Issues in financing climate resilience

Despite the progress made on several technical fronts at the UN’s climate summit in Marrakesh (COP22) last November, a deadlock persists over climate finance which, despite several international commitments remains marginal to global capital flows. Urgent action is needed not only to reduce greenhouse gas emissions, but also to help countries become resilient to adverse climate change impacts. Developed countries, however, are fiscally constrained and momentum is gathering around the need to mobilise private and institutional finance in meeting the commitment of $100 billion a year for adaptation and resilience in the developing world.

The World Bank estimates that some $158 trillion worth assets — double the total output of global economy — could be in jeopardy without preventable action. Understanding climate risks therefore is vital to ensure capital is allocated efficiently and optimally.

Ground report

Many actions to improve climate resilience take place within local markets where there is a supply and demand for products and solutions that protect assets from climate risks — such as water-efficient irrigation technologies, storm resilient building materials, water harvesting services, flood control, climate resilient crops and seeds. However, these private transactions are rarely accounted for under labels such as “climate resilience” or “climate adaptation.”

Nor are the local financial markets, in developing countries, deep and robust enough to offer a broad range of financial instruments and products to support these transactions, leading to their imminent failure in securing viability-gap funding either from governments, or multilateral development banks. As much of these market activities related to climate resilience remains “hidden in plain sight”, products and solutions that help assets to adapt to climate risks, remain largely unrecognised.

Beyond the obvious

What is needed is a deeper understanding of the benefits offered by climate resilience to better inform business decisions regarding climate risk transfer schemes such as insurance. No industry has done more analysis on the issue of climate-related risks than the insurance sector, and promising models such as parametric insurance schemes are being piloted across the globe. But insurance against climate risks is prohibitively costly, unavailable or likely to disappear without a strong government support. Here the Government should intervene in facilitating privately-funded risk mitigation activities by establishing sound regulatory framework, and market- enabling policies.

Such regulations should help ensure solvency, while facilitating licensing, product innovation and reinsurance placement and international risk pooling and diversification. In addition, public vehicles can be efficiently designed to allow the private sector to insure a large portion of risk, while leaving only a residual risk (in very extreme circumstances) to public sector funding.

Projects to adapt to climate change rarely offer a clear rate of return due to high upfront cost, a longer gestation period capacity constraints and technological limitations. Due attention should be given for improving capacity for bankable project development, implementation and monitoring, and evolving commonly acceptable technical standards.

The financial sector globally needs to develop markets for instruments to invest in resilience main streamed projects. Instruments such as catastrophe risk insurance, contingency fund, disaster-relief fund, restoration fund, contingent credit at preferential rate, micro-credits; climate bond, social protection-bond need to be soundly designed and rightly targeted to beneficiaries’ needs.

Where change is needed

Even for the Indian State governments climate finance is evolving as an important avenue to finance their climate change action plan. However, climate finance, in its current form, is just the cumulative costs of projects identified under this plan, whereas technically it refers to the incremental cost of ‘climate proofing’ of the investment that takes into account potential climate risks and, the costs of making the infrastructure more resilient to such risks.

Thus an analytical framework is necessary to combine potential climate risks with a systematic cost-benefit analysis which can help decision-makers prioritise adaptation measures. Favourable policy and institutional actions are important preconditions for successful introduction or scaling up of financial instruments. Such actions, through public-private partnership, can help tackle the underlying drivers of inadequate insurance, especially lack of risk awareness or experience with risk management products and practices; unaffordability, especially among lower-income households or small enterprises; and fundamental limits to insurability.

Continued and careful use of donor support, such as for the initial capitalisation of risk pools may also be necessary to accelerate the closing of coverage and preparedness gaps. Policy actions need to focus on how the Government can encourage financiers and investor to ‘take the long-term view’ on climate financing by harnessing the public balance sheet, market incentives, blended finance, environmental legislation, market coherence, encouraging cultural transformation and, enhanced information flows among the stakeholders.

Majority of the capital intensive items in the State climate plans are mixed actions and contribute to conventional development activities. Examples include agricultural research and extension, irrigation, forestry conservation and urban infrastructure. So, a complementarity between climate finance and conventional development funding will have dual benefits, firstly by improving the quality of proposals for securing international funds and, secondly helping in better bargaining for the share of the State budget as the State budgeting process will assign higher priority to development actions that also deliver climate resilience.

The writer is a management consultant

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