By Katherine Browne, Daniel Duma, Miquel Muñoz Cabré, Felipe Sanchez, and Zoha Shawoo, Stockholm Environment Institute
Next week’s high-level summit for a “New Global Financing Pact” will bring together world leaders and representatives from major multilateral financial institutions, civil society organizations (CSOs), and the private sector, to pioneer new ways to steer financial resources to simultaneously address climate change, biodiversity, and sustainable development challenges. The Paris event builds on the Bridgetown Initiative, a call issued in 2022 to transform the current multilateral financial system by making it more just and channeling financial resources toward solving these multiple crises. Proponents of the initiative advocate sweeping reforms to reduce debt burdens, free up additional funding for climate change mitigation and adaptation, and channel private finance to both climate and sustainable development. Indeed, it is hard to imagine the world achieving these global aims without devising more effective financial tools to get there.
How should the world address these calls to remake the current international financing architecture? What changes are needed?
Our research at the Stockholm Environment Institute spans a range of topics related to finance to address climate change and sustainable development – including matters on financing green infrastructure, industrial transitions, cross-border climate risks, fair and effective adaptation, and loss and damage. Based on this work, we propose seven measures that can inform the discussions at the Summit, catalyze financial reforms, and retool financial levers in ways that can unlock funds needed to gain traction on these intertwined crises.
Prioritize climate-critical infrastructure in debt restructuring processes.
Context: In countries with non-investment-grade credit ratings, most large-scale investments critical to climate and development are conditional on governments being able to issue sovereign guarantees. The sovereign debt crisis plaguing numerous countries, particularly in Africa, has led to debt restructuring proceedings and arrangements with the International Monetary Fund (IMF) that place limits on contingent liabilities, including guarantees, for the government. These provisions are effectively preventing financial closure for climate-critical infrastructure, such as renewable energy projects. These delays will further slow the deployment of infrastructure even in countries with a pipeline of otherwise viable projects.
Actions: Multilateral financial institutions (MFIs) should explicitly address climate infrastructure in debt restructuring processes. Given the urgency and magnitude of the development and climate challenges, the world cannot risk another “lost decade.” Solutions must be found, particularly for clean energy to continue to be deployed even during macroeconomic shocks and their aftermath.
Establish currency safeguards in climate-infrastructure lending.
Context: In many low- and middle-income countries (LMICs), high interest rates and short maturities make local currency finance an unattractive option for climate infrastructure. Thus, the predominant source of finance for infrastructure has been hard currency, long-term concessional lending, particularly through development finance institutions (DFIs). This, however, exposes the borrower (and ultimately the government) to currency risk, making debt service more expensive over time. This risk materialized recently in the economic aftermath of the pandemic, as rising interest rates in the US and Europe led to local currency depreciation, exacerbating debt distress. This is particularly relevant for investments where there is a currency mismatch between revenues and debt service, such as in renewable energy.
Actions: DFIs should establish currency risk safeguards in their lending. In the same manner that DFIs set social and environmental safeguards, DFIs should determine under what conditions hard currency loans would create unsustainable debt burdens detrimental to the development mandate of borrowing countries. When these situations arise, DFIs should consider subsidizing currency hedging as an effective way to achieve their mandate.
Address cross-border climate risks by investing in systemic resilience.
Context: Climate risks are complex and interconnected. The impacts of climate change in one country may spill over to neighboring countries and those thousands of kilometers away. Drought in wheat growing regions, for example, can lead to price spikes and famines in import-dependent countries. Risks travel across countries via ecosystems, infrastructure, river basins, supply chains, commodities, and migration. Most DFIs steer climate risk funding to national scales that do not address cross-border, systemic resilience.
Actions: DFIs should make interventions to address cross-border systemic risk. DFIs should overcome their current siloed approach and seek to enhance the resilience to climate risk at the regional and global levels. DFIs could begin to pursue systemic resilience in two ways. First, the World Bank and regional development banks should increase adaptation funding for regional cooperation and risk management. Second, DFIs should support institutions in establishing innovative approaches for long-term cooperation between countries, such as investing in strategic grain storage capacity.
Mobilize multilateral finance to decarbonize industry in emerging economies.
Context: If the new green industrial revolution is to be both effective and fair, it must happen globally. A major hurdle for industry decarbonization worldwide is access to finance. In emerging economies, this challenge is compounded by both higher risk premiums and the precedence that other national development priorities have in multilateral assistance decisions. The UN Secretary-General has called on wealthier countries to support climate mitigation in emerging economies, and the Group of 20 (G20) has also highlighted the need for capital mobilization to support the deployment of climate technologies. Nevertheless, the coordination needed to make this happen for industry is lacking.
Actions: DFIs should mobilize blended finance and technical assistance for new facilities to bring breakthrough green technologies to industries in emerging economies. Leaders from the Global South can coalesce under the Bridgetown Initiative to demand such dedicated assistance and signal their willingness to decarbonize heavy industries.
Leverage private sector mobilization through risk mitigation programmes.
Context: There are high expectations about the role that private sector finance will play in closing the climate investment gap. Yet commercial investors have specific mandates with regard to returns and risk tolerance, stemming from the expectations of their depositors and investors. Finance only flows when projects and investment opportunities fit investors’ mandates. Certain sectors are particularly suitable for private finance, such as utility-scale renewable energy. However, investment has been limited in some regions, including much of sub-Saharan Africa. To achieve climate and development goals, this must change.
Actions: DFIs should increase support for risk mitigation programmes that help projects in developing countries meet the risk/return criteria of private financiers. With technical assistance, project preparation, and risk mitigation and sharing, projects in developing countries can attract private finance investment. DFI-backed risk mitigation programmes reduce the cost of capital, making projects more affordable. Even in countries facing difficult macroeconomic conditions, such programmes have succeeded in securing finance for important but risk-laden projects, such as non-creditworthy utilities. Such initiatives need to be expanded, improved, and accelerated.
Give affected communities sufficient loss and damage finance and decision-making power.
Context: Following the decision to establish a new loss and damage fund at UNFCCC COP 27, negotiations continue to decide how it will work and who will provide the funds. SEI research has found that for loss and damage finance to be both fair and effective, it should be in the form of grants, largely drawn from public finance. Funding must not exacerbate existing debt burdens in recipient countries. Such funding should come with few strings attached. Additionally, loss and damage finance should include a high level of local ownership, giving affected communities decision-making power over the use of funds.
Actions: DFIs should provide reconstruction grants and suspend debt repayments in the aftermath of a natural disaster, freeing up fiscal space for affected countries to fund their responses. This should be in addition to any support provided to the loss and damage fund. To ensure an inclusive and effective recovery, a proportion of reconstruction grants should be earmarked to flow directly to local communities. Reconstruction grants should avoid stringent access requirements. They should be managed and utilized by local actors according to their needs.
Above all, modernize the financial system to improve its ability to address these intertwined, global problems.
Context and actions: The current financial system requires a rethink, and time is of the essence. The upcoming summit and the Bridgetown Initiative are starting points. Key players will debate various possibilities and their details, but all involved should be able to agree on one thing. To make progress towards a more equitable and climate-resilient world demands change.
Katherine Browne, Daniel Duma, Miquel Muñoz Cabré, Felipe Sanchez, and Zoha Shawoo are researchers at the Stockholm Environment Institute.
This perspective piece is part of a series authored by researchers from the Stockholm Environment Institute (SEI), published in partnership with IISD. In the series, SEI researchers examine ways to implement the 2030 Agenda without abandoning principles, diluting aims, or leaving people behind.