January 13 – There’s a big black hole in the finances needed for the climate and energy transition.
Spending today (primarily on mitigation) is around $600 billion. Africa alone needs $3 trillion by 2030, and according to the IMF, the world needs between $3 and $£6 trillion a year until 2050. It sounds like a lot, but private investors have the money: they control assets worth some $210 trillion; banks potentially another $200 trillion. How can they be persuaded to spend some of it?
The answer hinges on risk. Low- and middle-income countries are risky propositions for investors, says Chris Clubb, managing director of Convergence Finance, a non-profit set up to increase investment going into those countries to achieve the sustainable development goals. The country risk and currency risk are so high that investors would be failing in their fiduciary duty to pension-holders, shareholders and stakeholders – or be non-compliant with regulations – if they did invest.
But the appetite is there, suggests Clubb, if risk could be reduced to bring it under the barrier. And this is where blended finance comes in: to use public sector finance to reduce the level of risk to something acceptable to private investors.
Groups like the U.N.-convened Net-Zero Asset Owners Alliance, with $10 trillion assets under management, “are saying three things: one, we have the money that we’re looking to invest. Two, we’ve looked at developing countries, and we would like to invest the money there, but the risk is just simply too high for us. And three, if you can, through blended finance, create fiduciary investments, we will be investing.”
Blended finance is not a new idea, but it hasn’t taken off as anticipated after the launch of the U.N. Sustainable Development Goals (SDGs) in 2015. “We are not blending to scale. We are blending small – project by project. And so, we’ve got to break some glass in order to blend more,” Jay Collins, vice chairman of banking, capital markets, and advisory at Citigroup, told an audience at a side event at COP27 in November.
Convergence has tracked more than 700 blended finance deals that have been put together over the past 15 years. Often, says Clubb, only one donor government provides funding, which limits the size of the blended finance vehicle. On average those deals are around $70 million – too small alone to change the landscape.
Bringing governments, multilateral development banks (MDBs) and the private sector together can change that. One example is the Climate Finance Partnership, announced at COP26 by asset manager BlackRock.
Its focus is on renewables, transmission and energy storage infrastructure in Latin America, Asia and Africa.
The fund was oversubscribed, raising $673 million. Of that, $130 million of so-called catalytic funding – a safety buffer to reduce the risk to the private sector – was raised from Japanese, French and German governments, alongside TotalEnergies and philanthropic donors, including Grantham Environmental Trust. The private investors who are protected from the greatest risk committed five times as much – $523 million. The partnership is soon to ink the first deals.
There were a range of pledges made at COP27 in Sharm el-Sheikh. In a five-year partnership with Kenya, the UK government is committing around £13 million to a new guarantee company that will lower the risk for investors and is expected to unlock another £80 million in climate finance for six projects across energy, agriculture and transport.
The clean energy pillar of Egypt’s newly launched Nexus on Food, Water and Energy programme attracted $500 million from international partners, including the United States, Germany and the EU, to accelerate the country’s renewables deployment.
The financing is expected to unlock at least $10 billion in private investment to install 10 gigawatts (GW) of solar and wind energy by 2028 and retire inefficient gas power capacity.
At COP27 a Just Energy Transition Partnership (JET-P) to help Indonesia transition from coal, committed to mobilise $10 billion in public funding from partner governments. Private sector investors, members of the Glasgow Financial Alliance for Net Zero (GFANZ), will raise another $10 billion. This was followed in December by a $15.5bn JET-P package to help Vietnam achieve its clean energy goals, with the private sector committing to match $7.75 billion in public funding.
The agreements built on the $8.5 billion JET-P for South Africa announced in 2021 at COP26.
But compared to what’s required, these projects barely scratch the surface. South Africa’s investment plan, launched a year after the partnership was announced, suggests $98.7 billion will be needed over the next five years to begin the country’s transition from coal. Funding sources have been identified for about half that figure.
At least a third is expected to come from private sources, but observers of the process say donor countries have not used the past year to mobilise the necessary level of concessional finance that would attract the private investment required. Nor have they addressed the huge debt that has been built up by the state-owned power producer, Eskom, which adds to investor risk.
Scale of funding is one issue. What it’s spent on is another. The bulk of climate finance projects – around 90{1b90e59fe8a6c14b55fbbae1d9373c165823754d058ebf80beecafc6dee5063a} ‒ target mitigation, not adaptation. That’s partly because mitigation projects (such as renewable energy) can generate cash flows to provide returns to investors, whereas adaptation projects generally don’t produce revenues.
Anjali Viswamohanan, policy director at the Asia Investor Group on Climate Change (AIGCC), says much more innovation, time and effort is needed to come up with projects that build resilience and produce returns.
One example could be the building of a seawall around a low-lying area, with an integrated road project that would generate returns, for example from road taxes. “We need to get all stakeholders – not just the private investors – together to think about the adaptation and resilience issue from a systemic level,” says Viswamohanan.
In any case, investors will have to be thinking about the physical risks posed by climate change to the assets they hold, and how to build resilience for them. The AIGCC has urged governments to clearly lay out a financial strategy to underpin national adaptation plans and bring private and philanthropic funders together with government and multilateral development banks to identify co-investment opportunities.
Clubb argues that the multilateral development banks could easily double or triple their finance commitments from $140 billion a year at present and distribute some of the financial exposure to private investors through blended finance.
MDBs who lend to governments for public sector projects (such as climate adaptation) don’t currently mobilise funds from the private sector, while entities such as the International Finance Corp (part of the World Bank group) who do mobilise private funds for private sector projects don’t generate as much investment as they could.
From the perspective of most experts, “the multilateral development banks are the most systemically under-utilised development tool that the development community has,” he adds.
Speaking at COP27, Nick Holder, chief operating officer for Prudential Africa, said he wanted to see the multi- and bilateral development banks expand their activities and scope of financing to provide more capital.
“We’re really looking for greater scale in concessional capital, in supporting blended finance solutions that de-risk investments, not just on a project-by-project basis, (but) on a much larger scale, both to make it easier to invest, and to ensure diversification.”
He described how its support for a $14 million project for solar energy in Vietnam took a relatively large effort in terms of due diligence and looking for certification. “It was a good thing to do, it was the right thing to do, but it’s not yet scalable.”
Convergence, in collaboration with aid agencies and a range of private and philanthropic investors, has put together an action plan for climate and SDG mobilisation to double investment into developing economies to $530 billion. They say the action plan can be implemented within a year, and without additional public sector resources.
“There needs to be a critical mass of funding that can de-risk the investment if we want to invest at scale … and that needs to be allocated to the best global examples, no matter where they come from,” says Clubb.
Crucially, the catalytic funders like MDBs, need to collaborate to create large enough funds to make an impact on climate and SDG goals.
USAID, the international development arm of the U.S. government, which worked on the plan, has agreed to collaborate with the development agencies of the five Nordic governments to establish a financing vehicle to catalyse $1 billion before COP28 next year in the United Arab Emirates.
Reform of the MDBs is high on the international agenda, with the Sharm el-Sheikh Implementation Plan agreed at COP27 calling for them “to define a new vision and commensurate operational model, channels and instruments that are fit for the purpose of adequately addressing the global climate emergency”.
It also emphasises the need for grant-based resources – as opposed to loans – for adaptation and for the least developed countries, something powerfully argued for by Barbados prime minister, Mia Mottley.
Since 2015, says Clubb, “we’ve had two north stars, the Paris Agreement and the U.N. SDGs, that have allowed us to begin to quantify the amount of investment that’s actually required.
A significant challenge is the multilateral development bank and development finance institution system – legacy mandates and processes are not aligned to the speed required or to increasing financial commitments and mobilising private finance. Their shareholders need to reset their compass towards those north stars.”
A lot is riding on the IMF and World Bank spring meetings to find agreement to chart that new course.
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