Raising the stakes on climate funding – the significance of blended finance

The G20 Summit in New Delhi recently recognized the need for increased global investments to meet the climate goals of the agreement. To implement their climate goals by 2030, developing countries will require $5.8-5.9 trillion. An additional $4 trillion per year is needed for clean energy technologies by the end of this decade to reach net zero emissions by 2050.

According to recent IMF data, fossil-fuel subsidies reached a record $7 trillion last year, which means oil, coal, and natural gas cost the equivalent of 7.1% of global GDP.

To meet the set targets, a substantial amount of climate finance is required. However, investing in climate initiatives can pose additional risks, especially due to the lack of a well-established track record in key sectors of climate investment, both globally and in India.

Green projects, while promising long-term benefits, often require significant upfront investment. Hesitancy among investors is compounded by increased risk perceptions, a lack of universally defined green standards, geopolitical and foreign exchange risks, and concerns about greenwashing.

Institutional investors, wielding substantial capital, tend to favour areas with well-defined business models, cash flow transparency, and sizable investment opportunities, criteria that are met by a limited set of climate assets. 

The majority of investments in climate-related sectors are directed towards relatively mature industries that have established business models, such as renewable energy, and increasingly, electric vehicles.

Blended finance and concessional capital have a pivotal role in reducing risk thresholds for investing in climate themes globally, and in India. From a governmental perspective, availability of blended finance enhances the effectiveness of financial support by promoting economically viable businesses that generate long-term climate outcomes. It also reduces the risk threshold for global investors who are interested in investing in climate themes and in India, thereby increasing the flow of climate investment funds into the country.

To attract large-scale institutional investment for climate objectives, it is crucial to create a portfolio of projects that offer an appropriate risk-reward profile and can be easily invested in by such investors. Blended finance structures, which combine concessional and commercial capital, can help balance risk-reward profiles and lower the risk threshold for private capital. This is particularly important when investing in climate themes that are not yet mature commercially, or in regions with perceived geopolitical and currency risks.

Globally, there are various structures available to utilize blended finance for mobilizing private capital. These structures can create a multiplier effect of 2-5x in terms of commercial equity and 20-30x including commercial debt and equity. It is crucial to increase this ratio for the effectiveness of blended finance in mobilizing large pools of commercial capital to achieve India's climate targets and encourage investment in areas related to key programmes such as Faster Adoption and Manufacturing of (Hybrid &) Electric Vehicles (FAME), Sustainable Alternative Towards Affordable Transportation (SATAT), climate-focused PLIs, and the Green Hydrogen Mission.

For instance, first-loss facilities help absorb the first economic loss before other investors lose value. This can significantly improve the risk-return profile for other investors. Public institutions and governments can offer guarantees that act as a strong signal for investors and help address country-specific or development risks. To mitigate the risk of country-specific currency, global investors can use forex hedges, forward contracts, and swaps. Viability gap funding can establish the viability of the first set of investments and catalyze private capital that would otherwise wait for increased maturity and improved risk-return profiles before investing in a nascent sector.

Both equity and debt capital providers must reconsider their financing priorities to not only concentrate on green asset classes and technologies but also on how they use digital technologies to connect with customers, evaluate risks, and manage relationships. We should take several steps towards a digitally green future, and everyone must join the Call for Climate Action to create a better world for the next generation.

Dhanpal Jhaveri is CEO, Eversource Capital and vice-chairman, Everstone Group.