Growth is being driven by private sector and commercial capital, suggesting that investors are becoming smarter, more efficient, and bolder, a new report concludes.
Record levels of investment deploying blended finance to tackle climate change impacts in developing countries were recorded in 2023, with annual growth driven mainly by private sector and commercial capital rather than donor capital, according to a new report from Convergence, a network of organisations involved in blended finance.
Annual financing in the climate blended finance market grew 120% in 2023 to $18.3bn (€16.7bn) in aggregate investment, up from $8bn in 2022 despite the macroeconomic pressures affecting broader climate finance for the developing world. This represented 80% of the total blended finance market. By contrast, growth in non-climate blended finance investments was flat.
Private sector increase
Convergence highlighted the strong contribution to growth from non-donor sources. Private sector investment increased 200% to around $6bn in 2023, with corporates and project developers being the most active commercial investors. Meanwhile, commercial financings from development finance institutions and multilateral development banks rose by 60% to $4.7bn.
The latest data follows on from Convergence’s annual report on the entire blended finance market, published earlier in the year. The publication of this first annual climate-themed report was prompted by an increased investor focus on climate and a need for up-to-date data on the topic, the network said.
Joan Larrea, CEO at Convergence, said the findings were grounds for optimism.
“After years of seeing blended finance, and climate blended finance more specifically, fall short of expectations, the findings from this report are heartening. It’s telling us the market is finally getting smarter, more efficient, and bolder with how it uses limited catalytic capital,” she said.
According to the report, financial institutions have been the most active private sector investors in in climate blended finance over recent years, investing $7.2bn in renewable energy and $4.2bn in energy efficiency or emissions reductions in the years 2021-23.
Public sector spending in climate blended finance still outpaced that from private sources, accounting for $8.9bn in 2023 compared to $6.2bn in 2022. Convergence said the rise was due partly to a growth in the investment volume of guarantees and insurance, propelled by a change in international rules that now allow these to count towards donor countries’ overseas development assistance commitments.
Climate adaptation investment lags behind
Despite the positive signs, much faster progress is needed, according to Convergence, particularly in mobilising investment to tackle climate adaptation, where private sector involvement remains limited. This is often perceived as an area that offers fewer opportunities and carries more investor risk than climate mitigation measures, such as renewable energy projects, which help mitigate carbon emissions increases.
In the 2021-23 period, 132 blended finance transactions targeted climate mitigation, with a total value of $26bn, while only 32 transactions targeted adaptation, with a total value of $3.5bn.
Convergence suggests investors could be persuaded to commit more to adaptation by increasing the focus on so-called cross-cutting transactions, which include both mitigation and adaptation elements. By including familiar mitigation elements, the hope is that traditional investors will be prepared to accept any perceived higher risks on the adaptation side. The report identified 63 cross-cutting blended finance transactions in 2021-23, with a total value of $10bn.
Several factors could explain the rise in private investment in climate blended finance, Ilsa Weinstein-Wright, a research associate at Convergence, told a webinar to launch the report.
These included the growing attractiveness of long-term assets with retained values, such as green bonds, the increasing commercial viability of renewable energy in emerging markets and the presence of deals with larger ticket sizes attractive institutional investors.
She noted a growing trend towards climate deals delivering large-scale solutions, with six climate blended finance deals exceeding $1bn in 2023, roughly equal to the previous five years combined. Many of these deals were for large greenfield infrastructure and energy projects, with a heavy reliance on financing through commercial bank loans.
“However, we are also observing progress in the emergence of portfolio level assets that fulfil the investment criteria of institutional investors, such as the $1.11bn SDG Loan Fund,” she said. Institutional investors contributed $1bn of the total for that fund, which was led by Allianz and FMO.
Weinstein-Wright said the emergence of these large transactions was significant because they had contributed to the substantial growth of the blended finance market, and because they represented “a signpost of blended finance, more consistently and more effectively, opening the tap of institutional investor capital flows”.
NDC opportunities
The report also includes a section throwing the spotlight on Nationally Determined Contributions (NDCs), the commitments made by countries under the 2015 Paris Agreement to cut GHG emissions and adapt to climate change, which are due for renegotiation in early 2025. The report includes Rwanda, Belize and Indonesia case studies.
Convergence said the quality and detail of current NDC frameworks varied considerably across countries, so the update would provide an opportunity for governments to provide more substantive and granular information on the policy platforms behind their climate targets and the technological and sectoral opportunities that might attract and leverage private investors.
