Expert Speak Terra Nova
Published on Apr 03, 2021
Green Capital: Sustained Finance for Sustainable Growth

The empirical case for climate action has been made. With a few exceptions, governments and world leaders agree that there is a need for a decisive response, a sentiment enshrined in the near-global consensus over the 2015 Paris Agreement. To achieve the goals of the Agreement, however, financing is crucial. This is especially true for emerging and developing economies where governments must prioritise poverty, healthcare, and infrastructure. Financing for the developing world’s low carbon transition must, instead, come from alternative sources. The expected sources of this funding are developed countries, as prescribed by Article 9 of the Paris Agreement.

Unfortunately, the traditional economic powers have not followed through on the pledges they made in 2015. According to UN estimates there is currently only US$38 billion worth of finance flowing from developed countries to developing countries for climate related activities – slightly more than a third of what was originally pledged<1>. However, even the original pledges made in Paris might not be enough. As mentioned during the panel, the amount of financing needed to truly generate a clean energy revolution in the developing world would be closer to US$500 billion.

There is, however, a way to bridge the financing gap. Private capital can provide a solution to the paucity of funds for climate action projects in the developing world. Institutional investors (a catchall term for pension funds, insurance firms, and sovereign wealth institutions) control the preponderance of private capital in global markets within Organisation for Economic Co-operation and Development (OECD) nations. The majority of the US$84 trillion worth of assets under management in the OECD are contributing only marginal profits to their owners, with certain debt instruments actually providing negative returns when inflation is accounted for<2>. Matching these institutional investors with low carbon projects in emerging and developing economies can be beneficial for all people involved; especially given the double digit returns that renewable energy projects have demonstrated<3>. Despite the apparent synergies, finding matches between these two parties has proven to be difficult.

In order to increase the quantum of funding from the OECD for climate action projects in the developing world, there are four main challenges that need to be addressed. First, the domestic business conditions within most developing economies need to be improved to provide the correct risk-reward proposition for institutional investors. Second, governments in the developing world need to streamline their domestic planning and policy at sub-national and local levels to help create a pipeline of bankable projects. Third, institutional investors need to improve their capabilities and expand their scope of due diligence for both “green” projects and projects in emerging and developing economies. Finally, innovative financial vehicles, platforms, and instruments such as blended finance, green investment banks, and asset backed securities need to be mainstreamed in order to provide risk mitigation for the developed world and liquidity for the developing world.

These challenges have been already been identified by scholars and policy analysts from the OECD<4> and the developing world<5>. Yet, Traditional, market-driven economic solutions are simply not enough. As Sumant Sinha, CEO of ReNew Power , mentioned during the panel, to truly push for a global low carbon transition, what is needed is a re-examination of the incentives associated with investing in “green” projects. This is especially true for international financial institutions, which have been a key cog in facilitating the uptake of climate action projects across the world. The assistance that has been provided to date, however, has been based on the principle of market returns confining these institutions to “safe” projects.

There is a case to be made for international financial institutions to receive lower than market returns in certain scenarios — especially when providing credit guarantees or hedging facilities. This is especially important for currency hedging facilities, as emerging and developing countries are still being penalised for the perceived volatilities of their currencies. As Mr. Sinha elucidated in his remarks, to truly catalyse a low carbon transition across the world, public finance institutions might have to reconcile themselves to receiving a two percent return for the provision of hedging facilities instead of their standard five percent return. While multilateral development banks may have to lower their profit margin on the provision of the financial instrument, the trickle down effects could significantly increase the uptake of climate action projects across the world.

As the deadline for significant action draws closer, it imperative that all stakeholders take concerted steps towards reducing the environmental costs that humanity has run up on its proverbial historical credit card. Governments must improve their business ecosystems and ensure that their policies are streamlined at state and district levels. The private sector must engage in capacity building to ensure that it has the ability to evaluate all projects and to foster the emergence of innovative financial instruments. International governmental organisations must be more willing to stepout of their comfort zone and earn only marginal profits on certain climate related facilities. It is only through collaboration and willingness to change traditional approaches, that a truly sustainable future can be achieved for the world.

This essay originally appeared in Raisina Dialogue Conference Report 2019

<1> UNFCCC Standing Committee on Finance: 2018 Biennial Assessment and Overview of Climate Finance Flows Technical Report.





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