Last November, while rescue teams continued to grapple with the aftermath of Hurricane Milton in Florida, members of the UN Climate Change Conference, COP29, convened in Baku to discuss how similar catastrophes could be prevented, and climate finance was one of the central topics. What can be understood by this somewhat vague term and what are its achievements and objectives? Let’s explore climate finance in detail.
What is climate finance?
While an official definition of climate finance does not exist, in a broad sense the term includes financial mechanisms at the international level as well as national public and private funding for projects and initiatives that focus on climate protection.
In 2019 and 2020, 24% of all climate finance was raised in the international realm, while 76% was generated and spent domestically. Until recently, the public source of funding was higher but private sector financing is now catching up. In terms of financial instruments, 61% of climate finance was issued in the form of debts. Only 16% of loans were considered to be concessional and cheaper than those originated from the general market. Meanwhile, 34% of climate finance could be labeled as equity, while grants accounted for only 5%.
Climate funding categories
The climate finance concept, viewed by type of activity, can be split into three categories.
1️⃣ Funding provided to support initiatives aimed at climate change mitigation, which currently accounts for an estimated 91% of all climate finance flows.
2️⃣ Funding for adaptation to climate change and increasing infrastructural resilience against climate impacts which has in the past accounted for 7.5% of the financial flows.
3️⃣ Funding for capacity building in developing countries including finance for investments that aim to reduce greenhouse gas emissions and strengthen the institutional and technical capacities of states to address climate change. This third pillar of climate finance is often intermingled with Loss and Damage Finance and is addressed jointly by humanitarian and development assistance as well as climate funds and risk transfers.
Why is climate finance necessary?
Since climate finance was first introduced in 1997 when the Kyoto Protocols were signed and the Clean Development Mechanism was introduced, awareness of climate change and its impact on livelihoods has grown.
In 2009 in Copenhagen, Denmark, the developed world committed to mobilize US$100 billion of public finance in developing countries per year by 2020.
In view of the fact that annual climate finance flows worldwide were estimated to be US$1.3 trillion in 2022, and that damage caused by the climate and weather alone reached US$92.9 billion in the U.S. during that year, in retrospect this pledge appeared to be sufficiently realistic.
However, despite the massive expansion of climate finance into the private sector and the implementation of innovative financing mechanisms, the goal was only achieved two years later in 2022, with an estimated US$115.9 billion of annual funding being directed to developing countries.
Adaptation finance reached US$32.4 billion in 2022, while private finance grew by 52% in 2022 compared to previous years, being estimated at US$21 billion. Since adaptation needs will reach US$340 billion in 2030 and US$565 billion in 2050, this type of climate finance is severely underfunded.
As the total volume of finance under private management reaches US$210 trillion, the current contribution to climate finance is an even less significant drop in the ocean.
However, even if annual climate finance flows double, the amount will still be far from sufficient as the need for resilience and green investment climate finance for developing countries is estimated to be US$6 trillion per year until 2030 and US$10 trillion every year thereafter.
One general conclusion can therefore be reached. The actual lack of funding is not the main problem behind the underfunding of climate finance, instead, it is the areas on which the funding focuses and where priority is given.
Furthermore, over 50% of climate finance consists of loans that are issued in line with market conditions, as opposed to grants or investments which better correspond with needs, which raises questions as to the adequacy and relevance of the level and type of financing.
