- Current political and economic issues succinctly explained.
Countries around the world have pledged to combat climate change, launching plans to reduce their carbon dioxide emissions to keep global heating “well below” 2°C (3.6°F) above preindustrial levels. Additionally, countries have committed to protecting communities from the already unfolding consequences of climate change. While governments generally recognize that this two-pronged climate adaptation and mitigation process will cost trillions of dollars, they have yet to produce plans for financing it.
What is “climate finance”?
Climate finance is any “local, national, or transnational financing—drawn from public, private and alternative sources of financing—that seeks to support mitigation and adaptation actions that will address climate change,” according to the United Nations. Mitigation efforts, such as renewable energy development, seek to curb greenhouse gas emissions; adaptation, on the other hand, focuses on making existing infrastructure and practices more resilient to a changing climate, such as by improving the communities’ weather resistance and restoring biodiversity.
Most public climate finance consists of debt, often in the form of loans. For instance, countries can borrow money from commercial banks to achieve their climate goals. Moreover, multilateral development banks (MDBs), such as the World Bank, can offer “concessional financing” for climate projects—below-market-rate debt with a more generous grace period for repayment. Equity investments, in which an investor buys a stake in a given project, account for roughly one-third of climate finance projects, while grants—which don’t need to be repaid—make up a small minority.
Governments and multilateral institutions deliver about half of this funding, with development finance institutions, such as the United Nations’ Green Climate Fund (GCF) and the World Bank, contributing the most. The GCF, which is the world’s largest climate fund, has raised almost $30 billion in pledges from dozens of countries; it disburses that funding to local development banks, nonprofits, and other organizations to facilitate more than two hundred projects in developing countries. The other half of climate financing comes from private enterprises.
How much money is needed to protect communities against the worst effects of climate change and achieve net-zero greenhouse gas emissions?
Estimates vary, but all exceed trillions of dollars a year. The Glasgow Financial Alliance for Net Zero, a coalition of leading global financial institutions, projects that reaching net-zero emissions will require at least $125 trillion in investments by 2050, or about $5 trillion a year. Other estimates predict that it will cost nearly double that amount. To adequately prepare developing countries for extreme weather and other consequences of climate change, the cost could reach $300 billion each year by 2030, according to UN estimates.
But even as researchers diverge on the total investment needed, they agree that current spending is far short of what is necessary, especially for poor countries to protect themselves. For instance, climate-related damages can cost upward of 20 percent of gross domestic product (GDP) for smaller island nations, who contribute the least to greenhouse gas emissions but typically suffer the greatest from climate change, often due to their geographic location and a lack of financial and institutional infrastructure.
In 2009, wealthy countries committed to mobilizing $100 billion in annual climate finance for low-income countries by 2020, but they marshaled just $83 billion that year, according to the Organization for Economic Cooperation and Development (OECD). Now, they are reportedly considering a plan to up those commitments to $1 trillion annually, despite not meeting the smaller goal. And even if wealthy countries—whose emissions have contributed the most to global warming—do embrace and meet that larger goal, they will still fall short of developing countries’ climate finance needs, which the United Nations expects to rise to at least $6 trillion by 2030.
How is climate finance used?
Because climate finance has such a broad definition, projects range widely in scope. That said, most climate financing funds are directed towards mitigation—it composed around 90 percent of total financing in 2021. Climate adaptation made up around 7 percent that year. One reason for this imbalance, experts say, is that climate adaptation projects are difficult to define, as they are highly context-specific. Compared with mitigation, which focuses on reducing greenhouse gas emissions, metrics for measuring the damage avoided through adaptation investments are harder to identify.
Mitigation initiatives are heavily focused on the energy sector, the industry that burns the most fossil fuels, which is the leading cause of climate change. South Africa, for example, received an $8.5 billion financing pledge in 2021 to help with decarbonization initiatives, such as retiring coal-fired power plants and creating renewable energy capacity. In the United States, President Joe Biden signed into legislation the Inflation Reduction Act of 2022, which directed hundreds of billions of dollars’ worth of federal tax credits, loans, and research grants toward boosting domestic manufacturing capacity for clean energy and other climate-related programs, such as initiatives to promote electric vehicles. Experts consider the law to be the largest and most ambitious climate bill in U.S. history. Adaptation projects, on the other hand, include efforts such as constructing desalination plants in the Maldives to address declining rainwater and transitioning smallholder coastal farmers in Vietnam from collecting scarce marine resources to beekeeping and mangrove restoration, to name just a few examples.
Meanwhile, several market-driven solutions are gaining in popularity. These include tradable carbon credits and so-called debt-for-nature swaps, which relieve sovereign debt in exchange for conservation efforts. However, there are no internationally recognized parameters for climate finance, which has led to discrepancies between the amounts countries say they have invested in such initiatives and the amounts tallied by watchdog nonprofits.
What are the main challenges to climate financing?
Funding. The biggest challenge is the lack of funding for climate projects, especially for low-income countries. “No government in the world has enough money to get the job done,” U.S. climate envoy John Kerry said at the annual UN climate conference in 2022, suggesting countries will have to rely on the private sector to meet funding needs. Some experts argue that attracting more equity financing from commercial investors—pension funds, insurance companies, and private-equity firms, for instance—would be a better instrument than debt because this would tie foreign investors to projects longer and shield developing economies from a debt crisis.
Institutional capacity. Other analysts have raised concerns that many poor countries lack the financial infrastructure to channel massive foreign investments into productive projects, which could panic investors and unsettle fragile economies. Another hurdle, experts say, is that many MDBs currently lack the capacity to facilitate the world’s climate finance needs. Furthermore, research finds that a majority of MDB financing is disproportionately concentrated in climate mitigation, with less focus on adapting businesses and communities to handle climate risks. Part of the reason for this misalignment stems from a dearth of climate expertise at these institutions, says CFR climate expert Alice C. Hill.
Accountability mechanisms. There is no existing mechanism to hold governments and institutions accountable for meeting financing promises. Wealthier nations have been found to overreport their investment estimates or fall short of their responsibilities, while “green funds”—which allow private investors to contribute to ESG investing—are not required to disclose their investments’ carbon footprints or emissions output, resulting in greenwashing.
What’s next for climate finance?
Climate finance will be a central point of discussion at this year’s UN climate conference, COP28. Some experts believe risk-sharing strategies that blend public and private money could make commercial lenders more willing to support climate projects. Other experts are pushing for climate funds, such as the GCF, to increase their grants to developing countries’ national and local institutions, which would allow these countries direct access to funds and local ownership over these projects.
Multilateral bank reform will also be discussed at the conference. COP28 Chair Sultan bin Ahmed Al Jaber plans to address reforms that will “unleash more concessional dollars, lower risk, and attract more private finance for vulnerable communities.” Similar measures were raised last year with the Bridgetown Initiative, which proposed a plan for richer countries and the private sector to provide more money to MDBs.
Meanwhile, regulators around the world have started to tackle greenwashing in investor markets. The European Union, for example, implemented the Sustainable Finance Disclosure Regulation in March 2023, which aims to enhance transparency of so-called green investing. Moreover, during a CFR meeting, World Bank President Ajay Banga endorsed carbon credit offsets and said the World Bank could serve as an arbiter for their validity.
While new initiatives and policies demonstrate that climate financing efforts are evolving and improving in many cases, the window for world governments to mitigate the harms of climate change is closing fast. “We need to have far greater ambition,” Hill says. “And we need to act with greater urgency.”
Will Merrow created the graphic.