Taking stock of COP27, MSc Development Studies alum Alejandra Padin-Dujon sketches the top five emerging ‘fashions’ in climate financing which look set to take hold in 2023 including risk pooling, debt swaps, windfall taxes and the IMF’s special drawing rights.
Winter is upon us, and with it, the post-COP lull for international climate finance trend setting. After a Fall 2022 season featuring vintage ideas as well as fashion-forward creations, policymakers and observers alike look ahead to the Spring 2023 collection. So, what can we expect to debut on the climate stage in a few short months? The buzz: continued momentum for “innovative sources of finance.” Whether these raise new revenue, like windfall taxes; redistribute untapped reserves, à la Special Drawing Rights; reinvent financial instruments, like international risk pooling; embrace an environmentalist take on climate policy, like biodiversity investments; or take a minimalist route with debt swaps; here are the top five trends to watch.
Trend 1: International risk pooling
Category: Disaster risk finance
Regional or international risk pooling (“vintage” by climate finance standards, meaning approximately 15 years old) aims to dilute the risk profile of climate-vulnerable countries by casting a wide net: most of the Caribbean, in the case of the insurance partnership Caribbean Catastrophe Risk Insurance Facility Segregated Portfolio Company, or many African countries, in the case of the African Risk Capacity. Often, risk pooling is harnessed to lower disaster risk insurance costs for participants in the pool. Benefits include the possibility of speedier and more liquid pay-outs than humanitarian assistance offers; drawbacks include overhead costs, and unsustainable, unaffordable premiums—plus scanty data and imprecise modelling, which can lead to mismatches between need and cash influx (known as “basis risk”).
Spotlight: Global Shield
At COP27, the G7 and V20 countries announced the creation of a “Global Shield” programme parallel to formal negotiation processes that would mobilise—or ultimately, simply redirect—finance pledges toward disaster relief and disaster risk management for climate-vulnerable developing countries. At the press release for the launch, Germany explicitly named insurance and regional risk pools as possible directions for the Global Shield. Germany further indicated that initial discussions regarding the form of the Shield—presumably, types of finance mobilised, conditions for disbursement, and recipient projects—would take place in early 2023.
Trend 2: International Monetary Fund Special Drawing Rights
Category: Emergency liquidity
Style: Reinvented basics
The International Monetary Fund (IMF) possesses a financial instrument called “special drawing rights” (SDRs). These are a reserve asset redeemable for hard currency and could be voluntarily redistributed from developed countries to developing countries—including middle-income countries that are especially climate vulnerable—to provide emergency liquidity, or a rapid infusion of multipurpose assets to respond to extreme climate events.
Spotlight: Bridgetown Agenda
In September 2022, Prime Minister Mia Mottley of Barbados—a well-known figure in international climate finance circles—released the brainchild of policymakers and academics convened over the summer in Bridgetown, Barbados. Their task: to conceive solutions to the interrelated crises of high debt burdens and financial struggles due to climate change and Covid-19 in developing countries. This “Bridgetown Initiative” produced a concise set of proposals called the Bridgetown Agenda. The Agenda’s “Step One” implores the IMF to “re-channel at least US$100 billion of unused Special Drawing Rights” to “those who need it.”
The Bridgetown Agenda garnered significant attention by negotiators and press alike at COP27 in November. Hopes remain that its proposals may be actualised in some form in the new year.
Trend 3: Windfall taxes
Category: Increasing revenue streams
Windfall taxes are an accessible and immediate way to access extra funds to fight the climate crisis: tax normal or “excessive” (large and unexpected) profits from highly culpable sectors like the energy industry.
Spotlight: UK windfall tax
In light of energy companies’ large profits, particularly due to the war in Ukraine, the UK government has increased its 25% on oil and gas companies to 35% from January 2023. There is also a new 45% windfall tax on the profits of electricity generators. Combined, these measures are expected to generate £14 billion in revenue next year.
However, deficiencies in the design of an existing 40% UK levy on oil and gas companies that operate in the UK continental shelf mean that fewer than 35 groups pay the existing tax—and Shell paid no windfall taxes on excess UK profits in 2022.
Trend 4: Biodiversity finance and nature-based solutions
Category: Mitigation (lowering emissions) and adaptation (green infrastructure)
Style: Boho chic
Nature-based solutions are nothing new. Forests and mangroves are famous carbon sinks, furthering efforts to limit and lower global emissions. Ecosystem-based adaptation also supports the idea of “green infrastructure” as natural seawalls and other forms of climate protection.
Biodiversity discourse and negotiations, while not intrinsically related to climate change, have recently been collapsed with climate discourse and concerns, leading the UK government to pledge at least £3 billion of its international climate finance budget (itself from the aid budget) toward nature.
Spotlight: Convention on Biological Diversity (COP15)
The Convention on Biological Diversity (COP15) is currently taking place in Canada, hosted by the Chinese government. Press coverage of COP15 frequently classifies it under the banner of climate change. The UN portal Principles for Responsible Investment writes:
Nature and climate are two sides of the same coin. COP27 and its biodiversity equivalent COP15 play important roles in advancing policy responses to the climate and nature crises […] COP15 has the potential to be the ‘Paris Moment for Nature.’
It appears that this contemporary “nature-climate” trend will continue and proliferate through 2023.
Trend 5: Debt-for-climate swaps
Category: Debt relief
Debt-for-climate and debt-for-nature swaps—forms of debt restructuring or relief in exchange for debtor countries’ investment in climate or nature initiatives—could offer a structural solution to high indebtedness, funding constraints, and the climate crisis.
However, large-scale debt-for-climate or debt-for-nature swaps are still rare, limiting their impact on developing countries’ financial resilience. In 2021, Belize struck a landmark deal leading to exceptionally large savings of US$250 million—12% of GDP—but the sum pales in comparison to the country’s debt of over 125% of GDP in 2020.
Spotlight: Caribbean debt swaps
The bleakness of the picture aside, Caribbean islands continue to advocate for—and secure—debt-for-climate swaps. In late 2021, the Alliance of Small Island States entered a partnership with the Open Society Foundation to make Antigua and Barbuda a pilot debt-for-climate swap country. The Open Society for the Finance for Acting on Climate in the Eastern Caribbean (FACE) project will be implemented in partnership with the Organisation of Eastern Caribbean States Commission. It includes a US$500,000 grant and covers approximately US$245 million worth of Antigua and Barbuda’s public debt (20% of the whole). Immediately prior to COP27, Barbados secured a debt-for-nature deal spinning US$150 million of its sovereign bonds into cheaper debt in exchange for protecting marine areas.
À la mode
As policymaking modistes and humble, fashion-conscious policy wonks devise and follow the trends of 2023 it seems that rebranded and recycled fashions are at the forefront. Will these trends produce new results? Are these truly “innovative” sources of finance? Look-book aside, it’s too early to tell – we’ll have to wait and see.
The views expressed in this post are those of the author and do not reflect those of the International Development LSE blog or the London School of Economics and Political Science.
Main Image: A man plants a tree as part of a reforestation project in Central Kalimantan, Indonesia. Credit: WRI/James Anderson via Climatevisuals.org.