Editing IPCC:AR6/WGIII/Chapter-15 (section)

=== 15.5.1 Definitions ===

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The analysis of financing gaps in climate action, which is used to measure implementation action and mitigation impact(FS-UNEP Centre and [[#BNEF--2019|BNEF 2019]] ) cannot be carried out as a pure demand-side challenge, in isolation from the analysis of barriers to deploy funds (e.g., [[#Ramlee--2013|Ramlee and Berma 2013]] ) and to take investment initiatives. These barriers are ‘friction that prevents socially optimal investments from being commercially attractive’ ( [[#Druce--2016|Druce et al. 2016]] ). They are at the root of the ‘microeconomic paradox’ of a deficit of infrastructure investments despite a real return between 4% and 8% (Bhattacharya et al. 2016), of the low share of carbon-saving potentials tapped by dedicated policies such as energy renovation programmes ( [[#Ürge-Vorsatz--2018|Ürge-Vorsatz et al. 2018]] ), and, more generally of a demand for climate finance lower than the volume of economically viable projects ( [[#de%20Gouvello--2010|de Gouvello and Zelenko 2010]] ; [[#Timilsina--2010|Timilsina et al. 2010]] ).

A few exercises tried assess the consequences of the perpetuation of these drivers on the magnitude of the financing gap. They suggest, comparing the evolution of the infrastructure investment trends (beyond energy) by comparison with what they should be in an optimal scenario, a cumulative deficit between 19% ( [[#Oxford%20Economics--2017|Oxford Economics 2017]] ) and 32% ( [[#Arezki--2016|Arezki et al. 2016]] ). The volume of this gap is of the same order of magnitude as the incremental infrastructure investments (energy and beyond) for meeting a 1.5°C target (2.4% of the world GDP on average) (Box 4.8 of SR1.5 ( [[#IPCC--2018|IPCC 2018]] )) calculated by exercises assuming no pre-existing investment gap. This figure is consistent with the 1.5% to 1.8% assessed by the [[#European%20Commission--2020|European Commission (2020)]] for Europe and the 2% of the [[#IMF--2021d|IMF (2021d)]] for the G20, which do not encompass many developing countries for which economic take-off is today fossil fuels dependent. For low- and middle-income economies, Rozenberg and Fay’s (2019) results suggest to increase the infrastructure investments by 2.5 to 6 percentage points of GDP to cover both the reduction of the structural investment gap and the specific additional costs for bridging it with low-carbon and climate-resilient options. These assessments indicate the challenge at stake but do not exist at very disaggregated sectoral and regional levels for sectors other than energy.

The below quantitative analysis does not differentiate between financing gaps driven by barriers within or outside the financial sector given that the IAM models as well as most other studies used do not incorporate actual risk ranges depending on policy strength and coherence and institutional capacity, low-carbon policy risks, lack of long-term capital, cross-border currency fluctuation, and pre-investment costs and barriers within the financial sector that discourage private sector financing. They comprise short-termism ( [[#UNEP%20Inquiry--2016b|UNEP Inquiry 2016b]] ), high perceived risks for mitigation-relevant technologies and/or regions (information gap through incomplete/asymmetric information, (Kempa and Moslener 2017; Clark et al. 2018)), lack of carbon pricing effects ( [[#Best--2018|Best and Burke 2018]] ), home bias (results in limited balancing for regional mismatches between current capital and needs distribution, ( [[#Boissinot--2016|Boissinot et al. 2016]] )), and perceived high opportunity and transaction costs (results from limited visibility of future pipelines and policy interventions; SME financing tickets and the missing middle, ( [[#Grubler--2016|Grubler et al. 2016]] )). In addition, barriers outside the financial sector will have to be addressed to close future financing gaps. The mix and dominance of individual barriers might vary significantly across sectors and regions and is analysed below.

The interpretation of the quantitative analysis thus needs to be performed, taking into account the qualitative needs assessment in [[#15.4.1|Section 15.4.1]] and the evolution of parameters that determine the risk-weighted relative attractiveness of low-carbon and climate-resilient investments compared to other investment opportunities. With some institutions having announced climate finance commitments and/or targets (see also Box 15.4), the actual asset allocation of commercial financial sector players including sectoral and regional focus will respond to tangible and financially viable investment opportunities available in the short term. Robust long-term pathways to create such conditions for a significant private sector involvement rarely exist and expectations on private sector involvement in some critical sectors/regions might be too high (Clark et al. 2018).

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