At COP28, one question was on all assembled policymakers’ minds: how will we be able to mobilize the trillions of dollars needed to meet our Paris Agreement goals of reducing emissions and limiting temperature increases to less than 1.5° C by 2030?
WHAT is climate finance, and WHY is it important?
Climate finance builds consistent financial flows from public and private sectors to fund the activities required to mitigate the impacts of, or help people adapt to, our changing climate.
Globally, we’re making progress; climate finance has nearly doubled between 2019/2020 and 2021/2022. But while the annual average of climate finance flows has reached an all-time high of $1.3 trillion, it still falls dramatically short of what’s needed each year to keep us on track to limit global warming.
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Mitigating and adapting to climate change costs money, and lots of it. In fact, we need over $2 trillion dollars annually to go to developing and emerging economies, excluding China, to finance adaptation and mitigation challenges. Some solutions require big changes: new infrastructure, cutting-edge technology, and building climate-resilient value and supply chains. Many of these big shifts require government resources, but growing threats of a debt crisis can make it difficult or impossible for countries to take on loans to finance these transitions, making the climate crisis feel insurmountable for developing nations. To make capital more affordable and accessible to developing countries, we need more private-public partnerships and entrepreneurial ventures–even if the up-front dividends come in the form of reduced greenhouse gasses or avoided losses rather than dollars. (Although, research has shown that investing in climate action now can help us avoid nearly $1,266 trillion in social and economic losses, nearly five times our return on investment).
Who can help fill the climate finance gap?
A great deal of capital is still sitting on the sidelines of the climate crisis, especially when it comes to the private sector. Finding a way to mobilize this capital is critical if we are to achieve our climate goals. According to Climate Policy Initiative’s (CPI) Global Landscape of Climate Finance 2023, the private sector accounted for nearly half of the estimated $1.3 trillion in climate finance flows in 2023. Still, the flow of finance continues to fall far short of what is needed. In particular, as the CPI report cites, “less than 3 percent of the global total (USD 30 billion) went to or within least developed countries (LDCs)... and the ten countries most affected by climate change between 2000 and 2019 received just USD 23 billion; 4 less than 2 percent of total climate finance.”
Why is there such a gap? The barriers to public and private investment are because of the nature of the investments, which are often to build more climate-resilient, energy-efficient, or cleaner infrastructure. Reducing environmental degradation, building climate resilience, and improving conservation weren’t seen as “investable” by the private sector. Building and vetting a pipeline of investment opportunities takes time, expertise, and resources, which has to be weighed against the potential return. In short, investing in climate change comes down to risk and return.
USAID is focused on reducing these barriers through a combination of partnership engagement, policy support, Mission and Operating Unit support, and financial instruments.
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USAID has a history of encouraging investment in a myriad of climate challenges, including supporting the creation of green supply chains in the agriculture sector in Asia, facilitating the issuance of green bonds in India to finance renewable energy, and creating a green bank in the Caribbean to finance low carbon energy solutions. As shown below (Figure 3), finance providers have different expectations and emphases on risk and return. Actors in the “High Risk/High Return” quadrant are willing to make big bets because they believe they will generate above-average returns. On the other hand, those in the “Low Risk/High Return” quadrant are risk-averse but still expect a significant return on investment, often because of fiduciary responsibilities to their stakeholders.
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The “Low Risk/Low Return” quadrant represents an opportunity to more easily deploy capital towards climate investments in less risky sectors and markets–but in limited quantities. USAID’s sweet spot is to facilitate greater risk and build the larger ecosystem by supporting projects with a high potential for impact without demanding financial returns. This builds space for greater innovation for viable solutions that may eventually be financed by more traditional finance providers, such as the U.S. International Development Finance Corporation or other multilateral investment banks. By shifting the risk/return ratio, USAID hopes to create a channel to increase the flow of private resources to reach the ambitious target of mobilizing $150 billion by 2030.
Stay tuned for Part 2 of Bridging the Gap: Why Climate Finance Has Become a Core Part of USAID’s Development DNA to learn more about approaches to increase climate finance and where climate finance fits into international development.
Sashi Jayatileke
Sashi Jayatileke is a Senior Climate Finance Advisor with USAID’s Center for Climate-Positive Development leading coordination and providing technical leadership on climate finance to USAID and its partners seeking to mobilize finance for climate goals. She also oversees the Climate Finance for Development Accelerator (CFDA), a USAID initiative to mobilize $2.5 billion in public and private climate investments by 2030 to fund a range of climate change mitigation and adaptation solutions focused on scaling up the transition to an equitable and resilient net-zero economy. Sashi brings two decades of experience in the development and implementation of projects focused on private sector development, impact investing, women's economic empowerment, and financial inclusion.
