COP27: On the Money?
COP27's Finance Day brought the focus to the Private Sector, but what was missing?
NOTE: I was not at COP27 but watched about 15 hours of Finance Day sessions between the opener, the Nordic Pavilion, and the US Center.
As we covered last time, emerging markets are at the center of the discussions at COP27, focusing on action, not just commitments. COP27 Day 3 was Finance Day, covering how to bring capital to action.
The discussions on Finance Day primarily focused on blended finance, progress since COP26, and new programs to meet the $1T annual external contribution for developing countries needed to deal with the climate crisis. With up to $2.4T needed by 2030, the risk of inaction is significant.
In case you aren’t familiar, blended finance takes traditional public and philanthropic funding and augments it with funds from the private sector. As climate change is a massive risk, every available capital vehicle must be pursued.
There were two sides to the discussion of how funds should be used at Finance Day: Mitigation and Adaptation. Mitigation is what makes the headlines today, it’s the commitments (and hopefully action) around GHG emission reductions, the transition to green energy, carbon removal technologies, and more. This seems to be the focus for the US. Adaptation focuses more on climate risk, examining the global and local health and geographic risks. It’s important to note that adaptation only accounts for about 2.5% of climate finance.
Not all countries will be able to adapt in time, though. That is where Loss and Damage come in, which will be discussed in the second half of COP27.
Still, it’s worth noting that the day before Finance Day, New Zealand pre-empted the conversation by committing $20M to a fund focused on Loss and Damage. Over the past 20 years, climate change has caused close to $800B in damage in developing countries and will likely increase as things worsen.
This public policy move is still woefully underfunded by what is needed globally, but I’m hoping it inspires other countries to act as COP27 continues.
Kicking off Finance Day with a look at technology
At the opening of Day 3, Al Gore showed off Climate Trace, which measures mitigation efforts. Gavin McCormack talked about the technology and its application Still, Gore delivered the punch by stepping in on the technical conversation, explaining at one point how satellite imagery, public data sets, and sensor data come together with Artificial Intelligence to uncover insights into the reality of emissions. By better understanding where emissions are coming from, countries can take steps to mitigate the activity.
Adaptation is left a little behind here, but technology is still a critical tool for governments to use to protect citizens and biodiversity. When combined with predictive AI, technologies like this can also help uncover the propensity for extreme weather events, biodiversity loss, wildfires, and more.
In my experience, most companies focus on operational reductions and environmental management, which is mitigation. In some cases, depending on the industry, this mitigation could be material but certainly always worth pursuing regardless. The risks of ignoring adaptation are inescapable and broadly material because it directly impacts people and natural capital.
Laments about funding priorities aside, technologies like Climate Trace can help investors understand project and country progress over time, which is required to unlock capital further and one way to de-risk investments over time.
Capital Allocation: A Game of Risk
Private markets make investments based on risk/return analysis. Unless we are talking grants or concessionary loans, investors want a return on their investments, which puts developing countries in a precarious position.
And so, de-risking investments was much discussed because it is one of the most significant challenges to securing private investment in developing countries. This is one area where multilateral development banks (MDBs) can help. For example, the Global Center on Adaptation (GCA) and the European Bank for Reconstruction and Development (EBRD) “will cooperate across all areas of focus of the Africa Adaptation Acceleration Program (AAAP), a program launched…to mobilize $25 billion over five years to accelerate and scale climate adaptation action across the African continent.”
Simply kicking off the investment as a first-mover can de-risk it for the private sector. Faheen Allibhoy, Managing Director, JP Morgan Development Finance Institution, discussed a similar idea to how this would accelerate private investment.
She also covered some of the procedural/logistical items investors look for:
Detailed impact disclosures in the offering letter
Reporting and tracking of metrics
Standardization of products (loan, bond, equity transaction)
Another example of de-risk was provided at the Nordic pavilion, where Denmark’s Investment Fund for Developing Countries showed this slide, which outlines the progress of their SDG investment fund. Per their site:
The fund offers advice and risk capital for projects supporting the development in strategic sectors in developing countries. This includes climate, agribusiness and food, the financial sector, water as well as production and infrastructure.
The graphic shows that the Danish State is now piloting covering the guarantee. From there, institutional investors can add additional capital against a portfolio of projects with more confidence. In effect, the risk moves from the private markets to citizens, which means a social contract needs to be in place to support this effort.
It is worth noting that the IFU did not invent an entirely new framework to follow for the SDG Investment Fund but utilizes what has been previously built. This echoes Allibhoy’s third point above that investors want something familiar.
Over Finance Day, the favorites were these familiar investment vehicles like loans, project finance, and insurance. When innovation was discussed, it centered around leveraging these existing products in new combinations, but always with an eye on de-risking.
Missing were radical new ideas for capital allocation and concessionary loans and grants. Another challenge I didn’t hear discussed is how much of the global economy is US currency-based, which can slow international capital deployment to local projects.
Investors want what’s tried and tested, but that might not be enough. I’m worried that when we place risk first and leverage the existing systems that have been funneling money and resources from the Global South to the Global North, we miss the opportunity to drive change, lift people in developing countries, and drive equitable growth.
In other words, the chance to build a more equitable world while solving the climate crisis is passing us by to manage financial risk and maintain the status quo.
Another attempt at carbon credits
Not all discussions involved tried and true financial products. The US is making another attempt at something tried but not proven yet. John Kerry, the special climate envoy for the US, announced generating funds through verifiable and high-quality carbon credits, dubbed the “Energy Transition Accelerator.” This would supplement other efforts underway, like blended finance.
The reception of the announcement was mixed due to the checkered history of carbon credits (for example, you buy an offset from a forest, but it burns down). Kerry assuaged fears in his speech with well-designed points and contingencies, and many corporates seem interested, but only time will tell how it will play out.
India’s first green bond
A few days after Finance Day, India announced its first green bond to attract international investors. Interestingly, the bond will be issued in Indian rupees, not dollars. As stated above, going around the US dollar can make the investment risky for international investors, meaning the investments might primarily be domestic but could allow for a more effortless flow of funding to the local level.
Let’s use this as an opportunity to look at how critical the local level is to these investment products.
Mari Pangestu, Managing Director of Policy and Partnership, World Bank, described a project in Ethiopia and its success in the last US Center panel. She noted the approach of local stakeholder engagement in the decision-making process.
What's interesting about it was the innovation about involving the rural community to talk to the partners and the government what needs to be done.
She goes on to describe the triple win of the project:
The land being more productive
Carbon reserves and climate impact
The livelihood increase
and a fourth, the increase in asset ownership by women
So, local engagement is critical for project success and appears to be a multiplier, but again you have to unlock international funding and translate it into local currency. India could garner international investment with a well-developed framework that involves local stakeholders like the Ethiopia project.
Another consideration comes from an interesting comment by Juan Pablo Bonilla, Manager of the IDB's Climate Change and Sustainable Development Sector, on the same panel.
If ratings agencies, instead of penalizing at the country level, start rewarding resiliency, you are going to start having the right incentives from the public side to maybe then have less premiums from the insurance companies and the private sector.
As if the US government was listening, the US removed India from its currency monitoring list that same day (seemingly unrelated). None of the country’s credit ratings have changed, but they don’t change very often as you can see here:
I believe that India and other countries will be able to secure international investment when investors are convinced that the flow of capital is eased through local currency and engagement. This requires hard work on the front end to secure the investment, as Allibhoy called out, and on the execution, as Pangestu described.
If traditional finance is the path forward, the world must watch for exploitation and neo-colonialism. When risk and returns are put above all, we will only exacerbate the problem and solve nothing.
So let’s watch and hope. If a developing country can quickly execute funds and prove impact through metrics, perhaps backed by technology, it will create that tried and true pattern. This is something every investor would want and provide non-pecuniary benefits for all.