Promotion of green finance

Explanation

The AfDB recognises that climate finance flows in Africa are dominated by non-private actors, particularly compared with other regions globally. Private finance accounts for only 14% of total climate finance in Africa (and is heavily concentrated in the energy sector, at 74%); no other world region has a private sector contribution lower than 35%.[1] This is further compounded by Africa having the lowest leverage ratio globally, at just 0.16, despite having the lowest default rates on infrastructure projects, at just 1.3% (lower even than Western Europe at 4.6% and North America at 6.6%). Moreover, the private sector investment which does occur is typically concentrated in a subset of African countries (such as South Africa, Kenya, Morocco, Egypt, and Nigeria) with already relatively developed financial markets and robust regulatory frameworks, receiving more than half of Africa’s total private finance flows.

Mobilising the necessary resources for climate action will undoubtedly require greater private sector involvement throughout Africa. An estimated total of USD 242.4 billion annually is needed between 2020 and 2030 for the implementation of updated Nationally Determined Contributions (NDCs) across Africa, of which USD 213.4 billion in private finance. With the annual figure only around USD 30 billion as of 2022, continued yearly shortfalls are further compounding annual needs.

Greening the system

In this context, the AfDB is undertaking a variety of initiatives to green the financial system and increase private finance mobilisation in Africa. As part of these efforts, the AfDB is a member of the African Financial Alliance on Climate Change (AFAC), which works to green the financial industry through “knowledge sharing, climate risk-mitigating financial instruments, climate risk disclosure and climate finance flows”. AFAC membership includes public development banks, central banks, commercial banks, ministries of finance, insurance companies, stock exchanges, SMEs, and sovereign wealth and pension funds, seeking to mobilise private capital for climate mitigation and adaptation in Africa.

As part of its work with AFAC, the AfDB has launched the African Green Bank Initiative, to be supported by USD 1.5 billion from the African Green Finance Facility Fund (AG3F). This initiative is intended to de-risk investments in low-carbon and climate-resilient projects in Africa, engendering long-term investor confidence to mobilise private sector finance. It also seeks to strengthen the capacity of local financial institutions in developing a pipeline of robust, bankable green projects. Through technical assistance and co-financing, it aims to develop an “ecosystem of local green finance mechanisms”. Since the launch of the initiative, the AfDB has raised funds to build capacity for green finance facilities in several local financial institutions.

Other AfDB initiatives include conducting training and knowledge sharing with the Organisation of the East African and Southern African Insurers to raise awareness and promote greening the financial system. The Bank is also a governing member of the Making Finance Work for Africa (MWF4A) initiative, intended to coordinate financial sector development interventions across the continent. Further notable examples include providing early-stage financing as part of the Agri-Food SME Catalytic Financing Mechanisms (ACFM) and providing funding to support green mortgage products, such as in Kenya.

Innovative financial instruments

At the institutional level, the AfDB is the first and only MDB to initiate a synthetic securitisation scheme – namely, the innovative “Room2Run”. The scheme works as a guarantee mechanism, freeing up capital (up to as much as USD 2 billion) for increased lending, by external partner(s) (in this case, the UK government) taking on risk exposure from the AfDB’s balance sheet. Room2Run therefore enables the AfDB to increase lending for climate, with the UK only liable in the case of a default that exhausts the first loss cover of the African Trade Insurance Agency. This is notably not the first risk transfer undertaken by the Bank, which has previously exchanged sovereign risk exposure in partnership with the Inter-American Development Bank (IDB) and the International Bank for Reconstruction and Development (IBRD).  

In terms of further balance-sheet optimisation measures, the AfDB has revealed it is working to implement the G20 Capital Adequacy Framework (CAF) recommendations. It has made progress in key areas including: clarifying processes for capital calls, reflecting the value of preferred creditor status in its CAF, and through the aforementioned large-scale risk transfers. There remains room for further progress, particularly in terms of reflecting the value of callable capital in the Bank’s CAF and leverage ratio.

The Bank, alongside the IDB, also led a proposal to rechannel the International Monetary Fund’s (IMF’s) Special Drawing Rights (SDRs) through MDBs, to unlock funds for climate and development. This proposal would entail the issuance of hybrid capital by MDBs, with shareholders using SDRs to acquire these instruments, without compromising their reserve status. MDBs can in turn leverage the SDRs received to mobilise resources at low cost from capital markets, multiplying funds by a factor of three to four. In May 2024, the IMF approved the use of SDRs for the acquisition of hybrid capital, effectively greenlighting this proposal.

At the operation level, there is ample evidence of the AfDB utilising tailor-made financing instruments, such as through its role as a core investor for the Facility for Energy Inclusion, which seeks to address the lack of finance for small, distributed energy to enhance energy access.[2] The Facility functions mainly by providing senior and mezzanine debt financing (in both hard and local currency) to small scale projects (on-grid, mini-grid and off-grid). It thereby seeks to alleviate the high transaction costs faced by small scale projects and increase the flow of capital to the energy sector. Providing financing in local currency helps SMEs to overcome currency risks and technical barriers to borrowing in hard currency, hence improving access to capital.

Another notable example is the AfDB’s “green shares” investment in the Eastern and Southern African Trade and Development Bank (TDB). This transaction involved the AfDB investing in a first-of-its-kind equity instrument that enables institutional investors to support TDB’s climate action with risk capital, with each dollar invested (USD 15 million by the AfDB) to be leveraged up to four times.

Green bonds

The AfDB has had a long-running (since 2013) Green Bond Program which aims to support African countries’ transition to green growth, as outlined in the Bank’s Ten-Year Strategy. The AfDB has committed to issuing at least one green bond per year, though with the caveat of “market conditions permitting”. This programme preceded the Green Bond Principles of the International Capital Market Association (ICMA) and has since been aligned with these principles.

The AfDB’s long-standing Green Bonds Framework required projects to be qualifiable in full as “either promoting low-carbon or climate resilient development” – essentially contributing either to mitigation through “significant” emissions reduction, or to adaptation through reducing vulnerability and strengthening resilience. In assessing eligibility, the Green Bonds Framework primarily relied on the Bank’s methodology for tracking climate change mitigation and adaptation finance.

In 2023, the AfDB issued a new Sustainable Bond Framework which combines and updates the pre-existing green and social bond frameworks. This will allow the Bank to issue three types of bonds going forward: green, social, and sustainability bonds. Green and social bonds each have their own individual (updated) eligibility requirements, while sustainable bond proceeds can be used to finance a portfolio of both green and social projects. For green bonds, eligible project categories include:

1. renewable energy[3]
2. sustainable mobility
3. energy efficiency
4. environmentally sustainable management of living natural resources and land use
5. sustainable water and wastewater management.

All projects are screened for strong environmental and/or social outcomes for selection to the Bank’s “Sustainable Project Portfolio”. Final agreement on eligibility is to be agreed by the Treasury Department and the Bank’s operations teams. As part of this, the Bank’s Energy Environment and Climate Change Department is consulted annually on the shortlist of projects selected for green bond funding.[4]

The AfDB will issue an impact report for projects financed by green, social, and sustainability bonds at least on an annual basis. The sustainable bond framework indicates example impact metrics for each eligible project category, with emissions reductions included across all five green bond project categories. Impact reporting is to be based on ex ante estimates made at the project approval phase, meaning that actual results achieved in a given year or period will not be made available. For indicators such as emissions reductions, monitoring results achieved ex post (as opposed to only relying on ex ante estimations) can serve as valuable confirmation that green and/or sustainable bond funding for a given project has indeed contributed to the forecasted impact in practice. 

As of 2023, the AfDB’s green bond portfolio has committed a total of USD 3.8 billion across 47 eligible green projects across sectors. According to discussions between E3G and the AfDB, the Bank has also supported central banks (e.g., those of Kenya, Gabon and Nigeria) in the past through technical assistance for the issuance of sovereign green bonds.

While the most recent Sustainable Bond Newsletter does not include a breakdown for use of proceeds with respect to climate mitigation versus adaptation – the 2022 Green & Social Bond Newsletter does. Notably, this reveals that green bond funds do not follow the trend of AfDB climate finance going mostly toward climate adaptation, with 77% of funds going to climate mitigation projects. This pattern is mirrored by the sectoral breakdown of green bond funding (as of 2023). Eligible green projects under the Sustainable Bond Framework in two of the three largest recipient sectors (energy and transport) only list climate change mitigation under the “environmental objectives and benefits”.[5] Projects in the water sector make up the second largest sectoral recipient of green bond funding at 25% and include both mitigation and adaptation under the listed environmental objectives and benefits.  

Recommendations: 

• The AfDB should augment the impact reporting of its sustainable bonds framework to also consider ex post results in order to verify real-world outcomes, beyond relying only on ex ante Ex post monitoring can serve as valuable confirmation that green bond funding for a given project has indeed contributed to the forecasted benefits (for which funding was allocated) in practice.
• The AfDB should consider revising its eligibility categories for green bond funding in light of . This could involve incorporating climate adaptation projects as eligible green projects within the existing categories (where not already listed under “environmental objectives and benefits”) and/or creating an additional, dedicated eligibility category for climate change adaptation projects across sectors. The AfDB could also consider issuing dedicated “Climate Adaptation Bonds” (as has been done by peer institutions such as the AIIB) to raise more funds for climate adaptation projects from its bond issuances.
• The AfDB should consider restoring the breakdown for use of proceeds with respect to climate mitigation versus adaptation in future iterations of the Sustainable Bond Newsletter (in line with the previous best practice of the Green & Social Bond Newsletter).

[1] Most notably, regions such as Latin America and the Caribbean (49%), East Asia and the Pacific (39%) and South Asia (37%) all have significantly higher private sector contributions.

[2] See the “Energy access and fuel poverty” metric for further details.

[3] The framework effectively avoids leaving scope for hybrid energy projects by including a ceiling on life-cycle GHG emissions as a condition for eligibility. All eligible projects must also be aligned with the Common Principles for Climate Mitigation Finance Tracking.

[4] Information received directly from the AfDB.

[5] The majority of funding (58%) flows to the energy sector (made up of 32% toward renewables and 26% for energy efficiency projects), with the transport sector being the third largest recipient sector at 16%.