Climate data will need to get out of government labs and into commercial applications. Photo: NASA

Adaptation Finance – Fresh Winds Beginning to Blow?

17/02/2017

In our piece on adaptation last week, we looked at the current state of adaptation finance, and found it grinding along  in the slow lane of overall green/climate finance. This week we look at some of the developments that may mean more pressure on the accelerator

To recap briefly on the present rather gloomy landscape:

  • At $27 billion, adaptation finance was only some 7% of total climate finance in 2014
  • The UN has identified a potential ‘adaptation gap’ of between $140-300 billion a year by 2030
  • The major regional gaps are in Latin America/Caribbean, Sub-Saharan Africa and South Asia
  • Coastal Protection and Energy/Infrastructure/Buildings are the main sectoral gaps at present (though there are gaps everywhere and in all sectors)
  • It would appear that the Green Climate Fund, the intended major source of public funding for adaptation under the Paris agreement, is not yet meeting its goal of a 50/50 split between mitigation and adaptation

So where to begin, to shift to higher gears?

Our first observation, from discussions with the Climate Funds Update team, is that some countries are far better at attracting public finance than others, including concessional finance for adaptation, and that this capability is not linked to the size or sophistication of the country. So an obvious basic step is for countries to study their more successful peers and seek support (for example from capacity building donors) to up their game.    Perhaps this is the kind of thing that the new Global Centre of Excellence on Adaptation could assist with.  The ND-GAIN adaptation tool we feature alongside this blog should also help countries understand how their perrs are doing better.

Meantime, NGOs, politicians and negotiators need to continue the pressure on developed countries to honour their commitments, especially on the $100 billion per annum promised to the GCF. A forum for this now exists, in the Global Goal on Adaptation established as part of the Paris Agreement.

Public/Private Approaches

Looking beyond the purely public purse, we can see ‘hybrid’ solutions and structures that are being developed, that is solutions that combine public and private sources of finance, usually with the former being used to de-risk the participation of the latter in some way.  Two organisations that seem to be leading the way on this are the Climate Investment Funds and the Climate Finance Lab.

In a recent report by VividEconomics on private sector investment in adaptation in developing countries, the Climate Investment Funds gave a number of examples of how its Pilot Programme for Climate Resilience (PPCR) has helped to attract private funding into adaptation projects (see the Box for an example).  Analysing nearly 50 projects ranging from climate-smart agriculture to hospital construction, it found that public funds (from MDBs, the PPCR and other donors) accounted for $1.7 billion of a total project value of $5.4 billion, suggesting that private sources accounted for some $3.7 billion (roughly 2/3rds) of the cost in one way or another.

PPCR Case Study:  Improving resilience in agriculture and small business in Tajikistan
Cotton Farming in Tajikistan. Photo: World Bank

CLIMADAPT is a pilot climate finance facility developed by the EBRD to finance sustainable technologies and practices for climate adaptation in Tajikistan.  Dependent on mountainous rainfall and snowmelt for its water supply, and with 25% of its GDP coming from agriculture, the country is very vulnerable to climate variation, and suffers also from increasing soil erosion. Funded through USD 5 million each of commercial loans from the EBRD and concessional loans from the PPCR, CLIMADAPT is intended to build resilience among households, farmers and private businesses.

Funds from the facility are channelled through local financial institutions, including microfinance lenders, and to date have financed projects such as new orchards, rainwater harvesting systems, improvements in window and door insulation, and drip and sprinkler irrigation.

Assuming that loans do not cover the full cost of projects, the private sector finance in this example consists of the contributions made by borrowers to these costs (including, no doubt, contributions in kind such as unpaid labour).  In this pilot phase the microfinance lenders appear to be simply on-lending the public funds.  Further iterations of the facility would presumably require them to take risk alongside the public funds, for example by providing partial guarantees of their loans rather than cash.

A notable feature of hybrid funding solutions is that integrate technical assistance for capacity building and knowledge transfer

Again in the realm of hybrid finance, one of the pilot projects recently to come out of the Climate Finance Lab is a platform for promoting insurance of catastrophe risk, losses from which have averaged $180 billion a year for the last decade, with 70% of these losses uninsured. The platform consists of three elements:

  • Open source loss modelling software, allowing users such as local insurance companies to ‘plug-and-play’ a range of standardised data to calculate the potential economic damages and financial risk of catastrophic events
  • An open access web-based marketplace to link demand for risk analytics with suppliers of data, models, tools and services
  • Capacity building through provision of training to model developers and users

The Lab estimates that if this platform became the underpinning of catastrophe risk insurance markets in the Philippines, Indonesia, and Bangladesh, it could indirectly facilitate an additional $1.4 to $6 billion of property insurance coverage in these countries.

A notable feature of both these pilot hybrid approaches is the integration of capacity building, clearly signalling an intention towards expansion and replicability over time.

A Basic Typology of Adaptation Actions

In a report published at COP21 (see Chapter 7), I suggested a threefold basic typology of adaptation actions that could include  elements of private finance:

  • Hybrid actions, where mitigation and adaptation occur in the same action. For example, eco-tourism projects that are specifically designed to have economic benefits for local communities, thus increasing their resilience, as well as mitigation effects
  • Integrated actions, where planning or other regulation of projects that would occur anyway can be used to effect adaptation. For example, planning permission for a coastal housing development, purely privately financed, could include reclamation or sea defence provision that would create protection for communities beyond the development, as a form of planning gain that is now routine in developed countries
  • “Viability-enhanced actions”, where the adaptation action can be made financially viable through mechanisms such as (a) payments for services derived from the action (e.g. ecosystem services, REDD+), (b) compensation for avoiding certain actions or (c) via credit sale mechanisms such as the “vulnerability reduction credit” suggested by the HigherGround Foundation

We have also recently reported how IETA is seeking to use carbon pricing to support the financing of NDCs, including adaptation.

The Private Sector Engages

What about more ‘pure’ private sector engagement?

The Global Adaptation & Resilience Investment Working Group (GARI), launched at COP21, issued a discussion paper in 2016 which surveyed some 150 investors and other private sector stakeholders. The paper usefully summarises the position of the private sector in the adaptation landscape:

“Private sector engagement is operationally important to address the effects of climate change: The private sector owns and controls important assets and infrastructure, creates and provides products and services, and engages and supports communities, all of which will be affected by climate change. Moreover, the private sector can be an important source of expertise, management talent, and innovation to understand climate risks. It can produce and disseminate technologies at scale, develop technologies and business models to make current and future investments resilient, and bring the practical capacity and resources to develop and produce new products and services that will be important for climate adaptation. In addition, there is growing recognition that coordinated approaches to adaptation and resilience that bring the full range of stakeholders from the public and private sector together will be required to address the broad and interrelated impact of climate change. Moreover, analysts suggest that the private sector can both contribute to and benefit from the non-financial “resilience dividends” of adaptation and resilience on equity, communities, and ecosystems.”

To illustrate how private sector engagement in adaptation could be promoted, GARI has floated the idea of a fund that would invest in companies involved in one way or another in adaptation supply chains.  Under the heading of Coastal Protection, for example, there will be companies engaged in such activities as the design of early warning systems, the manufacture of advanced weather-resilient materials or the creation of flood maps.

Many of these investment opportunities would initially be found in developed countries, but an inbuilt feature of the fund would be to transfer technology to developing countries at both the company level  – for example by encouraging subsidiaries based there – or via technical assistance.  In developing countries, fund investments might initially go to companies that have cost or human resources advantages over developed country competitors, for example companies engaged in data-gathering and processing. Many of the new flood maps now in use in India, for example, are being created by a local company in joint venture with a US firm.

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Major corporations will see an opportunity in the massive “hard” adaptation  works that will be needed, and find ways to finance it

So far SMEs seem to feature as the likely actors in adaptation.  Large companies, however – and indeed multinationals – will surely also become major players. The Asia-Pacific region, for example, has scores of thousands of kilometres of coastline that are at risk from sea-level rises, and on these coasts sit twenty of the world’s largest cities.  The effects of climate change will create wholesale needs for “hard” adaptation – sea defences, new or re-sited climate resilient infrastructure, movements of populations into new and climate-resilient settlements, port and airport work (see Box), relocation of tourism facilities – as well as “soft” measures such as early warning systems.

The opportunities from this “hard” adaptation are not yet discussed publicly by large companies, but we can be sure they will move to find financing structures that allow them to benefit from the massive work programmes needed. As this occurs, the issue will be fairness (for communities and other stakeholders), not finance.

Case Study:  Singapore Airport to be Jacked Up
The new terminal at Singapore’s Changi airport will be “jacked up” against sea-level rises Photo: Nan-Cheng Tsai

One typical example of a major commercial opportunity from climate change adaptation was the announcement in Singapore’s Climate Action Plan, published in July 2016, that the new terminal at the city’s Changi airport will be built 5.5 metres above sea level, significantly higher than the 4 metres required for other land reclamation projects.  Singapore’s National Climate Change Secretariat also announced that relevant government agencies are reviewing the resilience of Singapore’s transport, telecommunications and energy infrastructure.  Adding such resilience is likely to add substantially to infrastructure costs – one DFI, for example, uses a rule of thumb of about 6% additional costs for climate-resilient infrastructure – but one person’s cost is another person’s potential earnings.

A fundamental problem for private sector mobilisation is lack of data.  Regulatory changes will throw some light on climate-related risks – the French government enforcing greater disclosure of carbon risks to businesses in public reports would be an example. But businesses really need data to understand the risks they face at the asset level, i.e. the farm or the airport or vehicle fleet that they own. As of now, such data is patchy at best and mostly doesn’t exist, for two main reasons.

Firstly, there are no agreed definitions.   There is no agreed measure for how much adaptation is going on or its effectiveness. There is no unit such as tonnes of carbon avoided (the bedrock for evaluating mitigation), which can be divided by dollars invested to understand how efficiently things are being or could be done.

Second, there are no agreed scenarios for businesses to plan for.  Very localised ones are emerging, for example in Hong Kong, but the risks businesses face will be different in different places – droughts, floods, stresses in the agricultural supply chain, variability in wind or water levels affecting even the performance of wind and hydro renewables plants. So a significant catalyst for progress would be to agree the datasets and scenarios which can form the common basis for resiliency stress testing for the same risk anywhere in the world.  Proponents of this approach argue that the IPCC model is global and uniform, and is therefore an obvious starting point for a common dataset and standards.  (We note, however, that the Task Force on Carbon-related Financial Disclosures has yet to address this point in its recommendations.).

With such a common approach in place, the same dynamic as has been seen in renewables could start to emerge in adaptation.  Seawalls would be one obvious example – an agreed stress testing scenario for sea levels would permit aggregation of demand for sea defences, which in turn would create ‘virtuous circles’ in terms of data, materials, building techniques and costs. It’s not just public assets that will need sea defences, private assets will need them too, but the dynamic applies to all physical assets, whether public or private, and their dependent value chains. Climate effects on airports, for example, would damage outcomes for not just the airport owners but also for plane manufacturers and operators, travel companies, catering operations,  and the investors in all those companies. Agreed standards would allow all of these interests to co-operate far more easily and extensively on ways to protect their assets.

The insurance industry is broadening and lengthening its data – 10,20, 50 year forecasts are needed

One adaptation tool that both public and private asset owners need is insurance.  As we noted above, only 30% of assets in the world are presently protected, and this level is much lower in the emerging world.  The insurance industry sees an opportunity in this, and is looking at broadening its data significantly, not just in terms of new geographical markets but also in terms of the duration of forecasts, which is critical to long-term insurance against climate effects.  If, for example, insurers could go beyond one-year extreme weather peril insurance and forecast 10, 20 or even 50 years forward, then products could be created that address climate effects on ports, airports, infrastructure and buildings over their working lives. Insurers want this data and so do planners and people building and financing infrastructure.  As we saw in the Climate Finance Lab case study above, seed and technical assistance finance can be injected from public funds to kickstart essential data pipelines.

Climate science and data will migrate out of government labs and into commoditised risk products

The drive to put a price on climate risks will see the commoditisation of climate science and data, currently mainly confined to government met offices and similar sources.  There is an analogy here to the commoditisation of credit risk, which over the past few decades has developed from a highly specialised analytical discipline focused on large corporations to a largely data-driven, automated function which drills down to segmented aspects of the credit risk attached to individuals.

Clearly, all of these private sector evolutions in adaptive capacity are at an early stage, but we believe the landscape for adaptation finance is far more complex than it has seemed to date and we are likely to see far greater private sector participation in ‘adaptation finance’ – perhaps just not under that name.   There are powerful incentives for innovative risk management products and techniques to emerge because some companies are threatened and others will see a commercial opportunity.

The genius of the private sector is that it is capable of scaling such products at speed. The danger is that products are confined to major markets and not inclusive of all threatened economies and communities.  This is where policymakers, aid agencies, MDBs and DFIs must step up, insisting, for example, on knowledge transfer and inclusivity as conditions of their support for private initiatives.

We recently reported on the use of ‘green covenants’ by the UK Green Investment Bank.  Why not knowledge transfer or inclusivity covenants as well?

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