need to meet institutional standards. Various institutions offer support to strengthen this capacity, such as the GCF Climate Finance Readiness Programme, that provides country-specific support to access funding from the GCF.
- Improve public investment management: Under climate change, the well-founded principles of good investment management need to be supported by appraisal tools that can deal with the uncertainty of climate change. Cost-benefit analysis with Real Options is a useful approach, and lead to scalable infrastructure that can accommodate climate needs, or creative solutions like the Stormwater Management and Road Tunnel system in Kuala Lumpur, Malaysia.
Good practice is also emerging in mobilizing private finance:
- China: the Chinese government has taken various steps to promote the clean development mechanism (CDM), which allows developing countries to implement emission-reduction projects to gain certified emission reduction (CER) credits to be sold to developed countries. Key ministries were involved in the development of CDM, providing the necessary political backing for the diffusion of CDM projects.
- Brazil: to foster the growth of a green bonds market, in 2016 the Brazilian Federation of Banks and the Brazilian Business Council for Sustainable Development have released the Guidelines for Issuing Green Bonds in Brazil 2016, which guides agents operating and stakeholders of the Brazilian fixed income market on how to issue green bonds.
- China: in 2016 a pool of 7 Chinese government agencies released Guidelines for Establishing the Green Financial System, which aims to promote investments in environmentally friendly activities and discourage investments in polluting ones. For instance, these Guidelines encourage the diffusion of environmental risk analysis among financial companies.
- Indonesia, Kenya, Mexico, Mongolia, Nigeria: these countries have set up official awards to promote and publicly acknowledge companies that are performing particularly well in developing green finance.
Peer exchange among Finance Ministries offers the opportunity to have a constructive debate on how to access and effectively/efficiently use international public finance as well as on how to create a policy environment able to mobilize private finance.