Adaptation projects, which focus on mitigating the impacts of climate change, often struggle to secure private financing as they are seen as risky. This hampers the ability of vulnerable communities to implement necessary measures to protect against climate threats. As the urgency for climate action grows, exploring mechanisms to de-risk these investments becomes crucial.
Investment in climate adaptation shows returns: Every billion dollars spent on coastal flooding adaptation reduces economic damages by $14 billion, and $16 billion annually in agricultural investment could prevent 78 million people from hunger, according to the U.N. Environment Programme. Despite these benefits, current targets for increasing international finance to low- and middle-income countries by 2025 and potential future goals for 2030 will not be sufficient to close the adaptation finance gap.
The global community spends less than $30 billion annually on climate adaptation, representing only about 8% of the projected $387 billion required each year. “There are simply not enough public resources available to meet the full extent of adaptation needs,” said Esther Choi, associate at World Resources Institute, also known as WRI, adding that private finance has the potential to play a much larger role.
The objective of de-risking projects is to increase the financeability for both public and private sector lenders and to attract investors seeking acceptable risk-adjusted returns. Devex spoke with four climate finance experts to better understand how these mechanisms might help support the financial needs of local adaptation.
Private investors are hesitant to invest in adaptation projects for several reasons, Choi explained.
One, risk and returns. Adaptation projects are seen as riskier due to the unpredictable and complex nature of climate impacts. “These projects frequently result in more obvious public benefits rather than direct financial returns,” which are less appealing in the short term despite potential medium- to long-term profitability, she said.
Two, lack of information. Investors often don't have comprehensive data on climate impacts, future risks, and adaptation outcomes, Choi said. So far, it hasn't been fully measured how effective ecosystem-based adaptation approaches are, and monetary value hasn't been assigned to all their potential environmental and social benefits, she explained, which makes it hard to determine the financial returns on these investments.
Three, long investment horizon and project size. Adaptation projects usually require long-term commitments of 10-20 years and have high upfront costs with long payback periods, making them less attractive to investors who prefer shorter-term and larger-scale projects, she said.
What is ‘de-risking’ in local adaptation?
De-risking means implementing strategies and measures to reduce, transfer, or mitigate the risks associated with investing in climate adaptation projects in low- and middle-income countries, Choi explained. De-risking can play an important role in advancing local adaptation projects because it can attract investment and additional sources of capital, enhance project viability, and build local capacity, she said.
This can be achieved through financial instruments such as guarantees, insurance, and grants ("financial de-risking") as well as supportive policies such as tax incentives and streamlined approval processes ("policy de-risking"), Choi said. The first works on lowering the perceived financial risks of the projects or their geographic locations, while the latter helps improve the overall investment environment, she explained.
One increasingly common de-risking technique is blended finance. According to the WRI, combining different types of capital with varying return expectations can mitigate financial uncertainties and knowledge gaps that typically deter private investment.
For instance, the Ocean Finance Company’s initiative in the Galapagos, put together a blended finance model that combined grants, fixed-income investments, and higher-risk capital to appeal to investors with varying risk appetites.
Risk-tolerant capital is another tool being used: funds or investments that are willing to accept a higher level of risk to achieve potential returns or to support initiatives. By being the first to absorb potential losses, it can reduce the perceived risk for other investors, making it easier to attract additional private capital. An example is the Green Climate Fund's first-loss equity in the Global Fund for Coral Reefs, which agreed to take initial losses to encourage other investors to participate, wrote the WRI.
Risk transfer tools are designed to shift risk to a third party. Insurance is the most common risk transfer tool. For example, flood insurance can help a community rebuild after a severe flood by providing the necessary funds to cover damages.
Parametric insurance is a type of insurance that pays out a predetermined amount based on the occurrence of a specific event, rather than the actual loss incurred. For example, in the context of climate adaptation in India, parametric insurance is experimenting with paying out when a certain level of heat is recorded. This type of insurance can be more efficient and more quickly distributed than traditional insurance.
An example of risk transfer in action is the pilot carried out by the U.N. Refugee Agency and insurance company African Risk Capacity at the Dzaleka camp in Malawi. With over 50,000 refugees and asylum seekers, the camp is currently severely impacted by climate change and overpopulation. Parametric insurance is being used to provide financial support when drought risk thresholds are met.
UNHCR told Devex that the insurance premium is funded by humanitarian and philanthropic sources, with payouts made by the insurance company. The payout, which has already been triggered, serves as a short-term relief mechanism, supplemented by medium-term activities to prevent negative coping mechanisms, Mojisola Terry, the ARC Partnership lead overseeing climate insurance implementation at UNHCR, told Devex.
When disasters strike, governments often have to reallocate funds for urgent needs, but with insurance policies, they can respond without diverting funds from their original investment purposes. This ensures continuity in development projects and enhances investor confidence, said Precious Nkoka, development officer at UNHCR and technical lead for the African Risk Capacity at the Malawi level.
The aim is to make emerging markets more resilient by including vulnerable groups, such as refugees, in economic recovery efforts, said Terry, explaining how smaller operations, like those in Malawi, often receive less attention and funding compared to larger crises. Hence, UNHCR is focusing on finding predictable and dignified sources of real-time funding for their initiatives, she said.
At the corporate level, the organization has established a Climate Financing Hub and the Refugee Resilience Fund to mobilize additional resources and provide strategic financial coverage. Complementing these initiatives, UNHCR Malawi is implementing climate-smart projects at the country level to improve productivity for refugee farmers and the use of parametric insurance to enhance disaster preparedness. This multitiered strategy ensures a robust response to climate-related challenges, combining financial mechanisms with on-the-ground adaptive measures to support the resilience of forcibly displaced populations.
Ultimately, the focus is on including forcibly displaced communities in building the capacity of African governments for readiness, contingency planning, and faster recovery, through alternative funding, she said.
Looking ahead to 2025, UNHCR plans to scale up these initiatives to several countries in southern Africa, including Zambia, Zimbabwe, Mali, and likely Ethiopia.
It's important to recognize that not all projects are suitable for de-risking or private finance, especially in vulnerable, low-income regions, Choi said. A potential shortcoming could arise if private investment prioritizes countries with stronger capital markets, which could potentially neglect the most vulnerable regions needing substantial support.
“While there is a recognized need for increased adaptation finance from both public and private sectors, many adaptation investments will ultimately have to be covered by public funds due to these constraints,” Choi added.
Over time, adaptation measures and practices to improve resilience will need to be mainstreamed across businesses of all sizes, said Valerie Laxton, senior associate at WRI's Finance Center. This involves that both smaller enterprises and larger corporations understand the impacts of climate change on their operations. They should take proactive steps to protect themselves, their activities, and the environment through resilience-building initiatives, Laxton said.
Ultimately, the goal will likely be to integrate climate adaptation into regular business strategies and reduce vulnerability to climate impacts over time.
First, is the need to improve “predictable power,” Laxton said. This means developing environmental risk assessments and models that include localized climate risk and local features.
Another approach is scaling tools that can be used more frequently and for a broader range of investments. Many of the financial instruments are relatively well known, said Laxton — it’s not that they are complex, but rather they are underused.
Greater cooperation between local or subnational entities and national financial institutions could also play a role — with partnerships that prioritize investments in projects incorporating adaptation measures, she added.
Finally, Laxton emphasized the importance of enhancing education about adaptation and climate impacts. This includes raising awareness among stakeholders about the challenges posed by climate change and the necessary strategies for adaptation. There is also a need to establish or elevate standards for climate-resilient infrastructure and water management at the national level where applicable, she said, adding that this approach is necessary for adaptation efforts to be well-informed, effective, and aligned with broader national resilience goals.
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