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

== 15.1 Climate Finance – Key Concepts and Scope ==

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Finance for climate action (or climate finance), environmental finance (which also covers other environmental priorities such as water, air pollution and biodiversity), and sustainable finance (which encompasses issues relating to socio-economic impacts, poverty alleviation and empowerment) are interrelated rather than mutually exclusive concepts ( [[#UNEP%20Inquiry--2016a|UNEP Inquiry 2016a]] ; [[#ICMA--2020a|ICMA 2020a]] ). Their combination is needed to align mitigation investments with multiple SDGs, and at a minimum, minimise the conflicts between climate targets and SDGs not being targeted. From a climate policy perspective, climate finance refers to finance ‘whose expected effect is to reduce net GHG emissions and/or enhance resilience to the impacts of climate variability and projected climate change’ ( [[#UNFCCC--2018a|UNFCCC 2018a]] ). However, as pinpointed in the AR5, significant room for interpretation and context-specific considerations remains. Further, such definition needs to be put in perspective with the expectations of investors and financiers (see Box 15.2).

Specifying the scope of climate finance requires defining two terms: what qualifies as ‘finance’ and as ‘climate’ respectively. In terms of what type of finance to consider, options include considering investments or total costs (Box 15.1), stocks or flows, gross or net (the latter taking into account reflows and/or depreciation), and domestic or cross-border, public or private (Box 15.2). In terms of what may be considered as ‘climate’, a key difference relates to measuring climate-specific finance (only accounts for the portion of finance resulting in climate benefits) or climate-related finance (captures total project costs and aims to measure the mainstreaming of climate considerations). One should even consider the investments decided for reasons unrelated with climate objectives but which contribute to these objectives (hydroelectricity, rail transportation).

In many cases, the scope of what may be considered as ‘climate finance’ will also depend on the context of implementation such as priorities and activities listed in countries’ Nationally Determined Contributions (NDCs) under the Paris Agreement ( [[#UNFCCC--2019a|UNFCCC 2019a]] ) as well as national development plans more broadly targeting the achievement of SDGs. Hence, rather than opposing the different options listed above, the choice of one or the other depends on the desired scope of measurement, which in turn depends on the policy objective being pursued. The increasingly diverse initiatives and body of grey literature address a range of different information needs. They provide analyses at the levels of domestic finance flows (e.g., [[#UNDP--2015|UNDP 2015]] ; [[#Hainaut--2018|Hainaut and Cochran 2018]] ), international flows (e.g. [[#OECD--2016|OECD 2016]] ; AfDB et al. 2018), global flows ( [[#UNFCCC--2018a|UNFCCC 2018a]] ; [[#Buchner--2019|Buchner et al. 2019]] ), the financial system (e.g., [[#UNEP%20Inquiry--2016a|UNEP Inquiry 2016a]] ) or specific financial instruments such as bonds (e.g., [[#CBI--2018|CBI 2018]] ). Common frameworks, reporting transparency are, however, necessary in order to identify overlaps, commonalities and differences between these different measurements in terms of scope and underlying definitions. In that regard, the developments of national and international taxonomies, definitions and standards can help, as further discussed in [[#15.6|Section 15.6]] , and [[IPCC:Wg3:Chapter:Chapter-17|Chapter 17]] in AR6 WGII report.

Beyond the need to scale up levels of climate finance, the Paris Agreement provides a broad policy environment and momentum for a more systemic and transformational change in investment and financing strategies and patterns. Article 2.1c, which calls for ‘making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development’, positions finance as one of the Agreement’s three overarching goals ( [[#UNFCCC--2015|UNFCCC 2015]] ). This formulation is a recognition that the mitigation and resilience goals cannot be achieved without finance, both in the real economy and in the financial system, being made consistent with these goals ( [[#Zamarioli--2021|Zamarioli et al. 2021]] ). It has in turn contributed to the development of the concept of alignment (with the Paris Agreement) used in the financial sector (banks, institutional investors), businesses, and public institutions (development banks, public budgets). As a result, since AR5, in addition to measuring and analysing climate finance, an increasing focus has been placed on assessing the consistency or alignment, as well as respectively the inconsistency or misalignment, of finance with climate policy objectives, as for instance illustrated by the multilateral development banks’ joint framework for aligning their activities with the goals of the Paris Agreements ( [[#MDBs--2018|MDBs 2018]] ).

Assessing climate consistency or alignment implies looking at all investment and financing activities, whether they target, contribute to, undermine or have no particular impact on climate objectives. This all-encompassing scope notably includes remaining investments and financing for high-GHG emission activities that may be incompatible with remaining carbon budgets, but also activities that may play a transition role in climate mitigation pathways and scenarios ( [[#15.3.2|Section 15.3.2]] .3). As a result, any meaningful assessment of progress requires the use of different shades to assess activities based on their negative, neutral (‘do no harm’) or positive contributions, (e.g., [[#CICERO--2015|CICERO 2015]] ; [[#Cochran--2019|Cochran and Pauthier 2019]] ; [[#Natixis--2019|Natixis 2019]] ). Doing so in practice requires the development of robust definitions, assessment methods and metrics, an area of work and research that remained under development at the time of writing. A range of financial sector coalitions and civil society organisations as well as commercial services providers to the financial industry have developed frameworks, approaches and metrics, mainly focusing on investment portfolios (Institut Louis Bachelier et al.. 2020; [[#IIGCC--2021|IIGCC 2021]] ; [[#TCFD%20Portfolio%20Alignment%20Team--2021|TCFD Portfolio Alignment Team 2021]] ; [[#UN-Convened%20Net-Zero%20Asset%20Owner%20Alliance--2021|UN-Convened Net-Zero Asset Owner Alliance 2021]] ), and, to a lesser extent for real economy investments ( [[#Micale--2020|Micale et al. 2020]] ; [[#Jachnik--2021|Jachnik and Dobrinevski 2021]] ).

'''Key findings from AR5 and other IPCC publications.''' For the first time the IPCC in AR5 ( [[#Clarke--2014|Clarke et al. 2014]] ) elaborated on the role of finance in a dedicated chapter. In the following year, the Paris Agreement ( [[#UNFCCC--2015|UNFCCC 2015]] ) recognised the transformative role of finance, as a means to achieving climate outcomes, and the need to align financial flows with the long-term global goals even as implementation issues were left unresolved ( [[#Bodle--2018|Bodle and Noens 2018]] ). AR5 noted the absence of a clear definition and measurement of climate finance flows, a difficulty that continues ( [[#Weikmans--2019|Weikmans and Roberts 2019]] ) (Sections 15.2 and 15.3). The approach taken in AR5 was to report ranges of available information on climate finance flows from diverse sources, using a broad definition of climate finance, as in the Biennial Assessments in 2014 and again in 2018 ( [[#UNFCCC--2014a|UNFCCC 2014a]] , 2018a) of the Standing Committee under the UNFCCC: Climate finance is taken to refer to local, national or transnational financing – drawn from public, private and alternative sources of financing – that seeks to support mitigation and adaptation actions that address climate change ( [[#UNFCCC--2014b|UNFCCC 2014b]] ). For this chapter, while the focus is primarily on mitigation, adaptation, resilience and loss and damage financing needs cannot be entirely separated because of structural relationships, synergies, trade-offs and policy coherence requirements between these sub-categories of climate finance (Box 15.1).

The AR5 concluded that published assessments of financial flows whose expected effect was to reduce net greenhouse gas (GHG) emissions and/or to enhance resilience to climate change aggregated USD343–385 billion [[#footnote-013|4]] yr –1 globally between 2010 and 2012 ( ''medium confidence'' ). Most (95% of total) went towards mitigation, which was nevertheless underfinanced and adaptation even more so. Measurement of progress towards the commitment by developed countries to provide USD100 billion yr –1 by 2020 to developing countries, for both mitigation and adaptation ( [[#Bhattacharya--2020|Bhattacharya et al. 2020]] ) – a narrower goal than overall levels of climate finance – continued to be a challenge, given the lack of clear definition of such finance, although there remain divergent perspectives ( [[#15.2.4|Section 15.2.4]] ). As against these flows, annual need for global aggregate mitigation finance between 2020 and 2030 was cited briefly in the AR5 to be about USD635 billion (mean annual), both public and private, implying that the reported ‘gap’ in mitigation financing of estimated flows during 2010 to 2012 was slightly under one-half of that required ( [[#IPCC--2014|IPCC 2014]] ).

More recent published data from the Biennial Assessments ( [[#UNFCCC--2018a|UNFCCC 2018a]] ) and the Special Report on Global Warming of 1.5°C ( [[#IPCC--2018|IPCC 2018]] ) have revised upwards the needs of financing between 2020 and 2030 to 2035 to contain global temperature rise to below 2°C and 1.5°C respectively by 2100: USD1.7 trillion yr –1 (mean) in the Biennial Assessment 2018 for the former, and for the latter, USD2.4 trillion yr –1 (mean) for the energy sector alone (and three times higher if transport and other sectors were to be included). The resulting estimated gaps in annual mitigation financing during 2014 to 2017, using reporting of climate financing from published sources, was about 67% for 2015, and 76% for the energy sector alone in 2017 ( ''medium confidence'' ), and greater if other sectors were to be included. While the annual reported flows of climate financing showed some moderate progress ( [[#15.3|Section 15.3]] ), from earlier USD364 billion (mean 2010/2011) to about USD600 billion (mean 2017/2020), with a slowing in the most recent period 2014 to 2017, the gap in financing was reported to have widened considerably (Sections 15.4 and 15.5). In the context of policy coherence, it is also important to note that reported annual investments going into the fossil fuel sectors, oil and gas upstream and coal mining, during the same period were about the same size as global climate finance, although the absence of alternative financing and access to low-carbon energy is a complicating factor.

Adaptation financing needs, meanwhile, were rising rapidly. The Adaption Gap Report 2020 ( [[#UNEP--2021|UNEP 2021]] ) reported that the current efforts are insufficient to narrow the adaptation finance gap, and additional adaptation finance is necessary, particularly in developing countries. The gap is expected to be aggravated by COVID-19 ( ''high confidence'' ). It reaffirmed earlier assessments that by 2030 (2050) the estimated costs of adaptation ranges between USD140 and 300 billion yr –1 (USD280 and 500 billion yr –1 ). Against this, the reported actual global public finance flows for adaptation in 2019/2020 were estimated at 46 billion ( [[#Naran--2021|Naran et al. 2021]] ). The costs of climate disasters meanwhile continued to rise, affecting low-income developing countries the most. Climate natural disasters – not all necessarily attributable to climate change – caused some USD300 billion yr –1 economic losses and well-being losses of about USD520 billion yr –1 ( [[#Hallegatte--2017|Hallegatte et al. 2017]] ).

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=== Box 15.2 | Box 15.1 | Core Terms ===

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This box defines some core terms used in this chapter as well as in other chapters addressing finance issues: cost, investment, financing, public and private. The chapter makes broad use of the term ''finance'' to refer to all types of transactions involving monetary amounts. It avoids the use of the terms ''funds'' and ''funding'' to the extent possible, which should otherwise be understood as synonyms for ''money'' and ''money provided'' .

'''Cost, investment and financing: different but intertwined concepts''' '''.''' ''Cost'' encompasses capital expenditures (CAPEX or upfront investment value leveraged over the lifetime of a project) operating and maintenance expenditures (OPEX), as well as financing costs. Note that some projects e.g., related to technical assistance may only involve OPEX (e.g., staff costs) but no CAPEX, or may not incur direct financing costs (e.g., if fully financed via own funds and grants).

''Investment'' , in an economic sense, is the purchase of (or CAPEX for) a physical asset (notably infrastructure or equipment) or intangible asset (e.g., patents, IT solutions) not consumed immediately but used over time. For financial investors, physical and intangible assets take the form of financial assets such as bonds or stocks which are expected to provide income or be sold at a higher price later. In practice, investment decisions are motivated by a calculation of risk-weighted expected returns that takes into account all expected costs, as well as the different types of risks, discussed in [[#15.6.1|Section 15.6.1]] , that may impact the returns of the investment and even turn them into losses.

''Incremental cost'' (or ''investment'' ) accounts for the difference between the cost (or investment value) of a climate project compared to the cost (or investment value) of a counterfactual reference project (or investment). In cases where climate projects and investments are more cost effective than the counterfactual, the incremental cost will be negative.

Financing refers to the process of securing the money needed to cover an investment or project cost. Financing can rely on debt (e.g., through bond issuance or loan subscription), equity issuances (listed or unlisted shares), own funds (typically savings or auto-financing through retained earnings), as well as on grants and subsidies

'''Public and private: statistical standard and grey zones.''' International statistics classify economic actors as pertaining to the public or private sectors. Households always qualify as private and governmental bodies and agencies as public. Criteria are needed for other types of actors such as enterprises and financial institutions. Most statistics rely on the majority ownership and control principle. This is the case for the Balance of Payment, which records transactions between residents of a country and the rest of the world ( [[#IMF--2009|IMF 2009]] ).

Such a strict boundary between public and private sectors may not always be suitable for mapping and assessing investment and financing activities. On the one hand, some publicly owned entities may have a mandate to operate on a fully- or semi-commercial basis, for example state-owned enterprises, commercial banks, and pension funds, as well as sovereign wealth funds. On the other hand, some privately owned or controlled entities can pursue not-for-profit objectives, e.g., philanthropies and charities. The present chapter considers these nuances to the extent made possible by available data and information.

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=== Box 15.2 | International Climate Finance Architecture ===

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International climate finance can flow through different bilateral, multilateral, and other channels, involving a range of different types of institutions both public (official) and private (commercial) with different mandates and focuses. In practice, the architecture of international public climate finance is rapidly evolving, with the creation by traditional donors of new public sources and channels over the years ( [[#Watson--2019|Watson and Schalatek 2019]] ), as well as emergence of new providers of development co-operation, both bilateral ( [[#Benn--2017|Benn and Luijkx 2017]] ) and multilateral (e.g., Asian Infrastructure Investment Bank), as well as of non-governmental actors such as philanthropies ( [[#OECD--2018a|OECD 2018a]] ).

The operationalisation of the Green Climate Fund (GCF), which channels the majority of its funds via accredited entities, has notably attracted particular attention since AR5. [[IPCC:Wg3:Chapter:Chapter-14#14.3.2|Section 14.3.2]] (in Chapter 14) provides a further assessment of progress and challenges of financial mechanisms under the United Nations Framework Convention on Climate Change (UNFCCC), such as the GCF, the Global Environment Facility (GEF) and the Adaptation Fund (AF).

The multiplication of sources and channels of international climate finance can help address growing climate-related needs, and partly results from increased decentralisation as well financial innovation, which in turn can increase the effectiveness of finance provided. There is, however, also evidence that increased complexity implies transaction costs ( [[#Brunner--2014|Brunner and Enting 2014]] ), in part due to bureaucracy and intra-governmental factors ( [[#Peterson--2019|Peterson and Skovgaard 2019]] ), which constitutes a barrier to low-carbon projects and are often not accounted for in assessments of international climate finance. On the ground, activities by international providers operating in the same countries may overlap, with sub-optimal coordination and hence duplication of efforts, both on the bilateral and multilateral sides ( [[#Ahluwalia--2016|Ahluwalia et al. 2016]] ; [[#Gallagher--2018|Gallagher et al. 2018]] ; [[#Humphrey--2019|Humphrey and Michaelowa 2019]] ), as well as risks of fragmentation of efforts (Watson and [[#Schalatek--2020|Schalatek 2020]] ) which slows down coordination with international providers, national development banks and other domestic institutions.

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=== Box 15.3 | Mitigation, Adaptation and Other Related Climate Finance Merit Joint Examination ===

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Mitigation finance deals with investments that aim to reduce global carbon emissions, while adaptation finance deals with the consequences of climate change ( [[#Lindenberg--2013|Lindenberg and Pauw 2013]] ). Mitigation affects the scale of adaptation needs and adaptation may have strong synergies and co-benefits as well as trade-offs with mitigation ( [[#Grafakos--2019|Grafakos et al. 2019]] ). If mitigation investments are inadequate to reducing global warming (as in the last decade) with asymmetric adverse impacts in lower latitudes and low-lying geographies, the scale of adaptation investments has to rise and the benefits of stronger adaptation responses may be high ( [[#Markandya--2019|Markandya and González-Eguino 2019]] ). If adaptation investments build greater resilience, they might even moderate mitigation financing costs. Similar policy coherence considerations apply to disaster risk reduction financing, the scale of which depends on success with both adaptation and mitigation ( [[#Mysiak--2018|Mysiak et al. 2018]] ). The same financial actors, especially governments and the private sector, decide at any given time on their relative allocations of available financing for mitigation, adaptation and disaster-risk reduction from a constrained common pool of resources. The trade-offs and substitutability between closely-linked alternative uses of funds, therefore, make it essential for a simultaneous assessment of needs – as in parts of this chapter. Climate finance versus the financing of other Sustainable Development Goals (SDGs) faces a similar issue. A key agreement was that climate financing should be ‘new and additional’ and not at the cost of SDGs. Resources prioritising climate at the cost of non-climate development finance increase the vulnerability of a population for any given level of climate shocks, and additionality of climate financing is thus essential ( [[#Brown--2010|Brown et al. 2010]] ). Policy coherence is also the reason why mitigation finance cannot be separated from consideration of spending and subsidies on fossil fuels. Climate change may additionally cause the breaching of physical and social adaptation limits, resulting in climate-related residual risks (i.e., potential impacts after all feasible mitigation, adaptation, and disaster risk reduction measures have been implemented) ( [[#Mechler--2020|Mechler et al. 2020]] ). Because these residual losses and damages from climate-related risks are related to overall mitigation and adaptation efforts, the magnitude of potential impacts is related to the overall quantum of mitigation, adaptation, and disaster risk reduction finance available ( [[#Frame--2020|Frame et al. 2020]] ). All categories of climate finance thus need to be considered together in discussions around climate finance.

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