Climate finance: The key to a sustainable future

Climate change is one of the most pressing issues facing our world today. Rising global temperatures, melting ice caps, extreme weather events – the impacts are being felt across the globe and pose significant challenges to economic growth. Urgent action is needed to mitigate climate change and adapt to its effects.

Reversing the climate crisis requires massive global investments. The annual financial needs for mitigation and adaption measures are set to increase steadily to an average estimate of USD 9 trillion in 2030, eventually soaring to a staggering USD 10 trillion a year by 2050.* Currently available levels of climate finance are multiple times below the needed amounts. Developing countries, where the effects of climate change are most severely felt, find it particularly challenging to finance the necessary measures.

Climate finance has been a central element of global climate change negotiations since 1992. The Cancun Climate Change Agreements of 2010 called on developed countries to jointly “mobilize” USD 100 billion annually by 2020 to address the needs of developing countries. While this might seem a commendable goal, the world’s first-ever global stocktake at the UN Climate Change Conference (COP28) in December 2023 showed that both financial contributions and mitigation efforts are far from meeting commitments.

The more we wait, the higher the costs, both in terms of mitigating global temperature rise and coping with its impacts. So let’s examine what climate finance truly entails and explore financing solutions that can help address the climate crisis.

* Source: Climate Policy Initiative

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What is climate finance?

Defining climate finance continues to be a topic of intense debate. According to the United Nations Framework Convention on Climate Change (UNFCCC), “Climate finance refers to local, national or transnational financing – drawn from public, private and alternative sources – that seeks to support mitigation and adaptation actions that will address climate change”.

How this plays out in real terms is slightly more complex. Climate finance is just one of many terms employed to describe the movement of funds in the context of climate-related matters. In general, though, a distinction can be made between “sustainable finance” that takes a broad environmental, social, economic and governance approach, and the narrower concept of “green finance”, concerned only with environmental issues. Even more narrowly focused are those actions targeting exclusively climate change mitigation and/or adaptation, which we call climate finance.

In all cases, though, total climate finance includes all financial flows whose expected effect is to reduce net greenhouse gas emissions and/or enhance resilience to the impacts of current and projected climate change.

What are climate finance flows?

Climate finance flows encompass the allocation and distribution of financial resources with a specific focus on supporting projects, programmes and activities related to climate change. These funds are directed toward initiatives that address both mitigation (reducing greenhouse gas emissions) and adaptation (building resilience to climate impacts).

How does capital “flow” from one country to another? Flow diagrams shed some light on how countries are giving and receiving climate finance, but also on the types of finance offered by different donor countries. They reveal, for example, the proportion of funding allocated to adaptation versus mitigation projects, and whether financial support primarily comes in the form of grants or loans.

What types of investment are needed?

Broadly speaking, there are three key categories that receive climate financing, each supported by specialized climate finance solutions designed to mobilize and channel funds towards climate action.

  • Mitigation investments are directed to reducing greenhouse gas emissions and include funding projects related to renewable energy sources.
  • Adaptation investments focus on enhancing resilience to climate change impacts, for example by supporting infrastructure improvements that can withstand extreme weather events.
  • Dual-benefit investments serve both mitigation and adaptation objectives, such as sustainable agriculture initiatives that contribute to carbon sequestration while improving food security.

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What are the instruments of climate finance?

Climate finance encompasses a variety of instruments. To meet the increasing demand for capital, innovative climate finance solutions have emerged to finance or refinance projects and assets that contribute to climate action. Some key financial instruments include:

  • Grants and donations: Grants provide non-repayable funds to support climate-related projects and initiatives. They usually operate as a results-based financing where the disbursement of funds is tied to the successful delivery of specific outputs (e.g. infrastructure).
  • Debt swaps: Debt-for-climate swaps are financial arrangements where debtor countries negotiate to restructure their existing debt in exchange for a commitment to invest the freed-up resources in climate change mitigation and adaptation projects within their own borders. This mechanism is especially beneficial for countries grappling with substantial debt burdens.
  • Equity shares: Equity typically refers to ownership stakes or shares in companies or projects. Equity shares in climate-related activities allow investors to support initiatives aligned with climate goals while potentially earning returns based on the project’s success.
  • Green bonds: A green bond is a fixed-income instrument designed to support specific climate-related or environmentally friendly projects.
  • Guarantees: A guarantee represents a commitment where the guarantor (for example a development finance institution or an export credit agency) pledges to fulfil the debtor’s obligations to the debt provider. Specifically in the context of climate change mitigation and adaptation activities, guarantees play a pivotal role in unlocking private-sector funding by mitigating the perceived financial risks associated with climate initiatives.
  • Concessional loans: These differ from traditional loans because they offer favourable terms: longer repayment periods or below-market interest rates. They are granted by major financial institutions, such as development banks and multilateral funds, to developing countries for high-impact projects to combat climate change and build a more sustainable future.

The choice of instrument, and the way it is delivered, can significantly influence whether the finance effectively achieves its mitigation and adaptation objectives. For this reason, establishing the appropriate mix of climate finance solutions for the country, sector and project is critical to maximizing the impact of climate finance.

Measuring the effectiveness of climate finance

Accurately measuring the efficacy of climate finance initiatives in channelling funds towards impactful projects remains a complex task. At its core, it involves tracking financial flows that are explicitly aimed at addressing climate change mitigation, adaptation and resilience efforts. This includes funding from various public and private sources, such as government budgets, international aid, private investments, and innovative financial instruments such as green bonds and carbon markets.

Challenges persist in accurately capturing and categorizing climate finance flows. For example, distinguishing between climate-specific funding and general development assistance can be challenging, as many development projects contribute both to climate adaptation and mitigation. Additionally, tracking private-sector investments in climate-friendly projects can be tricky due to the lack of standardized reporting practices.

However, measuring climate finance performance goes beyond tracking financial flows alone. Climate financiers want to be reassured with solid data that their engagement will not be perceived as “greenwashing”. For example, green bonds are typically issued to raise money for climate-friendly investments; yet the link between genuine climate-friendly measures and their impacts can sometimes be tenuous, for lack of transparency and adherence to standards.

Climate finance safeguards

Robust measurement frameworks are essential for tracking progress, ensuring accountability and guiding future investments. To address these challenges, efforts are underway to improve transparency, consistency and comparability in climate finance reporting. That’s why major financial institutions, including the World Bank, are embracing new technologies like blockchain to create more transparent, verifiable and scalable climate finance solutions.

International Standards also play a significant role in attracting and managing climate finance. Not only do they ensure transparency, reliability and accountability in financial flows, but they help to measure, report and verify the environmental impact of investments related to climate change.

  • ISO 14097 Greenhouse gas management and related activities
  • ISO 14100 Guidance on environmental criteria to support green finance
  • ISO 14001 Environmental management systems
  • ISO 32210 Sustainable finance

Having complete oversight of a project’s environmental impacts is key in determining whether it qualifies for climate finance. Completeness of information is a core principle of ISO 14100, a standard that helps organizations on both sides of the financial transaction determine the environmental risks and opportunities associated with potentially beneficial projects, assets and activities. By adhering to global standards, investors can ensure their funds are directed towards projects that genuinely contribute to climate change mitigation or adaptation.

Where we are now…

Climate finance solutions will remain a cross-cutting theme for the foreseeable future. While discussions often focus on financial support from affluent nations to developing countries, the transition toward sustainable finance presents significant obstacles for the world as a whole. The primary challenge lies in efficiently channelling funds to where they need to go.

At COP28, discussions continued on setting a “new collective quantified goal on climate finance” in 2024, taking into account the needs and priorities of developing countries. The new goal, starting from a baseline of USD 100 billion per year, will be a building block for the design and subsequent implementation of national climate plans that need to be delivered by 2025.

According to the UNFCCC, the next two years will be critical. At COP29, governments must establish a new climate finance goal, reflecting the scale and urgency of the climate challenge. And at COP30, they must come prepared with new nationally determined contributions that are economy-wide, cover all greenhouse gases and are fully aligned with the 1.5 °C temperature limit.