Scaling up Adaptation Finance: Opportunities for the Financial Sector
Countries that signed the Paris Agreement agreed to work together to decrease greenhouse gas (GHG) emissions to limit the increase in global temperature to 1.5 degrees Celsius. Many projects that will mitigate global warming by lowering GHG emissions are underway and in development. These projects need significant financing.
As well as mitigating global warming, we must also adapt to the changing climate. We must build new dams, upgrade bridges, change our agricultural practices and make other changes to adapt to new patterns of weather and precipitation. But financing for adaptation is lagging. In developing countries, the annual costs of adaptation are estimated to be $160 to $340 billion by 2030, and from $315 to $565 billion by 2050.
The difference between what is needed for adaptation and what is being spent is known as the “adaptation financing gap”. The World Economic Forum (WEF) says that closing the adaptation financing gap would save millions of lives and billions of dollars in disaster response. It would also slow climate migration. There is urgent need for adaptation funding in sectors such as water management, agriculture, infrastructure, and disaster risk management.
IFC’s Green Banking Academy (GBAC) is an online banking knowledge initiative designed to help financial institutions and the private sector learn about green investments and enhance their green portfolios. Financing for projects that contribute to climate adaptation and resilience is “green” finance. GBAC can help financial institutions understand the opportunities available in scaling up financing for adaptation and resilience. IFC can help financial institutions identify adaptation investments and develop new financial instruments to support clients’ adaptation and resilience needs.
“Adaptation needs in the developing world are set to skyrocket to as much as $340 billion a year by 2030. Yet adaptation support today stands at less than one-tenth of that amount. The most vulnerable people and communities are paying the price. This is unacceptable.”
UN Secretary-General António Guterres
UNEP Press Release, Nov. 2022
Climate Change Mitigation Vs. Adaptation
Mitigating climate change is not always the same as adapting to current and future realities. Sometimes there are trade-offs between mitigation and adaptation. For example, as temperatures rise, people adapt by investing in cooling technologies. These technologies may increase GHG emissions and work against climate change mitigation.
Sometimes there are positive links between mitigation and adaptation. Restoring a forest is a form of adaptation that also reduces GHG emissions. When grain farmers reduce tillage, they are adapting to changing rainfall patterns while also sequestering carbon in the soil.
It can be difficult to quantify the co-benefits between climate mitigation and adaptation. Identifying these benefits and ensuring that adaptation plans do not work against climate change mitigation is an important first step.
“Investments in adaptation represent less than 10% of all climate finance. Increasing private adaptation finance will be crucial, both for managing their own climate risk and for filling the gap in public funding.”
Anup Jagwani, IFC Climate Business Manager
IFC news story, July 2022
Climate Adaptation and Resilience
“Climate adaptation” and “resilience” are often used interchangeably, but they are different terms.
- Climate change adaptation is adjusting to the impacts of climate change by changing behaviors and practices. For example, planting different crops as precipitation patterns change. Increasing knowledge is a form of adapting, for example, developing better storm warning technology. Adaptation can be as severe as relocating communities to safer areas.
- Resilience is the capacity to withstand shocks and keep operating. For example, a cellphone tower that can withstand stronger storms is resilient. Healthcare systems that can cope with multiple crises at one time are resilient. Climate resilience is the ability of a system to withstand the impacts of climate change.
Climate adaptation and resilience can happen in two ways: incremental or transformational. Incremental changes are gradual changes made over time, like changing crop varieties to adapt to higher temperatures. Transformative changes are larger changes, such as giving up farming and taking on a new livelihood. In its report “Enabling Private Investment in Climate Adaptation and Resilience”, the World Bank says that, in the long run, climate change will require deep transformative change in many areas. This may include transforming economic systems by adding climate risk disclosure for all investments and including climate risks in credit ratings.
Jennifer J. Sara, Global Director, Climate Change Group, World Bank Group
World Bank Blogs, July 2022
Measuring the Climate Adaptation Finance Gap
Climate change is already causing severe economic impacts. In 2021, the reinsurer Swiss RE estimated the economic loss from natural catastrophes at $270 billion. The Economist Intelligence Unit estimates that, by 2050, the average loss in real GDP due to climate change will be 3 percent in Eastern Europe and 1.7 percent in Western Europe.
Every year the United Nations Environment Programme (UNEP) publishes an Adaptation Gap Report (AGR) that describes gaps in global progress on planning, financing and adapting to climate change. UNEP’s most recent report, released in November 2022, had the alarming title “Too Little, Too Slow: Climate Adaptation Failure Puts World at Risk.” This report says global temperatures are already 1.1 ̊C above pre-industrial temperatures. Based on the policies currently in place, UNEP says, we can expect temperatures to rise to 1.8 ̊C above pre-industrial temperatures by 2099.
Although 84 percent of countries that are UNFCCC members have climate adaptation plans, not all of these countries have set aside funds to implement these plans. The funding gap is most severe for developing countries, which will need $160 to $340 billion annually by 2030 to adapt to climate change. This is far more than the $200 million developing countries targeted to provide for both adaptation and mitigation in 2020. In 2020, only $83.3 billion of the targeted $100 billion was provided. Of this, only $28.6 billion was directed toward adaptation.
The adaptation finance gap is wide and growing. Early action will pay off. IFC estimates that $800 million invested in early warning systems can reduce climate disaster losses by $3 to 16 billion.
“Climate change is landing blow after blow upon humanity, as we saw throughout 2022: most viscerally in the floods that put much of Pakistan under water. The world must urgently reduce greenhouse gas emissions to limit the impacts of climate change. But we must also urgently increase efforts to adapt to the impacts that are already here and those to come.”
Inger Andersen, Executive Director of UNEP
Press Release, Nov. 2022
Filling the Climate Adaptation Financing Gap
The $28.6 billion provided to developing countries in 2020 came from the public sector. Private sector funding for adaptation is difficult to measure and is not well-tracked. Climate change mitigation spending is easier to measure because it is easier to define – climate change mitigation projects lower GHG emissions. The potential range and purpose of adaptation projects is much wider, leading to inconsistent reporting and measurement.
There are several taxonomies to classify “adaptation” investments. Three of these are the OECD Rio Markers assessment, the multilateral development banks’ (MDB’s) Joint Methodology for tracking adaptation finance, and the EU’s Taxonomy for Sustainable Activities.
The OECD Development Assistance Committee (DAC) Rio Markers classify investments as adaptation-related if they are intended to reduce vulnerability to current and expected climate change impacts. This includes maintaining or increasing resilience with increased ability to adapt to or absorb climate change stresses, shocks, and variability. This methodology scores investments as:
- “2”, principal, if adaptation is the primary motive for the investment;
- “1”, significant, if adaptation is a benefit of the investment, but not the primary motive; and,
- “0”, if the investment does not target adaptation.
The MDB’s Joint Methodology draft framework for classifying investments as adaptation investments uses a three-step framework:
- Establish a vulnerability to climate change;
- Find a way to reduce that vulnerability; and,
- Establish the link between the proposed investment and the vulnerability.
There is also an EU Taxonomy for Sustainable Activities. This includes six environmental objectives, one of which is adaptation. With this taxonomy, an adaptation investment must:
- Make a substantial contribution to adaptation;
- Do no significant harm to the other five environmental objectives (climate change mitigation; sustainable use and protection of marine and water resources; transition to a circular economy; pollution prevention and control; and protection and restoration of biodiversity and ecosystems);
- Comply with minimum social safeguards; and,
- Comply with technical screening criteria, which will require identifying and assessing risks and determining how the investment can reduce those risks.
Without decisive action, things are set to get worse because we are clearly not on the right trajectory for cutting global emissions.
Bo Li, Managing Director IMF
Private Sector Financing for Climate Adaptation
There are many reasons why the private sector is not investing heavily in climate adaptation:
- There is a lack of data to guide decision-making and limited clarity on where investment is needed.
- The returns to investments are perceived to be low, and often actually are low. Benefits from adaptation are often public goods, and it is difficult for one investor to capture the economic benefits. For example, everyone benefits when a dam is reinforced to prevent urban flooding.
- The benefits of financing adaptation projects often accrue to the poor, who have limited ability to pay. For example, installing cooling equipment in public places.
- Large-scale adaptation projects have long-term planning horizons. These are difficult to sell to short-term investors.
- Many needed investments come with a relatively low price, between $30 and $50 million, a level that may not appeal to traditional investors.
Despite these challenges, there are many ways the private sector can profit from investing in adaptation. Here are some examples:
- Energy companies can lower their risk of loss by weather-proofing power lines or underground cables;
- Farmers can increase yields and profits by investing in new seed varieties that are adapted to an evolving climate;
- Retrofitting buildings can lower energy and water costs and make buildings more resilient to extreme weather;
- A company investing in power backup equipment can prevent losses in the case of a weather-related power outage.
“Adaptation is not a cost, it is an investment. However, adaptation finance remains grossly insufficient to address the needs of developing countries.”
Simon Steill, UN Climate Change Executive Sector
Twitter, March 2023
IFC and Adaptation Funding
IFC has identified four areas where high returns can be realized from adaptation financing: infrastructure and resilience; water supply and management; resilient agriculture, and equipment and services. Many investments in these sectors will be financially profitable. IFC can help financial institutions develop new financing instruments for adaptation investments. These might include green bonds, sustainability-linked finance, blue bonds and loans, and other new instruments.
Some adaptation investments are not as financially profitable as other opportunities. The private sector, including financial institutions, may need support to make these investments. IFC can provide support through blended financing, loan guarantees, risk-sharing, co-financing, and other innovative solutions.
For financial institutions with existing or potential investments in the building sector, IFC’s Building Resilience Index can help identify climate risks. The tool provides location-specific information about hazards and information about ways to decrease risk. The tool can be used to assess the resilience of buildings.
“IFC is working to increase its proportion of adaptation finance, and a more significant proportion of IFC’s projects are expected to have adaptation finance components. … Looking forward, we expect to see more opportunities for public-private partnerships, and innovative financial structures that scale up our investments in this area.”
Anup Jagwani, IFC Climate Business Manager
IFC news story, July 2022
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For more information about GBAC or to schedule an assessment of your climate capabilities, please email email@example.com to contact a member of our ECA GBAC team. IFC experts are available to provide you with more information about innovative approaches to investments in climate change adaptation and resilience. We are looking forward to working with you. Stay green!