OPINION: Three key private finance initiatives for financing a 1.5°C degree target
Kamleshan Pillay, CDKN’s Climate Finance Lead, outlines three potentially game-changing initiatives to enhance private finance of climate action, in response to the release of the IPCC Special Report on Global Warming of 1.5°C.
The 8 October release of the Intergovernmental Governmental Panel on Climate Change (IPCC)’s Special Report on Global Warming of 1.5°C again highlights the urgent need to scale up financial resources for climate action. Despite this well-documented need, the mobilisation of climate finance continues to be slow, with only US$3.5 billion committed by the Green Climate Fund as of September 2018. This sentiment was recently echoed by the French President, Emmanuel Macron, who stated that we are lagging behind our delivery of the Paris Agreement and we need to shift global finance “from the day to day business, to climate business.”
Even though adjusting to a 1.5°C target will change financing needs and timelines, there is a consensus that the private sector will need to play a more active role if we are to meet this target. Below are the three potential game-changers that could assist in meeting the financing needs of a 1.5°C degree transition.
As mentioned by the IPCC Special Report, infrastructure investments which integrate resilience measures and transformative approaches may alleviate the impacts of climate at 1.5°C at various scales. Therefore, instruments which are able to raise significant amounts of capital for infrastructure investments – such as bonds – are vital if we are to meet the US$ 1.5 trillion of financing needed globally every year to 2030 to fully implement the Paris Agreement. Green bonds can be described as traditional bonds with proceeds earmarked towards green initiatives. According to the State of the Market report 2018 on Bonds and Climate Change, the labelled green bond market is currently made up of 498 green bond issuers with US$389 billion of outstanding bond volume. This illustrates the rapid growth of the market since the first green bond issuance by the World Bank in 2007.
Despite the growth of the market, most issuances have occurred within European, Asia-Pacific and North American markets which suggests that barriers still exist which deter issuers from engaging in the green bond market. In African and Latin American markets, low credit ratings still remain a challenge, however the use of public climate finance could act as a guarantee to de-risk these investments. Initiatives such as the Global Green Bond Partnership launched at the Global Summit on Climate Action will undoubtedly raise greater awareness and capacity of issuers.
Considering the notable increase in economic losses from extreme weather events in the last decade, growing the product offerings in the insurance sector will result in greater adaptation finance. Climate insurance can be useful where residual risks are too costly for the public sector to manage. Furthermore, if based on environmental indices and thresholds, climate insurance can deliver quick payouts thereby reducing long term vulnerability.
The complexity of the instrument often causes mistrust and therefore insurance penetration in some parts of the world remains low (<5% in Africa). The incentive side of insurance also needs significant attention – that is a greater understanding of how proactive climate adaptation and risk reduction contributes to overall resilience and therefore premium reduction benefits. Despite these barriers, climate insurance has had significant success at the macro-level with sovereign risk pools such as the African Risk Capacity (ARC) and the Caribbean Catastrophe Risk Insurance Facility (CCRIF) delivering, in most cases, timely support to minimise immediate post-disaster losses. In terms of political support, the German government has been a champion of climate insurance instruments most notably the InsuResilience Solutions Fund (ISF), initiated by KfW Development Bank (KfW) on behalf of the German Federal Ministry for Economic Cooperation and Development (BMZ) and the recent support of ARC Replica policy within the African Risk Capacity. A caveat should always be stated when touting climate insurance – it is not meant to be the silver bullet for greater adaptation finance. Rather it is designed to work with other climate risk instruments to deliver comprehensive climate risk management.
Task Force on Climate-related Financial Disclosure (TCFD) & Principles for Responsible Investment (PRI)
In 2015, Mark Carney, the Governor of the Bank of England, delivered a strong warning to the financial sector: start understanding the risk that climate change poses or potentially deal with significant losses in the future. The Task Force on Climate-related Financial Disclosures (TCFD) has provided a starting point to create awareness among private sector actors on understanding their exposure to climate impacts. This is illustrated by the set of voluntary climate risk disclosure guidelines published in 2017. The work of the TCFD moves beyond simply evaluating transition risk, allowing for a more holistic view of the scenarios that need to be considered in financial decision making.
The uptake of climate risk guidelines by the banking sector could have significant implications on lending patterns in the future. It is likely that once the methodologies to assess climate risk are formalised, this will result in a shift towards greener investments catalysing greater involvement from others in the business sector. The TCFD is complemented by initiatives such as the United Nations supported Principles for Responsible Investment (UNPRI). The UNPRI are envisioned to be a set of voluntary and aspirational principles to facilitate the integration of Environmental, Social and Governance (ESG) factors into decision making.
Adding political will to the mix
The initiatives mentioned above could allow for new and additional sources of climate finance, highlighted by the IPCC as crucial for implementing 1.5°C consistent climate responses. However, despite the ability of these instruments to deliver sustainable financial flows, political will remains the critical factor in creating an enabling environment for the private sector to act decisively.