Climate Finance

Climate finance refers to local, national or transnational financing—drawn from public, private and alternative sources of financing—that seeks to support mitigation and adaptation actions that will address climate change. It involves mechanisms to raise and channel funds towards developing countries and subnational actors to reduce greenhouse gas (GHG) emissions and enhance sinks as well as to adapt to the adverse effects and reduce the impacts of climate change.

Sources of climate finance

There are various sources that provide climate finance. Public sources include national budgets, climate funds such as the Green Climate Fund, and other multilateral and bilateral climate funds. Private sources include private equity funds, institutional investors, commercial banks, and development finance institutions. Alternative sources include carbon markets, carbon taxes, insurance, and remittances.

A key public source of climate finance is the Green Climate Fund, which was established in 2010 by the United Nations Framework Convention on Climate Change (UNFCCC) to support projects, programmes, policies and other activities in developing country Parties. As of 2022, the Green Climate Fund has received pledges of over $10 billion from donor countries such as Germany, France and Japan.

Another major multilateral climate fund is the Global Environment Facility, established in 1991. It provides grants to developing countries for projects related to biodiversity, climate change, international waters, land degradation, the ozone layer, and persistent organic pollutants. The GEF has provided over $22 billion in grants and mobilized an additional $117 billion in co-financing from 1991 to 2022.

Needs for climate finance

It is estimated that developing countries will require between $140 billion to $300 billion per year by 2030 to implement climate actions. However, current levels of global climate finance fall far short of this estimated need.

According to the UNEP Gap Report 2022, global climate finance flows totalled around $680 billion in 2022, an increase from $612 billion in 2021. However, only around $29 billion, or about 4% of total climate finance, went to adaptation in 2021. This is vastly inadequate given that climate impacts are already being felt and adaptation needs are growing rapidly.

Developing countries face major challenges in accessing climate finance due to limited institutional capacity and an unfavorable investment climate. There is an urgent need to scale up public sources of climate finance as well as engage private investors through innovative financing instruments and mechanisms that de-risk investments in climate projects in developing nations.

Mobilizing private climate finance

With public climate finance falling short, there is significant focus on mobilizing private capital to fund climate actions. Private finance is essential given its potential scale. Some initiatives to mobilize private climate finance include:

• Green bonds: Bonds issued to fund projects or activities with environmental benefits, such as renewable energy or energy efficiency. The green bond market has grown rapidly to over $1 trillion in outstanding bonds since 2007.
• Blended finance: Concessional public finance is blended with private capital through mechanisms like first-loss guarantees or interest rate subsidies to derisk investments and crowd-in private funding for climate projects.
• Carbon markets: Emissions trading schemes and voluntary carbon markets provide financial incentives for low-carbon investments and technologies. The market size was about $304 billion in 2021.
• Sustainable investing: Assets under management integrating environmental, social and governance factors have grown exponentially, reaching $40 trillion globally in 2022. This represents an enormous pool of capital that could potentially be tapped for climate-aligned investments.

Thus, climate finance involves mobilizing funds from various public and private sources to support both climate change mitigation and adaptation actions around the world. However, current financing falls far short of estimated needs, especially for adaptation. Innovative approaches are urgently required to scale up and leverage private sources of capital for climate investments globally.