Climate finance
Climate finance is an umbrella term for financial resources such as loans, grants, or domestic budget allocations for climate change mitigation, adaptation or resiliency. Finance can come from private and public sources. It can be channeled by various intermediaries such as multilateral development banks or other development agencies. Those agencies are particularly important for the transfer of public resources from developed to developing countries in light of UN Climate Convention obligations that developed countries have.
There are two main sub-categories of climate finance based on different aims. Mitigation finance is investment that aims to reduce global carbon emissions. Adaptation finance aims to respond to the consequences of climate change. Globally, there is a much greater focus on mitigation, accounting for over 90% of spending on climate. Renewable energy is an important growth area for mitigation investment and has growing policy support.
Finance can come from private and public sources, and sometimes the two can intersect to create financial solutions. It is widely recognized that public budgets will be insufficient to meet the total needs for climate finance, and that private finance will be important to close the finance gap. Many different financial models or instruments have been used for financing climate actions. For example green bonds, carbon offsetting, and payment for ecosystem services are some promoted solutions. There is considerable innovation in this area. Transfer of solutions that were not developed specifically for climate finance is also taking place, such as public–private partnerships and blended finance.
While public funding plays an important role in U.S. climate finance, the majority of climate-related investment in the United States is provided by private sources. According to the International Energy Agency, most clean energy and low-carbon investment in advanced economies is financed through private capital, including corporate balance sheets, project finance, bank lending, and capital markets, with public policy primarily serving to reduce risk and improve investment incentives. Public climate policies such as tax credits, loan guarantees, and regulatory standards are therefore designed not only to fund projects directly but also to mobilize significantly larger volumes of private investment toward mitigation and resilience objectives.
There are many challenges with climate finance. Firstly, there are difficulties with measuring and tracking financial flows. Secondly, there are also questions around equitable financial support to developing countries for cutting emissions and adapting to impacts. It is also difficult to provide suitable incentives for investments from the private sector.
Definition and context
Climate finance is "finance that aims at reducing emissions, and enhancing sinks of greenhouse gases and aims at reducing vulnerability of, and maintaining and increasing the resilience of, human and ecological systems to negative climate change impacts", as defined by the United Nations Framework Convention on Climate Change Standing Committee on Finance.UNFCCC obligations
Under the UN Climate Convention, climate finance refers to transfers of public money from high income countries to low and middle income countries. This would be in light of their obligations to provide new and additional financial resources. The 2015 United Nations Climate Change Conference introduced a new era for climate finance, policies, and markets. The Paris Agreement, which was adopted at that conference, defined a global action plan to put the world on track to avoid dangerous climate change by limiting global warming to well below 2 °C above pre-industrial levels. The agreement covers climate change mitigation, adaptation, and finance. The financing element includes climate-specific support mechanisms and financial aid for mitigation and adaptation activities. The aims of these activities are to speed up the energy transition towards a low-carbon economy and climate-resilient growth.At the 16th Conference of the Parties in 2010 developed countries committed to the goal of mobilizing jointly USD 100 billion per year by 2020 to address the needs of developing countries. The decision by the 21st Conference of the Parties also included the commitment to continue their existing collective mobilization goal through 2025. In 2025, a new goal is expected to be adopted.
However, the amount of finance actually provided was estimated to be well below what had been targeted. According to OECD figures, climate finance provided and mobilized reached $83.3bn in 2020 and $89.6bn in 2021. This means that the US$100 billion per year by 2020 target has been missed.
Policies to Mobilize Private Capital
Tax credits and production incentives are explicitly designed to "crowd in" private investment in renewable energy, storage, and low-carbon technologies. The Inflation Reduction Act and the Bipartisan Infrastructure Law employ long-term predictable incentives, loan guarantees, and public co-investment to lower the risk and cost of capital for investments in climate finance projects. Empirical studies indicate that public policy and concessional finance can mobilize significant private capital flows into clean energy.Global estimates of financing needs
Global climate finance was estimated to have reached around $1.3 trillion per year in 2021/2022. However, much more is needed to keep global temperature rises within 1.5°C and avoid the worst impacts of climate change. A 2024 report estimated that climate finance flows must increase by at least sixfold on 2021/2022 levels, reaching $8.5 trillion per year by 2030.Subcategories
finance is investment that aims to reduce global carbon emissions. Adaptation finance aims to respond to the consequences of climate change. These two subcategories of climate finance are normally considered separately. However, the two areas are known to have many trade-offs, co-benefits and overlapping policy considerations. The Paris Agreement is an important international agreement between governments, which has also helped to engage financial institutions in the climate agenda. The third aim of the Agreement is to make finance flows consistent with the mitigation and adaptation goals of the agreement. The Agreement called for a balance of climate finance between adaptation and mitigation.Finance for mitigation
Global climate finance is heavily focused on mitigation. Key sectors for investment have been renewable energy, energy efficiency and transport. There has also been an increase in international climate finance towards the 100 billion target. Most of the estimated US$83.3 billion provided to developing countries in 2020, was targeted at mitigation. On a worldwide scale, mitigation financing accounts for over 90% of investment in climate finance. Around 70% of this mitigation money has gone towards renewable energy, however low-carbon mobility is a key development sector. Global energy investment has increased since the 2020 COVID-19 pandemic crisis. However, the crisis has placed great additional strain on the global economy, debt and the availability of finance, which are expected to be felt in years to come.Mitigation costs and mitigation financing needs
In 2010, the World Development Report preliminary estimates of financing needs for mitigation and adaptation activities in developing countries range from $140 to 175 billion per year for mitigation over the next 20 years with associated financing needs of $265–565 billion and $30–100 billion a year over the period 2010–2050 for adaptation.The International Energy Agency's 2011 World Energy Outlook estimates that in order to meet the growing demand for energy through 2035, $16.9 trillion in new investment for new power generation is projected, with renewable energy comprising 60% of the total. The capital required to meet projected energy demand through 2030 amounts to $1.1 trillion per year on average, distributed between the large emerging economies and the remaining developing countries. It is believed that over the next 15 years, the world will require about $90 trillion in new infrastructure – most of it in developing and middle-income countries. The IEA estimates that limiting the rise in global temperature to below 2 Celsius by the end of the century will require an average of $3.5 trillion a year in energy sector investments until 2050.
A meta-analysis from 2023 investigated the "required technology-level investment shifts for climate-relevant infrastructure until 2035" within the EU, and found these are "most drastic for power plants, electricity grids and rail infrastructure", ~€87 billion above the planned budgets in the near-term, and in need of sustainable finance policies.
Finance for adaptation
Finance is an important enabler for climate adaptation, for both developed and developing countries. It can come from a variety of sources. Public finance is provided directly by governments or via intermediaries such as development finance institutions. It can also be channeled through multilateral climate funds. Some multilateral climate funds have a specific focus on adaptation within their mandate. These include the Green Climate Fund, the CIFs and the Adaptation Fund. Private finance can come from commercial banks, institutional investors, other private equity or other companies or from household or community funding. The vast majority of tracked finance has originated from public sources. This is partly because of the lack of a well-defined income stream or business case with an attractive return on investment on projects.Finance can be delivered through a range of instruments including grants or subsidies, concessional and non-concessional loans as well as other debt instruments, equity issuances or can be delivered through own funds, such as savings. The largest proportions of adaptation finance have been invested in infrastructure, energy, built environment, agriculture, forestry/nature and water-related projects.
Only around 4-8% of total climate finance has been allocated to adaptation. The vast majority has been allocated to mitigation with only around 1-2% on multiple objectives.