March 1, 2024

Climate and Carbon Finance: Financing the Transition to a Low-Carbon Economy

Climate change poses one of the greatest threats to our planet. The impacts of a changing climate are already being felt worldwide through increasing temperatures, rising sea levels and more extreme weather events. To avoid the worst consequences of climate change, global net greenhouse gas emissions must be reduced to near zero by 2050 according to the Intergovernmental Panel on Climate Change (IPCC). This will require a rapid and wide-ranging transition across all sectors of the global economy. Financing this transition in a way that promotes sustainable development and limits global warming to well below 2°C will be one of the biggest challenges of the 21st century. This article explores the evolving landscape of climate and carbon finance – the financing mechanisms that are being developed and deployed to effectively address climate change through investments that support low-carbon, climate-resilient development.

The Cost of Climate Action

Estimates vary but it is clear that the cost of transitioning to a low-carbon economy and building climate resilience will be massive. The International Renewable Energy Agency estimates global investments in renewable energy and energy efficiency needs to increase from around $310 billion currently to over $800 billion annually by 2030. The World Economic Forum calculates that annual infrastructure investment alone will need to increase by $2.5 trillion to $3.5 trillion by 2030 to meet climate targets. Developing countries will require even greater investment as they continue to build their economies. The IPCC estimates that global investment and financial flows need to shift by $2.4 trillion away from fossil fuels if the world is to meet agreed climate goals under the Paris Agreement. This massive capital reallocation represents both a huge financial challenge but also opportunity.

The Emergence of Climate Finance Mechanisms

In response to the need for climate action at global scale, national governments and international bodies have developed innovative financing mechanisms to channel public and private capital towards low-carbon, climate-resilient solutions across the world. Some of the major mechanisms that have evolved include:

– Green Climate Fund (GCF): Established in 2010 as part of the UNFCCC, the GCF is the largest dedicated multilateral fund assisting developing countries with climate adaptation and mitigation projects. So far the GFC has mobilized over $10 billion in funding.

– Global Environment Facility (GEF): Established in 1992, the GEF is an international partnership among 183 countries that supports projects that protect the global environment in areas including climate change, biodiversity, forests and international waters.

– Green Bonds: Bond instruments where the proceeds are used exclusively to finance or refinance eligible green projects. Global issuance of green bonds has grown exponentially in recent years, surpassing $500 billion in total outstanding.

– Carbon Markets: Market-based mechanisms including emissions trading schemes and offset programs established under the Kyoto Protocol and Paris Agreement that put a price on carbon and use financial incentives to reduce emissions and unlock low-carbon investment. Major carbon markets include the EU ETS and China’s national emissions trading scheme.

– Bilateral & Multilateral Climate Funds: Country-specific climate funds established by developed countries on bilateral basis or through multilateral development banks to provide public climate finance to developing countries. Key examples are the UK’s International Climate Fund and the World Bank’s Climate Investment Funds.

Scaling Up Private Finance

While public funds will continue playing a crucial role, the bulk of financing for climate action will need to come from private sources. Mobilizing private capital at the necessary scale requires overcoming various risks and barriers perceived by institutional investors and the private sector. Innovative financing instruments and de-risking mechanisms are being developed and scaled up to unlock private investment flows for climate. Some examples include:

– Green/Climate Bonds: Mitigating risk through credit enhancement allow larger institutional investors to participate in capital raised through green bonds. Total issuance surpassed $500 billion in 2020.

– Blended Finance Vehicles: De-risking public funds are paired with private capital through structured vehicles like facilities, funds-of-funds to scale up the overall capital base committed to high-impact climate projects. Examples include Get.invest and the Green Climate Fund’s Private Sector Facility.

– Carbon Market Derivatives: Financial derivatives built around carbon credits bring in private investors and provide tools to better manage and hedge climate-related investment risks. Futures contracts now available on major voluntary carbon markets.

– Climate Risk Insurance: New insurance products help tackle physical and transitional climate risks, reducing downside for climate-aligned investments and encouraging more private capital flows to vulnerable communities and sectors. Examples include risk pooling facilities.

Challenges and the Road Ahead

As the climate crisis deepens, scaling up climate finance rapidly and mobilizing private sector investment on a truly global scale present major political, economic and technical challenges. Issues around investment prioritization, accountability, distributional fairness and management of transition risks must be addressed. Increased international cooperation as well as innovative public-private blended finance structures will be needed to align finance flows with climate objectives. With concerted effort building on progress already made, climate and carbon finance can play a pivotal role in fulfilling the promise of the Paris Agreement and transitioning humanity to a prosperous low-carbon future.

*Note:
1.      Source: Coherent Market Insights, Public sources, Desk research
2.      We have leveraged AI tools to mine information and compile it