Mobilizing private investment and unifying decarbonization pathways
While national governments and MDBs are central to meeting climate-related investment needs, the private sector is also a critical source of financing. Organizations such as the IMF, World Bank and FSB have essential roles to play in mobilizing private capital, both directly (i.e., as catalytic conveners or financial standard-setters) and indirectly (i.e., through the provision of liquidity facilities in response to macroeconomic shocks).
By acting as convening bodies between the public and private sectors, such institutions and their associated agencies can help to encourage private sector participation in global development priorities such as the SDGs and the Paris Agreement. For example, the Global Infrastructure Facility (GIF), a G20 initiative supported by the World Bank and some economically advanced countries, provides funding and advisory services to countries seeking to structure, design and select sustainable infrastructure projects in emerging markets. The GIF also acts as a platform for information on bankable public–private partnerships (PPPs) using private capital.
A further step to scale up private climate investment (alongside public investment) is for all institutions in the international economic architecture to adopt a common climate scenario framework. Specifically, if such institutions, and as many of their member countries as possible, agreed to adopt the same decarbonization pathway towards net zero GHG emissions, it could render economic and financial modelling more effective in influencing future private investment decisions. Currently, different decarbonization pathway scenarios envisage a variety of policy permutations: (1) a supply-side mix of renewable energy systems with some high-cost elements (e.g. hydrogen), combined with more energy-efficient infrastructure; (2) continued fossil fuel usage – at least for a period – combined with much higher energy efficiency; or (3) increased use of bioenergy with carbon capture and storage (BECCS) technology. Making a choice as to which pathway is best – or at least, given the many complex variables, finding a working consensus to that effect – and determining how it should be applied in individual countries with particular characteristics would reduce policy uncertainty. Consequently, it would reduce the perceived riskiness of private investments in climate action. It would, therefore, lower investors’ required rates of return. This could help to accelerate climate action, increasing the scope for investments to capture economies of scale and reduce transition costs.
In short, just as the TCFD provides a global, common disclosure framework for climate risks in investment portfolios, a common climate scenario framework adopted by institutions across the international economic architecture would provide consistent decarbonization assumptions to inform private climate-related investment.
Mainstreaming climate change in the international economic architecture
Many of the institutions in the international economic architecture were late to recognize climate change as a macroeconomic issue. These organizations should move rapidly now to fully embed climate-related issues within all their workstreams – whether research, policy advice, development aid, market risk assessments or debt sustainability analysis.
According to the Sixth Assessment Report by the IPCC, the international community has just a few years to avoid the worst effects of global warming. To catalyse global efforts on climate change, macroeconomic policy measures need to be fully aligned with national climate change strategies. Economic recovery packages during and after the 2008–09 global financial crisis and the COVID-19 pandemic missed unique opportunities to address interconnected economic and environmental crises. It is imperative now that institutions and governments treat climate change holistically rather than as a standalone issue.
A coordinated climate response is required from the international economic architecture, preferably with strong links to the scientific climate community as well. For example, better coordination of country policy reviews and adaptation plans between the OECD, the World Bank and the UNFCCC would pinpoint specific policy issues and the financing needs associated with meeting countries’ nationally determined contributions (NDCs) – which commit to climate change mitigation targets and adaptation plans. Similarly, initiatives such as the OECD’s Green Growth Policy Reviews and the UNFCCC’s National Adaptation Action Plans – already important efforts to assist countries in understanding their exposure to climate risks – would benefit from greater coordination between institutions in the international economic architecture. This is particularly relevant to the task of aligning development goals and scaling up technical capacity support.
One specific example of enhanced coordination is the International Just Energy Transition Partnership, launched by France, Germany, the UK, the US, the EU and South Africa to support the latter’s decarbonization efforts. The partnership’s
goal is to mobilize $8.5 billion through grants, concessional loans and risk-sharing instruments.
Another option would be to use the G20 or G7 to convene quarterly meetings to consider and address specific financing gaps in major GHG-emitting countries. Such a process could assist in providing policy and financial support, backed up by continual reassessments of country NDCs. It would also identify the annual financing gaps that would need to be filled to ensure countries meet their NDCs within the next few years.
A further challenge is to phase out international public financing of development projects that contribute to increased GHG emissions in developing economies. This is where the full mainstreaming of climate action could play a role – encouraging institutions in the international economic architecture to examine the exposures to climate risk in their own portfolios, as well as the exposures implied in the policy reviews and technical support they offer to member states. MDBs should lead by example and apply TCFD disclosure criteria to their own portfolios. This would demonstrate commitment to the Paris Agreement and facilitate further private investments. The IFC has already begun to take steps to offer disclosures under the TCFD guidelines and is working with partner institutions to manage and identify potential climate risks. Other MDBs should emulate its actions.
Systemic efforts to embed climate considerations throughout the operational systems of economic institutions should be complemented by coordination with national finance ministries. Finance ministers in some countries are already coordinating climate efforts through the G20 finance track, as well as through the Coalition of Finance Ministers for Climate Action. These efforts, however, are not taking place in all member countries. Some of the policy support and guidance that certain MDBs provide to member states could help countries shape five- and 10-year development priorities around climate goals. The World Bank’s CCDRs, for example, could be used to identify issues around financial stability and the risks of climate change.
While fully mainstreaming climate action in the international economic architecture is a critical step, it is also important that it is done in a way sensitive to three key concerns of developing countries. The first is that MDBs should continue to perform vital roles not perceived as central to action on climate change (although they may, in practice, be closely linked). These include funding international priorities on global health – seen as particularly important in the context of responses to the COVID-19 pandemic – but also wider national development finance needs in education and infrastructure. A second key concern is that the policies adopted by institutions in the international economic architecture should take full account of the differences between countries in terms of how each needs to respond to climate change. Such policies should include recognition that key features of the transition may vary from one country to the next. Thirdly, it is essential that international economic institutions give enough attention to adaptation measures as well as mitigation, given the lack of emphasis on the former in the past, particularly in private sector investment.
Making climate disclosure mechanisms mandatory
The international economic architecture has an important role to play in widening the use of climate-related financial disclosures. A mixture of positive incentives and regulatory requirements – in other words, ‘carrot’ and ‘stick’ measures – will be needed. Organizations such as the OECD should incentivize national governments to establish dialogues with the private sector with the aim of boosting corporate interest in the TCFD. Institutions such as the IMF (which has already undertaken such efforts) can support the rollout of a global disclosure and compliance process by encouraging asset managers to disclose their corporate and investment strategies for climate-oriented investments. The benefit of these dialogues would be not only to align private sector interests with national climate ambitions, but to create a common reporting framework across countries. Institutions in the international economic architecture can also lead the way by giving their full support to the International Financial Reporting Standards (IRFS) Foundation as the central oversight body for climate-related accounting standards. Such a consensus would make practical sense, given its recent establishment of the International Sustainability Standards Board (ISSB), which has proposed rules on climate-related disclosures.
A key step to catalyse further private investments and align the international financial system with the goals of the Paris Agreement is to convert voluntary reporting into mandatory regulatory disclosures.
While the TCFD has provided a global benchmark for reporting and risk comparisons, its reporting mechanism is ultimately voluntary. A key step to catalyse further private investments and align the international financial system with the goals of the Paris Agreement, in tandem with full recognition of the climate risks inherent in existing assets, is to convert voluntary reporting into mandatory regulatory disclosures. This process would require a concerted effort by world leaders, through diplomatic negotiations and global investor input, to agree on a set of baseline targets and reporting requirements. Some countries, such as the UK, are already moving to align TCFD recommendations with their domestic regulatory reporting frameworks. The G7 and the G20 should complement these efforts by introducing minimum requirements of their own for mandatory climate disclosures. All signatories to the Paris Agreement should follow suit by aligning their regulatory guidelines with the disclosure recommendations set forth by the TCFD.
Linking debt relief to climate action
Organizations such as the World Bank and the IMF already promote debt relief (debt service suspension, debt restructuring or debt forgiveness) where needed. However, they need to integrate this policy area more closely with action on climate change.
Faced with rising debt as a result of COVID-19 relief efforts, energy price shocks and continued geopolitical tensions, many developing countries have struggled to balance competing development priorities. This increases the risk of climate policies being sacrificed or delayed in order to make fiscal room for other spending priorities, including debt servicing. As of February 2023, around 62 countries are currently in or at risk of debt distress, compared to only 22 countries in 2015. While pandemic recovery and climate resiliency measures need not be mutually exclusive, many countries are choosing to prioritize the former, rather than commit to longer-term climate change adaptation investments. This is exacerbated by fiscal constraints. In other words, rising debt in developing economies is ultimately inhibiting essential investments in climate change adaptation and mitigation.
It is therefore imperative that major creditor nations support debt relief efforts aimed at freeing up fiscal resources in low- and middle-income countries. They should additionally facilitate ways of increasing these countries’ ability to make new climate infrastructure investments (including by attracting private capital). Institutions in the international economic architecture can support this by, for example, helping countries assess their climate risk vulnerabilities in the context of their national debt profiles. They can also offer guidance on economic restructuring to render countries more resilient to future climate shocks.
Some of these approaches, along with ‘debt-for-nature’ programmes (see below), are already being considered, including through the World Bank’s GRID framework. Debt relief and debt restructuring, linked to climate action, should be better supported and coordinated across the international economic architecture. Despite the efforts of the IMF and World Bank, disagreements between Paris Club members, China and the private sector have slowed decision-making for several debt-distressed African countries seeking debt relief.
Debt-for-nature swaps are not new. In the 1980s, many middle-income countries renegotiated repayment obligations in return for commitments to fund conservation and community forest management. One example was Costa Rica, which used debt-for-nature swaps to invest in ecotourism and enlarge the country’s national parks. Today, Costa Rica is on the path to becoming carbon-neutral, thanks in large part to previous debt relief and increased investments in conservation and ecotourism.
Such initiatives need to be replicated and increased in scale. Historically, debt-for-nature swaps have been very small relative to the trillions of dollars needed for climate investments. Between 1985 and 2015, only $2.6 billion was leveraged through such swaps, while 39 countries were involved. Institutions in the international economic architecture need to support the development of additional performance-based debt instruments that build off the successful precedent of previous debt-for-nature swaps. Potential options include ‘blue bonds’, which are financial instruments that support investment in healthy oceans and maritime ecologies; and nature-based performance bond (NPB) programmes, which involve reducing debt payments for countries in return for increased investments tied to measurable nature-based targets (e.g. wetland restoration, forest protection, wildlife conservation). An example of the latter involved the US government, in coordination with the Nature Conservancy, providing $15 million for debt-for-nature swaps to the Jamaica government in 2004. The 20-year bilateral debt swap was aimed at forest conversation activities, with the intention to conserve the country’s tropical forests as carbon sinks for GHG emissions reduction. Beyond conservation efforts, debt-for-nature swaps can be used to finance the long-term maintenance of adaptation measures established under existing short-term projects with limited budgets.
International economic institutions should facilitate the establishment of a coalition of creditors and debtors as potential participants in climate-based debt swap programmes and related instruments.
These actions may, in turn, support climate change adaptation and/or mitigation, while the NPBs that underpin them can attract private investors with a new suite of green asset purchases. To support this work, international economic institutions should facilitate the establishment of a coalition of creditors and debtors as potential participants in climate-based debt swap programmes and related instruments. Additionally, the institutions should support the scaling up of such instruments through demonstrations and provisions of structural advice and assessment support for viable GHG emissions reductions projects. They should also support the establishment of regulatory standardization processes to provide investors with comparable data on climate outcomes. For instance, the UN Economic Commission for Africa has begun to develop medium-term green investment strategies linked to immediate debt relief. Similarly, the Finance for Biodiversity Initiative (F4B), composed of several MDBs and international organizations, has proposed a nature and climate sovereign bond facility. Such efforts, however, need to be better consolidated and coordinated.
Debt relief tied to climate action is not a quick or comprehensive solution to the challenge of debt distress. There are concerns, for example, as to whether developing countries will agree to conditional debt forgiveness when alternative arrangements may come with very limited or no climate conditionalities. These concerns have been articulated by the IMF’s Independent Evaluation Office, which detailed how conditional international support during the Asian financial crisis in the late 1990s led many Asian governments to take subsequent steps to ensure they would not be reliant on IMF loans in the future. While these policy concerns may have some validity, it is also important to recognize that imperfect solutions may be necessary, given the urgency of the climate challenge. It is also worth reiterating that climate change may contribute more to debt burdens in the future if borrower countries and international organizations do not address the risks today.
