Editing IPCC:AR6/WGIII/TS (section)

=== TS.6.4 Investment and Finance ===

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'''Finance to reduce net GHG emissions and enhance resilience to climate impacts is a critical enabling factor for the lo''' '''w-c''' '''arbon transition. Fundamental inequities in access to finance as well as finance terms and conditions, and countries’ exposure to physical impacts of climate change overall, result in a worsening outlook for a global Just Transition (''' '''''high confidence''''' ''').''' Decarbonising the economy requires global action to address fundamental economic inequities and overcome the climate investment trap that exists for many developing countries. For these countries the costs and risks of financing often represent a significant challenge for stakeholders at all levels. This challenge is exacerbated by these countries’ general economic vulnerability and indebtedness. The rising public fiscal costs of mitigation, and of adapting to climate shocks, is affecting many countries and worsening public indebtedness and country credit ratings at a time when there were already significant stresses on public finances. The COVID-19 pandemic has made these stresses worse and tightened public finances still further. Other major challenges for commercial climate finance include: the mismatch between capital and investment needs, home bias [[#footnote-002|31]] considerations, differences in risk perceptions for regions, as well as limited institutional capacity to ensure safeguards are effective ( ''high confidence'' ). {15.2, 15.6.3}

'''Investors, central banks, and financial regulators are driving increased awareness of climate risk. This increased awareness can support climate policy development and implementation (''' '''''high confidence''''' ''') {15.2, 15.6} .''' Climate-related financial risks arise from physical impacts of climate change (already relevant in the short term), and from a disorderly transition to a low-carbon economy. Awareness of these risks is increasing, leading also to concerns about financial stability. Financial regulators and institutions have responded with multiple regulatory and voluntary initiatives to assess and address these risks. Yet despite these initiatives, climate-related financial risks remain greatly underestimated by financial institutions and markets, limiting the capital reallocation needed for the low-carbon transition. Moreover, risks relating to national and international inequity – which act as a barrier to the transformation – are not yet reflected in decisions by the financial community. Stronger steering by regulators and policymakers has the potential to close this gap. Despite the increasing attention of investors to climate change, there is limited evidence that this attention has directly impacted emission reductions. This leaves high uncertainty, both near term (2021–30) and longer term (2021–50), on the feasibility of an alignment of financial flows with the Paris Agreement goals ( ''high confidence'' ). {15.2, 15.6}

'''Progress on the alignment of financial flows with low-GHG emissions pathways remains slow. There is a climate financing gap which reflects a persistent misallocation of global capital (''' '''''high confidence''''' ''') {15.2, 15.3} .''' Persistently high levels of both public and private fossil fuel-related financing continue to be of major concern despite promising recent commitments. This reflects policy misalignment, the current perceived risk-return profile of fossil fuel-related investments, and political economy constraints ( ''high confidence'' ). Estimates of climate finance flows [[#footnote-001|32]] exhibit highly divergent patterns across regions and sectors and a slowing growth {15.3} . When the perceived risks are too high, the misallocation of abundant savings persists and investors refrain from investing in infrastructure and industry in search of safer financial assets, even earning low or negative real returns ( ''high confidence'' ). {15.2, 15.3}

'''Global climate finance is heavily focused on mitigation (more than 90% on average between 2017–2020) (''' '''''high confidence''''' ''') {15.4, 15.5} .''' This is despite the significant economic effects of climate change’s expected physical impacts, and the increasing awareness of these effects on financial stability. To meet the needs for rapid deployment of mitigation options, global mitigation investments are expected to need to increase by the factor of three to six ( ''high confidence'' ). The gaps represent a major challenge for developing countries, especially Least-Developed Countries (LDCs), where flows have to increase by the factor of four to seven for specific sectors such as AFOLU, and for specific groups with limited access to, and high costs of, climate finance ( ''high confidence'' ) (Figure TS.25) {15.4, 15.5} . The actual size of sectoral and regional climate financing gaps is only one component driving the magnitude of the challenge. Financial and economic viability, access to capital markets, appropriate regulatory frameworks, and institutional capacity to attract and facilitate investments and ensure safeguards are decisive to scaling-up funding. Soft costs for regulatory environment and institutional capacity, upstream funding needs as well as R&amp;D and venture capital for development of new technologies and business models are often overlooked despite their critical role to facilitate the deployment of scaled-up climate finance ( ''high confidence'' ). {15.4.1, 15.5.2}

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'''Figure TS.25 | Breakdown of recent average (downstream) mitigation investments and model-based investment requirements for 2020–2030 (USD billion) in scenarios that likely limit warming to 2°C or lower.''' Mitigation investment flows and model-based investment requirements by sector / segment (energy efficiency in buildings and industry, transport including efficiency, electricity generation, transmission and distribution including electrification, and agriculture, forestry and other land use), by type of economy, and by region (see Annex II Part I Section 1: By region is based on intermediate level (R10) classification scheme. By type of economy is based on intermediate level (R10) classification scheme, which considers ‘North America’, ‘Europe’, and ’Australia, Japan and New Zealand’ as developed countries, and the other seven regions as developing countries). Breakdown by sector / segment may differ slightly from sectoral analysis in other contexts due to the availability of investment needs data. The granularity of the models assessed in Chapter 3, and other studies, do not allow for a robust assessment of the specific investment needs of LDCs or SIDSs. Investment requirements in developing countries might be underestimated due to missing data points as well as underestimated technology costs. In modelled pathways, regional investments are projected to occur when and where they are cost cost-effective to limit global warming. The model quantifications help to identify high-priority areas for cost-effective investments, but do not provide any indication on who would finance the regional investments. Investment requirements and flows covering downstream / mitigation technology deployment only. Data includes investments with a direct mitigation effect, and in the case of electricity, additional transmission and distribution investments. See section 15.4.2 Quantitative assessment of financing needs for detailed data on investment requirements. Data on mitigation investment flows are based on a single series of reports (Climate Policy Initiative, CPI) which assembles data from multiple sources. Investment flows for energy efficiency are adjusted based on data from the International Energy Agency (IEA). Data on mitigation investments do not include technical assistance (i.e., policy and national budget support or capacity building), other non-technology deployment financing. Adaptation only flows are also excluded. Data on mitigation investment requirements for electricity are based on emission pathways C1, C2 and C3 (Table SPM.1). For electricity investment requirements, the upper end refers to the mean of C1 pathways and the lower end to the mean of C3 pathways. Data points for energy efficiency, transport and AFOLU cannot always be linked to C1–C3 scenarios. Data do not include needs for adaptation or general infrastructure investment or investment related to meeting the SDGs other than mitigation, which may be at least partially required to facilitate mitigation. The multiplication factors show the ratio of average annual model-based mitigation investment requirements (2020–2030) and most recent annual mitigation investments (averaged for 2017–2020). The lower and upper multiplication factors refer to the lower and upper ends of the range of investment needs.

Given the multiple sources and lack of harmonised methodologies, the data can only be indicative of the size and pattern of investment gaps. The gap between most recent flows and required investments is only a single indicator. A more comprehensive (and qualitative) assessment is required in order to understand the magnitude of the challenge of scaling up investment in sectors and regions. The analysis also does not consider the effects of misaligned flows. {15.3, 15.4, 15.5, Table 15.2, Table 15.3, Table 15.4}

'''The relatively slow implementation of commitments by countries and stakeholders in the financial sector to scale up climate finance reflects neither the urgent need for ambitious climate action, nor the economic rationale for ambitious climate action (''' '''''high confidence''''' ''')''' '''.''' Delayed climate investments and financing – and limited alignment of investment activity with the Paris Agreement – will result in significant carbon lock-ins, stranded assets, and other additional costs. This will particularly impact urban infrastructure and the energy and transport sectors ( ''high confidence'' ). A common understanding of debt sustainability and debt transparency, including negative implications of deferred climate investments on future GDP, and how stranded assets and resources may be compensated, has not yet been developed ( ''medium confidence'' ). {15.6}

'''There is a mismatch between capital availability in the developed world and the future emissions expected in developing countries (''' '''''high confidence''''' ''').''' This emphasises the need to recognise the explicit and positive social value of global cross-border mitigation financing. A significant push for international climate finance access for vulnerable and poor countries is particularly important given these countries’ high costs of financing, debt stress and the impacts of ongoing climate change ( ''high confidence'' ) ''.'' {15.2, 15.3.2.3, 15.5.2, 15.6.1, 15.6.7}

'''Innovative financing approaches could help reduce the systemic under-pricing of climate risk in markets and foster demand for investment opportunities aligned with the Paris Agreement goals. Approaches include de-risking investments, robust ‘green’ labelling and disclosure schemes, in addition to a regulatory focus on transparency and reforming international monetary system financial sector regulations (''' '''''medium confidence''''' ''').''' Green bond markets and markets for sustainable finance products have grown significantly since AR5 and the landscape continues to evolve. Underpinning this evolution is investors’ preference for scalable and identifiable low-carbon investment opportunities. These relatively new labelled financial products will help by allowing a smooth integration into existing asset allocation models ( ''high confidence'' ). Green bond markets and markets for sustainable finance products have also increased significantly since AR5, but challenges nevertheless remain, in particular, there are concerns about ‘greenwashing’ and the limited application of these markets to developing countries ( ''high confidence'' ). {15.6.2, 15.6.6}

'''New business models (e.g., pay-as-you-go) can facilitate the aggregation of small-scale financing needs and provide scalable investment opportunities with more attractive risk-return profiles (''' '''''high confidence''''' ''').''' Support and guidance for enhancing transparency can promote capital markets’ climate financing by providing quality information to price climate risks and opportunities. Examples include SDG and environmental, social and governance (ESG) disclosure, scenario analysis and climate risk assessments, including the Task Force on Climate-related Financial Disclosures (TCFD). The outcome of these market-correcting approaches on capital flows cannot be taken for granted, however, without appropriate fiscal, monetary and financial policies. Mitigation policies will be required to enhance the risk-weighted return of low-emission and climate-resilient options, accelerate the emergence and support for financial products based on real projects, such as green bonds, and phase-out fossil fuel subsidies. Greater public-private cooperation can also encourage the private sector to increase and broaden investments, within a context of safeguards and standards, and this can be integrated into national climate change policies and plans ( ''high confidence'' ). {15.1, 15.2.4, 15.3.1, 15.3.2, 15.3.3, 15.5.2, 15.6.1, 15.6.2, 15.6.6, 15.6.7, 15.6.8}

'''Ambitious global climate policy coordination and stepped-up public climate financing over the next decade (2021–2030) can help redirect capital markets and overcome challenges relating to the need for parallel investments in mitigation. It can also help address macroeconomic uncertainty and alleviate developing countries’ debt burden post-COVID-19 (''' '''''high confidence''''' ''').''' Providing strong climate policy signals helps guide investment decisions. Credible signalling by governments and the international community can reduce uncertainty for financial decision-makers and help reduce transition risk. In addition to indirect and direct subsidies, the public sector’s role in addressing market failures, barriers, provision of information, and risk-sharing can encourage the efficient mobilisation of private sector finance ( ''high confidence'' ) {15.2, 15.6.1, 15.6.2} . The mutual benefits of coordinated support for climate mitigation and adaptation in the next decade for both developed and developing regions could potentially be very high in the post-COVID era. Climate-compatible stimulus packages could significantly reduce the macro-financial uncertainty generated by the pandemic and increase the sustainability of the world economic recovery {15.2, 15.3.2.3, 15.5.2, 15.6.1, 15.6.7} . Political leadership and intervention remain central to addressing uncertainty, which is a fundamental barrier for the redirection of financial flows. Existing policy misalignments – for example, in fossil fuel subsidies – undermine the credibility of public commitments, reduce perceived transition risks and limit financial sector action ( ''high confidence'' ) ''.'' {15.2, 15.3.3, 15.6.1, 15.6.2, 15.6.3}

'''The greater the urgency of action to remain on a 1.5°C pathway, the greater need for parallel investment decisions in upstream and downstream parts of the value chain (''' '''''high confidence''''' ''').''' Greater urgency also reduces the lead times to build trust in regulatory frameworks. Consequently, many investment decisions will need to be made based on the long-term global goals. This highlights the importance of trust in political leadership which, in turn, affects risk perception and ultimately financing costs ( ''high confidence'' ) ''.'' {15.6.1, 15.6.2}

'''Accelerated international cooperation on finance is a critical enabler of a low-carbon and Just Transition (''' '''''very high confidence''''' ''').''' Scaled-up public grants for adaptation and mitigation, and funding for low-income and vulnerable regions, especially in Sub-Saharan Africa, may have the highest returns. Key options include: increased public finance flows from developed to developing countries beyond USD100 billion a year; shifting from a direct lending modality towards public guarantees to reduce risks and greatly leverage private flows at lower cost; local capital markets development; and, changing the enabling operational definitions. A coordinated effort to green the post-pandemic recovery is also essential in countries facing much higher debt costs ( ''high confidence'' ). {15.2, 15.6}

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