February 21, 2023

The World Bank ready to scale-up its climate financing

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At A Glance

Rightly or wrongly, media coverage following the end of COP27 has focused primarily on its unambitious outcomes. However, one aspect of COP27 that may not have received enough attention is the interview that Axel Van Trotsenburg (Managing Director of Operations of the World Bank) gave to Reuters, where he explained that the World Bank is ready to make a "decisive contribution" to scaling-up climate finance, but it needs "fresh funds" to do so.

What is climate finance?

Climate finance is financing provided at a local, national or transnational level, the proceeds of which are to be applied towards helping cut greenhouse gas ("GHG") emissions and/or adapting to climate change. Multilateral Development Banks ("MDBs") such as the World Bank are a vital source of funds for climate financing. In addition, they are critical in driving capital flows to developing countries, since they can provide technical assistance to help develop projects, as well as improving governments' institutional capacity.

How does the World Bank currently provide climate finance?

The World Bank group provided $31.7 billion in climate finance in 2022, its highest annual total to date. This financing was primarily sourced from World Bank issued Sustainable Development Bonds and Green Bonds, which are debt securities for which a percentage of the bond proceeds are put to 'sustainable' or 'green' initiatives.

It's important to acknowledge that the World Bank's methods of providing climate finance are often criticised, mainly in relation to:

(1) A lack of transparency: Oxfam's Unaccountable Accounting 2022 Report claimed that up to 40% of the World Bank's reported $17.2 billion of 2020 climate financing cannot be independently verified. Oxfam's report partially attributes this to the fact that while many of the financed projects have a climate-related component, their main objective is not to address climate change; and

(2) A focus on offering debt instruments: Many countries most in need of climate finance already face heavy debt burdens. According to the World Bank's International Debt Report 2022, around 60% of the poorest countries are in, or at a high risk of, debt distress. There is therefore a substantial risk, that if these countries partake in climate finance funded projects, they would need to divert capital from socio-environmental programmes in order to service such climate finance debt.

Such shortcomings have sparked calls for reform, including from the US Treasury Secretary, Janet Yellen, who recently called on the World Bank to "evolve" the way it provides climate finance.

A move towards 'blended finance'

Noting the above criticism, the World Bank may well find it appropriate to adopt a different approach to how it funds its "decisive contribution". One approach may be to increase the effective use of blended financing structures currently employed by the World Bank that amalgamate public capital from concessional sources with private capital. The advantage of such a structure is that the public capital would help to hedge against the 'conventional' risks of investing in emerging markets (such as currency and inflation risk), thereby making the investment more attractive to private investors. This may then lead to the introduction of new market participants. More generally, the World Bank could more effectively use several instruments that it currently employs to enhance its blended finance structures, including through the continued use of:

Debt instruments: One way to encourage joint public and private sector participation in emerging market climate finance projects may be for the World Bank to more regularly adopt junior rather than senior lender position, thereby absorbing additional risk;

Equity instruments: The World Bank already employs equity instruments through the likes of the Green Climate Fund, however it may wish to consider further prioritising flows of capital from its own equity funds whilst also continuing to participate in third party equity funds;

Grants: The World Bank (and other MDBs) do offer grants, however, according to Stern's 2022 Report, such grants fall short of the equivalent offered by multilateral climate funds and bilateral aid agencies. In light of the debt stress that many developing countries are under, the World Bank may consider increasing the amount of grant funding it provides;

Guarantees: As the OECD suggests in the Role of Guarantees in Blended Finance 2021 Report, guarantees can be more effective than debt or equity instruments in mobilising private capital, so perhaps the World Bank may consider increasing the number of guarantees that it offers; and/or

Technical assistance: Whatever finance structure is adopted, it can be supplemented by the provision of technical assistance from the World Bank, including grant-like resources that are used for project preparation.

Regardless of the exact approach the World Bank adopts in making its "decisive contribution" to additional climate financing, more proactive measures from the World Bank may help to drive capital flows to emerging markets jurisdictions that can be applied towards cutting GHG emissions and/or adapting to climate change.

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