Shifting & Mobilizing
Private Finance
Shifting & Mobilizing
Private Finance
To meet global climate goals, the private sector will need to play a more significant role in financing climate action. Governments can institute various economic and financial instruments and policies to shift private sector behavior from business as usual towards a path more in line with their NDC targets. These policies include risk-sharing mechanisms, fiscal policy tools and regulatory measures to increase transparency or shift behavior away from unsustainable activities.
Carbon pricing is an effective policy tool for countries seeking to advance their decarbonization strategies.
Countries need to cut their current greenhouse gas emissions by around 45% by 2030 in order to meet the Paris Agreement’s goal of keeping global temperature rise below 1.5 degrees C. However, current decarbonization policies are not nearly ambitious enough: Without stronger action, temperatures are expected to rise by 2.8 degrees C by the end of the century.
Putting a price on carbon is one of the most efficient policy approaches to reduce GHG emissions across countries and regions. Carbon pricing allows flexibility in how and where emissions are reduced, and can give industry options on where to cut emissions.
What Is Carbon Pricing?
Carbon pricing is a policy tool used by governments to reduce greenhouse gas emissions by establishing a monetary cost for emissions, either by taxing emitters directly or through a credit trading system (World Bank 2022). This helps drive emissions reductions economy-wide or across priority areas, such as the electricity sector. Carbon pricing can also stimulate investments in low-carbon technology. It includes two main policy mechanisms: carbon taxes and emissions trading systems.
Carbon taxes refer to taxes on GHG emissions, which are levied on emitters, such as power plants, for each ton of CO2 emitted. Taxes can be placed directly on emissions, or on the fossil fuels based on the emissions from their combustion. For example, the government of Chile approved a carbon tax in 2017 with a fixed price of $5 per ton of CO2 emissions, and a tax on emissions including Particulate Matter (PM), Nitrous Oxide (NOx), and Sulfur Dioxide (SO2). The main sectors covered were energy, industry, agriculture and mining. The following year, tax revenues increased about $186 million and emissions reductions were reported at -1.10% for CO2, -7% for PM, -2% for NOx and -0.01% for SO2.
Emissions trading systems (ETS) place limits or caps on a country or region’s total greenhouse gas emissions. The objective of an ETS is to set a cap on GHG emissions in one or more economic sectors, typically those where emissions can be accurately measured, such as power plants and other energy-intensive industries. The EU’s ETS, for example, covers emissions from sources such as civil aviation and steel. Unlike carbon taxes, which put a direct price on CO2, ETS are market-based systems which price emissions based on supply and demand. The caps ensure that there is a hard limit on emissions, and they can become stricter over time. There are two main ETS types: cap-and-trade and baseline-credit systems (see Table 1).
Table 1 | ETS Type
| ETS category | How It Works |
|---|---|
| Cap-and-trade systems | A limited number of tradeable GHG emissions allowances are created, corresponding to the emissions limit. The allowances represent the right to emit a specific amount of emissions, and companies must utilize allowances to match their emission levels. Allowances are distributed through an auction, based on allocation rules, or a combination of the two. Allowances can be bought and sold, providing an incentive for companies to reduce their emissions. |
| Baseline-credit systems | Emission level baselines are established. Entities earn emission credits if they generate emissions below the baseline and must surrender credits if they exceed it. Earned emission credits can be sold to entities who exceed the baseline, providing incentives for those entities to reduce their emissions. |
Box 1 | ETS in Mexico
The Mexican government launched the first ETS pilot in Latin America in 2020. Its goal was to cover facilities generating at least 100,000 metric tons of CO2 each year—almost 40% of national GHG emissions. A cap-and-trade system, it established caps of 271.2 MtCO2 for 2020 and 273.1 MtCO2 for 2021. The pilot affected 2,828 companies and lasted for two years, to be followed by a one-year transition and operational phase-in.
Source: ICAP 2022
Source: WRI authors, World Bank 2022, Haites 2018
The trading of emissions between countries is a third approach to pricing emissions. In this case, high-emitting countries can purchase emission credits from lower-emitting nations, following rules established under Article 6 of the Paris Agreement. The selling country must agree not to count those emission reductions toward their own NDC but instead make a “corresponding adjustment” to make sure that emission reductions are not counted twice.
What Are the Benefits of Carbon Pricing?
Carbon pricing can have a significant impact on emissions. By changing the incentive structure, carbon prices, when high enough, can alter an investment’s risk-return profile and thus encourage investment in technologies and efficiencies that lower emissions. By making fossil fuel emissions more and more expensive, the cost of emitting carbon will begin to exceed the cost of deploying greener technologies or finding ways to reduce emissions. A positive example can be seen in Sweden, where the carbon price is about $125 per Mt, the highest in the world. Sweden imposed a carbon tax in 1991 and has successfully lowered emissions while maintaining economic growth.
Carbon pricing can generate government revenue. As regulators of natural resources, governments are uniquely positioned to price carbon. Pricing carbon directly internalizes society-wide costs related to emissions and pollution. In addition, revenues from emissions trading systems can be used to address potential negative impacts of climate action, such as job losses or the impact of higher fuel prices on poorer populations.
What Are the Challenges of Carbon Pricing?
In many cases, carbon pricing has not been effective because prices were too low. It is difficult to reach a price—through taxes or through a market system—that makes fossil fuels less competitive than clean technologies without causing negative economic impacts, particularly in fossil-fuel dependent industries such as steel or cement. This often makes it politically challenging to implement meaningful carbon pricing. Many initiatives have had limited real-world impact on GHG emissions.
It is difficult to set carbon prices that will result in the desired level of emission reductions. There may need to be adjustments made to tax levels if targets are not met. ETS systems have an even higher price volatility. The lack of predictability can discourage investment in lower-emission alternatives.
Conclusion
Strategic carbon pricing can be an effective lever for reducing emissions from high-polluting sectors of the economy. Carbon taxes can incentivize cleaner technologies while making fossil fuels more expensive; trading systems can use supply-and-demand to control emission levels across industries and geographies. Both these systems can reduce sectoral or national emissions efficiently while encouraging innovation.
The prices on carbon must be high enough, which is not easy. Many attempts at carbon pricing have had only modest impacts on carbon emissions, largely because the prices have been too low. Setting carbon prices high enough, either through taxation or through the design of trading or credit systems, can be politically challenging given the impact such pricing typically has on the economy. Using income generated from the pricing mechanisms to help ameliorate some of these impacts can help address these challenges.
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Risk-sharing mechanisms can increase access to climate finance for the private sector and governments by receiving assurances from a third party.
A persistent climate finance gap continues to exists. With less than 50% of current climate funding coming from private finance, instruments that encourage additional private investment are urgently needed. Crucial to filling the climate finance gap are financial mechanisms that help diminish investment risk while providing preferential market rates. Within these innovative financial mechanisms, loan guarantees can play an important role.
What Are Loan Guarantees?
Loan guarantees are risk-sharing mechanisms that transfer all or part of the risk to a third-party investor or institution acting as a guarantor. These mechanisms are designed with the goal of reducing private sector risks associated with climate finance projects. This allows private sector market participants to find more acceptable risk-return profiles within climate investments. Most importantly, loan guarantees can be utilized if a project defaults and the return rate is not as anticipated, providing assurance to the investor.
How Do Loan Guarantees Work?
Loan guarantees are risk-sharing mechanisms wherein the guarantor absorbs part of the financial risk. In essence, if the investment fails, the guarantor will cover some of the investor’s losses. Guarantees help encourage investment in climate-related activities by reducing real or perceived risks associated with such investments. Loan guarantees can be combined with other financial instruments, such as grants, loans and private capital. This can help to diversify portfolios and lower risk profiles.
Figure 1 shows a simplified example of a loan guarantee. The point of the guarantor is to lower the risk on loans and other finance instruments intended for the project. For example, a private sector investor may find it too risky to invest in a renewable energy project in a developing country where the regulations around power purchase agreements or the political environment are uncertain. A guarantee provides the investor some protection against these risks.
Example: Green Guarantee in South Africa
The Green Guarantee Company aims to finance energy, transport, water and building investments in South Africa. The objective of the project is to create a guarantee and technical assistance facility where international investors can access a credit enhancement structure. The project provides borrowers with guarantees aligned with the Climate Bond Standard. The facility is expected to unlock access to $10 billion for climate investment in infrastructure development. What makes this financial vehicle innovative is its flexibility, enabling investors to decide how much and what kind of investments they want to make. The facility secures risk-sharing for counterparties to be incentivized.
Source: Climate Finance Lab 2022
What Are the Benefits of Loan Guarantees?
The main benefit of a loan guarantee is the potential to channel private investments into climate initiatives, where they otherwise would not go. If used well, guarantees can help tip the scale for a private investor, enabling investment in a new region, technology or solution. Guarantees can improve the credit profile of a project by lowering risk, especially when it comes to innovative and capital-intensive investments in climate infrastructure and technology.
Loan guarantees are especially useful in helping to reduce risks related to climate finance projects, such as regulatory, market, environmental and social risks. These risks might originate from new, untested technologies or unstable political environments. This instrument is especially relevant in countries with high investment risks and low access to finance.
What Are the Challenges of Loan Guarantees?
Loan guarantees require governments to have stable credit situations. Loan guarantees cannot be implemented without liquidity or credible financial environments. One way to address these shortcomings are to receive credit enhancement support by credible national development banks or multilateral institutions.
Climate finance capacity-building remains an issue in developing countries. It is crucial for ministries and national financial institutions to strengthen capacities and understand the role and structuring of guarantees at a national level.
Loan guarantees sometimes need several public and private financial stakeholders working together to enhance risk-sharing schemes. Developing countries sometimes need access to multilateral institutions and international funds that help them structure and channel climate finance resources.
Conclusion
Loan guarantees can be an important climate finance instrument when countries need to enhance the risk-return profile for investors. They can be used to promote clean technologies and large infrastructure projects that are high-risk and capital-intensive. Risk-sharing among private and public financial stakeholders is a key asset that makes loan guarantees a valuable part of the concessional funds available to accelerate climate investments.
In the context of climate finance, loan guarantees should focus on areas where the technology is nascent or in investment environments with high risks. Loan instruments should be aligned with the Green Loan Principles, which include assessment, measurement and monitoring requirements such as performance indicators, KPIs, climate change mitigation and adaptation goals. Guarantees can act as de facto insurance mechanisms, providing assurance to an investor that a loan is backed by credible guarantors who in the case of default absorb some of the loss.
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Utilizing blended finance and catalytic capital is key for countries seeking to mobilize climate funds from the private sector.
What Is the Role of Blended Finance and Catalytic Capital?
Blended finance combines concessional finance with non-concessional, often private, capital. Concessional finance is funding provided with more attractive rates compared to the market. It can be a loan with low interest rates or longer grace periods, or similar features. By providing concessional finance, public institutions the risk-return profile of the investment, making it more attractive to private investors seeking a financial return.
In blended finance arrangements, concessional finance essentially operates as catalytic capital—capital that enables or catalyzes further investments that, in its absence, would not have happened. Catalytic capital often accepts disproportionate levels of risk and/or concessionary returns (below the market rates and having longer payback periods). Debt, equity and guarantees can all serve as catalytic capital.
Governments, philanthropists and other parties might offer concessional, or catalytic, finance for specific kinds of projects they want to see happen. This could include climate-friendly infrastructure investments, agricultural initiatives and other undertakings where the possibility for a profit exists, but high levels of risk keep private institutions from investing.
What Are Some Examples of Blended Finance?
Blended finance can take diverse forms and include a mix of financial instruments. The following table describes the main financial instruments used for blended or catalytic finance:
Table 1 | Concessional Finance Instruments
| Concessional finance instrument | Definition and highlights | Example |
|---|---|---|
| Concessional loans | These often offer low and preferential interest rates, long payback periods and extended grace periods. | The Urbasolar Solar Project, a 30 MW solar field in Burkina Faso, had a total project cost of $42 million. To secure private finance, the project developer received $34 million in debt from the Emerging Africa Infrastructure Fund (EAIF) on concessional terms to improve the project’s creditworthiness and ensure bankability. |
| Guarantees and risk mitigation instruments | These instruments transfer a part of the financial risk to the guarantor. Investors are provided reassurance that a minimum amount of their financial obligations will be repaid in the case of a borrower default. | The Green Climate Fund provided $9 million in guarantees and $1 million in grants to a distributed solar project in Pakistan. The guarantee facility will finance 43 MW of solar installation in small and medium enterprises and support existing lending through a scheme launched by the State Bank of Pakistan. The scheme will allow a private bank (JS Bank) to expand the scope of the project further (GCF 2022). |
| Grants | These are contributions given by one entity without the need of repayment. Grants are often used in combination with other concessional funds to make projects more feasible. | The Impact Loan eXchange (ILX) Fund I was launched in 2022 with a $750 million commitment from a pension provider and a goal of reaching $1 billion within three years. The investment platform is focused on energy access and clean energy, sustainable industry and infrastructure, inclusive finance and food security. Grants from Germany, UK and the Netherlands in 2017 provided initial support. |
| Capital investments | These are investments in a company or in a fund, expecting returns on the investments. These generally originate from impact or private investors and can be mixed with other concessional funds or take a later return tranche than other investors. Equity investments are helpful to make projects commercially viable. | The Green Growth Equity Fund is helping India accelerate low-carbon and resilient energy technologies. Equity is being used to directly invest capital into smaller funds that catalyze low-carbon projects. |
Sources: Canu, et al. 2020, and WRI authors.
How Does Blended/ Catalytic Finance Help to Increase Climate Finance?
This type of finance can help attract private investment in climate solutions, which are needed at much higher levels. While some projects will only be appropriate for public investments (e.g., initiatives that will never bring a financial return), catalytic finance and blended finance arrangements can mobilize further private finance when structured correctly.
Catalytic/blended finance can help to reduce different types of real or perceived risks. For example, a loan guarantee may protect against political risks. Or a concessional loan may encourage investors to finance a new technology that lacks a proven track record. Through a mix of financial instruments, catalytic finance makes investments more attractive for investors, including those who would otherwise not fund climate actions.
What Are the Challenges Countries Face in Blended/ Catalytic Finance?
Blended finance deals can be complex. Many blended finance structures involve multiple financial stakeholders and complex risk-sharing arrangements among the parties. They can require lengthy negotiations and pose legal difficulties, which take time and resources to resolve successfully.
It can be difficult to know how much concessionality is required to attract new investors. When using concessional finance it is important to be careful not to spend funds where investors would have invested anyway, thus unnecessarily subsidizing private actors. This can be difficult to determine, but there are often tipping points in certain sectors that make commercial viability evident and thus do not warrant using concessional finance. Similarly, institutions need to be ready to provide sufficient levels of conditionality where it is warranted.
Blended finance will not always be the solution. Some geographies, technologies or types of projects will not be appropriate for blended finance. Countries in conflict or with highly unstable governments may be too high-risk for private investors to enter, even with de-risking structures in place. Others, like small-scale interventions in poorer communities, may not yield sufficient financial return to warrant private sector involvement.
Conclusion
Blending concessional funds with other types of finance is essential for climate finance mobilization. In the race to achieve national climate goals, countries need to access diverse sources of funding. The combination of development finance and private investment can be a vital tool to attract commercial investments in projects that would otherwise be perceived as too risky. With the participation of philanthropic, private, public and other funding sources, blended finance has helped scale up innovative approaches to climate change mitigation and adaptation action. It shares and diversifies the risks that keep countries from more active climate engagements.
Blended finance takes careful analysis and negotiation. Multiple stakeholders are often involved, with various interests and levels of risk tolerance. These interests must be carefully balanced between partners to allow for appropriate levels of concessionality to attract new investment.
Tax credits are useful policy mechanisms to accelerate investments in climate technology.
What Are Tax Incentives in Climate Finance?
Tax incentives are public policy mechanisms that can be used to encourage investment in certain technologies, products or services. They function by reducing the amount of tax a consumer or company must pay to the government. Tax credits are frequently used to support specific industries and initiatives, such as low-emission transportation or renewable energy. They can come in different forms, such as tax rebates or tax holidays.
Tax incentives can help equalize cost differences between products that are climate-aligned and those that are not. For example, credits can bring down the cost of electric vehicles, so that their purchase price is more in line with vehicles having internal combustion engines. Countries from Norway to Tunisia have reduced taxes on electric vehicles to increase investment in this new type of transportation. For climate-related incentives, the government often specifies the tax credit amount depending on the emission reduction potential of each technology.
How Do Tax Incentives Work in Practice?
Tax incentives reduce taxes on specific goods and services to encourage investments. They are implemented by the government and targeted at certain products, sectors or types of investors. One prominent example is the United States’ Inflation Reduction Act, passed in 2022, which provides about $270 billion in tax incentives. This includes incentives related to renewable energy, energy storage, zero-emission transportation and more. These credits are targeted at consumers as well as businesses.
Tax incentives can also be used to balance the rising costs associated with climate action. In Canada, the government uses a tax credit to help households offset the cost of pollution pricing. Payments are made to households in certain Canadian states where pollution pricing is being implemented, with rural households receiving a slightly higher amount.
What Are the Benefits of Tax Incentives in Climate Finance?
Tax incentives can bring new investments to climate-friendly products whose cost might otherwise be prohibitive. Many of the climate technologies supported by tax credits have high initial capital expenditures, such as clean hydrogen, solar, wind and geothermal sources of energy. Tax incentives help to bring those initial prices down, making the up-front cost more comparable to high-emission alternatives. Under the right circumstances, this can have a significant impact on investment flows.
Tax incentives can have a significant impact on emissions without regulation. Under the right circumstances, tax incentives can have a large impact on emissions. And this can be done without making use of less politically popular solutions, like carbon pricing or emission regulations, which can emphasize costs instead of benefits.
What Are the Challenges of Tax Incentives?
Not all consumers will benefit from tax incentives. For example, those that do not pay taxes will not profit from a reduced tax burden. This includes people working in the informal sector, subsistence farmers and others without a recorded income.
Tax incentives may not have the desired impact on investments. Structuring tax incentives often involves complex decision-making and limited information. Studies on tax incentives in developing countries have found that some incentives may have been implemented unnecessarily because other factors influenced investment more heavily, particularly in countries with weak governance. Countries with stronger governance benefited more from providing tax reductions.
Conclusion
Tax incentives provide a tool to incentivize private investments in climate technology. Under the right circumstances, they provide a huge opportunity for governments to deploy early-stage and more mature clean technologies into their markets. Nevertheless, there are still limitations on the role of tax credits and their accessibility for many end users.
To make tax incentives effective, they must be structured to provide the right amount of tax relief. Too much relief will drain government budgets, many of which are already under strain. Too little incentive may have limited impact on investments. In countries where other dynamics limit investments, tax incentives may not be the most appropriate tool.
Tax credits should have a progressive timeline for phase-out. Like any incentive, tax incentives should not remain indefinitely, but should be phased out or adjusted as the market matures. These adjustments should be announced early on, to allow investors and individuals to adjust.
Monitoring the impact of tax credits is key. The credit will be successful if the climate objective for which it was created is met. Laying the foundations for tracking success and adjusting as necessary will be essential to effective implementation.
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Public-private partnerships are long-term cooperative mechanisms that foster private sector investments in climate projects.
What Are Public-Private Partnerships?
Public-private partnerships (PPPs) are cooperative arrangements between public and private actors to implement public services. PPPs are generally implemented through long-term contracts between the private sector and government entities, with the goal of ensuring a minimum level of service, sharing risks and achieving efficiency. The role of the private sector is to help improve the delivery of public infrastructure and services.
Climate elements have begun to emerge in PPPs. As the growing intensity and frequency of extreme weather events increases projects’ risks, governments and the private sector have started to include climate change considerations in PPP policy and projects. Countries frequently turn to PPPs to help close funding gaps, access larger financing pools and incorporate private sector expertise to deliver public services. Both mitigation and adaptation projects have benefited from increased resources and private sector involvement.
How Do Public-Private Partnerships Work?
PPP contracts can be structured in a myriad of ways. They generally include three key elements: a formalized partnership defining the respective roles and responsibilities of public and private actors; risk-sharing among public and private actors; and financial reward for private parties.
There are several common structures used for infrastructure PPPs. One traditional arrangement is build-own-transfer (BOT), where the private partner builds and then operates the project for a period, generating revenues through fees, tolls (or other payments) before transferring the ownership and operating rights back to the government. A more complex arrangement is design-build-finance-operate-maintain (DBFOM), where the private operator is in charge of financing the project, via debt or equity. Figure 1 illustrates a PPP arrangement featuring multiple investors, including the government, development banks and other parties.
A PPP Example: Metrobus in Mexico City
Metrobus, the Bus Rapid Transit (BRT) system in Mexico City, is one of the most advanced PPPs in Latin America. The project was originally initiated by the government and the World Bank and is now run by Mexico City’s Metropolitan Environment Commission’s public program PROAIRE. The aim was to bring both climate and public benefits. The project established a PPP model where the government of Mexico City is the main initiator and service manager. Private companies assisted in providing private financing for some of the lines and operate the BRT system under 10- and 20-year contracts and in managing fare collection. A trust fund is used to pay the transportation companies, which are private and state-owned.
Source: OECD 2012
What Are the Benefits of Public-Private Partnerships?
One benefit of PPPs is that they allow risk sharing between public and private institutions. Depending on the risk-sharing arrangements, PPPs can allow governments to shift some risk to the private sector. For example, the arrangement could make the private investor responsible for cost or schedule overruns. The amount of risk transfer that occurs will depend on the project goals and corresponding contractual arrangements.
Under the right circumstances, PPPs can allow public infrastructure projects to be delivered more efficiently– including projects focused on climate solutions. Cooperation between public and private stakeholders can help projects take advantage of the strengths of both the public and private actors. For example, the private partners may bring a focus on efficiency, while public actors can supply regulatory and policy support, as well as a directive to act in the public interest.
PPPs can channel more funds toward climate action. PPPs can attract investors to projects they would not undertake without government partnership, including climate-related initiatives. Governments can also use PPPs to integrate climate into traditional infrastructure development, ensuring that critical infrastructure projects (e.g., in the transportation and energy sectors) are built to lessen and withstand climate impacts.
What Are the Challenges of PPPs?
Skepticism or concerns about costs of implementing a PPP. Key stakeholders may oppose or resist to ceding control of a public asset or service to a private party. This might result in lack of political support, potentially delaying project implementation.
PPPs can be more complex to implement than traditional structures. The use of more complex financing schemes and the need for technical support can result in higher transaction costs than traditional public climate investments. High transaction costs can make PPPs unfeasible, especially for small projects or where market and political barriers are high.
Conclusion
PPPs allow private investors to participate in public projects. The potential to partner with different private sector parties can allow governments at national, regional, and local levels to develop larger and more efficient climate projects. PPPs can be used in climate finance initiatives for energy, water, transport and other infrastructure investments.
PPPs need to be developed carefully and with attention to the proper role of the private sector and the balance of rights and responsibilities between the actors involved. The focus should be on a balanced risk and reward allocation that creates value for the public sector and allows efficient execution and maintenance of public service projects with climate benefits. Access to specialized expertise will speed up and increase the quality of projects, and enhance the innovation, design, execution and maintenance of climate initiatives.
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Climate efficiency standards encourage private sector investments in clean technologies and practices to lower GHG emissions.
What Are Climate Efficiency Standards?
Climate efficiency standards are regulations or guidelines that governments put in place to encourage investments in low-emission, high-efficiency products and services. Examples of efficiency standards include rules limiting vehicle emissions, standards for household appliances, and similar restrictions. The aim of efficiency standards is to encourage purchasers to invest in more efficient technologies. This, in turn, can motivate the development of newer and more efficient options.
Climate efficiency standards are already helping countries reduce consumption of energy and resources. Efficiency standards most often relate to the consumption of energy, but can also focus on other resources, such as water. Recent research indicates that these standards are helping some countries reduce their national electricity consumption by up to 15% and their national GHG emissions by up to 10%.
Where Are Climate Efficiency Standards Applied?
Efficiency standards are used in a variety of sectors, including energy, agriculture, water, transport and buildings. In the energy sector, standards are mostly used for industry, transport and buildings. Standards can be voluntary or mandatory.
Table 1 | Types of Climate Efficiency Standards
| Type of standard | Definition | Main industry uses | Examples |
|---|---|---|---|
| Energy Standards | Energy standards are designed to save energy and reduce GHG emissions | Industry | LED energy-saving light bulbs, industrial low emissions heating systems |
| Buildings | District energy for heating, low-carbon residential refrigeration standards | ||
| Transport | Electric bus standards, public transport emission standards | ||
| Agriculture standards | Agriculture standards are aimed at regulating the use of energy, water, pesticides and other pollutants | Agriculture | Efficient water use standards, pesticide-regulating standards, energy-efficient and climate-smart agriculture technology standards |
| Water Standards | Water standards are designed to increase the efficiency of water use and reuse | Water systems in cities and industries | Stormwater management and reuse standards, water-efficient irrigation systems |
Sources: WRI authors, UNEP-CCC 2023
Box 1 | South Africa Example
South Africa’s Energy Efficiency Standards and Labeling program aims to develop minimum energy performance standards (MEPS) for different products. These MEPS focus on improved air quality and water conservation and are expected to reduce CO2 emissions by 6.8 million metric tons by 2030.
In Brazil, the National Energy Conservation Program (PROCEL), overseen by the Ministry of Mines and Energy and managed by Electrobas (Brazil’s federal holding company in the energy sector), was launched in 1985 at federal and local levels. PROCEL aims to encourage people to reduce electricity consumption through municipal energy management and energy performance labels for appliances, as well as the replacement of inefficient equipment. This resulted in energy savings of approximately 23 billion kilowatt hours (kWh) in 2018 and additional savings related to CO2 emissions and energy consumption, as shown in Figure 2.
What Are the Benefits of Climate Efficiency Standards?
Climate efficiency standards encourage the private sector to increase investments in clean technologies and practices. In this way, efficiency standards can be used to guide markets and change industrial consumption patterns. Both mandatory and voluntary standards encourage investment in goods and services that are more efficient and in line with climate mitigation or adaptation goals.
Efficiency standards allow available electricity to go further. In places with low levels of access to electricity, efficiency standards can help available electricity meet more of the need. Ghana, for example, implemented an appliance labeling program that has reduced demand for additional electricity generation, resulting in savings worth tens of millions of dollars.
Climate efficiency standards can encourage investment in innovation. Ambitious standards can incentivize the development of new, cleaner technologies, from energy-efficient appliances to water-efficient growing techniques.
Implementation of standards can ensure that a country does not become a dumping ground for old, inefficient appliances or vehicles. Many countries today have efficiency standards in place for appliances, vehicles, heavy machinery and similar equipment. Inefficient and polluting products not meeting these standards are often sent elsewhere—in many cases, to developing countries which are seeking cheaper products. These countries can benefit by establishing their own standards to counteract this dumping.
What Are the Challenges of Climate Efficiency Standards?
Although many countries now have some form of efficiency standards, they are often too low to result in improvements. According to the International Energy Agency, more than 80 countries employ minimum energy performance standards, but these often have little effect since technology has advanced beyond the level of the standard. Standards need to be regularly updated to reflect changes in technology.
Rigorous efficiency standards may result in higher prices and temporary product shortages. Efficiency standards that promote new technologies may result in higher prices and more complex supply chains. To enable their effective implementation, governments may need to provide financial incentives, such as subsidies or tax incentives. New financial arrangements may also be required to allow consumers of more efficient products to pay over time as benefits from greater efficiency accrue.
Conclusion
Governments have a crucial role in guiding industry behavior through the use of efficiency standards. They should continue to drive industries toward decarbonization and resilience through climate-related efficiency standards. Strategies implementing mandatory caps or voluntary guidelines and labeling, supported with financial incentives, can help achieve these goals.
Setting appropriate standards requires an understanding of available technology and how it may develop. This will require a market study on product availability, pricing, and how the standards may impact the existing market. Some standards will be best implemented gradually, to let producers and consumers adjust to new requirements.
Technologies and capabilities to ensure effective monitoring and compliance with the standards must be available. Without processes that allow monitoring of implementation of the relevant standards, it will be difficult to know whether success is being achieved, and when and how to adjust.
Climate-related risk disclosures inform investors about their exposure to different types of risks by providing enhanced transparency around the climate impact of investments.
Climate-related risk disclosures are one of the main instruments to help shift private finance toward climate compatibility. Companies report disclosures to the government and to their investors; climate-related risk disclosures introduce climate-relevant information to these disclosures.
Industry, governments and civil society are focused on regulating corporate climate reporting to align the global financial system with international climate goals. One important development in this regard was the creation of the Task Force on Climate-Related Financial Disclosures (TCFD) by the Financial Stability Board (FSB) at COP21, which intended to reduce the climate-reporting gap across the corporate sector. The launch of the International Sustainability Standards Board (ISSB) at COP26 in Glasgow further helped to unify reporting standards.
What Is Climate-Related Risk Disclosure?
Climate-related risk disclosures—voluntary or mandatory—introduce transparency across the corporate sector. Disclosure helps stakeholders involved in the financial system to understand how their investments relate to climate impact, both in terms of how investments contribute to climate change and how climate change might pose risks to these investments. With this understanding, investors can make more informed decisions and reduce climate risk in their portfolios and in the economy as a whole.
What Are the Main Components of Climate Disclosure?
According to several international standards, the most common components of disclosure include: governance, strategy, risk management, metrics and targets (see Figure 1). Within them are specific questions that may be more specific as to what each jurisdiction wants to disclose.
Key terms in climate-risk disclosure include:
- Climate-related risks. These risks can be classified as physical, related to climate change impacts like fires and floods. Or they can be transitional, that is, regulatory or technological risks related to the transition to a low-carbon economy (see Table 2).
- Materiality. Companies need to disclose how climate-related risks impact them financially. This is referred to as single materiality, where companies are expected to disclose detailed financial risks related to climate change. Double materiality refers to the company’s impact outside the organization on the environment and society.
- Direct and indirect exposure to emissions. Direct exposure relates to the impact generated or controlled by the company, while indirect relates to the emissions generated by the energy consumed and purchased by the company, as well as other upstream and downstream emissions along the company’s entire value chain (see Table 1).
Table 1 | Types of Climate Risks
| Climate-related risk categories | Risk classification | Definition and examples |
|---|---|---|
| Physical risks | Acute risks | These are driven by the increased severity of weather events. They include hurricanes, floods or cyclones. |
| Chronic risks | These are related to gradual changes in climate patterns. They include sustained higher temperatures and heat waves. | |
| Transition risks | Policy and legal risks | These are driven by climate policies or regulations such as clean energy policies, carbon-pricing mechanisms and other factors that impact the economy. |
| Technology risks | These are related to technological innovations linked to the low-carbon transition, such as innovative renewable energy technologies and battery storage. | |
| Market risk | This is related to shifts in supply and demand for products and services due to climate change. | |
| Reputation risk | This is related to the perception of an organization’s behavior regarding climate change and the low-carbon economy. |
Source: World Resources Institute 2021
What Are the Benefits of Climate-Related Risk Disclosures?
Climate-related risk disclosures help improve monitoring of the climate risks facing companies and their investors. By enhancing transparency, disclosures can elevate governance of the financial system and enable its participants—from private investors to governments to regulators with responsibility for global macro-financial stability—to plan their investments and management strategies to align with a warming world and a transitioning economy.
What Are the Main Challenges for Countries to Implement Climate-Risk Disclosure Policies?
There is an immediate need to improve the climate data used to develop disclosure standards and monitor them. Quality climate data is still lacking, particularly as it relates to physical climate risks facing companies and their supply chains. Data is constantly improving, but many current disclosures rely on estimates, projections or data that is not yet disclosed to the public or regulators.
A solid commitment from the corporate sector, including the financial sector and companies, is required. Companies may believe additional reporting imposes undue costs or is too burdensome given the difficulty of obtaining high-quality climate data.
There is still a lack of harmonization across jurisdictions. Although several climate disclosure standards have emerged, most notably the TCDF framework, countries have yet to define international benchmarks for companies and investors.
Conclusion
Companies and investors need to develop their capacity to carry out accurate risk assessments and associated transition plans, targets and strategies. An inability to identify real climate risks can lead to gaps in disclosed information and false data, which will not help the reporting company or its investors. New expertise and technical ability are required.
Mandatory reporting requirements help enable the measurement of climate risk across the entire economy, providing a more comprehensive picture for both investors and regulators. Although international standards have identified disclosure categories and methodologies that support best practices and cover the entire value chain, they are not sufficient in themselves to ensure adequate and comparable reporting. Regulators must apply these standards to disclosures at the national level.
Climate disclosure needs to go beyond the financial sector. Disclosures are equally important for financial institutions and real-economy companies. Disclosures help companies understand their risks and opportunities, set their strategies and governance, and make appropriate investments and divestments to align with a low-carbon transition. The exercise of measuring and disclosing their climate risks can set corporations on a path towards decarbonization and resilience.