Introduction

In a world with many competing priorities, the investment resources needed for the climate transition are substantial. On the one hand, it is estimated an additional US$ 1 trillion per year will be needed by 2030 in external flows and private finance for emerging market economies (excluding China) to meet the projected investment needs and forestall the climate crisis. On the other hand, another US$ 1.5 trillion or more of domestic resources will be needed to complement external financing. It is important to understand that in many  countries these domestic resources will come from taxation.

There is increasing recognition that substantial resources could be mobilised from the private sector if effective carbon markets are developed. While the private sector engagement in climate financing in many emerging and low-income countries has been very low, they could provide substantial financing through carbon credit markets.

The current state of climate financing

A substantial part of climate financing to date has been to respond to climate/weather events in-country. On the Africa continent, for example, countries like Mozambique spent 5–8% of their gross domestic product responding to Hurricane Ian, the same is true more recently for the floods affecting Pakistan.

Alternatively, climate financing initiatives by the private sector are responding to incentive schemes set up by national governments. As a result, a majority of the climate financing remains in its country of origin, with 76% of climate finance in 2019/2020 raised domestically. It is also primarily concentrated in the advanced economies of East Asia and the Pacific, which are dominated by China, Western Europe and North America.

In the 2019/2020 cycle, these regions attracted the majority of private finance at 81% while public finance accounted for the largest source of funding in many climate-vulnerable regions: which was 86% in sub-Saharan Africa and 63% in South Asia. Finance for adaptation and crosscutting activities is lagging, with 90% of total climate finance targeting mitigation activities – in particular, energy systems at 51% and transport at 26%.

Low-income economies with less ability to raise resources are obliged, in the absence of domestic revenue, to raise debt to respond to the climate challenge. A total of 63% of climate finance in 2019/2020 was raised as debt, of which only 16% (or US $61 billion) was low-cost or concessional. If these trends persist, low-income countries will face solvency issues before they can satisfactorily respond to the now recurrent climate disasters confronting them.

The current model, where low-income countries need to incur debt in an environment where most are already in moderate or high risk of debt distress, is an unjust model, especially when we consider that the main causes of debt distress are the war in Ukraine and the war against inflation in the United States and Europe, which has increased debt service costs in many emerging market economies. These exogenous risks only compound the climate crisis for many developing and low-income economies.

A just financing system for the climate transition will help low-income and emerging market economies adequately value their contributions to the climate challenge, monetise and use these flows to respond to the challenges. This means accelerating the development of functional carbon credit markets. While developed as well as some developing countries have been polluting, many low-income countries have been helping sequester carbon and keep the climate from overheating. It is time we put a just price on these efforts and allow countries to use the proceeds from carbon markets to help address climate challenges. Whereas these funds will not solve all the problems and additional external finance will still be needed, accelerating the development of carbon markets will provide substantial financing for many low-income countries.

The low-income countries with most of the carbon assets are not benefiting from the market. Over 60% of revenue from emission trading schemes in 2021 – which represents 41% of all carbon pricing revenues – came from the European Union. A preliminary assessment of the voluntary carbon market based on satellite data suggests that over a third, or 30%, of the world’s carbon sequestration needs by 2050 could be met by nature-based removal in African countries.¹ The estimates further show that carbon credits can generate about US$ 1 billion when priced at US$ 10/tCO2e, about US$ 82 billion at US$ 120/tCO2e for the African continent. To benefit from these schemes, Africa needs to develop the infrastructure needed to attract buyers seeking to offset their emissions.

In light of the magnitude of resources needed for adaptation and mitigation in low-income countries, as well as the slow pace of reaction of the official development sector to raising finance, working on market-based approaches to leverage the private sector is critical. The private sector in many industry segments has already committed to net zero strategies, buying carbon credits to offset emissions in the interim a substantial part of their strategy. Voluntary carbon markets allow companies to purchase offsets to cover the differential between their own decarbonisation efforts and carbon-neutral status. They also empower corporations to offer capital through the purchased offsets, which are largely projects found in the developing world.

What is needed to get the carbon credit active?

First, there must be consensus that carbon offsets and carbon credit markets are an essential pathway to achieving net zero. While many industries have committed to net zero, the technologies needed to transition to cleaner production systems are still under development. In the meantime, carbon offsets could and should serve as the goal. This is a ‘win–win’, as it provides resources for those able to help sequester carbon, particular low-income countries.

Second, a strong governance system is essential for both the supply and demand of credits. The Integrity Council for the Voluntary Carbon Market (IC-VCM) is designing ‘Core Carbon Principles’ as a minimum benchmark for quality, which all voluntary carbon market standards should strive to meet in their procedures and requirements. At present, environmental and social safeguards, as well as measures to promote sustainable development benefits, vary significantly across existing standards.² To be credible, buyers and sellers of credits need to engage and support the Science-Based Targets Initiative and the Voluntary Carbon Markets Integrity Initiative, which aim to shape common understanding and standards.

Third, the G20 could provide the fora for standardising a market-based approach to pricing carbon, so there are no inequities in the market and carbon with similar DNA (Deoxyribonucleic acid) in different jurisdictions should fetch the same price. Currently, there are vast differences in price, with low-income countries traditionally being at the low end of the grid.

Fourth, transparency is key. Information infrastructure can  help increase transparency – for instance, ratings for credit quality – and should prioritise open-source data and methodologies as much as possible.

Fifth, low-income countries need capacity building to set  standards; create the legal framework for the operationalisation of carbon markets; and develop appropriate revenue-sharing agreements with relevant constituencies.

The private sector has an important role to play in accelerating the climate transition. They will need to multiply investments into emerging markets, accelerate innovation to support the just energy transition, and create jobs. However, while waiting for countries to put in place the reforms needed, develop bankable projects, and crowd-in concessional and philanthropic resources to make projects attractive, the private sector can contribute through well-developed carbon markets in raising domestic revenue and supporting the protection of the natural capital in these countries. More focus should be placed on this to crowd-in the resources needed for the challenges ahead. Ultimately we need to move streamline the agencies dealing with carbon pricing and most importantly move from the voluntary to the assessed market.³