The climate finance report: are we clearer now?

5 November 2010
Articles and blogs
The report by the High-Level Advisory Group on Climate Change Financing (AGF) is an interesting read which should have clarified ‘how to significantly scale-up long-term financing for mitigation and adaptation strategies in developing countries from various public as well as private sources, and how best to deliver it’. But in truth it has confused me a little.

It was meant to be straightforward. After the US$100 billion a year in new and additional climate finance by 2020 had been negotiated, we needed to consider the sources of such finance. In reality it is more complex than that because the negotiations failed to define what is included in climate finance. Given a fixed number, anybody interested in minimising the flows will try to classify everything in the world as counting as climate finance. Climate finance recipients, on the other hand, would argue that only net flows and grants would count whilst the private sector contribution would be excluded. So the report shows that, depending on the definition used, it is easy or difficult to reach the US$100 bn a year. Astonishingly, the Advisory Group itself states it did not seek an ‘agreed formula on what financing flows should count and on what should not count towards the US$100 billion per year’. What is the point of a number without a definition?

What the report could have done was to use an established method for counting cross-border flows. Climate finance constitutes financial flows from one country to another, and the appropriate method to measure this seems to me to use the balance of payments concept (BoP), which includes current transfers, direct investment and portfolio investment such as debt and equity securities. It also can be used to describe gross and net flows – the ultimate effects of climate finance will depend on gross as much as net flows.

Transfers

Transfers include public finance which are ‘estimated at face value’ but there are no indications of the implications for aid. There is, therefore, no view on how ‘direct budget contributions’ are financed. If they are financed out of aid, then it will be important to understand the effect on development. Whilst the AGF report analyses sources of climate finance based on revenues, efficiency, incidence, equity, practicality, acceptability, additionality and reliability, the terms of reference lack ‘development effects’ as a further criterion.

Direct investment

Direct investment includes companies taking a minimum 10% equity stake. On this BoP basis, all foreign direct investment (FDI) would count towards climate finance as long as it finances some eligible mitigation or adaptation activity (defined as bottom-up). This compares to the report’s view that private capital refers to ‘flows of international private finance resulting from specific interventions by developed countries’. Should we care less about private finance to eligible climate activities when it is not based on specific interventions (e.g. new investments in energy-saving-embodied technical change, windmills or solar panels)? And will the dynamic spillover effect count (which is potentially endless), or just the static effects? Again, the BoP concept would not need to make a distinction as it looks at actual flows not intended flows.

Portfolio investment

Under the BoP concept portfolio investment would include sovereign wealth funds and institutional investors, but these are not considered in detail in the report. This misses a trick just ahead of the G-20 summit – as the G-20 development group is considering exciting proposals to provide advance market commitments for green power, why could we not think about how best to blend ODA and sovereign wealth? The BRIC countries (Brazil, Russia, India, China) hold some US$3 trillion of wealth and are looking for high returns (incidentally, Africa’s return on US and UK FDI is 3 times higher than those in the rest of the world). Climate finance from richer countries to poorer countries could address global rebalancing by transferring funds from low-yield activities (such as US securities) to high returns.

Clarity and lessons

We need to break out of a vicious circle. The report clarifies that US$100 bn of climate finance can be provided if the carbon price is high, but the level of the carbon price depends on negotiating international climate targets. At the same time, international climate targets are more likely when negotiations work smoothly, which in part depends on certainty of the provision of climate finance to poorer countries. But, without a clear definition of climate finance, do poor countries actually know what they have bargained for?

Finally, should the climate finance debate draw lessons from the Aid for Trade (AfT) debate? Both AfT and climate finance have well established motives: to compensate poorer countries for previous actions of rich countries (e.g. preference erosion and environmental damages). There has been a task force for both: whilst the AfT task force clarified the definition but did not agree a target number, the AGF hasn’t clarified the definition but has kept a target number. Both concepts need to lead to new and additional finance, but both have struggled to agree on a baseline to verify this. AfT was initially about volumes, but has now moved to a discussion of effects and monitoring. Climate finance still has to make the transition towards studying the effects in detail.

To this end, I agree with my colleague Neil Bird’s comments: the number has been secured, the definition has not, but what we really need to know is which climate finance activities achieve the best results.