The Inflation Reduction Act represents a massive opportunity to deploy targeted public funding to mobilize private investment in climate action across the U.S. But how can these public funds be deployed to maximize their intended impact? Is there anything we can learn from outside the U.S., where innovative public climate finance practices have been in place for more than two decades?
Three lessons learned from other countries and regions stand out from CPI’s work around the world.
- The importance of pre-development funding
There is a classic dilemma in climate finance: communities have projects and investors have money, yet the projects don’t get funded. Why? The standard explanation is that most projects presented to investors are not “bankable” – not suitable for market-rate investment. Bankability can be impeded by many different barriers: uncertain revenues, high upfront costs, lack of creditworthy offtakers, lengthy permitting processes, lack of trained personnel, and the search costs of finding good projects.
For example, climate infrastructure—think electric buses, zero carbon buildings, resilient water supplies, and renewable energy—typically involves a lengthy development process that requires initial capital investment long before generating revenues. Once a project is identified, the project sponsor—a developer, municipality, community organization—needs to develop feasibility studies, define the business model, conduct environmental and social impact assessments, apply for permits, and prepare a site, among many other tasks. While the development phase of a project usually only requires 3-5% of the total investment cost of a project, this is also the riskiest phase of the project, making financing difficult to come by, especially for under-served communities. Without fully-prepared, “shovel ready” projects to put forward, communities miss out on the larger private investment resources available for infrastructure projects, for example, from institutional investors and other large asset owners and managers.
This problem is prevalent around the world. But so are solutions to address it.
In emerging markets, the City Climate Finance Gap Fund (Gap Fund) has been operating since 2020 to address the gap cities encounter between having a climate action plan and having well-defined, “bankable” projects. Administered by the European Investment Bank and World Bank, the Gap Fund takes in applications for grants and technical support to get projects from the earliest stages of identification through to later development stages. The Gap Fund team works with city networks like C40 and ICLEI to source projects, and with later-stage project preparation facilities and development banks to help cities find the resources to move to the next stage of project development and onto construction. As of September 2022, the Gap Fund has already provided support to 95 cities in 36 countries.
Smaller cities and under-served communities in the U.S. face similar constraints, which have fueled successful calls for new pre-development funding in the infrastructure and climate bills. But to reach the Biden Administration’s goals of ensuring that 40% of climate funding reaches under-served communities—and to truly get the leverage and scale promised by the Inflation Reduction Act—the leaks in the project pipeline development ecosystem will need to be fixed. For example, some of the funding under the Greenhouse Gas Reduction Fund could be allocated towards this objective.
Many public- and community-focused finance institutions—community development finance institutions, green banks, agricultural lenders, credit unions, among others—have the potential to increase their climate financing substantially and take on more ambitious climate change commitments and strategies. As these institutions begin to hire expert staff, assess best practices, and come up with and implement their own strategies, there is a risk of duplication and inefficiency if everyone is working in silos.
- Better cooperation among public finance institutions
Internationally, public development banks have formed climate-focused working groups, clubs, and alliances to exchange best practices, improve their financing products and accelerate their adoption, make joint commitments to signal ambition to the market, and adopt common taxonomies and tracking methodologies that optimize markets and reduce claims of greenwashing. Among others, the multilateral development banks have a longstanding Joint MDB Working Group on Climate that unifies measurement and management approaches, tracks their action collectively, and offers a forum for exchange on difficult technical issues such as how to support clients to increase their own ambition. Many bilateral and national development banks are members of the International Development Finance Club which includes a capacity building fund and access to a shared pool of consultants. In 2020, the French government launched Finance in Common, a global network of public development banks which aims to align financial flows with the Sustainable Development Goals and the Paris Agreement.
In the U.S., associations of community development finance institutions and green banks are already playing a coordinating role, with many paying particular attention to the design of the $27 billion Greenhouse Gas Reduction Fund, anticipated to be a key federal funding source for their efforts. Networks like Resilient Cities Network have built tools for CDFIs to evaluate potential investments for resilience. Once the funding starts flowing, more and deeper efforts like formal alliances or a shared advisory services model will be needed to help coordinate financing institutions’ activities so that high-integrity practices are implemented efficiently and impactfully.
- Measuring progress against finance needs to drive adaptive action and investment
Climate finance needs to be tracked according to the outcomes it achieves for decarbonization and climate resilience, as well as other key economic and social impacts. But it’s also highly valuable to track the financing itself: who’s doing the financing, what type of financing instruments they are using, to what sectors and communities is the finance flowing, and what and where are the gaps. Tracking helps improve resource mobilization efficiency by providing a baseline for discussion about the current state of financing. This then helps leverage different finance types effectively, target future funding strategically for maximum impact, and increase transparency and accountability around public and private expenditures and investment.
Outside the U.S., a number of countries, including Brazil, France, Germany, India, Indonesia, Kenya, and South Africa, have developed “climate finance landscapes” to support these objectives. In South Africa, where the government recently agreed to a robust investment plan for the energy transition, the Presidential Climate Commission will be using regular climate finance landscapes to track progress against that investment plan and adjust their approaches as needed. The Landscape of Climate Finance in France provides a basis for public debate on the mobilization of climate finance within the framework of the Energy Transition Law (Art 174). CPI produces the annual Global Landscape of Climate Finance that is used in international policy processes such as the UNFCCC. Significantly, these landscapes track both public and private investment.
In the U.S., energy investment at the national level is tracked by Bloomberg New Energy Finance, and Vibrant Data Labs recently developed a Climate Finance Tracker to understand venture capital investment. Yet a holistic view—across all climate relevant sectors including energy, agriculture, adaptation, and water, and integrating local, state, and federal funding—is still missing.
Consistent with the Paris Agreement, every country will determine its own path to decarbonization and how that will be financed. At the same time, many countries around the world are facing the same challenges as they work to use limited public funds to accelerate progress. The U.S. can learn from how other countries and regions have tackled similar problems around how to most effectively deploy public finance, including through pre-development funding, cooperation models for public finance institutions, and tracking of progress.