The spotlight will be on climate finance as the delegates gear up for future climate negotiations in Baku, Azerbaijan. Dubbed the “Finance COP,” this has been a series of talks characterized by significant funding to meet net-zero emissions by 2050 and protect vulnerable regions from impacts of climate change. Here’s a glimpse at some key concepts in climate finance and their relevance in global climate action.
The Scope of Climate Finance
Climate finance refers to funding that is required to implement climate change mitigation and adaptation. UNEP defined it as financing from both domestic, national and international sources for projects aimed at reducing emissions or enhancing resilience to the effects of climate change. This flows in through grants, loans, subsidies, equities and guarantees from both commercial sources- many banks and private investors- as well as public ones, including governments and development banks.
Although the term is sometimes used interchangeably with “green finance,” climate finance is more specifically aimed at mitigating climate change rather than a broader environmental cause, such as biodiversity. Climate finance is a sub-component of sustainable finance, which encompasses such other social objectives as healthcare and education, in addition to environmental goals.
Climate finance is the amount of resources directed from developed to developing countries aimed at assisting in efforts to mitigate and adapt to climate change. However, developing countries argue that only public funds should qualify as climate finance because private capital is profit-driven and might not meet their specific needs.
Obstacles in Climate Adaptation Financing
It is much more important for developing countries because those countries are vulnerable to the impacts of climate, yet have lesser amount of investment into developing adaptation infrastructure. Regions thus rely more on public funds in implementing climate adaptation projects that usually lack commercial appeal to attract private investments.
Current flows of climate finance, however, are a far cry from levels necessary to meet adaptation needs. The main financing challenges arise from the inability to establish bankable business cases for adaptation projects and to develop standardized metrics to measure benefits. Adaptation projects face concerns about policy support and data, deterring participation by the private sector.
Such challenges will only be addressed through the efforts of the public and private sectors, longer-term funding from international institutions, and innovative funding structures like blended finance, risk-sharing mechanisms, and guarantees. For instance, blended finance combines public and private investments to minimize the risks so that more private investors would be attracted to adaptation projects.
Financing Tools for Extreme Climate Events
This, however, is where most of the world needs financial mechanisms that can provide rapid recovery support for affected communities and countries as such extreme events due to climate change are becoming increasingly frequent, including hurricanes, floods, and droughts. Amongst the various players in this area are parametric insurance and resilience bonds.
Parametric Insurance
Parametric insurance provide payout based on predetermined triggers rather than waiting on damage assessment, which can delay financial support post disasters. An illustration of this is that when there is a hurricane of a certain intensity, for instance, there will be automatic payout for the insured. Although this model can come in handy with regards to coming up with prompt relief, premiums on parametric insurance tend to be relatively high. This will further limit its accessibility. Public funds or subsidies might decrease the premium costs, hence rendering parametric insurance as an instrument that a more vulnerable community could use.
Resilience Bonds
Resilience bonds are a type of debt instrument that financiers provide for infrastructure projects that assist communities to survive the impacts of climate. They are linked with insurance; if an insured project is damaged during a climate event, the bond will pay compensation to cover the repairs. The resilience bond has been structured to encourage a developer to invest in strong, resilient, and disaster-resistant infrastructure, which leads to low premiums.
International Finance Institutions and the Role of Public Funds
International public finance institutions have played a significant role in climate adaptation in providing low-cost, long-term loans to developing nations for climate projects. Through grants and guarantees, these institutions also make it easier to attract private capital through risk reduction for investors.
Private capital will be indispensable in the pursuit of climate adaptation, but integrating it into funding structures raises several challenges. Advocates of developing nations argue that public funds such as grants and concessional loans are better positioned at the helm because they lack profit motivation, making some private funds misaligned with urgent climate goals. However, on renewable energy and other climate solutions expected to attract private investors, private capital may take up some gaps in global funding.
Moving Forward with Global Climate Finance Solutions
Delegates at the Baku climate summit will ensure that gaps in these policy frameworks and strategies will be tackled. The above includes ideas on how governments, private investors, and international institutions can better cooperate with each other. Stakeholders will advocate clear, deep regulatory support, as well as new innovative financing tools, in terms of adaptation metrics.
A critical component in meeting the climate goals is global climate finance, where effective funding solutions will be needed for mitigation and adaptation. The Baku summit represents an opportunity to improve understanding of climate finance and drive policymakers, international organizations, and financial institutions to take big steps towards supporting climate resilience around the world.
Source: Adapted from United Nations Environment Programme (UNEP) and international finance reports.