Climate Finance is an umbrella term that encompasses different kinds of financial instruments used to support activities that help develop sustainable infrastructure. It includes establishment of renewable energy plants and storage systems, efforts of adapting to changing climate conditions, developing resilience to disasters that result from changing climate and extreme weather conditions. Another aspect of climate finance is issuing loans in exchange of a guarantee from a corporation or government that they will work in line with the sustainable development goals set by either the United Nations, or is a set of mutually agreed upon terms between the lender and the borrower based on climate goals.
It all started in 1994, with the establishment of GEF(Global Environment Facility). Working with the World Bank as a trustee which helped mobilize funds, it is funded by developed countries and the funds are used for furthering the vision of UNFCCC in developing countries.
In Copenhagen, at the UNFCCC conference 2009. Foundations were laid down for what became a global goal 6 years later- to stop temperature from rising beyond 2 degree celsius from preindustrial levels, this decision was based on the IPCC Fourth Assessment Report. Developing countries demanded the developed nations to fund the adaptation and mitigation measures against inevitable effects of climate change that were caused by emissions from developed nations.
In 2010, the parties to the convention decided to establish the Standing Committee on Finance to assist COP in handling finances. Its roles include helping the COP in mobilizing funds for the goals set by the UNFCCC and suggesting roadmaps for future flow of capital. It also reviews the flow of funds.
Before we delve into details of different financial instruments there’s one more thing worth discussing, the commodification of GHG emissions. The Kyoto Protocol allowed countries to sell carbon emission units to other countries, a developed country which can afford to generate more of its power from renewable sources can sell some units of carbon emission to a developing country which needs to depend on more traditional power generation systems and fossil fuels. This system prevents GHG emissions from increasing but ensures that countries that need to use carbon intensive fuels for development have an option.
It’s not a financial instrument, but it gave way to a whole new market of carbon credits. Emission units can be borrowed and sold under the mechanism established by the Kyoto Protocol. The mechanism has two elements– registry systems and transaction logs. Registry Systems keeps accounts of emissions of countries that are party to the Kyoto protocol, emissions are measured in tonnes of CO2, one metric ton of CO2 equals One Kyoto Unit. The transaction log connects regestiries and verifies all the transactions in real time.
Different Financing Mechanisms
The World Bank issued the first Green Bond in 2008. Since then Green Bonds have become a popular way of financing renewable energy and climate action projects. Green bonds offer tax benefits to its investors, and the money invested goes into development of projects that will have positive environmental impact.
Debt issued in foreign currency for the purpose of financing a green initiative can be bought by a willing domestic party– e.g. an NGO or an investor.
It is a form of agreement between the lender and the borrower under which the borrower agrees to fulfill obligations related to sustainable development.
These loans are offered at lower interest rates for climate change related activities, they may also have very long periods of repayment along with other preferential conditions specific to the given project.
Major Climate Finance Funds
Green Climate Fund
In 2010, Green Climate Fund (GFC) was established by the UNFCCC, it offers financial aid to developing countries working towards the common goal of keeping the global temperature from rising beyond 1.5 degree celsius, set by the Paris Climate Agreement. It offers help in the form of grants, concessional debt and guarantees. It is mandated to spend half of its budget adaptation and half of mitigation measures, and at least 50% of the adaptation budget must be spent on SIDS(Small Island Developing States), LDCs(Least developed countries), and African States. It aids all the developing countries in fulfilling their Nationally Determined Contribution(NDC) targets of sustainable development.
Global Environment Facility
GEF has been there since 1994, managing the financial mechanisms of the UNFCCC. It organizes funds for developing countries for building resilience and helping them develop in a sustainable way.
Special Climate Change Fund
This multilateral fund was started in 2001, at the UNFCCC conference. It is managed by the GEF and the purpose of this fund is to fund sustainable development and climate resilience activities in developing nations.It focuses on projects relating to: adaptation; technology transfer and capacity building; energy, transport, industry, agriculture, forestry and waste management; and economic diversification.
Least Developed Countries Fund
The LDCF is also managed by the GEF. It helps underdeveloped countries in executing their National Adaptation Programme of Action (NAPAs) – which is designed to fulfill the most immediate needs of a particular country.It helps in technical and institutional capacity building. Areas of focus include agriculture and food security; natural resource management; water resources; disaster risk management and prevention; coastal zone management; climate information services; infrastructure; and, climate change induced health risks.
Operationalized in the year 2010, Adaptation Fund(AP) helps vulnerable communities in developing nations in adapting to climate change.It is financed by government and private donors, and also from a two percent share of proceeds of Certified Emission Reductions (CERs) issued under the Protocol’s Clean Development Mechanism projects.CDM (Clean Development Mechanism) allows developing countries to earn CERs (each equivalent to 1 ton of carbon dioxide emissions, often called carbon-credits). The CERs can then be bought or sold in the market and helps countries meet and manage their emission reduction targets set by Kyoto Protocol.
The World Bank Group
The World Bank engages in climate change mitigation and adaptation efforts with many countries, businesses and institutions. The following constituents of the World Bank have the most engagement with climate related efforts. With the adoption of the new Climate Change Action Plan all the activities that the world bank finances must adhere to the norms set by the Paris Climate Agreement.
The International Bank for Reconstruction and Development
The primary lending arm of the World Bank, it helps middle income countries by providing loans for infrastructure development and economic growth.It also provides technological solutions and knowledge resources. It has reserved 50% of its funds for investment in sustainable development goals.
The International Development Association
It is a part of the World Bank that is focused on helping very poor countries by providing loans at very low to zero interest rates. It supports sustainable development activities, job creation and economic growth in 74 poorest countries of the world. IDA’s investment helped the Indian Green Revolution.
The International Finance Corporation
It is one of the largest financial investment institutions that was established with focus on investment in the private sector. It provides support through financial investment and advisory services to businesses and governments. It has financed multiple large renewable energy projects in Asia and Africa
The Multilateral Investment Guarantee Agency
It was created to promote the flow of foreign direct investment in developing countries. It is committed to helping IDA countries, Fragile and Conflict-Affected Situations (FCS) and climate finance. It only supports projects that meet high environmental standards.