How to Blend It? Mixing Public and Private Finance to Implement the Paris Agreement

We saw the year 2015 close with a cheer as nearly 200 countries adopted the landmark Paris Agreement during the COP21 climate negotiations. The agreement sets a goal to limit global warming to well below 2 degrees Celsius, ties countries to continuous ambition and reporting, and sets the foundations for a new market mechanism under the United Nations to increase overall action on climate change. It also brings the spotlight back on financing climate mitigation action.

Now in the New Year, after the stardust has settled, we find ourselves back in the real economy, and wonder how we can mobilize the trillions of investments needed to implement the Paris Agreement and keep to the ambitious limit for global warming.

The snapshot of the current the state of play for investment thankfully shows that we do not have to start from scratch: In 2014, public and private entities already invested close to USD 400 billion in low-carbon and climate-resilient activities, particularly solar PV (USD 134 billion) and onshore wind (USD 66 billion). Just last year, asset managers pledged to de-carbonize at least USD 600 billion worth of assets under management.

Nonetheless there is work to be done. We have to at least triple overall low-carbon investments to meet the financing needs for limiting global warming to well below 2 degrees, and we still rely on having more than one-third of this investment come from public sources that are scarce by definition. According to the International Energy Agency, investments in renewable energy plants (geothermal, wind and solar PV), public transport infrastructure and green buildings will need to drastically increase if we want to meet our climate targets.

Looking at the big picture, the natural next step is to delve deeper into the realm of blended finance: we need to patch up the shortage of public resources with private sector capital - be it at the project or the fund level. Blended finance can in other words be seen as the combination of commercial (or quasi-commercial) finance with concessional finance.

Ultimately, blended finance is nothing new. Multilateral development banks have been blending concessionary public finance with commercial sources for a long time, and continue to do so. For instance, IFC, the private-sector arm of the World Bank, has blended sources of finance to invest in Mexican wind power, concentrated solar power in South Africa and to channel funds through local commercial banks to enhance energy efficiency in Turkey. National governments have set up new investment vehicles to crowd-in private capital alongside public resources. A highly successful example is the EU Global Energy Efficiency and Renewable Energy Fund (GEEREF) that provides public anchor funds for private equity funds to finance a plethora of renewable energy projects - from small hydro to geothermal, solar, and biomass - alongside other energy efficiency initiatives. The de-risking effect of GEEREF's public anchor investments has an incredible impact: for every USD of GEEREF capital, around 47 dollars of private finance are invested in projects.

It is not a question of to blend or not to blend, but rather how to blend. Should we do more of the same? The answer is no, simply in view of needing new investors, better information, clearer development outcomes and more advanced technology to reach our climate goals.

First of all, so-called "traditional" blended finance does not target all types of investors, and it has particularly left out the direct involvement of institutional investors in low-carbon infrastructure finance. New initiatives, such as the German Global Climate Partnership Fund or the Dutch-led Climate Investor One de-risk climate-friendly assets, giving pension funds the means to start investing at the climate fund level.

Secondly, investors need better information to invest in climate-friendly public assets. Development banks have been pioneers in issuing green bonds to signal to investors that proceeds of bond issuance are used for environmentally sound projects. This allows them to blend concessional public climate finance with private commercial capital from new sources. Under the Low Carbon City Lab, South Pole Group is together with partners developing solutions for cities in Latin America and Asia to issue green bonds as a way to blend their own public sources with finance from capital markets.

Third, blended finance works best when focused on mitigation projects with high development benefits, through, for instance, carbon finance and results-based payments for delivered impacts: investing in mitigation projects that result in valuable development co-benefits, in line with the global development agenda, creates a domestic willingness to pay to co-finance and leverage investment in mitigation actions. The best way to implement such mitigation projects is via blended finance. A practical example is the climate change mitigation action taken in Vietnam's cement sector: by designing a full-scale scheme of clearly specified Nationally Appropriate Mitigation Actions (NAMAs) with the help of expert partners, the Ministry for Planning and Investment of Viet Nam managed to attract international climate finance through the carbon market and other support mechanisms, and through that, support up-scaled mitigation action. It also succeeded in drawing the commercial banking sector into cleantech finance.

Finally, blended finance should not just target commercially mature technology, such as wind and solar PV, but also earlier stage technologies that still have to develop their full potential. On behalf of the Swiss Federal Office of the Environment, South Pole Group and Emerald Ventures are managing the new Technology Fund that provides publicly-backed guarantees for climate-friendly start-up companies. The fund has, among others, provided loan guarantees for innovative companies that develop technologies for industrial process steam, heat recovery modules, substitution of peat with corn fibers and fully integrated PV roof modules that also improve insulation of buildings. The guarantees enable these innovative ventures to access credits from commercial banks at an early stage. Guarantees provided will help the companies to overcome the financing death valley.

Looking into the future, we need to scale up effective approaches to blended finance and new innovative ideas. A key institution to implement new ideas for blended finance is the Green Climate Fund that has already taken some promising steps: it has pledged to use its initial USD 10 billion of capital not just for simple grants and loans, but also for de-risking instruments, such as guarantees. Furthermore, it has recently accredited Deutsche Bank as an implementing entity, a major step compared to other climate funds that just accept public institutions as implementing partners.

If designed well, blended finance has an immense potential to help governments leverage official funds with private capital, sharing both the returns and the risks, while still working towards social, environmental and economic goals.