Blended Finance, the Remedy for Climate Transition?

Two-thirds of the worldwide emissions of greenhouse gases are attributed to developing and emerging market economies, many of which are vulnerable to climate change. In order to cut pollution and adjust to the tangible impacts of climate change, these economies may require major funding in the years ahead.

Many also have significant debt and tight budgets as a result of the pandemic, as well as greater government borrowing rates alongside rising interest rates globally, making it extremely challenging for public finance to address pressing climate financing demands.

Because of these issues, mobilizing private wealth on a big scale would be critical to accomplishing their climate goals. Financial markets alone cannot complete the task, but integrating public and private resources provides distinct benefits by lowering investment risk and generating more finance. Multilateral development organizations and global financial institutions can help by developing blended finance structures to change the risk-return profile for emerging markets during the environmental transition.

It is critical to begin by creating an appealing investment climate and rules that encourage private participation. Environmental policies and finance complement each other since better policies draw private sector investment, which aids in meeting policy objectives. Carbon taxes are the most effective instrument for making high polluters pay for the environmental expenses they incur and thereby channeling private capital toward lower-emitting initiatives.

Climate regulations and pledges in general, such as the Paris Agreement’s Nationally Determined Contributions, can indicate to investors to drive investment toward a low-carbon market. Creating a solid environmental information architecture for information, taxonomy, and disclosures could also be beneficial.

Multilateral banks for development and foreign financial institutions play an important role in attracting considerably greater amounts of private financing. They can offer technical assistance in developing projects, strengthening governments’ administrative ability, and developing local currency securities markets to increase the pool of domestic investors.

Banking institutions can raise the anticipated risk-adjusted yield for private investors by volunteering to be the first to bear losses in green finance instruments and securitizations. With proper governance, public support can help minimize the moral hazard connected with promises, which involves the danger that profits are privatized while damages are socialized. As a component of their annual $100 billion contribution to emerging and developing countries, developed economies could support public equality.

Furthermore, equity funds can leverage existing public funds. When it comes to developing and emerging economies, development bank contributions are equaled by less than 30 percent of the quantity from private sources. Smaller transactions by the World Bank Group’s International Finance Corporation and Amundi SA, Europe’s biggest investment group, contrast. The IFC-Amundi structured vehicle received 16 times the amount of private investment.

Green infrastructure investments would continue to be a major tool for less-developed markets, and banking institutions would inevitably perform a fundamental and long-term role. More climate finance might be routed through development banks to facilitate such initiatives by growing their capital base and collaborating with the private sector.

Public funds, especially those from development banks and global financial organizations, might help establish greener or climate-structured funds in which volatility is divided among lower tiers, potentially attracting much more private investment to acquire the senior tranches.

Furthermore, if green or climate institutions put money into climate project equity, banking institutions and corporate lenders may be more ready to lend. As a result, public funds offer incentives at the financing and project levels and can be combined with private and government funds.

The Opportunity for Change

Regrettably, corporate climate finance confronts several challenges, ranging from future policy uncertainties and technology costs that boost the cost of capital to additional impediments such as limited data and unappealing risk-return profiles. Despite these obstacles, corporate climate capital can assist emerging economies in meeting the Paris Agreement’s goals.

Innovative financing arrangements can attract more investors with varying risk levels and investment horizons. Investment products such as green stocks and bonds can assist increase the investor base in greater emerging nations with functional bond markets by attracting institutional investors such as insurance firms and pension funds.

The Bottom Line

Climate financing is crucial for several reasons. Providing additional investment can fast-track the growth of the industry as well as provide an extra financial vehicle for investors.