Climate Finance: Meaning, Contributors, Example (2024)

What Is Climate Finance?

The term climate finance has both broad and narrow uses. In its broad sense, it refers to an enterprise that uses financial institutions or technologies to advance the cause of environmental sustainability, such as by developing or deploying new solar panels or other renewable energy sources. In its narrow usage, climate finance refers to the transfer of capital from developed to developing nations in adherence to international agreements such as the 2016 Paris Agreement.

Understanding Climate Finance

Climate change is the long-term progression of patterns in the world's climate. These changes are commonly related to human activities such as the use of certain nonrenewable resources like fossil fuels. Once burned, these energy sources help raise the Earth's temperature by releasing greenhouse gases into the atmosphere. Climate finance is a way for individuals and nations to help fight climate change.

In the most general sense, climate finance refers to any type of financing used to tackle climate change. Financing normally takes place on the municipal, national, or international level and comes from various sources—both public and private.

The topic of climate finance is growing in international importance, as countries and companies become increasingly aware of the risks and opportunities associated with climate change. For instance, the United Nations Environment Programme (UNEP) reported in September 2019 that between 2010 and 2019, global investments in renewable energy technologies exceeded $2.5 trillion, roughly quadrupling the global energy capacity associated with renewable sources.

Contributors to Climate Finance

Various financial institutions and technologies played an essential role in facilitating this shift in global energy infrastructure. Among the examples of how finance plays a role in this process include the use of:

• Banks and other intermediaries to transfer capital overseas.
• Financial markets to price energy commodities.
• Derivative markets to hedge and exchange risks related to energy prices.
• Stock exchanges and investment vehicles to facilitate investment in renewable energy companies.

Climate finance encompasses all of these activities, which are likely to accelerate even further in the coming years.

As noted above, the term also has a more narrow meaning. In this sense, it relates to the question of how developed countries should support developing ones in their transition toward energy sources and other technologies with improved environmental footprints. These discussions are frequently contentious and raise a slew of morally ambiguous questions.

OECD Climate Finance Forecasts

The OECD presented two scenarios for future levels of climate finance provided and mobilized by developed countries for 2021-2025. These scenarios are based on a OECD analysis of forward-looking public climate finance information submitted by developed countries. The information on future levels of climate finance is inherently uncertain with factors such as legislative processes, macroeconomic conditions, and project pipelines in partner countries affecting future spend expectations.

When forecasting climate finance, the OECD prepared one scenario based on countries and development banks fully delivering on their climate finance commitments. As has been the case with the original agreement from COP15, the second scenario is rooted in delays in scaling up climate finance due the variety of variables and constraints discussed below.

Example of Climate Finance

Let's look at an example to show how climate finance works in the real world. A common demand from developed countries, such as those in North America and Europe, is that developing nations, such as those in Asia or sub-Saharan Africa, should refrain from relying on new coal-fired power plants. On the other hand, these developing countries often contend that this demand is hypocritical since developed countries were able to exploit coal and other inexpensive fossil fuels during their own periods of industrialization.

For this reason, many believe that developed countries have a moral obligation to subsidize developing countries by helping them invest in more environmentally friendly energy sources such as wind, solar, and hydroelectric power.

Special Considerations

The debates around climate change become increasingly difficult when one seeks to find the exact definition of a developing country and to determine how much responsibility each country has for carbon emissions.

Should the United States provide subsidies to China, for example, due to the fact that its per capita income is still far below that of the United States? Many Americans are likely to consider this politically unacceptable, citing China’s rapid development in recent years.

Political discussions surrounding climate finance can also prove contentious around the question of which investments should be considered eligible for funding under the climate finance programs. For example, some would argue that child education should receive funding, on the grounds that it would reduce population growth and therefore help curb emissions. However, others may wish to restrict climate finance initiatives to projects with a more direct and near-term association with climate change.

The Bottom Line

Climate finance refers to the financial resources allocated to address climate change challenges. It supports mitigation projects, such as renewable energy and emissions reduction, as well as adaptation efforts, including resilient infrastructure and community resilience. More specifically, climate finance may outline strategic forecast spend on international agreements such as Conference of Parties mobilizations.