Five years ago, 197 governments promised to limit the impacts of climate change. Today, we are still very far from realizing that promise, as climate change impacts continue unabated. No continent has more to lose from this inaction than Africa, from worsening health outcomes, the destruction of natural resources, landscapes, and biodiversity, to significant economic losses at the macro and micro levels. This is further compounded by weak policies and regulatory frameworks not suited to support nationally determined contributions (NDCs) to reduce CO2 emissions and adapt to climate change, as well as limited funding available to implement critical programs and projects.
Green finance has become more mainstream in recent years, with the emergence of the global green bond market that could be worth $2.36 trillion by 2023. However, only $2 billion worth of green bonds had been issued in Africa by Q4 of 2019, representing 17 issuances. Risk mitigation and credit enhancement are vital to Africa’s nascent market, and the application of blended finance in green finance is one way to scale investments that can strengthen the region’s ability to mitigate and adapt to climate change.
Blended finance is the use of catalytic capital from public or philanthropic sources to increase private sector investment in sustainable development. It is a way to reach key development and environmental objectives, while attracting private investment in the region.
Blended finance has a demonstrated track record when it comes to both climate action and financing sustainable development goals (SDG) linked projects. Convergence data indicates that 15% (representing $31 billion) of historical blended finance transactions in developing countries targeted SDG 13 on climate action, while 48% ($97 billion) were directly linked to renewable energy, sustainable agriculture, water and sanitation, sustainable cities, and life below water. At the same time Sub-Saharan Africa is the most frequently targeted region in blended finance transactions – accounting for 45% of historical transactions. But for blended finance to catalyze greater green finance and bring in the volumes of private investment that are needed for climate mitigation and adaptation in the region, we need to first see more African governments and stock exchanges define clear policies and establish robust regulatory environments that support green finance.
There has been some momentum. In South Africa, the Johannesburg Stock Exchange (JSE) sets clear rules for green listings with a dedicated division for green bond issuances. In Ghana, the government has worked to create an enabling environment that incentivizes private investment in green finance projects through the provision of full and partial government guarantees, (concessional) debt and equity, as well as tax and insurance incentive schemes, in a bid to drive its low-carbon development plan. It has additionally set emission reduction targets for lighting, cooking, and cooling, and launched a “green growth fund” to finance adaptation projects. Nigeria and Kenya have also seen the issuance of sovereign and corporate green bonds respectively, the proceeds of which will be used to finance renewable energy projects and green-certified affordable housing for students. Despite these positive developments, scaling interventions and catalyzing larger volumes of private investment remain difficult.
Some of the limitations to embracing green finance in the region include: (i) The lack of clear policies and regulatory frameworks; (ii) Limited or non-existent national budget allocations to green finance; (iii) Limited national capacity in developing and implementing green finance standards, processes, and projects; and (iv) Limited ability to engage with private investors. Below I discuss two considerations that could help tackle some of these constraints.
1. Implement green fiscal reforms
Green fiscal policy instruments could prove to be transformational in scaling investments in green finance, however they require deep political will to be implemented. For instance, environmental taxes can be levied to limit emission levels, provide incentives to transition to cleaner, low-carbon options, while generating revenues that can be used by government to fund public adaptation and mitigation programs and projects. Green investment incentives can include feed-in-tariffs for renewable energy generation, as well as subsidies to shift from fossil fuels. Carbon taxes are also applicable and have been used in countries like South Africa with subsidies to transition from fossil fuel-based energy sources to solar water heaters.
To attract private investment at scale to support their green finance objectives, governments can leverage both policy de-risking instruments that address market failures and remove the underlying barriers to private investors, and financial or market-based incentives. These can include issuing national targets, facilitating and streamlining the licensing and permitting processes for various projects, as well providing public equity co-investments, concessional capital, and so on.
The Global Energy Transfer Feed-in-Tariff (GET FiT) program is a blended finance solution that was developed to facilitate a climate resilient, low-carbon development path for East Africa and provides an insightful illustration. Its first rollout was in Uganda and it helped to strengthen the enabling environment for private investment in renewable energy projects, while providing long-term capital to increase the availability of least cost electricity. GET FiT Uganda provided feed-in-tariffs and other premiums to attract private investment. It received donor funds from the governments of Norway, the UK, Germany, and the EU-Africa Infrastructure Trust Fund. Public funding leveraged five times its funding in private investments, with senior debt of $494 million provided by Deutsche Bank. The World Bank also provided a partial risk guarantee and technical assistance. The program, which is now being implemented in Zambia with positive outcomes, further highlights how blended finance can be used as an effective approach to drive more private investment towards green finance.
Other countries can learn from this example to deepen and scale their green fiscal reform processes, implementing appropriate policy and financial instruments to catalyze greater volumes of green finance to drive green growth in the region.
2. Green the Central Banks to attract private investment at scale
Climate change is a major systemic risk for the financial sector. Corporates and banks in developed markets have already begun to factor in environmental considerations in their risk models to avoid the high financial costs, as well as the adverse reputational and regulatory risks they present. They are also increasingly reporting and disclosing information about their “green strategies” and steps to build climate resilient operations.
African central banks have a role to play in helping to “green” financial systems in the region, particularly where weak public institutions poorly implement environmental regulations. “Green” central banks could wield significant influence in promoting environmental mandates within the banking sector through green policy instruments and green finance guidelines, enforcing disclosure requirements, and allowing differentiated capital requirements. This application of blended finance approaches is critical where limited public funding can be strategically directed to be truly catalytic for mobilizing green finance at scale.
As an example, the Central Bank of Nigeria (CBN) directed commercial banks and national Development Finance Institutions to adopt sustainable banking principles to incorporate Environmental, Social, and Governance (ESG) guidelines in their operations. The CBN further committed to provide certain financial incentives, as needed, to those institutions that took concrete steps to incorporate the principles in their operational, enterprise risk management, and governance frameworks.
One outcome of CBN’s directive was that in March 2019, Access Bank announced the issuance of a NGN 15bn ($41m) corporate green bond, which was the first of its kind in Africa. The Climate Bonds Certified Bond could provide a strong demonstration effect for other corporates in the country. The five-year, 15.50% fixed rate green bond, issued on 1st April 2019 was fully subscribed, and was the first corporate bond to benefit from the Nigerian Green Bond Market Development Program launched in June 2018 by FMDQ, Climate Bonds Initiative, and the UK Aid funded Financial Sector Deepening (FSD) Africa.
Central banks in the region could be a powerful force for stimulating green finance and could apply blended finance approaches to help create the right enabling environment and compelling incentives for scaled and faster adoption.
Climate change is an urgent, shared global challenge, with the African continent likely to experience the worst impacts if more ambitious climate action is not taken. Adapting to and mitigating this risk will require a large increase in the availability of green finance products. To do this, countries will need to leverage blended finance approaches that have already achieved some modest success, scaling these interventions, and undertaking appropriate green fiscal reforms with complementary policy instruments to truly unlock private capital. It’s a massive challenge, but green finance that leverages blended finance approaches for de-risking might just be our best chance.
*Originally published on The Exchange - Africa's Investment Gateway. *
By Ladé Araba, former Managing Director at Convergence