Financing our Future: Climate Finance

By Hayden Siratt

Climate finance continues to be a pressing issue in combating climate change. The current measures have not been sufficient to raise and mobilise enough capital to meet the UN’s ambitious goals to limit the warming of the planet and mitigate the effects of climate change. Whilst COP26 was a step in the right direction, the practical deployment of its plans and goals will be difficult. 

Climate finance, simply, refers to local, national or transnational financing that seeks to support mitigation and adaptation actions that will address climate change. Large amounts of long-term investment are needed to reduce the impact of climate change and transition to a more sustainable global economy. Climate finance allows for the coordination of the financial resources necessary to meet that goal.  

Climate finance has not always been unified under a single authority, but there have been many funds that operated independently. The first effort at bringing a financial mechanism for the UN Framework Convention on Climate Change (UNFCC) was the Global Environment Facility (GEF). At COP16, parties established the Green Climate Fund (GCF) as the financial mechanism accountable to the COP. There were several other climate funds established in the early 2000s such as the Special Climate Change Fund, Least Developed Countries Fund, and the Adaptation Fund. These funds did not come under one authority until the 2015 Paris Climate Change Conference where it was agreed that the operating entities of the financial mechanisms shall serve the Paris Agreement. 

The Paris Agreement has been seen as the most significant climate agreement to date. The agreement set out goals to reduce the warming of the planet below 1.5 C and pushed for countries to set new ambitious goals every five years. The Paris Agreement also provided a framework for “financial, technical, and capacity building.”  This brought more coordination in climate finance allowing for all the different funds and financial mechanisms to be brought together under the Paris Agreement. 

However, many experts agree that the Paris Agreement does not go far enough and countries’ current pledges could result in a 2.7 C rise by 2100. Even from the framework that the Paris Agreement provides and the commitments among nations, there are still issues with the mobilisation of capital flows for climate finance. Developed nations at COP15 in Copenhagen pledged to mobilise $100 billion for climate finance by 2020; however, this did not happen and recent projections do not think it will until 2023. There is also controversy around those figures as that data comes from the OECD, which is made up of wealthy countries, meaning that those figures could be overestimated and not reflect the true nature of climate finance. By not having a clear definition of what counts as climate finance, countries could be overreporting how much they are contributing. For example, developing countries have raised concerns about the lack of “new and additional funding” recently. In reality, we may be further below the $100 billion goal than previously thought. All these controversies and failed commitments demonstrate the fragile nature of climate finance. COVID-19 has tested climate further. 

The COVID-19 pandemic has further highlighted core issues with climate finance. Developing countries were hit hardest by the economic fallout from the pandemic, and this now creates a dual-issue where the world must combat two global crises: climate change and COVID-19. Developing countries already found it difficult to adapt their economies to climate change, and with the economic pressures from COVID-19 as well as the issue of vaccine inequality hampering recovery efforts, developing countries are even more restricted in their ability to scale sustainable projects. If countries cannot include green actions in their economic recovery plans, COVID-19 creates a serious problem that could see the fight against climate change take a step backwards. To make matters worse, developing countries cannot incorporate green efforts on their own. 

However, since the pandemic, companies have started to change their attitudes towards Environmental, Social and Governance (ESG) tools and metrics. Companies have begun to use these new tools and metrics to help assess risk when investing and see the wider social and environmental impact of their projects. This changing tune of major corporations is a step in the right direction as financial leaders met at COP26.

Though major corporations are starting to prioritise climate change. There are already core issues in climate finance revolving around both how capital could be raised from public as well as private sources as well as how it should be mobilised, and this was put under increasing pressure from COVID-19. These are the issues that financial leaders faced as they convened at COP26. 

In his speech at COP26, Rishi Sunak, Chancellor of the Exchequer for the UK, outlined three goals for addressing the issues of climate finance. The first involved increased support from the wealthiest countries and pledged $500 billion in investment by 2025. The second goal outlined goals to mobilise private finance. The last is the most ambitious goal, the complete rewiring of the global financial system for net-zero. This entailed having better climate data to track global progress for climate mitigation and efforts, sovereign green bonds to boost investment, mandatory sustainability disclosures which force firms to provide their targets for net-zero, increased climate risk surveillance, and stronger global reporting standards. These goals and plans were echoed by the other finance leaders from the US, EU, developing nations, and the leaders of the World Bank and IMF. (The full addresses can be viewed here.) These goals were also solidified by a joint statement by the Multilateral Development Banks. 

The plans and goals announced at COP26 by the world’s financial leaders aim at fixing many of the problems in climate finance in the context of COVID-19. One of the first key issues that needs to be fixed is the reporting of climate finance and clearer data. Currently, climate data is inaccessible to large parts of the world, particularly low tech and lower-income countries. With ever-expanding, it is important to make sure that data is readily accessible to all to unlock new opportunities in the fight against climate change. Improving climate data allows for more transparency on climate change and allows us to track the progress being made which could alleviate the concerns raised about just how much climate finance is being added and mobilised every year.

There should be more avenues for raising capital to help achieve the demands of climate change and allow countries to finally achieve and move beyond the $100 billion a year goal of additional climate finance. Green bonds are one such way for more funds to be raised. Green bonds work similarly to normal bonds in that they are issued by a government or multilateral financial institution and are purchased by investors to finance a project. The difference between a green bond and a regular one is that the capital raised by green bonds is meant only for environmentally friendly projects.

In the last few years, the green bond market has seen an explosion of growth, from the market being around $2.6 billion in 2012 to being worth over $776 billion in 2021, in part by large firms finding ways to finance their goals for net-zero. They are primarily issued by the World Bank; however, private banks, such as Deutsche Bank and JP Morgan, have helped governments arrange the issuance of green bonds recently. While there could be a concern that green bonds are just a way to “greenwash” firms and countries, where they take green bonds and use them to finance projects with little or no environmental impact, most green bonds after the Paris Agreement are subject to external review which helps with transparency and ensuring the capital raised is sent to the right places. There is now empirical evidence that shows a correlation between the issuance of green bonds and the increase in environmentally friendly projects. Though green bonds can work as a great way to raise capital for climate finance, most of the global south receives very little of the proceeds from the issuance of green bonds. Steps need to be taken to allow for the countries that need climate finance the most to be able to have access to funds raised by green bonds.

The mobilisation of private capital is also key for fighting climate change. It allows for more capital to be secured and opens alternative ways for investment to reach sustainable projects. The Glasgow Financial Alliance for Net Zero is a private group that has already secured $130 trillion in financial assets dedicated to the mitigation of climate change. By re-wiring the global financial system for net-zero, it would give firms and investors the necessary incentives for investing in sustainable projects and striving for net-zero in their businesses. COVID-19 nearly broke the global financial system and offers a chance at rewiring the global financial system. With countries drawing up economic recovery plans, this presents the perfect opportunity for countries to incorporate green goals within their recovery plans and repair their broken financial systems for net-zero. 

There are a few different goals and plans which countries could implement. Mandatory sustainability disclosures would hold firms accountable for their environmental footprint. Another plan is to take away any incentive to use non-sustainable resources. One way to do this is a carbon tax. Currently, over 85% of the carbon that is emitted is not taxed; this means that there is not any monetary negative incentive on polluting. However, if a tax is implemented then it would give firms an incentive to seek sustainable alternatives so that they do not incur an extra cost. Cutting VAT taxes or other taxes while introducing a carbon tax could be a way to keep a carbon tax from becoming a politicised issue while also rewiring the tax system for net-zero. Though all these plans and goals would help fix many of the problems with climate finance, issues arise when it comes to practicality. 

Though there are new and innovative ways of raising capital for climate finance and continued support from the private sector, there are issues in the actual mobilisation of these cash flows. Developing countries are seen as risky by international investors, due to underdeveloped capital markets, incomplete data, and volatility, and so they may be less likely to finance projects in these countries, which need it the most. On the domestic side, there are not many policies discouraging the use of fossil fuels and climate-oriented projects are seen as riskier and not as profitable as conventional projects. This leads to firms and investors not feeling like they should or need to change their ways. Though COP26 laid out goals and plans to fix these incentivising issues, it would take a monumental domestic and international change which may be easier said than done. 

One example is the US. Due to the politicisation of climate change in the US, the US is split on climate finance and climate change in general. Though Biden has reversed many Trump-era policies such as the withdrawal from the Paris Agreement and he has committed more money to climate finance, there is still the longevity of commitments that should be of concern. If the US flip-flops on climate policy every four years, then it is very unlikely that the US can be a reliable partner and leader for the future of climate finance. 

Climate finance before COP26 was fractured, and the issues caused by COVID-19 further exacerbated the core issues. The goals set out by the finance ministers at COP26 were ambitious but were a watershed moment in the history of climate finance. If these goals are achieved, then we will most certainly be one step closer in our fight against climate change. Though COVID-19 does present the opportunity to “build back better” by incorporating green goals in recovery plans, it will take a monumental effort and coordination on a global scale to achieve these goals to truly fix climate finance. 

“The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.”

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