Nations have agreed to $300 billion in climate finance. How are they going to pay for that? – National

The trillion-dollar question today is where the vast sums of money needed to tackle climate change will come from, especially for developing countries.

Getting governments to raise more money was the big focus at the UN climate conference that concluded this week, but as a wave of criticism over weak funding commitments shows, alternatives are also needed.

“There's just not enough money from government sources,” Catherine McKenna, CEO of Climate and Nature Solutions and former federal environment minister, said in an interview.

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To help narrow the substantial gap, there is increasing pressure to use so-called blended financing, which uses scarce public dollars to enrich a project's finances enough that it makes sense for the private sector to invest.

“We have to be creative to get the right incentives to make this happen,” McKenna said before countries agreed last weekend to pool at least $300 billion a year by 2035.

The model is especially needed in developing countries, where the risks are greater and the business case is therefore more difficult to make.

This helps explain why such a large group of countries only gets about 15 cents of every dollar spent on clean energy globally.

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With the aim of addressing the shortage, FinDev Canada announced a blended financing platform just as COP29 kicked off. In partnership with Mitsubishi Financial Group and anchored by an investment from the Green Climate Fund, the platform has set a funding target of $1.5 billion to help up to 25 developing countries.

The fund will seek to follow up on Canada's previous, smaller-scale efforts using blended finance, such as a partnership that helped kick-start green energy in Uzbekistan.

In 2020, Canada, along with other organizations, provided $17.5 million in financing at below-market rates to help launch a $100 million solar project – the first in Uzbekistan to get.

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Once that hurdle was cleared, one of the co-investors helped create a second solar project more than twice the size, with fewer concessions. Shortly afterwards, a wind energy project started without any reduction in financing.

The funding model is intended to deliver on these difficult early projects and pave the way for even more projects, says Nnamdi Igbokwe, director of thought leadership at Convergence.

“That is why blended finance has become so important, because it is a mechanism that enables the mobilization of the private sector in a way that would otherwise effectively be excluded.”

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Convergence, a Toronto-based group focused on increasing the use of blended finance, found that the model was used for $18.3 billion in climate finance last year, up from $8 billion a year earlier.

Importantly, the total included six deals worth more than a billion dollars each.

“We are starting to see smarter use and more efficient use of catalytic capital, making multibillion-dollar transactions increasingly consistent,” Igbokwe said.

That's important because taking a bite out of the trillion-dollar global financing targets will require a steady stream of billion-dollar transactions, Igbokwe said.

But ramping up the model is far from easy.

Blended financing adds layers of complexity to financing agreements. The public concessions consist of a range of options, from lower interest rates to agreeing to be the first to absorb any losses, and all this must be negotiated on top of regular commercial terms.

The risk perception of the projects and countries also makes it difficult for many private banks to invest at all, because regulations limit the type of credit risk they can take.

There's also not enough data being shared about how past projects have performed, Igbokwe says, which could help change these risk perceptions.

And then there's the challenge of finding projects that are promising enough and large enough to invest in, but that don't quite meet the threshold for conventional financing.

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Overall, these barriers have caused the model to take off much more slowly than Convergence and others had hoped.

“It's quite complex,” said Susan McGeachie, CEO of the Global Climate Finance Accelerator.

Part of the problem is that each deal is so customized that it's difficult to apply the terms to the next, so it's moving slowly, she said.

But it is still “hugely useful” in helping to close the financing gap, and if it were not difficult, blended financing would not be necessary.

“The whole point is to address that market gap. So if it was to be standardized, all the concessional players would have had to leave and go to something else that would fill a new market gap,” McGeachie said.

She noted that it is not only useful abroad. There is also potential for Indigenous communities and climate projects at home as Canada makes better use of government-funded lenders such as the Canada Infrastructure Bank.

For example, BMO is working with the public bank to offer cheaper loans for office building renovations to reduce emissions.

Others, however, are concerned about the fixation on using private markets and are calling for much larger direct lending to public projects by public banks.

“We have seen market-based mechanisms fail time and time again,” said Susan Spronk, an associate professor focused on international development at the University of Ottawa.

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Spronk helped found a group that opposed the use of blended finance, concerned about the country's poor record on water privatization and other efforts to take advantage of some of the world's poorest people.

While renewable energy has a simpler business case, turning a profit on adaptation projects such as storm surge barriers and wildfire prevention is far from easy.

There is increasing attention to adaptation efforts, including the FinDev platform that has reserved 70 percent for this, but Spronk is concerned that blended finance is not suitable for this task.

“It is doomed to be a very expensive way to achieve a climate transition.”

David Bhamjee, chief strategy officer at FinDev, said in a statement that the fund will help meet the demand for blended finance and show others how to replicate its success.

Many others, like McKenna, argue that there simply isn't enough government funding, so it's important to figure out how these private deals can work, even in challenging circumstances.

“People will have to work very hard to find the solutions and ensure that the money doesn't just go to the easy places.”