How to finance the adaptation gap

The world is not currently on track to achieve the Paris agreement’s goals. Emissions are continuing to rise, future emissions are forecast to be higher than the carbon budget consistent with limiting climate change to 1.5 degrees Celsius and fossil fuel production is expected to further increase given current policies.

Global warming increases the severity and frequency of tropical storms, reduces agricultural productivity especially in the tropics, increases the incidence, morbidity and mortality of many infectious diseases and, by raising sea levels, threatens the existence of low-lying countries such as Kiribati. According to the World Bank, global warming may also push an additional 132m people into poverty.

Significant investment is required to adapt to climate change. This investment is needed in a wide range of areas including infrastructure resilience projects such as seawalls, climate-smart agricultural programmes, such as developing drought-resistant crops, and ecosystem restoration, such as restoring wetlands.

There is a significant finance adaptation gap. Adaptation investment stood at just $63bn in 2021-22, which is far below the $212bn needed per annum by 2030 for adaptation investment in developing countries alone. This investment is dominated by the public sector, with private sector financing making up just 2% of tracked adaptation investment. Going forward, increased private sector financing will be needed to assist countries, businesses and communities adapt to climate change.

The limited private investment in tracked adaptation financing was reflected in interviews with pension funds and sovereign funds as part of OMFIF’s Transition Finance Working Group. None of these funds had set explicit targets for investment in adaptation, nor did they have adaptation investment strategies in place. In addition, only one fund explicitly mentioned that it had a plan to focus more on adaptation financing.

Five steps for global funds

Going forward, pension and sovereign funds could consider five steps to ratchet up their adaptation financing.

First, funds should consider how they will define, measure and report investment in adaptation. This may involve actively engaging with existing initiatives such as the Adaptation and Resilience Investors Collaborative, which has published a report providing a clear, consistent and robust framework for measuring the impact of investments on adaptation and resilience. It may also involve funds integrating this framework into their internal and external reporting processes.

Second, funds should consider setting explicit targets for investment in adaptation. This would mirror the approach taken by some sovereign funds and pension funds that have set explicit targets for mitigation financing.

Third, funds may wish to actively engage with the companies that they are invested in to ensure that they are well-placed to take advantage of increased demand for adaptation solutions. For example, have agricultural products companies fully considered future demand for drought-resistant crops? Are construction companies well placed to profit from future demand for seawalls and other flood defences?

Fourth, given that some climate change adaptation investments may have broad societal benefits but limited financial returns, pension funds and sovereign funds may need to work with concessional financiers and governments to ensure that adaption investments offer the risk-adjusted returns necessary to attract private capital. A key reform in this area may be further developing risk-tolerant structures whereby concessional financiers assume initial losses when co-investing with pension funds and sovereign funds.

Fifth, given that there is an urgent need for adaptation investment in small island developing states, which have small populations and economies, many projects may be too small to attract larger sovereign funds and pension funds, and financial mechanisms may need to be developed to pool investments across numerous jurisdictions.

In conclusion, there is an urgent need for increased investment in adaptation. Going forward sovereign funds and pension funds could undertake further work to define, measure and report adaptation investments, set explicit targets for investment in adaptation and increase blended and pooled financing of adaptation.

Daniel Wilde is an Economic Adviser, Commonwealth Secretariat.

This article featured in the Transition Finance Working Group’s first report, ‘Global public funds and transition finance’. Listen to the working group members discuss the key findings of the report.