July 5 – Agreement on the need to massively increase private sector finance to developing and middle-income countries to allow them to transition to clean energy was a clear outcome of the recent Summit for a new Global Financial Pact in Paris. Turning this theory into practice is complicated, yet it is totally doable if all actors in the worlds of policy and finance accept this new reality and stop pretending business-as-usual is an option.
Despite French President Emmanuel Macron’s enthusiasm and energy throughout the event and the attendance of some big names from the Global North, notably US Treasury Secretary Janet Yellen, the summit was largely powered by ideas from Global South leaders. If the solutions they put forward on debt, reducing borrowing costs for developing countries and bringing in more private finance are to be enacted, leaders from all countries must be fully signed up to the need to reform the global financial system.
Despite the insistence on increasing private finance at the Paris summit, there is a long way to go if high-level words are to be turned into dollars. In high-income countries, more than 80% of green investment is funded by the private sector; in emerging and developing countries, the share of private sector investment in renewable energy projects is a mere 14%.
Central to changing this uneven state of affairs is the de-risking of investments in countries with lower financial ratings, shaky governance and where private investors are not used to placing significant amounts of money.
It is no secret that the cost of capital presents a fundamental barrier to investment in developing countries compared to countries with international reserve currencies. As Avinash Persaud, special climate advisor to Barbados Prime Minister Mia Mottley, points out, the average interest cost for a similar solar farm is 10.6% a year in countries such as Brazil, India, Indonesia, Mexico and South Africa, compared with 4% in the EU.
Blended finance and risk-sharing instruments can incentivize private sector participation in climate projects, as can greater collaboration across the whole of the financial ecosystem, including between bilateral development finance institutions and local development banks.
The sharing of knowledge, best practice and expertise is also vital to boost investor confidence and create an enabling environment for private investment in developing countries, as is the testing and sharing of learnings around new business models.
New ways of working should include a move away from traditional methods of managing finances based on balance sheets and the adoption of approaches that allow banks to share the risks associated with loans with a range of investors. Such “originate-and-share” or “originate-and-transfer” models enable better risk distribution and make climate projects financially stronger and more sustainable.
Better, open-source, well-interpreted data can likewise help ease the minds of investors by demystifying markets they know little about. The World Bank should also accept the recommendations of the G20, and make requirements under the capital adequacy framework fit for purpose in this new reality.
These changes are all well-recognized as necessary for the world to meet climate and sustainability goals, ensure clean energy, reduce emissions, and allow countries in Africa and Asia to develop and bring electricity to those people who are still living without energy.
Yet, they are not being implemented. From 2019 to 2021, $14 billion was invested globally in climate-blended finance transactions, compared with $36.5 billion from 2016 to 2018, says Convergence, a blended finance network, with the proportion of annual climate-blended finance relative to overall levels of blended finance declining by 74% between 2016 and 2018.
Reforming the financial sector and its institutions will demand the full commitment of multilateral development banks, regulators and philanthropists. However, their commitment cannot simply be to de-risk or increase private sector financing. They must become active part of a global framework that accepts that the world is transitioning. These institutions, and the people who lead them, must help create a viable narrative that treats the world as a single system in which all sectors and countries are moving together towards a clean-energy economy.
This is the story that must be discussed, not only in climate talks, but also at Davos and in all financial gatherings. The transition, and achieving it, must be the world’s mainstream narrative. The current system and the “truths” that we tell about finance, risk and returns, will not get the world to net-zero.
By the time of COP28 in Dubai in December, we need a solid plan that will convince finance institutions and investors to put their money in renewable energy and climate adaptation projects in all countries, whatever their credit rating.
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