The climate crisis

The need for urgent climate action is more acute than ever, with the Intergovernmental Panel on Climate Change (IPCC)’s most recent assessment reports on adaptation¹, mitigation² and the physical science of climate change outlining in stark detail both the opportunities and risks that will be encountered over the coming decades.³

Despite the 2022 IPCC report on mitigation processes and pledges declaring that it is ‘now or never’ when it comes to limiting a rise in the average global temperature to no more than 1.5°C, it concludes that greenhouse gas emissions are continuing to grow, with potentially devastating consequences. Moreover, the reports warns that we will face multiple climate hazards even if this Paris Agreement goal is achieved.

We are already experiencing the consequences of changes to our climate. The IPCC has asserted that human- induced climate change – including more frequent and intense extreme climate events – has caused widespread losses and damage to nature and people, with droughts, floods, wildfires and marine heatwaves affecting the food security, nutrition and livelihoods of some of the world’s most vulnerable populations.

According to the World Meteorological Organization, the probability that at least one of the coming five years surpasses the 1.5°C limit is now 48%.⁴ As recently as 2015, there was zero chance of this happening in the following five years. By 2020, however, the chances of this happening had surged to 20%, then to 40% in 2021, when the global average temperature rose to 1.1°C above pre-industrial levels.

Every additional rise in global temperatures increases the perils – such as water scarcity, malnutrition and heat waves – faced by people across the planet. Here, the developing world is disproportionately affected, particularly the poor and most vulnerable, including women and children. On top of this, businesses will be exposed to physical risks arising from extreme weather events affecting operations and supply chains; market demand risks; regulatory risks; and reputational and legal risks.

The need to invest in climate innovation

Avoiding catastrophic climate change requires accelerating the adoption of existing climate technologies and business models, as well as the development of new technological and business solutions. Innovations in policy, culture, institutions, science, technology, management and finance are all needed if we are to get back on track. The past decade has seen the emergence and diffusion of several transformative climate innovations, which have kept open the window of opportunity to avoid catastrophic climate change.

The costs of solar photovoltaics, wind and batteries, for example, have dropped at an annual rate of close to 10% for several decades. By contrast, the prices of fossil fuels are, after adjusting for inflation, very similar to what they were 140 years ago. Should renewable energy and storage technologies maintain their current deployment growth rates, they will replace fossil fuels in two decades.

Delivering on the promise of innovation will require significant increases in investment. Indeed, the IPCC estimates that US$ 1.6–3.8 trillion in new climate investments will be needed annually through to 2050 if global warming is to limited to below 1.5°C, with an additional US$ 140–300 billion needed annually to adapt to climate change impacts.

It is clear that climate investment needs far outweigh the availability of public funding. Achieving investment on this scale therefore means capitalising on current and emerging technological innovations by scaling up investments in assets that also maximise the development co-benefits of climate action.

Barriers to investment in new climate solutions in developing countries

There are, however, a number of technical, political, regulatory, institutional, market, macroeconomic and infrastructure barriers to investment in new climate solutions, particularly in developing countries. For example, complex, inconsistent or opaque licensing procedures lead to transaction delays and costs. Moreover, even the best new green energy technology in the world will not be competitive if fossil fuels are heavily subsidised. These barriers exist at all phases of innovation – emergence, deployment and widespread adoption – and translate into higher hurdle rates for entrepreneurs and financiers, who will require higher expected returns before investing their time and personal equity. At present, these higher financing costs are negatively affecting the attractiveness of technological and infrastructure climate investments.

In addition, there is a heightened risk perception surrounding climate investments in developing countries. Pricing climate risks is a daunting challenge for investors, who must estimate the likelihood of various climate scenarios and their implications for physical, liability and transition risks at the firm and project levels. The mispricing of risks is compounded by strong home- country preference and global investors’ limited familiarity with developing markets. Research on default rates published in 2020 by the international credit rating agency Moody’s demonstrates that the probability of default attributable to project financing in Africa (0.69%) and Asia (0.7%) is higher than in Western Europe (0.4%), though lower than North America (1.12%).⁵

Moody’s data demonstrates that investing in infrastructure in developing countries is not significantly riskier over the long term than investing in infrastructure in developed countries. Thus, establishing an enabling policy and capacity environment for climate investment; de-risking first-mover climate investment in order to establish a commercial track record; and sharing knowledge regarding commercially successful investments at scale in each geography are all critical to addressing actual and perceived climate investment barriers in developing countries.

The unique role of the Green Climate Fund

Working together, the public and private sectors have a critical role to play in overcoming these barriers and closing the financing gap. This is at the heart of what we at the Green Climate Fund (GCF) do.

GCF was established as a pivotal part of the global climate architecture, tasked with channelling finance to developing nations in order to help realise the climate ambitions identified by these countries as critical to their needs. GCF has grown to become the world’s largest dedicated multilateral climate fund, channelling over US$ 10.5 billion in funding to 196 projects, amounting to more than US$ 37 billion in assets under management when co- financing is included. GCF is a partnership organisation, co-investing in climate initiatives originated by over 200 public and private partner agencies and firms, including some of the largest commercial banks. With these partners, GCF aims to catalyse climate finance at scale through four workstreams.

The first of these workstreams involves creating an enabling environment for climate action through supporting integrated climate strategies and policies. According to some estimates, integrated energy, water, urban and transport infrastructure could reduce total infrastructure needs by 40%. Under this workstream, a key GCF priority is supporting developing countries craft green economic stimulus measures to recover from the COVID-19 pandemic and, in doing so, access long-term affordable finance without increasing their debt burden. Depending on their design, COVID-19 recovery packages may either entrench our dependence on fossil fuels or accelerate the transition to net-zero, climate-resilient economies.

The second workstream involves accelerating climate innovation through investments in new and innovative technologies, business models, financial instruments, and practices. GCF supports accelerators and incubators, providing early-stage financing to climate innovators to pilot new climate solutions. For example, GSF is working with the private sector in its US$ 279 million investment in the Amazon Bioeconomy Fund, supporting new bio- businesses across six Latin American countries with the aim of reducing emissions and enhancing climate resilience.

The third workstream involves de-risking investments by using blended finance instruments and making first- mover investments in new climate solutions, thereby helping establish a commercial track record and crowd in private finance. While the energy transition remains a key focus for GCF, the fund is increasingly leveraging its capacity to use a variety of financial instruments to make blended finance work better for the most vulnerable by facilitating adaptation and ecosystem-based solutions. Though the intertwined nature of ecosystems, biodiversity and human society creates emerging risks, it also offers opportunities for transformational adaptation interventions.

GCF is, for example, providing up to US$ 125 million of first-loss equity to the Global Fund for Coral Reefs, a US$ 500 million private equity fund with Pegasus Capital Advisors, to encourage investments in the blue economy, including sustainable fisheries and aquaculture, eco-tourism, and productive use of kelp forests. Moreover, through providing essential growth equity to entrepreneurs to help save coral reefs and improve the livelihoods of millions of people across 17 countries, the fund hopes to catalyse several times this amount. If successful, the fund will demonstrate that investing in coral reefs protection is a legitimate investment for both institutional investors and individual savers. In essence, it would create a new asset class – a prerequisite for achieving finance at scale.

The fourth and final workstream involves strengthening domestic financial institutions. These institutions can play a critical role in driving climate transformation, which is why GCF is supporting them to mainstream climate risks across their investment decision-making. Through providing these institutions with dedicated credit lines and/or supporting the issuance of green bonds to access capital markets, GCF will enable the financing and widespread adoption of commercially proven new climate solutions.

An example of this work can be seen in the Inclusive Green Financing Initiative (IGREENFIN I), a new project being implemented in partnership with the International Fund for Agricultural Development. IGREENFIN I will provide dedicated credit lines to local agricultural banks, thereby enhancing access to credit and technical assistance for local farmers, farmers’ organisations, cooperatives, and micro and small-sized enterprises. The project is part of the ambitious Great Green Wall initiative to reverse land degradation in Africa.

Conclusion

The realities of climate change make it imperative that, despite competing pressures on public budgets, climate action is not postponed, and investment is made in a robust global recovery that deepens climate ambitions. The momentum from COP26 in Glasgow should be accelerated as we prepare for COP27 in Egypt.

Transitioning to low-emission, climate-resilient pathways will require fundamentally overhauling how governments, businesses and societies operate. Together, we can remove barriers to investment in climate change adaptation and mitigation, close the finance gap and work to deliver the paradigm shift needed.