Understanding the Global Push for Climate Finance

Introduction

Countries around the world have pledged to reduce their carbon dioxide emissions to keep global warming below 1.5°C (2.7°F) of preindustrial levels—the globally agreed upon threshold to avoid the dangerous and cascading effects of climate change. Additionally, countries have committed to protecting communities from the already unfolding consequences of climate change. Governments generally recognize that this two-pronged climate adaptation and mitigation process will cost trillions of dollars. Some progress has been made. Yet funding still falls far behind what is needed, especially by developing countries most at risk of the damages caused by extreme climate events, such as rising sea levels, drought, extreme heat, and flooding.

What is “climate finance”?

Climate finance is defined by the United Nations as any “local, national, or transnational financing—drawn from public, private and alternative sources of financing—that seeks to support mitigation and adaptation actions that will address climate change.” Mitigation efforts, such as renewable energy development, seek to curb greenhouse gas emissions. Adaptation, on the other hand, focuses on making existing infrastructure and practices more resilient to a changing climate, such as by improving the communities’ weather-resistance and restoring biodiversity. 

Most public climate finance consists of loans. For instance, countries can borrow money from commercial banks to achieve their climate goals. Moreover, multilateral development banks (MDBs), such as the World Bank, can offer concessional financing for climate projects—below-market-rate debt with a more generous grace period for repayment. Equity investments, in which an investor buys a stake in a given project, account for roughly one-third of climate finance projects; grants—which don’t need to be repaid—make up a small minority.

Governments and multilateral institutions deliver about half of this funding, with development finance institutions, such as the United Nations’ Green Climate Fund (GCF) and the World Bank, contributing the most. The GCF, the world’s largest climate fund, has raised almost $30 billion in pledges from dozens of countries; it disburses that funding to local development banks, nonprofits, and other organizations to facilitate more than two hundred projects in developing countries. The other half of the financing comes from private enterprises, such as Altérra, the biggest for-profit investment fund, launched by the United Arab Emirates at last year’s UN climate conference (COP28) to mobilize $30 billion in private investments to climate action.

How much money is needed and how much has been invested?

Estimates vary, but all exceed trillions of dollars per year. The Glasgow Financial Alliance for Net Zero, a coalition of leading global financial institutions, projects that reaching net-zero emissions will require at least $125 trillion in investments by 2050—about $5 trillion per year. Other estimates predict nearly double that amount. The Potsdam Institute for Climate Impact Research, a German government-backed research organization, estimates that addressing the damages inflicted by climate change will cost around $38 trillion per year by 2050. To adequately prepare developing countries for extreme weather and other consequences of climate change, the cost could reach $300 billion per year by 2030, according to UN estimates.

Many researchers agree that current spending is falling short of what is necessary. The analysis and advisory organization Climate Policy Institute estimates that climate financing flows will need to increase sixfold to $8.5 trillion between now and 2030 to keep the global temperature within 1.5°C (2.7°F) below preindustrial levels. That’s despite the all-time 2021–22 record of climate financing flows of $1.2 trillion, almost double the 2019–20 amount.

Figures for climate adaptation funding, however, are more challenging to estimate. That’s because cost models can miss the intangible consequences of climate change, such as missed schooling or increased violence due to heat and other climate extremes. A 2023 UN report estimates that the cost of adaptation in developing countries is around $215 billion per year this decade, but private banking institutions have predicted as much as $2 trillion a year by 2026. 

Experts say funding needs to prioritize low-income countries and small island states, which contribute the least to greenhouse gas emissions but typically suffer the most from climate change due to their geographic locations and lack of financial and institutional infrastructure to adapt. Climate-related damages could cost upward of 20 percent of gross domestic product (GDP) for smaller island nations, though funding needs for developing countries could be ten to eighteen times greater than current financing commitments by MDBs and developed countries, according to UN estimates.

How is climate finance used?

Most climate financing funds are directed toward mitigation, which made up approximately 91 percent of total financing in 2021 and were largely concentrated in the transport and energy industries, whose emissions are the leading causes of climate change. Meanwhile, climate adaptation made up around 5 percent that year. One reason for this imbalance, experts say, is that the impacts of climate adaptation projects are difficult to define because the projects are highly context-specific relative to mitigation projects, which can be measured by reduction of greenhouse gas emissions. 

Another reason is that clean energy is becoming much more cost effective and attracting more private investments than even a decade ago, International Energy Agency Executive Director Fatih Birol said at a CFR event in September 2024. Mitigation investments, he pointed out, are not necessarily driven by climate concerns but instead by “economics, energy security, and industrial policy reasons.” 

Mitigation initiatives include South Africa’s $8.5 billion financing pledge in 2021 to help with decarbonization initiatives, such as retiring coal-fired power plants and creating renewable energy capacity. The country received around $640 million of the pledges in the form of loans by 2023. In the United States, President Joe Biden signed the Inflation Reduction Act of 2022, which directed hundreds of billions of dollars’ worth of federal tax credits, loans, and research grants toward boosting domestic manufacturing capacity for clean energy and other climate-related programs, such as initiatives to promote electric vehicles. Experts consider the law to be the largest and most ambitious climate bill in U.S. history.

Adaptation projects, on the other hand, aim to prepare communities and businesses to build resilience and adjust to climate risks. Such efforts include, for example, constructing desalination plants in the Maldives to address declining rainwater and transitioning smallholder coastal farmers in Vietnam from collecting scarce marine resources to beekeeping and mangrove restoration, to name a few.

Meanwhile, several market-driven solutions are gaining in popularity. These include tradeable carbon credits and so-called debt-for-nature swaps, which relieve sovereign debt in exchange for conservation efforts. However, there are no internationally recognized parameters for climate finance, which has led to discrepancies between the amounts countries say they have invested in such initiatives and the amounts tallied by watchdog nonprofits.

What are the main challenges to climate financing? 

Funding. The biggest challenge is the lack of funding for climate projects, especially for low-income countries. “No government in the world has enough money to get the job done,” U.S. climate envoy John Kerry said at the annual UN climate conference in 2022, suggesting that countries will need to rely on the private sector to meet funding needs. Some experts argue that attracting more equity financing from commercial investors—pension funds, insurance companies, and private-equity firms, for instance—would be a better instrument than debt because it would tie foreign investors to projects longer and shield developing economies from a debt crisis.

Mounting debt. Several vulnerable developing countries are stuck in a climate debt trap, in which fiscal constraints prevent climate protections for those most at risk. Developing countries already face high borrowing costs and have incurred deep debt under the current multilateral banking system to develop foundational infrastructure. Furthermore, when countries are more at risk of climate disasters, their borrowing rates increase. Taking on more debt means that several developing countries could be unable to pay for fundamental social services or forced to divert recovery and emergency funds to debt repayment during climate disasters.

Institutional capacity. Other analysts have raised concerns that many poor countries lack the financial infrastructure to channel massive foreign investments into productive projects, which could panic investors and unsettle fragile economies. Another hurdle, experts say, is that many MDBs currently lack the capacity to facilitate the world’s climate finance needs and disproportionately concentrated money in climate mitigation. Part of the reason for this misalignment stems from a dearth of climate expertise at these institutions, says CFR climate expert Alice C. Hill.

Accountability mechanisms. No existing mechanism holds governments and institutions accountable for meeting financing promises. Wealthier nations have been found to overreport their investment estimates or fall short of their responsibilities, and green funds—which allow private investors to contribute to ESG (environmental, social, and governance) investing—are not required to disclose their investments’ carbon footprints or emissions output, resulting in greenwashing. Some wealthier countries have taken advantage of the lack of accountability to inflate the mobilized amount for climate financing projects.

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UN Climate Talks

1992–2023

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What’s next for climate finance? 

New initiatives and policies demonstrate that climate financing efforts are evolving and improving, but experts say that the window for world governments to mitigate the harms of climate change is closing fast.

Finance steps continue to be a central point of discussion at UN climate conferences as funding commitments fall short of what is needed to stave off the worst of climate change. In 2009, wealthy countries committed to mobilizing $100 billion in annual climate finance for low-income countries by 2020; that goal was met in 2022, according to the OECD. 

The New Collective Quantified Goal (NCQG), a critical part of the 2015 Paris Agreement, aims to provide more realistic climate financing ambitions to support developing countries in their climate actions. World leaders will be setting another NCQR for after 2025 at COP29 in Baku, Azerbaijan. Other global efforts, such as the Bridgetown Initiative, propose a plan for richer countries to finance climate action as well as achieve the UN sustainable development goals by mobilizing $500 billion in private capital and $300 billion in MDB lending per year, mostly aimed at climate adaptation. Moreover, the historic loss and damage fund, declared at COP27 in 2022 and operationalized the following year at COP28, created a financial support tool for vulnerable countries experiencing devastating climate effects. The $700 million pledge during COP28, however, represents less than 0.2 percent of the losses developing countries face each year.

Some experts believe that risk-sharing strategies that blend public and private money could make commercial lenders more willing to support climate projects. Other experts are pushing for climate funds, such as the GCF, to increase their grants to developing countries’ national and local institutions, which would allow these countries direct access to funds and local ownership over these projects. Multilateral bank reform is also a large part of this equation. Prime Minister of Barbados Mia Mottley said at a CFR event in September 2024 that “fundamental reform is needed” for MDBs, such as the World Bank, to make the institutions fit to act as “guardians of the global public commons.” 

Meanwhile, regulators around the world have begun to tackle greenwashing in investor markets. The European Union, for example, implemented the Sustainable Finance Disclosure Regulation in March 2023, aiming to enhance transparency of sustainable financial products.