Climate change in least developed countries: How blended finance could help meet mitigation needs

After this summer, the list of destructive impacts stemming from climate change is at once more familiar, remarkable and terrifying: Sea-level rise, ocean acidification and desertification led to increasingly devastating extreme weather events such as fires, cyclones, hurricanes, floods and droughts across the world.

While these events are increasing, literally in our backyards, the countries that are most likely to experience their grave impacts are the world’s 46 least developed countries (LDCs). This is particularly problematic as these countries lack critical financing to support climate-resilient measures and infrastructure, and also rely extensively for income on ocean-based sectors, particularly in small-island developing states (SIDS).

The urgency of the challenge is why it is time for the global financial architecture to seriously consider blended finance – defined by the OECD as the strategic use of development finance for the mobilization of additional finance towards sustainable development in developing countries – as an essential tool to deliver the necessary investment to support aggressive climate action.

The World Bank estimates that up to 1.9% of the world population is at risk of falling into extreme poverty due to the effects of climate change – most of them concentrated in sub-Saharan Africa and South Asia. It adds that food prices are the most important factor impacting sub-Saharan Africa, while health effects, natural disasters and food prices are all important in the South Asian context. This heightened vulnerability is despite the fact that the LDCs are responsible for less than 1% of historical anthropogenic greenhouse gas emissions, according to the UN Conference on Trade and Development in 2017.

Development finance represents the major source of international climate finance flows to developing countries, including LDCs. By aligning activities and finance with the objectives of the Paris Agreement, development cooperation providers – such as governments and grant-giving institutions – can support LDCs in accelerating the transformation to zero-emissions pathways, implementing measures for adaptation to adverse climate impacts, and building climate resilience.

Yet current efforts to mobilize private capital for climate action in LDCs are far from being up to the task. Despite the commitment of developed countries to jointly provide and mobilize $100 billion of public and private climate finance to developing countries annually through 2025, total climate finance provided and mobilized by developed countries for developing countries only reached $78.9 billion in 2018. The latest OECD data show that while the volume of private finance for climate action in LDCs is increasing over time and accelerated in recent years, it still accounts for only 7% of all private finance mobilized. Of all private finance in LDCs, only 37% targeted climate action, amounting to $1.6 billion (on average in 2018-2019).

These figures prove that many development cooperation providers still lack the mandates, resources, incentives and – notably – the strategies to mobilize development finance to support the LDCs in advancing appropriate climate action. Without bolder action consistent with the global mitigation and adaptation goals of the Paris Agreement, not only will appropriate climate action never materialize, but the shared global ambition of ending extreme poverty for all people by 2030 will be unattainable.

As one of the tools in the development co-operation “toolbox”, blended finance investments can make development finance work harder, by using below market rate development finance to leverage commercial finance that otherwise would not be targeted to sustainable development. As discussed this past March during the meeting of the OECD DAC Community of Practice on Private Finance for Sustainable Development, development finance donors, such as governments and grant-giving institutions, have a critical role to play in supporting and advancing climate action in LDCs through blended finance; specifically by providing concessional finance, capacity-building and technical assistance, and sharing knowledge and best practices to mobilize additional resources and skills from the private sector.

Blended finance funds and facilities can help catalyze transformative investments that address climate change. The BUILD Fund, developed in partnership with the United Nations Capital Development Fund (UNCDF), aims to address the missing middle financing challenge – businesses and projects with capital needs too large for microfinance but still considered too small and risky by commercial financial institutions – primarily in the LDCs. By adopting a blended finance approach, the BUILD Fund is designed to leverage private finance into the fund; and consequently, provide semi-commercial funding to UNCDF’s pipeline of SMEs, financial service providers and local infrastructure projects.

One of the BUILD Fund’s four thematic focus areas is green economy and renewable energy. In June 2021, the BUILD Fund made its inaugural investment, providing $500,000 working capital facility to Mwezi Ltd, a last-mile solar energy solutions distributor targeting rural Kenya. This investment will enable Mwezi to expand neighbouring LDCs including Uganda, Ethiopia and Rwanda.

As called for in the OECD/UNCDF 2020 report Blended Finance in the Least Developed Countries, blended finance interventions targeting climate action should align with LDCs’ NDCs and other adaptation plans, and support those sectors where adaptation needs are the greatest, such as agriculture, water and ecosystem preservation, but also public health. This requires working with local actors that execute climate action, such as local communities that often lead adaptation measures and cities for mitigation action. An example is the Green Climate Fund (GCF)’s sub-national Climate Fund, an impact equity fund aiming to catalyze long-term public and private investment for mitigation and adaptation projects at sub-national level in developing countries, approximately a third of which are LDCs and SIDS. The GCF’s $150 million equity investment will bear the first losses (if any) and thus is expected to mobilize equity contributions of an additional $600-750 million from private investors.

Additionally, through the Local Climate Adaptive Living Facility (LoCAL), UNCDF has supported partner institutions to receive direct access to the GCF, with two local authorities ultimately benefitting: Benin’s Fonds National pour l'Environnement et le Climat and the Bhutan Trust Fund for Environmental Conservation.

With the 26^th UN Climate Change Conference of the Parties (COP26) providing the appropriate spotlight for this critical issue, it is encouraging to witness that some LDCs have already submitted updated NDCs; and more are planning to submit new and updated NDCs, National Adaptation Plans and long-term strategies. As momentum for greater climate ambition is increasing, and in light of the urgent needs of LDCs, we call on all countries and partners to harness the potential of blended finance to unlock commercial investment for both mitigation and adaptation in line with LDCs’ needs.