Climate finance: transforming the global financial system at COP27 and beyond

World leaders, ministers, diplomats, activists, lobbyists, and civil society groups convened in Sharm El-Sheikh from 6th-18th November 2022 for COP27. Shortly after, delegates converged on Montreal from 7th-19th December for COP15 for crucial talks on conservation and biodiversity. Sust Global has been following developments closely and has produced a series of articles that explores the most interesting developments to emerge from proceedings and explains the key outcomes contained in the final agreement. We cover the core themes that shaped debate, including climate finance, climate justice, physical climate risk and adaptation, the role of carbon offsets, biodiversity, and more.

We’re building the intelligent climate data infrastructure required to enable people and organizations to thrive on a changing planet. As we do so, we aim to provide high quality insights and analysis on the broader context in which our work takes place, and what it means for climate-conscious operators moving forward.

In the second entry into our series, we explore one of the defining issues of the summit: climate finance. It is abundantly clear that there needs to be a rapid scaling up of both public and private finance for climate adaptation and mitigation if we are to avert global catastrophe. Below, we review the current state of climate finance, examine the various initiatives and roadmaps that may hold the key to unlocking more capital, and look beyond COP27 to see where we go from here.

The Egyptian presidency succeeded in facilitating focused discussion of climate finance

In addition to securing the historic agreement on the global loss and damage fund, one of the most significant achievements emerging from the Egyptian COP presidency is its success in facilitating focused discussions on climate finance.

Throughout the two-week program of events, climate finance was the recurring theme connecting discussions and initiatives that cut across geography, industry, governments, and both public and private sectors. Leaders from developing countries were able to secure buy-in from key stakeholders, and the conference has laid the groundwork for further progress over the coming months as the major institutions governing the global financial system meet to discuss the climate crisis.

Where we are and where we need to go

Two long standing, and heavily overlapping, issues in climate finance converged at COP27 and informed many of the multilateral conversations taking place at the summit. These issues are the ongoing failure of wealthy nations to meet their commitments to provide $100bn in climate finance to vulnerable countries, and the goal of resolving the persistent misallocation of capital by making global financial flows consistent with net zero and resilient development.

A decade of broken promises

Many delegates at COP27, particularly those representing vulnerable nations, repeatedly highlighted the conspicuous gaps between the commitments developing nations have made to providing financial support in dealing with the climate crisis and the actual funds that have been received.

In 2009, wealthy nations pledged to provide $100bn a year in climate finance to developing nations by the year 2020, the vast bulk of which was to be provided by governments and public development banks with remaining contributions coming from the private sector. However, a recent projection suggests that this pledge will eventually be met in 2023. It is also difficult for many developing nations to access and deploy what funds have been delivered due to a lack of concessional finance (low interest loans and grants), an issue which has also contributed to the chronic imbalance of investment between decarbonisation and resilience to the risks already exacerbated by climate change.

It is also increasingly plain to see that even if the actual funds delivered were in line with current targets, there would still be a yawning gap between the support available and the financial resources required by lower and middle income countries to address the climate crisis. Funds for adaptation in particular lag far behind current and projected future needs. In its recent report, UNEP estimates that financial flows to support the implementation of adaptation projects are five to ten times below annual need, with the gap widening.

While industrialized countries have committed to providing $40bn in annual adaptation finance by 2025, the projected need is forecast to be between $160-340bn a year by 2030. A further report commissioned jointly by the UK and Egyptian COP presidencies outlines annual external climate finance requirements in emerging markets and developing countries (EMDCs) will be $1tn by 2025 and $2.4tn by 2030. The current delivery of funds for both climate change mitigation and adaptation therefore represents just a small drop in a rising ocean of need.

The persistent failure of the Annex II nations in the UNFCC (i.e. developed countries legally obligated to contribute to the costs of developing countries) to meet their climate finance obligations has undermined trust and soured negotiations at successive COPs. The lethargy of advanced economies in providing even the modest sums promised under existing pledges does not bode well for the future of the historic loss and damage fund announced at COP27.

Nevertheless, the summit provided a forum in which several bold new initiatives and roadmaps were negotiated and announced, with some new ideas gathering enough momentum to offer reason for cautious optimism.

Scaling up climate finance

As mentioned above, a report issued by the Independent High-Level Expert Group on Climate Finance sets out annual climate finance requirements in EMDCs (excluding China) at $1tn a year by 2025 and $2.4tn by 2030. While this sounds like an unrealistically ambitious target to set for climate finance, there are currently $483tn assets held by public and private investors and institutions across the globe.

There is enough cash available to prevent further climate harm, decarbonise economies, move to more sustainable systems of land use, and reduce the physical impacts of climate change. The challenge is in ensuring that capital is allocated in accordance with our urgent climate objectives. This will require a root-and-branch transformation of an international financial system that is not fit for purpose in addressing the climate crisis.

In their report, Finance for climate action, the authors of the report identified several key steps required in their roadmap for realizing the necessary investments and their finance:

  • Accelerating investment in mitigation and adaptation projects, with these investment projects developed rapidly and at scale.

  • Mobilizing private finance at scale, with the private sector making the largest increase in foreign and domestic investments.

  • Revamping the role of the multilateral development banks (MDBs) - tripling annual financial flows from MDBs and development finance institutions in the next 5 years, and increasing engagement with shareholders and client countries.

  • Delivering on and expanding the scope of concessional finance to EMDCs: This requires a doubling of concessional finance provided by rich countries in 2019 by 2025, together with innovative mechanisms of improving access to low-cost finance to a wider pool of recipients (including special drawing rights, voluntary carbon markets, philanthropy, and more).

  • Tackling indebtedness - one-third of all developing countries and two-thirds of low-income countries are at high risk of debt distress. This makes it nearly impossible to fund vital investments in climate resilience and decarbonisation.

The authors of the report are keen to stress that the $1tn figure should not be viewed as the new $100bn pledge. They write:

‘The $1 trillion per year is a very different concept – it is a requirement based on an analysis of the investment and actions necessary and the domestic finance potentially available, for an internationally agreed and vital purpose. The $1 trillion is not the new $100 billion. The latter was negotiated, not deduced from analyses of what is necessary for a purpose.’

Though the report is a roadmap rather than any sort of legally binding agreement, the lesser reported text of the final COP27 agreement included calls for major reforms to the global financial system. This injected real momentum behind the recommendations of the report, as well as similar plans and existing initiatives broadly aligned with the core conclusions of its research.

A bold plan for mobilizing capital in the developing world

The Houses of Parliament in Bridgetown, Barbados.

Among the plans championed by delegates at COP27, the one that received the widest coverage and most focused attention was the Bridgetown Initiative, spearheaded by Mia Mottley, the prime minister of Barbados. Named after the island nation’s capital city, where it was originally conceived, the plan makes demands for bold and far-reaching reforms to the architecture of the global financial system.

The plan

Much like the authors of the Finance for climate action report, Mottley and her supporters view rising sovereign debt as a ‘hidden but decisive’ aspect of the climate crisis in EMDCs. For example, the Caribbean islands carry more debt relative to the size of their respective economies than almost anywhere else on the planet. This creates a fiscal burden that makes it impossible to pay for the resilient infrastructure necessary to protect themselves from climate-related disruption - an issue that is particularly challenging in a climate where Category 4 or 5 storms are becoming an annual near-certainty.

Exposure to the impacts of climate change (i.e. extreme weather events) further exacerbates the debt burden of low-lying developing countries and has become a self-perpetuating cycle. In the Caribbean, much of the region’s debt burden might not exist were it not for a series of extreme weather events intensified by the warming climate. Much of Jamaica’s existing debt is tied back to its recovery after Hurricane Gilbert, which caused $4bn worth of damage in 1988. In the wake of Hurricane Maria in 2017, financial losses in Dominica were 224% of its 2016 GDP, which represents a loss equivalent to a $44tn hit to the US economy.

Storm damage caused by Hurricane Maria on the island nation of Dominica.

EMDCs also face further hurdles in the form of higher costs of capital. When wealthy nations borrow money on international capital markets they typically pay interest rates between 1-45. For nations in the Global South, the cost of interest rises to 12-14%. Consequently, the nations least responsible for the historical emissions fuelling climate change end up paying twice for its impact: first through the physical damage caused to their economies and then through the higher cost of capital.

To ensure that indebted nations are able to adapt to the impact of climate change, the Bridgetown Initiative calls for the following:

  • The introduction of special loan clauses in government bonds that allow for debt repayments to be suspended when a country is hit by a natural disaster or a pandemic. Barbados is a pioneer of such clauses, having issued the first sovereign bonds to include a clause that allows for a 2-year moratorium on payments to creditors in the event of a ‘predefined natural disaster’ earlier this year.

  • Drastic reforms to MDBs, with the World Bank singled out for particular criticism for being too risk averse in its lending to EMDCs. The Bridgetown Initiative echoes calls made in a recent external review commissioned by the G20 nations for enhanced dialogue with credit ratings agencies and client countries to lower the cost of capital. It also calls for MDBs to lend a further $1 trillion by raising their risk appetite and including donor guarantees and special drawing rights (SDRs) when determining their lending room.

  • The establishment of a Climate Mitigation Trust, backed by $500bn in SDRs (much of which are currently held by nations who do not need them). Proponents of the plan claim that a Climate Mitigation Trust could be used to borrow a further $500bn from the private capital markets that could be lent out at low interest rates for investment in major climate mitigation and adaptation infrastructure projects. The plan claims that this blended approach could unlock up to $5tn in private capital overall.

The Bridgetown Initiative largely resonates with other calls for reform made recently by various African finance ministers and the V20 coalition of climate-vulnerable economies. In a ministerial communique issued shortly prior to COP27, the V20 called for ‘an immediate reform of the sovereign debt restructuring architecture’, as well as increased access to concessional finance to offset the high cost of capital experienced by developing nations.

These calls for reform gained significant traction and high-profile support throughout COP27. The French president, Emmanuel Macron, called for a ‘shock of concessional financing’ and announced that a task force had been established to draw up climate finance solutions ahead of the World Bank and IMF annual meetings in Spring 2023.

Similarly, US climate envoy John Kerry announced that he wants to work with Germany to come up with a strategy by the next World Bank meeting in April 2022 to ‘enlarge the capacity of the bank’ to help vulnerable countries adapt to the impact of climate change.

While it remains to be seen whether encouraging rhetoric leads to much (or any) tangible action, COP27 arguably represents a watershed moment in climate finance. Finally, wealthy nations are beginning to understand that climate change has altered the traditional dynamics of debt and development.

The role of private capital

Another core theme in the climate finance discussions that dominated COP27 was the role of the private sector in providing access to vital funds to EMDCs.

It’s evident that there is both great potential and great need to increase the amount of private sector in climate mitigation and resilience projects, with much talk of the trillions of dollars in capital markets waiting to be unlocked with the appropriate mechanisms.

EMDCs will not be able to finance the scale of their long-term climate mitigation and adaptation investment programmes and development goals without a significant increase in investment from the private sector. However, in 2019/20 81% of private sector funds invested in climate-related projects are concentrated in the advanced economies of East Asia and the Pacific, North America, and Western Europe.

Even blended finance initiatives (involving public and private partnership) struggled to encourage investors to channel funds to where they’re most urgently required. In 2021, MDBs managed to successfully mobilize $13bn in private capital for investment in low- and middle-income countries, but this figure rose to $28bn in high-income countries.

Like many others during the build up to COP27 and throughout the summit itself, high profile figures from across the finance industry are also advocating for reforms to the global financial system to facilitate the faster mobilization of private capital to address the climate crisis.

For example, in a report released to coincide with proceedings in Sharm El-Sheikh, Aviva investors called on the IMF, the World Bank, and global financial rulemakers to create a global plan to oversee an orderly and just transition to net zero and speed up deployment of capital to emerging markets. The Aviva Investors CEO, Mark Kersey, said: "The global economy and financial system are currently financing their own destruction because the global financial architecture is not fit for purpose," echoing similar remarks made by COP delegates throughout the conference.

In one of the clearest messages emerging from summit talks, delegates representing a diverse range of public and private interests were firm in their demands that major reforms to the financial system, its governing institutions, and the public development banks be undertaken as a matter of urgency.

However, root-and-branch transformation of the global economy will take time and the sustained effort of various international institutions that don’t have a particularly encouraging track record for dynamism in climate finance. EMDCs on the frontline of the climate crisis need access to substantially increased concessional funds immediately. In the absence of sweeping institutional reform, other innovative mechanisms are emerging to engage private capital in climate development projects in vulnerable regions.

Voluntary carbon markets touted as innovative solution

Throughout proceedings at COP27, voluntary carbon markets (VCMs) have emerged as one of the key mechanisms through which money can be raised for climate adaptation and mitigation which wealthy countries have failed to provide in line with their commitments.

VCMs are decentralized marketplaces where organizations can purchase carbon credits to compensate for their greenhouse gas emissions in order to meet net zero targets. Carbon credits are tradeable units each representing one metric ton of carbon dioxide (or equivalent greenhouse gas) avoided or removed from the earth’s atmosphere. When a credit is retired on the appropriate register, the purchaser can claim to have ‘offset’ the equivalent amount of carbon from their total emissions.

The voluntary carbon market has proven to be an effective way of directing private investment into climate-action projects that would not otherwise be possible. These projects take many forms, but the most common include renewable energy farms, community cookstove initiatives, and ‘nature-based solutions’ such as forest conservation, coastal habitat restoration, and green-grey infrastructure. These projects often offer significant ‘co-benefits’ for local communities, including protection of biodiversity, new jobs, prevention of pollution, and improved public health.

Mangroves planted in a coastal restoration project in Yogyakarta, Indonesia.

VCMs and carbon offsets are increasingly touted by policymakers across the globe as a rapidly scalable source of private finance for addressing climate challenges in EMDCs. For example, the US used COP27 to announce the launch of its new Energy Transition Accelerator - a carbon offset plan designed to expedite the clean energy transition in the developing world by funding renewable energy projects.

The US will develop the program in partnership with the Rockefeller Foundation and the Bezos Earth Fund and will seek input from both the public and private sector. The American climate envoy, John Kerry, has claimed that Chile and Nigeria have already expressed interest in the scheme, which will initially run to 2030 with the possibility of a further extension to 2035.

Nations in the developing world are also taking a leading role in scaling up VCMs with the announcement of their own programs to encourage the development of more projects that generate carbon credits in the Global South. One such effort is the Africa Carbon Markets Initiative (ACMI), inaugurated at COP27 and led by a steering committee of African leaders, CEOs, and carbon experts.

The ACMI intends to drastically increase African participation in VCMs, with the continent currently producing only a tiny fraction of its carbon credit potential. The principal ambition of those involved is to facilitate the production of 300 million carbon credits annually across Africa by 2030. They have calculated that this will generate $6bn in revenue and support the creation of 30 million jobs. Their ambitions by 2050 are even bolder, with an annual production target of 1.5 billion carbon credits in order to unlock $120bn in revenue and create 110 million jobs.

The ACMI is working with national governments across the continent to scale carbon credit production with VCM activation plans. It is also engaging with major carbon credit purchasers and financiers including Standard Chartered, Nandos, and Exchange Trading Group to secure advance financing commitments totalling hundreds of millions of dollars to support this rapid scaling up of production and signal strong demand for African carbon credits.

Many of those engaged in climate finance debates view initiatives of this kind of exactly the kind of public-private partnership described in reports such as Finance for Climate Action required to catalyze private capital in service of climate adaptation and the clean energy transition. However, the use of carbon credits and their role in addressing the climate crisis remains controversial among many civil society groups, climate scientists, climate activists, and in indigenous communities.

The voluntary carbon market is still in the nascent stages of development - government regulators have yet to apply much scrutiny to the emerging sector, nor do they enforce standardized criteria for quality and integrity. This lack of oversight has, inevitably, led to several abuses by actors on both the supply and demand side of the value chain. This includes persisting issues with shoddy accounting at the developer level, with many projects drastically overstating the amount of carbon they actually remove from the atmosphere.

There are also deeply troubling reports that carbon markets might be aiding in the theft of Indigenous lands. Many of the carbon sinks targeted by offset scheme developers are located in forest land historically claimed and inhabited by Indigenous Peoples. There are concerns that the scaling up of VCMs endangers the well-being of these communities, who are at risk of land grabs and other human rights violations.

Finally, many activists and climate scientists are also alarmed about the potential misuse of carbon credits in service of corporate greenwashing. There are claims that, in addition to the lack of transparency and methodological rigor involved in calculating accurate carbon removal, carbon credits might be construed as a ‘get out of jail free’ card deployed by organizations to avoid reducing their emissions at source.

On balance, providing the correct safeguards are in place, the benefits of VCMs greatly outweigh the challenges posed in implementing them at scale with integrity. A report released at COP27 by the UN’s new High-Level Expert Group on Net-Zero Emissions Commitments of Non-State Entities, recognized the enormous value of high quality carbon credits in raising vital funds towards supporting climate-action projects in vulnerable nations. It concluded that:

"As best-practice guidelines develop, non-state actors meeting their interim targets on their net zero pathway are strongly encouraged to balance out the rest of their annual unabated emissions by purchasing high-integrity carbon credits."

What now?

Achieving crucial objectives in climate finance will require bold reform and innovation across Finance for climate action report provides a succinct summary of the steps needed to make meaningful progress over the next 12 months and beyond:

‘There is a significant role for public policy and government action to foster investment, and complementary roles for the private sector, MDBs, international financial institutions, and concessional finance of various forms. Powerful multipliers can emerge from the complementary strengths of all sources of finance.’

Through its success in focusing sustained attention on climate finance issues during COP27, the Egyptian presidency has built substantial momentum for further action in 2023, with annual meetings at the World Bank and the IMF in the spring proving the first key litmus test for progress.

As fundamental reforms to the global financial system are a long-term project, there is enormous scope for innovation in the private sector to support the scaling of innovative funding mechanisms that lower the cost of capital in the developing world, such as voluntary carbon markets, in the immediate future.

For instance, tackling the challenges highlighted by the many valid criticisms of VCMs requires new technologies to improve the transparency and quality of carbon credit projects. This is essential not only in ensuring that carbon credits remove the promised quantity of greenhouse gas emissions from the atmosphere, but also in catalyzing private investment in climate adaptation and mitigation projects by enabling transparent de-risking processes.

Unlocking funding for such projects entails building trust among all stakeholders. This case study, which details how a non-profit nature-based solutions project developer uses data produced by Sust Global to support its financing model, showcases the potential of cross-sector partnerships involving innovative private enterprise to direct funding to vital climate adaptation solutions.

In the VCM and beyond, private investors, financial institutions, corporations, NGOs, and more all require access to reliable forms of climate intelligence to support the transition to a climate-informed economy. At Sust Global, we are building the intelligent climate data infrastructure to enable every organization to become climate-informed as we work towards a resilient, low-carbon future.

In part 3 of our COP27 explained series, we look at how the world is finally waking up to physical climate risk, and what efforts are being done to understand and adapt to this new reality. You can read more research and insights from the frontline of the climate economy on our blog.

Cookie consent

We use cookies to give you the best online experience. Please let us know if you agree to all of these cookies.