The Mount Washington Hotel, venue for the Bretton Woods Conference in 1944. Photo: Pinterest

Time for another walk in the Bretton Woods?

06/11/2017

Two reports last week, in the run-up to COP23, provided a(nother) wake-up call on the pace of progress in finance for implementing Paris.  First, UNEP’s annual report on the emissions gap said that current plans from national governments, and pledges made by private sector companies and local authorities across the world, would lead to temperature rises of 3°C or more by the end of this century.  This of course far outstrips the less-than-2°C Paris goal, never mind the 1.5°C ambition.   

At the same time, the Climate Policy Initiative’s annual Landscape of Climate Finance reported that finance for Paris actually fell in 2016, to $383 billion from a high of $437 billion in 2015. A more optimistic figure published recently for climate-related investment (for 2015) is the IFC’s estimate of approximately $1 trillion (though this includes ‘green finance’ elements like the EV market of $163 billion). Either figure is still only a fraction of the $6 trillion that New Climate Economy has estimated is needed every year to 2030, just for infrastructure.

If we take the CPI ‘Landscape’ figure of approximately $400 billion and add another $350 billion to cover data gaps in the report [1], we get say $750 billion as some kind of  guess as to climate finance raised in 2016 (strictly our guess, in no way ascribed to CPI). If we then take the NCE’s figure of $6 trillion a year as some kind of estimate of the financing need (though acknowledging the possible presence of apples and oranges), we are short of that need by a factor of 8. If the figure was more like the  IFC’s estimate of $1 trillion in 2015, we are a factor of 6x out.  Either would signal a dangerous failure to make progress on climate finance at the speed we need.

As it happens, last week also saw NDCi.global’s first birthday.  From our investigations during the past year, including our recent reader survey, we believe it’s clear that the reason why climate finance is not picking up pace (or is even going backwards) is that its design is, to put it mildly, sub-optimal.

Finance is not on the menu at the COP this year – a fair enough decision given the importance of progressing the rule book. But if you are going to be at the COP this week and next, here are some questions we suggest you might like to ask at any panels you attend where finance comes up. They centre around the architecture of climate finance, and some are very wide in scope and scale. They need to be: we believe it’s not an exaggeration to say that, faced with surely the biggest global challenge since post-World War 2 reconstruction, it’s time for some thinking about climate finance on a Bretton Woods scale [1], not just continued tinkering.

At the end of this blog, we make some suggestions for the blueprint we would put forward for such a ‘Bretton Woods 2’ assembly.


Note: In this blog we use the definitions of climate and green finance we have developed

If you are going to the COP in the next fortnight, here are some questions we suggest you might like to ask at any panels you attend where finance comes up

Download the questions as a PDF

1. Who’s running the show on Paris finance?

There’s a process for running the climate negotiation side of the Paris agreement, most publicly the COPs themselves.  There’s also quite a long list of UNFCCC finance mechanisms and facilities – ten of them in fact.  But there’s almost no sense that these are connected in any meaningful way, or that they are working towards a co-ordinated internal agenda, let alone that they are making the vital connections with the private finance universe, which is where the $ trillions necessary to finance Paris actually reside. If we’re 8x down on where we need to be on funding, don’t we now need to contemplate a “finance director for Paris” with a brief and powers to create a global strategy and the public/private to deliver on it?

2. Divide and conquer?

UNFCCC has the triumph of Paris behind it, and will no doubt continue to do a good job on writing the rule book for the future and then enforcing it.  But the truth is that a mechanism and skillset for negotiating complex policy and scientific outcomes is utterly different to that for creating successful financial outcomes.  The current UNFCCC finance facilities are the results of hard won battles and painfully convoluted negotiations and some important precedents have been established along the way.  But we’re in a new world where operationalization and rapid deployment is the name of the game, requiring a very different set of actors and skill sets to ensure efficient, effective and accountable financial supply and implementation.  We need financial architects to complement the policy architects running the UNFCCC.  Would it really be unthinkable to place the responsibility for the finance side of Paris in more appropriately qualified hands, and leave the UNFCCC to get on with what it does best, which is intergovernmental negotiations?

There’s one possible ready-made candidate – the IMF, a body that presently seems to lack a role equal to its global clout.  Yes, we know: for many in developing countries, it’s the Count Dracula of global institutions.  But there are growing signs that it recognises its own responsibility for some of the downsides of globalisation and more readily favours a wider spectrum of financing solutions and definitions of economic health.  As an applicant for the Paris Finance Director role, it does have the significant advantage of knowing something about global finance and how to coordinate it, and it does have credibility with the private sector.

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By the way, if it’s a concern for developing countries and especially LDCs, that splitting out the negotiation and finance sides of Paris would reduce their leverage in negotiations, we don’t believe that would be the case. The responsibility for developed countries to deliver the funding they’ve promised at the UNFCCC doesn’t go away because the delivery mechanism has moved home, and nor does the transparency over delivery.  In fact, with a highly experienced and hard-headed operator like the IMF in charge, it might very well improve.

3. Why have we got nearly ten times as many climate finance funds as there are jobs for them to do?

There are some thirty bi- and multi-lateral climate finance funds out there, but they basically only do three things – institutional readiness, adaptation and land use / REDD+. That means there are 30 agendas for applicants to navigate, all a bit different, rather than 3, which inevitably makes access many times harder than it needs to be, especially for small, more local applicants.  We can’t afford to lose the money in these institutions, as they are vital for non-commercial or experimental activities, but we can surely afford to merge a lot of them, just as you would expect to happen in any market that’s efficient for its users.  Another job for a Finance Director…

4. What’s the GCF for?

It seems the GCF itself doesn’t presently know the answer to this question, so it’s definitely one worth asking.  The answer, for sure, isn’t what it currently seems to think it’s for, which is to be all things to all people. In a logically arranged climate finance landscape, you could posit that the “free money” climate funds (see question 3) would do all the readiness and adaptation work that doesn’t have any commercial angle, while the GCF would be the prime  interface between “official” public finance and private finance for Paris-related projects. With such a clear role, it could use its precious high-risk-appetite money to create leverage of lower-risk-appetite private money, including for some adaptation finance that has revenue streams attached. There could be a simple demarcation for GCF and non-GCF projects:  If they can be leveraged, the GCF should handle them.  If they can’t, the donor climate funds, linked to ODA and private philanthropy should take them on.

5. What are the Development Finance Institutions (DFIs) for?

In an optimal climate finance architecture, the DFIs would be the critical gateway for private finance into emerging markets and new technologies.  They would de-risk initial investments into these markets and technologies, enabling private finance to get comfortable with the risks and work out longer term unsubsidised modalities for investment. At present, however, for the most part the DFIs seem to regard themselves as public sector investment banks, and are incentivised to accumulate assets with at or near commercial rates of return and often in an opportunistic rather than a strategic way.  Very little of their capital is directed towards early-stage, higher risk investments, and what’s directed at climate-related projects tends to be focussed on energy.  The DFIs argue that their principal objective must be to maintain their AAA ratings, as this enables them to provide capital at lower cost.  Leaving aside that many of their clients would burst into laughter at the notion of DFI capital being cheap, there is in fact significant scope for risk appetites to be lifted without endangering ratings or sustainability. If you’re from a developed country (as shareholders in these institutions, developed countries have board member representation), find out who your DFI board members are (normally civil servants) and challenge them to question the DFIs they govern far more closely over their roles and risk appetites.

6. Who’s counting?

It’s telling that we have no clear, ‘official’ estimate of either climate finance needs or our success in meeting them – we can only guesstimate them.  One important aspect of this statistical penumbra is that we have no idea how we are doing on finance for conditional elements of the NDCs (conditional that is on the countries receiving external finance).  These account for a significant proportion of many countries’ commitments, including those of large countries such as India.  If these conditional commitments are not met, then the Paris outcome – at 2.7°C already in excess of the less-than-2°C target let alone the 1.5°C ambition – is well in excess of 3°C.  Similarly, we presently have no way of linking what this blog calls ‘green finance’ (i.e. finance undertaken mainly by companies or financial institutions in the ‘ordinary course of business’, but which happen to fulfil NDC objectives) with the NDCs themselves. Fundamental data such as this is surely a key part of any well-designed architecture, and providing it also surely a natural role for a Finance Director, and not just a Standing Committee of non-financial-experts (as in the UNFCCC).

Blue-sky Blueprint

So what might an ideal climate finance architecture look like?  Here’s some blue-sky thinking:

There are two levels at which institution build-out and alignment needs to take place, national and global.

At the national level:
  • Governments need to be assisted with whatever capacity building and technical assistance they require to draw up “NDC Finance Plans” (NFPs), linked to other sustainable growth or SDG strategies. The purpose of these plans is to “concretise” (sometimes literally) the NDCs, taking them “from paper to projects”. Ideally such plans would be built up using a standard project categorisation system so that aggregation to lower the cost of capital can take place at a country or regional level
  • Countries then need a “clearing house”, probably run by the finance ministry or other national focal point for NDC implementation. Proposed adaptation and mitigation projects arising out of the NFPs would be brought forward to this clearinghouse by NDC implementing ministries or other promoters. Here they would be “triaged” by a process such as the Climate Finance Accelerator that was successfully run in London recently.
  • The triage mechanism would be run by an in-country team comprising representatives of governments, national and international development or green banks, local private sector investors (for example, local banks, insurers and pension funds) and the international capital markets. It would prioritise projects and categorise them in terms of how they could be financed: donor-only, private sector only, or blended
  • Projects would then be brought forward to likely intermediaries and financiers to be taken into the actual financing / transaction completion process. The “accelerator” process will thus create a pipeline of projects investable by different parties in different ways
 At the global level, there would be four key players or sets of players:
  • A “Paris finance directorate” (“PFD”) charged with co-ordinating the “infrastructure” for channelling all forms of finance in support of the Paris agreement (see below)
  • The “official” climate funds. Ideally, under the guidance of the PFD, and with the co-operation of bi-lateral government donors where funds were not directly under the control of the PFD, these would be slimmed down in number and agendas. With the exception of the GCF, they would focus on projects with no revenue stream and would be donor-reliant, providing institutional capacity building and readiness, adaptation projects with no commercial element, and very high-risk experimental financing instruments. The GCF, meanwhile, should drop out of donor-only financing and major instead on blended finance projects.  In particular, it should focus on de-risking climate projects for the private sector, giving them space to understand both new technologies and new geographies
  • The bi- and multilateral DFIs, which would have much clearer mandates on their risk appetites and be charged by their shareholders with addressing all NDC sectors, not just the easier ones to finance such as energy. Management incentivisation would be changed to focus a reasonable proportion of DFI capital on their de-risking role and not on returns-focussed commercial asset accumulation.  DFIs would work with the PFD to align their agendas and create a more strategic approach to NDC financing
  • The overall donor sector, including ODA and private philanthropy. Ideally, like the official climate funds and the DFIs, these donors would work with the PFD to align agendas, streamline application processes and become more co-operative and strategic
The “Paris finance directorate” would have the following roles:
  • Monitoring and reporting on climate finance flows, as well as green finance that is supporting NDC objectives.
  • Streamlining and coordinating the work of the “official climate funds” under its control and working with bi-lateral funds, DFIs and donors to do the same.
  • Addressing climate gaps via the redirection of climate fund or DFI capital.
  • Supporting and promoting the creation of NDC Finance Plans and accompanying project clearing house/prioritisation /accelerator mechanisms as described above.
  • Creating and owning global tools such as the standard project categorisation system.
  • Promoting the creation and sharing of data for climate finance products, for example, insurance products.
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[1] Comprised of $231 bn CPI identifies but leaves out for energy efficiency, plus guesstimates for private sector investment in transport, land use and adaptation

[2] The 1944 Bretton Woods conference was called by the UN to determine how to regulate the international monetary and financial order after the conclusion of World War II. It led to the creation of the World Bank and the IMF

 

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2 thoughts on “Time for another walk in the Bretton Woods?

  1. I’m in total agreement that the architecture needs to change, with the creation of a ‘Finance Director for Paris’ at the top of the list! And the streamlining of climate funds is a close second for me.

    I also agree that we need to separate out financial flows to projects that, at this point in time and within the current financial architecture with all its shortcomings, need grant funding. This is done on a regular basis by governments all over the world when building certain infrastructure such as fresh water systems, hospitals and schools, so applying that to NDC requirements should not be too much of a stretch.

    I have 3 questions:
    1. Your solution seems to give rise to a Catch-22 situation: because there’s always a funding shortfall in developing countries (and in developing countries if areas like infrastructure are considered), some of these (typically adaptation-related) projects, once identified, are likely to never move into implementation. This is anathema to most democratically-elected governments, since it shows their failure to deliver on what is needed, so they might hesitate to highlight these projects in the first place. (“Yes, we built this hospital but it won’t be able to help all of you in 20 years time when you get malaria or suffer from heatstroke”). How do we ensure that NDCs reflect the ‘true need’?

    2. The national-level process has similarities to many budgetary processes run by governments in terms of identifying a need, prioritising those needs, allocating funding and borrowing or using the private sector to meet funding gaps. This works well in some countries but not in others.
    Are there lessons that can be drawn from that?

    3. I like your proposed role for DFIs in the international architecture. However, I think the issue can’t be addressed without addressing the global financial architecture. The AAA rating of multilateral and OECD DFIs such as IFC and EIB is partly because of the callable capital that is backed by AAA rated countries. It’s also because of the way they are run (asset quality, risk management etc). Moving further away from a pure returns-focus could affect this, decreasing the cover provided by the callable capital and increasing the chance that it is called, potentially affecting the risk rating of the sovereign guarantors. This cosy architecture needs to change to allow what you suggest needs to happen with DFIs. (Of course climate change impacts will likely result in a similar deterioration in credit quality but that’s another discussion). Is this likely?

    1. Thanks for these comments, Malango. On your questions:
      1. I’m not sure things like hospitals are what the adaptation funds are there to finance. If the national policy is free healthcare and the country doesn’t have enough money to provide that itself, then that’s probably a job for ODA. The point is that with a proper project identification and “triaging” system, proposals would get directed to the places where they are most likely to find funding
      2. Only that we find ways to share best practice! I think there are very few countries (even developed ones) where governments are good at talking to private sector financiers
      3. I think the true high-risk projects call for quite small amounts of capital if they are properly structured. There may also be ways of separating out high-risk from low-risk activities via restructuring the institutions themselves. I think the risk aversion is as much or more about the fear of being seen to back things that fail, than it is about the actual risk of a downgrade. Finally, the callable capital is a tiny fraction of developed country balance sheets. For example I think the UK has 3 billion of called capital in the EIB and a further 6 uncalled. If all that was called, it wouldn’t feature give the size of the overall national debt, even if not only was called but then all lost. Hope this helps!

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