by Konstantinos Kotoulas
Below are examples of financing mechanisms that either include climate adaptation or can be used to form new independent solutions. These examples constitute innovative ideas that are currently at an exploratory phase and have not yet been verified as being able to become mainstream. The underlying aim is to unlock pools of funding and direct them to projects in developing economies.
There is no “one model fits all” solution, therefore each of the ideas presented will have to be further refined to reflect country- specific considerations and project-specific elements depending on its nature, size, and type of climate risks. The suggestions serve to form a basis for further discussion and elaboration on the viability, constraints, and applicability of each option. It is expected that, as
climate adaptation gains ground in the international socioeconomic and political agenda, so will the requirements and incentives for such characteristics in public infrastructure with financing availability being the main catalyst.
Climate Adaptation Bond (CAB) by MDBs/NDBs
Like the green bonds, issuance of CABs by MDBs or NDBs (perhaps even in local currencies) could contribute to either supporting projects that incorporate climate adaptation or funding a project’s specific climate adaptation mechanism. The latter case may be an instrument that is insured against backdrops or failures of the adaptation infrastructure to protect against the identified climate risks, either through additional insurance by the respective agency or by cover in the financing documentation (similar to ECA covers) whereby the project company does not default in case of inability to repay loans due to climate-related disruptions. Given the increasing interest by the investor community for green bonds or otherenvironmentally related bonds, the likelihood is that interest for such instruments, initially for ones by the MDBs and gradually for ones by NDBs, will also be developed alongside the growing importance of and focus on climate adaptation.
Project CAB (PCAB)
Essentially project-specific bonds that carry a CAB certification. Like CABs above, the PCAB can be raised either as additional financing to the project with adaptation mechanisms alongside the other financing tranches or as a finance pool specifically funding the cost of adaptation. In this case, several considerations will have to be addressed, such as the credit rating of such bonds and their coordination with other lenders and currencies. However, provided there is appropriate support in the form of cover, it could enhance available liquidity. One example of support could be that the MDB would insure the bond against the project company failing to repay the bondholders because of the inability of infrastructure to protect against preidentified climate risks. This would also improve the project’s credit rating, although EMDE countries’ credit ratings may limit such improvements.
Let’s assume a public authority aims to raise private bank financing to finance the cost of climate adaptation assets such as a wall against rising sea level, anti-flooding measures, or required materials against extreme temperatures. Such tranches of financing, within an infrastructure project, could benefit from some form of credit support, depending on the country’s credit quality and the project, as well as the level of existing private financing activity in the country. Such credit support may include: (i) guarantees in case of inability by the project company to repay the loan, (ii) seniority of such tranches in the cash waterfall, (iii) security over the project’s assets, (iv) restrictive covenants until such loan is repaid, or a combination of the above. Especially if supporting climate mitigation goes alongside receiving some form of certification (a “scout” badge), such financing by commercial lenders will likely be strategically aligned with the growing importance of the climate-related objectives and agenda.
Introduce a levy on the businesses that benefit from the project to cover the cost of adaptation. This may have political implications and may be unrealistic to suggest in developing economies. Therefore, only businesses that can sustain such a levy should be considered in any case. Such levies have widely been used in developed economies, generally without political controversy, given that the benefits for thebusiness far outweigh the cost of protection and, most importantly, the cost of business disruption.
Indirectly finance the extra cost of adaptation through specific tax incentives (e.g., tax breaks equivalent to the amount spent on climate adaptation) given to the project company, whether at the company or the holding level or even in capital repatriation. The project company will then be responsible for covering the cost of adaptation measures within their existing budget and proposal, assuming that the adaptation measures are sufficient and to the required standards, limiting the likelihood of climate-related disruptions, and consequently the impact on such risk allocation.
Climate Adaptation Credits
Incorporate climate adaptation in guidelines or policies, whereby a sponsor that develops projects with climate adaptation is eligible for climate adaptation credits—attributed a value—thereby incentivizing the private sector to participate in and complete such projects regardless of location. To the extent that such credits can be quantified and have a commercial value, they can fund part of the project’s capital costs.