How to finance the response to climate change

08 November 2010

With appropriate policies and/or incentives, a substantial part of the additional investment and financial flows needed could be covered by the currently available sources. However, improvement in, and an optimal combination of, mechanisms, such as the carbon markets, the financial mechanism of the Convention, ODA, national policies and, in some cases, new and additional resources, will be needed to mobilize the necessary investment and financial flows to address climate change.

Financial issues under a future climate change regime with increased effectiveness will require:

Private sector investments constitute up to 86% of investment and financial flows and are thus another important means to enhance investment and financial flows to address climate change in the future.

Policy certainty is important for investors. A longer-term international agreement on climate change broadens the range of mitigation measures that are attractive investments.

Additional external public funding for climate change mitigation and adaptation will be needed particularly for sectors in developing countries that depend on public investment and financial flows.

Particular attention will need to be given to developing countries, because although they currently account for only 20–25 per cent of global investments, their expected rapid economic growth means that they will require a large share of investment and financial flows.

a. Potential of the carbon markets

One way of enabling increased funding is by means of the carbon markets.

The Kyoto Protocol’s Clean Development Mechanism (CDM), which permits industrialized countries to invest in sustainable development projects in developing countries and thereby generate tradable emission credits, already shows a significant potential to leverage domestic and international investments.

A high post-2012 demand for emission reduction credits could allow the expansion of the carbon market, which would in turn stimulate additional supply of credits. Emission caps, emission trading and project based mechanisms can thus play an important role in promoting the cost-effectiveness of fighting climate change.

Funding for the Adaptation Fund post-2012 depends on the continuation of the Clean Development Mechanism (CDM) and the level of demand in the carbon market.
Assuming that the adaptation levy of 2% on CDM projects applies post 2012, the level of funding could be:

The level of funding available to the Adaptation Fund would be small compared with the estimated needs for adaptation (several billions worldwide). The Adaptation Fund could be further expanded with additional sources of funding.

b. Potential of ODA

Official Development Assistance (ODA) funds are currently less than 1 per cent of investment globally. Least developed countries, such as Sub-Saharan Africa, and smaller developing countries, still attract very limited private sector investment and continue to rely on ODA and soft loans from international financial institutions.

c. Potential of national policies

Policies are needed both in developed and developing countries.

In terms of private funds, governments set the rules for the markets in which investors seek profits. If current market rules are failing to attract or drive private investors into lower-carbon, more climate-proof alternatives, governments can introduce policies or incentives to help address these market failures. This includes:

Governments also need to shift the focus of their own investments. Governments are responsible for 10-25 per cent of the investment in new physical assets. Currently most of those investments are driven by local development priorities. In developing countries in particular, shifting funding to climate change related investments has to take social and development priorities into account.

d. Potential of international coordination of policies

Governments set the rules for the markets in which investors seek profits. Relevant policies are needed both in developed and developing countries.

International coordination of policies by Parties in an appropriate forum will be most effective. Areas where international coordination would be beneficial include technology R&D and deployment, and energy efficiency standards for internationally traded appliances and equipment.

The major reductions in emissions between the reference and the mitigation scenarios rely on the increased energy efficiency and shifts in the energy supply from fossil fuels to renewable, nuclear and hydro and large-scale deployment of CCS. Much of the shift will need to occur in developing countries where energy demand is projected to grow most rapidly.

Multilateral and bilateral funding is a significant source of investment in developing countries (1 to 7%).

Source: http://unfccc.int/press/fact_sheets/items/4982.php