What Is Climate Finance?
The term climate finance has both broad and narrow uses. In its broad sense, it refers to an enterprise that uses financial institutions or technologies to advance the cause of environmental sustainability, such as by developing or deploying new solar panels or other renewable energy sources.
In its narrow usage, climate finance refers to the transfer of capital from developed to developing nations in adherence to international agreements such as the 2016 Paris Agreement.
- Climate finance is a broad term that can refer either to the role of finance in facilitating efforts to address climate change or to the obligations owed by richer nations to poorer ones.
- Discussions around climate finance are increasing in importance, as the world wrestles with climate change’s visible and severe effects.
- Climate finance is used to incentivize investment and development in renewable energy infrastructure, sustainable agriculture, or other adaptations to climate change.
- Many argue that developed economies should subsidize the adoption of environmentally friendly energy sources by developing nations, along with other such investments.
- By 2023, developed countries will have spent up to $100 billion on climate finance initiatives, according to the OECD.
Understanding Climate Finance
Climate change is the long-term progression of patterns in the world's climate. These changes are commonly related to human activities such as the use of certain nonrenewable resources like fossil fuels. Once burned, these energy sources help raise the Earth's temperature by releasing greenhouse gases into the atmosphere. Climate finance is a way for individuals and nations to help fight climate change.
In the most general sense, climate finance refers to any type of financing used to tackle climate change. Financing normally takes place on the municipal, national, or international level and comes from various sources—both public and private.
Altogether, developed countries are expected to contribute $100 billion to climate financing initiatives by 2023, according to the OECD.
The topic of climate finance is growing in international importance, as countries and companies become increasingly aware of the risks and opportunities associated with climate change. For instance, the United Nations Environment Programme (UNEP) reported in September 2019 that between 2010 and 2019, global investments in renewable energy technologies exceeded $2.5 trillion, roughly quadrupling the global energy capacity associated with renewable sources.
Contributors to Climate Finance
Various financial institutions and technologies played an essential role in facilitating this shift in global energy infrastructure. Among the examples of how finance plays a role in this process include the use of:
- Banks and other intermediaries to transfer capital overseas.
- Financial markets to price energy commodities.
- Derivative markets to hedge and exchange risks related to energy prices.
- Stock exchanges and investment vehicles to facilitate investment in renewable energy companies.
Climate finance encompasses all of these activities, which are likely to accelerate even further in the coming years.
As noted above, the term also has a more narrow meaning. In this sense, it relates to the question of how developed countries should support developing ones in their transition toward energy sources and other technologies with improved environmental footprints. These discussions are frequently contentious and raise a slew of morally ambiguous questions.
Example of Climate Finance
Let's look at an example to show how climate finance works in the real world. A common demand from developed countries, such as those in North America and Europe, is that developing nations, such as those in Asia or sub-Saharan Africa, should refrain from relying on new coal-fired power plants. On the other hand, these developing countries often contend that this demand is hypocritical since developed countries were able to exploit coal and other inexpensive fossil fuels during their own periods of industrialization.
For this reason, many believe that developed countries have a moral obligation to subsidize developing countries by helping them invest in more environmentally friendly energy sources such as wind, solar, and hydroelectric power.
$11 Billion Per Year
The U.S. expects to invest $11.4 billion in climate finance measures by 2024, according to the National Resources Defense Council.
The debates around climate change become increasingly difficult when one seeks to find the exact definition of a developing country and to determine how much responsibility each country has for carbon emissions.
Should the United States provide subsidies to China, for example, due to the fact that its per capita income is still far below that of the United States? Many Americans are likely to consider this politically unacceptable, citing China’s rapid development in recent years.
Political discussions surrounding climate finance can also prove contentious around the question of which investments should be considered eligible for funding under the climate finance programs. For example, some would argue that child education should receive funding, on the grounds that it would reduce population growth and therefore help curb emissions. However, others may wish to restrict climate finance initiatives to projects with a more direct and near-term association with climate change.
How Is Blended Finance Used for Climate Issues?
Blended finance is a funding strategy that seeks to attract investments from both public and private actors. It is often used to attract commercial capital to support development projects, thereby increasing funding for these projects and providing investors with a profitable return. Blended finance can also be used to combat climate change, according to the World Economic Forum. This model can attract money from private investors to support mitigation projects when public funds alone are not sufficient.
How Does Climate Change Affect Finance?
Because the economic effects of climate change are difficult to predict, climate change is likely to increase the uncertainties facing capital markets. For example, increased risks of wildfires, floods, and droughts will increase the potential losses for insurers and investors. These uncertainties are likely to result in higher long-term costs for the financial sector.
How Much Does the EU Contribute to Climate Finance?
The EU and its member states contributed a combined 23.2 billion euros in public climate financing to developing countries in 2019, according to the European Commission. This figure includes the United Kingdom, which left the EU in 2020. Excluding the British contribution to climate finance, the EU contributed 21.9 billion euros in 2019.