Editing IPCC:AR6/WGII/Chapter-6 (section)

=== 6.4.5 Financing Adaptation in Cities, Settlements and Infrastructures ===

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The amount invested in urban adaptation is limited. The Cities Climate Finance Leadership Alliance tracked USD 3.7 billion of investments in adaptation projects in 2017–2018, of which only 3–5% had an urban component (Richmond et al., 2021). Cities and settlements frequently face barriers of inadequate financing for climate adaptation and mitigation ( [[#Cook--2018|Cook and Chu, 2018]] ). Finance barriers interact with economic barriers and socioeconomic conflicts and need to be considered within an integrated perspective (Hinkel et al., 2018).

Many early leaders in climate adaptation are, therefore, perhaps unsurprisingly, political capitals or financial centres in the Global North with much larger resource envelopes and well-developed fiscal and financing capacities (Westerhoff, Keskitalo and Juhola, 2011; Shi, Chu and Debats, 2015).

The funding required to deliver climate change adaptation will depend on choices made about climate mitigation ( [[#IPCC--2018|IPCC, 2018]] ). Still, the cost of adapting to a global temperature increase of 1.5°C will be a fraction of the cost of adapting to a global temperature increase exceeding 3 o C ( [[#IPCC--2019a|IPCC, 2019a]] ; [[#IPCC--2019b|IPCC, 2019b]] ; Hoegh-Guldberg et al., 2018). It will also depend on selected adaptation options, as they have different capital requirements, operating costs and returns on investment (See 6.3). Finally, costs depend on financing sources and mechanisms selected.

Broadly, there are two options for adaptation investment: funding, direct expenditure in preparation for or response to climate change impacts, and financing, the deployment of market-based instruments to attract third-party resources to an adaptation action ( [[#Keenan--2018|Keenan, 2018]] ; Banhalmi-Zakar et al., 2016). Using funding can be a lower-cost strategy, as there is no third party expecting a return on investment. However, using financing can expand the total resources available for adaptation ( [[#White--2019|White and Wahba, 2019]] ).

The choice of funding and financing mechanism is often based on implicit economic world views (Keenan, Chu and Peterson, 2019) or on the technical support available to sub-national governments, such as preparing municipal bonds or contracting for public–private partnerships ( [[#Bisaro--2018|Bisaro and Hinkel, 2018]] ). The urban finance literature has long called for critical interrogation of these choices, as adaptation finance has profound justice implications (Khan et al., 2020). However, the literature on adaptation investments is limited (Harman, Taylor and Lane, 2015; Keenan, Chu and Peterson, 2019). The use of municipal debt such as green bonds, for example, intensify the financial and environmental risks borne primarily by the poor, the working class or people discriminated against because of race, sexual orientation or ability ( [[#Bigger--2019|Bigger and Millington, 2019]] ).

The climate imperative has not yet fundamentally changed urban infrastructure investment ( [[#White--2019|White and Wahba, 2019]] ). Mobilising adaptation investment in urban areas continues to depend on strengthening public finance capacities (particularly evaluating and integrating climate risk into economic decisions) and meeting private investors and lenders’ expectations. Climate change creates new investment risks and physical risks ( [[#Martimort--2016|Martimort and Straub, 2016]] ), and highlights the limitations of current models to account for risk and uncertainty when pricing investments ( [[#Keenan--2018|Keenan, 2018]] ). Private investors and lenders do not seem ready to provide adaptation finance on significantly easier or cheaper terms than conventional finance ( [[#White--2019|White and Wahba, 2019]] ). However, a variety of means for financing climate change adaptation in urban areas exist (Table 6.10).

'''Table 6.10 |''' Finance instruments to deliver adaptation in urban areas. Source: adapted from Richmond et al. (2021) and [[#UN-Habitat--2016b|UN-Habitat (2016b)]]

{| class="wikitable"
|-
! Type of finance

! Finance source

! Instruments

! Examples of specific instruments in urban settings

|-
| rowspan="2"| Public

| Municipal government

| Local revenue generation

| Utility fees

Open space funds/land value capture

General obligation bonds

Local property, income and sales taxes

|-
| State/Provincial government

National government

| Grants, incentives, technical assistance funds

| Insurance

Tax advantages

Low-cost project debt

Infrastructure investment funds

Shared taxes

Intergovernmental funding transfers/revenue sharing

|-
| rowspan="2"| Public finance

| National development finance institutions (DFIs)

Bilateral DFIs

Multilateral DFIs

| Grants, project debt (low-cost market rate), technical assistance, risk instruments

| Risk mitigation support of PPP

Project level debt

Project preparation facilities and other technical advisory

Insurance

|-
| Climate funds

| Grants, debt, equity, guarantees

| Dedicated climate fund

|-
| rowspan="8"| Private

| Commercial FIs

| Project debt and equity (market rate), guarantees

| Internal climate risk mitigation

PPP financing

Climate loans

|-
| Private equity (PE)/infrastructure funds

| Project equity (market rate)

| Direct urban infrastructure investments

Corporate equity investment

|-
| Institutional investors

| Project debt and equity (market rate)

| Direct urban infrastructure investment

Corporate debt and equity investments

|-
| Private insurance

| Insurance

| Public and private risk mitigation

Catastrophe bonds

Parametric insurance

|-
| Corporate actors

| Balance sheet financing and project equity (market rate)

| Internal risk mitigation

Leasing

PPP

|-
| Household

| Balance sheet financing

| Internal climate risk mitigation

|-
| Non-profits, philanthropies and foundations

| Grants, technical assistance, donations

| Microfinance

Impact investment

|-
| Communities

| Grants and collective support

| Risk sharing

Upgrading funds

Community development funds

Crowdfunding

|}

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==== 6.4.5.1 Urban Adaptation Financing Gap ====

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Cities and settlements in higher-income countries typically have access to funding that could be used to enhance resilience and build adaptive capacity; this includes both the private resources of individual households and firms (which varies significantly within and among cities) and public budgets of different government tiers (see Table 6.10).

Depending on fiscal devolution levels within a country, public revenues may be collected and managed primarily at the national, state, metropolitan or local level. In federal countries, sub-national governments collect an average of 49.4% of public revenues, compared with only 20.7% in unitary countries ( [[#OECD/UCLG--2019|OECD/UCLG, 2019]] ). For example, sub-national revenues represent over a quarter of total public revenues in Belgium, Canada and Denmark, but less than 5% in Greece, Ireland and New Zealand ( [[#OECD/UCLG--2019|OECD/UCLG, 2019]] ). The share of the national revenue transferred to sub-national governments also varies significantly among countries: grants and subsidies account for over three-quarters of sub-national government revenue in Malta, but less than a quarter of sub-national revenue in Iceland ( [[#OECD/UCLG--2019|OECD/UCLG, 2019]] ). A local government’s capacity to collect revenues is further mediated by incomes within a city (which dictates the prospective tax base) and the capacity of civil servants to administer taxes, fees and charges. The result is that metropolitan and local governments’ budgets vary dramatically, across and within countries. For example, per capita municipal budgets vary from USD 1114 in Saskatoon and USD 2682 in Peterborough (Canada), USD 2635 in Leipzig and USD 3638 in Freiburg (Germany), to USD 4907 in Bristol and USD 5612 in Aberdeen (UK) ( [[#Löffler--2016|Löffler, 2016]] ).

Revenue streams are often insufficient relative to the scale of adaptation requirements. For example, Kano, Nigeria, is a large urban area that urgently needs investment in human development and climate resilience but where a fragmented local government has little capacity to finance their climate plans (Mohammed, Hassan and Badamasi, 2019). Many local governments are unable to mobilise funds for adaptation as they face competing priorities, meaning that resources for resilience must be allocated by higher levels of government ( [[#Hughes--2015|Hughes, 2015]] ), which also perceive opportunity costs to adaptation investments. Funding from non-state actors is, therefore, proving important. For example, in the USA, private foundations and non-profit organisations account for 17% and 16%, respectively, of adaptation support in urban areas (Carmin, Nadkarni and Rhie, 2012). However, tapping into these funding sources raises complex questions about accountability and ownership of urban adaptation (Chu, Schenk and Patterson, 2018). Land reclamation may foster real estate markets and mobilise finance for adaptation, as shown in Germany, the Netherlands and the Maldives (Bisaro et al., 2019).

City governments need to anticipate climate shocks and stresses, and design their operating models and investment plans accordingly to ensure financial resilience (Clarvis et al, 2015). Climate risks threaten fiscal models, for example, a drought may disrupt water revenues by reducing total water consumption and incentivising households and firms to invest in independent water storage or supply infrastructure (Simpson et al., 2019). Storm surges and sea level rise may threaten sunk investments in revenue-generating infrastructures such as toll roads or electricity generation and transmission systems. .

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==== 6.4.5.2 Barriers to Adaptation Investments ====

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Common sources of adaptation finance might include donor agencies including the Green Climate Fund, sovereign funds (e.g., the Bangladesh Climate Change Resilience Fund) and private finance from commercial banks, investment companies, pension funds and insurance companies (Floater et al., 2017). These capital sources have different risk–return expectations and investment horizons, so they will suit different types and stages of projects. Many sub-national governments in the Global North have access to well-developed domestic, if not global, capital markets to raise and steer finance for urban investment (Banhalmi-Zakar et al., 2016).

However, investments in ''ex ante'' urban climate adaptation may prove less attractive to these financiers than other opportunities because of their long maturities and high risk (Keenan, Chu and Peterson, 2019) (see also Table 6.11). Many generate economic returns primarily through avoided losses from climate impacts, which are difficult to measure and are, in any case, more attractive to funders than financiers ( [[#Kaufman--2014|Kaufman, 2014]] ). ''Ex post'' , insurance already plays a critical role in protecting urban households, firms and other stakeholders from the full economic costs of high-severity, low-frequency events by sharing risk over time and space. Insurance can also be designed to incentivise risk-reducing behaviours and investments (Banhalmi-Zakar et al., 2016; [[#Paddam--2017|Paddam and Wong, 2017]] ). Some researchers suggest that, in urban environments, insurance practices are helping to establish adaptation and risk as a new area of public health and public protection. For example, local governments are using new risk transfer instruments, such as re-insurance and catastrophe bonds, to fund investments in resilience projects and disaster recovery ( [[#Collier--2021|Collier and Cox, 2021]] ). However, the commercial feasibility of private sector insurance depends on more robust estimates of current and future risks, and premiums commensurate with the ability and willingness of consumers to pay. Therefore, ''ex ante'' investments must complement insurance schemes to improve climate modelling and reduce climate risk (Surminski, Bouwer and Linnerooth-Bayer, 2016). The private sector also faces practical barriers to invest in adaptation.

'''Table 6.11 |''' Barriers to finance adaptation in urban areas (Richmond et al., 2021)

{| class="wikitable"
|-
! Barrier application to urban adaptation

Barriers to adaptation finance

!
|-
| Poor policy environment

| Municipal policy environment lacks conditions supportive to private adaptation investment (e.g., lack of requirements that private sector organisations operating in cities implement climate risk mitigation strategies or invest in systemic resilience).

|-
| Poor institutional environment

| Legal and regulatory infrastructure in the city lacks clarity of purpose toward addressing urban climate risks (e.g., no limitations on development in high climate risk areas).

|-
| Poor market environment

| Market environment is unsupportive toward adaptation investment (e.g., lack of creditworthy partner municipalities for private sector engagement).

|-
| High cost of projects and unknown value add

| The value or benefit of the technology is uncertain; private sector actors do not sufficiently consider climate risk in decisions; upfront costs of technology are high.

|-
| Lack of technical capacity

| Prospective users of technology do not have technical capacity to implement (e.g., limited or siloed expertise in implementing resilient urban infrastructure solutions).

|-
| Limitations of private insurance

| Insurance has to date largely not been engaged in cities to efficiently transfer risk or incentivise adaptive action and the private insurance industry is facing considerable risk associated with the accelerating impacts of climate change in.

|}

National governments typically determine the fiscal transfers that sub-national governments receive and the taxes, fees and charges they permit to collect (see for example CBO, 2016). Local governments may strengthen their own source revenue collection and management capacities to better exploit these funding streams and improve their balance sheets, but their total budget will be limited to these funding sources (Ahmad et al., 2019). The amount of local public funding available for urban adaptation depends on the relationships across different government levels.

Similarly, mobilising private finance for urban adaptation projects demands robust institutional, fiscal and regulatory frameworks, which are typically national authorities’ responsibility. For local governments to access private finance for adaptation may require national (or in federal countries, state) governments to reform policies and rules governing municipal borrowing, public–private partnerships, land value capture instruments and other financing mechanisms ( [[#Ware--2017|Ware and Banhalmi-Zakar, 2017]] ). Such fiscal reforms tap into fundamental political and policy issues, such as local governments’ autonomy or the tariff-setting powers of national ministries ( [[#Gorelick--2018|Gorelick, 2018]] ; [[#White--2019|White and Wahba, 2019]] ).

Access to private finance can support infrastructure development through private provisioning, public–private partnerships (PPP) and public debt arrangements ( ''high confidence'' ) (see also [[#6.4.1.2|Section 6.4.1.2]] ). Private provisioning attracts coastal adaptation investment when returns are high (e.g., when there is a real estate market associated with it) ( [[#Bisaro--2018|Bisaro and Hinkel, 2018]] ). Public–private partnerships attract investments from dredging and construction companies that involve a large share of operational costs ( [[#Bisaro--2018|Bisaro and Hinkel, 2018]] ). Public debt instruments appear less successful in supporting investment in adaptation infrastructure. Real estate firms focus on adaptation actions if they perceive climate change impacts such as flooding may impact their activity, mostly focusing on adaptation action as a means to gain competitive advantage ( [[#Teicher--2018|Teicher, 2018]] ).

There have been numerous attempts to innovate in climate finance, for example, mobilising community and cooperative forms of finance, or crowdfunding, which have already proven effective in the context of mitigation ( [[#De%20Broeck--2018|De Broeck, 2018]] ). A well-studied instrument in urban environments is land-value capture. Land-value capture refers to communities’ ability to capture the benefit of increased land values that result from public investment or other government actions ( [[#Germán--2020|Germán and Bernstein, 2020]] ). There is considerable potential to mobilise land-value capture for adaptation ( ''limited evidence'' , ''medium agreement'' ), but its potential remains unexplored ( [[#Dunning--2020|Dunning and Lord, 2020]] ). While there are numerous examples of the mobilisation of land-value capture to finance sustainable development action ( [[#Li--2019|Li and Love, 2019]] ; Wang, Samsura and van der Krabben, 2019), there is ''limited evidence'' of its use in climate adaptation (see Case Study 6.2). These innovations are particularly important in contexts where resources are very constrained, such as in the financing of adaptation in African cities (See Box 6.7).

Corruption in urban adaptation and disaster risk management finance is a considerable but little researched challenge observed from all world regions (Sanderson et al., 2021). Corruption generates maladaptation, increasing risk, for example where infrastructure is constructed with faulty design, substandard materials and inadequate maintenance (Kabir et al., 2021). More widely, corruption increases vulnerability and reduces capacity by damaging the body politic, distorting markets and reducing economic growth ( [[#Alexander--2017|Alexander, 2017]] ). The construction and infrastructure industries are repeatedly identified as sources of corruption ( [[#GIACC--2020|GIACC, 2020]] ; [[#Chan--2017|Chan and Owusu, 2017]] ; Sanderson et al., 2021). Corruption and misuse of climate finance is exacerbated by limited public access to information, political considerations in finance decision making and lack of accountability for decisions and actions (Kabir et al., 2021). In construction, Owusu et al. (2019) found causes included too-close relationships, poor professional ethical standards, negative industrial and working conditions, negative role models and inadequate sanctions throughout the phases of construction. Post-disaster response and reconstruction, and periods of surge funding following international or national policy priorities are especially vulnerable to corruption, with increased funding and pressure to lower norms of financial management ( [[#Imperiale--2021|Imperiale and Vanclay, 2021]] ). Mixed delivery mechanisms have been shown to reduce corruption, for example where civil society organisations are involved in project approval stages, although there is also a risk that civil society organisations will themselves become entangled in corruption. International donors have a role to play in working with government and civil society to promote wider scrutiny and transparency of financing processes and project delivery through promoting media and press freedom and legislation for access to information to reduce corruption by enhancing transparency and accountability (Kabir et al., 2021).

Expanding the resource envelope available for adaptation investment is often beyond the authority or competency of city governments. Sovereign and state governments have critical roles to play in providing funding or securing finance for adaptation investments. Such a role is particularly important where the impacts of climate change are distributed inequitably across a country, so that the costs borne by a city may exceed local budgets.

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'''Box 6.8 | Challenges to Investment in Adaptation in African Cities'''
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In Africa, new investment in institutions can support other enabling conditions for climate-resilient urban development ( [[#Robins--2018|Robins, 2018]] ). While several studies reveal the net economic benefit of climate-resilient, low-carbon African cities ( [[#Global%20Commission%20on%20Economy%20and%20Climate--2017|Global Commission on Economy and Climate, 2017]] ), structural impediments remain to the mobilisation of investment for the types of public good infrastructure that would unlock this benefit (Dodman et al., 2017).

Since the 1960s, gross capital formation (sometimes called Gross domestic investment) has been less than 22% in Africa, whilst in East Asian countries, it has risen to 42% (OECD, 2016). Africa faces an estimated 40% infrastructure financing gap, but this gap is almost certainly higher in the continent’s rapidly growing cities (Baker and McKenzie, 2015). Relative poverty, weak or absent local fiscal systems, and contested tenure that prevents land being used as collateral, have restricted investment in African cities (Berrisford, Cirolia and Palmer, 2018; Dodman et al., 2017). Sub-Saharan African countries are reaching the 40% urban threshold at national per capita incomes of around USD 1000 per annum, significantly poorer than South-East Asian and Latin American cities at the same level of urbanisation (Freire, Lall and Leipziger, 2014). Absolute poverty, in conjunction with weak revenue collection and low levels of investment, render conventional infrastructure finance difficult ( [[#Smolka--2013|Smolka, 2013]] ; [[#Global%20Commission%20on%20Economy%20and%20Climate--2017|Global Commission on Economy and Climate, 2017]] ; Berrisford, Cirolia and Palmer, 2018; [[#Cirolia--2019|Cirolia and Mizes, 2019]] ). Sprawled urban development in Africa might make the provision of public services both more energy intensive and three times more expensive than high-density developments ( [[#Collier--2016|Collier and Venables, 2016]] ).

Data on private finance in African cities are inadequate ( [[#OECD--2017|OECD, 2017]] ), but all of Africa secured just 3.5% (USD 46 billion) of global foreign direct investment (FDI), despite a 10.9% increase in 2018 ( [[#UNCTAD--2019|UNCTAD, 2019]] ). Mining and the extraction and processing of fossil fuels accounted for almost a third of greenfield FDI in Africa in 2018 ( [[#UNCTAD--2019|UNCTAD, 2019]] ). The FDI secured by cities has tended to serve an urban elite and has been used to build shopping malls, housing settlements and airlines ( [[#Watson--2015|Watson, 2015]] ). It is also unevenly distributed across the continent and within cities. Five countries; Egypt, South Africa, Congo, Morocco and Ethiopia, accounted for more than half the total FDI in 2018 ( [[#UNCTAD--2019|UNCTAD, 2019]] ), leaving large parts of Africa’s growing cities described by financiers as ‘high risk’ and their citizens deemed ‘unbankable’ (UCLG, 2016).

Private financiers have begun entering public–private partnerships with African cities, often supported by bilateral agreements between the respective countries, including the growing number of Asian and Middle-Eastern countries contributing to infrastructure in African cities ( [[#Cirolia--2019|Cirolia and Rode, 2019]] ). In the absence of enforceable spatial plans and strong urban governance, the risk remains that individual investment projects that are completed will aggregate to create urban systems that are at risk from climate change through the locking-in of inequality, urban sprawl, flooding and greenhouse gas emissions (Dodman et al., 2017; Wachsmuth, Cohen and Angelo, 2016). These risks will constitute a future burden for asset owners, financiers and insurers, and cause a progressive hemorrhaging of economic opportunities in Africa’s urban centres (UCLG, 2016).

Securing climate finance for urban development is contingent upon robust multi-level governance arrangements ( [[#Tait--2017|Tait and Euston-Brown, 2017]] ; [[#OECD/UN-Habitat--2018|OECD/UN-Habitat, 2018]] ). Such investments are needed for cities that do not yet have the balance sheets or rate-paying citizens required to enter financial markets on favourable terms. Similarly, Central Banks have a crucial role in managing the transition risks within cities and limiting the systemic impact of stranded urban assets due to technology shifts or sea level rise ( [[#Safarzyńska--2017|Safarzyńska and van den Bergh, 2017]] ).

New energy, water and sanitation technologies alter the public good nature of urban services and offer novel opportunities for private sector financiers and blended finance. Still, financial sector innovation remains necessary if technological innovation is to be scaled ( [[#Cities%20Climate%20Finance%20Leadership%20Alliance--2015|Cities Climate Finance Leadership Alliance, 2015]] ; [[#European%20Environment%20Agency--2020|European Environment Agency, 2020]] ). UNEP has cited anecdotal evidence of a ‘quiet revolution’ toward a more developmental and sustainable global finance sector, in part due to global environmental, social and governance requirements, and industry initiatives within the financial and insurance sectors (UNEP, 2015). Scope remains to strengthen Development Finance Institutions programmes, such as the World Bank’s City Creditworthiness Programme and the activities of China’s ExIm Bank, with a bespoke urban climate dimension.

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