Building on the data analysis presented in Chapter 2, case studies and interviews, as well as the challenges in financing adaptation analysed in Chapter 3, this chapter identifies possible action areas through which international climate finance providers can increase the volume, accessibility, and effectiveness of finance for adaptation in developing countries. The five recommended action areas are: i) assessing the consistency of forward spending plans with the call to collectively double climate finance for adaptation by 2025; ii) supporting developing countries’ efforts to strengthen their capacities, policies and enabling environment for finance for adaptation; iii) strengthening development practices and systems to ensure efficient delivery of adaptation finance; iv) deploying public and blended finance instruments strategically to mobilise private finance for adaptation; and v) exploring and tapping into alternative financing sources and mobilisation instruments for adaptation.
Scaling Up Adaptation Finance in Developing Countries
4. Action areas for scaling up current finance sources and unlocking additional finance for adaptation
Abstract
Public finance is a crucial resource for investments in adaptation. This chapter elaborates five key action areas where international providers and other relevant actors can focus their efforts to substantially increase the adaptation finance that they provide, more strategically use it to mobilise additional finance from the private sector, and also facilitate and increase developing countries’ access to adaptation finance. Options offered for each of these action areas can contribute to overcoming the barriers identified in Chapter 3. These action areas, which complement and overlap one another, are addressed to international providers of climate finance.
4.1. Action area 1: Assess the consistency of forward spending plans with the call to collectively double climate finance for adaptation by 2025, including in co-ordination with other international providers
Article 9 of the Paris Agreement states that the “provision of scaled-up financial resources should aim to achieve a balance between adaptation and mitigation” (UNFCCC, 2015[1]). The 2021 Glasgow Climate Pact urges developed countries to at least double the provision of climate finance for adaptation by 2025 relative to flows provided in 2019 (UNFCCC, 2021[2]). Consistent with the aims of Article 2.1c of the Paris Agreement, bilateral development finance providers that are members of the OECD DAC committed in 2021 to strengthen the support for climate change adaptation and resilience in developing countries through the DAC Climate Declaration (OECD, 2021[3]).
International providers have acknowledged the importance of funding climate adaptation in their 2016 Roadmap, 2021 Delivery Plan and 2022 update towards this plan (Group of Donor Countries, 2016[4]; Group of Donor Countries, 2021[5]; Group of Donor Countries, 2022[6]). Also in 2021, as part of its Strategy on Adaptation to Climate Change, in 2021 the European Union (EU) pledged EUR 100 million to the Adaptation Fund (European Commission, 2021[7]). The following year during COP27, Denmark, Finland, Germany, Ireland, Slovenia, Sweden, Switzerland, and the Walloon Region of Belgium announced a total of USD 105.6 million in new funding for the Global Environment Facility (GEF) Least Developed Countries Fund and its Special Climate Change Fund. In doing so, the providers stressed the need for even more support targeting immediate adaptation needs of low-lying and low-income states (GEF, 2022[8]). In addition, Italy, Sweden and the Climate Investment Funds have launched the Nature, People and Climate Investment Program to finance initiatives promoting natural resource conservation and climate resilience, and Italy has pledged USD 160 million towards this initiative (Group of Donor Countries, 2022[6]). The United States has launched the President’s Emergency Plan for Adaptation and Resilience (PREPARE), which is a whole-of-government effort to help more than half a billion people in developing countries adapt to and manage the impacts of climate change, including by scaling-up adaptation finance six-fold to over USD 3 billion per year by 2024. Some providers are targeting adaptation through climate and nature finance synergies, for example by recognising the importance of nature-based solutions for adaptation.1 In addition, multilateral institutions have made adaptation-related finance commitments in recent years. Notably, the World Bank Group has committed to increase its direct adaptation climate finance to reach USD 50 billion over 2021-25 (World Bank, 2019[9]), and the AfDB has taken steps to significantly increase the share of its climate finance targeting adaptation (AfDB, 2023[10]).
As these targeted investments suggest, international public finance is a key instrument to enable broader finance flows. Accelerating the deployment of public climate finance for adaptation, notably concessional finance, would have a direct, short-term, and almost immediate impact on levels of adaptation finance provided. Concessional finance for adaptation is also necessary to tap into other potential sources of finance for adaptation. Recognising that each donor has different circumstances and starting points, it is timely for providers to consider their spending plans and investments in adaptation in light of the Glasgow Climate Pact’s call to double finance for adaptation.
This action area is foundational to scaling up adaptation finance and mobilising additional adaptation-related climate finance. The four additional action areas discussed in this chapter are complementary in that they can make the deployment of public finance for these purposes easier and more effectively The action areas outlined in following sections include options for providers to expand finance by supporting a strengthened policy and enabling environment in developing countries; capitalising on the overall permanent lending capacity of multilateral and bilateral actors; replenishing soft capital windows to allow the expansion of their operations to lower-income countries and less-profitable sectors; and using resources strategically to unlock private finance for sustainable development at the transaction level.
4.2. Action area 2: Support developing countries’ efforts to strengthen their capacities, policies, and enabling environment for finance for adaptation
Improving the enabling environment in developing countries will be critical to expanding and unlocking additional adaptation-specific finance and other finance sources. The Addis Ababa Action Agenda is especially salient in this action area as it establishes that each country has primary responsibility for charting its economic and social development pathway (UN DESA, 2015[11]). While providers thus can support developing countries in improving their enabling environment, developing countries themselves also need to take action in this space.
4.2.1. Support the development of institutional capacity, policies and markets
Developing countries often face a significant capacity challenge that affects their ability to access, attract and absorb climate finance (Nightingale et al., 2019[12]). In their 2020 nationally determined contributions (NDCs) to the United Nations Framework Convention on Climate Change (UNFCCC), 113 of 169 developing countries stated that they required capacity development for their national adaptation plans (NAPs) (Pauw et al., 2020[13]). The indicated needs for capacity development exceed the needs for finance and technology in many developing countries’ national reports to the UNFCCC (UNFCCC SCF, 2021[14]). In addition to technical assistance and training, capacity development addresses fundamental capacity constraints resulting from limited resources. As noted by (Casado Asensio, Blanquier and Sedemund, 2022[15]), specific capacity needs identified by developing countries include:
strengthening sectoral, national, and subnational capacities
integrating adaptation into sectoral planning processes
mainstreaming climate change and raising awareness among local actors, communities, and the private sector
developing finance proposals
supporting NAPs and decision making with regard to the actions to be undertaken, impact assessment, risk and disaster forecasting
developing co-ordination mechanisms, legislation, policies and action plans
strengthening national ownership of capacity building to ensure sustainability, including improving the research capacity in climate change
developing information systems, understanding and managing climate science, information and associated impacts
contributing to climate negotiations.
Historically, international providers have played a crucial role in supporting developing countries to address these challenges, as illustrated by the initiatives in Table 4.1 (UNFCCC SCF, 2021[14]). From 2018-19, 44% of total climate-related development finance targeted climate-related capacity development activities, an indication of its critical importance to international providers and developing countries (Casado Asensio, Blanquier and Sedemund, 2022[15]). The international community, including the OECD DAC, increasingly prioritises capacity development in climate change and beyond (Casado Asensio, Blanquier and Sedemund, 2022[15]). Relatedly, strengthening the overall investment environment in developing countries will also have beneficial effects for adaptation. Macroeconomic stability, social cohesion, and the rule of law are considered pre-conditions for sustainable development, lower investors’ perceived investment risks and increase their capacity and willingness to invest (in both mitigation and adaptation activities). For adaptation specifically, international providers can support developing country governments in several different areas (OECD, 2015[16])):
Increase the availability of climate-related data and services. Such information can drive capital where it is most needed and ensure impactful investments in adaptation. The World Meteorological Organization, the UN Development Programme (UNDP) and the UN Environment Programme (UNEP) created the Systematic Observations Finance Facility (SOFF) to support least developed countries (LDCs) and small island developing states (SIDS) in collecting, processing and exchanging climate data for effective adaptation efforts and investments (WMO, 2021[17])) (for further details on the case study please refer to case study 1 in Annex A). SOFF further aims to leverage the private sector as both a producer and user of observational data. More broadly, via this greater data access, SOFF can catalyse local private sector investment related to data and help financial institutions better understand seasonal and climate change trends and their impacts on local markets (Tsan et al., 2019[18])). Further capacity in developing countries on climate-related data and services requires a holistic view on statistical ecosystems rather than producing isolated data for individual project applications or monitoring systems (OECD, 2023[19]). Options in this regard include supporting knowledge systems, relying on existing data for project proposals (including local knowledge and unofficial sources), and regional approaches (OECD, 2023[19]).
Support the development of policies that can unlock adaptation finance. By creating economic opportunities and incentives to stimulate adaptation investments, governments can address both supply and demand. On the supply side, these can include creating and implementing robust policy frameworks in key sectors such as agriculture, land use and infrastructure, for instance by requiring that adaptation be considered in critical infrastructure or land use projects (OECD, 2015[20]). Policies can take the form of fiscal incentives to adapt, public utility pricing or subsidies, and tax relief for companies investing in adaptation. Providers can support such reforms through policy-based loans (PBLs) combined with technical assistance. For example, a PBL from the Asian Development Bank (ADB) supports policies for institutionalising climate-resilient agriculture in the Philippines, including the adjustment of rice cultivation calendars and new guidelines for implementing plant breeding innovations (ADB, 2022[21]).
Facilitate market creation and expansion by boosting demand and supply for adaptation projects. This support can include public procurement of climate-resilient solutions, which creates demand and private sector awareness of the potential of such solutions, thus driving markets and competition (OECD, 2021[22])). International providers, in addition to direct financing of climate-resilient solutions, can also conduct eligibility assessments and provide technical assistance and technology demonstration workshops to structure the most appropriate technical solutions for local markets. In Tajikistan, the European Bank for Reconstruction and Development (EBRD), in partnership with the Climate Investment Funds’ Pilot Program for Climate Resilience (PPCR) and the United Kingdom government, launched the USD 10 million Climate Resilience Financing Facility to increase access to climate technologies. The facility aims to support local partner banks to provide loans to households and businesses that are investing in climate resilience and also provide these local banks with the technical capacity development to finance climate technologies (EBRD and CIF, 2014[23])). On the supply side, grants or concessional loans for solutions that contribute to adaptation actions and/or support adaptation-related research and development are also important (OECD, 2015[20]) (OECD, 2021[24])). As funding for research tends to be limited in developing countries, international providers can play an especially critical role. The renewable energy programme of the African Enterprise Challenge Fund, for instance, provides capital and technical support to projects aimed at expanding energy access in sub-Saharan Africa. The programme has received funding from the EU, the Swedish International Development Cooperation Agency, and other international providers (AECF, n.d.[25])).
Scale up effective capacity development approaches and assist in establishing effective institutional set-ups to support developing countries’ efforts to access and absorb adaptation finance. Institutional capacities play a vital role in the mobilisation, administration, and efficient use of adaptation finance. Strengthening these capacities in developing countries could help them attract and manage these financial resources more effectively. Such support could involve assistance in establishing national climate funds (see Box 4.1), improving budgetary and fiscal systems to channel climate finance, establishing central focal points for climate finance, or establishing a robust monitoring, reporting, and verification system to track and account for the use of adaptation finance. International providers can play a crucial role in this regard by providing capacity development, e.g., through technical assistance or support for institutional strengthening. An example is the Green Climate Fund (GCF) Readiness and Preparatory Support Programme, which assists countries in developing their institutional capacities to access and manage GCF resources (Green Climate Fund, n.d.[26]). As many existing initiatives support capacity development ad climate finance readiness in developing countries (Table 4.1), providers could focus on streamlining and scaling these programmes rather than creating new ones (OECD, 2023[19]).
Table 4.1. Selected initiatives on capacity development for climate change
Source: Casado Asensio, Blaquier and Sedemund (2022[27]), “Strengthening capacity for climate action in developing countries: Overview and recommendations”, https://doi.org/10.1787/0481c16a-en.
Box 4.1. The role of National Climate Funds in accessing adaptation finance: The Rwanda Green Fund (FONERWA)
National Climate Funds
National climate funds are country-specific financing mechanisms for climate change mitigation and adaptation efforts. They mobilise resources through domestic and international sources, public-private partnerships, and private sector investments and channel funds from multilateral organisations and other institutions. By tailoring financial support to a country’s needs, national climate funds promote country ownership and alignment with national strategies and, enhance climate finance coherence. Best practices to maximise benefits include strong governance, alignment with national strategies, stakeholder engagement, partnerships with international providers, and innovative financing instruments (Flynn, 2011[28]).
The Rwanda Green Fund’s approach
The Rwanda Green Fund is a national climate fund that has managed to facilitate the country’s direct access to international climate finance. The fund was established in 2010 as the first national climate fund in Africa and has been fully operational since 2017. Its objective is to streamline and rationalise external aid and domestic finance. Rwandan government ministries and agencies, districts, and civil society organisations (CSOs) including academic institutions and the private sector can access financing from the Rwanda Green Fund, whose investment products include grants, innovation investments and credit lines.
In the public sector, institutions identify climate finance products and submit full project proposals to the fund, which then uses its specific expertise to submit project proposals – to multilateral climate funds, multilateral development banks (MDBs) and bilateral providers – and to secure funding. In the private sector, the Fund works through a joint facility with the Development Bank of Rwanda whereby the Development Bank hosts a credit line, and the fund hosts an incubator and project preparation facility. The fund is the focal institution for climate finance in Rwanda, but ministries and other institutions may also submit projects to providers themselves. The fund adds value mainly through its specific expertise in planning climate finance projects and writing funding proposals, enabling smaller institutions to access climate finance and channelling climate finance to the local level.
The Rwanda Green Fund historically worked on the base of individual projects but is currently moving into country-led programmatic approaches. While the government leads the programming process with regard to setting priorities and identifying necessary actions, the fund structures the programme, breaks it down into sub-projects and engages with providers to secure funding for these projects.
Source: Flynn (Flynn, 2011[28]), Blending Climate Finance Through National Climate Funds: A Guidebook for the Design and Establishment of National Funds to Achieve Climate Change Priorities, https://www.undp.org/laopdr/publications/blending-climate-finance-through-national-climate-funds.
4.2.2. Enhance the role of local governments and communities in delivering and implementing adaptation action
Enabling more direct access to financing for local actors could increase the absorptive capacity for adaptation financing in recipient countries, especially given that many adaptation needs are specific to local contexts. Local actors are well placed to implement effective adaptation measures due to their more nuanced understanding of specific climate hazards, causes of vulnerabilities and local responses to past climate-related events (OECD, 2021[22]). Not all adaptation projects can or should be locally led, especially those addressing framework conditions, policies, or larger infrastructure investments. At the same time, for specific areas, locally-led adaptation has the potential to make better use of local knowledge and coping mechanisms (Westoby et al., 2021[29]; IIED, 2021[30]). In the long term, local ownership and embedment in local institutions have the potential to ensure sustainability of interventions after the funding ends (McNamara et al., 2020[31]). Local climate action can also better deal with issues of gender inequality and social exclusion (OECD, 2021[22]). However, the data on delivery channels (Chapter 2) and interviews conducted for this report suggest that national governments of recipient countries are the primary and often only point of contact for bilateral and multilateral providers. Direct contact with local actors is rare. Communities, local actors, small CSOs and small businesses have no direct access to many sources of adaptation finance or access is limited by local actors’ financial, technical, or human resource constraints (OECD, 2021[22]).
Providers could consider the following actions to enhance the role of local governments and communities in delivering and implementing adaptation action:
Support multi-level co-ordination for climate resilience. Multi-level co-ordination within developing countries is important both to align local adaptation with national strategies and to ensure that local realities feed into national adaptation policies (OECD, 2021[22]). Providers can support multi-level co-ordination by supporting existing government initiatives in decentralisation, design technical assistance programmes specifically for already well-established local institutional arrangements or provide support for knowledge management systems based on both local knowledge and scientific data (OECD, 2021[22]). For example, the European Union and the United Kingdom supported the process of drafting local adaptation plans for action in Nepal, linked to the National Adaptation Programme for Action to help bridge the gap between central planning and local priorities (Regmi, Star and Leal Filho, 2016[32]).
Support the climate finance readiness of local actors. Providers could provide dedicated capacity development and climate finance readiness support to local actors to enhance their ability to access climate finance. The ADB Community Resilience Partnership Program, for example, aims to scale up adaptation finance to communities and is operationalised through a multi-donor trust fund that finances capacity development, project preparation and small proof-of-concept investment projects (ADB, 2021[33]). The program seeks to enable communities to receive large-scale public finance for community-led projects at the nexus of climate, gender, and poverty, for example in adaptative social protection or training for climate-resilient skill development. Providers of readiness support and capacity development for adaptation could join forces to address gaps in reaching local actors and scale up existing programmes targeted at local actors (OECD, 2023[19]).
Establish small grant facilities that are directly accessible to local actors. The German International Climate Initiative has established the IKI Small Grants facility, which issues calls for proposals from local and regional organisations for project sizes ranging from about EUR 60 000 to EUR 200 000 (GIZ, n.d.[34]). The facility selects organisations in a one-step process and supports them through dedicated capacity development. The Adaptation Fund (2021[35]) has launched a similar initiative. Such small grant facilities have the potential to reduce the number of intermediaries in project implementation, strengthen project ownership in local communities and fund projects that would otherwise not fit the funding criteria of large providers. One drawback of the small grants and open call model is that the review process could be more demanding for providers than the review for larger project sizes. Another is that providing local organisations direct access to finance could favour local organisations with high existing institutional capacity, with the risk that some of the most vulnerable communities could be sidelined.
Support national climate funds to channel finance to the local level and support subnational adaptation funds. National climate funds can serve as intermediaries between communities and funders. The Rwanda Green Fund, for example, provides the expertise to draft applications to multilateral climate funds based on project ideas received from local actors (Box 4.1). Similarly, subnational adaptation funds serve to channel adaptation finance to subnational governments and are typically managed by elected local authorities with a high level of accountability to local communities (OECD, 2021[36]). Kenya, Mali, Senegal, and Tanzania have already introduced subnational climate adaptation funds under the devolved climate finance approach (LIFE-AR, 2019[37]). Bilateral and multilateral providers may provide finance to these subnational funds directly or fund intermediary mechanisms such as national climate funds with the purpose of channelling finance to subnational funds.
Fund adaptation action by civil society actors in developing countries. Providers can act to increase the funding provided directly to CSOs in developing countries, thus localising adaptation finance. A recently published OECD toolkit for enabling civil society recommends that providers set funding targets for civil society, dedicate staff capacity to funding civil society and use multi-year funding to enable predictability (OECD, 2023[38]). Given the need for localised adaptation action, these recommendations could be relevant to adaptation finance as well. Civil society actors could directly implement local projects, for example in rural development, but might be most useful as intermediaries channelling adaptation finance from providers to local communities, thus reducing the number of counterparties for international providers (IIED, 2021[39]). For example, the Mesoamerican Territorial Fund (Fondo Territorial Mesoamericano), managed by the Indigenous Mesoamerican Alliance of Peoples and Forests (Alianza Mesoamericana Pueblos y Bosques) extends small grants directly to local communities and Indigenous peoples for projects in nature protection and social inclusion (AMPB, 2020[40]).
Work with microfinance institutions to help small businesses adapt. To reach small businesses and smallholder farmers, providers can work with microfinance institutions, for example by providing guarantees and thematic credit lines or insuring their portfolios against climate risk (case study 2 in Annex A). Microfinance institutions are suitable vehicles to scale up adaptation finance to local actors as they often have experience working with development finance providers and have pre-existing networks with small businesses, smallholder farmers and the poor (Agrawala and Carraro, 2010[41]). For example, the PPCR and the Inter-American Development Bank (IDB) supported a private sector cooperative mutual bank in Jamaica to extend small loans to micro, small- and medium-sized enterprises (MSMEs) in the agriculture and tourism sectors for projects aimed at helping these businesses adapt to climate change (Climate Investment Funds, 2018[42]). The partner bank was chosen for its network in rural communities and helped reach small businesses in sectors highly vulnerable to climate change.
Shift from community-based to locally led adaptation. Momentum is building to shift from community-based to locally led adaptation, evidenced by the broad endorsement of the International Institute for Environment and Development (IIED) Principles for Locally Led Adaptation.2 Community-based adaptation projects, focused on the communities most vulnerable to climate change and using principles of bottom-up and participatory adaptation, became popular among providers and implementers in the 2010s (Westoby et al., 2020[43]; Kirkby, Williams and Huq, 2017[44]). But evaluations found that while such projects led to greater consideration of communities’ needs and capacities, they may have failed to result in a shift of decision-making power from implementers to local actors (McNamara et al., 2020[45]; Westoby et al., 2020[43]). Funding managers do not sufficiently consider local knowledge, strengths, assets and contexts and often spend only limited time with the targeted communities, leading to unsustainable projects or low uptake of proposed technical solutions (Westoby et al., 2020[43]). The IIED principles call for greater local ownership and a shift in the management of adaptation projects to the local level (IIED, 2021[39]). Providers that endorse the principles could identify projects or sectors where the principles can be implemented and where they could gain operational experience in shifting decision-making power to local actors while also working to improve the climate finance readiness of local actors.
4.2.3. Support developing countries to prepare adaptation project pipelines.
There is a significant need to support developing countries to identify and develop adaptation projects that meet the requirements of international providers and can attract private sector investors. A noticeable gap exists in developing countries concerning project pipelines, resulting in a deficiency of funding proposals. This leads to a lack of demand in the form of funding proposals. A top priority identified by developing countries in their NAPs is building capacity for adaptation finance readiness, in particular regarding climate finance management structures, writing project proposals, and monitoring and evaluation. Many specifically point to the GCF Readiness and Preparatory Support Programme as a model.
While providers already offer considerable support to developing countries in terms of general capacity development, adaptation planning and feasibility studies, among others, they could consider using capacity development more strategically to help countries identify adaptation projects that align with national development priorities. Options to better support development of adaptation projects include:
Leverage providers’ unique competitive strengths and expertise to deliver targeted capacity development. JICA exemplifies this approach in its disaster risk reduction (DRR) projects, drawing on Japan’s extensive technical know-how. JICA begins its engagement in vulnerable developing countries by offering specialised training with local engineers, dubbed knowledge co-creation programmes, to address specific adaptation goals such as flood prevention. Once participants complete the training, they are encouraged to work with their government to craft project proposals that JICA will ultimately support financially. Typically, these projects first receive small grant financing before evolving into more comprehensive infrastructure projects. As they progress, the projects may be scaled up with the help of external funds, for example from the GCF, that further expand their scope and impact.
Target support for adaptation planning towards identification of projects. Common adaptation planning tools such as NAPs and NDCs vary significantly in terms of the level of detail, and many fall short of identifying investable project pipelines (Chapter 3). Providers could specifically focus their support for NAP processes on helping the stakeholders identify potential projects and financing strategies. The GCF is particularly active in this area, having approved 69 requests for NAP support totally USD 162 million. Together with its implementing partners, the GCF could leverage this support to also help developing countries prepare project pipelines. Recipient countries have noted they have difficulty complying with complex and fast-changing NAP guidelines and have called for NAP processes to allow more flexibility. In some cases, delays in the NAP process meant that originally identified pilot programmes became outdated but could not be changed retrospectively. Based on these experiences, there is a case for providers of NAP support to streamline technical requirements and allow countries greater flexibility in setting priorities for planning while encouraging countries in the NAP process to become as concrete and detailed as possible in terms of projects. International providers also could facilitate peer-to-peer learning and exchange among developing country governments on climate change and adaptation. An example is the One UN Climate Change Learning Partnership, a joint initiative of over 30 multilateral organisations that support countries to achieve climate change actions via online learning resources (UN CC:e-Learn, n.d.[46]).
To facilitate the preparation of project proposals in developing countries, providers also could consider harmonising funding requirements, as previously discussed, and exploring different modalities for the delivery of adaptation finance, especially policy-based finance (PBF) and programmatic approaches (further explored in sections 4.3.2 and 4.3.3). Additional options that providers could take to help develop adaptation project pipelines in developing countries include:
Allow for more flexibility in defining adaptation projects. There is currently no shared understanding of what constitutes an adaptation project. In interviews for this report, representatives of several developing countries mentioned disagreements with providers on the nature of adaptation projects, for example regarding large infrastructure investments. At the same time, while some current development projects contribute broadly to adaptation, they are not identified as adaptation projects. Allowing for greater flexibility in the definition of adaptation projects and enabling developing countries to more freely determine which investments they consider as contributing to their resilience could facilitate planning processes and lead to more project proposals for adaptation finance.
Work with developing countries upstream to identify development projects with a potential for adaptation. Providers could help recipient countries identify more adaptation projects by engaging them in a dialogue – upstream in the planning process of development projects – about adding an adaptation component to projects planned with other objectives. Especially in contexts where adaptation is not high on the political agenda, providers can add value by identifying resilience aspects of projects. The IDB has used such an approach to scale up its climate finance. Where countries propose construction of specific infrastructure, for example, the IDB not only provides expertise in terms of climate-resilient planning but also discusses with the country the possibility of adding a vulnerability assessment. Alongside, the IDB also offers capacity development and support for more holistic adaptation planning with the aim to replicate such efforts within countries’ own resources.
4.2.4. Facilitate private sector capacity to seek and access finance for adaptation-relevant investments
Beyond its role as a potential additional source of finance for adaptation, the private sector can play a central role in scaling climate change adaptation efforts.3 Private sector enterprises will engage in adapting their operations (even if they do not view it as adaptation) to sustain profitable operations. Such strategic modifications could aim to bolster resilience, for instance changes in agricultural practice such as crop variety transitions or protective measures for production lines against climate volatility. Enterprises also could prioritise enabling adaptation activities such as investing in the development of early warning systems or weather forecasting technologies to lessen the impacts of climatic events (European Commission, 2021[47]; Mullan and Ranger, 2022[48]).
Businesses capacity to plan for and respond to climate impacts hinges on their access to pertinent information, awareness of potential impacts, ability to adapt, and financial capability to adjust their investments into adaptation. To align their operations and processes with climate change (e.g. via a new adapted product line, purchase of additional material, etc.), enterprises may use their internal allocation of resources before tapping into additional, external financial resources. For instance, a private enterprise could use already existing revolving credit lines or use retrained earnings/equity resources to support adaptation. With sufficient internal resources, the enterprise is unlikely to issue a new bond, apply for a new loan, or raise additional equity for adapting its own operations.4 At the same time, if external finance is necessary but unavailable, businesses may forgo adaptation due to financial constraints.5
A vast body of evidence across different regions and sectors establishes that lack of access to finance as a key constraint to MSME growth and a key service input for private sector productivity (Arnold, Mattoo and Narciso, 2006[49]; Beck and Demirguc-Kunt, 2006[50]) and hence more specifically also to adaptation activities enabling further growth in a changing enabling environment (see also (OECD, 2021[22]). At the same time, it remains a challenge for informal MSMEs to access finance, whether for climate-related purposes or not (Casado Asensio, 2021[51]).
Considering these barriers, governments and development co-operation and development finance providers can play a key role in fostering adaptation action in the private sector by ensuring that enterprises can access climate finance. Some options are as follows:
Support financial institutions and facilities make debt finance more available to businesses that lack sufficient internally available funds to invest in and adapt to climate change. Equipping local financial institutions (LFIs) with the means, technical capacity and/or risk backing to take up lending operations is a well-established way to increase access to finance for small- and medium-sized enterprises (SMEs) that are unable to access debt finance because of their (small) size, (new or innovative) business models, or (unfamiliar) sectors. International providers, development finance institutions (DFIs) and other development co-operation actors offer liquidity facilities that increase the funds available to LFIs for on-lending for (adaptation) activities (OECD, 2021[24]), (OECD, 2021[52]); risk-sharing facilities that decrease the burden of risk for LFIs of new and unknown operations (OECD, 2021[53]); and technical assistance that helps LFIs establish operational and risk-related credit processes (Figure 4.1). For example, Proparco is providing finance to Banco Aliado of Panama, which engages in lending operations with SMEs focused on energy efficiency and renewable energy – enterprises that previously had no access to finance (Proparco - Groupe Agence Française de Développement, n.d.[54]). Similarly, the Agence Française de Développement (AFD) is supporting Credit Agricole of Morocco to increase access to finance for sustainable agriculture that is adapted to climate change (Le Matin, 2020[55]).
Figure 4.1. How liquidity facilities can boost access to finance for end borrowers
Source: OECD (2020[56]) DAC methodologies for measuring the amounts mobilised from the private sector by official development finance interventions, https://www.oecd.org/dac/financing-sustainable-development/development-finance-standards/DAC-Methodologies-on-Mobilisation.pdf
Support capacity of LFIs in climate-related risk management, which can ultimately increase their exposure to borrowers that have adapted to climate change. The Asia-Pacific Climate Finance Fund, set up by the ADB and backed several international providers, is one example. It offers capacity development in the form of grants to both sovereign and non-sovereign financial intermediaries such as guarantee providers, financial institutions and reinsurers, thus enabling them to adjust their financial risk management approaches to accommodate the adoption and financing of climate technologies (case study 2 in Annex A). This support helps financial intermediaries adapt to the impacts of climate change, for instance by increasing insurance for microfinance institutions, and support adaptation of their clients by providing access to finance for investments for climate adaptation and resilience.
Support development of tailored financial instruments for adaptation. By favouring and scaling well-adapted activities over activities that are not well adapted and therefore are less sustainable (and profitable), providers could potentially reward and hence financially incentivise adaptation efforts with lower cost of capital. The Development Bank of Japan’s business continuity management (BCM) loan programme, for example assesses and rates corporations on their disaster prevention, business continuity and crisis management measures as part of the due diligence process for lending (case study 6 in Annex A). Borrowers with good ratings can access finance at preferential interest rates. Designed largely to encourage DRR given the risk of seismic activity in Japan, this approach also addresses climate change adaptation efforts, for example in the form of flood risk reduction. A similar programme is in place for SMEs whereby the Japanese Ministry of Economy, Trade and Industry conducts the adaptation assessment and facilitates accredited (i.e., adapted) SMEs to access finance from local public development banks. From a provider of finance perspective loans to adapted activities carry less potential for default due to climate change-related disasters and thus can be distributed at a lower risk-return profile.
Support the development of business models for adaptation goods and services and for developing products and services that enable adaptation. For example, the IDB, GEF and other providers provide grants to support the Adaptation SME Accelerator Project, which is run by the private sector firm Lightsmith Group (case study 3 in Annex A). The project aims to support selected SMEs in their effort to scale their adaptation services in developing countries, for example with respect to water management products, provision of weather data and food waste management.
4.3. Strengthen development practices and systems to ensure efficient delivery of adaptation finance
There are opportunities to improve the delivery of finance for adaptation and support the mainstreaming of adaptation into development assistance. International development and climate finance providers have a range of concrete actions and options available to enhance delivery and support.
4.3.1. Set internal quantitative targets for adaptation finance
Establishing internal targets for the allocation of development and climate finance towards adaptation activities can help guide and incentivise providers’ boards and governments in their decision-making processes. Setting targets allows providers to more effectively allocate resources to achieve a balanced distribution of climate finance for both short-term resource allocation and long-term strategic planning while also taking into account the needs of developing countries. By encouraging providers to incorporate and mainstream adaptation considerations into development projects that may not initially have a primary climate-related objective, internal targets additionally enhance the overall impact of climate finance.
When setting internal targets for adaptation finance, providers should carefully consider implementation strategies to ensure that (a) the targets have a degree of flexibility so that providers can continue to meet funding requests from developing countries and (b) the targets are combined with robust mechanisms to ensure the quality of adaptation projects. At the same time, quantitative targets for adaptation finance are particularly relevant for providers with extensive portfolios of development and climate-related projects. But such targets may be less relevant for institutions with a clear competitive advantage in a specific climate objective such as the International Fund for Agricultural Development, which primarily focuses on adaptation in the agricultural sector.
The implementation of quantitative adaptation targets can vary across providers depending on their institutional and governance structures. Options that providers can consider include:
Set organisation-wide targets expressed in relative terms. For centralised institutions such as multilateral climate funds, organisation-wide targets (e.g., a 50:50 balance between mitigation and adaptation) offer a unified strategy for allocating adaptation finance, simplify decision-making processes and foster consistent funding approval decisions. However, such targets may not suit decentralised organisations or bilateral providers without national development banks and could result in a top-down approach that does not fully consider individual departments’ unique advantages and expertise.
Set department-specific absolute targets for decentralised institutions. Department-specific targets enable a tailored approach to allocating adaptation finance, allowing departments with unique competitive advantages to operate within specific climate objectives. This approach prevents biased behaviour in favour of adaptation-related projects but requires careful co-ordination and communication between departments to ensure overall organisational objectives are met. It could also lead to inconsistent decision-making processes and funding approval across the organisation.
Strengthen specific funding windows or dedicated funds for adaptation. Specific funding windows and dedicated funds for adaptation ensure focused resource allocation while maintaining a balance with mitigation and other development objectives. Dedicated funding windows enhance transparency, accountability, and visibility of adaptation efforts. To avoid additional administrative effort and further complicating adaptation finance architecture, providers could consider providing existing structures with additional funding rather than establishing new initiatives. While working with specific funding windows and dedicated funds, providers could also try to maintain some flexibility to respond to changing priorities or emerging needs in the climate finance landscape.
Integrate adaptation into results frameworks. As a step towards mainstreaming adaptation considerations in all development activities, providers could include climate-sensitive outputs and climate-related indicators and baselines throughout the results framework of projects (OECD, 2023[57]) Due to the context-specific nature of adaptation, such results frameworks need to be based on context analysis and stakeholder consultations. They should also maintain flexibility to adapt to changing scenarios and consider longer-term climate impacts. In addition, providers could consider aligning adaptation-related results frameworks with national results frameworks and UNFCCC processes. In practice, this could mean using indicators that can account for climate adaptation. The OECD (2023[58]) toolkit, Effective Results Frameworks for Sustainable Development, provides detailed guidance and best practices.
4.1.1. Consider windows or minimum levels of funding for the most vulnerable countries
Targets for geographical allocation of adaptation finance can ensure that the poorest and most vulnerable countries are reached. The following concrete options can be considered to ensure a more balanced allocation of adaptation finance across different countries:
Apply graduated country caps. Graduated country caps allow the specific needs and absorptive capacities of recipient nations to be considered in allocating adaptation finance. This approach recognises that the scale and urgency of adaptation needs vary across countries. A potential drawback to this option is that determining appropriate cap levels for each country adds to the complexity and may lead to delays in funding allocation and disbursement.
Set levels of funding for vulnerable countries: Establishing minimum floors or dedicated funding windows for the most vulnerable countries, such as LDCs and SIDS, guarantees a certain level of finance allocation to address their adaptation needs. This approach ensures these countries receive predictable and stable funding, enhancing their ability to plan and implement adaptation measures. However, it may also create challenges in balancing the allocation of resources among other recipient countries and could inadvertently divert funds from other critical areas.
Establish vulnerability-based allocation or access criteria. Such criteria ensure that resources are directed towards countries with the most pressing adaptation needs. Another option could be to tailor access criteria to the needs and specific circumstances of vulnerable groups such as SIDS or LDCs. The United Nations Office of the High Representative for the Least Developed Countries, Landlocked Developing Countries and Small Island Developing States, for example, suggests that relevant stakeholders create a dedicated envelope for SIDS under the GCF’s Enhanced Access framework with flexible funding criteria (United Nations and Climate Finance Access Network, 2022[59]). However, determining which countries are most vulnerable can be contentious and may lead to disagreements among providers and recipients. Given the diverse nature of climate impacts, universally accepted criteria for vulnerability may be hard to establish. Of relevance in this context is the ongoing UN work to develop and implement a Multidimensional Vulnerability Index, which could help provide guidance on the direction of adaptation finance towards the most vulnerable countries (UN, 2023[60]).
Promote co-ordination to foster balanced allocation of adaptation finance. A key enabler of more equitable access to adaptation finance is tailored capacity development to address disparities in individual, institutional and systemic capacity and improve the overall quality of project proposals. To ensure a balanced allocation of adaptation finance, it is advisable to promote co-ordination across countries. As shareholders of MDBs and climate funds, providers could work together to strengthen existing funds and funding windows with explicit minimum floors designated for countries that currently receive limited financial support. Doing so would particularly benefit vulnerable countries such as SIDS, LDCs, and remote countries that lack strong historical or trade ties with providers and that may otherwise be overlooked.
4.3.2. Move from project-based adaptation to programmatic approaches
To foster the development of impactful adaptation project pipelines, providers could engage with developing countries to increase the use of programmatic approaches. Unlike one-off project interventions, programmatic approaches embed a set of smaller and often interlinked projects within multi-year programmes at regional, country, or sectoral level that are aligned with national strategies and priorities. The result is that programmes then include several aligned projects with common objectives and interlinkages. Financing is provided over longer periods and is more predictable. As adaptation is a continuous process that should ideally be planned in long-term strategies, as they are in NAPs, it requires consistent and reliable funding over several years (Anderson, Huq and Mitchell, 2008[61]). By providing reliable funding, encouraging long-term planning and building longer-term partnerships between providers and recipients, programmatic approaches can lead to better buy-in by national governments and develop local capacities for planning impactful projects under multi-year programmes (United Nations and Climate Finance Access Network, 2022[59]). Programmatic approaches can also increase the effectiveness of adaptation finance as they help providers approach adaptation in a more integrated, holistic and cross-sectoral manner (United Nations and Climate Finance Access Network, 2022[59]).
An evaluation of the PPCR’s programmatic approach, for instance, found that it contributed to improved institutional readiness and policy change (CIF, 2018[62]). Specifically, in the planning phase of projects, the programmatic approach together with the reliability of funding led to coordinated, first-mover projects, which proved particularly helpful in countries where adaptation planning was just starting (CIF, 2018[63]). The evaluation also noted that many countries that had a programmatic approach to planning reverted to a project-based approach in the implementation of sub-projects of the programme, but that countries that continued programmatic approaches achieved better outcomes than the former (CIF, 2018[63]). Where it was sustained, the programmatic approach led to more flexibility in the implementation of projects, as it allowed countries to re-allocate resources to other projects, when priorities or contexts changed (CIF, 2018[62])).
As the PPCR example demonstrates, programmatic approaches can contribute both to scale-up, especially in countries where adaptation finance is at low levels, and to enhanced effectiveness. Providers of adaptation finance could take the following actions to encourage programmatic approaches:
Support the adaptation planning process. Extensive stocktaking, planning, and consultation of stakeholders are needed to establish the right programmatic approach to adaptation, determine priority sectors and define sub-actions under the programme. The NAP process presents an opportunity to undertake some of these steps but should be more directly linked to programmes for adaptation. The UNFCCC Adaptation Committee calls for additional guidance and support for developing countries to develop adaptation programmes (UNFCCC, Adaptation Committee, 2022[64]). These can be integrated in existing instruments, especially the GCF readiness support, that then could be used more strategically to support the planning of adaptation in the form of programmatic approaches instead of isolated projects.
Ensure country ownership in programming. Providers could initiate the use of programmatic approaches through their funding practices, which would be particularly useful in cross-country programmes. However, domestic actors should ultimately own programmatic approaches on a country level with providers coming in to provide targeted technical support and fund sub-projects under the programme (United Nations and Climate Finance Access Network, 2022[59]). To enable developing countries to lead the programming, providers could support the establishment and use of national climate funds or other focal points. For example, the Rwanda Green Fund, as outlined in Box 4.1, takes the lead in co-ordinating and structuring programmatic approaches in Rwanda and then engages in dialogues with providers on where they can contribute to sub-projects. The United Kingdom provided technical assistance to support operationalisation of the fund (CIDT, n.d.[65]).
Commit reliable funding to programmatic approaches. Providers should consider committing reliable finance to programmatic approaches at early stages. This would allow recipient countries to move ahead with programmatic planning with some clarity about whether sub-projects are likely to receive funding. Once a programme is in an implementation phase, providers should allow for flexibility in the use of funding for sub-projects to enable countries to reprogram if necessary. Programmatic approaches could also entail mixing project finance with budgetary support, for example in the form of PBF, to also give countries more flexibility in implementing the programme. The PPCR’s programmatic approach combines a country-level investment plan with a predictable funding envelope, allowing for some flexibility in terms of particular projects to be implemented.
Explore the use of country platforms for adaptation Country platforms could be established to bundle programming support from providers and recipients and co-finance projects. Country platforms in climate finance have so far exclusively focused on mitigation (Box 4.2) but have advantages that can apply to adaptation finance as well, especially for some of the countries with the greatest adaptation needs. Key elements of mitigation country platforms that could be used for adaptation platforms include building on existing planning tools, working towards concrete goals, ensuring high-level political commitment, bringing together different types of international providers and modalities of adaptation finance, and using public money strategically to mobilise private finance (Hadley et al., 2022[66]) Country platforms for adaptation will therefore be most suitable for countries with comprehensive existing planning tools, identified adaptation objectives and high political attention on adaptation. These conditions may be present in some of the most physically vulnerable countries such as SIDS. While the developing country government should lead any process to establish a climate platform by, providers can promote the concept by providing advice to governments, committing funding to nascent platforms and strengthening existing co-ordination mechanisms.
Box 4.2. How country platforms work in mitigation finance: The Just Energy Transition Partnerships
Country platforms are understood as government-led partnerships to align international finance with national and international goals in developing countries (ODI, 2022[67]), serving as a single focal point to channel and co-ordinate technical assistance and international finance (public and private) towards a common goal (Carney, 2021[68]). In the context of scaling up climate finance through programmatic approaches, they have gained popularity in recent years as a means of overcoming the persistent challenge of co-ordination between international providers and recipients. Inclusive, meaningful multi-stakeholder dialogues are important in the establishment of country platforms, which typically combine a high-level political agreement between a developing country and a group of providers, a significant package of concessional resources, and a co-ordination structure (Hadley et al., 2022[66]). By co-ordinating all actors involved in climate finance in a country, these platforms help overcome the fragmentation of climate finance into one-off project interventions (Hadley et al., 2022[66]). Country platforms also aim to mobilise large-scale private finance by improving the co-ordination between the private sector and local governments, addressing barriers to private investment, and packaging projects for private investors (Hadley et al., 2022[66]).
Country platforms in climate finance are focused on mitigation, though providers could consider adapting the concept to adaptation finance. A prominent example of a country platform for mitigation finance is the Just Energy Transition Partnership (JETP) between South Africa and the International Partners Group (IPG), comprised of EU, France, Germany, the United Kingdom and the United States. The partnership was launched at COP21 to help achieve South Africa’s NDC by reducing annual greenhouse gas (GHG) emissions to between 420 and 350 megatons of CO2 equivalent until 2030 while enabling a just transition. The JETP benefits from high political attention from all partners, as demonstrated in the initial IPG commitment of USD 8.5 billion for 2023-27 and the establishment of a Presidential Climate Finance Task Team and related inter-ministerial committee in South Africa. The investment plan for the initial 2023-27, published in 2022, builds on existing country-led planning tools, particularly the NDC and a Just Transition Framework adopted by the South Africa cabinet. This plan focuses on three investment sectors as well as cross-cutting investments in skills development and municipal capacity development aimed at the local level. Similarly, the initial IPG pledges focus on capacity development, investment projects and policy-based budget support. As investment needs for the just transition far exceed the initial IPG pledges, there is an emphasis on using these pledges strategically to catalyse additional public and private money at scale. Public money is used primarily to invest in state-owned infrastructure such as transition grids to enable private investments in renewable energy generation. In addition, grant funding is used to support capacity development and just transition investments in communities affected by coal phase-out.
Following the example of the JETP with South Africa, the Group of Seven (G7) has worked to establish JETPs with other countries that have urgently need renewable energy expansion and phase-out of fossil fuels, and in 2022 and 2023, JETPs have been established with Indonesia, Senegal and Viet Nam.
Source: Hadley (2022[67]), “Country platforms” for bold climate action?, Source: (The Presidency, Republic of South Africa, 2022[69])Source: Hadley (2022[67]), “Country platforms” for bold climate action?, https://odi.org/en/insights/country-platforms-for-bold-climate-action/ ; Hadley et al. (2022[66]), Country platforms for climate action: Something borrowed, something new?, https://cdn.odi.org/media/documents/ODI_Emerging_analysis_Country_platforms_for_climate_action.pdf ; The Presidency, Republic of South Africa (2022[69]), South Africa’s Just Energy Transition Investment Plan (JET IP), https://www.thepresidency.gov.za/content/south-africa%27s-just-energy-transition-investment-plan-jet-ip-2023-2027
4.3.3. Increase the use of policy-based climate finance for adaptation
The concept of programmatic approaches and country platforms entails combining technical assistance, investment projects and policy reforms. Budget support to support broad programmes and policy reforms can be an important element in such approaches and could increase donor co-ordination (Hadley et al., 2022[70]). However, there are only a few examples of PBF in adaptation finance, and sectoral budget support represented only 6.9% of adaptation-related development finance from 2016-20.6 While this is more than the 3.5% of overall development finance channelled through budget support over the same period, there remains untapped potential to use PBF and budget support to build enabling environments for climate resilience (Fardoust et al., 2023[71]).
PBF is development finance channelled as unearmarked budget support that is disbursed once the recipient undertakes an agreed-upon set of policy reforms (IDB, 2018[72]). In adaptation specifically, PBF could address the need for sectoral planning and for establishing better enabling environments and framework conditions for adaptation. As such, PBF can be used strategically to complement project-type interventions and increase their effectiveness, for example within programmatic approaches. Adaptation PBF can be sectoral – for example, addressing reforms in the water sector – or take holistic approaches with policy reforms towards adaptation in all sectors. Adaptation can also be mainstreamed into PBF with other principal objectives or implemented as part of cross-cutting climate PBF (Neunuebel et al., 2023[73]). Importantly, PBF can help developing countries establish the right enabling conditions to unlock additional adaptation finance, for example by supporting the establishment of dedicated planning institutions, the adoption of sector strategies or the mainstreaming of adaptation in budgeting processes. By providing recipient governments more flexibility in the use of finance, PBF can increase ownership and recipient control over the use of funds and reduce transaction costs (Horstmann, Leiderer and Scholz, 2009[74]; Grittner, 2013[75]). These advantages come into play especially when PBF is based on systematic, locally owned planning and embedded in a programmatic approach.
PBF may not be suitable for all recipient countries, however. PBF in other development finance is mainly used in middle-income countries with strong public financial management systems as the provision of unearmarked budget support requires a certain level of trust in the country systems from a providers’ perspective (Fardoust et al., 2023[71]). PBF is also typically delivered as policy-based loans (PBLs), which makes it also an unsuitable instrument for highly indebted countries. Policy-based grants can be an alternative but are currently offered by very few providers.
Furthermore, as PBF is delivered as general budgetary support line, ministries relevant to adaptation (e.g., rural development, health, environment) may not have an incentive to request PBF instead of earmarked project finance. PBF has therefore primarily been implemented with ministries of finance, which has led to a certain bias in their content for public financial management reforms. To scale up adaptation-related PBF, it is important for providers to consider such dynamics in recipient country governments and create incentives for line ministries to engage. Providers could consider the following models for the use of PBF for adaptation:
Link adaptation PBF to support of sectoral planning and strategic policy actions for adaptation. Many providers provide support to recipient country governments in the form of technical assistance for planning processes, development of adaptation strategies and capacity development, which often implies contributing to legislative reform agendas. PBF can support the implementation of these reforms, for example policy set-ups outlined in NAPs. Reforms in a PBF should be ambitious but realistic, and the provider should engage in strategic policy dialogue with the recipient beyond individual projects (AFD, 2019[76]). PBF is often delivered in multiple phases starting with support for less contentious change and gradually increasing to support more ambitious reforms.
Mainstream adaptation in PBF with wider development objectives and explore cross-cutting climate PBF. Adaptation considerations can be included as a component in PBF with wider development objectives. In a World Bank PBL to Panama, for instance, the reform pillar on fiscal management included a policy for integrating disaster risk analysis into public investment planning (World Bank Group Archives, 2016[77]). Adaptation policies could also be supported together with reforms for mitigation action in cross-cutting climate PBF instruments. An example is the cross-cutting climate PBL in the Philippines, co-financed by the AFD and ADB and with a component targeting adaptation in agriculture and natural resources, including reforms such as establishing a Climate-Resilient Agriculture Office and new legislation on resilient agriculture (ADB, 2022[78]). By gradually introducing policy reforms related to adaptation in PBF that has other development objectives, providers can foster a dialogue with recipient countries and contribute to raising awareness for adaptation in legislation processes.
Use PBF when countries are in urgent need of support. PBF can be a useful tool in post-disaster and crisis contexts, as described in Box 4.3 as such finance allows allow for flexible use of funds, which significantly shortens the time needed for planning and project preparation.
Explore the use of PBF as policy-based grants in contexts where loans are not feasible. Loans represented 78% of adaptation-related budget support in 2016-20. But PBLs are not appropriate for all countries, including some of the most vulnerable such as LDCs and SIDS, due to their debt limits. To overcome this challenge, providers could instead provide policy-based grants or policy-based loans with a considerable grant component to countries with high debt levels. MDBs, currently the main providers of PBLs, could deliver some of their grant finance in the form of PBF for adaptation. In addition, major providers of grant finance, especially bilateral providers, can engage more actively in policy dialogue with grant recipients and move towards policy-based instruments.
Embed PBF in multi-donor initiatives and programmatic approaches. PBF is often an element of multi-donor initiatives and programmatic development planning, including as an accompaniment to investment projects. PBF is also often paired with technical assistance to develop the capacities needed to plan and implement reforms. While more of the large multi-donor programmes focus on mitigation than on adaptation, the Resilient Kerala Program (Box 4.3) demonstrates how providers can support adaptation on a bigger scale. Programmatic approaches could also include PBF components to support planning as well as an enabling environment.
Box 4.3. Policy-Based Finance: The Resilient Kerala Program
The state of Kerala in southern India, highly vulnerable to natural disasters due to its geography, experienced devastating floods in 2018. Insufficient preparation and a lack of co-ordination of the emergency response exacerbated the impacts of the flood, creating momentum to enhance disaster preparedness. The government of Kerala first established the Rebuild Kerala Initiative and, together with international development partners, the Rebuild Kerala Development Programme, a comprehensive programme to improve preparedness for natural disasters encompassing policy reforms, strategic planning, capacity development and investment projects. PBLs from the World Bank and KfW supported implementation, with additional support for investment and technical assistance and the Asian Infrastructure Investment Bank, ADB, the EU, JICA and the UN provided additional support for investment and technical assistance.
The first World Bank Development Policy Operation under this programme was a USD 250 million concessional loan and contained conditions for disbursement: issuing guidelines for project selection and preparation; and budgeting for the programme; updating the State Disaster Management Plan; submitting a Draft River Basin Conservation and Management Act to the Legislative Assembly; adopting a state sanitation and waste management strategy; and or creating a single land record and integrated map for Kerala. KfW provided co-financing in the form of a concessional loan of EUR 100 million. These reforms were drawn from previous strategy documents elaborated with the support of international providers. Technical assistance under the programme targeted, for example, the provision of open data for improved risk assessment, flood monitoring and forecasting; capacity development of the Directorate of Environment and Climate Change; and public financial management at the state and local levels. Investment projects linked to the programme included an additional EUR 170 million loan from KfW for the climate-resilient construction of damaged roads.
The Resilient Kerala Program shows the advantages of PBLs and programmatic approaches for adaptation in certain situations. It created a local strategy with strong ownership around which donors can organise their broader programmatic approach and investment projects, establishing a basis for effective support and partnership. The strong political momentum after the 2018 floods led to high government attention to adaptation and to ambitious policy reforms systemically addressing disaster preparedness. Providers of climate finance also contributed to detailed planning efforts far beyond the level of detail of NAPs or NDCs, which proved useful in identifying necessary policy reforms as well as investment projects.
Embedded in this programmatic approach, PBF played an important role. Funding needs were estimated at USD 4.4 billion in a post-disaster needs assessment. The rapid disbursement and flexibility of PBLs proved vital in responding to immediate needs. Combined with technical assistance and capacity development, the PBLs also incentivised quick implementation of necessary reforms.
Source: Interview with KfW ; KfW (2019[79]), KfW supports climate-resilient infrastructure in India, https://www.kfw-entwicklungsbank.de/International-financing/KfW-Development-Bank/About-us/News/News-Details_550528.html ; World Bank Group (2019[80]), India – First Resilient Kerala Program Development Policy Operation (English), https://documents.worldbank.org/en/publication/documents-reports/documentdetail/476681561946430308/india-first-resilient-kerala-program-development-policy-operation
4.3.4. Seek to streamline and improve the interoperability of processes for accessing climate finance for adaptation
Navigating the international adaptation finance architecture can be daunting to many developing countries, especially as different providers often have different access modalities, eligibility criteria and administrative requirements for developing countries’ project proposals. Capacity development at the individual and organisational levels in recipient countries can enhance access to adaptation finance, and it is crucial that providers of climate finance support this activity. At the same time, some interventions can be undertaken upstream to support countries in their efforts to access and utilise funds effectively. Providers could consider the following options:
Improving the interoperability of project applications and reduce transaction costs for applicants by streamlining and standardising application procedures across different climate finance providers. This would save countries time and resources when applying for funding. In this regard, the GCF and GEF jointly issued a Long-Term Vision on Complementarity and Coherence that proposes, among other things, that the two funds collaborate and co-ordinate on programming and develop common guidance for project design and measuring project impact (GEF and GCF, 2021[81]). Another example is the joint MDB Working Group on Climate Finance Tracking’s updated methodology for tracking climate change adaptation finance (EIB, 2022[82]), which clarifies the activities that MDBs consider to be adaptation finance, thus lowering transaction costs of recipient countries that are working with several MDBs. Though not limited to adaptation finance, the Mutual Reliance Initiative of the AFD, the European Investment Bank and KfW also aims to facilitate co-operation among different providers, which also would have the effect of reducing recipients’ transaction costs (EIB, 2023[83]). Even with these initiatives, there is room to further improve the interoperability and reduce costs for accessing climate finance. For example, encouraging mutual recognition of accreditation between multilateral climate funds could reduce duplication of efforts and further streamline access to resources. Beyond the joint MDB methodology, there is also untapped potential for further improvement in the interoperability of standards and guidelines across different types of providers, including bilateral providers and multilateral climate funds.
Encourage climate funds to provide direct access to resources. Direct access can reduce costs for developing countries and enable smaller, locally led adaptation projects with high country ownership (Box 4.4). However, accreditation can be a complex and arduous process, complicated by factors such as stringent criteria, intricate application processes and applicants’ capacity constraints. Therefore, most projects are still implemented by multilateral implementing entities (as discussed in section 2.3). Several initiatives to facilitate direct access have potential to be scaled up. One is the GCF’s project-specific assessment approach pilot that allows for one-step project appraisals without requiring a full accreditation of the implementing entity. It will be important to monitor and evaluate the success of this approach. Also promising are enhanced direct access initiatives that facilitate and streamline accreditation procedures, making it easier for developing countries to access funding.
Streamline the architecture of climate funds to address fragmentation by avoiding the creation of new funds while encouraging existing funds to enhance collaboration and ensure complementarity. Funds also could work towards improvements in terms of transparency, efficiency, and impact. The joint GCF and GEF Long-Term Vision on Complementarity and Coherence, as noted, is a step in that direction (GEF and GCF, 2021[81]). Including explicit statements on collaboration and complementarity in strategic documents could also help foster accountability as would drafting additional shared complementarity strategies. Calls for broader multilateral reform beyond complementarity could also address fragmentation of climate finds, including by reducing the number of funds and funding windows (section 3.3).
Provide capacity development for the preparation of funding applications by focusing on long-term comprehensive strategies that encourage sustainable learning cultures in developing countries. These could include moving away from the fly-in fly-out consulting model and short-term, project-based initiatives and instead investing in multi-year partnerships that value and develop local knowledge. As noted in a study by the OECD (2023[19]) on climate-related development finance for SIDS, international providers can support developing countries in accessing adaptation finance by placing experts, preferably hired locally or regionally, directly in government institutions to offer training and ensure talent retention. This approach would include long-term embedding of additional personnel, pooling advisory services where needed, absorbing trained staff from previous capacity interventions, developing tailored capacity activities for domestic stakeholders, providing continuous on-the-job training, and utilising or creating regional support networks to facilitate peer-to-peer learning. Such initiatives have resulted in significant financing for various projects in SIDS, demonstrating their efficacy (OECD, 2023[19]).
Box 4.4. Direct Access to Multilateral Climate Funds
Direct access is a funding channel of multilateral climate funds in which a domestic entity of the recipient country is responsible for planning and implementation of a project and no intermediaries such as multilateral, international or bilateral entities are involved (Caldwell and Larsen, 2021[84]). Direct access was piloted by the Adaptation Fund and has since been adopted as a financial mechanism by most climate funds, including the GCF. Direct access requires accreditation of a national entity at the climate fund, which can be a long and arduous process depending on the readiness and capacity of the applicant entity. Many funds limit direct access to smaller projects based on the entity’s capacity constraints, leaving bigger infrastructure investments still largely implement by non-domestic actors. For fragile states and very small SIDS, the institutional requirements for direct access are especially difficult to fulfil (LDC Expert Group, 2020[85]). In an effort to ensure equitable access between national and multilateral implementing entities, the Adaptation Fund has set a cap of 50% for direct access entities. However, direct access through recipient governments made up only 6% of climate funds’ adaptation finance over 2016-20 while multilateral organisations implemented 79% of such funding.1 Climate finance through direct access was least prevalent in LDC and fragile states and accounted for only 14% of disbursements in upper middle-income countries over that period. In light of capacity constraints in national administrations, access through multilateral organisations might have enabled quicker project approvals and disbursements, because experienced international entities with high fiduciary standards were more easily accredited with the new funds. Indirect access also allows bilateral DFIs and MDBs to implement project pipelines that exceed their financial resources or risk appetites, as several providers noted in interviews for this report.
Increasing direct access to climate finance offers several benefits to developing countries. Direct access can reduce implementation costs for developing countries as they otherwise pay considerable mark-ups to implementing agencies. Direct access may also increase alignment with national priorities and ownership (Garschagen and Doshi, 2022[86]; IMF, 2021[87]; United Nations and Climate Finance Access Network, 2022[59]). The process of accreditation is also valuable in developing capacity and reliable national systems, which in turn can attract investment from other sources and improve the sustainability of projects since as direct access entities are well placed to continue initiatives after international finance ends. Finally, research has found projects implemented through direct access are closer to local needs and more likely to involve local authorities (Manuamorn and Biesbroek, 2020[88]).
1. The following multilateral climate funds included in this analysis are the Adaptation Fund; the Climate Investment Funds (including the Clean Technology Fund and the Strategic Climate Fund); the GCF; the GEF (including the LDCF and Special Climate Change Fun); and the International Fund for Agricultural Development.
Source: Caldwell and Larsen (2021[84]), Improving Access to the Green Climate Fund: How the Fund Can Better Support Developing Country Institutions, https://doi.org/10.46830/wriwp.19.00132 ; Garschagen and Doshi (2022[86]), Does fund-based adaptation finance reach the most vulnerable countries?, https://doi.org/10.1016/j.gloenvcha.2021.102450 ; LDC Expert Group (2020[85]), Gaps and needs related to the process to formulate and implement national adaptation plans, and ongoing activities of the Least Developed Countries Expert Group, the Adaptation Committee and relevant organizations related to addressing those gaps and needs, https://unfccc.int/sites/default/files/resource/Gaps-and-needs-Naps-March-2020.pdf ; Fouad et al. (2021[87]), Unlocking Access to Climate Finance for Pacific Island Countries, https://doi.org/10.5089/9781513594224.087 ; United Nations and Climate Finance Access Network (2022[59]), Accessing Climate Finance: Challenges and opportunities for Small Island Developing States, https://www.un.org/ohrlls/sites/www.un.org.ohrlls/files/accessing_climate_finance_challenges_sids_report.pdf ; Manuamorn and Biesbroek (Manuamorn and Biesbroek, 2020[88]), Do direct-access and indirect-access adaptation projects differ in their focus on local communities? A systematic analysis of 63 Adaptation Fund projects, https://doi.org/10.1007/s10113-020-01716-4
4.4. Deploy public and blended finance instruments strategically to mobilise private finance for adaptation
Beyond the efforts to strengthen the enabling environment highlighted above, significant untapped potential exists for development actors to engage directly – at a transaction, project or programme level – to unlock private finance for adaptation. This is primarily relevant to adaptation interventions that can have a revenue stream but are not yet commercially viable (see Section 3.1.). Here, blended finance plays a crucial role – complementing other action areas presented in this report by helping overcome initial barriers that adaptation projects may face.
As elaborated in Box 4.5, blended finance is the strategic use of development finance to unlock commercial finance for sustainable development in developing countries (OECD, 2018[89]). The focus on supporting projects complements improvements to the enabling environment highlighted above (OECD, 2018[89]). Blended finance can enhance returns and/or reduce the risks faced by private investors, with the aim of making projects commercially viable. This can be achieved using concessional finance, such as from aid agencies, or non-concessional or market-rate development finance, such as DFIs’ own resources. In the case of market-rate development finance, the benefits arise from additional characteristics that the mobilised private investor can leverage – such as development actors’ due diligence capacity, know-how, local presence and longer-term commitment to market-building (OECD, 2018[89]). As such, development finance can serve a demonstration effect by highlighting to other private actors the viability of adaptation-themed investments (Tall et al., 2021[90]).
While current levels of private finance mobilised by official development finance for adaptation are low, existing efforts demonstrate the potential of private finance for adaptation and identify pathways for development actors to unlock this potential. Six of these efforts are presented in greater detail in Annex A. These case studies inform the options discussed in this section to work with and through the private sector to scale the mobilisation of private finance or private investments into adaptation activities.
Box 4.5. The OECD DAC Blended Finance Principles and associated guidance
The OECD defines blended finance as “the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries” (OECD, 2018[91]). It is one of many tools in the development finance ecosystem – and particularly key to the mobilisation of commercial capital.
The OECD DAC Blended Finance Principles, endorsed by the DAC in 2017, aim to help bilateral and multilateral providers, development co-operation agencies, philanthropies and other stakeholders design and implement effective, efficient, and transparent blended finance programmes. Since then, they have been embedded into the international development architecture – for example by being referenced under a number of G20 and G7 Presidencies, and shaping discussions on blended finance best practices within the UN, the European Union and the World Economic Forum (OECD, 2020[92]).
There are five OECD DAC Blended Finance Principles:
Principle 1. Anchor blended finance use to a development rationale.
Principle 2. Design blended finance to increase the mobilisation of commercial finance.
Principle 3. Tailor blended finance to local context.
Principle 4. Focus on effective partnering for blended finance.
Principle 5. Monitor blended finance for transparency and results.
The OECD Blended Finance Guidance advises how to put these principles into policy practice (OECD, 2021[93]). For now, this guidance is sector-agnostic but will be strengthened throughout 2023/24 with the addition of financial instruments including green, social and sustainability (GSS) bonds and risk sharing mechanisms, as well as through thematic updates in the form of dedicated Guidance on blended finance for adaptation and biodiversity.
Source: OECD (2018[91]), OECD DAC Blended Finance Principles for Unlocking Commercial Finance for the Sustainable Development Goals, https://www.oecd.org/dac/financing-sustainable-development/development-finance-topics/OECD-Blended-Finance-Principles.pdf; OECD (2020[92]), Blended finance guidance & principles (webpage), https://www.oecd.org/dac/financing-sustainable-development/blended-finance-principles/guidance-and-principles/; OECD (2021[93]), The OECD DAC Blended Finance Guidance, https://doi.org/10.1787/d571f17c-en
4.4.1. Integrate private finance mobilisation objectives into relevant adaptation transactions, projects and programmes
The call to mobilise further private finance extends beyond adaptation. It initially emerged in the context of the Addis Ababa Action Agenda and subsequent blended finance efforts (OECD, 2018[89]). Currently, the international financial architecture faces increasing pressure to enhance its role in climate financing, including by unlocking additional private finance to augment total funding for climate action. Several proposals demand reform of MDBs, including calls for greater risk exposure through the use of blended finance instruments.
Although these reform processes are still ongoing, international providers play an important role already now. They could start acting on mobilisation by integrating the objective of private finance mobilisation through a bottom-up approach that formulates mobilisation ambitions on adaptation within given transactions, projects, and programmes. Public finance will remain crucial in financing adaptation outcomes in many circumstances – but making mobilisation objectives explicit could help international providers select the most effective and appropriate financial tools. International providers could also consider disbursing concessional funding with a clearly expressed expectation or even conditionality to mobilise private finance and then chose the channel accordingly. This must all be done in the context of clear adaptation objectives.
Public international finance interventions for adaptation unlock private finance through a variety of financial instruments including debt, equity, credit enhancement and grants (Annex A). Private finance can also be mobilised at different levels or transmission mechanisms (Figure 1.3). This can be done, for example, via a developing country government which issues adaptation-specific bonds. Mobilisation can also take place at the project level (e.g. via direct investment in special purpose vehicles or public-private partnerships that serve an adaptation purpose such as flood protection); at the portfolio level (e.g. via buying shares of investment funds that on-lend or provide equity to adaptation-related SMEs or projects); and at the financial institution or enterprise level (e.g. via direct investment in companies that provide adaptation services such as weather forecast data).
Private finance can also be catalysed via an improved enabling environment that is conducive to private investments in adaptation. International providers can leverage upon the variety of entry points to progressively build markets of private finance for adaptation. For example, the EBRD issued its first climate resilience bond also to help familiarise the private sector with investing in adaptation7 (see case study 5 in Annex A). Efforts to improve data access – via grants and technical assistance – may in turn also support the catalysation of private sector investments in local data processing and forecasting (case study 1 in Annex A).
Even when using private sector-related instruments, spelling out mobilisation ambitions upfront and pursuing them throughout implementation are important to the effective mobilisation of private finance. Engaging private sector actors early can clarify if and how they can participate in specific deals and transactions. Doing so is particularly relevant to financing adaptation, where private actors generally lack expertise and a track record.
4.4.2. Tailor the use of public and blended finance instruments to unlock private finance that corresponds to the needs and characteristics of adaptation activities
Efforts to mobilise private finance for adaptation are at an early stage. International public finance providers and development finance actors should thus invest in exploring, piloting and eventually scaling tailored approaches to support adaptation and increase adaptation finance. Recognising the unique aspects of adaptation finance and private investor preferences should yield dividends in the long run. International providers should exploit the full range of development finance instruments – from grants to market-rate development finance interventions – to effectively unlock further private finance for adaptation that responds to the specific characteristics and needs of adaptation activities. Examples include:
Use grants to create an enabling environment conducive to private investments in adaptation. Grants play an established role in creating an environment conducive to private investments in adaptation. The Asia-Pacific Climate Finance Fund (case study 2 in Annex A) exemplifies how grants can drive the development and uptake of risk management tools in financial intermediaries. The Systematic Observations Financing Facility (SOFF) (case study 1 in Annex A) shows how grants can contribute to data as a means to adapt. Grants can also establish conducive enabling environments for SMEs that provide services and products enabling adaptation, as demonstrated by the Lightsmith group’s Adaptation SME Accelerator Project (ASAP) (case study 3 in Annex A). The initiatives highlighted in the case studies also demonstrate the role of grants in overcoming the technical barriers which prevent countries from systematically integrating adaptation considerations into broader development projects. Development grants and public domestic finance will continue to play a leading role in building the ecosystem and the enabling environment. That being said, it is important to note that while grants can be used for blending, on their own they are not blended finance instruments as such.
Use grants strategically to unlock private finance by tailoring risk-return options to the adaptation project lifecycle stage. Early in the project lifecycle stage, grants can be used to provide early-stage capital to cover feasibility studies. While fundamental in driving investments into adaptation, these are not directly associated with any returns generated by the underlying activities. It is important to develop rigorous processes for grant allocation, in line with the options for consideration outlined in section 4.3.1. This could involve, for example, setting targets for geographical allocation, and developing shared key performance indicators (KPIs) to assess the expected impact on adaptation of different projects. Grants can also be used to support early-stage innovative adaptation projects through the development stage: the uncertain cash-flows and the uncertainty around the adaptation effects on these cash flows underscore the significant role of development finance. The ASAP, for example, supports SMEs to overcome barriers to scale and commercialisation (case study 3 in Annex A). The Climate Investor Two (CI2) fund includes a development fund focusing on the planning and development of water and sanitation infrastructure projects with adaptation spill-over effects (case study 4 in Annex A); a second and complementary fund focuses on providing equity for construction, a generally high-risk phase when operations have yet to generate cash flow. While the Cl2 development fund is providing grant-based instruments and hence no financial return, the construction fund is mobilising further private finance by introducing a layered structure that provides tailored risk-return options for different investor types. The senior tranche, when private investors come in, is protected by a junior tranche of concessional development finance providers and a mezzanine tranche of market-rate development financiers.
Use portfolio approaches to link capital markets and institutional investors with adaptation projects. These approaches can unlock private finance upstream at the portfolio level, through project aggregation. Examples include collective investment vehicles like the CI2 Construction Equity Fund, which brings in institutional investors (case study 4 in Annex A). The EBRD’s climate resilience bond issuance (case study 5 in Annex A) targeted private investors to familiarise them with adaptation more broadly while also setting an example for potential issuers. In both cases, adaptation projects are identified, evaluated, and initiated by an intermediary – climate fund managers and the EBRD – and financed by a mix of development finance and commercial investment. Standardised capital market instruments such as green, social and sustainability (GSS) bonds are used to (re)-finance sustainable projects (Box 4.6). Such portfolio approaches typically target larger projects rather than SMEs. For example, the proceeds of the EBRD’s climate resilience bond are used to finance projects within the EBRD’s Climate Resilience Portfolio made of up EUR 1.4 billion in operating assets (case study 5 in Annex A). The EBRD uses the proceeds of a USD 700 million climate resilience bond for its operations in infrastructure, financing for business and commercial operations, and agricultural systems such as water-efficient irrigation systems. Other portfolio approaches include risk-sharing mechanisms such as portfolio guarantees and credit lines, as well as securitisation8 (OECD, 2021[94]; ImpactAlpha, 2023[95]). Private financiers with large volumes to invest, and who seek liquid and profitable ventures, are often unfamiliar with adaptation and are unlikely to engage in the origination of adaptation deals – also due to a lack of local presence and knowledge. Intermediaries can connect adaptation-specific demands as well as institutional investor preferences, and more broadly familiarise investors with the area of adaptation. In these contexts, the intermediation function plays a crucial role. This role can be fulfilled both by development actors that have a track record and existing portfolio in developing countries (including on adaptation), such as DFIs, as well as private actors such as fund managers, who are established players in the management of blended finance funds (Dembele et al., 2022[96]). Via such approaches, a clear link is made between investor profitability and the positive impacts of investment of adaptation, thus addressing economic and financial barriers identified in Chapter 3.
Box 4.6. Green, Social and Sustainability (GSS) bonds for adaptation
GSS bonds are use-of-proceeds instruments. Issuers commit to using the proceeds to (re-)finance projects considered to have a positive environmental and/or social impact. For investors, they provide greater transparency over what the earnings of the bond are used for and help meet growing expectations over sustainable mandates. For issuers, they are a source of long-term, diversified and low-cost funding for projects with a clear development focus. The GSS bond market has experienced very significant growth in recent years. Yet it remains largely concentrated in developed countries: in 2021, only 7% of the overall GSS bond market was issued in ODA-eligible countries. Significant support from international providers is therefore needed in this area (OECD, 2023[97]).
Climate adaptation is already being financed with GSS bonds – but to a very limited extent. According to the Global Center on Adaptation, 16.4% of global green bonds (as of September 2020) also targeted activities related to adaptation – yet only 6% of these were from emerging markets (Amundi and IFC, 2022[98]). A few sovereigns – such as Fiji, Indonesia, the European Union, and New Zealand – have issued GSS bonds earmarking climate change adaptation as one of the eligible use-of-proceeds categories (Climate Bonds Initiative, 2022[99]; Amundi and IFC, 2022[98]). Fiji’s issuance is particularly noteworthy as it was one of the few sovereign bonds of which the majority of proceeds are allocated to climate change resilience. The EBRD’s climate resilience bond also stands out as the world’s first with this label and to earmark all proceeds to resilience (case study 5 in Annex A).
Significant potential therefore exists to use GSS bonds to finance adaptation, especially given the urgency of increasing adaptation finance and the growing interest from issuers and investors in these instruments. Challenges remain – both in ensuring that GSS bonds contribute positively to adaptation, and in scaling their use, especially in developing countries. There is also a lack of bankable projects large enough for GSS bond financing, and this may be especially the case for adaptation specifically. GSS bonds are often used to refinance existing assets, therefore making it difficult to prove their additionality and impact. Studies have also found limited issuer commitments regarding the use-of-proceeds of bonds (Curtis, Weidemaier and Gulati, 2023[100]), and the enforceability of any commitments also remains limited (Zettelmeyer et al., 2022[101]). International providers therefore have an important role in helping overcome these challenges to advance issuances of GSS bonds in developing countries, and realise the potential of these instruments for sustainable development and climate adaptation.
Source: OECD (2023[97]), Green, Social and Sustainability bonds in developing countries: The case for increased donor co-ordination, https://www.oecd.org/dac/green-social-sustainability-bonds-developing-countries-donor-co-ordination.pdf ; Amundi and IFC (2022[98]), Emerging Market Green Bonds Report 2021, https://research-center.amundi.com/article/emerging-market-green-bonds-report-2021; Climate Bonds Initiative (2022[99]), Sustainable Debt: Global State of the Market 2022, https://www.climatebonds.net/resources/reports/sustainable-debt-global-state-market-2021; Curtis, Weidemaier and Gulati (2023[100]), Green Bonds, Empty Promises, http://dx.doi.org/10.2139/ssrn.4350209 ; Zettelmeyer et al. (2022[101]), Geneva 25: Climate and Debt, https://cepr.org/publications/books-and-reports/geneva-25-climate-and-debt
4.4.3. Undertake regular assessments of needs for concessional finance
The need for blended finance will evolve over time. Successful transactions help reduce the costs of future interventions by demonstrating feasibility and enabling “learning by doing”. Over time, this can reduce the need for concessional finance to support adaptation actions that can potentially generate market-level or close-to-market-level returns. The result is a dynamic evolution of the use of blended finance, where the use of concessional finance is continuously assessed throughout different stages of a project and also of a market’s development more broadly (OECD, 2022[102]).
While significant grant funding might initially be necessary to stimulate an adaptation solution, once the solution is proven and scaled, the grant component should gradually decrease in repeat transactions and give way to other reimbursable instruments. For example, grant funding will be needed in the project development phase of a nature-based solutions project – for fundamental research on the impact of adaptation and respective data development – and market-rate finance can then step in to support the infrastructure in the projects’ operational phase as well as the applied research and roll-out of specific technologies (UNEP Copenhagen Climate Centre and OECD, 2022[103]). The CI2 fund, which provides solutions across the lifecycle of water and sanitation projects, also shows how the use of blended finance can be tailored to different project stages and eventually phase-out over time (case study 4 in Annex A). Grants were used for project development; a mix of grant and concessional development finance was deployed for construction, which also mobilises additional private finance; this was followed by a more market-oriented refinancing fund during operational phase of the infrastructure.
Ultimately, the use of blended concessional finance should strive towards market creation and exiting once commercial markets are functioning (OECD, 2020[92]). Especially given the scarcity of developmental resources, permanent subsidisation is neither desirable nor self-sustainable, leading to market distortion or maladaptation. Therefore, concessional finance that is disbursed to unlock private finance should be linked to the ongoing status of market failures that prevent stand-alone private finance for adaptation, rather than being of structural nature. If continuous development finance support is needed to attract private finance for adaptation objectives, then context and conditions may not be suitable for blended finance, suggesting a need for other instruments from providers’ toolboxes. Otherwise, blended finance may risk using scarce development resources to over-subsidise the private sector for risks that will continue to persist in the area of adaptation financing in the absence of market development (OECD, 2020[104]). This aligns with an understanding of blended finance as a dynamic, transitory approach; over time, private financiers and investors accumulate experience, data and knowledge in adaptation, leading towards increased reliance on commercial finance.
While public finance will continue to play a crucial role in financing adaptation, some sectors and adaptation activities are already more suitable for more market-oriented financing solutions (section 3.1, Table 3.1). For instance, the more financially viable activities– such as integrating climate resilience into the design of new infrastructure –can progressively increase their reliance on commercial finance. Figure 4.2 is a stylised visual representation of the potential evolution over time of the role of development concessional finance. The figure focuses on three subsectors in the water and sanitation sector, as this type of market evolution clearly will not apply to all sectors (OECD, 2019[105]).
Indeed, based on the specific context and market conditions of different sectors, international providers can strategically select from their financial toolbox, using grants, concessional development finance, non-concessional development finance and market-rate development finance to provide effective support. Mitigation and adaptation objectives may call for differentiated approaches in climate development finance, using limited grant resources for adaptation and focusing non-concessional development finance on mitigation. Indeed, the Independent High Level Expert Group on Climate Finance calls for a new approach to finance that takes advantage of the complementary strengths of different sources to ensure the right volumes and types of finance for different spending priorities for climate action, and to reduce the cost of capital more broadly. According to the Expert Group, for example, private sector investors typically need to operate with shorter financing terms and require relatively robust revenue streams (Songwe, Stern and Bhattacharya, 2022[106]).
Figure 4.2. Current state of transaction-level mobilisation and its potential evolution towards increased reliance on commercial finance
Note: The x-axis of the graph displays a time dimension, indicating the evolutionary role of development finance in unlocking private finance within sectors.
Source: OECD (2019[107]), Making Blended Finance Work for Water and Sanitation: Unlocking Commercial Finance for SDG 6, https://doi.org/10.1787/5efc8950-en; OECD (2018[108]), Making Blended Finance Work for the Sustainable Development Goals, http://dx.doi.org/10.1787/9789264288768-en.
4.4.4. Use blended finance as a tool to encourage mainstreaming adaptation into projects
Blended finance can be used as an incentive to mainstream adaptation elements into projects that are undertaken for other reasons, such as clean energy projects. Currently bankable projects can be adjusted to ensure that they contribute more significantly to adaptation, for example by harnessing spill-over effects by redirecting or cross-leveraging.
Mainstreaming adaptation into mitigation infrastructure projects is a particularly promising way to unlock private investors. One way of doing this could be to integrate climate resilience into the design of new infrastructure, such as water-proof cables that are more expensive in a new port but will resist flooding. Another alternative could be to make existing infrastructure resilient, for instance by using heat-proof concrete when refurbishing a motor route. For any investment, there should be an assessment of whether measures to increase resilience are needed and of the most cost-efficient way of implementing these. Strengthening adaptation by exploiting spill-over effects from projects that do not primarily target adaptation relies on the fact that mitigation projects, through their project finance nature, can ringfence cash flow generation and be scaled. In such projects, the high degree of cash flow predictability associated with infrastructure and project finance provides certainty to investors about their repayments and returns, with adaptation aims also incorporated into the project. The CI2 fund, for example, has a mandate to mobilise private finance and it harnesses spill-over effects through its explicit focus on both adaptation and mitigation (case study 4 in Annex A).
4.4.5. Develop strengthened practices to measure, understand and maximise the adaptation impact of mobilised finance
Numerous factors make the monitoring and evaluation of adaptation challenging – among them measuring attribution, dealing with rapidly changing baselines, setting measurable and specific targets and indicators, factoring the long-term and uncertain nature of climate change adaptation, and overcoming gaps in data availability (OECD, 2015[109]; OECD, 2023[57]). Understanding the adaptation impact is challenging, and especially so in the context of blended finance transactions. These involve multiple partners and intermediaries, making it harder to establish causal links between inputs and results. Further, concerns have been raised about the associated risks and unintended impacts of using blended finance without the right policies and understanding in place (OECD, 2018[89]).
A crucial first need is for shared, harmonised metrics and KPIs to demonstrate and assess the adaptation impact. These will make it easier to understand and compare the impact and effectiveness of different projects and activities and assess vulnerability. Importantly, they will help drive funding where it is most needed and where it can have the greatest impact. The complexity and wide-ranging scope of both climate change and adaptation actions make it hard to identify adaptation metrics. The effectiveness of climate adaptation interventions is often measured by looking at processes and outputs rather than outcomes – for example, by using indicators that relate to the policies and plans put in place rather than assessing how the intervention might have reduced climate risks and increased adaptive capacity (OECD, 2023[57]). Indeed, according to the International Platform on Adaptation Metrics, the difficulty in quantifying adaptation and the underlying lack of consensus on adaptation metrics have been identified as the key reason behind the insufficient mobilisation of finance for climate adaptation (2022[110]).
The International Platform on Adaptation Metrics is working towards designing adaptation metrics to encourage stronger adaptation financing and policymaking. The OECD Impact by Design Toolkit also provides a best practice guide on selecting adequate indicators to measure climate adaptation and resilience. From a business perspective, looking at the profitability and sustainability of businesses working on adaptation projects can also be important. If the market is willing to pay for a technology or data service intended to support adaptation, this in itself is an indicator of success – and therefore a metric to consider for adaptation. Using this as a metric can be a first step, to be built on and improved on. Taking a step back, the private sector, which is ultimately closer to adaptation projects and activities, should participate in developing best practices and KPIs. International providers therefore have a role to play in bridging gaps between different actors.
Also needed is better measurement of the effectiveness and outcome results of blended finance transactions, including to understand which blended finance instruments are mobilising the most commercial capital and specifically addressing adaptation, for example (OECD, 2015[109]). Relatedly, the lack of transparency on blended finance operations has been identified as a major obstacle to the mobilisation of private finance (OECD, 2023[111]). Understanding the impact of specific actions on adaptation then ultimately rests on strong measurement and monitoring for results, as well as transparent and comparable reporting. Well-designed results frameworks facilitate evidence-based decision-making, learning, accountability towards goals and actions, and communication. The OECD Impact by Design Toolkit provides guidance on designing effective results frameworks (OECD, 2023[57]).
4.5. Explore and tap into alternative financing sources and mobilisation instruments for adaptation
A number of innovative alternative instruments have emerged within the development and climate finance space beyond those more traditionally used by established sources. These instruments offer significant potential to bridge the financing gaps for sustainable development and climate. Several options are open to providers and developing countries to test some of these instruments and used them to scale up finance for adaptation.
4.5.1. Clarify and exploit the role of Special Drawing Rights in financing adaptation
Special drawing rights (SDRs), the international reserve assets created by the International Monetary Fund (IMF) to supplement its member countries' official reserves, have the potential to bolster adaptation finance for developing countries by: improving developing countries’ liquidity and financial capacities; supporting IMF-administered trust funds; and, potentially increasing MDBs’ lending capacity. SDRs can be allocated by the IMF if there is a long-term global need to supplement existing reserve assets, provided that it will avoid both economic stagnation and deflation, and excess demand and inflation. General SDR allocations require an 85 percent majority of the total voting power of members that are participants in the SDR Department of the IMF. SDRs could be used to help scale up adaptation finance in a number of ways:
Developing countries can hold allocated SDRs to augment their international reserves, or use them to acquire usable currency or repay IMF obligations. An SDR allocation gives IMF members both SDR assets (SDR holdings) and corresponding liabilities (SDR allocations). If a country’s SDR holdings fall below their cumulative SDR allocations, the country is obligated to pay the floating SDR interest rate (about 4% as of October 2023) on the shortfall until the SDR holdings match the cumulative SDR allocations (IMF, 2023[112]). The allocated SDRs would increase the member’s gross international reserves and are typically managed by either the country's Central Bank or the Finance Ministry. With stronger reserve buffers and financial resilience, these countries can potentially attract more adaptation finance from international sources, such as MDBs, climate funds, and private investments. Moreover, countries can voluntarily channel their SDRs to the IMF or prescribed holders including MDBs. The IMF allocates SDRs to its member countries based on their IMF quota shares (broadly related to their economic size) meaning that a larger share of SDRs is allocated to advanced economies and emerging markets. It is estimated that low-income countries are only allocated 3.3% of all SDR allocation (IMF, 2021[113]).
Many advanced and emerging economies with robust international financial standings have chosen to channel SDRs to two IMF-administered trust funds. The IMF Poverty Reduction and Growth Trust (PRGT) provides concessional financing to low-income countries, helping them develop sound macroeconomic policies, which are critical for fostering macroeconomic stability, poverty reduction, and building resilience to shocks of all kinds. The IMF Resilience and Sustainability Trust (RST) provides financing for countries to build resilience to external shocks, including to climate change- and pandemic-related risks. The IMF Executive Board has already approved eleven countries for arrangements under the RST. Beyond the IMF-administered PRGT and RST, the Bridgetown Initiative has proposed the establishment of a Global Climate Mitigation Trust, to be endowed with USD 500 billion of SDRs. This would bring an important shift in how such programmes are financed, currently reliant on the developmental assistance budgets of donor countries (ECA-ECLAC, 2022[114]). Indeed, in terms of accounting for adaptation finance provided and mobilised by developed countries, the use of SDRs through the RST raises fundamental questions around defining the scope of adaptation-specific finance versus broader categories of finance for climate resilience and general resilience, which encompasses a wider array of economic challenges, including but not limited to climate resilience (see Chapter 1).
Finally, allocated SDRs could be used to potentially increase MDBs’ lending capacity. Some MDBs are exploring the issuance of SDR-denominated hybrid capital instruments. Current proposals for the use of these instruments could enable additional lending of three to four times the amount of hybrid capital created by the SDRs. Leveraging the multilateral banks' capability to amplify investments, this could see SDR 100 generating between SDR 300 and SDR 400 in new development lending (Lazard, 2022[115]). Ultimately, the channelling of SDRs to MDBs should be a collaborative decision, taking into account primarily the consensus between MDBs and SDR-lending countries (Andrews and Plant, 2021[116]). At the same time, many potential contributors (such as European Union members) face legal obstacles to purchasing these instruments, and MDBs continue to collaborate with shareholders to refine arrangements. The IMF is broadly supportive of SDR channelling to MDBs and is updating its legal infrastructure to allow for this new use.
4.5.2. Build on international carbon markets to provide financing for adaptation in developing countries
Article 6 of the Paris Agreement, though primarily focused on GHG mitigation, also supports adaptation through multiple channels, including market approaches to promote both mitigation and adaptation. Specifically, it offers a framework for international carbon markets through Article 6.2, which introduces the concept of internationally transferred mitigation outcomes (ITMOs) and their accounting framework, and through Article 6.4, which outlines a new mechanism to contribute to the mitigation of GHG emissions.
In particular, under the new Article 6.4 mechanism, a 5% share of proceeds (SOP) from Article 6.4 Emission Reductions (A6.4ERs) generated by carbon markets will be allocated to the Adaptation Fund, providing financial support for climate adaptation projects in vulnerable developing countries. A 2% SOP destined to finance the Adaptation Fund was already implemented under the Kyoto Protocol’s Clean Development Mechanism (CDM). As of May 2023, monetisation of the levied CDM CERs has provided USD 215 million of the Adaptation Fund’s cumulative USD 781 million (World Bank, 2023[117]). (LDC Climate Change, 2021[118]) provided one of the few estimates of the impact of the 5% SoP under the Paris Agreement, finding that the levy could generate as much as USD 2.7 billion for the Adaptation Fund. Their study, however, was conducted prior to the adoption of the Article 6 rulebooks and does not take into account the most recent developments in this area, including the fact that the SoP will not be mandatory for transactions under Article 6.2 markets. The figure could therefore be a material overestimate, though indicating that the Article 6.4 levy might raise more finance for the Adaptation Fund than did the CDM. The SoP from Article 6.4 could also have positive influence on other similar mechanisms, raising further resources for adaptation.
4.5.3. Embed adaptation and resilience considerations in emerging sustainable finance definitions, instruments and products
Innovative sustainable finance instruments and products have emerged in recent years to boost finance for climate change. Individually, none of them will be the silver bullet to reach the necessary finance levels; rather, they must be seen as tools to be used and assessed. Many of these instruments are in the early stages of development and application – and currently either omit adaptation or focus less on adaptation than on mitigation. It is important to monitor the potential of these instruments and products to scale up adaptation finance, and possibly modify them to fit this purpose. Although many such instruments exist, this section explores two – sustainability-linked bonds (SLBs) and tax securitisation – to exemplify the potential that they hold for mobilising finance for adaptation.
SLBs are financial instruments in which issuers commit to pre-defined sustainability objectives and the structural and/or financial characteristics of the bonds then change depending on whether these objectives are met. As the proceeds are not project-specific and can therefore be used for general purposes, SLBs have strong potential as instruments to finance adaptation: they do not require a pipeline of bankable assets and allow for flexibility as the impacts of climate change develop. Relatedly, the change in structural and/or financial characteristics incentivises issuers to meet adaptation targets. The first SLB was issued in 2019, and issuances have predominately (98%) come from corporates. Two sovereigns, Chile, and Uruguay, issued SLBs in 2022, linking the bonds to their respective Paris Agreement NDCs. According to NatureFinance estimates, SLB issuances from emerging market and developing economy sovereigns could reach between USD 250 billion and USD 400 billion by 2030, up from USD 3.5 billion at the end of 2022 (Kulenkampff and Pipan, 2023[119]). This growth could drive significant finance towards adaptation projects. For example, SLBs can be used to mobilise capital to cover funding gaps for adaptation solutions. SLBs can also enhance the accountability and credibility of country’s adaptation pledges and NAPs by setting clear targets and metrics and providing financial incentives to achieve them (Kulenkampff and Pipan, 2023[119]). The International Capital Market Association (ICMA) published an Illustrative KPI Registry for SLBs, which includes KPIs tied directly to adaptation (e.g. the percentage of invested assets managed in accordance with ESG-criteria “including climate adaptation objectives” (ICMA, 2023[120]). The World Bank has also published a list of potential sovereign KPIs that would be both appropriately ambitious for investors and achievable for issuing countries. Among these are indicators related to adaptation (e.g. whether a country has adaptation communications and a NAP) (World Bank Group, 2021[121])).
SLBs are more flexible than use-of-proceeds GSS bonds (Box 4.6) in that they do not lock issuers into specific technologies or projects (Rimaud, 2023[122]). In the context of adaptation, this feature means there is greater freedom to switch to different solutions as technologies, and the impacts of climate change, develop. However, as such new instruments, the impact of SLBs remains uncertain and there are barriers to scaling them. For example, assessing the ambitiousness of the sustainability objectives set by issuers is challenging – especially as these need to reflect different country contexts. Another challenge is the lack of timely data, especially in developing countries, to demonstrate progress towards targets (World Bank Group, 2021[121])). Structural loopholes, such as late target dates and call options, also make SLBs less effective (Ul Haq and Doumbia, 2023[123]).
Securitisation of fees and taxes is another promising instrument recently applied to financing climate adaptation. This entails issuing a bond backed by the cash flows of fees or taxes with a strong cash record, with the bond proceeds then used to finance climate resilience and adaptation. Securitisation raises large-scale financing and attracts private capital that may otherwise be hard to mobilise for climate adaptation projects with limited revenue generation potential. In the United States, the securitisation of fees and taxes has already been used to pay for climate change damages, and proposals have been made to use it to fund air quality, climate and vehicle electrification programmes (Legislative Analyst's Office, 2021[124]; ImpactAlpha, 2023[95]). This instrument has also already been successfully used in developing country contexts. Ghana, for example, has securitised education and petrol taxes to improve access to education and pay off legacy debts in the banking sector, respectively (ImpactAlpha, 2023[95]). These examples suggest that the securitisation of taxes and fees could be used in African countries to finance adaptation.
At the same time, at an aggregate level, this instrument does not increase overall amount of financing available to governments for adaptation but helps to frontload adaptation investments and thereby to prevent harmful and costly impacts from climate change. However, securitisation models are complex to design, apply and manage successfully – and developing country governments as originators may lack the knowledge, regulation, or capacity to do so. The feasibility of this instrument also relies on the existence of a tax or fee with a strong cash flow, a population that can pay such tax, and a government that can collect it – which can be challenging in many developing country contexts (OECD, 2023[125]).
4.5.4. Consider the relevance of debt-for-adaptation swaps
International providers have used the practice of debt in some specific circumstances to alleviate the debt burden of developing countries. The Paris Club of creditor countries also reschedules and/or cancels debt in its effort to find sustainable solutions to debtor countries in difficulty, treating USD 614 billion of debt since 1956 (Club de Paris - Paris Club, n.d.[126]). Providers of concessional finance have also supported debt relief on an ad hoc, bilateral basis. While debt relief may not contribute to new and additional development finance flows to developing countries, it essentially converts an obligation to repay funds into a grant. This then frees up fiscal space for the recipient country to repurpose principal and interest into public investment. This type of relief can be paired with macroeconomic reforms. (Club de Paris - Paris Club, n.d.[126]).
Debt-for-nature swaps are a specific form of debt relief whereby creditor countries or institutions agree to reduce or cancel the debt owed to them in exchange for the debtor country's commitment to invest in conservation, ecosystem restoration or climate-resilient infrastructure. Debt-for-nature swaps could serve as a model or instrument for mobilising and channelling adaptation finance while also promoting environmental conservation and sustainable development. They could be structured to provide debt relief in exchange for a nation’s investment commitment in a sector or project that contributes to adaptation. Such swaps could also include commercial debt. In some situations, debt-for-nature swaps can be a viable tool to address multiple, concurrent crises such as namely unsustainable debt, biodiversity loss and climate change (Kelly, Ducros and Steele, 2023[127]). By freeing up fiscal space, they can allow countries to improve climate change resilience without the government having to sacrifice spending on other priorities (Georgieva, Chamon and Thakoor, 2022[128]). Unlike debt forgiveness or debt restructuring that tend to benefit only the debtor, debt swaps can have benefits for creditors too, via the allocation of greater fiscal space by debtor economies for increased investment in the climate space (Shirai, 2022[129])
To date, debt-for-nature swaps have not focused specifically on adaptation projects and activities (Hebbale and Urpelainen, 2023[130]), though they can unlock climate finance with benefits for adaptation. For example, in a debt-for-nature swap signed in January 2023, EUR 12 million of debt repayments owed by Cabo Verde to Portugal will be put in an environment and climate fund (Goncalves, 2023[131]). Importantly, the swap is tied to KPIs for national climate and nature goals, the details of which are still being finalised. Cabo Verde must meet these goals to receive the debt relief, with any remaining fiscal space used for other development priorities (Kelly, Ducros and Steele, 2023[127]; IIED, 2023[132]).
Debt swaps in general, however, entail a complex process. Addressing debt and environmental issues separately is typically more effective, and climate-conditional grants have proven more efficient. Some swaps, including Belize’s 2021 debt-for-nature swap, have been criticised for being very expensive and ultimately having a relatively small impact on debt relief. There is also limited scope for using these tools beyond SIDS or other small economies due to the size of debt involved and the need to convince numerous public and private actors to participate in such complex transactions (Padín-Dujon, 2023[133]).
Moreover, debt swaps cannot restore solvency unless they involve a large portion of a nation's debt, which none so far have done. Nor are swaps a substitute for debt restructuring, though they can complement it when resources such as grants are scarce and a country's debt is unmanageable (Georgieva, Chamon and Thakoor, 2022[128]). In addition, any debt relief impacts a country’s creditworthiness perception in relation to current and future lenders (or bond holders), including private sector actors. Future issuances of sovereign debt – a major source of funding – may be impacted by such instruments that make use of – technically – default on current repayment obligations. As such, they are intended to be a one-off fix rather than scalable or replicable at the country-level as a regular instrument. The fundamental intention needs to be and should continue to be to avoid debt distress situations in the first place.
For debt-for-nature swaps to be successful, they need to be underpinned by effective governance in the debtor country and a strong monitoring and enforcement system. It is also important that the KPIs be established in line with debtor country government’s existing climate or adaptation commitments as well as local stakeholders’ priorities (Kelly, Ducros and Steele, 2023[127]). International providers could usefully therefore support SIDS via capacity development – for example in designing and understanding the swap schemes or in structuring the bonds that will form part of the swap (OECD, 2023[19]).
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Notes
← 1. Australia, for instance, has initiated an AUD 9.5 million (Australian dollars) programme to foster nature-based solution projects via Pacific non-governmental organisations. Similarly, Canada has pledged CAD 315 million (Canadian dollars) for a programme using nature-based solutions to increase climate resilience in sub-Saharan Africa and to facilitate partnerships among Indigenous populations. The United Kingdom, in its 10 Point Plan for financing biodiversity, stresses the need for nature-based solutions that can deliver significantly on both adaptation and mitigation. For further details, see https://www.gov.uk/government/publications/political-vision-the-10-point-plan-for-financing-biodiversity.
← 2. The principles are currently endorsed by 80 organisations among them DAC member bilateral development agencies. The organisations include the Danish international development agency Danida; the Dutch Ministry of Foreign Affairs; Irish Aid; Swedish International Development Cooperation Agency; United Kingdom Foreign, Commonwealth and Development Office; the United States https://www.gov.uk/government/publications/political-vision-the-10-point-plan-for-financing- biodiversity Agency for International Development; and multilateral climate funds such as the Adaptation Fund, Climate Investment Funds and the Global Environment Facility.
← 4. Such activity will not be reflected in the accounting measures presented in this paper, including the amounts mobilised by official development interventions (see previous section). In general, a discussion is ongoing how to capture such adaptation efforts; the European Commission, for example, considers as environmentally sustainable capital expenditure (CAPEX) or operational expenditures (OPEX) for economic activities that contribute substantially to climate change adaptation (European Commission, 2021[47]).
← 5. As market forces incentivise adaptation enterprises that do not adapt in their respective business may not be doing so as this would be economically inefficient.
← 6. This refers to adaptation-related development finance marked as sectoral budget support in the DAC CRS database. It should be noted that within the Rio markers methodology, general budget support cannot be marked as adaptation-related finance.
← 7. The impetus was revealed in consultations with the EBRD undertaken for this report.
← 8. Securitization refers to the credit risk trancing of a portfolio of underlying cash flows stemming from a variety of assets such as loans or tax flows, in which “investors buy parts of this credit risk varying by the degree of subordination. Within such structures, first loss tranches provide credit enhancement, i.e., comfort to senior tranche investors” (OECD, 2021[94])