The recent UN COP26 climate negotiations have once again revealed how the world’s wealthiest nations are failing to deliver on their commitments to the developing world. This was perhaps most powerfully symbolized by the failure of OECD countries to provide $100 billion a year in capital as promised. Yet a far greater shortcoming of public climate finance is its persistent failure to attract the private capital that increasingly appreciates the long-term imperative of climate action and will be essential if the world is to spend the trillions necessary to combat climate change.
Multilateral Development Banks (MDBs) are well placed to help, including by developing strategies to mobilize climate capital financed by rich countries. Mobilizing public finance to unlock private capital has become a cliché. But, even if the problem is not new, the time has come to refocus attention.
How is public capital used?
Total climate finance averaged $632 billion a year in 2019/20, up nearly 75% from the start of the decade, according to the Climate Policy Initiative’s latest annual survey. Public capital accounted for 51% of total investment, but the bulk was invested domestically — OECD support for climate efforts in developing countries was only 12%, or $78 billion (see Figure 1 ). Developing regions were heavily dependent on public capital, led by sub-Saharan Africa, where public finance accounted for $17 billion out of a total annual investment of $19 billion (see Figure 2).
It is estimated that $4 trillion to $5 trillion of investment per year is needed to meet global decarbonization goals, sums far too large to be expected from public funds. Thus, private capital will have to take a big step forward, and quickly. Despite growing commitments from the investment community, private capital alone is unlikely to close the spending gap. In developing economies, this is largely due to investment risk (real and perceived) and related illiquidity. Risks are varied, but include construction, policy/legal, currency and customer/credit. Instead, it is expected that public funds and support will be needed to help mobilize this private investment – this has been the assumption for some time.
There are several reasons why MDBs are well placed to lead the public sector effort to mobilize private climate capital. For starters, they can mitigate at least some of the risks for private investors given MDBs’ knowledge of operational and political conditions in the developing world, and their experience in project planning and lending. MDBs also have experience supporting public sector investments (and most climate infrastructure will be government-owned). They are efficient, leveraging collateral to borrow up to 12 times the funds donated by their government shareholders. And finally, the World Bank’s shared ownership structure ensures that while most countries participate, the wealthiest economies bear the bulk of the financial burden.
MDBs also have experience supporting public sector investments (and most climate infrastructure will be government-owned).
In recent years, MDB white papers have embraced this idea. However, in 2020, MDBs only mobilized $0.26 of private climate capital for every $1 of MDB investment in low- to middle-income countries ($9.9 billion out of $38 billion), according to a joint self-declaration. While this undoubtedly reflects institutional inertia, it is also likely symptomatic of the conservatism that stems from shareholder (government) expectations.
Changing MDB incentives to stimulate more private capital
As the World Bank and others have noted, more successful mobilization of private investment likely begins with shifting the strategic focus of MDBs to achieve transformation. From this, according to the story, stems a shift in how success is measured, which may include less emphasis on capital preservation – and the resulting prevalence of senior loans in historical financing mechanisms (see Figure 3 ) – and more emphasis on explicit target engagement.
This shift can have a dramatic effect on how public funders manage their capital. This can push them to use capital more wisely, reserving it only for risks that the private sector is unlikely to bear. It also allows MDBs – and especially their private sector arms such as the World Bank’s IFC – to have greater risk tolerance, which in turn enables greater use of various financial tools. For “classic” project financing, these may include:
- Equity for the approval/construction phase of a plant that is replaced by private capital (largely debt) when the plant is in operation (an example of this model is the ARM-Harith Cities & Climate Transition fund ( ACT) recently introduced by the Climate Policy Initiative Innovation Lab).
- Subordinated debtprivate debt taking leading positions
- Warrantieswhich have proven effective in raising private capital even if they do not address all facets of project risk.
- syndication (sales) of portions of existing portfolios to the private sector, thus “freeing up” this public capital to make new investments (the African Development Bank’s Room2Run, published in 2018, is an example).
In a more “unconventional” way, redirection allows MDBs to use their capital to drive systemic change, for example to sponsor the scaling up of technology, likely through grants or equity, and to inspire countries to implement positive clean energy policy changes through results. – based financing.
Orchestrating such a radical shift in/on top of the MDB mandate will not be easy. Aside from securing buy-in and defining terms from government shareholders, this represents a significant investment for MDBs, ranging from scaling up operations to building additional capacity around capital management. and managing new measures of success.
There is also a basis for skepticism that MDBs will be “exploited” by private financiers (one of the areas of criticism of World Bank pandemic bonds, for example) and safeguards, such as transparent and competitive bidding and reverse auctions. , should be used to make the use of public funds as efficient as possible.
The key point is that the societal goal is to promote massive amounts of private investment as quickly as possible and private finance will simply need to have the right incentive to invest. MDBs have the unique scaffolding to provide this catalytic role. Governments should act to add climate capital to MDB coffers and work with the institutions themselves to set aggressive targets for mobilizing private capital.