"CMIA helped to explain the potential for project-based mechanisms across a variety of constituencies and is a key voice driving the conversation on results-based finance and sector approaches for scaling-up emission reduction investments. We urgently need input from organisations like CMIA to operationalise Art 6 of the Paris Agreement."

Mr. Franz-Josef Schafhausen, former Director General Climate Change, European and International Affairs, Federal German Ministry of the Environment, Nature Conservation, Building and Nuclear Safety

Climate finance: bridging the gap to a sustainable future   

23rd July 2024 by CMIA

According to the IPCC, there is a possibility that more than 50% of the temperature will exceed the average limit of 1.5 degrees Celsius between 2021 and 2040. While the challenges seem daunting, as, with every tenth of a degree, the infrastructure and systems the world has built – power grids, homes, livelihoods – will come under greater stress, our modern world was simply not designed for such high temperatures, but there is one crucial tool that would power different solutions: climate finance. 

This article aims to explore the importance of climate finance and how the investment drive towards a low-carbon economy can accelerate the transition to a neutral economy that supports immediate action.  

 

The urgency of climate action 

The Paris Agreement outlines the ambitious goal of limiting global warming to 1.5°C.   To achieve this goal, we need to significantly increase investments in low-carbon energy sources. Estimates suggest that we need to triple current investments to reach $4 trillion per year by 2030 1. 

 

The role of climate finance 

Climate finance closes the gap by financing two key areas: 

  • Mitigation: Reduce greenhouse gas emissions through industrial decarbonization, considering the value chain processes and energy sources used (manufacturing, transportation, agribusiness, electricity generation, among others). 
  • Adaptation: Create adaptation mechanisms that help communities adapt to the impacts of climate change, such as anticipating possible changes in biodiversity, building dams to protect coastal areas from rising sea levels, or developing drought-resistant crops. 

 

Traditional sources of climate finance 

  • Private investments: Banks, insurers and other financial institutions are increasingly directing funds towards companies and projects that demonstrate their commitment and shift towards social, environmental and financial sustainability. Through green bonds and impact investments based on national taxonomies (examples: European Taxonomy, Mexican Sustainable Taxonomy, Colombian Green Taxonomy, among others) that describe economic activities that are classified as sustainable activities. 
  • Public funds: Governments play a vital role by allocating budgets, offering tax incentives and investing directly in companies committed to impact reduction goals. 
  • International Climate Funds: Organizations such as the Green Climate Fund (GCF) provide financial assistance to developing countries. 

 

The cost of capital and its impact 

The cost of capital, which is the rate a company pays for borrowing money, plays an important role in investment decisions. Some countries, both at the private and public investment level, have increased interest rates for companies that do not annually demonstrate their transition to activities that generate less environmental and social impact. This is the reason: 

  • Lower cost of capital boosts investment: Lower cost of capital makes it easier for companies and countries to finance initial investments in clean energy projects.  
  • Impact on different energy sources: Renewable energy sources, being more capital-intensive, are more sensitive to changes in the cost of capital compared to fossil fuels. 

 

World Economic Forum Report: Key Findings 

A recent report by the World Economic Forum highlights the importance of the cost of capital and climate policies in accelerating the transition to clean energy. Here are some key points: 

  • Reducing the cost of debt can lead to increased investments in both low- and high-carbon energy. However, this effect is stronger in the case of low-carbon energy, especially in developed regions. 
  • Sound market-based climate policies, such as carbon pricing, can further incentivize investments in low-carbon energy by making them more cost-competitive with fossil fuels. 
  • Rising interest rates could negatively impact investments in low-carbon energy, highlighting the need for additional policy interventions to ensure affordability. 

 

The road ahead 

Climate finance plays a key role in achieving a sustainable future. By reducing the cost of capital and implementing sound climate policies, we can accelerate investments in clean energy sources and mitigate the worst effects of climate change.  

Financial institutions also have a responsibility to ensure that their investments are in line with net-zero emissions targets. As United Nations: Principles Responsable Investments explains “This involves assessing the environmental impact of investments, engaging with high emitting industries to ensure a sustainable transition to clean energy and, where appropriate, supporting a managed phase-out or divestment of high carbon assets, while financing clean energy and sustainable projects”.  

 This is a critical juncture. By closing the climate finance gap and making clean energy more affordable, we can pave the way for a greener future for all.