Climate finance: multiplying the numbers will not solve the equation alone

Much of the discussions at COP28 will focus on the 100 billion USD/year target decided at Copenhagen to support climate investments in the Global South, and on the new climate finance goal set to replace it. But, whilst keeping our eyes on the volumes laid on the table, we also need to look more into the impact of every dollar spent. Identifying and building on the value added of every actor in the economy is essential to avoid overlaps and maximise synergies. Three types of actors have a pivotal role to play in the paradigm shift: governments, public financial institutions and private financial institutions.

COP 28 is taking place at a crucial time, when average global temperatures have for the first time exceeded the goals set out in the 2015 Paris Agreement and the world – foremost of which developing countries – is experiencing the adverse effects of climate change on populations and economies. COP28 also marks a milestone in international cooperation on climate change. There, we are expected to take stock of the progress made since 2015, when the Paris Agreement was signed, and prepare the next Nationally Determined Contributions (NDC) due in 2025 to collectively ratchet up ambition. The stakes are high.

So are the daunting estimations of the financing needed for sustainable development and climate action. The latest reports (Bhattacharya et al.) suggest that an additional 1 trillion USD/year will need to be mobilised by external finance sources (public and private) until 2030 to fund the 2.4 trillion USD/year investments requirement for climate and nature in developing countries (excluding China). The rest will need to be found through domestic resource mobilisation. Calling it a challenge is an understatement.

Much of the discussions at COP28 will focus on the New Collective Quantified Goal (NCQG) on climate finance, set to replace the 100 billion USD/year climate finance target decided at Copenhagen to support climate investments in the Global South. This new objective is critical to ensure a change of scale in the volume of investments. Yet, these discussions are likely to be complex because of the difficult geopolitical context and increasing distrust from emerging market and developing economies (EMDEs), who are still waiting to see the previous 100 billion USD/year engagement be met. They will expect the NCQG to be ambitious and just, avoiding increased debt burden and ensuring equitable distribution among the countries and sectors that need it most (Pauw et al.).

But multiplying the numbers will not solve the equation alone. We need to take a step back and, whilst keeping our eyes on the volumes laid on the table, also look more into the impact of every dollar spent. Money isn’t infinite, particularly public money. Innovative financial mechanisms and conducive policies will be critical to crowd in the private sector and invest every dollar available in a way that is consistent with a low-emission and resilient development. This objective of making all financial flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development is embedded in the Paris Agreement (Article 2.1(c)) and reflected in the Sharm el-Sheikh dialogue on the scope of Article 2.1(c), to be discussed at COP28. Adding a qualitative prism to the discussion implies looking at the global picture to understand where the money comes from and goes to (I4CE) and concentrate efforts on shifting investments that are detrimental to sustainable development pathways towards investments that are consistent with Paris Agreement objectives. Identifying and building on the value added of every actor in the economy is an essential part of the exercise since it can avoid overlaps and maximise synergies in financing low-emission and resilient development pathways. Three types of actors have a pivotal role to play in the paradigm shift: governments, public financial institutions and private financial institutions.

First, governments are Parties to the Paris Agreement and the leading actors of its implementation.

Their individual commitments – translated into NDCs – set the collective ambition of the Agreement and define the reference country development pathways for investors to consider. These commitments taken on the international scene, including on quantified objectives for aligned or misaligned activities (e.g. fossil fuel phaseout), engage public level action and provide clear signals to other actors on where the transition is headed and which investments are at risk of becoming stranded.

The impact of these commitments drastically increases if they are associated with concrete action by governments to align public finance by increasing finance for climate action while eliminating negative investments. This involves translating NDCs into Long-term Strategies (LTS) and further breaking them down into financial transition plans. It also requires the creation of conducive environments – through both regulations (e.g. financial regulation on climate-related risk disclosures and macroprudential risks, public procurement, etc.) and incentives (e.g. compliance carbon pricing instruments, public subsidies, etc.) – to make local and foreign investments happen and stop harmful and locked-in investment (such as fossil fuels or imported deforestation).

COP28 will allow governments to take public commitments to raise their ambition. These will likely include announcements on improved NDCs and sectoral announcements (e.g., targets on renewable energy, fossil fuels, forest conservation etc.). The question is how ambitious these engagements will be and if they will they be in line with the Paris Agreement’s core objective of “limiting a global temperature rise well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5°C”.

Second, Public Developments Banks (PDBs) – be they national or international – have a key supporting role to play in financing a low-emission and resilient transition.

As the main financing arm of governments, they are instrumental in addressing some of the main investment barriers that prevent the market from effectively responding to the risks and opportunities posed by climate change (such as the high cost of capital and market accessibility for medium and small size enterprises). In addition to this countercyclical role, PDBs also fill the space where the private sector won’t go because of its specific constraints and risk/return expectations. As such, PDBs are seen as key providers of concessional funds for projects with crucial development impacts, such as social infrastructure, adaptation projects, and loss and damage finance. As the impacts of climate change increase, the funds needed for these projects will continue to escalate. Despite all the efforts made to better leverage the balance sheet of PDBs – impelled by the G20’s Independent Review of Multilateral Development Banks’ (MDBs) Capital Adequacy Frameworks – the money available through PDBs will not suffice to change the trajectory the world is taking if it is used in a constant manner. Transformational action is required to maximise the impact of every dollar spent by PDBs on low-emission and resilient development pathways.

PDBs, particularly MDBs and Development Finance Institutions (DFIs) are ideally placed to support ambitious government action – for example through technical cooperation and policy-based lending for the development of LTS – and support systemic changes – for instance of the financial sector through engagement, capacity building and standard setting. Hand in hand with governments, they are the main guarantors of orderly pathways as they have the capacity to address some of the main consequences of the transition (locked-in assets, social impacts, biodiversity loss, etc.). Coordination (international and local) is critical to meet the last mile and ensure that local populations are included and involved in the transition.

A reform of international PDBs is underway – as incarnated by the World Bank’s evolution roadmap, which seeks to adapt the institution’s mission, operations and resources to the challenges of today’s world. New approaches and tools are being tested to increase the impact and efficiency of international cooperation and to strengthen the role of EMDEs in the transition. The Bridgetown Agenda catalyses some of the main asks of EMDEs who collectively push for governance and financial reform of the international financial system for vulnerable countries to have a voice and adequate support to face the climate crisis (avoiding new layers of vulnerability induced by increased debt burdens).

COP28, will hopefully confirm that a change in practice of international PDBs is on its way with some announcements to be expected on support to the development of ambitious country strategies (through LTS facilities) and on country-level collaboration (through country platforms), among others.

Last, private financial institutions are not directly bound by the Paris Agreement but have a key role to play and have progressively been involved in the achievement of its objectives.

At COP 26, in Glasgow, a group of financial institutions came together under the Glasgow Financial Alliance for Net Zero (GFANZ) to contribute to accelerating the decarbonisation of the economy, thereby acknowledging their role in achieving Paris Agreement objectives. As a result, some important commitments were taken by the private sector to reach net-zero emission targets at a given point in time. Dedicated regulations have simultaneously begun to be implemented (e.g. in Europe) to compensate some of the weaknesses of voluntary action (lack of ambition, challenges associated with measuring and reporting, etc.). In the space of two years, dedicated methodologies have been developed to walk the talk of decarbonisation. But, despite these recent developments, much work still needs to be done to align all the activities of private financial institutions, so that they stop financing harmful projects at the very least and effectively contribute to a low-emission and resilient development at the very best.

This important paradigm shift involves the systematic integration and continuous improvement of climate-related risks and opportunities management (transition and physical) and the identification of investment opportunities pushing the development of mitigation and adaptation solutions by invested corporates. Under the right conditions (economic, institutional, legal, etc.) significant volumes of finance can be invested by the private sector to fund projects with climate co-benefits, and – conversely but as importantly – be divested from assets with negative impacts on climate change.

So, at COP28, we will also be watching out for progress on the ambition of private financial actors and for improved guidance for them to live up to their commitments.

Every actor has something to expect from the negotiations that will resume next Thursday in Dubai, but governments, PDBs and private financial institutions will be at the forefront of the discussion as the key actors in financing the transition. Their commitments will be scrutinised by EMDEs, who as main recipients of climate and development finance will judge their ambition and credibility as signs of trustworthiness. Agreements on an ambitious NCQG, an effective and just Loss and Damage fund and a comprehensive Global Adaptation Framework are some of the positive outcomes that could restore confidence in the increasingly fragmented international financial system – which is already embarked in a long process to adapt to the new face of the world today.