Climate finance – the sun shines on a perennial hot topic

Wealthier countries are coming under growing pressure to increase climate finance to developing countries.

Promises made

Richer countries in 2009 pledged to mobilise USD 100bn a year by 2020 to help developing countries respond to climate change. Parties to the 2015 Paris Climate Agreement reaffirmed their commitment to this target and agreed to set a new one by 2025 with USD 100bn per year as a floor.

Climate finance towards this goal can come from public and private sources, including:

Missing the target

Because of a delay in reporting, it remains uncertain how close to the USD 100bn target developed countries were in 2020. Developed countries will not be required to report their climate finance data for 2020 to the UN Framework Convention on Climate Change before January 2022. The OECD – which tracks climate finance provided by its members – has also indicated that a final figure will not be available until the first quarter of next year at the earliest. However, the most recent data produced by the OECD suggests that they were off track before 2020. Various civil society organisations also suggest that the actual figures are far lower and that developed countries have overstated their donations by a large margin because they include loans, as well as grants, and these funds are often provided to projects with a large non-climate element. 

Regardless of disputes over the accounting methodology to assess current climate finance levels, there is a general consensus that developed nations are falling short both in their pledges and in what developing nations require. On the fifth anniversary of the signing of the Paris Agreement in December 2020, UN Secretary General Antonio Guterres said that they were “lagging badly”.

Adapt or mitigate

Climate finance is intended to support developing states to 1) mitigate climate change by pivoting to a low-carbon economy and 2) adapt to the inevitable rise in global average temperatures and the associated increase in chronic and acute climatic events.

Mitigation

The vast majority of funding (approximately three quarters) goes towards climate change mitigation, with an even higher share of private finance devoted to this goal. This reflects the fact that it is easier to mobilise private capital towards new business opportunities in the energy transition. In fact, the majority of private climate finance goes just to the energy sector, with transport also a key recipient. 

Adaptation

Finance for climate change adaptation makes up the rest. It is a much less attractive destination for private capital given that adaptation projects do not offer the same financial returns as mitigation ones. This means that developing states are particularly reliant on rich government pledges to fund this area. Governments also make up most of the recipients. According to the UN Environment Programme (UNEP), the smaller number of private sector recipients are concentrated in sectors that are likely to be among the most directly impacted by the increase in chronic and acute weather events, such as agriculture and tourism, as well as in sectors such as insurance that will play a key role as countries prepare for the consequences of rising temperatures.

More needed

Developing countries will need a significant increase in finance for both mitigation and adaptation in the years ahead. As all parties to the Paris Agreement come forward with revised pledges (Nationally Determined Contributions or NDCs) outlining how they intend to adapt to and mitigate climate change in the next decade, many developing countries are including pledges that are conditional on more funding. If this funding does not materialise, ambitious and concrete mandates and policies may not either. Even if it does, some pledges will require a level of funding absorption and project implementation capacity that many low-income countries have not so far demonstrated.

In its NDC, the Ethiopian government estimates that USD 236bn will be needed from international sources (80% of the total funding requirement) to finance its mitigation and adaptation efforts in the years to 2030. Brazil’s revised NDC calls for an additional USD 10bn in finance per year to help preserve the Amazon rainforest. Overreliance on international finance that remains elusive will reduce the credibility of some mitigation and adaptation commitments. Companies eyeing the green investment space will need to closely follow the dynamic in target markets.

Private and public finance will continue to be mobilised more easily for mitigation efforts, especially in the energy sector. Solar and wind projects will likely become even more attractive investments as the costs continue to tumble. The expansion of electric vehicles and more efficient modes of transport will also create opportunities for investment. So too will infrastructure and real estate – improving energy efficiency of buildings is a key emissions reduction goal for many governments in the years to 2030. 

Although it is also rising, adaptation finance is likely to continue to lag behind mitigation finance in the years ahead. Furthermore, the gap between the funds mobilised and the funds required will likely grow significantly. The costs of adaptation are set to increase sharply with rising average annual temperatures. In its Adaptation Gap report published in January 2021, the UNEP estimates that the annual costs of adaptation (already at USD 70bn per year) could reach USD 300bn by 2030 and USD 500bn by 2050 – far above the sums that developed nations are currently able to mobilise. For Small Island Developing States (SIDS), adaptation costs and the operational and infrastructure risks that stem from rising sea levels will increase most sharply.

Many countries are courting adaptation funding specifically to make them more attractive destinations for all other forms of investment. Changes in regulatory frameworks will create a range of opportunities in other sectors that will differ by country. 

At a country level, costs have long placed a strain on budgets, though the economic fallout from COVID-19 has made this more acute. At a summit convened by US President Joe Biden in April, the leaders of countries including India, Indonesia and South Africa used their speaking slots to highlight the importance of new financing. Bangladesh’s Prime Minister Sheikh Hasina claimed that her country was spending approximately USD 5bn (2.5% of GDP) on dealing with the impacts of climate change alone. At a separate summit convened by UK Prime Minister Boris Johnson in December 2020, Kenya’s President Uhuru Kenyatta stated that losses from climate change could soon reach 3% of GDP per year. Without a significant increase in adaptation financing, the costs will continue to rise, placing upward pressure on sovereign risks and in turn reducing the budget for mitigation. Meanwhile, a lack of clear data on future financing impedes plans for how to spend the funds that are made available.

The road to COP26

Wealthy governments including the UK, US, Canada and Germany have in recent months announced plans to increase climate finance (though the UK is continuing with plans to cut its foreign aid budget). Pressure will continue to mount on wealthy nations in the coming months to increase their commitments. The UK has made increasing climate finance a central goal of its G7 presidency this year, and it is also one of the host country’s top four goals for COP26. Despite the positive announcements by wealthy nations, the issue will return as a key source of tension at the conference.

Failure to secure additional financing – and then, over the coming years, negotiate more ambitious targets – would significantly impede the ability of developing countries to mitigate and adapt to climate change. It would sap trust among developing nations in climate negotiations more broadly. In the short term, it has the potential to further expose fault lines widened during the pandemic over issues such as the inequitable access to COVID-19 vaccines.