The amount of climate finance in Africa falls dramatically short of what is needed to implement Nationally Determined Contribution (NDCs) in the region. CPI estimates Africa’s climate finance needs at an average of USD 250 billion annually from 2020-2030, which must be provided by private and international public investors (CPI 2022a). Meanwhile, total annual climate finance mobilized in Africa in 2020 was only USD 29.5 billion (CPI, forthcoming).
Meeting Africa’s climate finance needs will require significantly higher levels of investment, especially from the private sector. Due to the high real and perceived risks associated with investing in the continent, the private sector has traditionally played a marginal role in the provision of climate finance in Africa, accounting for only 14% of total flows in 2019/2020 (CPI, forthcoming). Given the scarcity of public finance – with governments’ budgets further aggravated by the COVID-19 pandemic and Russia’s invasion of Ukraine – the private sector must play a more prominent role in closing the climate finance gap in Africa.
This will require a shift in existing and planned investments from dirty technologies toward climate action, as well as mobilizing large capital pools such as pension funds and sovereign wealth funds currently holding over 700 billion in assets under management in Africa (CPI 2022a). Huge opportunities also lie in harnessing Africa’s great and increasing capacity for innovation, where entrepreneurs in the green economy are developing climate solutions in the form of new business models and financial products.
Barriers related to financial market depth, governance, project-specific characteristics, and enabling skills and infrastructure have stifled private investment in African climate solutions to date. The relevance and intensity of the different barriers is highly context-dependent, differing by geography, sector, and sub-sector. For instance, projects in the energy, transport, and building sectors are characterized by high up-front costs and lengthy preparation and construction processes which make early-stage investment especially risky. Project-level barriers in the Agriculture, Forestry and Other Land Use (AFOLU) sector limit commercial viability, necessitating a greater share of concessionality than for more commercially mature sectors. Critically, currency risk is a prevailing issue across the four sectors analyzed – necessitating greater mobilization of local currency investment.
Harnessing climate investment opportunities in Africa will require innovation in financing structures and strategic deployment of public capital to ‘crowd-in’ private investment at levels not yet seen. Mobilizing investment in African climate solutions at scale will require going beyond traditional financing approaches. Innovative climate finance structures can be deployed to improve capital efficiency and overcome the barriers to finance which have stifled investment to date.
For example, traditional financial instruments, such as concessional debt and grants, are widely used in Africa, but could be deployed more efficiently to target specific barriers to finance when included in a broader financial structure. More complex solutions (e.g., structured finance and capital market instruments) have been incorporated into innovative financial structures in more mature markets, such as Egypt, South Africa, and Kenya, and hold great potential for further deployment to catalyze local private investment in climate solutions.
We provide a framework for how these financial and non-financial solutions can be efficiently deployed to overcome barriers to finance and capitalize climate solutions in Africa. Given their specific characteristics, financial instruments and mechanisms should be deployed depending on the unique geographic and sectoral context of an investment opportunity. Some instruments can be deployed narrowly to address acute barriers to finance, such as the use of guarantees to overcome early-stage construction risk associated with climate infrastructure. Other instruments offer broad solutions to chronic barriers to finance; for example, carbon finance presents an opportunity to finance projects with high climate impact but persistent revenue risk, such as clean cookstove distribution, land restoration and avoided deforestation, or methane abatement.
In this paper, we detail four such innovative instruments that have been launched across the continent:
- TerraFund for AFR 100 has deployed a standardized process to deploy early-stage catalytic finance and technical assistance to spur the growth of grassroots innovators operating in the challenging land restoration sub-sector.
- The Sub-National Climate Finance Initiative uses a blended private equity instrument that targets a 20:1 private-to-public finance leverage ratio for its investments in mid-sized climate infrastructure projects.
- Kenyan real estate developer Acorn has financed its green student housing portfolio by launching three separate capital markets instruments to attract a range of investors with different risk profiles.
- Revego Africa Energy has aggregated a diversified portfolio of operating renewable energy assets into Africa’s first YieldCo, providing an avenue for risk-averse and hard to reach institutional investors to fund climate solutions.
Recommended actions for increasing deployment of innovative finance:
- Identify and understand barriers constraining finance more granularly by sector and geography. In an environment where projects face numerous barriers simultaneously, private investors must assess risks affecting each investment decision based on its geographic and sectoral context. Building on their catalytic role public investors should then deploy capital in a targeted way to address the specific barriers constricting private investment.
- Match instruments with barriers. Public and private investors must tailor their financial instruments and strategies depending on the acute or chronic nature of the barriers identified. Different instruments have varying degrees of effectiveness in overcoming specific investment barriers and risks. The framework developed in this study can serve as a toolbox for private and public investors to deploy the climate finance solutions in line with their mandates and risk appetite to most effectively overcome these barriers.
- Match instruments with project and technology lifecycles. Climate finance investments are typically long-term endeavors, with differing considerations across project and technology lifecycles. Public and private investors must look to deploy different financial instruments and strategies in direct response to these lifecycle-dependent considerations. Specifically, as projects and technologies mature, the use of grants and concessional finance by public investors should be gradually phased out, leaving space for the private sector to realize commercial returns. The use of capital market instruments (such as green bonds and YieldCos) can facilitate exit and refinancing at later stages.
- Enhance engagement and co-financing with local stakeholders. To increase the effectiveness and impact of their investments, international private and public investors must work in collaboration with local financial and political stakeholders. This can help build capacity among local investors and inform targeted action by governments to improve investment conditions. Given the urgent need for more local currency finance, international investors must include local private investors in co-financing structures. In recognition that local private sector leverage is necessary to achieve climate objectives at the scale required, public investors should increasingly view mobilization of local private investment in climate solutions as an end in and of itself.
- Support innovation by establishing conducive policy and regulatory frameworks. Governance barriers remain one of the most relevant impediments to climate finance in Africa. While investors can deploy innovative solutions to mitigate governance-related risks, these can only be fully addressed through concerted action by local policymakers and regulators. To lower risk perception and build investor confidence, climate policy frameworks and long-term roadmaps are needed. Policymakers and regulators can foster climate finance innovation by adopting policies which support local capital markets and reduce administrative and regulatory barriers to finance.
With a dynamic entrepreneurial environment and climate finance needs eight times higher than the amounts currently invested, the African continent presents a massive investment opportunity for investors to advance the deployment of climate solutions in the coming decade. In order to capitalize on this opportunity and bridge the African climate finance gap, climate finance innovation most focus on deepening financial markets on the continent – both conventional (i.e., debt and equity markets) and non-conventional (i.e., carbon markets) – through direct investment and capacity building activities. This paper provides a framework for identifying how financial instruments can be combined in innovative ways to overcome barriers to finance and catalyze African climate solutions and entrepreneurship. Accelerating progress in what is a fragmented climate finance ecosystem will require improved coordination, knowledge sharing, and combined action from development and public finance providers, private investors, and local policymakers.