Bad versus Better Ways to Leverage Private Investment in the Global Fight for 1.5 Degrees

As the UN Conference of the Parties met in Glasgow (COP26), the topic of climate finance was one of the most debated issues. Richer and poorer countries alike suggested the need for more climate finance, as well as agreeing stronger targets for adaptation spending. That’s good: we know that responding to the climate crisis in developing countries is going to take a lot of money. Rich countries should provide a lot more of that money than they are, and urgently. Indeed, $100 billion in annual grant financing would still be less than what rich countries owe given their share of greenhouse gas stocks and the potential costs of climate change.

But beyond concerns over whether rich country public finance will materialize at scale, there are equally consequential decisions pending about how best to deploy that support to achieve the even greater scale that is needed, the long-sought (seemingly mythical) “billions to trillions.” While hopes for mobilizing private finance for climate response were boosted by the investment firms managing a collective $130 trillion who signed onto net zero pledges at the COP, actually getting the private trillions to move south remains a huge challenge. And two leading proposals point to the risks of missing the mark, one by misdirecting support and the other by failing to achieve adequate scale.

Two approaches to leverage climate finance

BlackRock, a US-based investment manager with about $10 trillion in assets, has proposed a $100 billion dollar annual grant mechanism to “de-risk” private climate investments—essentially deploying large public subsidies in rich countries to achieve greater private investment in developing countries. Separately, US Treasury Secretary Janet Yellen joined the UK in proposing that a long-standing World Bank trust fund start borrowing money in capital markets to raise $500 million in additional annual concessional climate finance.

The BlackRock proposal is larger both in scale and risk than Yellen’s, but both approaches share a weakness: they are considerably less efficient ways of delivering climate finance to developing countries at scale than our earlier proposal for climate-dedicated capital increases at the multilateral development banks.

Here’s how the BlackRock team lays out the current problem: we need a trillion dollars in external finance each year to finance the green transition in low- and middle-income countries, most of which will come from the private sector; we don’t have time to address the “root causes of country risk” that prevent the finance from flowing; and multilateral development bank efforts to “mobilize” climate finance from the private sector through co-investments in their projects only generates about $1 of private finance for each $1 of multilateral development bank finance. Thus, they say, “the only way, in our view, to mobilize private capital at the scale and speed needed is through… greater public sector exposure to loss,” through approaches like insuring the returns of high-income country investors in low and middle income country climate-related investments. The BlackRock team suggests this requires $100 billion of grant finance from rich countries each year, comparing it to the grant element of existing climate finance of about $17 billion.

But it isn’t true that the only way that money can be used to help fix the climate crisis is on a grant basis passed through to private investors like BlackRock in order to de-risk their investments. Indeed, the proposal from Secretary Yellen points to a different approach, one that “leverages” the private sector mostly through bond markets, while relying on an existing multilateral mechanism (the Climate Investment Funds, or “CIFs”) that mostly supports developing country governments—in essence, borrowing in private capital markets to scale up public climate investments. The fault in Yellen’s proposal isn’t in the design. In fact, this is exactly the sort of approach that should be prioritized. Rather, the CIFs model is deficient primarily in its potential scale. Choosing a trust fund at the World Bank over the World Bank itself (as well as other multilateral development banks, or MDBs) misses the opportunity to achieve significantly greater leverage in the use of grant resources.

As banks, the MDBs leverage their capital by borrowing money from the financial markets in order to lend more money to clients. That is how $18 billion of paid in official capital at the World Bank currently supports an outstanding loan portfolio of $223 billion. That’s a ratio of 1:12 and the Bank has space to lend more. (True, MDBs have their borrowing guaranteed by member governments, but that “callable capital” has never, in fact, been called, nor does it represent a real cost for donor countries). It is on top of that leverage on the liabilities side of their portfolio that MDBs manage to do some leverage on the asset side through co-financing individual projects with the private sector. If the asset-side leverage is about 1:1, the total leverage of official finance through the World Bank is in the region of 1:24 for backend and frontend combined. This 1:24 ratio of capital (which will still be there tomorrow) to development financing looks considerably more attractive than the 1:10 ratio of grants (which are “one and done”) to development financing proposed by BlackRock.  

Advantages to the multilateral banking approach

Beyond the less favorable leverage obtained through the BlackRock proposal, there are several other advantages to the multilateral banking approach.

First, it is better suited to support public sector investments alongside private sector ones which, given the considerable majority of global infrastructure is owned and operated by governments, is a rather important feature. The World Bank reports that 83 percent of total infrastructure investment in developing countries is public, including 79 percent of energy investments are public sector and fully 88 percent of transport investments. And even looking at infrastructure projects with private participation, 55 percent of the financing came from public sources.

Second, MDB finance is more flexible. It can support policy change alongside specific investments, and policy change is a huge part of climate response. The IMF estimates global subsidies and unpriced externalities related to fossil fuels add up to about $5.5 trillion for example. Policy lending can support a shift toward better fuel pricing (and a better environment for private infrastructure investment, if that is a priority).

Third, MDB “backend” financing mobilizes private resources at scale in competitive, transparent bond markets that ensure the largest, cheapest amount of private finance is leveraged for each public dollar. Sadly, that’s considerably better than the performance to date we’ve seen on “front end” subsidies and guarantees to the private sector to back infrastructure investments, including by MDBs themselves, where non-competitive approaches alongside bespoke and secretive deals abound. Backend financing also provides the scale and transparency that the global financial firms looking for green investment opportunities are seeking.

Fourth, The MDB leverage model is proven. BlackRock doesn’t provide much in the way of evidence that each $1 in grants under its model will unlock $10 of climate-friendly investments in low- and middle-income countries. On the other hand, MDBs have been raising capital in international bond markets for decades. We know they can deliver. Furthermore, the banks already exist, and have fifty-plus years of institutional capital in some cases. As BlackRock notes, we need more climate finance urgently. This is surely the wrong moment to be trying to create massive new grantmaking operations in development finance institutions and elsewhere to funnel $100 billion of public resources to the private sector in low- and middle-income countries (especially given the considerable challenges that existing development institutions designed to channel subsidized public resources to private sector projects appear to be facing).

A climate finance solution effective at scale

While the BlackRock team should go back the drawing board, Secretary Yellen should get a bigger drafting table. Rather than raising a few hundred million from leveraging a trust fund, the US and its partners should propose raising hundreds of billions from leveraging capital increases at the World Bank and the regional development banks. As we have outlined, a climate dedicated capital increase at the MDBs could support lending on projects and policy shifts that will measurably reduce greenhouse gas emissions and improve climate resilience, providing financial resources to developing countries at considerably lower rates than they could access in the capital markets. The capital increase would help provide new purpose to the MDB system in middle income countries, as well as being transparently new and additional support for mitigation and adaptation. It could be the cornerstone of more ambitious climate financing arrangements to be discussed at next year’s conference of the parties.