Green Infrastructure Financing: The Role of DFIs Derisking Mechanisms

Smart city

Smart Green Infrastructure (SGI) presents a huge investment opportunity globally, with an estimated USD100 trillion worth of climate action infrastructure required by 2030; in order to meet the Paris Agreement emissions reduction targets. However, there is a shortage of finance as well as a shortage of identifiable, investment-ready, and bankable projects. There is also lack of a clear understanding of what type of assets and projects qualify for green financing.

Under the Paris agreement, all countries agreed to take collective action on climate change to keep global temperature increases to no more than 2°C above pre-industrial levels. African countries’ Nationally Determined Contributions (NDCs) to the Paris Agreement outlined bold ambitions to build climate-resilient and low-carbon economies. To implement its NDCs, Africa will require more than $3 trillion in mitigation and adaptation investments by 2030. Almost all African countries have pledged to strengthen climate action to reduce greenhouse gas emissions and strengthen resilience. However, many of the commitments are conditional on receiving adequate financial, technological, and capacity-building support.

Africa contributes only 3.8 % of global greenhouse gas emissions, compared to 23% in China, 19% in the US, and 13% in the European Union, but its people bear a disproportionate share of the devastating effects of more extreme weather patterns. Droughts and floods are becoming increasingly common in Africa as food production declines, natural ecosystems get altered, and biodiversity plummets. All of these factors combined make adaptation spending in Africa a high priority not only for bio prosperity; but also for economic resilience.

Global Trends in Green Finance

Quality infrastructure is known to be a driver of economic growth and a foundation for broader socio-economic and industrial activity to achieve UN SDGs (Sustainable Development Goals). Green finance must be significantly scaled up to meet global climate targets and infrastructure needs. Governments cannot close this gap alone, so mobilizing private capital more so from institutional investors is pivotal. Growing investor interest in green projects has resulted in the development and expansion of innovative financial products. The global green bond market, for example, has grown rapidly, with cumulative total issuance expected to surpass USD1.5 trillion in 2022.

Green financial instruments can be used to attract and tap into global green capital. At the 2021 United Nations Climate Change Conference (COP26), the Glasgow Financial Alliance for Net Zero (GFANZ), committed to over USD130 trillion of private capital to transform the economy to net zero. The number of commitments and allocation of capital to green assets trends in an upward trajectory. The number of global funds linked to Environmental Social and Governance (ESG) doubled from $21B in 2019 to $51.1B in 2020. Similarly in previous years from 2013 to 2017, the total capital allocation towards green assets by large pension funds increased from 2.6% to 7.5%. These increases were seen across asset classes such as green bonds, green equity indexes, and other green assets.

To mobilize private finance on a large scale, the risks of green investments must be reduced to levels acceptable to investors. This can be achieved in part by smoothening the investment landscape through the use of guarantees, co-financing between the private and public financiers, and innovative insurance products.

Role of DFIs in Smart Green Infrastructure Financing

Development finance institutions (DFIs) play an important role in making green projects more bankable and investable by providing de-risking instruments and technical assistance during project design. This financial and capacity-building assistance can build trust in institutional investors and encourage them to fund green infrastructure. DFIs also help to reduce macroeconomic risk by underwriting loans and providing liquidity at low-interest rates. Development banks are often better conversant with political risk and macroeconomic conditions in developing nations, and as such are well-positioned to enhance access to capital in order to boost sustainable investment in the region.

In summary, DFIs can serve as a platform for attracting private capital and catalyzing investment from a larger pool of private actors to fund green infrastructure projects. They can achieve this by offering blended finance schemes, credit enhancement mechanisms, and de-risking instruments such as viability gap funding, first-loss provisions, contingent, and A/B loans. These facilities will reduce risk exposure and improve economic incentives for investors; and aid in the generation of more bankable project pipelines. On the other hand, individual countries and economic regions should also establish a sustainable finance roadmap that specifies rules and regulations for the implementation of green taxonomy. The roadmaps will facilitate and direct the flow of global green capital into the domestic markets, as well as provide a guide to ensure investment is channeled into the priority SDG and climate assets.

 

Author: Victor Otieno

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