Over a decade ago at COP15 in Copenhagen wealthy countries committed to invest at least $100 billion per year into emerging markets to assist them in cutting their greenhouse gas emissions and manage the effects of climate change. As discussions began at COP26, this decades-long commitment remains unfulfilled.
More systematically tapping into the private sector to meet the urgent need for scaled climate finance has been a keystone issue in this year’s climate conference. Publicly held companies are experiencing mounting pressure from shareholders to at least set targets for net-zero or carbon-neutral operations and portfolios. COP26 also saw a pioneering initiative led by Mark Carney, called the Glasgow Financial Alliance for Net Zero (GFANZ), aimed at ensuring that private firms too are part of the global transition to greater sustainability.
However, high-perceived risk prevents developing markets from accessing the vast amounts of capital held by the world’s leading asset managers, pension funds and institutional investors to invest in climate interventions. The median sovereign credit rating, as classified by the Big 3 rating agencies, for the 145 developing countries, is non-investment grade. This translates into unaffordable capital costs for borrowers. The COVID 19 pandemic has also exacerbated the impact of other risk considerations, such as foreign exchange (FX) volatility, further reducing the bankability of investment opportunities.
This tension reemphasizes the importance of blended finance to scale current volumes of climate finance to developing markets. Structuring climate investment through blended finance can help assuage institutional investor risk-concerns by directly addressing credit concerns (for example through concessional guarantees), enhance returns profiles (via subordinated concessional investments from donors), and limit FX exposure (through concessional currency risk insurance products). This can help bridge the climate financing gap in emerging markets and even incentivize privately owned firms to take part in the climate finance transition.
The State of Blended Climate Finance
Convergence’s recent State of Blended Finance Report 2021 and FCDO report confirm that blended finance is critical for climate action. Climate finance has consistently represented a significant portion of the blended finance market – between 2015-2020, 47% of closed transactions targeted climate outcomes (159 of 336 total deals). Moreover, approximately half of total aggregate blended finance flows during this period were towards climate-focused opportunities – $39.1 billion of $79.2 billion total.
Climate mitigation finance makes up the majority of this deal flow and most of the aggregate financing (~$35.3 billion). Much of this investment is directed towards renewable energy development (72% of mitigation focused transactions). Blended finance for climate adaptation activities amounts to approximately $11 billion in total financing. The bulk of both blended mitigation finance and adaptation finance is destined for Sub-Saharan Africa, which represents 47% and 54% of mitigation and adaptation transactions respectively.
The Path Forward for Blended Climate Finance
Far greater volumes of private climate finance are required to hit climate goals, such as the $100 billion commitment or the Nationally Determined Contributions outlined by the Paris Agreement Blended finance too must accelerate efforts to channel more investment to the field.
Convergence has observed a noticeable uptake in several adaptation finance sub-sectors since 2018, such as in climate-smart agriculture and resource management (68% of adaptation deals in 2018-20), yet there is still significant room for scale. Commercial appeal and revenue streams are more difficult to project for adaptation interventions given their innovative nature and lack of track record. But progress in this area is crucial. UNCTAD estimates that annual climate adaptation costs could reach $300 billion by 2030, and up to $500 billion in 2050 if mitigation targets are breached.
Blended finance can play a central role in crowding in greater private sector financing for adaptation activities through the deployment of blended aggregation structures like funds, that aggregate smaller transactions into diversified portfolios that meet the ticket size requirements of large-scale investors.
For mitigation activities, more regular use of blended green bonds, whereby donor or public institutions provide design-stage or technical assistance grants to assist with the instrument’s design and placement, or purchase a subordinated tranche on concessional terms, could help reach key institutional investors like pension funds and insurance companies, as well as contribute to the development of local green capital markets. One example is Acorn Holdings’ $65 million green bond to fund the construction of green buildings for student housing in Kenya. Jointly listed on both the London and Kenya Stock Exchanges and rated B1 by Moodys, the bond received backing from GuarantCo in the form of a concessional guarantee.
Donor and public entities remain the primary funders of blended climate finance, however their share of total financing has declined in recent years. The proportion of total investments in climate transactions on concessional terms has also fallen, making up 28% of all commitments between 2018-2020.
While this might be a signal that private sector investors are becoming more comfortable investing in blended climate deals, it also suggests a scarcity in the market of an essential tool to mobilize greater private sector participation; concessional finance. Larry Fink, CEO of global investment manager BlackRock, underscored the importance of concessional financial instruments for climate action, stating that to mobilize $1 trillion in private climate finance, at least $100 billion in grants and subsidies would be needed. Large public institutions like Multilateral Development Banks and bilateral Development Finance Institutions (who accounted for the greatest proportion of public commitments, 31% of commitments in 2018-20) need to adopt a more systematic approach to supporting blended climate finance, including more investment on concessional terms. Likewise, donor governments should earmark more climate-focused Official Development Assistance to private sector instruments.
Blended Climate Finance at COP26
Blended climate finance has seen good traction at COP26, featuring in the launch of a series of initiatives and transactions. Examples include the launch of the Global Fund for Coral Reefs, a structured blended fund aiming to save and protect the world’s coral reefs; The Forest Investor Club a network of public and private investors committed to support sustainability in the land sector and in which Convergence is a founding member; and Convergence’s support alongside the Australian government for four new blended finance solutions that will mobilize around $300 million for renewable energy, sustainable agriculture, and sustainable forestry across Southeast Asia and the Pacific. The UK also announced £66 million in additional funding for Mobilising Institutional Capital Through Listed Product Structures (MOBILIST), its flagship programme to mobilise large scale investment through publicly listed markets.
We need to seize this momentum. To do this we need to scale proven blended finance structures and adapt the use of public financing to mobilize greater private sector capital to satisfy past climate promises, like the $100 billion commitment, and better confront the most urgent issue facing the world today.