International climate finance: key to a global deal

19 March 2010

Financing to address the impacts and causes of climate change was one of the success stories of Copenhagen. Although the overall outcome fell far short of expectations, the commitment by developed countries to provide $30 billion in short-term funding, and $100 billion per annum in long-term funding by 2020, represented a significant step forward in the UN climate negotiations. Having made the commitment, the challenge now facing the international community is agreeing how exactly to deliver and transparently use the funds.

The immediate focus is mobilizing the short-term funding. It is generally accepted that the $30 billion – due to be delivered over three years to 2012 – will come principally from the public purse in developed countries. The EU has already pledged $10 billion, Japan $15 billion and the US a relatively meager $1.8 billion. The remainder will be made up from contributions from other OECD countries, such as Canada and Australia.

A key question is how this funding will be delivered. Developing countries’ preference is to see the finance directed through central funds under the UNFCCC, such as the Adaptation Fund, which is collectively controlled by Parties. In contrast, a lot of developed countries prefer to use bilateral arrangements and other multilateral-type funds such as the World Bank’s Climate Investment Funds, or the Global Environment Facility. Developing countries are often wary of these funds because of previous difficulties in accessing finance from these sources.

Another concern that developing countries have is whether the funds pledged will actually be “new and additional”. Diversion of existing aid flows to climate change funds has been identified by a number of NGOs as a possibility. At a time when public finances are under considerable strain in developed countries, some governments will certainly find it politically challenging to increase funding for international causes while cutting back on domestic services.

Despite such challenges it will be crucial for a meaningful amount of funding to begin flowing as soon as possible. This is necessary to rebuild trust between developed and developing countries, much of which was lost in Copenhagen. Achieving this will also require agreement on how both the flow and use of the funding will be monitored, reported and verified. Without such transparency finance negotiations are unlikely to progress far.

Negotiators and observers alike will be looking to the UN Secretary-General’s recently established ‘High-Level Advisory Group on Climate Change Financing’ for direction on solving many of these issues. This body will be chaired by the Prime Ministers of Ethiopia and the UK and consists of heavy-weight economic and financial figures, including President Obama’s chief economic advisor, Larry Summers, international financier George Soros and ministers from China, India and South Africa. The group’s objective is to provide practical proposals on how to scale up both the short and long-term financing agreed in the Copenhagen Accord.

Scaling up the long-term financing represents a particular challenge. Unlike the short-term funding, which will largely come from government coffers of richer nations, the scale of the long-term finance flows will require considerable private sector involvement. Carbon markets, or more precisely offset credit mechanisms such as the CDM, were long seen as the obvious mechanism for transferring finance. However, with uncertainty over the establishment of carbon markets in the US, Japan and elsewhere, the potential for this type of mechanism to deliver in the medium term is now questioned.

Increasing attention is therefore turning to additional and alternative sources of financing. Revenues from economic instruments placed on emissions from international aviation and maritime transport, for example, could amount to tens of billions of dollars per annum. A Tobin Tax – essentially a small (e.g. 0.5%) tax on all international financial transactions – has also found support in some areas.

One of the more promising and large-scale sources of untapped finance are institutional investors, such as pension funds. Many of these organizations are eager to invest in the considerable low-carbon technology and infrastructure opportunities in developing countries. At present however the risk profile of such investments is often too high to justify the kind of predictable and steady investment projects that these funds are seeking. Several proposals to lower these risk profiles by leveraging smaller amounts of public finance have been made, including from the Institutional Investors Group on Climate Change (IIGCC), which represents around 4 trillion in assets under management (see IIGCC Financing Mechanisms).

Unleashing all these sources of private financing, however, depends on policy and decision makers agreeing and then implementing the right regulations and incentives. At present there remains considerable resistance in some developing country governments to the role of private sector investment. Convincing governments of all stripes of the crucial and beneficial role of private sector finance and investment will be one of the key challenges for all those seeking an effective global climate agreement in the next 12 to 24 months.

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