Blended Finance as a Tool to Promote Climate Action and Combat Climate Change across Africa
Introduction
The issue of climate change has become a pressing global concern, yet financing to address its effects has experienced a decline in public support, slow private investment, and a regression in blended finance for climate. Blended finance entails the collaboration between public, private, and philanthropic entities to tackle climate challenges.
The latest report from Convergence on the state of blended finance, with a focus on climate finance, underscores the need for a more ambitious use of blended finance to attract significant private investment for climate solutions tailored to the needs of developing nations. While official financial support for lower- and middle-income countries has increasingly targeted climate goals, there are concerning trends.
In 2020, a considerable portion of bilateral official development assistance (ODA) from OECD countries was allocated to climate finance. However, the following year saw a decrease in this percentage, reversing the previous upward trend. Although the overall ODA figures have grown, private investment mobilized by official development finance for climate remains lower than pre-2015 Paris Agreement levels.
This decline in climate blended finance transactions reflects the challenges faced by the blended finance market in 2022, including a 45% reduction in deal volume and a 55% decrease in climate blended finance. [i]
Blended Finance for Africa
Emerging markets and developing economies are responsible for two-thirds of global greenhouse gas emissions. They are also highly vulnerable to climate hazards and require substantial financing for emission reduction and climate adaptation. However, these countries face many challenges such as high debt, constrained budgets due to the pandemic, and rising global interest rates. It is challenging for public finance alone to meet their climate financing needs.[ii]
To achieve climate objectives in these economies, mobilizing private capital on a large scale is crucial. Combining public and private capital can reduce investment risk and attract more funding. Multilateral development banks and international financial institutions can play a key role by creating blended financing structures to alter the risk-return profile for climate transition projects in emerging economies.[iii]
Blended finance has the potential to serve as a valuable instrument in addressing the issue of climate change in Africa. Several ways in which blended finance can be utilized to support climate action in Africa have been identified. Firstly, it can be employed to support Small and Medium-sized Enterprises (SMEs) which constitute a significant part of the private sector across sub-Saharan Africa. Given that the technology required to adapt to climate change is expensive, SMEs will require blended finance to enable them adopt to these technologies. By utilizing blended finance, African SMEs can address the effects of climate change and create growth opportunities for firms. [iv]
Another area where blended finance can be leveraged is in green infrastructure. There is a significant opportunity to extend access to many African SMEs, particularly in the agricultural sector, since Africa's vast infrastructure gap could be filled with green agriculture. Blended finance can help African SMEs invest in green infrastructure and adopt certain green agricultural practices by lowering costs. SMEs still have significant potential for positively impacting the environment if they are given greater access to green infrastructure.[v]
Furthermore, blended finance can be utilized to mobilize private investment, as despite the growing consensus that climate change is one of the defining crises of our times, blended finance flows for climate action have regressed. Blended finance must be used more ambitiously to mobilize private investment at scale into climate solutions that are tailored to meet the needs of developing nations. Blended finance is a structured form of financial collaboration between public, private, and philanthropic actors. Multilateral development banks and international financial institutions can provide support through creating blended financing structures to alter the risk-return profile for the climate transition in emerging economies.[vi]
Blended finance instruments can also offset investment risks and incentivize climate investment in Africa during these turbulent times. Debt-for-climate swaps can help alleviate Africa's debt burden while contributing to environmental sustainability. Successful African-led initiatives need support and additional investments. Additionally, achieving universal access to energy must be built on massive investment in renewables, unlocking millions of jobs. In these times of turbulence, blended finance instruments can offset investment risks and incentivize climate investment in Africa.[vii]
Mechanisms for integrating Blended Finance to promote climate action and combat climate change
1. Incentivize Private Participation: To encourage private sector involvement in climate projects, governments can offer and promote fiscal incentives such as tax incentives, subsidies, and grants. Another effective way to fund climate-friendly projects is through the promotion of green bonds issued by both public and private entities. Additionally, providing tax benefits for investors in green bonds can incentivize more investments in these types of projects. Governments can also develop and offer financial instruments like guarantees and insurance to reduce the risks associated with climate investments, thus making them more attractive to private investors.[viii]
Enhance Climate Information Architecture: To address the challenges posed by climate change, it is crucial to establish a reliable climate information system that provides transparent and standardized reporting on climate-related financial flows, risk assessments, and impacts. Additionally, creating standardized definitions and categories for climate projects can facilitate the identification and support of climate initiatives by investors.[ix]
Multilateral Development Banks (MDBs) and International Financial Institutions (IFIs): To enhance the effectiveness of MDBs and IFIs, it is recommended that they integrate climate and private sector mobilization key performance indicators (KPIs) into their operations. This will enable them to align their activities with climate finance objectives and monitor their progress accordingly. Additionally, providing technical assistance to develop climate projects, strengthen government capacity, and fortify local financial markets can attract private investors and improve project outcomes.[x]
Blended Finance Structures: In order to increase private investment in climate projects, it is important to design risk-sharing mechanisms that involve both public and private partners. This can be achieved by creating blended finance structures that ensure that private investors are more willing to participate. Additionally, structured funds such as green bond funds can be created to allow investors with different risk profiles and investment horizons to participate in climate finance. Finally, development banks can be incentivized to take on initial losses in green funding vehicles and securitizations, leading to increased risk-adjusted returns for private investors who are considering equity investment.[xi]
Conclusion
Blended finance offers a promising solution to address the pressing issue of climate change. It can bridge the funding gap by combining public, private, and philanthropic resources. Key mechanisms for its successful integration include incentivizing private sector participation, enhancing climate information systems, and involving Multilateral Development Banks and International Financial Institutions.
Additionally, the use of blended finance structures, such as risk-sharing mechanisms and structured funds, can attract diverse investors and stimulate private investment in climate projects. Blended finance has the potential to drive climate action, especially in regions like Africa, by supporting Small and Medium-sized Enterprises, green infrastructure, and mobilizing private capital.
[i] ‘Blended finance to address climate change is declining and lagging’ https://www.esi-africa.com/finance-and-policy/blended-finance-to-address-climate-change-is-declining-and-lagging/
[ii] ‘How Blended Finance Can Support Climate Transition in Emerging and Developing Economies’ https://www.imf.org/en/Blogs/Articles/2022/11/15/how-blended-finance-can-support-climate-transition-in-emerging-and-developing-economies
[iii] Ibid.
[iv] ‘Small and Medium-Sized Enterprises, Blended Finance, and Climate Change in Sub-Saharan Africa’ https://www.csis.org/analysis/small-and-medium-sized-enterprises-blended-finance-and-climate-change-sub-saharan-africa
[v] Ibid.
[vi] ‘Blended Finance Tools Can Offset Risks, Incentivize Climate Investment in Africa, Deputy-Secretary General Tells Regional Forum’ https://press.un.org/en/2022/dsgsm1775.doc.htm
[vii] Ibid.
[viii] ‘ENABLING PRIVATE INVESTMENT IN CLIMATE ADAPTATION & RESILIENCE’ https://openknowledge.worldbank.org/server/api/core/bitstreams/127de8c7-d367-59ac-9e54-27ee52c744aa/content
[ix] ‘Strengthening the Climate Information Architecture’ https://www.elibrary.imf.org/view/journals/066/2021/003/article-A001-en.xml
[x] ‘Mobilizing Private Climate Financing in Emerging Market and Developing Economies’ https://www.elibrary.imf.org/view/journals/066/2022/007/article-A001-en.xml
[xi] ‘BLENDING PUBLIC AND PRIVATE FINANCE’ https://documents1.worldbank.org/curated/en/383411468197952433/pdf/106019-BRI-PUBLIC-EMCompass-3-EMCompass-Blending-Public-and-Private-Finance.pdf