Public Finance Mechanisms to Mobilize Climate Change Mitigation

The United Nations Environment Program (UNEP) has issued an overview report on Public Finance Mechanisms (PFMs) that can be used to mobilize investment in Climate Change Mitigation.  

At a time when governments around the world are developing strategies to stimulate economic recovery, public finance measures that lever commercial financing, or which build commercially sustainable markets that increase the Delivery of clean energy and other climate-mitigation technologies become particularly relevant.

The report is based on a substantial body of experience in a wide variety of developed and developing countries. It suggests ways in which PFMs could be used at the national and international scale, offers scale up and replication strategies, and identifies how they might fit into a new financial framework under the United Nations effort to deal with climate change.

In August 2007, the Secretariat of the United Nations Framework Convention on Climate Change (UNFCCC) published a technical paper, Investment and Financial Flows to Address Climate Change, which estimated that USD200-210 billion in additional investment will be required annually by 2030 to meet global greenhouse gas (GHG) emissions reduction targets. The technical Paper concludes that the lion’s share will need to come from the private sector and that it will require substantial additional public funding to mobilize and leverage that private capital.

The key questions now are: What should be the scale of new financing by governments? How can public monies mobilize and leverage sufficient commercial capital to achieve greenhouse gas emissions reduction objectives? In other words: how can the most be made of those new financing resources?

Public Finance Mechanisms (PFMs) vary in their structure and focus, but all broadly seek to mobilize commercial financing and build commercially sustainable markets for GHG mitigation activities. Examples of climate mitigation focused PFM include:

  • Credit lines to local commercial financial institutions (CFI) for providing both senior and mezzanine debt to projects;
  • Guarantees to share with local CFIs the commercial credit risks of lending to projects and companies;
  • Debt financing of projects by entities other than CFIs;
  • Private equity (PE) funds investing risk capital in companies and projects;
  • Venture capital (VC) funds investing risk capital in technology innovations,
  • Carbon finance facilities that monetize the advanced sale of emissions reductions to finance project investment costs;
  • Grants and contingent grants to share project development costs;
  • Loan softening programs, to mobilize domestic sources of capital,
  • Inducement prizes, to stimulate R&D or technology development,
  • Technical assistance to build the capacity of all actors along the financing chain

 There is a substantial body of experience with the use of these PFMs for promoting investments in energy efficiency (EE) and renewable energy (RE) technologies, in particular. Various mechanisms are needed to enable the development and deployment of technology along the technology innovation pathway. In developing countries PFMs have mostly been used to support technologies that are in the later stages of innovation but are still facing significant market barriers that inhibit their deployment. In developed countries some mechanisms are also targeting investments in pre-commercial technologies that have yet to enter the market.

If well managed, PFMs can bring down market barriers, bridge gaps and share risks with the private sector. To be successful, however, rather than operating in isolation they must be aimed at complementing national policy instruments such as regulations, taxes and market mechanisms. Their role is to help commercial financiers act within a national policy framework, filling gaps and sharing risks where the private sector is initially unwilling or unable to act on its own.

Besides being aligned with policy frameworks, PFMs must also be structured to act along the entire chain of financial intermediation, which can include development finance institutions (DFIs), CFIs, investors, equipment manufacturers and technology delivery companies. In many cases technical assistance (TA) programs are needed to build the capacities of these market actors to create a pipeline of investment-ready projects, a pre-condition for leveraging commercial funding.

A key question is how much commercial financing can be mobilized and leveraged by a given amount of public money? An assessment of experience with a number of different models of PFMs shows that typical leverage ratios range from 3 to 15:1.

Based on this assessment, it is estimated that if a concerted program of PFMs were scaled up, USD10 billion in public monies could leverage USD50-150 billion in total investment in the climate mitigation sectors.

This estimate is conservative in that it does not take into account the fact that many PFMs “roll over”, supporting multiple generations of investments, and help create markets that continue to grow after the public funds are expended or recouped. It is important, however, to consider that such calculations represent program capacity: the actual amount of capital mobilized depends on the size of the pipeline of bankable projects seeking investment.

The report provides a convenient Table that lists some of the most common PFMs used today in the energy efficiency and renewable energy sectors and summarizes the barriers and market segments they address.

The full report is available from the UNEP website

Source: United Nations Environment Programme

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