Climate adaptation: why private investment is needed

At COP28, a crit­ic­al and increas­ingly press­ing agenda was pushed into the spot­light: cli­mate fin­ance and the grow­ing fin­an­cial needs for adapt­a­tion meas­ures. This was clearly stated in the COP28 Presidency’s let­ter to the Parties, where an emphas­is was put both on deliv­er­ing old prom­ises and set­ting the frame­work on a deal on fin­ance: “We urge developed coun­tries to ensure that the goal of doub­ling adapt­a­tion fin­ance by 2025 is on track, as agreed at COP26 (…) In addi­tion, we have heard strong sup­port behind the idea that the GGA Frame­work must drive deep­er col­lect­ive action on adapt­a­tion fin­ance”¹.

The con­fer­ence opened with the adop­tion of the “loss and dam­age” fund accom­pan­ied by ini­tial fund­ing announced by sev­er­al coun­tries, includ­ing Ger­many, France and the UAE, sig­nalling a grow­ing focus on the mobil­isa­tion of cap­it­al towards the most impacted coun­tries and a grow­ing con­sensus on the chal­lenges emer­ging eco­nom­ies face². Although impacts of cli­mate change are seen world­wide, emer­ging coun­tries are at the fore­front of the crisis as they are most severely affected by accel­er­at­ing nat­ur­al dis­asters, floods, and droughts.

While there has been a not­able increase in over­all cli­mate fin­ance, with developed coun­tries provid­ing and mobil­ising a total of $89.6bn for devel­op­ing coun­tries in 2021, a 7.6% increase from the pre­vi­ous year, the focus of these funds on adapt­a­tion strategies remained lim­ited³. Between 2016 and 2021, only 25% of cli­mate fin­ance mobil­ised for devel­op­ing coun­tries tar­geted adapt­a­tion, and in 2021, adap­tion fin­ance even dropped by $4bn⁴. As the impacts of cli­mate change accel­er­ate and become more severe, scal­ing up adapt­a­tion action is fun­da­ment­al to lim­it harm and exploit poten­tial oppor­tun­it­ies. The more adapt­a­tion is left aside, the more loss and dam­age there is, ulti­mately lead­ing to a vicious cycle of cli­mate and eco­nom­ic vul­ner­ab­il­ity. The adap­tion fin­ance gap is grow­ing and the increase in inter­na­tion­al pub­lic fin­ance alone is unlikely to close it. And even though is has gen­er­ally been con­sidered less crit­ic­al than mit­ig­a­tion, this time around, “adapt­a­tion was hav­ing its moment at the COP28” as Tara L. Guel­ing from the Light­s­mith Group said.

Adapt­a­tion describes the pro­cess of adjust­ment to cli­mate change’s cur­rent and future effects, to mod­er­ate harm, min­im­ise dam­age or take advant­age of oppor­tun­it­ies that may arise⁵. Adapt­a­tion meas­ures are var­ied, going from farm­ers diver­si­fy­ing their crop vari­et­ies, to devel­op­ing cli­mate resi­li­ent infra­struc­ture. As the May­or of Istan­bul, Ekr­em İmamoğlu acknow­ledged dur­ing the EBRD Con­fer­ence “Green Cit­ies: Scal­ing-up Fin­ance for Sus­tain­able Urb­an­isa­tion” held on the 6th of Decem­ber at the COP28: “pri­or­it­ising adapt­a­tion pro­jects is essen­tial and there is an urgent need for fin­an­cial sup­port.” Tra­di­tion­ally seen as safe­guard­ing soci­et­ies from the adverse impacts of cli­mate change, adapt­a­tion action was seen as gov­ern­ment respons­ib­il­ity which relied on pub­lic investments.

Private fin­ance mobil­isa­tion for pub­lic invest­ments has pre­vi­ously been con­sidered in the con­text of gov­ern­ment debt in cap­it­al mar­kets. In the past year, how­ever, with the chal­lenges of the COVID-19 pan­dem­ic and the war in Ukraine, devel­op­ing coun­tries’ bor­row­ing capa­city has worsened, as did their capa­city for domest­ic pub­lic invest­ment in adapt­a­tion. As such, adapt­a­tion fin­ance over the years has mainly been driv­en by an increase in mul­ti­lat­er­al pub­lic cli­mate fin­ance, with loans seen as the most fre­quently used instrument.

How­ever, at the COP28, the need for the involve­ment of addi­tion­al act­ors was expli­citly stated as the adapt­a­tion fin­ance gap grows sig­ni­fic­antly. The last adapt­a­tion report gap indeed estim­ated that the costs would reach a range of $215–387bn/year for devel­op­ing coun­tries this dec­ade⁶. Con­sequently, vari­ous speak­ers and con­fer­ences focused on, and advoc­ated for great­er involve­ment of the private sec­tor to intensi­fy efforts in com­bat­ing and adapt­ing to the cli­mate crisis.

Cli­mate mit­ig­a­tion invest­ments, such as in renew­able energy infra­struc­ture, have received much more sup­port than adapt­a­tion invest­ments from the private sec­tor in pre­vi­ous years.

Cli­mate mit­ig­a­tion invest­ments, such as in renew­able energy infra­struc­ture, have received much more sup­port than adapt­a­tion invest­ments from the private sec­tor in pre­vi­ous years. In fact, as Suz­anne Gaboury from the Asi­an Devel­op­ment Bank sug­gests at the OCDE event held on the 3rd of Decem­ber at the COP28: “only 2% of adapt­a­tion fin­ance came from the private sec­tor and for them, the bar­ri­ers have been very com­plex. When it comes down to the rev­en­ue mod­el, adapt­a­tion is seen as an increased cost, while mit­ig­a­tion is per­ceived as an oppor­tun­ity. Adapt­a­tion is very sub­ject­ive com­pared to the mit­ig­a­tion side, and this can defer the poten­tial invest­ment. There are oppor­tun­it­ies but appro­pri­ate right tools are lack­ing, and there is no stand­ard­iz­a­tion. Increased stand­ard­ized frame­work approaches would be very important.”

Moreover, as Amar Bhat­tacharya from The Brook­ings Insti­tu­tion adds, the main chal­lenge for adapt­a­tion is that “it focuses on small scale and very con­text-spe­cif­ic pro­jects, which don’t work very well for investors. There is a need to bet­ter match the char­ac­ter­ist­ics of adapt­a­tion pro­jects with the expect­a­tions of investors. It is also hard because it is not very rev­en­ue gen­er­at­ing. Most adapt­a­tion pro­jects gen­er­ate sav­ings, rather than rev­en­ue. There is a need to make adapt­a­tion pro­jects cred­ible from an investors’ point of view by rely­ing on aggreg­a­tion struc­tures and cred­it enhan­cing structures”.

A few action areas to scale up cur­rent fin­ance sources and unlock addi­tion­al fin­ance for adapt­a­tion were dis­cussed at the COP28 – spe­cific­ally focused on the private sec­tor. The main ones high­lighted at the COP28 were the sup­port for devel­op­ing coun­tries in strength­en­ing their insti­tu­tion­al capa­city, policies, and mar­kets; as well as the stra­tegic role that devel­op­ment fin­ance, and spe­cific­ally blen­ded fin­ance instru­ments must mobil­ise private fin­ance for adaptation.

Although a vari­ety of factors are needed to lower investors’ per­ceived invest­ment risks, such as eco­nom­ic sta­bil­ity or the rule of law, regard­ing adapt­a­tion spe­cific­ally, increas­ing the avail­ab­il­ity of cli­mate-related data is key to effi­ciently alloc­ate impact­ful invest­ments in adapt­a­tion. This was high­lighted by Debbie Palmer, Dir­ect­or of Cli­mate Fin­ance in the UK Gov­ern­ment: “one of the biggest bar­ri­ers to invest­ments in emer­ging eco­nom­ies comes around the lack of data, which affects investors’ abil­ity to accur­ately price the risks and estim­ate the return. Pub­lic mar­kets have a key oppor­tun­ity to help build con­fid­ence and cor­rect the mis­con­cep­tion about the risk of the market.”

Improv­ing data can there­fore help reduce the bias and increase trans­par­ency, and thus cata­lyse private invest­ment in adapt­a­tion efforts. Inform­a­tion asym­met­ries and know­ledge gaps rep­res­ent an import­ant bar­ri­er for private investors, which is cru­cial to solve⁷.

In addi­tion, inter­na­tion­al devel­op­ment act­ors can play a crit­ic­al role in unlock­ing private fin­ance for adapt­a­tion. This is par­tic­u­larly the case for pro­jects that have an expec­ted stable rev­en­ue stream but are not yet com­mer­cially viable, and where devel­op­ment fin­an­ci­ers can help over­come ini­tial bar­ri­ers. Blen­ded fin­ance took a cent­ral role at the COP28 and appeared as a key innov­at­ive way to enhance returns and reduce the risks faced by private investors. Blen­ded fin­ance is defined by the OECD as “the stra­tegic use of devel­op­ment fin­ance for the mobil­isa­tion of addi­tion­al fin­ance towards sus­tain­able devel­op­ment in devel­op­ing countries”.

Using devel­op­ment fin­ance can stra­tegic­ally attract private investors by high­light­ing the viab­il­ity of adapt­a­tion invest­ments and enabling them to trust a new busi­ness mod­el, or type of investee⁸. The Emer­ging Mar­ket Cli­mate Action Fund (EMCAF) exem­pli­fies this ini­ti­at­ive through the part­ner­ship of Alli­anz Glob­al Investors and the European invest­ment Bank, which provides early-stage equity fin­an­cing to sus­tain­able pro­jects in emer­ging mar­kets, with a strong focus on adapt­a­tion⁹. As Milena Messori, Head of Divi­sion at the European Invest­ment Bank (EIB) high­lighted: “cli­mate adapt­a­tion is fin­an­cially viable, and we need to mit­ig­ate risk to attract the private sec­tor. Here, we are using pub­lic money as a cush­ion for the poten­tial first losses. Import­antly, it is not only about the risk itself, but about the per­cep­tion of the risk, which is much great­er. We can de-risk invest­ment by provid­ing com­fort that the ini­ti­at­ives are sol­id and that they will deliv­er in terms of impact and in terms of returns.”

There is a key role for inter­na­tion­al pro­viders to mobil­ise private funds. As Jen­nifer Mor­gan from the Fed­er­al Office of Ger­many high­lights, “MDBs need to scale up the use of guar­an­tees and bring in dif­fer­ent tools with short-term and long-term vis­ions”. Sim­il­arly, Jamal Saghir, pro­fess­or at McGill Uni­ver­sity added that “if we don’t improve con­ces­sion cap­it­al, the private sec­tor will not show up. Moreover, innov­at­ive instru­ments exist, such as the debt swap to nature, to foster coun­tries to focus on adapt­a­tion measures”.

At COP28, GAIA, a cli­mate change-focused blen­ded fin­ance led by MUFG and FinD­ev Canada, Canada’s bilat­er­al devel­op­ment fin­ance insti­tu­tion, was recog­nised as a lead­ing innov­at­ive plat­form to mobil­ise private sec­tor par­ti­cip­a­tion at scale. Lori Kerr from FinD­ev explains “GAIA is $1.5bn plat­form focused on 25 emer­ging mar­kets across Africa, Asia, and Lat­in Amer­ica. Import­antly, 70% of its total port­fo­lio invest­ments will go towards adapt­a­tion pro­jects in the most cli­mate vul­ner­able coun­tries in the world. We provide long-term loans from sources that were pre­vi­ously not avail­able. I am excited as the role private cap­it­al can play – the money is there, and I am excited about how to unlock this capital.”

This ini­ti­at­ive exem­pli­fies the neces­sity of hav­ing more patient cap­it­al¹⁰ to adequately match the long invest­ment hori­zon that adapt­a­tion pro­jects have. Some speak­ers, though, cla­ri­fy how they per­ceive the emphas­is on “innov­a­tion” that describe adap­tion-focused ini­ti­at­ives. For Mar­tin Ewald, the man­aging dir­ect­or of the Fund EMCAF: “This nar­rat­ive around innov­a­tion, I am not sure if it is the right nar­rat­ive to have because we need to rely on the ele­ment of trust to mobil­ise private cap­it­al. For me, the innov­a­tion is on the applic­a­tion, on how we define and focus on adaptation.”

Across con­fer­ence and con­ver­sa­tions, Mimi Ale­maye­hou, a lead­er in Devel­op­ment Fin­ance, high­lights the recur­rent men­tion­ing of “the lack of bank­able pro­jects”. There is indeed a sig­ni­fic­ant neces­sity to assist emer­ging eco­nom­ies to identi­fy and devel­op adapt­a­tion pro­jects that can attract and meet the require­ments of inter­na­tion­al private sec­tor investors. Innov­at­ive organ­isa­tions, such as Allied Cli­mate Part­ners came to light dur­ing vari­ous con­fer­ences on Private Cap­it­al Mobil­iz­a­tion in EMDEs and Innov­at­ive Vehicles, to show­case their ini­ti­at­ives: “In emer­ging eco­nom­ies, it is the first five dol­lars that unlocks the 95. How­ever, this early-stage cap­it­al is the hard­est to raise, and this is the invest­ment we aim to under­take to de-lock and de-risk. We cre­ate pipelines that oth­er investors can fol­low,” Ahmed Saeed, Chief Exec­ut­ive Officer of ACP, states.  Sim­il­arly, Astrid Man­roth, Head of the Glob­al Infra­struc­ture Facil­ity, high­lights how GIF, a glob­al G20 col­lab­or­a­tion plat­form “sup­ports nation­al gov­ern­ments and muni­cip­al­it­ies with resources and expert­ise to build bank­able pipelines in infra­struc­ture pro­jects. We sup­port pro­jects to help them scale.”

In emer­ging eco­nom­ies, it is the first five dol­lars that unlocks the 95. How­ever, this early-stage cap­it­al is the hard­est to raise.

These ini­ti­at­ives are on the rise and are key to best attract private fin­ance. It is import­ant to remem­ber, how­ever, that “no pro­ject is obvi­ously bank­able. It a pro­cess that involves identi­fy­ing the needs to trans­form it adequately and struc­ture it in a way that it becomes bank­able. It is not only about money, but also about expert­ise, about the human cap­it­al”, declares Imad N. Fak­houry, Dir­ect­or of the Infra­struc­ture Fin­ance Group at the World Bank. Ulti­mately, it is import­ant to build up the capa­city of coun­tries them­selves and trans­fer the expert­ise required to scale up pro­ject preparation.

In con­clu­sion, COP28 marked a sig­ni­fic­ant shift in the focus towards cli­mate fin­ance, par­tic­u­larly in the realm of adapt­a­tion meas­ures. The con­fer­ence called for increased private sec­tor involve­ment and for enhanced col­lab­or­a­tion to accel­er­ate the mobil­isa­tion of private adapt­a­tion fin­ance. Devel­op­ing coun­tries retained much of the focus for this top­ic as the impacts of cli­mate will be felt more heav­ily there, coupled with sub­stan­tial resources required for imple­ment­ing adapt­a­tion strategies.

Tra­di­tion­ally over­shad­owed by mit­ig­a­tion efforts, this pivot towards private cap­it­al for adapt­a­tion high­lighted the sup­port needed from inter­na­tion­al pro­viders and devel­op­ment Insti­tu­tions to de-risk invest­ment oppor­tun­it­ies and effect­ively cata­lyse private cap­it­al. Innov­at­ive approaches like blen­ded fin­ance, guar­an­tees and co-fin­an­cing were presen­ted as import­ant solu­tions for private cap­it­al mobil­iz­a­tion, as well as the devel­op­ment of bank­able pro­jects to attract private invest­ment. These strategies, coupled with improved data avail­ab­il­ity, improved mac­roe­co­nom­ic envir­on­ments and adequate policies, are crit­ic­al to raise investor aware­ness and change the per­cep­tion that adapt­a­tion is dif­fi­cult to sup­port with com­mer­cial finance.

Over­all, adap­tion can be a viable private invest­ment tar­get and while col­lect­ive efforts have been show­cased at the COP28, they still need to be strengthened fur­ther to bridge the import­ant fin­an­cing gap in devel­op­ing coun­tries¹¹.