Climate change is the most widely discussed topic at the moment. An overwhelming majority of people around the world are concerned about climate change. Given the critical situation of climate change for humanity, UN experts called on States at the 29th meeting of the Conference of the Parties to the UN Framework Convention on Climate Change (COP29) in Baku, Azerbaijan, to prioritise the protection of human rights with truly ambitious climate action plan to 2030, and agree to sufficient, transparent and legitimate funding. The slow onset events of climate change such as sea level rise, increased temperature and extreme events exemplified by more frequent and intense drought, severe heat waves, more severe storms, increased precipitation, and flash flood result in related losses and damages to nature and people. Other consequences of rising global temperatures include massive crop and fishery collapse, and the disappearance of hundreds of thousands of species. Climate induced displacement and relocation/migration of people emerged as a havoc for the affected people. More than 20 million people a year are forced to leave their homes by climate change.
The adverse impacts of the climate change can be addressed to some extent through different adaptation measures. Implementation of these measures need significant financial resources to adapt to the adverse effects and reduce the same. The United Nations Environment Programme estimates that adapting to climate change and coping with damages will cost developing countries $140-300 billion per year by 2030. Climate finance is also needed for mitigation. The Adaptation Gap Report 2023 estimates that due to growing adaptation finance needs and limited flows, globally the current finance gap is around US$194-366 billion per year for adaptation only. The sources of climate finance are mainly budgetary allocations of the states, international climate funds, multilateral development banks (MDBs), bilateral funds, and philanthropic organisations. However, these sources are not enough to fund the huge climate finance need for Bangladesh
As the 7th most climate change vulnerable country according to the Global Climate Risk Index (CRI) 2021, Bangladesh has a considerable need for climate finance. The National Adaptation Plan (NAP) 2022 of Bangladesh estimates it will need around $230 billion for the period 2023-2050 (which is about US$ 8 billion per year) as new and additional financing requirements for the implementation of the NAP. The country currently spends $1.2 billion annually. Bangladesh thus faces a $7.3 billion climate adaptation funding gap annually. The actual financing gap would be higher if the financing needs to implement the committed reduction of GHG emission made in the Bangladesh’s Nationally Determined Contributions (NDCs) 2021 are taken into account. The full implementation of the proposed mitigation actions identified in the NDCs will require about USD 175 billion within 2030. Only a small part of the total estimated climate finance need could be filled in from budgetary allocations. Climate finance flows from international climate funds, MDBs, bilateral and philanthropic sources to Bangladesh are also very meagre. As for instance, Bangladesh has received US$ 174 million in grants and US$ 290 million in loans from GCF for implementing 8 projects till date. In addition, so far, Bangladesh has received US$ 34.41 million from the Least Developed Countries Fund (LDCF).
Although Bangladesh is one of the least emitters of GHG (0.47 per cent of total global emission), it is serious victim of climate change. Since Bangladesh is particularly vulnerable to the adverse effects of climate change, and has capacity constraints as a least developed country, it can rightfully demand grant-based resources for adaptation from global sources as per Article 9.4 of the Paris Agreement. The reality is— Bangladesh has to accept loan with grants money for climate cause.
The large climate financing gap and the limited capacity of the public sector as stated earlier calls for leveraging private capital in the climate change space. But bringing in private climate finance is not simple, as private sector will be looking for bankable projects where they can earn financial returns. The private investors also have a perception of high risks in emerging markets that discourage them to invest. Climate Adaptation projects, in particular, are not considered bankable as these projects do not generate returns for private financiers for the risks they involve. Development of innovative financing tools such as blended finance can be a tool to encourage private investment. Blended Finance as a term was launched in 2017 at the Adis Ababa Innovative Finance Summit.
Blended finance, by combining public, private, grants, concessional and philanthropic finances to mobilise larger sums of capital, de-risks investments in climate projects and thus support generate more climate finance. Public institutions, multilateral development banks, climate funds, philanthropies and other organisations without profit motive can de-risk private investment by assuming first-mover and longer-term risks. Development financial institutions (DFIs) and MDBs, by providing grants, first take losses to leverage private finance. They also provide capital at concessional rates to reduce risks for private providers. As for instance, the World Bank signed $46m agreement with the Uzbekistan government to motivate energy efficiency. Under the project, the bank will purchase between 2 and 2.5 million tons of CO2 reductions. Institutional investors could also be a more relied-upon source of debt capital to climate blended finance. The UNCTAD notes that bringing institutional investors into project finance can lower debt spreads by about 8%, almost as much as securing a DFI/MDB.
A number of blended finance instruments can be leveraged to generate climate finance from private sources. These instruments include catalytic first-loss capital (CFLC) such as equity, grants, guarantees and subordinated debt. It is catalytic because, by improving the recipient’s (investors who receive protection from other investors) risk-return profile, CFLC catalyses the participation of investors that otherwise would not have participated.
For blended finance to be able to raise meaningful amount of private capital, first-loss-equity is a vital option. It gives comfort to investors in emerging markets as first-loss concept de-risks investment in early-stage companies. The investor/grant-maker, in this case agrees to take first-loss or subordinated position in an investment in order to catalyse the participation of co-investors that otherwise would not have entered the deal.
Blended finance structure the financial instruments such as grants, guarantees, debt and equity in innovative ways to reduce risk, advance social and environmental objectives thus catalyse private/commercial capital for climate or impact investment. The following example illustrates how blended financing instrument (in this case CFLC) uses innovative financial structure to increase private sector (commercial) appetite for climate cause or impact investment.
Example: An impact fund of Tk. 132.5 million was created by a composition of debt and grants. The debt structure in the fund has three layers: Tk 100 million in senior debt, contributed by private capital investors (five banks and an insurance company); Tk. 25 million in subordinated debt, provided by five mission-driven investors; and Tk. 7.5 million in first-loss capital (this is ‘loan loss reserve’) in the form of grants from three foundations (providers). This reserve serves as a first stop-loss for any individual transaction. If there is a loan default, the loss reserve absorbs the full loss related to the loan.
Each loan made from the credit facility is composed of 75 per cent from the senior tranche and 25 per cent from the subordinated tranche. In the event of a loss, the CFLC fund can be accessed only to make the senior investors whole (no amount for the junior lenders). In theory, if there is a large loss in one transaction, then the full Tk. 7.5 million can be drawn down in one instance. Alternatively, it could cover numerous small losses until the full amount of CFLC (i.e., Tk. 7.5 million) is exhausted. Losses exceeding the $7.5 million loan loss reserve would be absorbed by the subordinate investors. In this case, it is evident that there is a mechanism of first-loss capital (created out of ‘grant’ money) that acts as a cushion for private sectors to come forward to put their money into such innovative arrangement of blended finance. The significance of blended finance had been recognised in COP 29: “Blended finance is key to mobilising private capital for climate-related projects. It reduces investment risks, attracts new technologies, and ultimately speeds up the shift to a green economy. The issuance of UniBank’s first green bonds in Baku is a compelling example of this trend…”
Attracting funds from both the global climate funds and the private sector are critical in closing the adaptation finance gap. An appreciative mindset that cares for humanity, planet, and sustainability will surely promote blended finance concept to mitigate risks by the public sector or impact investors in a way that allows the private capital to make impact investment for climate cause.
Mohammad Abu Yusuf is an Additional Secretary in the Finance Division, Ministry of Finance, Government of Bangladesh. Views expressed in this article are the author’s own.
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