DEFINITION of Climate Finance

Climate finance is a finance channel by which developed economies partially fund or invest in sustainable development projects in emerging economies to encourage carbon neutrality.

Climate finance is a structured movement of assets from developed economies, such as the United States, to projects in emerging economies like India that encourage carbon neutrality, sustainable development or other practices that will mitigate climate change. Climate finance can be mandated by and funneled through nongovernmental organizations (NGOs), individual governments or private investment.

One of the primary international debates over possible global responses to climate change has been the issue of financing clean development projects. Developing nations like India and Brazil argue that addressing climate will burden their economies disproportionately. Most developed economies were industrialized before the risks of climate change became apparent, but under a climate change mitigation strategy, developing economies would have to rely on unproven and expensive solutions to build viable energy grids and mass infrastructure. Climate finance, in the form of loans or other forms of capital redirected from developed nations, alleviates this burden.

BREAKING DOWN Climate Finance

While many states with developed economies recognize the disproportionate burden of climate change mitigation strategies on developing economies, climate finance remains highly controversial. When international political bodies, like the United Nations Framework Convention on Climate Change (UNFCCC), attempt to bind nations to specific fiscal commitments, political gridlock generally ensues, at both the international and national level. The U.S., for example, cannot sign a treaty that forces the nation to take any direct action unless it has been approved by Congress, making federally directed climate financing unlikely in the current political climate. (See also: 5 Investment Risks Created by Global Warming.)

What (and Who) Should Be Financed

Further debate is incurred by discussions of how to spend the money. It is far from clear what activities would fall under the purview of "climate finance." It is clearly applicable for investment in renewable energy, for example, but less so for investments like child education, which may reduce population growth (and thus carbon emissions) in the long term but whose immediate effects (and possible returns) are much less clear.

It is also not entirely clear which economies or nations most deserve funds via climate finance. China, for example, has widely industrialized but still has hundreds of millions of citizens without consistent power. Further debates arise as to discretionary use of these funds. If an NGO or an investment bank channels investment for sustainable development to a nation, they will want assurance that the money will be well spent, which may lead to a degree of oversight. This can lead to tension between local governments (especially if they have autocratic or kleptocratic tendencies) and their potential investors. (See also: Preparing Your Portfolio for Climate Change.)

The Paris Agreement, reached at the end of 2015, opened up new political channels for climate finance to flow through, and more nations, both developed and developing, are insisting on climate change mitigation efforts. While the issue is still hotly disputed, climate finance (and its controversies) will likely be a mainstay of future economic policy for all nations.