Reforms and innovations in infrastructure financing can unlock billions – there is no time to lose
"We have multiple gaps to fund, requiring not billions, but trillions"
Climate and biodiversity reports show stark findings
To tie in with my previous article on the impact of COP 15, it is timely to recall that a high sense of urgency animated the conference in December 2022. The reports analysed by the delegates showed stark findings:
- The 2022 global Living Planet Report developed by the WWF reports an average 69% decrease in monitored wildlife population between 1970 and 2018.
- The 2019 report on biodiversity and ecosystem produced by IPBES indicates that the global rate of species extinction is already at least tens to hundreds of times higher than averaged over the past 10 million years. A total ecosystem collapse could not be ruled out based on other recent scientific studies.
Findings on the climate front are also sobering. The Synthesis Report published by the Intergovernmental Panel on Climate Change (IPCC Report) on 21 March 2023 confirmed that greenhouse gas (GHG) emissions are set to rise 11% by 2030, on a path to 2.2°C – 3.4°C by 2100, whereas GHG emissions should fall by 50% by 2030 to meet the Paris Agreement 1.5°C warming limit. The report calls for immediate action as the window of opportunity narrows rapidly. Water supply and severe water management issues in several countries led to the adoption of an urgent Water Action Agenda at the UN Water Conference on 24 March 2023.
IPBES rightly stresses that nature degradation cannot be stopped unless transformative changes occur across economic, social, political, and technological factors. This situation explains why the Global Biodiversity Framework (GBF) adopted at COP 15 brought about unprecedented commitments to halt and reverse biodiversity loss by 2030, and ongoing to 2050.
Transformative changes are needed – Can we make it?
Governments have recently illustrated their resolve. After 15 years of work ending in gruelling discussions, the UN members finally agreed on the High Seas Treaty on 4 March 2023, a major achievement for nature without which the GBF’s second target to protect a third of the sea (and land) by 2030 would have probably failed.
The private sector has also responded promptly. Only one month after COP 15, in January 2023, David Craig, co-chair of the Taskforce on Nature-related Financial Disclosure (TFND) reported that: “Many private sector organisations are already including nature and biodiversity into their strategies. They are taking a more integrated view across climate and nature and will use the COP 15 GBF agreement to formalise and increase ambition in their strategies and targets.”
We have multiple gaps to fund, requiring not billions, but trillions
Climate gap. Around USD90 trillion in climate-driven infrastructure investment is required by 2030 to reach global sustainability, according to World Bank 2019 data. Experts estimate that less than USD1 trillion a year is currently invested to address climate transition whereas a minimum of USD3.8 trillion a year would be required to meet the Paris Agreement objectives by 2030, leaving approximately a USD3 trillion yearly gap.
Biodiversity gap. The GBF calls for increasing financial resources from all sources, public and private, to mobilise at least USD200 billion per year in order to support national biodiversity strategies. The UNDP however reports that USD824 billion would be needed yearly to protect and restore nature, thus leaving a USD624 billion yearly gap.
Infrastructure gap. These findings are particularly pertinent for infrastructure, which has historically neglected the protection of nature, and which is responsible for 79% of GHG emissions, 88% of all adaptation costs, and consumes 60% of the world’s materials, as indicated by UNEP in its Infrastructure for climate action report. The GI Hub used recent data to estimate that the infrastructure investment gap has more than trebled from the 2017 global forecast of USD0.7 trillion a year to around USD3 trillion a year today.
Going forward, infrastructure investment must include climate and biodiversity considerations to play its role as the backbone of a healthy planet.
Enhancing the infrastructure finance ecosystem
Necessary key actions to unlock infrastructure financing are as follows.
Blended finance must be scaled up. Blended finance brings together public and private capital in the most complementary way. It uses limited catalytic funds and instruments from public or philanthropic sources to leverage private sector investment, to shift risks and to bring risk-return profiles in line with private investors’ expectations. Because of its inherent complexity, blended finance is underdeveloped, but it can be greatly expanded. Several recommendations have been made, including in a recent Action Plan presented by Convergence. We have also explained how blended finance could become a game changer and bring to market pivotal infrastructure projects that could otherwise never reach financial close.
In blended finance, risk mitigation instruments are key. These instruments include soft loans, contingent equity, and first-loss and backstop guarantees such as non-payment guarantees and political risk and foreign exchange insurance.
The scaling up of blended finance is predicated on the development of these instruments, which is largely for the multilateral development banks (MDBs) to do. The MDBs have historically preferred to deploy their capital through loans because more capital is committed on loans than on guarantees. However, it would be better to provide guarantees and to keep the MDB’s powder dry in a world of scarce public funds. In addition, guarantees carry a high leverage factor, opening the door for private lenders to provide senior loans. MDBs should see this point.
MIGA NHFO. One of the main barriers preventing institutional investors from investing in emerging markets (EMs) is the fact that EM projects are generally not investment grade – and often, the same applies to the host country. Investing below a BBB rating is a problem for institutional investors.
Guarantees like the MIGA Non-Honoring of Financial Obligations (NHFO) instrument can help. NHFO offers broad protection against a government’s failure to make a payment when due, which is a clear risk since infrastructure projects generally rely on government availability payments to recoup the initial investment. As a result of this protection, a non-investment-grade project can be enhanced to AAA level because MIGA, a World Bank Group (WBG) entity, benefits from the World Bank (IBRD) AAA rating. This instrument can open up EMs to institutional capital. The World Bank has not yet given MIGA the capacity to scaleup this instrument, and correcting this could be a game-changer for many projects.
Broader Project Preparation Facilities (PPFs) are needed. Bringing a project to RFP (request for proposal) level involves the pooling of commercial and technical expertise, and the backing of a strong public procurement process. This is not a trivial exercise; it may cost up to 10% of the total project capital cost. PPFs aid in this process and are generally led by MDBs. They are primarily needed in countries that are more vulnerable to climate change. As reported in the GI Hub 2021 Infrastructure Monitor, PPFs have grown significantly in the last 20 years, but their coverage is still fragmented, and the participation of the private sector has proven difficult. PPFs need a boost.
Reforms and innovations to be hailed
Reform of the World Bank Group and of the MDBs. On 9 February 2023, US Treasury Secretary Janet Yellen delivered a strong speech to urge the WBG to accelerate its reform, to free up more capital and address climate change among other global challenges. A fortnight later, President Joe Biden presented businessman Ajay Banga as the US nominee for the WBG presidency. From these signals and the G20 independent expert panel that reviewed MDBs’ capital adequacy frameworks (see below), it is understood the MDBs and Regional Development Banks are next for reform. Yellen indicated that ideas needed to be translated into action before the WBG spring meetings that commence this week.
The review of the MDBs’ capital adequacy framework is a first step. The independent review initiated by the G20 and presented in July 2022 invites the MDBs to revisit their capital adequacy frameworks, starting with how they define risk tolerance, in concert with their credit rating agencies, to better align their capital reserve with their risk history, and predictably to increase their lending capacity. Additional lending headroom could be found by extending more catalytic instruments and less debt facilities, thus inviting private capital to play a bigger role. The independent panel concluded that the MDBs could free up billions with very manageable changes without undermining their AAA ratings.
Further, a percentage of MDB loans should move from senior to junior and concessional positions to better scale up blended finance. The AAA rating could be maintained, if need be, through a replenishment mechanism similar to the one used by the International Development Association (IDA), which supports the poorest countries while maintaining a AAA rating backed by the WBG (the International Bank for Reconstruction and Development). The MDBs should also open up their PPFs to private investors and share with them their due diligence expertise in emerging markets.
JETPs can supercharge blended finance. Just Energy Transition Partnerships (JETPs) are multi-billion blended finance partnerships, set up for a given country, to facilitate the decommissioning of coal-fired power plants, mobilise private capital into decarbonisation projects, and deliver a ‘just transition’ for the population. South Africa, Indonesia, Vietnam, and India are all candidates. For example, in November 2022, Indonesia and international partners announced the setting-up of a USD20 billion JETP funded half from public donors, including the G7 countries, and half from private investors, led by the Glasgow Alliance for Net Zero (GFANZ). MDBs and private donors are expected to join. These massive opportunities are set to prove that large blended finance structures can work. Heavy lifting is however expected, as robust project pipelines need to be packaged, procurement policies adapted, and PPFs expanded. All these are good steps to maximise efficiency and accelerate the transition to clean energy.
Motherships like the Bridgetown Global Climate Mitigation Trust are welcome. The Bridgetown Initiative presented by PM Mia Mottley of Barbados outlines a series of transformative climate measures, one of which is called the Global Climate Mitigation Trust. The trust would hold USD500 billion of unused or new IMF Special Drawing Rights (SDRs) as collateral. SDRs give holders the right to borrow from other IMF members via the SDR basket of currencies at low rates. Half of the SDRs, worth approximately USD500 billion, are held by developed countries that don’t need them. The trust would step in and use the borrowing rights. The trust could also negotiate concessional facilities from MDBs and blend them with private debt raised on capital markets. Forecasts are for the trust to assemble and channel over USD3 trillion directly to projects firmly embedded in national climate plans. The re-allocation of SDRs is a brilliant idea and should be pursued.
Detrimental subsides must be redirected. COP 15 triggered a discussion followed by commitments to curb and redirect harmful subsidies. These subsidies are currently estimated at USD1.8 trillion per year, and are used to fund activities like deforestation, overfishing, monocultures, and fossil fuels. Under the GBF, these detrimental incentives must be reduced by at least USD500 billion per year by 2030, freeing up substantial capital to finance the biodiversity gap.
Carbon markets are crucial and should be made stronger. Countries tabled climate commitments under the Paris Agreement known as Nationally Determined Contributions (NDCs). 83% of NDCs intend to use carbon markets to finance GHG reductions. NDCs were updated at COP 26 in Glasgow in November 2021 as guidelines to advance international carbon markets were delivered. The good news is that, by the end of 2021, more than 21% of the world’s GHGs were covered by some form of carbon pricing, up from 15% in 2020. Biodiversity credits were further documented at COP 15 and well received by investors because they are broader than carbon credits. But things are far from perfect. Carbon taxes and markets are still immature, lack integrity, and are seen as too timid to properly incentivise polluters. More political will is required because these mechanisms were invented to materially accelerate the climate transition, and to fund it.
Disturbing climate and biodiversity findings have prompted reforms and innovations in infrastructure financing. As illustrated, these reforms and innovations can unlock billions that are ‘hidden’ in public development finance institutions. If used as catalytic capital targeted to leverage private capital, arguably by a factor of three to five times, billions can become trillions and close the gaps that have been discussed for so long.