Energy Transition

We need less talk and more action on climate finance

Climate finance: Portion of trees against office buildings, Hong Kong, China.

There is growing recognition of the importance of climate finance for adaptation and resilience. Image: Getty Images/iStockphoto

Rich Nuzum
Executive Director, Investments, Global Chief Investment Strategist, Mercer
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Sustainable Finance and Investment

  • There is momentum building around private investment that supports climate mitigation and adaptation, but the current shortfall against the necessary scale of investment is vast.
  • Estimates in the UN Adaptation Gap Report 2022 suggest the annual costs of adaptation in developing countries could be between US$160 billion and US$340 billion by 2030.
  • Building direct connections between institutional investors and deal sponsors and digitizing due diligence can catalyze climate finance.

Energy transition investment is critical to responding to the risks of climate change. Investment can increase the use of renewable energy resources, improve energy efficiency and enhance economic infrastructure and resilience to the effects of global warming.

With COP28 underway in Dubai, momentum is building behind private investment into clean and green technologies, infrastructure, and strategies that support mitigation and adaptation, but the current shortfall against the necessary scale of investment is vast. Projections for annual investment for adaptation of between $160 billion-340 billion by 2030 is five to 10 times below the levels outlined by the UN Adaptation Gap Report 2022.

Earlier this year, the launch of the World Bank’s Private Sector Investment Lab marked a step toward accelerating private capital mobilization across emerging markets. At a country level, the UAE has announced a $4.5-billion commitment to unlocking African clean energy.

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Mobilizing institutional capital in EMs

Institutional investors represent the largest pool of capital within the private sector. A growing proportion of institutional investors are seeking to build resilient investment portfolios through allocations that mitigate irreversible physical damage to the environment, disruption to communities and economies, and harm to the biosphere.

Current estimates suggest that institutional investors’ combined contribution to average annual investment flows into climate finance translates to just 0.01% of their asset base. While there is growing recognition of the importance of investment into adaptation and climate resilience, significant barriers remain to critical project development.

The limited volume and radically uneven distribution of capital flows are the most obvious barriers to getting more projects off the ground in emerging markets. For example, today, the African continent is home to 20% of the world’s population – and has abundant renewable energy resources – yet currently secures just 2% of global clean energy investment.

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Addressing risk in climate finance

An equally critical – but often overlooked barrier – is risk, and its knock-on effects on the cost of capital to projects in emerging economies. Even at scale, the cost of funding clean energy projects across Africa is at least two to three times that of equivalent projects in developed economies. On the positive side, this higher cost may represent an attractive expected return to private sector investors. However, the higher perceived risk of these investments discourages many investors from making allocations, causing aggregate allocation to be lower than they might be otherwise.

The climate finance equation in emerging economies is unlikely to be solved by an increase in capital alone; fundamental changes in the risk profile of investable projects and the associated cost of capital are also key.

When global investors consider investing into emerging markets, risks of political instability, conflict and corruption, aging infrastructure and technology, inconsistent policy and regulation, and economic volatility are among their concerns.

However, when we unpacked the case for investing in sustainable infrastructure in Africa, our research showed that while latent risks exist, there is little systematic evidence to suggest significant differences between the actual default rates of projects in African markets and other global regions. In other risk, the perceived risk has been higher than the actual incidence of realized risk.

More than eight in 10 (83%) respondents to Mercer’s 2022 Global Asset Manager Survey highlighted concerns around the level of transparency in other investors or creditors in companies or projects when assessing allocations to projects in emerging and frontier markets.

This lack of transparency creates challenges for both sides of investments, and in some cases, preventing otherwise investable deals from progressing to development.

Deal sponsors in emerging and frontier markets – and those primarily serving underserved populations in developed markets – frequently lack networks and visibility with international investors and other capital providers. This makes it more difficult, more costly and more time-intensive to source investment capital, even for otherwise bankable projects.

Improving transparency and changing risk perception is therefore crucial, but our research also indicates that a lack of connectivity between sustainable project developers and institutional capital is a limiting factor to the volume of projects getting off the ground. More than a third (34%) of asset managers report that enhanced visibility on impact investment opportunities is a key lever to unlocking and increasing capital allocations.

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How is the World Economic Forum fighting the climate crisis?

Catalyzing climate finance

Our new digital platform, Mercer’s Catalytic Investment Exchange, seeks to improve transparency and enhance sponsor visibility, by allowing preliminary due diligence between investors and sponsors of climate positive projects through a standardized digital questionnaire reflecting the interests and priorities of investors.

Digitizing the preliminary due diligence process helps expedite project counterparties coming together; increases the cadence of deal progression and execution; and, ultimately, supports the flow of more capital, more quickly to impactful projects. We piloted our platform during New York Climate Week and will host our next Catalytic Investment Exchange event in Dubai at COP28.

By increasing visibility, connectivity, and facilitating productive interactions between project sponsors and potential investors, we hope that Mercer’s Catalytic Investment Exchange can catalyze capital flows into green infrastructure, cleantech and green tech at scale, helping derisk direct investment in climate projects across markets most vulnerable to climate change.

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