GI Hub Explainer: Climate Finance
What is climate finance?
Climate finance for infrastructure is finance that aims to support the public or private sectors to address climate change through mitigation or adaptation. Climate finance can be applied to finance projects, programs, or regulatory changes.
In the infrastructure sector, mitigation might include support for clean energy projects such as wind or solar. Adaptation projects might include sea walls to deal with coastal inundation and rising sea levels, or dams that dealt with large-scale flooding.
What are the differences between climate finance, green finance, and sustainable finance?
Climate finance is a subset of environmental, or green, finance. Green finance is finance that supports action on the full range of environmental issues, including climate change. For example, green finance might include actions that support pollution reduction or biodiversity.
Green finance is in turn a subset of sustainable finance. Sustainable finance is a broad category that, like green finance, could include other issues that go beyond the environment to take in social, economic, and governance issues like anti-corruption indicators or improvements in labour market outcomes.
What is the purpose of climate finance?
Infrastructure finance is used to facilitate and boost investment in infrastructure projects, supporting economic activity and social and environmental goals. In the case of climate finance, there is a specific additional requirement that the asset must address pre-defined climate goals, so that the asset plays a role in either mitigating climate impacts or adapting to the impacts of climate change.
Climate finance acts as a signal to the broader community of the commitment of the project proponent to climate goals. Because of the high profile of the financial sector and infrastructure projects, climate finance in the infrastructure context also has potential to further raise awareness of the need for climate interventions and the financing options that are available to enable those interventions.
How does climate finance work?
Climate finance is often concessional. This typically means that lenders will provide finance at a below-market rate to support climate outcomes. This is particularly the case where development finance institutions such as multilateral development banks and other financing facilities provide climate finance to developing countries in support of climate goals. Concessionality may also take other forms, such as longer loan maturity or more flexible debt covenants. Concessional finance is also provided outside of the development context, for instance, from national governments for domestic purposes.
Although climate finance typically takes the form of loans, it can include technical assistance for borrowers and direct grants.
The availability of concessional climate finance provides a market-based signal to potential borrowers that projects which can support climate mitigation and adaptation will attract lower rates of finance or other favourable terms, and therefore become marginally more attractive for project proponents to take forward. This may mean that certain classes of projects, such as clean energy, become more attractive to proponents.
Proponents can also choose to alter prospective projects to give them characteristics that address climate change, and therefore make them eligible for climate finance. In both cases, the market-based signal drives behaviour.
What is the scale of climate finance?
According to the GI Hub’s Infrastructure Monitor report, green infrastructure accounted for 60% of private infrastructure investment in 2021 – a record share. Although the share of renewable energy in this mix has been falling, it is still expected that this figure includes a large proportion of climate-related projects.
In 2022, the World Bank delivered a record USD31.7 billion in fiscal year 2022 to support climate-related projects. In 2021, the Asian Development Bank provided USD1.3 billion for adaptation and USD3.4 billion for mitigation.
According to the not-for-profit Climate Policy Initiative, the rate of growth in climate finance has slowed in the last few years, and will need to increase significantly and rapidly for governments to adhere to their stated mitigation targets.
Image source: Climate Policy Initiative
Climate finance provides a signal to the infrastructure market that lenders prefer climate-based infrastructure projects or projects that otherwise address climate concerns. It typically includes an element of concessionality to enhance this market signal.
While climate finance continues to increase, more needs to be done to achieve most governments’ stated climate goals, and leveraging climate finance could be a way to get more sustainable projects, programs, and regulations progressed.