Nations have agreed to $300B for climate funding. How will they pay for it?

The trillion-dollar question these days is where the huge sums of money needed to address climate change are going to come from, especially for developing countries.

Getting governments to put up more was the big focus at the UN climate conference that wrapped this week, but as seen by a wave of criticism about weak funding commitments, alternatives are needed too.

“There’s just not enough money from government sources,” Catherine McKenna, chief executive of Climate and Nature Solutions and former federal environment minister, said in an interview.

To help narrow the substantial gap, there’s an increasing push to use something called blended finance, which uses scarce public dollars to sweeten the financials of a project enough that it makes sense for the private sector to invest.

“We need to be creative to get the incentives right to make it happen,” McKenna said before countries agreed on the weekend to pool at least $300 billion a year by 2035.

The model is especially needed in developing countries, where the risks are higher and so the business case is harder to make.

This helps explain why such a big group of countries are only getting about 15 cents of every dollar spent globally on clean energy.

Aiming to put a dent in the shortfall, FinDev Canada announced a blended finance platform just as COP29 got underway. In partnership with Mitsubishi Financial Group and anchored by a Green Climate Fund investment, the platform has set a $1.5-billion funding target to assist up to 25 developing countries.

The fund will look to follow on past, smaller-scale efforts by Canada using blended finance, like a partnership that helped kick-start green energy in Uzbekistan.

In 2020, Canada put up US$17.5 million in funding at below-market rates, alongside other organizations, to help get a US$100-million solar project — Uzbekistan’s first — off the ground.

Once that hurdle was cleared, one of the co-investors then helped get a second solar project going at more than double the size, with fewer concessions. Soon after, a wind energy project went ahead without any discounted funding at all.

The funding model is meant to help make those difficult early projects happen and clear the way for more to come, said Nnamdi Igbokwe, director of thought leadership at Convergence.

“That’s why blended finance has become so important, because it’s a mechanism that allows the mobilization of the private sector in a way that otherwise they would basically be precluded.”

Convergence, a Toronto-based group focused on increasing the use of blended finance, found the model was used for US$18.3 billion in climate funding last year, up from US$8 billion a year earlier.

Importantly, the total included six deals of more than a billion dollars each.

“We’re starting to see a smarter use, and a more efficient use, of catalytic capital to where billion-dollar deals are becoming more of a consistent thing,” Igbokwe said.

That’s important, because to take a bite out of global funding targets in the trillions, there needs to be a steady stream of billion-dollar deals, said Igbokwe.

But ramping up the model is far from easy.

Blended finance adds layers of complexity to funding deals. The public concessions come in a range of options, from lower interest rates to agreeing to be the first to take on any losses, all of which has to be negotiated on top of the regular commercial terms.

The risk perception of the projects and countries also make it hard for many private banks to invest at all, because regulations limit what kind of lending risk they can take on.

There’s also not enough sharing of data about how past projects have performed, said Igbokwe, which could help change those risk perceptions.

And then there’s the challenge of finding projects that are promising enough, and big enough, to invest in, but that don’t quite meet the threshold for conventional financing.

Altogether, these barriers have made the model ramp up much slower than Convergence and others had hoped.

“It’s pretty complex,” said Susan McGeachie, chief executive of the Global Climate Finance Accelerator.

Part of the problem is that each deal is so customized that it’s hard to apply the terms to the next one, so it’s slow-going, she said.

But it’s still “enormously helpful” to help fill the funding gap, and if it wasn’t hard, blended finance wouldn’t be necessary.

“The whole point is to address that market gap. So if it becomes standardized, any of the concessional players should have exited and gone to something else that address a new market gap,” said McGeachie.

She noted that it’s not just useful abroad. There is also potential for Indigenous communities and climate projects at home, as Canada makes better use of publicly funded lenders like the Canada Infrastructure Bank.

BMO, for example, has partnered with the public bank to offer lower-cost loans for office building retrofits to reduce emissions.

Others, though, are concerned about the fixation on using private markets, and are pushing for much greater direct lending to public projects from public banks.

“We’ve seen market-based mechanisms fail again and again and again,” said Susan Spronk, an associate professor focused on international development at the University of Ottawa.

Spronk helped found a group pushing against the use of blended finance, concerned by the poor track record of water privatization and other efforts to profit off some of the world’s poorest people.

While renewable energy has a more straightforward business case, making profits on adaptation projects like flood barriers and wildfire prevention is far from straightforward.

There’s increasing focus around adaptation efforts, including the FinDev platform that has earmarked 70 per cent towards it, but Spronk is concerned blended finance isn’t suited to the task.

“It is doomed to be a very expensive way to try to do a climate transition.”

David Bhamjee, chief strategy officer at FinDev, said in a statement that the fund will help meet demand for blended finance and show others how to replicate the success.

Many others like McKenna maintain there simply isn’t enough government funding to go around, so it’s important to figure out how to make these private deals work, even in challenging circumstances.

“People are going to have to really work hard to find the solutions, and to make sure the money isn’t just going to easy places.”