With COP27 taking place in Egypt in November, much attention will turn to the topic of adaptation in emerging markets and how to finance it.
As part of the Paris Agreement, developed countries were urged to make good on prior promises to scale-up their support for climate action in developing countries to US$100 billion per year by 2020. Commitments, however, have not translated into reality. Climate finance flows still fall short and mitigation wins the lion’s share.
At COP26, the Adaptation Fund received US$356 million from contributing national and regional governments in its efforts to finance projects for the most vulnerable. But adaptation will remain at the centre of discussions at this year’s COP27 in Sharm El Sheikh. The meeting being held in Africa gives the subject greater significance.
The economic and human impacts of climate change are increasingly evident. Flooding in Pakistan, hurricanes in the US, and food insecurity issues throughout Sub-Saharan Africa are testament to the need for resilient development. Development that minimises the potential loss and damage to economies, biodiversity and human wellbeing caused by climate change.
“The adaptation and resilience agenda is becoming more important,” said Vicky Sins, Decarbonisation and Energy Transformation Lead at the World Benchmarking Alliance. “Even within a one-and-a-half-degree warming scenario, it requires large parts of the world to adapt to a new way of living and working.”
Emerging and developing economies (EMDE) are the most vulnerable to the consequences of climate change.
“Developing countries have contributed little to global emissions, but they are where the impacts of climate change are going to be most keenly felt,” said Adam Matthews, Chief Responsible Investment Officer at the Church of England Pensions Board.
Without addressing the needs of emerging markets, the world will fail in its overall mission to address the consequences of human activity for climate, and those of climate on society.
Adaptation is also a challenge that cannot be deferred. For those already living with its implications, adaptation is the only option.
“This is not a future problem. This is a problem of today,” said Annika Brouwer, Sustainability Specialist with asset management firm Ninety One. “It falls on the developed nations to structure fair and attractive climate deals that enable recipient countries to adapt to climate change while still having the development agenda front and centre.”
Adapt to climate realities
The cost of achieving net zero alone by 2050 is huge. The International Energy Agency (IEA) projects a required annual capital spending on clean energy in emerging and developing economies (excluding China) to expand by more than seven times, from under US$150 billion in 2020 to over US$1 trillion by 2030.
Financing ‘green’ in the EMDEs is crucial for global decarbonisation given their strong projected increase in demographic and economic growth. “This will lead, among others, to higher energy demand. EMDEs need to leapfrog coal or, where installed, it needs to be phased out as soon as possible,” according to a spokesperson from the UN-convened Net Zero Asset Owners Alliance (NZAOA).
Mitigating the impact of climate change by reducing greenhouse gases (GHG) emissions is important, but insufficient. “But what is crucial to reiterate is that significant investments need to flow into adaptation,” said Sins.
It is a position held at the highest levels of the United Nations.
“Half of all climate finance must go to adaptation and resilience, to protect people and economies,” tweeted the intergovernmental agency’s Secretary-General António Guterres recently. “Unless funds are disbursed now, climate tragedies will multiply, with devastating consequences for years to come.”
It will need the combined force of public and private finance to reach those aspirations.
“Public and private commitments made at COP26 around adaptation and loss and damage financing were profound, but disappointing in practice,” said Brouwer.
That lack of follow-through presents a major problem if plans for mitigation and adaptation are both to be realised. It affects the level of trust between developed and developing countries and points to something awry in the current system for directing finance into emerging economies. It also has implications for the overall developmental agenda.
“The real issue here is with development capital,” said Brouwer. “There is a mismatch in what is being financed and how it’s being financed. For the developed world, climate has almost superseded development in emerging markets.”
She points to the conditionality tied to lending, such as the rate of return or the use of proceeds, as part of the problem. Finance may not flow easily to EMDEs, if it prolongs the life of high carbon assets. That is particularly pertinent in economies still heavily reliant on fossil fuels for energy generation, where development capital may not be available or where private finance is limited due to the fossil fuel link.
“In the face of rising energy demand, how do countries transition to a clean energy system when there is no instant renewable energy switch to turn on?” said Matthews. “New infrastructure needs to be built at the same time as using existing infrastructure. You’ve also got to consider the livelihoods and communities dependent on these industries. You’ve got to own that complexity.”
A well-intentioned focus on finance mitigation, can come at the expense of spending on adaptation.
Measures needed for adaptation are often less obvious than for climate change mitigation. Furthermore, many adaptation activities come associated with issues around commercial viability. Up-front costs of building resilience into infrastructure are higher, for instance, cash flow predictability is uncertain and there is a lack of track record.
“Adaptation finance is more complex than for mitigation as it touches massive amounts of small projects, refurbishments and requires close coordination with communities,” according to the NZAOA. “If we want to achieve large scale capital flows into the EMDEs we need to find a way to improve the risk-return profile in line with private investors’ requirements.”
Public funding will never be sufficient to close the adaptation finance gap in EMDEs, while the large bulk of private capital is risk averse. According to the UN Environment Programme’s ‘Adaptation Gap Report 2021’, adaptation costs in developing countries are five to ten times greater than current public adaptation finance flows.
Closing the gap requires the input of a wide set of actors to mobilise the quantum of capital needed to build resilience and adaptation. Blended finance is one way to release the financing blockage, with public money used in such a way that it alleviates risk and ‘crowds in’ the private sector.
Public/private collaborations will be key to mobilising private finance and will be even more important for adaption in comparison to mitigation where an investment track record has started to build.
There also needs to be a change in approach by all players in factoring in the future impact of climate change.
“It will take imagination,” said Sins. “It needs to be done in a multi-organised way and it also needs to include local knowledge.”
Close collaboration between communities and investors is required “to ensure that measures taken are appropriate and aggregated into diversified portfolios for which large institutional investors can provide the financing at scale and at appropriate risk-return levels,” according to NZAOA, which recently highlighted actions policymakers should consider to scale-up blended finance.
A key step is the reassessment of the contribution made by multinational development banks (MDB) to global development through a more efficient use of capital and a greater reliance on the insurance market. Through grants, concessional lending, direct investing and the provision of risk mitigation, development financial institutions (DFI) could crowd in private investment as well as play a critical role in providing essential technical assistance.
“Yet for all the value that MDBs and DFIs have brought to the promotion of economic development over the last half-century and more, their dominance of the development sector is judged to have crowded-out rather than crowded-in private lenders in certain market segments already mature enough for private investors,” according to NZAOA. “These institutions should be incentivised to maximise total investments, most importantly, through mobilising private capital.”
It says key performance indicators (KPIs) around the mobilisation of private sector capital would help increase the institutional focus of MDBs and DFIs and this could include a shift from originating and holding financial assets on their balance sheets to originating and distributing financial assets to private sector actors in relevant market segments of interest.
“MDBs and DFIs should also be enabled to take on more risk,” according to NZAOA. “In the form of local currency debt or equity finance, for example, which are currently under-supplied in EMDEs but critically needed.”
A change in approach is also required from private investors, as well as recognition of some of the perversities in the system, which may lead them away from opportunities to achieve long term adaptation and mitigation aims, for fear of missing short-term decarbonisation targets.
“You have to own the whole picture to drive transition,” said Matthews. “Investors need to think in a much more holistic, nuanced way, because simply having net zero targets that are blind to some of this reality means you could end up with a nicely aligned clean portfolio but one that doesn’t lead to real transition and real-world emissions reductions.”
With adaptation and resilience one of the topics under discussion at the COP27 meeting taking place in Sharm El Sheikh, it is another opportunity for emerging economies to better communicate their development needs to the ranks of public and private investors looking to finance carbon-free adaptation.
“The biggest call to action we’re hearing ahead of COP is that development capital and concessional capital needs to play a more catalytic role in incentivising private capital to go into those parts of the system,” said Brouwer.
It is an opportunity to rebuild trust between the developing and developed world that can’t be missed.