Private climate finance: 4 things to consider

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Laia Barbarà, Acting Head, Climate Strategy, World Economic Forum, Ameya Hadap, Specialist, Climate Innovation, World Economic Forum

• The private sector manages an estimated $210 trillion in assets.
• Further mobilizing that huge potential in the fight against climate change is essential.
• But private climate finance isn’t simple — governments must play a role in setting the right conditions to bring private climate finance to bear.

Recognizing the importance of private sector engagement in the climate fight, governments worldwide have begun implementing policies and incentives to catalyze private climate finance. These measures aim to create an enabling environment that fosters investment in clean energy, sustainable transport, green infrastructure, climate-resilient agriculture and more.

However, stimulating private climate finance entails more than just standard courses of action. It requires innovative levers and mechanisms tailored to incentivize investment, combat reticence, promote accountability and mitigate risks.

Here are four things to consider as we try to mobilize private finance against climate change.

1. Private capital is fundamental to financing the climate fight.

The climate crisis is too big, too serious and too urgent to rely on the resources of public institutions alone. Developing countries need $2–4 trillion annually to avert catastrophic climate change. Mobilizing private capital at scale is critical to meeting this financing need.

Over the last few years, the centrality of climate finance and the private sector to achieving net zero is evident. The solution set most often discussed involves greater public sector and multilateral development bank action to de-risk and incentivize — but the reality is that private climate finance investments have been slow in materializing, and in some cases almost inexistent.

Today, the private sector manages more than $210 trillion in assets. As enabling policies proliferate, the private sector has an unparalleled opportunity to deliver the investment needed to spur innovation and create thriving markets for climate, spanning clean energy, sustainable transport, green infrastructure or climate-resilient agriculture, to name a few.

2. We need to leverage the whole toolbox to spur investment.

Most instruments to stimulate private climate finance exist to make investment more favourable. At the highest level, policies that strengthen recipient countries’ economic fundamentals —whether through friendlier business governance, responsible debt management or other interventions — can increase investor confidence and encourage capital inflow. Similarly, public institutions, multilateral development banks, climate funds, philanthropies and other organizations without profit constraints can de-risk private investment by assuming first-mover and longer-term risk, funding the development of surrounding infrastructure, and building up the “connective tissue” around a particular project.

Better financial data, strong project pipelines, a robust integration of climate into financial risk assessments and the development of carbon markets with high-quality standards all make investment more attractive and impactful.

The right regulations, though, might also have a role to play as companies balance their desire to minimize environmental impact against profit maximization considerations.

For example, as scope 3 emissions fall under greater scrutiny, scope 3 decarbonization mandates could lead companies to finance the decarbonization of their own supply chains, with likely impacts on utilities, power producers and other members of suppliers’ energy ecosystems. Border carbon adjustments with a properly calibrated carbon price could achieve a similar effect as businesses look to maintain market access, and the right financial standards (such as those set by the Basel Committee) may allow private lenders to assume a higher amount of risk.

3. The right regulation can unleash the private sector and kick off a virtuous cycle of investment.

The regulation angle is symptomatic of the main problem with climate finance: most of the investment needed to achieve net-zero in emerging markets and developing countries (EMDCs) will need to come from the private sector, but the current investment environment is not set up to galvanize private capital flows at sufficient scale.

Most climate finance discourse focuses on the initial interventions from non-private sector actors that open up the pipeline for private finance, for which financial returns are the priority. These interventions will be incredibly important as enabling mechanisms for greater private sector involvement, especially in cases where returns are not assured.

However, since regulation can also materially affect what is profitable for a business and what is not, it will be a crucial part of the climate finance toolbox. If the signal is strong enough — whether through scope 3 requirements, border carbon adjustments or another avenue — companies will be compelled to reorganize their operations to “price in” the new costs they could incur if not aligned with those regulations.

If all these solutions were to be pursued in a complementary manner, the result would be a global economy in which companies are motivated to unleash large amounts of capital into EMDCs to protect their bottom lines and in which that capital stands the best chance of generating returns, engendering a virtuous cycle of climate investment.

4. Private sector participation in adaptation and loss and damage financing is tricky, but possible — if incentivized properly.

At first glance, in some segments of the overall climate finance picture, private sector capital does not fit very neatly. Namely, returns from climate adaptation projects are largely hard to come by on a project-by-project basis and almost nonexistent from projects meant to address loss and damage. In fact, most private sector involvement in the loss and damage issue currently takes the form of insurance. The mechanism by which the private sector would engage at scale with these non-mitigation activities in EMDCs across industries is currently unclear.

One answer could lie in the growing trend of climate litigation and other accountability measures, and in the increasing sophistication of attribution science to support attempts to ascribe climate harms to specific actors. Loss and damage contributions could theoretically allow companies to proactively reduce or obviate their liability, or to pay restitution after liability has been established. Adaptation finance, though likely more attractive to the private sector due to avoided costs and their benefits to long-term stability, may require an enforcement-based approach as well.

Any such measures should be executed in tandem with de-risking by public and multilateral institutions in order to maximize buy-in and impact across the economy, in contributor and recipient nations.

Unlocking the full potential of private climate finance is essential for addressing the climate crisis and building prosperous, sustainable economies. By leveraging innovative financial instruments, strategic partnerships, and rightsized regulations, we can mobilize private capital at scale and accelerate the transition towards a low-carbon economy — especially in those countries least responsible and most in need.