Reports

Designing smart green finance incentive schemes

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The disbursed and fragmented nature of international climate finance risks undermining efforts for scaled up and transformational change, warns a new report from E3G on designing smart green financial incentive schemes.

The international financial ecosystem for climate or “green” finance has been rapidly evolving in recent years. Development Finance Institutions (DFIs), a term which includes Multilateral Development Banks (MDBs), Bilateral Development Banks (BDBs) and National Development Banks (NDBs), are key players in the effort to support green projects in developing countries – distributing roughly US $121bn in resources in 2012 alone. These institutions offer a range of de-risking products on favorable terms that are designed to share risks with private sector investors. The establishment of the Green Climate Fund (GCF), which once operational is envisaged to become the primary vehicle for distributing climate finance to developing countries, will be an important development in this area.

There is a wide range of approaches amongst DFIs regarding the design and measurement and evaluation (M&E) of green incentives. Some DFIs only provide grants or loans, while others offer a range of financing options including concessional loans, equity, guarantees and other insurance products. While many DFIs have processes underway to measure the effectiveness of their efforts, to date there has been a lack of coordination between the major providers of green incentives which has led to a fragmented ecosystem. This fragmentation places unnecessary additional burdens on national governments and also limits potential for creating strong domestic green markets, thereby undermining the potential for a strong global green market that is necessary for the transition to a low carbon economy. E3G has identified several criteria that can help ensure ‘smart’ incentive schemes that are working towards this objective, including:

  • understanding and integration into the unique policy context and political environment in the target country;
  • importance of considering policy and institutional additionality alongside financial additionality;
  • targeting instruments to address specific barriers or risks; and
  • providing transparency and predictability of the incentive provided.

There is an urgent need for a more coherent global framework for green finance. The GCF could foster this by ensuring it has a complementary and catalytic role in mobilizing resources from both the public and private sector. This will not happen overnight, however, and so in the interim DFIs, in coordination with local Governments, should strengthen collaboration. This could take the form of an International Green Finance Protocol (i.e. a diplomatic code of conduct) that would promote convergence towards criteria and norms for the design of smart green incentives, prioritizing innovation and coherency in M&E of green finance. Any such work will need to be closely aligned with the evolution of the Green Climate Fund.

The reports notes that while DFIs have a key role to play, the process of designing green incentive schemes should be led by developing countries. Developing countries can use and attract climate finance more strategically, for example by directing international DFI activities through national financing strategies and programmes for green or climate investment. This would ensure international support is channeled most effectively in support of national objectives.

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