GI Hub Explainer: Climate Finance

What is the purpose of climate finance?

Infrastructure finance is used to facilitate and boost investment in infrastructure projects, supporting economic activity and social and environmental goals. In the case of climate finance, there is a specific additional requirement that the asset must address pre-defined climate goals, so that the asset plays a role in either mitigating climate impacts or adapting to the impacts of climate change.

Climate finance acts as a signal to the broader community of the commitment of the project proponent to climate goals. Because of the high profile of the financial sector and infrastructure projects, climate finance in the infrastructure context also has potential to further raise awareness of the need for climate interventions and the financing options that are available to enable those interventions.

How does climate finance work?

Climate finance is often concessional. This typically means that lenders will provide finance at a below-market rate to support climate outcomes. This is particularly the case where development finance institutions such as multilateral development banks and other financing facilities provide climate finance to developing countries in support of climate goals. Concessionality may also take other forms, such as longer loan maturity or more flexible debt covenants. Concessional finance is also provided outside of the development context, for instance, from national governments for domestic purposes.

Although climate finance typically takes the form of loans, it can include technical assistance for borrowers and direct grants.

The availability of concessional climate finance provides a market-based signal to potential borrowers that projects which can support climate mitigation and adaptation will attract lower rates of finance or other favourable terms, and therefore become marginally more attractive for project proponents to take forward. This may mean that certain classes of projects, such as clean energy, become more attractive to proponents.

Proponents can also choose to alter prospective projects to give them characteristics that address climate change, and therefore make them eligible for climate finance. In both cases, the market-based signal drives behaviour.

Conclusion

Climate finance provides a signal to the infrastructure market that lenders prefer climate-based infrastructure projects or projects that otherwise address climate concerns. It typically includes an element of concessionality to enhance this market signal.

While climate finance continues to increase, more needs to be done to achieve most governments’ stated climate goals, and leveraging climate finance could be a way to get more sustainable projects, programs, and regulations progressed.