The New Climate Economy (2016) estimates that approximately US$90 trillion of infrastructure investment is required globally by 2030, more than twice the current stock of global public capital, with over three-quarters needed for urban areas (roughly US$4.1–4.3 trillion per annum). Addressing the contribution of these urban centres to climate change is vital: urban infrastructure investment decisions taken over the next five years will determine up to a third of the remaining global carbon budget (NCE 2016). As such, the majority of climate finance allocated to date has been for mitigation activities – in 2017 for example, 382b USD was allocated to mitigation projects, 22b USD to adaptation projects, and 5b USD to projects with co-benefits (CPI 2017). While mitigation projects often represent low-hanging fruit in securing climate financing as there are often quantifiable outcomes in terms of abatement potential and/or the marginal cost of abatement, neglecting investment in adaptation has severe implications for the livelihood and wellbeing of citizens, as well as the economic functioning of cities under future climate scenarios.
This report aims to investigate how the overall quantum of adaptation finance flows may be better facilitated. This will first be first discussed by introducing the problem, followed by an identification of the actors within the system (broken down by the demand side of adaptation finance, and the supply side of finance), concluded with potential actions to overcome the barriers between bringing these actors together.
All countries have significant finance needs for implementing planned development and infrastructure in the coming decades. However, much of this planned development will require additional investment to be climate proofed. Adapting existing and future infrastructure for resilience against the impacts of climate change (as well as low emissions and carbon reduction) will require significant incremental investment, up to 100% for certain individual projects, but overall between 5% and 30% (IDA 2016). In order to substantially increase investment in resilience, there is a need to coordinate and scale up activities, build institutional capacity, provide access to finance, and deliver technical support not only to government at all levels, but also to the private sector (UNDP, 2012). There is therefore a critical need to scale-up sources and flows of financing for climate resilient infrastructure, in terms of more effective allocation of public sector finances, increased access to official development assistance, and leveraging of public sector investment in order to meet the challenge.
In some cases, ‘resilient development’ is development that is solely for the purposes of addressing future climate hazards. For example, in the case of coastal protection (i.e. flood walls, seawalls, or dykes). However, more often, planned ‘general development’ infrastructure can either be ‘future-proofed’ (to protect only that asset from future climate hazards) or scoped to confer resilience benefits to the wider area (for example, a needed roadway can be elevated and designed to confer flood protection). To obtain climate financing for such projects, the additionality must be assessed (i.e. what proportion contributes to adaptation or mitigation, and is therefore eligible for climate financing). In practice, it can be difficult to identify the proportion of a project attributable to each outcome and/or to assess the possible benefits conferred in terms of risk mitigation or avoided losses or damage under future scenarios.
In order to substantially increase investment in LCCR infrastructure there is a need to coordinate and scale up activities, build institutional capacity, provide access to finance, and deliver technical support not only to government at all levels, but also to the private sector. The need for transparent and accessible financial mechanisms is of increasing importance to countries and cities wanting to access funds to address climate change. However, the global climate finance landscape is rapidly changing. Most significantly, the largest international public fund – the Green Climate Fund – has become operational and other numerous other multilateral, bilateral, public and private sources have emerged and there are recent lessons and good practices.
The concept of “climate” finance readiness is described by the United Nations Development Programme (UNDP) as “the capacities of countries to plan, access, deliver, monitor and report on climate finance, both international and domestic, in ways that are catalytic and fully integrated with national development priorities and the achievement of the MDGs” (UNDP 2012b). There are four main components within this definition, they are:
· National capacities in place to plan for finance;
· Capacities to access different forms and types of finance at the national level;
· Capacities to deliver finance and implement/execute activities; and
· Capacities to monitor, report and verify on financial expenditures and associated results and impacts.
With the great gap of demand versus supply for capital investment in infrastructure of all kinds, including resilient infrastructure, there is a need for a paradigm shift in mechanisms and institutional capacity to bridge this gap. Multilateral development banks (MDB’s) have committed to substantially increase climate investments to meet these challenges, which means coordinating and scaling-up activities across the region (EBRD et al. 2017). However the overall capacity of MDBs to finance worldwide adaptation is small.
1.1 Supply Side of Adaptation Finance
The supply side of urban infrastructure finance essentially encompasses all actors that provide funding to governments and their institutions at all levels to implement projects – national, regional, and local. There are two main categories of mechanisms involved in infrastructure finance. The first is public sector financing, which includes government and city budget allocations, user charges by government, loans and bonds to/by governments, and public international grants, loans and guarantees. The second is private sector financing, including PPP or privatised entity equity investments, project finance, and bonds (FS-UNEP 2017a).
Public sources include:
· Development finance institutions
· Multilateral development banks (MDBs)
· Bilateral and national development banks
· International climate finance institutions
· National climate finance institutions
· UNFCCC financial mechanisms
· National Climate Finance Sources
· Export Credit Agencies
Private sources of climate finance include:
· Financial sector
· Commercial banks
· Institutional investors
· Pension funds
· Private equity and venture capital
· Corporate investors
· Other private investors
1.2 Demand Side of Adaptation Finance
The demand side of adaptation finance relates to the local on-ground institutions that utilise supply of money for project design, construction and operation. The government institutions involved and their structures are often unique within each country and city, but usually include the departments responsible for planning, construction, finance, utilities and the environment. Also diverse are the sources of funding for these agencies.
guarantees. The second is private sector financing, including PPP or privatised entity equity investments, project finance, and bonds.
1.3 Mechanisms and Instruments between Supply and Demand
There are numerous financial instruments in use to raise the finance needed to implement urban infrastructure projects. These mechanisms include those required to encourage and incentivise the private sector, reduce risk, ‘price in’ externalities, and to secure adequate financial returns to stimulate investment.
Unit 5 Part 2 (FS-UNEP 2017b) outlines instruments by which financial flows are transferred between parties, such as through tradeable assets (securities), grants, equity investment, taxes, and debt instruments (e.g. green bonds). In terms of where funds are ultimately utilised, broadly speaking, international funds are disbursed in three ways: to a country’s national Treasury to be allocated through the budget (as is the case with budget support) with varying ‘pass-through’ arrangements to cities; to extra-budgetary funds with their own governance arrangements outside of the budgetary process for allocation of funding; or project-based finance where funds are allocated and delivered directly to projects (UNDP 2012a)
Unit 6 (FS-UNEP 2017c) identifies six typological groupings of barriers to private investment in adaptation which include: financial barriers, information barriers, institutional barriers, political and regulatory barriers; technological barriers; and, social cultural barriers. Cities Climate Finance Leadership Alliance (2015) narrowed down key barriers to finance into six key issues include:
· Lack of city expertise in climate change and therefore in low carbon, climate adapted infrastructure;
· Uncertainty over regulatory & tax policies that affect low carbon, climate adapted infrastructure;
· Difficulties incorporating climate goals into urban infrastructure planning;
· Insufficient city control over infrastructure planning along with complex stakeholder coordination;
· Lack city expertise in climate financing;
· Lack of proven funding models at the city level; and
· High transaction costs.
With ever increasing numbers of international climate finance funds, carbon markets and private equity funds already providing “green” finance each with their own eligibility criteria, mobilising external finance in ways that are aligned with national systems and priorities is extremely complex. Furthermore, multiple types of finance (such as carbon finance, finance for REDD, GCF, etc.) and a variety of tools for delivering and packaging financing (such as sectoral approaches, performance-based payments, etc.) are rapidly emerging and evolving presenting additional challenges. While this new landscape of climate change funding mechanisms provides increased resources, it also brings increased complexity both at the national and city level. Requirements, processes and reporting differ among the funds and countries/cities are faced with the challenge of identifying which funds are appropriate for them, how to collect resources required to satisfy their requirements, how to blend them together, how to coordinate the actions funded by them and how to develop the methods to monitor and evaluate the results.
Furthermore, it is important for each of the cities to be able to review and assess the various funding sources available, identify what source might match their needs, and then to pursue the funding with robust applications. It may also be necessary to blend different types of climate finance (public, private, multi-lateral, bilateral and innovative sources of funding) which requires even greater capabilities. Whilst climate finance is about new and additional sources of funding, in practice there are many overlaps in modalities and ways of working with all types of development finance. There is therefore a need for familiarity and capacity to access a range of institutions and donors. MDBs can and must be at the forefront of directing their resources with the primary goal of leveraging scaled–up action by others, MDBs must fund the necessary investment in building institutional capacity, providing means to access to finance and delivering technical support.
A primary conclusion from the Overseas Development Institute’s recent flagship report on the effectiveness of climate finance was that climate funds must become more flexible and less risk averse (Norman and Nakhooda 2014). There is scope for funds to be more innovative in the provision of finance. Partial credit or risk guarantees and other innovative risk mitigation instruments for instance are a relatively unused form of finance that may be effective in some contexts to facilitate the participation of new investors and develop local capital markets.