Climate adaptation investment: funding gap, risk and opportunity
04 Apr 2022
An ‘atlas of human suffering’ is how the UN Secretary General described the latest Intergovernmental Panel on Climate Change (IPCC) climate change assessment report, released in February 2022.
The report noted that everywhere will be affected, that about half the global population live in areas which are “highly vulnerable” to climate change and that millions of people face the prospect of food and water shortages as a direct consequence of climate change, even at current expected levels of heating.
There are parallels between the Ukraine situation and climate change. The reliance of the West on Russian fossil fuels has been revealed and the West is now trying to untangle itself from this dependency. Other implications for the global economy come from the effect on supply chains for particular commodities (e.g., oil, nickel, wheat), highlighting the interconnected nature of global systems and the need to adapt to change.
Climate change is considered the biggest threat to global peace by the UN. The pressure on resources such as water in communities and economies that are already fragile and less able to cope, such as in the Egypt-Ethiopia Nile water dispute, illustrates this. Indeed, the Dafur conflict in 2003 is commonly described as the ‘first climate war’. Whilst these examples were relatively localised with little effect on global economies, we can see situations compounding, the interaction of multiple climate impacts creating risks across sectors and regions.
The focus so far of governments and investors has been on the mitigation of climate risk, i.e., reducing emissions, which is clearly essential. However, both developed and developing regions are already experiencing the physical effects of climate change: biodiversity loss, flooding (Germany, China), wildfires (Australia, US), drought and mass crop failure (Africa, South America); this list is long. The cost of this is already part of our global supply chains and businesses, and so presents a major investment risk.
Climate adaptation is the other side of the coin to mitigation, aiming to help people, places, economies adapt and live in a world that is changed by the climate. There are a wide range of activities that constitute ‘adaptation’. Five target areas identified by the World Bank are: early warning systems, climate-resilient infrastructure, improved dryland agriculture crop production, global mangrove protection, and projects to make water resources more resilient.
According to a World Bank report, the cost of climate adaptation could be up to $300 bn a year by 2030 in developing countries. With only $30-50bn p.a. currently being invested in global adaptation, and around 2% of that coming from the private sector, there is a huge financing gap. This is exacerbated by the fact that most private sector investment in adaptation has been in high income countries, where investment is least needed.
The World Bank’s report sets out three main barriers to attracting the volume of private finance needed as being:
- A lack of country-level climate risk and vulnerability data to guide investment decision-making;
- Limited clarity on the government’s capital investment gaps to achieve adaptation goals, and/or on where private investment is needed; and
- Low perceived or actual returns on investment. These barriers need to be overcome as delaying action will only increase the costs.
The IPCC report is clear that the economics of adaptation are sound. Delivering long term sustainable futures for people, planet and economies requires investors to recognise the risks already present and focus more on investing in companies that are funding adaptation, particularly in regions that need to adapt the most. Tackling these barriers and harnessing the private sector is a priority for the World Bank and the potential investment opportunity could grow quickly.
One solution is blended finance, where public or philanthropic capital can be used to redesign an investment to make it more attractive to institutional investors. For example, a developing country’s credit rating may be CCC – perhaps too high risk for an institutional investor. Blended finance can mix the public funding to create risk and return profile that works for institutional investors, and we are encouraged that the Net Zero Asset Owners Alliance recently started a project to look at the scaling up of blended finance solutions.
There are two areas where institutional investors can take action on climate adaptation today:
- Engagement with asset managers on adaptation in portfolios. What engagement and support are they providing companies to transition to more sustainable practices that support adaptation, particularly in the developing economies where supply chains may be based and those regions and communities that are most vulnerable?
- Exploring solutions with impact and determining the opportunities that currently exist to create real change along with the right risk-return profile. Nature based solutions are one. There is growing demand for private sector finance and an enormous need from businesses to help identify and adapt their models to be sustainable, no one is immune to the effects of climate change.
Financing adaptation is key to a ‘just’ transition. Seeking to create real world change alongside the appropriate level of risk and return should be core to any net zero investment strategy.
If you would like to explore how climate opportunities may be factored into your investment arrangements, please contact us, or your usual Hymans Robertson's consultant.