The Socially Inspired Investor Basic Investing

Climate Finance

Jason Fernando

Originally published 12.14.2020

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 the recommendations laid out in international agreements such as the 2016 Paris Agreement.

How Climate Finance Works

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 increasing greenhouse gases in 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.

IMPORTANT Climate finance—which takes place on the municipal, national, and international levels—may come from either public or private sources.

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.1

Various financial institutions and technologies played an essential role by 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—at times, implacable—raising a slew of morally ambiguous questions. 

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 achieve their current level of development in part by exploiting 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. Of course, this debate becomes increasingly difficult when one seeks to find the exact definition of a developing country. 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, such as the installation of renewable energy sources.

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