Innovative Finance Has a Major Role to Play in Tackling Climate Change
Green bonds have been described as a game-changer in the fight against climate change. With more than $50 billion in green bonds expected to be issued this year—and more than $532 billion mobilized in wider mitigation and adaptation projects—delegates at this week’s climate talks in Paris will surely sing their praises.
The success of the green bond can be credited to its easy re-imagining of a mainstream financial tool. Its wide adoption has revealed an appetite among diverse investor groups to put money into climate-friendly projects—from resilient infrastructure to energy efficiency—that offer a return for both the investor and the planet.
“The success of climate action requires more than just green bonds to meet the estimated $200-$300 billion a year necessary to help countries already affected by the worst consequences of climate change.”
But the future success of climate action will require more than just green bonds to meet the estimated $200-$300 billion a year that, according to UN estimates, will be needed to help countries already affected to address the worst consequences of climate change. What other traditional financial mechanisms might we re-imagine in order to bring billions more into the fold?
That’s the question we’ve posed as part of the Rockefeller Foundation’s Zero Gap work. We are already preparing some platforms, processes and partnerships that we believe may represent the dawn of a new generation of innovative finance for climate action. One product we are exploring is the use of catastrophe bonds to help ease the burden on African countries affected by increasingly devastating climate disasters. Known as ‘cat-bonds,’ these are paid out toward recovery efforts if certain disaster scenarios are met. If disasters are averted, investors get their money back, plus interest.
We are exploring the use of this model to help reduce the burden on African countries susceptible to weather-related disasters—such as drought, intense heat, or heavy rainfall—that are hindering their economic growth.
The idea is that private investors pay into the Extreme Climate Facility for a set period of time, for example three years. Over those years, donors such as development finance institutions provide “coupon payments” that will ultimately become the interest paid back to investors. If an extreme climate event occurs—above and beyond the events that climate insurance might cover, such as drought—all the invested money goes to support the affected country. If no extreme weather event happens in those three years, investors get their original investment back, plus the money that has accrued through coupon payments from donors.
The facility is anticipated to issue more than $1 billion in bonds over the next 30 years.
In addition to financial products, public-private partnerships using blended investments—funds from a range of investors—can also provide much-needed capital for climate interventions.
For example, the UN’s Land Degradation Neutrality Fund draws on both private and public financing to rehabilitate and sustain 12 million hectares (29.64m acres) of land every year that has been mismanaged and degraded by human activity, such as unsustainable farming practices. Reducing land degradation helps to mitigate climate change by absorbing more carbon, while also lowering the risks associated with climate change—landslides, drought, storms, and rising sea levels.
How does the fund work? Investments from impact investors or institutional investors, such as pension funds, provide financing to land owners or intermediary organizations to rehabilitate degraded land, restoring ecosystems and biodiversity, and returning soil to productive use. Investors see a return based on repayments on the loans or dividends from equity investments in activities, such as farming, that happen on the restored land.
Development finance institutions and donor agencies provide funding to offset the risk to private investors. The fund aims to mobilise $50 billion to rehabilitate 300m hectares of land worldwide in the next 20 years, reducing carbon emissions by an estimated 20 billion tonnes.
Innovative finance can support mitigation in other ways. For example, wildfires are increasingly common in the western United States, releasing carbon into the atmosphere and destroying forests that can absorb it.
The daily burden of fighting so many fires has kept the US Forest Service from focusing on fire prevention, even though it costs 40 times more to put out wildfires than it does to prevent them. So we’re helping to launch forest resilience impact bonds, which will raise funds from private investors to finance forest restoration to reduce the intensity and frequency of wildfires. Investors are paid back with returns made through the resulting cost savings.
These are just three examples of how innovative finance can move beyond green bonds to tackle the climate crisis. We hope leaders at the COP climate talks deliver a real commitment to create, test, and scale these solutions. If they don’t, we risk running out not only of money but also time.
A version of this post originally appeared on The Guardian.