In Part 1 of this series we looked at the government and financial actors in the Paris landscape. In Part 2, we took a stab at describing the sprawling web of organisations that influence these actors in various ways. This was a challenging task as many of them play a number of different roles. But we have still had an excellent response to this series as an “explainer”.
In this final post, we attempt to describe how the landscape needs to change. We share some important ideas for speeding up and scaling climate finance. We urge you to read and comment. If you agree with some or all of what we say, please share the post as widely as you can to help get Paris finance moving.
Technical terms are marked with a* and explained briefly in the Glossary
It is clear from the previous two commentaries that the Paris finance landscape is a crowded and complex one. It is also clear that the massive scale-up in financing that’s needed is still proceeding at a very slow pace.
In our view, what’s causing the hold-up is confusion in a number of areas, including over leadership, priorities and linkages. We suggest in this post five “anchors for action” to help address this confusion by allowing the different players to focus and strengthen their own work, and then align it with the work of others in far more effective ways.
We emphasise from the outset that these are not fully fledged proposals, more ‘seed crystals’ around which thinking can coalesce. Whatever your views, it is surely fair to say that some fixed and firm anchors are now needed.
The Anchors for Action
The five anchors for action we propose are as follows:
- Separate out finance and implementation of Paris from negotiation and MRV*, and create a new agency for the former operational tasks
- For adaptation, establish a “reference” scenario for warming on which planning can be based and around which design specifications and financial products can be created
- Make as much data as possible available on an open-source basis, again to facilitate the creation of financial and other products such as insurance and climate-risk scoring systems
- Establish a standard categorisation of climate actions, which can be used to make country sustainable development plans (including the revised NDCs) far more ‘finance-friendly’, and enabling the aggregation of smaller projects into portfolios which are big enough to be financed
- Rationalise the climate funds and reform the mission and risk appetite of development finance institutions (DFIs*) to ensure they are fully-aligned with their necessary role
* MRV = Monitoring, reporting and verification
Anchor 1 – Divide and Accelerate
The role the UNFCCC envisages for itself in the financing and implementation of Paris has never been clear to us. It has a Standing Committee on Finance, which has mainly devoted its efforts to collecting data on finance flows, and houses a number of climate funds, notably the GCF*. Its Secretariat has a small team that works with private and DFI financiers. But we have never seen any evidence of its ambition to take a leading role in the finance sphere, despite the ‘position being vacant’ for quite a while.
We believe it is time to acknowledge that the UNFCCC is indeed not the right entity to promote the financing of the Paris Agreement, and move on to a different arrangement. (In reaching this conclusion, by the way, we are encouraged by the fact that UN Deputy Secretary General Amina Mohamed has been signalling a similar view in recent statements.)
Under this new arrangement, UNFCCC would be charged with what it has been good at to date, which is negotiation and science. In particular, it would oversee finalising the ‘rule book’ for the Paris agreement and establishing the protocols for monitoring, reporting and verifying how countries stick to their undertakings. These responsibilities would include the raising of ambition levels over time, and the settlement of ‘climate justice’ issues such as the level of public money to be made available for adaptation, but not the finding or deployment of that cash.
A new agency could then be created, which would be responsible for promoting and co-ordinating efforts towards the physical implementation of NDCs and the financing of those efforts (let’s call it “FinImp”). We use the words ‘promote’ and ‘co-ordinate’ because although it may be desirable for FinImp’s credibility to have some resources of its own to deploy, its main role would be as a convener between the financial actors and influencers we have identified in Parts 1 and 2 of this series, seeking out and promoting best practice as this starts to emerge. It would not be a convention or other formal framework, but it would be required to provide periodic performance reports to the UNFCCC as mentioned below. It would need to have truly global governance, but at the same time an ability to act flexibly and responsively.
The in-house resources available to FinImp could be both financial and non-financial. In terms of financial resources, FinImp might become, for example, a new home for the GCF and other climate funds, once rationalised (see Anchor 5). Under the heading of non-financial resources might come tools such as the standard categorisation (see Anchor 4) and the corralling of data (Anchor 3).
FinImp would need to be staffed by a mix of policy and finance specialists. Since its key function would be to promote the kinds of blended finance packages needed alongside purely private finance instruments such as green bonds*, its finance people would need to have a good understanding (collectively) of finance across the board, from donor to DFI to commercial finance, including both domestic and international capital markets.
FinImp’s other key role would be to provide the linkage between the physical implementation of the NDCs and the formal measurement of Paris outcomes in terms of the GHG reductions etc, which would be done by the UNFCCC (see Box). This would clearly mean that there would need to be good working and reporting arrangements between the two entities, but with clarity on their respective roles, this should be very achievable.
FinImp and UNFCCC
It may be helpful to give a ‘worked example’ of how we see the split of responsibilities between FinImp and UNFCCC. Thus, Country X might have submitted an NDC calling for a GHG reduction of Y% via the installation of Z GW of renewable energy generation. The investment plan of Country X (which FinImp might have helped it find the resources to produce) would then specify that the Z GW was to be met by building 10 solar plants and 10 offshore wind plants. FinImp might then assist Country X to find financing for these plants, but UNFCCC would be responsible for recording and verifying that the capacity needed to meet the country’s offered GHG reduction target had indeed been installed for the purposes of the formal Paris agreement process. ‘Carbon’ evaluations of the project would likely have been part and parcel of the project financing and could thus be the basis for the verification process.
Anchor 2 – A Benchmark for Adaptation
For adaptation, and allied to Anchor 3 on data, we have heard from many sources of the need to establish an agreed scenario on possible warming. This would allow all actors to know what they should be planning for in terms of adaptation measures and thus to be able to create standardised approaches and specifications. For example, the Asia-Pacific region has hundreds of thousands of kilometres of coastline which will need various forms of action to either protect it from or adapt it to inundation. These would include everything from sea walls to altering the type of crops and coastal vegetation grown to relocation of human settlements and infrastructure. Having an agreed scenario would enable international co-operation on planning and implementation, and at the same time allow designers to specify the type of hard adaptation needed; manufacturers to gear up for production in volume and thus at lower cost; and financiers to create products such as insurance against worse outcomes than the benchmark.
There is clearly a major political element to this anchor, namely the risk that if the adaptation scenario is set at say 2°C while the Paris mitigation ambition remains at 1.5°C, this would at best create a gap between mitigation and adaptation reference points or, worse, the 2°C figure could subconsciously become a norm for the mitigation ambition.
These risks are real but we believe that, first, if we have the separation of the UNFCCC process from the financing process suggested above, there would be greater clarity on the continued prevalence of the Paris mitigation ambition at 1.5°C. Second, while setting an adaptation reference that is higher than that for mitigation means there is a danger of “over-adapting”, should the mitigation target be met. Nevertheless the precautionary principle should surely apply in this case. If the 1.5°C was achieved, then you might have some seawalls that are a metre higher than they need to be, or some villages relocated a mile further inland than has turned out to be necessary, but these would be far less costly outcomes than having to later retrofit for failure to meet the ambition.
It is important to emphasise that the reference scenario would be just that – a reference. Countries or corporations could choose to ignore it and set their own scenarios, either more optimistic or pessimistic. But it would now at least be transparent how the ‘personalised’ scenario differed either up or down, and financiers and insurers, for example, could price their products accordingly. For example, a country choosing to persist with an adaptation planning scenario seen as too optimistic by reference to the global scenario could find its sovereign rating affected and its cost of debt increased.
Who would fix the adaptation scenario is a moot point, but one possible comparison would be the setting of global capital ratios for financial institutions by the Bank for International Settlements under the Basel agreement.
Whichever way you look at the matter, the absence of a clear reference point will severely hold back adaptation actions, and will raise costs that could be avoided by standardisation.
Anchor 3 – Data, Data, Everywhere
As individuals we are all experiencing the data invasion – we are bombarded by it daily and also, mostly unwittingly, we provide it. Mostly this data is used to sell more stuff, but what’s striking is how lateral thinking can also turn ‘dumb’ data into highly useful products. For example, satnav apps use the GPS feature in the phones of several thousand drivers at any given moment to work out and communicate back to these drivers where traffic is slowing or jammed.
Similarly, microfinance providers are now using data from mobile money platforms to create sophisticated credit scoring systems for people on whom little or no “official” data exists. The availability of these scores dramatically expands the ability of these financiers to create affordable financial services appropriate for these populations.
The examples elsewhere are legion, but so far (as far as we can see) the smart use of data has not spread much in the climate finance space. There are micro-insurance products for agriculture whose payouts are based on physical data such as rainfall levels that aren’t open to interpretation and so don’t involve the costs of loss adjustment. But these have market penetration rates of maybe a few percent. Similarly, there are urban planning platforms that merge all kinds of datasets to create ‘smart’ and real-time advances on traditional planning systems, but these are few in number as yet, and struggling to find funding. Similarly, services such as Google Earth have started to be linked to solar intensity data to enable individuals to see if their rooftop could profitably house panels, but these systems are presently confined to the USA.
It’s not clear if the relative dearth of data-based services results from the data simply not existing, or not being available, or some mix of the two. With access to the necessary data, the private sector could create products ranging from insurance to mapping to climate risk scoring. Impetus is needed both to open-source as much data as possible from as many sources as possible, and then seed-fund creative usage of this data.
Our suggestion: make FinImp the home for a new climate finance ‘data commissioner’ charged with promoting both aims.
Anchor 4 – A Filing System
This anchor for action is probably the simplest, quickest and cheapest to achieve of the five, but would nevertheless in itself be transformational in terms of the chances of NDC-related projects getting financed. We recommend a simple, standardised categorisation of climate actions, whether adaptation or mitigation, at a level of granularity that allows projects to be put into identified folders and sub-folders so people can find them much more easily and also aggregate them.
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To take just one example: at present, a typical NDC will talk vaguely of creating X% of emissions reductions via the installation of Y GW of solar energy installations in country Z by date X. This is of no use to anyone looking across several NDCs – say in a region like the Caribbean – and trying to understand the manufacturing or financing opportunities they may represent. As illustrated in the figure below, a sector like “solar” needs to be broken out to at least three further levels of granularity. The first might be a distinction between on- and off-grid. Under off-grid, there would then be subcategories of say urban and rural and, under rural, further sub-categories of home rooftop systems and village-level mini-grids. For manufacturers or financiers to know that 15,000 village mini-grid systems are looked for in East Africa over the next 8 years becomes a graspable opportunity, intellectually, practically and economically.
Note: this example is purely illustrative of an approach to categorisation
This standard categorisation – which we suggest, is housed in FinImp – could be created on a rolling basis within a few years, by one or more consultancies working with financiers, planners and manufacturers to understand the level of granularity required and the best way of structuring the system. The most important sectors, like renewables, could be addressed first. The categorisation tool would then be freely available to countries as they develop their NDC and related sustainable development investment plans, and to manufacturers and financiers as they seek to create products to meet the needs. Everyone would now be using the same language and the same filing system, and, to the extent that accepted levels of GHG reduction could be put against certain project types (as has been done before in creating programmatic certified emissions reduction instruments), this would also help with the UNFCCC’s verification task.
Without some system along these lines, and because of the transaction size at which mainstream finance needs to operate to be cost effective, only the largest projects will ever get financed. Smaller projects that are nevertheless vital to the Paris Agreement will struggle to attract attention and money unless they can be bundled together into fundable packages, much as mortgages or car loans are today.
Anchor 5 – Upcycle the Climate Funds and the DFIs
Effectively employed public finance is critical to implementing the NDCs. Apart from what governments find to put in their national budgets, that means the global climate funds, the aid agencies and the development finance institutions (DFIs*) including, for present purposes, the multilateral institutions like the World Bank and the regional and bilateral development banks.
The purpose of public money must be directed to just one thing: gearing*. For those not familiar with the term, gearing is the notion that, as in a car’s gearbox, one small cog (public finance) can be made to connect with larger cogs (concessional and private finance) in such a way that its speed of rotation is magnified many times by the time the car’s tyres turn on the road. In the same way, to succeed in financing Paris, public finance in the smallest possible quantities must be made to efficiently lock into the largest possible quantities of private finance. We believe that the present public finance ecosystem is not achieving the efficiencies needed and will not be able to do so without a radical overhaul.
There are two main issues here. The first is multiplicity of sources and agendas, and the second is levels of risk appetite.
The climate funds are an illustration of the first problem. There are 22 multilateral funds dedicated to climate change action, the largest among these being the Green Climate Fund. Nine of these funds focus solely on mitigation (most of these being REDD* funds), six solely on adaptation, with the other seven covering both. These funds have had just under $30 billion pledged to them over the last decade. There are a further six bilateral funds (i.e. funds created by a single country).
While some of the activities of these funds have been exemplary in terms of their risk appetite – see for example our reports on projects in Jamaica and Fiji that were seeded by climate funds – there is ample evidence that countries find them hard to access and confusing to apply to. Of course, there are dangers in over-consolidating, but close to 30 funds in total is surely at least three times as many as is efficient, both in terms of administration cost ratios and in terms of agenda complexity.
The climate funds in our view need to be reduced in number via rationalisation, and their agendas streamlined accordingly. With a better categorisation of climate actions as called for in Anchor 4, it should also be possible to structure how these funds address the different categories of climate action identified, with the result that it will be much clearer to applicants where they might find appropriate funding, and much less of a 1000-piece jigsaw puzzle as to how they fit the various funders’ agendas together and respond to their differing reporting requirements. Carrying out such a rationalisation will mean countries having to be much less ‘precious’ about pet agendas and much more willing to see the big picture and act to promote key global priorities.
The aid agencies and DFIs also suffer from a multiplicity of agendas and much of what has just been said on that topic applies here too. Shareholders of the DFIs (typically national treasuries or aid departments) need to educate themselves far better on this issue and on the issue of risk appetite. We have covered elsewhere the growing calls for DFIs to take much more risk than they presently do, both in terms of their position within financing structures and in the localisation of funding delivery.
The aim of the changes we suggest is to massively increase the gearing that DFIs are achieving – a good example has been set by the EIB, whose target is now to achieve 15x external funding against the funding it provides. There’s a need for some transparency, here and DFIs could be required to report publicly on their gearing according to an agreed standard formula. Staff incentives could then be linked to measures of this kind rather than measures of asset growth or profitability.
DFIs point to their typically AAA ratings as a reason for the lower cost of funding they can often achieve for clients, and say they can’t take more risk and still keep these ratings. This is fair enough, but we believe they could be smarter about creating ‘sub-wallets’ within their portfolios to deliver much higher risk funding in small but highly catalytic amounts that would not threaten the overall rating. For example, every DFI could have a seed equity fund to act as public venture capital for climate-related commerce.
Switching the Power Source
In this series we have used the analogies of landscapes and maps. We might close with a different analogy, but one that nevertheless seems appropriate given the topic.
An internal combustion engine has some thousands of moving parts, with resulting complexity and costs to build, operate and maintain. An electric engine has about one tenth the number of moving parts, accelerates far faster, and is far cheaper to run and service.
Isn’t it time for the Paris finance juggernaut to switch its power source and go electric?