5 Ways to unlock private capital to tackle climate change

By: Mohamed Gouled (IFC Vice President, Industries)

The world is dangerously off course in its efforts to slow down climate change. Rising temperatures will particularly affect developing countries and emerging economies, yet these nations are the least equipped to address the consequences.

It’s estimated these countries need $2.8 trillion a year by 2030 to shift to low-carbon economies and protect their populations from the impacts of climate change. However, global climate finance flows today amount to $1.3 trillion a year, with only a fraction going to emerging economies.

With government budgets already strained, the private sector will have to play an increasingly larger role in closing this gap, providing as much as 80 percent of the needed finance. However, many institutional investors, global banks, and asset managers—who collectively manage approximately $400 trillion—are still hesitant to enter emerging markets because of real and perceived risks and a lack of sufficient bankable projects. Today, climate investment in emerging markets accounts for just one-fifth of the estimated need.

Take Africa, for example. Despite being the world’s most climate-vulnerable region, it attracts only 2 percent of global clean energy investment, and is projected to be $2.5 trillion short of the finance required to cope with the climate crisis. The reasons for this shortfall include lack of suitable regulations and transparency, insufficient availability of bankable projects, and heightened investment risk.

Yet these challenges are not insurmountable. Multilateral development banks and development finance institutions can work together with governments to create a better enabling environment for private investment to fuel the green transition, create jobs, and support economies.

Here are five ways to unlock capital to invest in climate action:

Develop standards to jump-start investor confidence and avoid greenwashing. Alongside national regulatory improvements, international standards can help boost investment. For instance, the Green Bond Principles—the widely accepted guidelines for the issuance and reporting of green bonds—have helped catalyze a nearly $1 trillion market, channeling capital into renewable energy, green infrastructure, and sustainable agribusiness. Guidance, capacity building, and investments that demonstrate what is possible all serve to accelerate the markets. In just two years, the International Finance Corporation’s (IFC) Blue Finance Guidelines, for example, have helped unlock $1.5 billion worth of blue loans and bonds, reducing marine pollution and supporting healthy oceans while generating growing demand for such financial instruments.

Build a long-term pipeline of climate projects to create new markets. To ease the entry of private capital into emerging markets, multilateral development banks and development finance institutions must work with national governments. Together, they can identify market barriers and promote reforms that encourage climate investors and put a price on carbon. They also need to support early movers and demonstration projects with project preparation.  For example, IFC’s engagement with water utilities has improved the resilience of the water supply for 60 million people in developing economies through its advisory services, investment products, and knowledge sharing. This is creating opportunities for future commercial water investment.

Share supporting data to address perceived investment risk. Investors need data on default and recovery rates of investments to manage risk and make informed decisions. To provide deeper insights into markets where it’s difficult to find reliable credit information, the Global Emerging Markets Risk Database (GEMs) Consortium recently published for the first time, as a full package, decades of default and recovery rates on private, sovereign, and sub-sovereign lending in developing countries. IFC also provided comprehensive analysis of the default rates of its corporate loan portfolio. These statistics suggest private sector investments in emerging markets are not as risky as many investors may believe. Information like this is critical to mobilize private investments in emerging markets, addressing one of the key recommendations of the G20.

Make climate investment in emerging markets more affordable and less risky. Blended finance, which uses modest allocations of donor or concessional funds to lower the cost of early demonstration projects and mitigate project risk while mobilizing commercial finance for development, can help achieve this goal. IFC’s experience shows that every dollar of concessional finance not only generates $7 in additional investment, but also helps create markets in multiple sectors. In green housing, for example, IFC leveraged $100 million of donor funds to unlock $80 billion of investment across 100 countries. Attracting private finance to the poorest countries is particularly challenging, but tools like the IDA Private Sector Window make it easier. This mechanism allows IFC, the Multilateral Investment Guarantee Agency, and co-investors to undertake higher-risk projects and lower the cost of climate investments that would not have otherwise been possible.

Design innovative platforms for private investors. Customized investment mechanisms can help institutional investors achieve their risk-return goals while channeling capital to a net-zero economy. They can also provide international investors with diversified exposure to new markets as they learn and build confidence. For example, over the last decade, IFC’s portfolio syndications platform has raised more than $16 billion from institutional investors and credit insurance companies, and its MCPP One Planet platform—the world’s first portfolio of Paris-aligned emerging market loans—has raised and committed $2.5 billion to date.

Mobilizing private investment in emerging markets will require governments, development finance institutions, and private investors to join forces, along with sovereign and philanthropic donors, to accelerate the transition to low-carbon, resilient growth. The goal of a flourishing, inclusive global economy on the livable planet is well worth it.