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How can financial innovations deliver climate justice?

Blog Sustainable Growth and Inclusive Growth

High-income countries owe an estimated US$ 192 trillion in compensation for climate damages. Low- and middle-income countries remain disproportionately affected by climate change with insufficient access to climate finance. Innovative financial approaches such as blended finance and pension funds can provide possible solutions to climate financing.

In 2022, Pakistan faced one of the worst flooding events – a monsoon on ‘steroids’ – the world had ever seen, affecting 33 million people and bearing economic losses of over GB£ 12 million. On this tragedy, the UN Secretary General, Antonio Guterres,  emphasised that "it is also a matter of justice" and countries that are "least responsible are the first to suffer". He called for a global climate finance shake-up to help prepare for the future.

Climate injustice and inequity

Estimates by Fanning and Hickel (2023) suggest high-income countries bear more responsibility for climate damage and owe a compensation of US$ 192 trillion to meet climate targets by 2050. To further underline the inequity of the situation, countries in Africa contribute the least to greenhouse gas emissions, while the G20 economies contribute the highest to CO2 emissions today.

Given this context, it is imperative that accessible financial resources reach   low- and middle-income countries (LMICs), and especially their fast-growing cities to tackle the crisis through adaptation and mitigation efforts. 

Yet, the US$ 100 billion per year by 2020 commitment of the UNFCCC COP15 at Copenhagen has not been met and adaptation finance requirements for low- and middle-income countries have been 5-10 times below the estimated needs. LMICs have also been unable to borrow freely due to high debt distress, and so remain stuck in a vicious cycle of debt and climate crises. While contributions have been improving year-on-year, LMICs still face obstacles such as higher interest rates to access funds. As a response to the climate debt and injustice faced by LMICs, a Loss and Damage Fund was set up in the in the recent COP27. However, the details of what this fund would entail and how it would be structured remain to be finalised.

Innovative financing for climate change

The reality of climate change, the enormity of the geographical and socioeconomic damages it possesses, and the severity of injustice and disproportionate adverse impacts for LMICs necessitates practical and innovative solutions in providing accessible climate finance, such as rethinking blended finance models and channelling pension funds towards adaptation efforts. Simultaneously, efforts need to be taken to also improve access to private sector funding towards climate financing in LMICs.

Growing private sector finance

As of 2020, most of the share of mobilised climate finance comes from the public sector, at over 80%, and raising private finance remains a challenge. Given their limited fiscal capacity, low- and middle-income countries face the burden of having to be a ‘low-risk’ country to access these resources. Pauw et al (2021) also show that public funds are channelled towards activities that have higher social returns and lower financial returns, thus making it less encouraging for private sector funding.

However, private sector’s involvement has grown in the past few years. Climate-related private sector equity instruments have grown nearly threefold from 2019 to 2022, and venture capital and private equity funding for climate change has vastly outpaced other investments in the broader market.

While improving access to private sector climate finance mobilisation remains a key step, revitalising blended finance models and utilising pension funds towards this are potential innovations that could be studied and implemented going forward.

Blended finance

Blended finance, wherein public funds can be strategically blended with private capital to attract further private funds, can improve the base for accessing capital while also creating an environment which is competitive enough for the private sector to participate in. This would also improve the commercial viability of climate projects. Within the blended finance model, debt and equity-based mechanisms could help raise capital, along with grant-based financing which is an instrument that the public sector already widely utilises.

The 10-year, US$ 625 million blended finance model fund Global Fund for Coral Reefs (GFCR) is an example, which now targets the blue economy and coastal livelihoods in countries in Africa, Asia-Pacific, Latin America, and the Caribbean. The blended finance model can play a key role in de-risking investment and enhancing further private capital into climate adaptation needs.

Pension funds

Pension funds are another useful and effective source of directing capital towards climate adaptation. It is also unique as a domestic own-source fund that depends on the country’s labour force – especially the public sector, in more recent years – that can be appropriately channelled towards financing for climate change.

Research on innovating by creating public asset managers to manage these funds, and reforming the role of private asset managers is ongoing. It is relevant to recognise that it is of a nation’s own interest and its future potential climate harm that these funds are deployed towards building climate-resilient infrastructure. These can be trialled in wealthier cities (such as the Public Solar NYC project) and can easily be expanded to more places around the globe. Given the size of these funds, which are a function of the public sector working population in most countries, LMICs are well placed to tap into the potential of making use of these funds. These can directly lead to coherent public investment towards domestic climate needs.

Ensuring disbursement and effective use of climate funds

It is pertinent that deposits made to climate funds actually lead to the uptake and utilisation of these, especially in climate vulnerable countries. Disbursement rates of climate funds are less than a third of the deposits, and sub-Saharan Africa is especially underrepresented in this, receiving less than 10% of these funds over the years. While newer funding mechanisms which are more liberal towards LMICs countries are welcome, the funds must also be flexible so that there is lesser backlog in translating these into viable projects. Central banks and domestic regulators could play an important role in creating and maintaining a transparent database of bankable projects that are accessible to public and private-sector investors to best leverage the existing funds in place.

The UN Sustainable Development Solutions Network can support these domestic institutions and play a vital role in strengthening the technical capacities of local governments, national governments, and central banks in implementing the strategies as agreed in the Paris Agreement in 2015. As the knowledge body and technical expert on SDGs, it is well placed to build the capacities of cities and local governments in being able to attract and mobilise resources for climate action. As the IMF has urged, strong local capacity must translate to channelling funds more swiftly and efficiently into countries whose needs are the highest.

As highlighted in the recently concluded LSE’s Environment Week, towards ensuring climate justice for all, further research is needed on where to best allocate funding towards climate adaptation. On both the blended finance model as well as innovative pension fund approaches, more research on their practical applications, in-country experiences and potential challenges is needed.

The UNFCCC COP28, which is to be held in the UAE later this year seeks to deliver a new deal on finance that is affordable, available, and accessible as a commitment towards climate action for the future. One hopes that conference leads to a consensus on ensuring innovative, practical, just and long-lasting climate finance solutions, and ensuring a fairer climate future for all.