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Climate adaptation: Funds work to address financing obstacles

Investment firms are working to deliver finance for climate adaptation and resilience by overcoming challenges such as the lack of common impact metrics, perceived lower returns and highly localised projects.

By Virginia Furness

Pakistan’s record floods this year illustrate that adapting to climate change will be a lot more difficult for some than others. (Photo by Graphic_Plus/Shutterstock)
  • Capital committed to climate adaptation and resilience makes up a small fraction of climate finance.
  • Issues such as tracking adaptation finance and measuring its efficacy and impact are holding up development...
  • … but firms such as Bamboo Capital Partners, Climate Investment Funds and Lightsmith Group are working on new approaches to address the challenges.

The lion’s share of climate finance flows into change mitigation – projects or solutions to prevent or reduce greenhouse gas emissions – with a far smaller pool of capital going towards funding for environmental adaptation and resilience.

Yet it seems inevitable that many communities will need help living with environmental change, as hopes fade that the world will achieve a 1.5C-or-below warming trajectory. Witness the catastrophic consequences of climate change such as the recent floods in Pakistan or the record-breaking drought in China.

Some $46bn of adaptation finance was delivered in 2019-2020, according to think tank the Climate Policy Initiative (CPI), up 53% from $30bn in 2017-2018. Yet the amount is still a small fraction of the $155bn-330bn needed annually for adaptation in developing countries, as estimated by the UN Environment Programme’s Adaptation Gap Report 2021, published in November last year (see also chart below).

There are certainly those – such as Stuart Kirk, the former head of responsible investment at HSBC Global Asset Management – who argue that more should be spent on climate adaptation than mitigation.

Finance challenges to climate adaptation

However, specialists cite several reasons why delivering adaptation finance is a major challenge, including tracking the efficacy of adaptation finance, a lack of common impact metrics, returns often below commercial rates and an absence of comprehensive national adaptation plans.

In addition, rising interest rates and broader market concerns may act as further barriers to private investment in adaptation finance, said Florian Kemmerich, managing partner at Bamboo Capital Partners, which focuses on such projects. He was speaking on a panel at Capital Monitor’s annual Making Sense of Net Zero event earlier this month.

Nonetheless, solutions aimed at delivering private-sector investment are emerging, say industry practitioners looking to engage the private sector and mobilise more investment for adaptation projects. Kemmerich and two other specialists discussed the topic during the same panel.

“We’re making good progress, but good progress is not enough,” says Lorie Rufo, senior climate change specialist at Climate Investment Funds (CIF), a multilateral climate finance mechanism for developing countries, based in Washington DC. “We know the challenge of adaptation finance is enormous.”

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A large part of this challenge, Rufo says, is that the most affected are the most vulnerable developing communities and countries, many of which are grappling with multiple crises, from the Covid-19 pandemic to food security issues following Russia’s invasion of Ukraine.

Research by the CPI indicates that 98% of adaptation finance in 2019-2020 was provided by public organisations.

Attracting private-sector capital

“We cannot rely on domestic resources or donor contribution to invest in climate change,” says Rufo. “We also need to engage the business community to explore how to make the challenges brought by climate change into an opportunity to create business and livelihood options.”

She runs the CIF’s Pilot Program for Climate Resilience (PPCR), a $1.2bn fund set up in 2008 to work with governments to develop wide-reaching climate adaptation programmes rather than just one-off projects and then help finance them with loans at interest rates below 1%.

The fund is backed by multilateral development banks and has invested $974m across 58 projects globally, supporting 2.8 million beneficiaries in 28 countries such as Bangladesh, the Kyrgyz Republic, Mozambique and Zambia. It mobilises $2.4 of additional capital for every $1 it deploys, says CIF.

The fund also works to engage the private sector, whether in the form of local businesses or international investors, by supporting the creation of bankable projects that offer a return on investment.

“We attract them to come and engage in adaptation and resilience building and there are a lot of success stories about how we can do it,” says Rufo. “It’s not just the private sector doing their thing, but it’s collaborating with the community, understanding the data and making available technical assistance and resources, as some in the private sector may need that to take on the risk.”

CIF’s private-sector engagement sits under its Private Sector Set Asides (PSSAs) programme, which provides concessional financing on a competitive basis to projects that engage the private sector in sustainable forestry, climate resilience and energy access through renewables. Under this programme, CIF has allocated $106m to support 13 projects, ranging from climate-smart hydropower in Tajikistan to water-efficient housing in Jamaica.

Another institution working to help mobilise private-sector capital is the CPI, which, among other focus areas, aims to increase the amount and effectiveness of finance addressing climate adaptation.

CPI is the secretariat of the Global Innovation Lab for Climate Finance, an incubator for climate finance instruments across mitigation and adaptation. The Lab has worked on 55 instruments, of which about 20 focus on adaptation.

One project CPI has supported is the launch of what it says is the world’s first private equity fund focused on climate adaptation and resilience by New York-based Lightsmith Group, a private equity firm focused on sustainable investments.

Closed in January the $186m Lightsmith Climate Resilience fund invests in growth-stage technology companies that address the effects of climate change in areas such as resilient food systems and catastrophe risk modelling. Investors include the European Investment Bank, US-based PNC Insurance and the Rockefeller Foundation.

Targeting economic returns

The fact that Lightsmith Group has raised a substantial sum from private finance is “a great signifier of the opportunity to have private investment in adaptation”, says CPI senior analyst Morgan Richmond.

The fund aims to deliver a gross internal rate of return of 20-25%, she tells Capital Monitor. It has already invested in three growth-stage firms: US-based water tech company Source Global; India’s WayCool Foods, an agriculture and food supply chain tech and services provider; and Solinftec, a Brazilian precision agriculture company.

The fund will report its impact through a proprietary system that will measure impact against a range of indicators such as climate adaptation, climate mitigation co-benefits, gender, biodiversity and economic development. It will also use Iris, a tool developed by the Global Impact Investing Network, to help measure and monitor impact.

Other projects endorsed by CPI include a $100m revolving loan facility proposed in 2022 to help shrimp farmers in South East Asia adopt controlled intensification and other responsible aquaculture practices, and climate insurance-linked resilient infrastructure financing, a long-term insurance solution.

Bamboo Capital, meanwhile, looks for growth opportunities in micro, small and medium-sized enterprises (MSMEs) that aim to help local populations deal with climate change.

Small ticket issues

But the small scale and localised nature of the investments make it hard to attract capital, particularly that purported to be ESG-aligned, Kemmerich says. “Mitigation is of course much larger-scale and is very often infrastructure, [but] we’re focused on MSMEs in emerging markets and therefore we look at smaller tickets, smaller companies and risky geographies.”

It is difficult to talk about pure-play short-term financial returns when it comes to these sorts of investments, Kemmerich adds. “From a business perspective, it is exciting to tap into huge underserved markets and long-term sustainable growth,” he says, but the initial capital will come from concessional sources with a 'question mark” over the involvement of mainstream financial investment.

To address this issue, Bamboo has launched and manages several blended finance impact funds to invest in small-scale on-the-ground MSMEs and has plans to aggregate those into an investible opportunity for institutional capital bond-like instruments. This way the financing will trickle down to smaller ticket sizes on the ground, Kemmerich says.

Adaptation finance is set to be a major focus at this year’s Cop27 climate summit – but the challenge of translating capital commitments into bankable and effective investment remains acute.

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