By Dr Moritz Kraemer, Chief Economist and Head of Research at LBBW Bank and Senior Fellow at the Centre for Sustainable Finance at SOAS, University of London and Dr Ulrich Volz, Professor of Economics and Director of the Centre for Sustainable Finance at SOAS, University of London and Senior Research Fellow at the German Institute of Development and Sustainability (IDOS).
Many developing countries are struggling under a high sovereign debt burden and rising interest rates that leave little fiscal space to meet their Nationally Determined Contributions under the Paris Climate Accord.
While the 80 economies designated by the World Bank as low-income countries (LICs) or lower-middle-income countries (LMICs) – home to over half the world population –contributed just over 17% of total world carbon emissions in 2021, and much less in terms of historical emissions, global population growth will be entirely driven by these countries in the coming decades. Their future contribution to global emissions is set to grow substantially if the foundations for low-carbon development pathways are not put in place today.
If poor countries were to embark on a fossil-fuelled growth process along the lines of high-income countries, the globally available carbon budget would soon be fully consumed. Poorer countries must therefore be enabled to make the necessary investments to lift their people out of poverty in a way that is compatible with global climate aspirations.
To enable these countries to invest in climate mitigation, we propose in a new report the establishment of a Finance Facility against Climate Change (F2C2) that would raise USD1 trillion. This sum is equivalent to one fifth of the total estimated cost of financing the Nationally Determined Contributions (NDCs) under the Paris Climate Accord for the 80 LICs and LMICs that would be eligible to receive funding from F2C2. The facility would mobilise funding with a substantial grant element through the issuance of green bonds earmarked for emission reduction programmes in LICs and LMICs.
The F2C2 bonds would be backed by rich nations’ future commitments of official development assistance, which cover the green bonds’ debt service obligations. This would allow the necessary frontloading of climate spending in poor countries, while minimising the short-term impact on donor countries’ stressed budgets.
Figure 1: Finance Facility against Climate Change
Source: Kraemer, Moritz and Ulrich Volz (2024), Mobilising A Trillion Dollars for Climate Mitigation in Poor Countries: A Proposal for a New Finance Facility against Climate Change, London: Centre for Sustainable Finance, SOAS, University of London.
F2C2 would emulate the successful example of the International Finance Facility for Immunisation (IFFIm), which was established in 2006 to raise funds through the issuance of vaccine bonds earmarked for immunisation programmes in low-income countries.
We envisage an annual issuance of USD100 billion of F2C2 bonds over the next decade, providing a liquid market. This period reflects the limited absorption capacity of receiving countries. Of the USD1 trillion raised through F2C2, a minimum of USD100 billion would be reserved for LICs.
F2C2 bonds would be structured to reflect the different stages of development of recipient countries. LICs will receive the funds as grants with no cofinancing requirement. LMICs would be expected to provide a 10% cofinancing contribution, but also receive highly concessionary conditions by applying a 50% “discount” on the most concessionary terms currently offered by the World Bank’s International Development Association, with a repayment period of 50 years including a ten-year grace period. This would result in a very low net present value of the recipient LMICs’ payment obligation with annual principal repayment of 1.25% of the total from year 11 to 50. F2C2 would be expected to enjoy preferred creditor status like other multilateral lenders.
As demonstrated through their past practice in the cases of IFFIm and NextGenerationEU, the rating agencies will treat the commitments of donor countries to support F2C2 on par with the full faith and credit of the sovereigns making that promise. As a result, F2C2 bonds will carry ratings in the AA or even AAA range. The exact rating will depend on the size and composition of rich countries’ commitments for future funding and possible overcollateralisation of pledges.
F2C2 will make it possible to generate the funds necessary for frontloading climate mitigation investments in poor countries where emissions are otherwise poised to rise very quickly in the coming decades. Using this tried and tested concept of financial engineering to fund climate investments in the Global South sidesteps the challenges that come about by currently tight fiscal positions in donor and recipient countries alike.
F2C2 effectively pushes the financial burden of fighting climate change to future generations of rich-country taxpayers. We consider this fair as they would be among the main beneficiaries if we were able to arrest global warming. But whatever our sense of intergenerational fairness may be, there are no good alternatives that would permit poor countries’ climate investments on the necessary scale. We need to use all practical solutions at our disposal, and F2C2 is such a financial solution. As the Paris climate objectives start to slip from our grasp, time is of the essence. We cannot afford to wait until public finances miraculously improve in rich and poor countries alike.
Confronting climate change has become a make-or-break priority requiring decisive collective action. F2C2 provides a framework that brings us closer towards securing a viable future.