What is climate finance?
What counts as climate finance?
‘Climate finance’ is a multifaceted concept. It generally refers to finance for activities aiming to mitigate or adapt to the impacts of climate change. However, it is sometimes conflated with the related and overlapping concepts of green finance, sustainable finance, and low-carbon finance.
Although there is no single definition of climate finance, the United Nations Framework Convention on Climate Change (UNFCCC) Standing Committee on Finance provides the closest thing to an official version:
“Climate finance aims at reducing emissions and enhancing sinks of greenhouse gases and aims at reducing vulnerability of, and maintaining and increasing the resilience of, human and ecological systems to negative climate change impacts.”
This definition of climate finance represents the flow of funds to all activities, programmes or projects intended to help address climate change: for both mitigation and adaptation, in all economic sectors, anywhere in the world.
Importantly, this definition only includes finance flowing directly to assets and activities and leaves out financial market activity, such as bank loans to companies or investments in private and public equity. This is to adhere to the core principle of avoiding ‘double counting’. (For example, counting both a loan from a bank to an energy utility as well as the investments in renewable energy generation made by the recipient company, using the proceeds from the loan, would mean counting finance for the same activity twice.)
The term ‘climate finance’ is also frequently associated with international diplomacy on climate change. In this context, climate finance implies “new and additional financial resources” provided by developed countries to developing countries so that they can meet the full and incremental costs of climate change and decarbonisation. Following countries’ initial commitment in 2009 (see below), the obligation to provide financial support was enshrined in Article 9 of the Paris Agreement.
In 2022, ahead of the COP27 UN climate conference, the Standing Committee on Finance reviewed definitions relating to climate finance. However, differences between developed and developing countries on this issue held back an agreement being reached on documentation and methodologies for the collective financial goal.
A related and much broader concept is ‘consistency’ or ‘alignment’ of financial flows with global climate goals. The Paris Agreement’s Article 2.1c requires Parties to the UNFCCC to “make finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”. ‘Consistency’ is not clearly defined under the UNFCCC, but ‘financial flows’ in this context are generally understood to include finance for real activities on the ground and activity in financial markets – prompting a wide range of initiatives, both public and private, in the financial sector.
How much climate finance has been provided globally?
A comprehensive assessment of climate finance is undertaken by the UNFCCC Standing Committee every two years, in its Biennial Assessment. The fifth of these, published in October 2022, found that global climate finance flows were US$803 billion per year on average in 2019–2020, a 12% increase from 2017–2018.
The scale of climate-related financial flows is still relatively small compared with other types of flow in the context of the wider financial system. For instance, in 2019 and 2020, an average of US$892 billion per year was invested in fossil fuels, global fossil fuel subsidies were worth US$450 billion, and environmentally harmful subsidies stood at US$1.89 trillion. Spending on the COVID-19 pandemic recovery came to US$2.49 trillion in 2020, of which $513 billion (one-fifth) was considered ‘green’.
The sectors that received the most finance in 2019–2020 were renewable energy (US$336 billion per year on average) and sustainable transport (US$169 billion). By contrast, tracked flows to agriculture, forestry and other land use were only US$16.5 billion, representing less than 2.5% of total climate finance.
Challenges in measuring climate finance
Data on climate finance flows are compiled using various methodologies and have varying interpretations, but the aim of bringing different sources together is to form a clearer picture of how much investment is taking place worldwide.
The landscape of climate finance can be considered from several dimensions, including:
- The source of finance – whether public, private or mixed, and whether from national governments, subnational governments, development banks, corporations, financial institutions, multilateral funds or another type of institution
- The type of finance, or instrument used to provide it (e.g. development aid, equity or debt), and whether it comes at market rates or is in some way concessional (lower cost)
- Where finance flows from and to (whether domestic flows within national borders, or international flows from one country to another [‘bilateral’] or from many countries [‘multilateral’] to another)
- The sector and purpose of the activity or asset that receives finance (including whether actions are directly or indirectly related to mitigation, adaptation or compensation for damages)
- Whether finance is incremental – that is, over and above what would have been provided anyway (“new and additional”).
The principal sources used by the UNFCCC for its Biennial Assessments are Climate Policy Initiative’s Global Landscape of Climate Finance and the International Energy Agency’s work tracking investments in zero- and low-emissions vehicles. Much of the finance tracked by these initiatives represents commitments – that is, an agreement to provide finance – rather than money delivered to the activities in question. This is due to the methodologies used to collect information from many of the major providers, including governments’ official development aid and lending by development banks.
Significant further work is required to understand the impact that climate finance achieves on the ground, in terms of its tangible benefits for climate change mitigation, adaptation and sustainable development. Measuring financial value does not consider the differing costs for climate change solutions in different regions or countries, and provides no information about the effectiveness of flows, such as resulting emissions reductions, increased resilience or the number of good quality jobs created.
How much climate finance is needed?
Many assessments of the quantity of finance needed to deliver on climate goals have been carried out – both at the global level (for instance, by the OECD, McKinsey, Vivid Economics, IRENA, IEA, SYSTEMIQ, Deutz et al.) and specifically for low-and middle-income countries (see, for example, IEA or Markandya and González-Equino). While the estimates vary substantially across studies, reflecting differences in scope and methodologies, they highlight five key areas where climate finance will be needed:
- Transforming the energy system
- Building adaptation and resilience
- Coping with loss and damage
- Restoring and protecting natural capital
- Methane abatement.
A 2021 review by the UNFCCC indicates that the finance needs expressed by developing countries in their Nationally Determined Contributions (NDCs) cumulatively amount to around $600 billion per year up until 2030. However, a lack of available data, tools and capacity for determining and costing such needs in several countries imply that these figures are likely an underestimate. A recent report from the Independent High-Level Expert Group on Climate Finance points to higher figures, concluding that to tackle climate change and drive development, emerging markets and developing economies (EMDEs) other than China will need to invest around $1 trillion per year by 2025, and around $US2.4 trillion per year from 2030.
What is the ‘$100 billion’ goal?
While climate finance has been a central element of the global climate change negotiations in one form or another since 1992, it is most often associated with the target of mobilising US$100 billion a year from developed countries for developing countries by 2020. This target was first agreed in the 2009 Copenhagen Accord and expanded upon in the Cancun Agreements in 2010, which established the Green Climate Fund (GCF) to act as a key delivery mechanism. In 2015, the Paris Agreement further reinforced this target, and extended it to 2025. It was not met in 2020, prompting developed countries at COP26 to outline a Delivery Plan for reaching the target.
The US$100 billion goal was determined by political negotiations, and only partly based on scientific evidence of the needs of developing countries, which are in fact much larger.
What is next for global climate finance: the New Collective Quantified Goal
Negotiations are now focused on raising ambition for a new goal after 2025: the ‘New Collective Quantified Goal (NCQG)’. This goal will be ‘collective’ as it will lay out joint efforts from both developing and developed countries to mobilise and deliver the funds, and ‘quantified’ as it will be determined by science-based assessments of the needs and priorities of developing countries. Deliberations kicked off at COP26, during which Parties to the UNFCCC set up a work programme to conduct technical expert dialogues, annual reports and regular consultations with Party and non-Party stakeholders on the NCQG. The aim is to set up this new goal by COP29 in 2024.
This Explainer was updated by Éléonore Soubeyran and Rob Macquarie.