Bridging the divide in climate finance: The EU’s leadership in directing climate finance to low-and-middle-income countries
Climate finance has garnered increased attention in recent years, resulting in the proliferation of green financial instruments. However, a significant challenge lies in effectively channelling these financial flows towards low-and middle-income countries. This not only hinders achieving the goals of the Paris Agreement but also threatens a just climate transition. The European Union (EU) is leading by example and providing a roadmap for policymakers, regulators and civil society to address this challenge.
Consequences of inadequate climate finance for global goals
Climate finance is a vague umbrella term for investments into economic activities that aim to mitigate climate change or enable adaptation. Despite various definitions, a common understanding and language regarding climate finance is still lacking. This poses a fundamental challenge for investors in developing new climate products or reporting on their climate investments.
Estimating the required capital for achieving global climate goals varies among sources. According to projections, developing economies and emerging markets (excluding China) will need to spend approximately USD 1 trillion annually by 2025 and USD 2.4 trillion from 2030 onwards. Also, approximately 70% of infrastructure investment required for decarbonisation must be directed towards developing and emerging markets.
Nevertheless, these economies face significant challenges in accessing climate finance. This halts our efforts to make the climate transition just and reach the goals in the Paris Agreement. Moreover, inadequate climate finance increases the vulnerability of emerging economies to climate-related disasters, reduced economic growth, and environmental degradation.
Barriers to accessing climate finance: risk factors in low and middle-income countries
Limited financial infrastructure, corruption, political instability, and poor governance are commonly attributed factors that hinder low and middle-income countries’ access to financing. These economies often lack developed capital markets and banking systems, which makes it challenging to mobilise climate finance and direct it towards the necessary goals. Uncertain political environments also contribute to investors’ reluctance to invest capital in these regions. Consequently, low- and middle-income sovereigns and companies headquartered in these countries tend to have lower credit ratings, making their financing a higher risk for financial institutions.
The persisting barrier of financial, political, and reputational risk now faces an additional layer: environmental, social, and governance (ESG) risk. Similarly, to lower credit ratings, these economies often have lower ESG ratings, and while ESG risk encompasses topics beyond climate, at the current maturity of the market, it is predominantly associated with climate adaptation and mitigation. It is not enough that developing and emerging markets are struggling with attracting capital; now, they also face the challenge of securing essential climate finance.
How the EU is spearheading directing climate finance to where it is needed the most
In the sustainability landscape, the EU is at the forefront of providing and regulating climate finance. The EU, the European Investment Bank (EIB), and EU member states collectively constitute the world’s largest source of public climate finance. In 2021, they provided over EUR 23 billion to help developing countries reduce emissions and build resilience against the effects of climate change. In 2022, the EIB launched a new arm, EIB Global, specifically providing financial and technical assistance to countries outside of the bloc, predominantly focusing on Africa, Asia and Latin America, as well as EU candidate countries. Almost half of EIB Global investments in 2022 were directed towards fragile and least-developed countries.
However, public spending alone cannot bridge the financing gap necessary to direct capital flows to low- and middle-income countries and allow a successful and just transition to net zero. Mobilising private capital is essential. The EU’s European Fund for Sustainable Development Plus (EFSD+) investment framework is a good example of a financial instrument specifically designed to support countries through a mix of guarantees, blended grants, and technical assistance. It aims to mobilise over EUR 500 billion in investments from the private sector during the 2021-2027 period, in conjunction with the External Action Guarantee and private capital flows.
The EU is also in the process of publishing its green bond standard, which is applicable to both EU and international companies. The EU Green Bond Standard (EUGBS) will mandate issuers to align at least 85% of the funds raised through the bond with the EU Taxonomy. Issuers will also verify their green bond framework by a third-party reviewer. Moreover, intending to lower administrative burdens, the European Commission plans to issue standardised templates for issuers to report on aligning the green bonds with the EU Taxonomy. The EUGBS will enable financial institutions to make informed decisions regarding climate investments and mitigate associated risks.
Unlocking the path to net zero: key takeaways on climate finance
To achieve the goal of net zero by 2050, it is crucial for low-and-middle-income countries to access climate finance. Increasing public funding and implementing blended finance solutions are commonly suggested methods to bridge the climate finance gap. The EU is leading by example by being the largest source of public climate finance to developing countries and by developing innovative financial instruments to mobilise capital flows from the private sector.