Asset managers feeling the heat on climate from pension funds

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Key points

  • With over USD 73 trillion in global assets, pension funds have significant financial influence on accelerating the transition to a low-carbon economy or prolonging the status quo of fossil fuel dependency.
  • About USD 15 trillion of pension fund assets have been delegated to third-party asset managers (AMs), making these companies key players in pension fund investment decisions. 
  • Climate change poses systemic risks to pension investments. Failing to address the risks could lead to a 33% loss in pension returns by 2050, threatening the future income of pension fund members. Conversely, clean energy supply presents a $60 trillion investment opportunity.
  • 200 major pension funds have begun divesting from fossil fuels in an effort to fulfil their fiduciary duty and act in the best interests of their members. However, AMs’ investment decisions for the pension funds they manage often do not reflect these concerns. 
  • Momentum is building among pension funds to hold AMs more responsible for the decisions they make on investing pension assets. Some major funds have recently pulled over USD 100 billion from managers like BlackRock and State Street because their climate strategies did not align with the funds’ long-term interests.

Why pensions matter to financial markets

Pension funds are significant players in the global financial system, holding over USD 73 trillion in assets globally between public and private funds, with the top 300 pension funds managing a combined USD 24.4 trillion at the end of 2024. 

This immense capital gives them substantial power to influence financial flows and drive the transition to a low-carbon economy by investing in climate solutions. However, pension funds also have the power to maintain the status quo by continuing to invest in fossil fuels, deforestation and other activities which harm the climate. 

Pension funds are critical tools for climate action due to their scale and long-term investment horizon.

Why climate change matters for pension funds

Pension funds are vehicles for long-term investments, designed to provide their members with income years or decades into the future. This makes them particularly vulnerable to climate change on a number of levels:

  • Physical risks such as the impacts of extreme weather events are already being experienced but are expected to escalate in the longer term. This means that investment decisions taken now may well become exposed to climate risks, such as sea level rise, that are not yet apparent.
  • Transition risks such as policy changes to mitigate climate change, which can in turn mean that some carbon-intensive assets such as coal power plants become obsolete before the end of their planned operating lives (known as stranded assets), while increasingly cheap new technologies such as renewables undercut ‘traditional’ energy sources.
  • Liability risks from potential litigation resulting from climate damage can lead to both financial and reputational damage.

Taken together, the interrelated nature of these risks poses a systemic risk to the global financial system, including to the value of pension funds, as climate impacts increase. 

The economic impacts of climate change are already being experienced. A 2024 study for the International Chamber of Commerce found that extreme weather events cost the global economy more than USD 2 trillion between 2014 and 2023, with USD 451 of this occurring in the final two years of the study period. As climate change accelerates, these costs are also expected to increase. Estimates vary, but a recent study found that a permanent 1°C of global warming reduces world GDP by over 20% in the long run.

The economic implications of climate change for pension funds in the longer term could be severe. A recent study by Ortec Finance, a financial modelling company, found that pension funds could lose 33% of their returns by 2050 in a high global warming scenario based on current trajectories. 

How climate change matters for pension holders

There are two main types of pension funds. Defined contribution (DC) pensions are private pensions where employees determine their level of contribution and the market determines their returns. Employers may contribute to these pension funds, but the primary savers are employees. Defined benefit (DB) pensions are set up and paid into by the employer to guarantee a set income for staff after retirement, normally based on final salary or length of service. Businesses rather than individuals pay into these schemes.

DC pensions are increasingly replacing DB pensions in many developed economies, directly exposing individuals to financial risks linked to how their pension funds’ investments perform. The financial impacts of climate change may therefore adversely affect the level of income that people receive from their DC pension.

DB pension holders are, in theory, more shielded from direct financial exposure, since pension fund payouts are set at specific, predefined levels. However, the funds themselves remain just as exposed to the financial risks of valuation loss due to climate change. If their assets do not generate sufficient returns, these funds risk being unable to pay out promised pension levels.

Understanding how ESG fits in pension funds’ fiduciary duty

The primary aim of pensions is to provide a level of income in later life. Most pension funds (asset owners) have a legal and ethical ‘fiduciary duty’ which can include the obligation to act in the best interests of their members. Environmental, Social and Governance (ESG) issues are playing an increasing role in many asset owners’ decision-making, in part because of the need to fulfil their fiduciary duty to provide their members with income over long timescales despite the threats posed by climate change.

The future security of pension funds will be eroded if returns are undermined by economic decline. But the implications of this are greater than just financial security. Adequate pensions can help avoid the stress and mental health issues associated with financial insecurity in later life as well as helping people avoid social isolation. In addition, the ability of older people to spend pension income contributes to economic growth. 

However, it is possible for pension funds to use their power in financial markets to reduce future climate-driven risks while also delivering for their members. S&P Global estimates that up to USD 60 trillion in cumulative investment will be needed in clean energy supply between now and 2050, presenting real financial opportunities while also reducing climate emissions. Investing in sustainable technologies makes strategic sense as they can produce higher dividends with lower risks. 

It is clear that pension funds increasingly recognise their role in shaping investment in future energy systems. As of the end of 2025, 200 pension funds across Europe, North America and Australia have begun to move away from fossil fuel investments, according to the Disinvestment Database. Although only one fund (Nest Foundation Collective in Switzerland) has no investment in the fossil fuel industry, 125 other funds have made binding commitments to divest fossil fuels from their portfolios by a specific deadline. A further 74 funds have set a binding deadline to move away from some types of fossil fuels.

Pension funds and asset managers

Pension funds delegate some or all of their investment decisions to asset managers (AMs), giving AMs significant control over how pension funds’ vast capital is deployed. The relationship between the two is crucial for effective climate action.

Like pension funds, AMs have a duty to manage the funds they are responsible for in a way that meets their clients’ financial goals and upholds their own fiduciary duty to the asset owners. AMs can influence the companies they invest in through voting at Annual General Meetings, direct engagement or choosing not to invest at all. 

However, AMs’ positions on sustainability may not always reflect the position of asset owners, including pension funds. AM companies take different levels of action on decarbonisation, with many continuing to invest in companies which develop or use fossil fuel resources. This means investment policies on climate change do not always reflect the climate values or risk tolerance of their asset owners. 

For example, a review by Reclaim Finance of 30 top US and European AMs found they had invested at least USD 16.9  billion in bonds issued by fossil fuel developers between January 2024 and June 2025. Only two of these AMs have committed to stop most of their new investments in oil and gas producers’ bonds.

Pension funds need to demand that their AMs adopt robust stewardship strategies that push companies toward a low-carbon transition, rather than merely using ‘engagement’ as a cover for continued fossil fuel investment. In an effort to align expectations on this, 35 pension funds have signed a letter setting out how they expect AMs to develop urgent strategies to address climate change. 

How are people making pensions work for the climate?

Individual members of large pension schemes cannot typically vote on investment decisions or directly influence AMs. However, collective voices and public campaigns have forced shifts in pension funds’ policies and asset allocation, as well as their regulatory focus.

A key example is the Make My Money Matter campaign in the UK, which mobilised people around the message that, in terms of cutting carbon, greening one’s pension is 21 times more powerful than switching energy, giving up flying, and going vegetarian combined. By raising awareness of the influence pension funds could have over climate action and ranking the performance of individual pension fund companies, the campaign helped get a commitment to meaningful net-zero targets from more than 60 pension funds representing more than GBP 1.5 trillion.

Recent actions by pension funds

The momentum is building behind pension funds holding AMs to account for their positions on climate change. Recent developments have removed over USD 100 billion from AMs because of the mismatch between pension funds and AMs on climate change and stewardship:

Natural capital is a high-return investment in resilience

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Key points:

  • Evidence from multiple sectors shows that investing in natural capital – the world’s forests, wetlands, rivers and other natural assets — delivers broad economic returns: driving affordable emissions reductions, reducing climate-related losses, and generating high-value benefits across entire ecosystems.
  • Land-based solutions such as reforestation, when combined with demand-side measures such as dietary change and waste reduction, could provide in the order of 50% or more of the cost-effective global mitigation needed over coming decades to limit warming to 2°C – mostly in tropical developing countries in Asia, Latin America and Africa. 
  • Protecting and restoring nature can also reduce the intensity of climate- and weather-related hazards by at least 26%, cutting losses in developing countries by up to a quarter in 2030. 
  • The world’s wetlands generate USD 39 trillion in ecosystem services each year – equal to 36% of global GDP.  If we protect them, they will provide annual ecosystem services worth approximately 40 times more than the adaptation finance currently needed in developing countries. 
  • Forests provide ecosystem services worth more than USD 7.5 trillion annually – around 100 times the annual adaptation finance needed by smallholder farmers to help secure the global food supply. 
  • Across studies, rehabilitating and conserving wetlands, restoring forests and landscapes, and transforming food systems generate outsized economic returns, with every USD 1 invested returning between USD 6.8 and 51, depending on the intervention.
  • Despite this clear economic case, current public and private financial flows are misaligned, with far too little directed to conservation, restoration and food-system transformation. Meanwhile, governments still channel vast sums each year into harmful environmental subsidies that drive costly land degradation, deforestation and food insecurity.

The economic case for investing in nature is clear

Evidence from multiple sectors shows that investing in natural capital – the world’s stock of natural assets and ecosystem services that support economies and human well-being – delivers strong and measurable economic value.

The gains range from affordable emissions reductions to cost-effective infrastructure and major savings in avoided climate-related losses. 

High returns across climate, resilience and infrastructure

Almost 40% of the cost-effective emissions mitigation needed by 2030 to stay under 2°C1 could be achieved using nature-based solutions. Forest conservation and restoration contribute a little over two-thirds, grassland and agricultural improvements about one-fifth, and wetland restoration about 14%. 

A more recent analysis estimated that, alongside demand-side measures such as dietary change and waste reduction, land-based solutions could provide in the order of 50% or more of the cost-effective global mitigation potential needed over coming decades for a 2°C pathway.2

The majority of this potential is located in tropical developing regions, particularly Asia, Latin America and Africa, where lower implementation costs and high opportunities in forestry and land-use make action particularly efficient.

In tropical countries, cost-effective natural climate solutions such as reforestation, mangrove restoration and agroforestry – the co-planting of trees and crops – could mitigate more than half of the national emissions in at least half of the countries, and even exceed total emissions in about a quarter.

Investing in natural capital also reduces the escalating costs of climate impacts. This is especially critical for developing countries, where the cost of climate-related ‘loss and damage’ (harms that go beyond what can be managed through adaptation) is anticipated to reach between USD 402 billion and USD 805 billion per year by 2030.

But by protecting and restoring nature, countries could reduce the intensity of climate- and weather-related hazards by at least 26%, cutting losses in developing countries by up to a quarter in 2030. This equates to a saving of at least USD 104 billion in 2030 for developing countries, compared with a business-as-usual pathway. 

The same applies to nature-based solutions that use or mimic natural processes to provide infrastructure services. Landscapes such as wetlands, sand dunes and forests can provide the same services as man-made “grey” infrastructure for meeting development goals (such as water purification) at half the cost.

In a scenario where just around 11% of global development infrastructure needs were met through nature-based solutions, the saving would free up almost 6% of the estimated global annual infrastructure budget (or USD 248 billion) for other development priorities.3 

For example, in the Gulf of Mexico, nature-based adaptation could prevent USD 49 billion in climate-related flood damages by 2030. This represents 85% of the total cost-effective risk reduction identified, and would cut projected losses by over 40%.

Nature-positive investments consistently deliver benefits that far exceed their costs

Across studies, rehabilitating and conserving wetlands, restoring forests and other natural landscapes, and transforming food systems all generate outsized returns. These are explored sector by sector, below. 

The benefit–cost ratios (BCRs) of investing in nature range from several dollars of benefit for every USD 1 invested, and in many cases are far higher (see Figure 1 and Table 1, in which  a BCR >1.0 indicates that the benefits outweigh the costs).

Figure 1
Table 1
Protecting the world’s wetlands can secure future ecosystem services worth almost twice global GDP

The world’s wetlands represent one of the most valuable investment opportunities in natural capital. Wetlands generate an average of USD 39.01 trillion in ecosystem services annually – equal to 36.7% of global GDP in 2023. 

The total long-term value of the benefits we get from wetlands – such as clean water, flood control and food – is remarkable. If we protect and sustainably manage these valuable environments until 2050, the world’s wetlands will provide ecosystem services worth more than USD 205 trillion over that period, a sum nearly twice the size of the global economy in 2023.

The median annual value of wetland ecosystem services – used for long-term projections – is around USD 8 trillion. This is approximately 40 times the adaptation finance currently needed in developing countries (estimated at USD 215 billion per year).4

Protecting mangroves alone prevents losses of over USD 80 billion per year by averting flood damage. Without these ecosystems, the annual global bill for flood damage would go up by more than 16%.  

Sustainable forest management could cost as little as 2% of the value forests currently generate each year in ecosystem services

According to FAO’s State of the World’s Forests 2022 report, the formal forest sector contributed USD 1.52 trillion to national economies in 2015 (the most recent comprehensive global data available). The formal sector includes direct activity within forestry and wood products industries, plus the ripple effects through supplier industries and worker spending. 

The investment needed to halt deforestation and achieve sustainable forest management this decade is estimated at USD 150 billion–460 billion per year. This is just 10-30% of the annual economic activity forests already generate. 

This estimate does not even account for the immense non-market value of forests. From carbon sequestration to water regulation, soil protection and biodiversity, forests provide ecosystem services valued at more than USD 7.5 trillion annually. This is 100 times greater than the annual adaptation finance needed by smallholder farmers to help secure the global food supply (USD 75 billion/yr).

Investing in forest protection and sustainable management would cost just 2-6% of the annual non-market benefits they provide. Put differently, for roughly a week’s worth of the value forests deliver annually, we could finance their protection for an entire year. 

Despite the clear economic case for investing in forests, total forest finance flows were only around one-fifth of the value of damaging environmental subsidies in 2023.5 Private financial institutions provided almost USD 9 trillion in finance to companies with high tropical deforestation risk in 2024.

Land degradation already costs the world more than twice the annual investment needed  to reverse it

As much as 40% of the world’s land is degraded, affecting over one-third of the global population. Land degradation, desertification and drought cost the global economy USD 878 billion every year – more than double the annual investment needed until 2030 to address these issues (USD 355 billion per year).

The cumulative investment needed by 2030 is roughly equivalent to what the world currently spends every year on harmful environmental subsidies.

Transforming global food systems could deliver staggering returns on investment 

Our current unsustainable food systems impose hidden costs of USD 15 trillion per year on society6 through environmental degradation, health-related factors and their contribution to structural poverty through food prices.

In contrast, globally transforming food systems would generate net benefits of USD 5 to 10 trillion per year – or between 5 and 10% of global GDP in 2023. 

With the costs of investing in agricultural research and development, reducing food waste, supporting dietary shifts, upgrading rural infrastructure and restoring habitats totalling just 200-500 billion USD per year, this represents a return of 11 to 51 times the initial outlay.7

  1. For a >66% chance of keeping global warming below 2°C above pre-industrial levels. Values are from 2017. ↩︎
  2. This is not a 2030 deliverable and is constrained by feasibility, land-competition and scope. Roe et al. (2021) estimate 8–13.8 Gt CO₂e yr⁻¹ of cost-effective (≤ USD 100 t⁻¹ CO₂e) mitigation potential from land-based and demand-side measures between 2020 and 2050. For comparison, the IPCC AR6 WG III (2022) finds that a likely-below-2°C pathway requires global GHG reductions of roughly 10–16 Gt CO₂e yr⁻¹ by 2030 relative to 2019 levels. This implies that the Roe et al. range represents half or more of the total cost-effective mitigation needed this decade for a 2°C pathway. While the time horizons differ, the Roe et al. range is of the same order of magnitude as the near-term mitigation challenge, indicating that land-based and demand-side actions could sustainably contribute roughly half or more of the required cost-effective reductions if feasibility barriers are addressed. ↩︎
  3. According to the report, global infrastructure needs are USD 4.29 trillion/yr. As nature-based infrastructure provides USD 248 billion/yr in savings, then USD 248 billion / 4.29 trillion = 5.8%. ↩︎
  4. The comparisons made here are used to show magnitude and are not intended as one-to-one reallocations. ↩︎
  5. According to the State of Finance for Forests 2025 report, potentially damaging subsidies reached around USD 406 billion in 2023, while in the same year, annual forest investment was USD 84 billion. ↩︎
  6. Value is Purchasing Power Parity (PPP)-adjusted for 2020. ↩︎
  7. The return on investment is derived from the Food System Transformation (FST) scenario in the Food System Economics Commission (2024) report, which estimates annual net benefits from transforming global food systems at USD 5–10 trillion per year, for annual investment costs of USD 200–500 billion (all in 2020 PPP, to 2050). Interpreting these figures as net benefits, the corresponding benefit–cost ratio (BCR) can be expressed as 1 + (net benefits / costs). Using the lower bound of benefits with the upper bound of costs gives a conservative BCR of 1 + (5 / 0.5) = 11, while the upper bound of benefits with the lower bound of costs yields an optimistic BCR of 1 + (10 / 0.2) = 51. This equates to roughly USD 11–51 in benefits for every USD 1 invested in food system transformation. ↩︎

Australia’s climate finance to Southeast Asia lags behind China  

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Key points

  • Southeast Asia is a key partner for both China and Australia. China’s voluntary climate finance to the region was around ten times Australia’s USD 1.2 billion in obligatory funding. 
  • Based on the NDCs of ASEAN countries, Australia should provide around USD 5.4 billion of climate finance to Southeast Asia by 2030. So far, it has delivered less than a quarter of its expected bilateral finance to Southeast Asia. 
  • At COP30, talks will likely focus on the New Quantitative Finance Goal, where developing countries, including Australia, must provide at least USD 300 billion in climate finance annually to developing countries. 

China outpaces Australia in ASEAN climate finance

Southeast Asia is one of the fastest-growing and climate vulnerable regions, where climate finance is a crucial mechanism in supporting decarbonisation and adaptation. 

China delivered around USD 12 billion in bilateral climate finance to Southeast Asia between 2012 and 2021, 10 times Australia’s USD 1.2 billion over the same period. The gap underscores China’s growing influence in the Association of Southeast Asian Nations (ASEAN), a bloc that is the largest trading partner for China and second largest trading partner for Australia.  

Our new analysis, based on OECD and WRI data, looks at climate finance flows to Malaysia, Indonesia, Laos, Cambodia, Vietnam, the Philippines, Timor-Leste, Myanmar and Thailand. It shows the efforts of Australia’s new government to increase its climate finance support to these key regional partners in recent years, such as a USD 2 billion investment fund.

Australia should provide around USD 5.4 billion of climate finance to Southeast Asia by 2030, based on the Nationally Determined Contributions (NDCs) of ASEAN countries – the national climate action plans submitted by governments to the UN (see Methodology below). So far, it has delivered less than a quarter of its expected bilateral climate finance to Southeast Asia’s decarbonisation efforts. 

Australia provided most climate finance to Indonesia (USD 585 million), while China provided most climate finance to Malaysia (USD 5 billion) followed by Indonesia (USD 4 billion), between 2012 and 2021.

Why is this important now? 

As a UNFCCC Annex II country, Australia is required to contribute to the delivery of at least USD 300 billion annually by 2035 in climate finance, as agreed in the new collective quantified goal (NCQG) at COP29 last year. 

Developed nations committed to take the lead by providing finance for developing countries’ climate action. China, though not obliged, provided around USD 4.5 billion of climate finance per year from 2013 to 2022 – equivalent to 6.1% of the total amount given by developed countries across the same period, according to the WRI. Amid debate over expanding the number of required donors to the climate finance goal, China has confirmed its contributions will remain voluntary. 

This discussion is now urgent – talks ahead of COP30 are focusing on two things: how to raise the NCQG’s more ambitious target of USD 1.3 trillion per year from a wider set of climate finance sources, and how much is needed by developing countries (excluding China) to supplement their domestic resources to adequately provide for the energy transition, adaptation measures, and responses to loss and damage.

Methodology 

Datasets


This analysis uses historical climate finance to Southeast Asia between 2012 and 2021 from

Australia’s attributed bilateral finance requirement to meet ASEAN NDCs by 2030 is estimated by taking:

  • the UNFCCC calculation of the volume of climate finance needed for Southeast Asia, as determined from NDCs, as USD 422.16 billion up to 2030; 
  • the multi-year average, post-Paris contribution of bilateral public finance to total climate finance from developed to developing countries as 37% from 2017 to 2022, according to the OECD; and
  • the WRI’s climate finance calculator result (with donor base set to UNFCCC Annex II countries) giving Australia’s bilateral share of Southeast Asia’s climate finance, normalising for historical emissions and economy size. 

Tropical Forest Forever Facility aims to incentivise forest protection

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Key points:

  • At COP30 in November, Brazil will formally launch the Tropical Forest Forever Facility (TFFF), which hosts the Tropical Forest Investment Fund (TFIF). It aims to raise an initial USD 25 billion in start-up capital, with a longer-term target of USD 125 billion. 
  • The fund aims to give tangible financial value to standing forests – providing long-term, reliable and results-based payments for developing countries to protect their forests. Estimates suggest it could nearly triple international non-reimbursable finance for forests, which could supplement eligible countries’ environment and forest ministries budgets by several times over. 
  • In contrast to typical conservation funds, TFFF is a forest-funding mechanism that generates returns for its investors.
  • The TFIF’s investment criteria aim to allocate capital away from high-emissions activities and support the energy transition using a diversified investment portfolio that excludes fossil fuels and deforestation-linked activities. This means that as well as paying for tropical forest protection, the fund also helps to accelerate the energy transition, while generating returns for investors. 
  • The TFFF was developed in close collaboration with Indigenous Peoples and local communities and commits at least 20% of forest payments to them, ensuring benefits reach those who safeguard forests on the ground.

Brazil’s forest finance plan advances towards COP30 launch

Forests are critical natural infrastructure for climate stability, water security, biodiversity and rural communities. But despite this, ongoing deforestation and degradation in an economic system that incentivises extractive industries puts these ecological services at risk. Forests receive less than 4% of international climate finance, a figure at odds with their value when protected. The Tropical Forest Forever Facility (TFFF) aims to tackle the conditions that encourage deforestation by providing tropical forested countries with long-term, reliable and results-based payments for protecting their forests. Initially presented by the government of Brazil at COP28, the TFFF will be formally launched at COP30 in Belém, Brazil.

How it works

Unlike typical conservation funds that rely on temporary grants or project-based funding, the TFFF is an investment fund designed as a permanent, self-financing vehicle, positioning forests as a global asset class which forested nations are compensated for preserving. While this idea might be new to conservation funding, the use of an investment portfolio to generate returns for investors is a very common finance mechanism.

The TFFF aims to attract USD 125 billion in blended finance: USD 25 billion of this is sponsor capital from governments and philanthropies that acts as insurance for private investors by absorbing any early losses.1The TFFF Concept Note 3.0 states that “The model assumes that all sponsor funds are received at the beginning of the life of the TFIF, although it may be that certain sponsors wish to make contributions over a few years. This would be acceptable if the commitment to fund were made via a legally binding pledge.” This implies that not all financing is needed upfront for the launch of the facility. This helps give major investors, such as pension funds, insurers and sovereign wealth funds, confidence to purchase up to USD 90-100 billion in bonds from the fund.2The TFFF uses a credit enhancement mechanism that includes a ‘two-tranche structure’ to achieve AAA ratings (the highest credit rating) and attract investors. The USD 25 billion ‘junior tranche’ from governments and philanthropies acts as a protective buffer that absorbs first losses, while the USD 90-100 billion ‘senior tranche’ raised through bonds is shielded from risk. Using statistical simulations to model thousands of investment scenarios, the TFFF found that with at least 18% junior capital, senior investors face less than 1% probability of losses. The contribution by governments and philanthropies is used as insurance to mobilise USD 90-100 billion from pension funds and investors, while the AAA rating ensures the fund can borrow at the lowest possible rates. The combined capital will then be invested by the Tropical Forest Investment Fund (TFIF), the investment arm of the facility. 

TFIF will manage this capital through a diversified portfolio of investment vehicles – mainly Emerging Market Developing Economy (EMDE) bonds, with a sustainability focus – targeting a 5.5% return on average over 20 years. This 5.5% return will go back to investors every year, and anything above this will be used to finance annual performance-based payments to up to 74 developing countries that hold over 1 billion hectares of tropical and subtropical forests.3If there is positive cash flow beyond the payment outflows, the extra capital will be retained in the fund and used to build its asset base.

Estimates suggest the fund could generate cashflow of USD 3.4 billion each year after costs and provisions – enough to pay eligible forested countries USD 4 for every hectare of protected tropical forest annually.4To put this number into perspective, the Amazon has 650 million hectares of forest. Payments under the TFFF are “expected to nearly triple the current volume of international non-reimbursable finance for forests”, representing multiple times the current national budgets of environment and forest ministries in some countries. 

To put the numbers into perspective, Congo Basin countries received a total of USD 40 million for forest and environment protection between 2017 and 2021, mostly through official development assistance (ODA) grants and loans. With a forested area of 200 million hectares, this works out to around USD 0.04 per hectare per year. Under the TFFF’s model, Congo Basin countries would have instead received USD 4 per hectare per year – or 100 times the value of these interventions. Unlike ODA loans, these TFFF payments would not create debt and would provide predictable, ongoing compensation for forest stewardship conditional on preservation. Moreover, whereas past financial flows often included support for activities such as timber production, which are not necessarily sustainable, the TFFF is explicitly tied to keeping forests standing. 

Criteria for funding 

To be eligible to receive funding, countries must have a deforestation rate of less than 0.5%.5Because key datasets show deforestation rates of roughly 0.3-0.6%, the TFFF will set an initial entry cap of 0.5% as a representative midpoint. This is intended to prioritise countries with below-average deforestation. The cap will be reviewed after the first three years. Recipients of forest payments must also demonstrate that these payments will not replace existing budgets or programmes already dedicated to forest conservation. Monitoring will be conducted using satellite data to assess canopy cover, with areas that have over 20-30% tree canopy cover eligible for Forest Payments.6As loss rates surge as canopy cover drops – rising from ~0.3% overall to ~2-3%/year below 50% – a 20–30% canopy-cover threshold targets areas that still qualify as forest but are at demonstrably higher risk of rapid loss, where incentives can have the biggest impact. Additionally, money will be deducted from payments in the case of forest loss and degraded forests, in proportion to the amount of damage and in the case of wildfires.7The TFFF Concept Note 3.0 writes that these guidelines “may be reviewed and refined over time to reflect improvements in scientific understanding and technical capacities.”

Concerns have been raised that 20% canopy cover remains too low as a threshold, especially for regions with historically high canopy density of 60% or higher, as it is far below typical definitions of dense forest. For example, the TREES (Tropical Ecosystem Environment Observations by Satellites) project defines >70% canopy cover as dense forest and 40-70% as ‘fragmented’ forest – that is, forest that is partly deforested, broken into patches. UNEP (2001) uses a 40% threshold for closed forests and 10-40% for open or fragmented forests. Setting the threshold to 20% effectively counts fragmented, partly deforested landscapes as ‘forest’, meaning logging could continue while still meeting the threshold.  

Further, the selected threshold can drastically change the area mapped as forest, particularly in forest-savanna transition zones. When the FAO lowered the forest definition to at least 10% forest cover in its Global Forest Resources Assessment 2000, Australia gained about 118 million hectares of ‘forest’ overnight.     

The WWF recommends setting a threshold of 50% for full payment and partial payments between 20% and 50% to better incentivise maintenance and restoration of dense forests.

Contributing USD 125 billion to financing the transition 

The fund aims to invest USD 125 billion (including the initial capital investment of USD 25 billion and USD 90-100 billion in market borrowing) in bonds that align with environmental and social safeguards and contribute to the sustainable transition. Its exclusion criteria, which avoid activities related to coal, peat, oil and gas8The TFFF Concept note 3.0 writes that “the full exclusion list for TFIF’s investment universe and the respective monitoring mechanism are currently under discussion with the rating agencies. go beyond standard multilateral development bank policies, setting a higher bar for transition-aligned investing.9For example, while the World Bank has ended coal and upstream oil and gas finance, it continues to finance “certain gas projects in the poorest countries in exceptional circumstances”.

The TFFF’s ambitious financing targets are well-supported by market capacity. There is ample capacity in financial markets for the TFIF to invest its capital within the guidelines of its sustainable investment strategy. In its latest briefing note, the TFFF estimates that there is “close to USD 1.9 trillion in outstanding hard-currency emerging-market papers” – that is, USD- or EUR-denominated bonds issued by emerging or developing sovereigns and companies. With investment capital of USD 90-100 billion, the TFIF would be targeting only 4.7–5.3% of this market. Further, the World Bank reported that “the cumulative amount of green, social, sustainability, sustainability-linked, and transition bonds issued in the market reached USD 6.3 trillion as of June 2025”, highlighting the significant pool of instruments that can meet TFIF’s key investment criteria. 

There are also signals that markets are open to large emerging market issuance: emerging market hard currency bond gross issuances in January this year were the highest they’ve been since 2011, at USD 58.3 billion, signalling strong investor demand.

Banks and companies in emerging markets (excluding China) have sold international bonds at the fastest rates since 2021, issuing at least USD 250 billion in bonds between January and July.  

Set against the new collective quantified goal on climate finance (NCQG) of USD 300 billion minimum climate finance for developing countries by 2035, the TFFF is significant but not sufficient, prompting some stakeholders to suggest that the TFFF financing should be additional to the USD 300 billion floor. 

How does the TFFF compare to other conservation finance frameworks? 

The TFFF complements credit- and project-based funds by providing annual payments to countries for keeping forests standing, channelling finance through country-led budgets and programming rather than one-off projects. It has prioritised simplicity and readiness in its design, including by using established technologies, institutions and policies, to avoid the pitfalls of complex programme design and methodologies that have slowed payment processes for other conservation programmes. To make monitoring accessible to forested countries, the need for high-cost approaches is avoided by using widely available satellite-based data. 

The TFIF does have some similarities with other nature-based funds and financing mechanisms, for example:

  • Environmental impact bonds (EIBs) are a pay-for-success debt financing mechanism that limits risk for project operators and rewards investors by linking repayment to the achievement of a desired environmental outcome. EIBs have been used, for example, to finance the construction of infrastructure to manage stormwater runoff in the US. 
  • Debt-for-nature swaps may also contribute to financing nature conservation; however, these instruments only make economic sense in a limited number of cases, according to the International Monetary Fund (IMF).
  • Crop Trust uses a similar endowment fund structure, with a blended finance base, to provide payments earmarked for crop diversity conservation activities. 
  • Legacy Landscapes Fund provides predictable, long-term payments for nature conservation. It uses a blended finance approach to source funding for “a diverse portfolio of 30+ outstanding protected areas by 2030.” Grants are provided to support the conservation of specific protected areas instead of as a results-based payment. 

Returns on investment: Why investing in forests matters

Forests are largely undervalued for the benefits they provide. Global forests are estimated to be worth as much as USD 150 trillion, almost twice the value of global stock markets and over 10 times the worth of all the gold on Earth. While carbon sequestration accounts for a substantial portion of this value, forests are invaluable beyond this – from regulating both local and regional temperature and rainfall, to the provision of natural products used in treating cancer and other illnesses.  

Protecting intact forests holds much higher value than the commodities that can be exploited from cutting them down. A recent World Bank report suggests that continued deforestation in the Amazon could cost Brazil alone USD 317 billion each year – seven times more than the profits that could be generated from commodities taken from the rainforest.

Built with Indigenous Peoples and local communities front and centre

Indigenous Peoples manage or hold tenure rights to around a third of the world’s intact forest landscapes, yet they receive little recognition or support for their actions. Centring Indigenous Peoples and local communities (IPLCs) in the TFFF is essential for its success. 

At the Brazilian government’s request, a technical working group was established in early 2025 to lead global engagement with IPLCs in co-designing the TFFF’s dedicated financial allocation. Additionally, a Global Steering Committee composed of 17 IPLC organisations was established to guide the design process. The TFFF also commits to establishing robust grievance and redress mechanisms to improve accountability of its operations. 

The TFFF commits to channel a minimum of 20% of forest payments to the Indigenous Peoples, local communities, and other forest owners and stewards that protect the forest, which recognises these critical contributions. 

Forest payments will be disbursed either to national treasuries or to designated public funds of participating countries, depending on each country’s institutional arrangements. However, some groups argue that this funding should be channelled directly to those responsible for forest stewardship.

Global Witness highlights that “the TFFF can only truly respect the long-term interests of forest communities if it treats them as more than beneficiaries and includes roles for their direct decision-making and leadership in the broader fund.” It adds that the TFFF should also support the legal recognition and formal land rights tenure of Indigenous communities. 

A work in progress

Crucial steps remain before the facility can get off the ground. Details of the TFIF shadow credit rating are expected to be finalised in September, and a decision will be made on whether the World Bank will serve as the host of the Secretariat following a meeting in October. A CEO also needs to be appointed to head the TFFF Secretariat.

The WWF has voiced support for the “establishment of a Technical and Scientific Advisory Panel to further refine monitoring and reporting systems” and for the TFFF Board to address this in a timely manner.

Discussions with forest countries, potential sponsor countries, IPLCs, and investors are ongoing. The legal and operational structure of the TFFF is expected to be well advanced for the anticipated launch of the facility at COP30 in Belém. This will be the key moment for tropical forest countries to commit to the TFFF and for investors to pledge financial support. 

As a permanent and long-term financing vehicle, the TFFF will need time to get off the ground. Financial returns and payments to countries will not be immediate. Leonardo Sobral, a forestry director at the Brazilian NGO Institute for Forest and Agricultural Management and Certification (Imaflora), told Mongabay that the TFFF’s “permanent” nature, alongside clear and transparent monitoring methods, could help avoid future setbacks.

  • 1
    The TFFF Concept Note 3.0 states that “The model assumes that all sponsor funds are received at the beginning of the life of the TFIF, although it may be that certain sponsors wish to make contributions over a few years. This would be acceptable if the commitment to fund were made via a legally binding pledge.” This implies that not all financing is needed upfront for the launch of the facility.
  • 2
    The TFFF uses a credit enhancement mechanism that includes a ‘two-tranche structure’ to achieve AAA ratings (the highest credit rating) and attract investors. The USD 25 billion ‘junior tranche’ from governments and philanthropies acts as a protective buffer that absorbs first losses, while the USD 90-100 billion ‘senior tranche’ raised through bonds is shielded from risk. Using statistical simulations to model thousands of investment scenarios, the TFFF found that with at least 18% junior capital, senior investors face less than 1% probability of losses. The contribution by governments and philanthropies is used as insurance to mobilise USD 90-100 billion from pension funds and investors, while the AAA rating ensures the fund can borrow at the lowest possible rates
  • 3
    If there is positive cash flow beyond the payment outflows, the extra capital will be retained in the fund and used to build its asset base.
  • 4
    To put this number into perspective, the Amazon has 650 million hectares of forest.
  • 5
    Because key datasets show deforestation rates of roughly 0.3-0.6%, the TFFF will set an initial entry cap of 0.5% as a representative midpoint. This is intended to prioritise countries with below-average deforestation. The cap will be reviewed after the first three years.
  • 6
    As loss rates surge as canopy cover drops – rising from ~0.3% overall to ~2-3%/year below 50% – a 20–30% canopy-cover threshold targets areas that still qualify as forest but are at demonstrably higher risk of rapid loss, where incentives can have the biggest impact.
  • 7
    The TFFF Concept Note 3.0 writes that these guidelines “may be reviewed and refined over time to reflect improvements in scientific understanding and technical capacities.”
  • 8
    The TFFF Concept note 3.0 writes that “the full exclusion list for TFIF’s investment universe and the respective monitoring mechanism are currently under discussion with the rating agencies.
  • 9
    For example, while the World Bank has ended coal and upstream oil and gas finance, it continues to finance “certain gas projects in the poorest countries in exceptional circumstances”.

Promises and reality of climate finance flows in Latin America and the Caribbean

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This briefing is also available in Spanish.

Key points:

  • Developed nations pledged USD 100 billion annually by 2020 to support developing countries with climate initiatives. This goal was achieved only in 2022, primarily by adjusting existing development finance.
  • Latin America and the Caribbean (LAC) countries face severe climate impacts, including droughts, heat waves and rainfall variability, which affect key sectors like agriculture, mining, and tourism. Economic impacts are significant, with potential GDP losses between 0.8% and 6.3% by 2030, reaching up to 23% by 2050.
  • The Inter-American Development Bank estimates that 7% to 19% of LAC’s GDP (up to USD 1.3 trillion by 2030) is needed for sustainable, resilient growth.
  • Current climate finance flows to LAC are only 0.5% of GDP, requiring an 8-10x increase to meet commitments outlined in Nationally Determined Contributions (NDCs).
  • LAC received 17% of international climate finance between 2016 and 2020, mostly in loans rather than grants, increasing regional debt burdens.
  • Many LAC countries spend more on debt interest than on social and climate expenditures, complicating sustainable financing for climate adaptation and mitigation.
  • Brazil, Mexico, Costa Rica, and Colombia received nearly half of the climate finance directed to the region, focused on mitigation over adaptation.

A little bit of climate finance history and why it matters

As evidenced by the increasing frequency and intensity of extreme weather events worldwide, managing the impacts of climate change requires substantial financial resources, which are out of reach of Global South countries. 

To tackle the challenges associated with financing climate change mitigation and adaptation, developed nations pledged under the Copenhagen Accord (December 2009) and the Cancun Agreements (December 2010) to allocate new and additional funding for climate initiatives in developing countries. Through the Copenhagen Accord, developed economies committed to jointly mobilising USD 100 billion annually by 2020 for developing countries. 

In 2021, during the Parties to the Paris Agreement meeting, the New Collective Quantified Goal on Climate Finance (NCQG) was settled as an upcoming global target for climate finance, expected to establish a baseline of USD 100 billion per year by 2025. This last commitment is expected to be negotiated during COP29 in Azerbaijan in 2024.

These efforts resulted in approximately USD 30 billion through the Fast-Start Finance initiative between 2010 and 2012. In 2022, developed countries provided and mobilised USD 115.9 billion in climate finance for developing nations, according to figures from the Organisation for Cooperation and Economic Development (OECD), finally meeting their annual target of USD 100 billion for climate action two years later than initially planned.

However, there have been some challenges to the OECD’s figures, with other bodies pointing out that some financing was overstated or double-counted with other assistance. The Center for Global Development (CGD) estimated total climate finance in 2022 at USD 106.8 billion, noting that the target was partially met by incorporating climate objectives into existing development finance flows and therefore not “new or additional,” as outlined in the Copenhagen Accord.

According to Climate Policy Initiative (CPI), climate flows continue to “fall short of needs”, particularly in developing and low-income economies and those especially vulnerable to climate change. As of 2023, less than 3% of the global total went to or within least developed countries (LDCs), while 15% went to or within emerging markets and developing economies (EMDEs), excluding China. The ten countries most affected by climate change between 2000 and 2019 – Puerto Rico, Myanmar, Haiti, Philippines, Mozambique, the Bahamas, Bangladesh, Pakistan, Thailand and Nepal – received less than 2% of total climate finance.

Figure 1: Climate finance provided and mobilised between 2013 and 2022

Climate change poses significant challenges  in Latin America and the Caribbean

As a region, Latin America and the Caribbean (LAC) accounts for only 6.7% of global greenhouse gas emissions but is highly vulnerable to climate change. Most countries are located in geographical areas that are particularly exposed to extreme weather events caused by greenhouse gas emissions, including heat waves and significant variability in precipitation levels and patterns. 

The region is also highly dependent on economic activities at risk from climate change, such as agriculture, mining and tourism, creating further economic need for adaptation and mitigation financing. Studies estimate a decline in regional per capita GDP due to climate change impacts ranging between 0.8% and 6.3% by 2030. By 2050, this fall could reach 23%.

Agriculture is expected to be the economic sector most affected by climate change in LAC, facing challenges such as soil erosion, changing rain patterns and pest infestations. This is a significant problem for the region as the World Bank estimates that agriculture, fishing and forestry represent 5.9% of LAC’s GDP in 2023. 

Energy presents another major challenge, as LAC is projected to have one of the highest increases in energy consumption globally, driven by anticipated economic growth. This pending demand highlights the importance of adopting a low-carbon development pathway to supply electricity to the region’s people and industry.

The region’s financing needs are not being met

The region’s financial frameworks are ill-equipped to deal with these challenges. LAC has the lowest levels of public investment globally, hindering its ability to build dynamic, job-creating economies resilient to climate change.

The Inter-American Development Bank (IDB) indicates that addressing the climate crisis in LAC will require annual spending on infrastructure services amounting to 2% to 8% of GDP, alongside 5% to 11% of GDP dedicated to tackling social challenges. Altogether, this would mean redirecting 7% to 19% of annual GDP – equivalent to between USD 470 billion and USD 1.3 trillion by 2030 – toward sustainable, resilient, low-carbon development goals.

The United Nations Economic Commission for Latin America and the Caribbean (ECLAC) estimates that annual investment needed to meet regional climate commitments, as outlined in the Nationally Determined Contributions (NDCs) under the Paris Agreement, ranges between 3.7% and 4.9% of the region’s GDP until 2030. 

ECLAC breaks this total down by type of financing. Mitigation actions related to the energy system, transportation, and deforestation reduction will require between 2.3% and 3.1% of regional GDP annually by 2030. Adaptation efforts, including early warning systems, poverty prevention, coastal protection, water and sanitation services, and biodiversity protection, will require investments of between 1.4% and 1.8% of regional GDP each year until 2030.

These financing needs translate to an annual flow between USD 215 billion and 284 billion between 2023 and 2030. However, climate finance flows to the region amounted to only 0.5% of regional GDP in 2020, requiring an increase of 8 to 10 times to close the funding gap. 

From 2016 to 2020, the region received an average of 17% of international climate finance each year, with 81% of this funding provided as loans rather than grants, further intensifying the region’s debt crisis. Climate action funding is nearly evenly split between public and private sources in LAC, highlighting a strong contribution from private sector players compared to other Global South regions. Africa, for example, gets nearly 90% of its climate financing from public sources.

Box 1: Climate change and debt, interrelated crisis?

According to the United Nations Trade and Development (UNCTAD), global public debt1According to the IMF, public sector debt “combines general government with public nonfinancial corporations and public financial corporations, including the central bank”. It also covers publicly guaranteed debt and external public debt. reached a record of USD 97 trillion in 2023, of which LAC countries account for 17% above the region’s share of the global population at 8.2%.  

The region faces significant debt-related challenges, particularly in light of the increasing financial demands of climate change – including adaptation, mitigation, and addressing loss and damage.

These issues are common across the Global South. Since 2022, interest payments on public debt have grown faster than public expenditures in developing economies: one out of every three countries spends more on interest payments than on social spending (which includes climate investment). 

In 2024, debt servicing is projected to consume 41.5% of expected budget revenue across developing countries. For context, this is a higher proportion than was seen during the debt crisis in Latin America in the 1980s before debt relief was provided.2The Latin American debt crisis was a financial crisis that began in the early 1980s when public debt of Latin American countries surpassed their capacity to generate income, making them unable to repay it. Debt service accounted for 35.3% of national incomes in Latin America in 1981, one year before the debt crisis began.

The reality of financing flows

Between 2013 and 2020, an annual average of just over USD 20 billion was mobilised in LAC to fund climate change mitigation and adaptation, which amounted to over USD 161 billion in this period. 

In 2020, the total reached USD 22.9 billion, representing a 14% increase from 2019 and a 32% increase from 2018, regaining much-needed upward momentum after falling from a 2017 peak. However, this represents only around 10% of the low-end annual total ECLAC estimates will be needed between 2023 and 2030 to meet climate finance needs, highlighting the inadequacies of financing provided and the gap left to fill going forward.

Of the 2020 total – which represented 0.5% of the region’s GDP – 90% came from multilateral development banks (MDBs) and green bonds, adding to the region’s debt burden.

Figure 2: Climate finance for LAC between 2013 and 2023

Climate Funds Update tracks multilateral climate funds, covering the period between 2003 and 2023. Though it does not capture the full financing picture, it is a useful tool to access regional financing over time and at the country level. 

With some exceptions, climate fund commitments have risen from USD 26.8 million in 2006 to USD 902.2 million in 2021, with notable jumps in 2009, 2014, 2018 and 2021, and a short period of declining commitments from 2014-2017. The most recent peak, in 2021, also marks the end of the growth trajectory for financing approvals, which have fallen to USD 311.5 million by 2023 (figure 3). 

The approval-to-disbursed ratio is notably higher during the first years of the analysis, largely tracking approvals through 2014 before falling off through 2017. Recorded disbursements rise in 2018 before tapering off again to very low levels by 2023. However, it should be noted that as well as a delay in disbursement, either as a result of slow contributor disbursal or slow recipient uptake, this may indicate a lack of information on the status of funds after approval.

Figure 3: Multilateral climate change funds for LAC per year

On a national level, climate finance in LAC is heavily concentrated in four countries – Brazil, Mexico, Costa Rica, and Colombia – that receive nearly half of the region’s funding. Mitigation activities – such as forest protection and reforestation – receive over five times the amount allocated to adaptation efforts from multilateral climate funds. Nearly all of this finance has been issued as concessional loans.

  • 1
    According to the IMF, public sector debt “combines general government with public nonfinancial corporations and public financial corporations, including the central bank”. It also covers publicly guaranteed debt and external public debt.
  • 2
    The Latin American debt crisis was a financial crisis that began in the early 1980s when public debt of Latin American countries surpassed their capacity to generate income, making them unable to repay it.

Expanding the contributor base: a solution for all climate finance woes?

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Key points:

  • Countries are set to prepare a new collective quantified goal for climate financing at the climate conference, or COP, in November 2024. This new goal offers an important opportunity to improve the way that climate finance is provided and increase the goal.
  • According to the OECD, developed countries finally met their objective of providing USD 100 billion in climate finance in 2022. However, this goal was not met on time, and the finance provided up until now has frequently been through instruments that are not necessarily adapted to developing countries’ needs.
  • Needs estimates show that developing countries will need at least USD 1 trillion per year to tackle climate change, illustrating the urgent need for increased financing.
  • To fill this gap, some countries and experts have suggested expanding the contributor base to include certain emerging countries.
  • While there is some justification for certain countries to join the ranks of contributors, most of these countries already contribute voluntarily in line with Article 9.2 of the Paris Agreement. These voluntary contributions are an important source of climate finance for developing countries.
  • Our estimates of a potential addition of more countries to the contributor base show that the current financing gap wouldn’t be significantly reduced even if countries voluntarily providing climate finance were to increase their contributions to the current level of developed countries.
  • Efforts to add new mandatory contributors require a broader discussion on the categorisation of countries under the UNFCCC and the Paris Agreement.

Current financing structures found lacking

Climate change mitigation, adaptation, and loss and damage are and will continue to be expensive, particularly for countries with fewer resources at their disposal. The principle of “Common but Differentiated Responsibilities and Respective Capabilities (CBDR-RC)” was enshrined under the 1992 United Nations Framework Convention on Climate Change (UNFCCC) to account for the different historical contributions to climate change and countries’ abilities to support climate action.1Climate Nexus, ‘Common but Differentiated Responsibilities and Respective Capabilities (CBDR-RC)’, 23 March 2017, https://climatenexus.org/climate-change-news/common-but-differentiated-responsibilities-and-respective-capabilities-cbdr-rc/. Developed countries, listed in Annex II of the Convention, were given responsibility for taking significant steps to mitigate climate change and to contribute to funding mitigation and adaptation efforts by developing countries (non-Annex countries).2United Nations, ‘United Nations Framework Convention on Climate Change’, FCC/INFORMAL/84/Rev.1(1992), page 21, https://unfccc.int/sites/default/files/convention_text_with_annexes_english_for_posting.pdf.

A first effort to this end was a goal of providing USD 100 billion per year of climate finance for developing countries by 2020 was set for in the nonbinding Copenhagen Accord in 2009.3UNFCCC, ‘Copenhagen Accord’, FCCC/CP/2009/L.7 (2009), https://unfccc.int/resource/docs/2009/cop15/eng/l07.pdf. This target was only met for the first time in 2022, although the USD 115.9 billion mobilised did represent nearly a 30% increase compared to 2021.4OECD, ‘Climate Finance Provided and Mobilised by Developed Countries in 2013-2022’ (OECD, 29 May 2024), https://doi.org/10.1787/19150727-en.

There is now an opportunity to reinvigorate global climate financing structures and accountability. According to the Paris Agreement, countries should agree to a new collective quantified goal (NCQG) for financial support for developing countries to mitigate and adapt to climate change before 2025.5UNFCCC, ‘Durban Platform for Enhanced Action (Decision 1/CP.17) Adoption of a Protocol, Another Legal Instrument, or an Agreed Outcome with Legal Force under the Convention Applicable to All Parties’, 15 December 2015, https://unfccc.int/resource/docs/2015/cop21/eng/l09r01.pdf. This is a key task for COP29 in Azerbaijan in November 2024. This new goal is meant to be needs-based, and while precise estimates vary, the evidence points to the need for at least USD 1 trillion per year.6Natalia Alayza, Gaia Larsen, and David Waskow, ‘What Could the New Climate Finance Goal Look Like? 7 Elements Under Negotiation’, 29 May 2024, https://www.wri.org/insights/ncqg-key-elements. Because of the scale of the financing required, some experts7W. Pieter Pauw et al., ‘More Climate Finance from More Countries?’, Current Climate Change Reports 10, no. 4 (24 July 2024): 61–79, https://link.springer.com/article/10.1007/s40641-024-00197-5. and countries, including Switzerland, Canada and the US,8Matteo Civillini, ‘Swiss Propose Expanding Climate Finance Donors, Academics Urge New Thinking’, Climate Home News, 16 August 2024, https://www.climatechangenews.com/2024/08/16/as-swiss-propose-ways-to-expand-climate-finance-donors-academics-urge-new-thinking/. have suggested expanding the list of countries mandated to contribute, also called the contributor base, to include emerging countries with high emissions and high incomes.

This briefing investigates estimates of funding needs and the current state of funding from developed and emerging countries to shed light on the potential impact of expanding the contributor base.

How much climate finance is needed?

Several estimates exist on developing countries’ needs for climate finance. The UNFCCC Standing Committee on Finance estimates a total of USD 5.8 trillion to USD 5.9 trillion will be needed to cover the costed needs of 153 developing country Parties, based on its assessment of nationally determined contributions (NDCs). This is likely to be an underestimation given that only a small proportion of needs were costed across the documents provided.9UNFCCC Standing Committee on Finance, ‘Executive Summary by the Standing Committee on Finance of the First Report on the Determination of the Needs of Developing Country Parties Related to Implementing the Convention and the Paris Agreement’ (Bonn, Germany: UNFCCC, 2021), https://unfccc.int/sites/default/files/resource/54307_2%20-%20UNFCCC%20First%20NDR%20summary%20-%20V6.pdf. Regionally, around USD 2.5 trillion of global need comes from African states, around USD 3.2 trillion from Asia-Pacific states and around USD 168 billion from Latin American and Caribbean states.

The Independent High-Level Expert Group on Climate Finance put forward the need for a mix of financing from private and public sources to reach USD 1 trillion per year by 2030 for emerging and developing countries10Excluding China. based on financing needs to transform the energy system and pursue a just transition, cope with loss and damage, invest in adaptation and natural capital, and mitigate methane emissions.11V Songwe, N Stern, and A Bhattacharya, ‘Finance for Climate Action: Scaling up Investment for Climate and Development’ (London: Grantham Research Institute on Climate Change and the Environment, London School of Economics, 2022), https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2022/11/IHLEG-Finance-for-Climate-Action-1.pdf. UN Trade and Development (UNCTAD) takes a different approach, suggesting a contribution of around 1% of gross national income (GNI) for climate finance, adding to the 0.7% of GNI that developed countries are supposed to allocate towards official development assistance (ODA). This would raise total funding to approximately USD 1.55 trillion per year by 2030.12United Nations, ‘Considerations for a New Collective Quantified Goal’ (Geneva: United Nations, 2023), https://unctad.org/system/files/official-document/gds2023d7_en.pdf.

Though the final figure these reports come to varies, in essence they tell us the same thing: at least USD 1 trillion per year will be needed to tackle the climate crisis, far above the USD 100 billion goal previously set.

While numbers this big may appear abstract, the funds they represent have real consequences on people’s lives. In the decade to 2022, heat-related deaths increased by 85% compared to the period from 1991 to 2000. By the end of the century, heat-related deaths will affect 683-1,537% more elderly people than currently.13Marina Romanello et al., ‘The 2023 Report of the Lancet Countdown on Health and Climate Change: The Imperative for a Health-Centred Response in a World Facing Irreversible Harms’, The Lancet 402, no. 10419 (16 December 2023): 2346–94, https://www.thelancet.com/journals/lancet/article/PIIS0140-6736(23)01859-7/abstract. And these are but a small fraction of the many health and economic impacts of climate change, illustrating the imperative to do more, faster.

Tracking climate finance – and accounting disagreements – to date

Developed countries have responsibilities under international law due to their historical emissions and their wealth to contribute financially to developing countries for mitigation and adaptation actions.14However, there is little clarity about which countries are defined as developed under the UNFCCC, leading to difficulties in tracking progress. Indeed, while developed countries are noted as being required to provide climate finance (Article 9.1 of the Paris Agreement), there is no specific delineation of which countries should be considered developed. Because of this lack of clarity, there is a de facto practice of relying on the 1992 country lists, with Annex II being often referred to as the developed country list for finance purposes. Other countries are encouraged to contribute under Article 9.2 of the Paris Agreement but are not required to do so.S Colenbrander, L Pettinotti, and Y Cao, ‘A Fair Share of Climate Finance? An Appraisal of Past Performance, Future Pledges and Prospective Contributors’, ODI Working Paper (London: ODI, 2022), 17, https://media.odi.org/documents/A_fair_share_of_climate_finance.pdf. The amount of climate and development finance provided and mobilised by developed countries15In this case, defined by the OECD as Australia, Austria, Belgium, Bulgaria, Canada, Croatia, Cyprus, Czech Republic, Denmark, Estonia, European Union, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Monaco, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, United Kingdom and the United States. is regularly tracked by the Organisation of Economic Co-operation and Development (OECD). Its calculations show that the USD 100 billion goal was achieved two years late, in 2022, mainly due to increased public climate finance (Fig. 1).16As of the time of writing, the OECD had not released data breaking down specific country contributions, although other authors have put forward estimates. See for example: L Pettinotti, T Kamninga, and S Colenbrander, ‘A Fair Share of Climate Finance? The Collective Aspects of the New Collective Quantified Goal’, ODI Working Paper (London: ODI, 2024), https://media.odi.org/documents/ODI_2024_Fair_share_climate_finance_new.pdf.

Fig. 1: OECD’s recording of climate finance from developed countries, 2013-2022 (USD billion)

Yet this conclusion has been challenged by other sources that contend that much of this financing is double counted with development aid budgets and includes loans, therefore concluding that the USD 100 billion climate finance goal has not been met. Research by Care International found that only 7% of climate finance from 2011 to 2020 was additional to official development assistance (ODA),17Andrew Hattle, ‘Seeing Double’ (Care International, 2023), https://careclimatechange.org/wp-content/uploads/2023/09/Seeing-Double-2023_15.09.23_larger.pdf. while Oxfam calculated that climate finance was overstated by as much as USD 88 billion.18Oxfam, ‘Rich Countries Overstating “True Value” of Climate Finance by up to $88 Billion, Says Oxfam’ (Oxfam GB, 9 July 2024), https://www.oxfam.org.uk/media/press-releases/rich-countries-overstating-true-value-of-climate-finance-by-up-to-88-billion-says-oxfam/.

Even when the OECD figures are taken at face value, they remain under 1% of the combined GNI of the contributing countries, reaching a maximum of 0.21% of their combined GNI in 2022, according to calculations by ZCA using World Bank GNI data and OECD climate spending data (see Table 1).

Table 1: Climate finance from current contributor base as a proportion of GNI, 2013-2022

ODI has calculated whether developed countries (defined here as Annex II countries) have provided their “fair share” of climate finance by looking at their GNI, cumulative territorial carbon dioxide emissions and population.19The calculation methods were established by Colenbrander, S, Y Cao, L Pettinotti, and A Quevedo. ‘A Fair Share of Climate Finance? Apportioning Responsibility for the $100 Billion Climate Finance Goal’. Working paper. London: ODI, 2021. https://media.odi.org/documents/ODI_WP_fairshare_final0709.pdf.The latest numbers referenced here come from L Pettinotti, T Kamninga, and S Colenbrander, ‘A Fair Share of Climate Finance? The Collective Aspects of the New Collective Quantified Goal.’The think tank finds that in 2022 while some countries like Norway, France and Luxembourg are hitting above their weight, other countries like the US, Greece and Portugal are providing less climate finance than they should be. Overall, according to the analysis, 11 out of 23 countries do not provide their fair share towards helping developing countries mitigate and adapt to climate, with the US providing 32% of its fair share, ahead only of Greece (see Table 2).20L Pettinotti, T Kamninga, and S Colenbrander, ‘A Fair Share of Climate Finance? The Collective Aspects of the New Collective Quantified Goal.’

Fig. 2: Developed countries progress towards meeting their fair share of climate financing in 2022 (%)

Another analysis by Bos, Gonzalez and Thwaites roughly followed this formula, with some variation to try to better account for population size and future development, but have nevertheless found that many developed countries are not providing enough climate finance.21Julie Bos, Lorena Gonzalez, and Joe Thwaites, ‘Are Countries Providing Enough to the $100 Billion Climate Finance Goal?’, 10 July 2021, https://www.wri.org/insights/developed-countries-contributions-climate-finance-goal.

Assessments of the quality of finance also show a lack of ambition from contributors. It is estimated that nearly 95% of current climate finance is in the form of debt (61%) or equity (34%), and around 80% of loans are made at market rates, adding to the debt burden of countries already likely to be over-indebted.22Climate Policy Initiative, ‘Global Landscape of Climate Finance A Decade of Data: 2011-2020’ (Climate Policy Initiative, 2022), https://www.climatepolicyinitiative.org/wp-content/uploads/2022/10/Global-Landscape-of-Climate-Finance-A-Decade-of-Data.pdf. The OECD estimates a lower amount, with bilateral finance loans being 79% concessional loans, 41% of multilateral climate funds and 23% for multilateral development banks. The difference can be attributed to differences in definitions of concessionality.OECD. ‘Climate Finance Provided and Mobilised by Developed Countries in 2013-2022’. OECD, 29 May 2024. https://doi.org/10.1787/19150727-en. Among contributors, the instruments used to disburse financing varies, with Japan and France having been found to tend to give proportionally more loans in their financing mix.23Colenbrander, Pettinotti, and Cao, ‘A Fair Share of Climate Finance? An Appraisal of Past Performance, Future Pledges and Prospective Contributors’, 26–27.

As many developing countries are already highly indebted, this form of climate finance can serve to further weaken the macroeconomic stability of developing countries and divert spending from public services. Least-developed countries and small island developing states spent USD 48 billion repaying such loans to G20 countries between 2020 and 2022, and payment amounts have been increasing over time.24IIED, ‘Climate-Vulnerable Indebted Countries Paying Billions to Rich Polluters’ (IIED, 2023), https://www.iied.org/climate-vulnerable-indebted-countries-paying-billions-rich-polluters.

A shortage of financing directed towards adaptation threatens to exacerbate the issue for vulnerable countries that are unable to take measures to protect themselves from extreme weather events caused by climate change without financing and in the face of high debt servicing requirements. As continued fossil fuel use increases the likelihood of extreme weather events, there will be an increasing need for adaptation financing.25Zero Carbon Analytics, ‘Unnatural Disasters: The Connection between Extreme Weather and Fossil Fuels’ (Zero Carbon Analytics, 2024), http://zaerocarbonlive.local/archives/energy/unnatural-disasters-the-connection-between-extreme-weather-and-fossil-fuels. Adaptation received just 8% of global climate finance recorded by the Climate Policy Initiative in 2020, at USD 56 billion out of USD 665 billion, and against USD 589 billion given to mitigation initiatives.26Climate Policy Initiative, ‘Global Landscape of Climate Finance A Decade of Data: 2011-2020’ (Climate Policy Initiative, 2022), https://www.climatepolicyinitiative.org/wp-content/uploads/2022/10/Global-Landscape-of-Climate-Finance-A-Decade-of-Data.pdf. Meanwhile, the UN Environment Programme estimates that there is a need for USD 215 billion per year for adaptation alone.27United Nations Environment Programme, ‘Adaptation Gap Report 2023: Underfinanced. Underprepared. Inadequate Investment and Planning on Climate Adaptation Leaves World Exposed’ (United Nations Environment Programme, November 2023), 35, https://wedocs.unep.org/handle/20.500.11822/43796;jsessionid=AC69CB2C709FC5BC0FB8124E18F1ED1.

Search for solutions to fill the finance gap

In light of these funding gaps, some stakeholders have considered the logic of expanding the funder base to include emerging countries like China, Brazil and Saudi Arabia.28Matteo Civillini, ‘Swiss Propose Expanding Climate Finance Donors, Academics Urge New Thinking’, Climate Home News, 16 August 2024, https://www.climatechangenews.com/2024/08/16/as-swiss-propose-ways-to-expand-climate-finance-donors-academics-urge-new-thinking/. They assert that the high emissions or high GNI of these countries mean they have a role to play in closing the funding gap.

Researchers have used several methods to determine whether emerging countries should be contributing (more) to climate finance, as there is no agreed-upon threshold or metric to determine which countries should be contributors. Most suggested models aim to compare both income and contribution to climate change of potential contributors to existing contributors, using the median values of GNI and emissions for Annex II countries against those of other countries.

ODI researches propose that non-Annex II countries should become contributors under three thresholds related to per capita GNI or emissions in comparison to a minimum number of Annex II countries. Accordingly, ODI suggests that Brunei, Israel, Kuwait, Qatar, Singapore, South Korea and the United Arab Emirates are potentially good candidates to provide funds.29Colenbrander, Pettinotti, and Cao, ‘A Fair Share of Climate Finance? An Appraisal of Past Performance, Future Pledges and Prospective Contributors’.

Another academic article published in 2024 looks at several metrics for historic emissions and capability to pay, as well as institutional affiliation (EU, OECD, G20) and countries’ payments to other multilateral funds. On the basis of these findings, the paper suggests that Czechia, Estonia, Monaco, Poland, Qatar, Saudi Arabia, Slovenia, South Korea, Turkey, and the UAE would be good candidates.30Pauw, W. Pieter, Michael König-Sykorova, María José Valverde, and Luis H. Zamarioli. ‘More Climate Finance from More Countries?’ Current Climate Change Reports 10, no. 4 (24 July 2024): 61–79. https://doi.org/10.1007/s40641-024-00197-5.

Meanwhile, the Center for Global Development creates multiple models to account for responsibility and capability to pay and finds that Mexico, Poland, Russia, Saudi Arabia, South Korea, Taiwan and the UAE should contribute.31Beynon, Jonathan. ‘Who Should Pay? Climate Finance Fair Shares’. CGD Policy Paper. Washington, DC: Center for Global Development, 2023. https://www.cgdev.org/sites/default/files/who-should-pay-climate-finance-fair-shares.pdf.

What could expanding the contributor base amount to?

To add to the analysis above, we have estimated the amount of financing from the combined group of countries frequently mentioned in the literature or in the press, to understand the financial impact if they contributed at the same rate as developed countries. To do so, we first calculated the average climate finance spending of developed countries32The same developed countries were included as those included in the OECD’s calculations, excluding Monaco for which GNI data is unavailable from the World Bank. as a percent of their GNI, using data from the OECD and the World Bank (see Table 1 above). This equalled 0.21% in 2022, the year with the most up-to-date data and when developed countries met their USD 100 billion target.

We then took this percentage and multiplied it by the GNI of each of the candidate countries. This analysis shows that countries that are not required to contribute to global climate finance have nevertheless raised on average almost 30% of developed countries’ spending, according to the latter’s average GNI contributions (see Table 2, column 5), with a total of USD 12.3 billion in 2022. This methodology likely underestimates the amount of finance given by emerging economies as it only considers multilateral development finance due to data availability limitations. Despite not having any requirements to contribute, these countries are already providing finance for climate action.

It also shows that if countries currently being considered as candidates for mandatory spending contributed at the same rate as developed countries actually provided in 2022, this could raise an additional USD 51.19 billion33This is the sum of all the candidate countries, excluding Czechia, Estonia, Poland, and Slovenia as they are already included in the OECD’s calculations for total climate finance and thus any funding would not be considered additional. or 5.12% of the USD 1 trillion minimum needed to meet developing countries’ needs.

Table 2: Estimated contribution of candidate countries’ spending

Like previous analyses, this evidence does not provide definitive answers to the political question of who should be paying more or less to meet global climate finance needs. But it does show that many countries are already stepping up without any binding rules and that mandating an increase of their participation to the current real level of developed countries will likely not make a meaningful dent in the current financing gap.

Therefore, the literature and the additional evidence provided here reinforce the need for more leadership from developed countries.34S Colenbrander et al., ‘“The New Collective Quantified Goal and Its Sources of Funding: Operationalising a Collective Effort”’, Working Paper (London: ODI, 2023), https://media.odi.org/documents/ODI_The_new_collective_quantified_goal_and_sources_of_funding.pdf. As the Centre for Global Development concludes, “the analysis confirms that developed countries should continue to take primary responsibility, with the USA in particular shouldering at least 40% of the burden in virtually every scenario.”35Beynon, ‘Who Should Pay? Climate Finance Fair Shares’, 13. Other experts agree, noting “If we are to timely address the pressing global needs of emissions reductions; adaptation; and averting, minimising and reducing losses and damages, the contribution of developed countries should remain central to any type of agreement around the NCQG.”36W. Pieter Pauw et al., ‘More Climate Finance from More Countries?’, Current Climate Change Reports 10, no. 4 (24 July 2024): 61–79, https://doi.org/10.1007/s40641-024-00197-5, 76.

Moving finance forward

The NCQG offers the opportunity for countries to come together and hammer out details that have until now been left aside. The three questions raised by ODI should be kept in mind during the upcoming NCQG negotiations: “First, how much should each individual developed country be contributing towards this target? Second, which states should be considered ‘developed countries’ for the purposes of climate finance provision and mobilisation? And third, what counts as climate finance and how can we compare countries’ different contributions and commitments?”.37Colenbrander, Pettinotti, and Cao, ‘A Fair Share of Climate Finance? An Appraisal of Past Performance, Future Pledges and Prospective Contributors’, 14.

While ODI and others have started to put together methodologies to define the level of contribution from developed countries based on historical emissions and ability to pay, the second question of clarifying the definition of the contributor base would require the UNFCCC’s annexes to be reworked and clarified. There have been two changes since the original categorisation in 1992: one in 2002 when Turkey was removed from Annex II, and the second when new EU Member States including Czechia and Malta asked to be put on the Annex I list.38W. Pieter Pauw et al., ‘More Climate Finance from More Countries?’

Expanding the contributor base has been a point of discussion since at least 2009, with strong feelings on both sides and a certain level of “arbitrariness” in any outcome.39W. Pieter Pauw et al., 76. Research recommends several ways forward, including creating a net recipients category and a list of countries excluded from giving finance to ease discussions going forward.40W. Pieter Pauw et al. The ODI recommends a similar approach, proposing the creation of a new category called “non-developed Parties” that would not be required to provide climate finance.41Pettinotti, L, T Kamninga, and S Colenbrander. ‘A Fair Share of Climate Finance? The Collective Aspects of the New Collective Quantified Goal’. ODI Working Paper. London: ODI, 2024. https://media.odi.org/documents/ODI_2024_Fair_share_climate_finance_new.pdf.

Beyond ensuring that the high-level target meets developing countries’ needs, it is critical to answer the ODI’s questions above to create accountability for meeting the target and ensure that reported finance is actually going where it is most needed. This includes discussions around loss and damage, which have remained outside of the financing goal up until now, but is a particularly contentious subject for negotiators,42Alayza, Larsen, and Waskow, ‘What Could the New Climate Finance Goal Look Like?’ and on adaptation, which has been neglected in climate financing to date.43Bos, Gonzalez, and Thwaites, ‘Are Countries Providing Enough to the $100 Billion Climate Finance Goal?’ Finally, the question of transparency and tracking of funds is critical to even be able to measure if what is pledged is delivered.44Bos, Gonzalez, and Thwaites.

Reforming climate finance: Unlocking funds from multilateral development banks

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Key points:

  • Multilateral development bank (MDB) funding is one of the fastest-growing sources of climate finance, increasing by nearly 3.3 times between 2012 and 2023.
  • MDBs could unlock hundreds of billions of dollars more in financing if they implemented reforms such as taking on more risk, innovating and boosting transparency, according to a G20 report.
  • Increased MDB funding will likely play an important role in the New Collective Quantified Goal (NCQG) – which will determine the amount of finance developing countries receive for climate mitigation and adaptation.

MDBs could unlock hundreds of billions in climate finance 

Multilateral development banks hold over USD 1.8 trillion in assets globally and play a critical role in climate finance by providing and mobilising funds for climate mitigation and adaptation. In a report published in April 2023, Zero Carbon Analytics highlighted how MDBs, unlike commercial banks, have unique financial strengths such as callable capital and preferred creditor status. However, their capital adequacy frameworks (CAFs), which help them assess whether they have enough capital to absorb potential losses, still don’t fully reflect these advantages. Risk aversion by MDBs, driven by a focus on maintaining AAA credit ratings, limits their willingness to expand lending, holding back billions in climate finance. 

A G20 expert panel found that reforms by MDBs could unlock hundreds of billions of dollars of financing in the medium term, while posing negligible risk to their financial stability.1For more information, see the Zero Carbon Analytics explainer: Climate change requires a new approach from international financial institutions. These reforms include taking on more risk, giving more credit to callable capital, innovating, improving credit rating agency assessments and boosting transparency. This funding could be a step towards the USD 8.6 trillion in funding required annually to implement climate action plans globally by 2030.

MDBs make moderate progress on reforms

The Center for Global Development (CGD) has monitored progress by seven MDBs on several reforms, including the G20 recommendations.2CDG reviewed progress by the African Development Bank, the Asian Development Bank (ADB), the Asian Infrastructure Investment Bank, the European Bank for Reconstruction and Development, EIB Global, the Inter-American Development Bank Group (IDBG), and the World Bank Group (WBG). In April CGD released an update to the tracker which showed that the majority of MDBs have indicated their intention to pursue most of the reform agenda items. In its October update, CGD said it was “a mixed picture, with promising signs of progress in some areas, while other important reforms have not yet been initiated and relatively few reforms have been fully completed.” The think tank added that some MDBs, including the Asian Development Bank and the Inter-American Development Bank Group, had made more progress than others.

At present, the progress the seven MDBs have made in implementing CAF measures could unlock up to USD 357 billion in additional lending headroom in the coming decade. 

However, there are several further actions they could take to unlock further lending. S&P predicted that MDBs could invest USD 500 billion–1 trillion more by revising their CAF policies, while posing no risk to their current credit ratings. While Fitch Ratings found that a dozen MDBs could collectively lend nearly USD 480 billion more before risking rating downgrades. 

Table 1: Progress by seven MDBs on reforms

MDBs’ current contribution to climate finance

MDBs’ current contributions to climate finance falls short of the trillions of dollars required annually to address climate change. In 2022, USD 1.26 trillion was invested in climate finance globally- with MDBs providing 8%3Zero Carbon Analytics estimation based on USD 99.45 billion. of this amount. MDBs’ contribution accounts for about 1% of the USD 8.6 trillion in climate finance needed annually by 2030. However, MDB’s contribution to climate finance is increasing each year. In 2023, MDBs provided about USD 125 billion for climate finance, up 26% from USD 99.45 billion in 2022. The majority of this funding goes to climate mitigation. In 2023, 67% of funding by MDBs went to climate mitigation, while 33% went to adaptation. 

In 2023, 60% of climate finance by MDBs went to low-income and middle-income economies – totalling around USD 74.7 billion. About 63% of this finance was provided in the form of loans4Zero Carbon Analytics analysis based on USD 47 billion (page 55) channelled through investment loans. – in a context where 53% of low-income countries are in or at risk of debt distress.

Figure 1: MDB’s climate finance per region per type of income 
Under-utilised finance tools by MDBs

In addition to the reforms in Table 1, MDBs could make greater use of several financial tools to scale up financing to developing countries. Equity finance currently makes up only about 1.8% of MDBs’ climate finance commitments in emerging markets and developing economies, according to the IMF. Equity finance currently accounts for 1.8% of MDBs’ commitments to climate finance in emerging markets and developing economies. However, equity investments by MDBs could draw in more private finance. Currently, every USD 1 invested by MDBs attracts USD 1.2 of private finance. By increasing equity investment, MDBs can signal to private investors that projects are viable and worth supporting. This can help reduce perceived risks and mobilise significantly more private capital. 

Private sector actors often emphasise that guarantees – where MDBs commit to repaying a loan if the borrower is unable to – are useful for making investments viable as they reduce risk and lower debt costs. Guarantees also have the highest mobilisation ratios, attracting an average of USD 1.5 in private capital for every USD 1 invested by MDBs, outperforming loans and equities by six times. However, despite their effectiveness, guarantees currently only account for 4% of MDBs’ total climate finance commitments. 

Similarly, project development typically accounts for 2-5% of a project’s total cost but can attract 20-50 times more early-stage investment. This leverage effect is critical in mitigating development risk, making early-stage funding more accessible and effective in advancing project viability. MDBs could leverage concessional financing to establish and expand project development facilities that offer technical assistance, advisory services, and customised models to foster earlier investment and help scale investment-ready projects in developing countries. 

Role of MDBs in the NCQG

The NCQG on climate finance is currently being negotiated ahead of COP29 in Azerbaijan. The stakes are high — the outcome of the negotiations will determine the size, contributors to and the scope of the new goal to support developing countries’ climate action. Achieving climate action (a four-fold increase in adaptation, resilience and mitigation compared to 2019), in developing countries excluding China requires additional annual investments of USD 1.8 trillion by 2030, while meeting SDGs needs extra spending of USD 1.2 trillion per year. The G20 expert group recommends channelling USD 260 billion annually through MDBs to achieve the goal, 78% of which should come from non-concessional lending. 

In light of this, the NCQG is likely to target an amount significantly larger than the USD 100 billion climate finance goal set in 2009, according to Boston University’s Global Development Policy Center. It would be difficult to meet the new goal “without major increases in MDB climate finance” the report said. MDB funding is the fastest-growing source of climate finance, increasing by nearly 3.3 times between 2013 and 2022. In addition, MDBs increased the amount of climate finance provided to low-and middle-income economies by over 26% in 2023 from 2022. 

However, researchers have pointed out that while MDB climate finance is likely to play an important role in the new NCQG, it should complement, not replace, grant-based finance. The new NCQG should differentiate clearly between different types of public finance, so the growth in MDB finance does not displace other forms of climate finance.

  • 1
    For more information, see the Zero Carbon Analytics explainer: Climate change requires a new approach from international financial institutions.
  • 2
    CDG reviewed progress by the African Development Bank, the Asian Development Bank (ADB), the Asian Infrastructure Investment Bank, the European Bank for Reconstruction and Development, EIB Global, the Inter-American Development Bank Group (IDBG), and the World Bank Group (WBG).
  • 3
    Zero Carbon Analytics estimation based on USD 99.45 billion.
  • 4
    Zero Carbon Analytics analysis based on USD 47 billion (page 55) channelled through investment loans.

Reforming climate finance: Addressing bias in sovereign credit ratings

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Key points:

  • Changes in sovereign credit ratings influence a country’s borrowing costs from international capital markets. Downgrades in particular can have severe repercussions for a country, making it difficult to source financing for climate mitigation and adaptation.
  • Researchers have raised concerns around countries in the Global South being subject to different standards in rating decisions, and around credit rating agencies (CRAs) potentially exacerbating economic crises. 95% of credit rating downgrades were applied to Global South countries during the Covid-19 pandemic, despite these countries experiencing milder economic contractions than countries in the Global North.
  • Critics of the current rating system have also raised concerns about a lack of transparency in rating methodologies and the potential for conflicts of interest.
  • Climate change could increase annual interest payments on sovereign debt by USD 22 billion–33 billion by 2100, even if global temperature rise is limited to below 2°C. CRAs have started to incorporate climate-related risks in sovereign ratings. However, this has largely had a negative impact on emerging markets, many of which are vulnerable to climate change.
  • The United Nations (UN) has called for the development of ratings that account for long-term factors on a country’s debt sustainability such as climate change and demographic trends, and that positively reflect developing countries’ investments in climate mitigation.
  • Global regulation of CRAs could ensure rating comparability, enforce transparency and evaluate analysts’ expertise. 
Finance will be key at COP29 and biodiversity COP16

Climate finance is set to be a central topic at the United Nations Biodiversity Conference (COP16) and the UN Climate Change Conference (COP29) this year, with Global South countries seeking accountability in financial pledges and access to finance on equitable terms.

This series of reports, titled ‘Reforming climate finance’, illustrates the influence of global financial institutions on high debt burdens and limited access to climate finance in the Global South. The reports examine the financial tools and institutional changes being discussed in international forums to address these challenges.

The series includes briefings on debt-for-nature swaps in Latin America and the Caribbean,  the impact of sovereign credit ratings on highly indebted countries, the inconsistencies between the International Monetary Fund’s (IMF’s) climate policies and conditionalities imposed on debtor countries, and transition finance in Asia.

Sovereign credit ratings influence countries’ borrowing costs

Credit rating agencies (CRAs) play a key role in determining a country’s cost of debt through the issuance of sovereign credit ratings – which measure a government’s ability to repay its debt. Sovereign ratings are used as a benchmark for investors to assess the risks of investing in government bonds. Changes in ratings, such as upgrades and downgrades, affect a country’s borrowing costs from international capital markets and generate market reactions such as price and interest rate adjustments.

Just like corporate and municipal bonds, sovereign credit ratings fall into two main categories: investment and speculative grade. An investment grade rating means a low risk of default (not being paid back), while a speculative grade indicates a higher risk of default.

  • Investment grade: Ratings in this category signal stable economic conditions and sound financial practices. Countries with investment-grade ratings from leading CRAs generally borrow at lower costs, as investors accept lower returns due to the lower risk involved.
  • Speculative or ‘junk’ grade: These ratings indicate a higher risk of default. Countries with speculative-grade ratings face higher borrowing costs because investors demand higher yields to compensate for the increased risk. This can result in higher interest payments on government bonds and potentially affect the country’s economic stability.

Sovereign assessments by the top three CRAs – Fitch, Moody’s and S&P – typically focus on eight key variables: per capita income, GDP growth, inflation, fiscal balance, external balance, external debt, economic development and default history. However, while the CRAs disclose their approach to sovereign credit ratings and these key determinants, these ratings are also based on qualitative factors such as political risk. The qualitative judgments made by the rating committee is a subjective interpretation of softer, less tangible information, and the public has a limited understanding of how this process unfolds. CRAs may also use additional factors that are not explicitly accounted for in the public scorecard. And while the three agencies use similar methods, they operate independently, which can result in differences in approach and rating outcomes for particular sectors or products, even when evaluating the same information.

Sovereign ratings also frequently act as a country-level baseline for corporate ratings. That means that firms cannot receive a higher rating than governments in the country they are based. One study found that this ceiling creates a barrier for private firms and can limit economic growth in regions, as downgrades in sovereign ratings lead to an increase in borrowing costs for companies, even if their financials are strong.

Impact of sovereign downgrades

Several studies have examined the impact of downgrades, many of them focused on emerging markets. The main findings are that downgrades increase borrowing costs, limit a country’s access to international finance markets, have spillover impacts across global markets, and generate financial instability. 

Climate finance

Sovereign credit rating downgrades raise borrowing costs through higher interest rates on government debt, adding to fiscal pressure and potentially limiting a country’s ability to access credit. In emerging markets with “relatively weaker economic fundamentals”, financial stability could become strained following a downgrade, as high debt burdens make them more vulnerable to capital outflows, currency depreciation and inflation. In order to avoid this, governments may adopt policies to address the immediate concerns of private investors, even when these policies conflict with their long-term sustainable development objectives.  

Downgrades may also discourage public investments in renewables and climate mitigation and adaptation due to high interest rates and limited access to credit. Without climate spending, climate impacts such as nature loss worsen. A University of Cambridge study shows that nature loss can trigger further rating downgrades, creating a self-perpetuating cycle. Attracting private finance for climate is also made more difficult due to “the lack of investment grade sovereign credit ratings for many EMDEs [emerging and developing economies]”, according to the IMF.

Sovereign spreads 

One study found a negative relationship between sovereign spreads and credit ratings in emerging markets, with higher ratings being associated with lower spreads, a relationship that has strengthened over the years.1The sovereign spread is the difference between the interest rate on a US treasury bond and a similar bond of another country. This measure is related to country risk: A higher spread implies higher perceived risk. When a country’s credit rating increases (indicating lower risk), its bond spreads decrease, indicating that investors demand less of a risk premium. Conversely, a lower credit rating results in higher spreads, meaning investors demand a higher risk premium.

Spillover effects

Several studies have found that sovereign downgrades have spillover effects across countries and financial markets. Even if an emerging economy is stable, negative sentiment following a downgrade elsewhere might lead to higher perceived risks for all emerging markets, causing rating agencies to take a more cautious approach with others.

This leads to a vicious cycle of market stress, downgrades, and reduced investor confidence in emerging markets.

If there is a price response to the credit rating change – for example from bonds – further outflows of capital may occur. One study found that sovereign ratings in emerging economies impact not only rated instruments – like bonds – but also stocks, and rating changes have spillover impacts to other countries, with neighbouring countries most affected. One study focused on the US and euro area countries found that while asset prices react strongest to other domestic asset price shocks, substantial international spillovers occurred, both within and across asset classes.

These knock-on and spillover effects – the magnitude of which depends on the type of announcement, the country experiencing the downgrade, and the CRA issuing the announcement – can destabilise financial markets by affecting institutional demand and market liquidity and acting as triggers for buying or selling.

Disproportionate impacts

Research shows that downgrades have a disproportionate impact compared to upgrades. One study found that government downgrades and imminent negative sovereign credit rating actions have a stronger effect than positive adjustments on the size and volatility of lending in emerging markets. Downgrades often trigger stronger market reactions because they are perceived as a signal of higher risk, especially in emerging markets where economic stability is more fragile. 

Analysis also shows that the top three CRAs tend to be slow to upgrade sovereign credit ratings compared to downgrading, which are usually faster and deeper. CRAs tend to overreact by downgrading sovereign ratings during periods of economic crisis and instability, while underreacting when upgrading during more stable times. One study found that previous downgrades negatively impacted future ratings, and domestic economic variables have limited influence on the ratings path once a country has been downgraded. This means that once a country is downgraded, it is extremely difficult for them to turn things around.

Critiques of CRAs

Bias against poor and emerging economies

Emerging markets were largely excluded from credit rating processes until the 1990s, with only 12 emerging market nations rated by Moody’s in 1993. In 2003, only 10 African countries were rated by the three top CRAs, but by 2021 that number increased to 31. The UN initially pushed for Sub-Saharan African countries to be included in the credit rating process in order to allow poor regions to access investment from the global bond market – crucial for funding development, infrastructure and economic growth. Many international investors tend to favour rated securities over unrated ones, even when both carry similar levels of credit risk.

However, while the same criteria should be applied consistently for sovereign credit ratings across regions, several studies have found that countries in the Global South have been subjected to different standards by CRAs. One study by researchers in Turkey found that CRAs consistently give higher ratings to developed countries regardless of their macroeconomic fundamentals such as government debt, GDP or inflation rates. They found that ratings often don’t consider the improved resilience of emerging markets to external shocks, and place undue weight on external financial pressures from developed economies. Sovereign risk ratings for emerging markets indicate more risk and volatility than what is seen in their actual market performance, which worsens the perception of instability. 

A later study also found that CRA’s assessments of poorer countries often deviate from the ratings suggested by improvements in their economic fundamentals, creating a self-fulfilling prophecy. Due to lower ratings, countries have to borrow at higher costs, which worsens their financial position and, in turn, could increase the risk of a potential default. This bias has significant implications for the Global South – a ‘junk’ rating limits a country’s ability to borrow and access international financial markets, as investors use sovereign ratings as a key benchmark when looking to invest in emerging economies.

Poor countries held to different standards

Zero Carbon Analytics analysed sovereign ratings for the World Bank Heavily Indebted Poor Countries (HIPC), all in the Global South, and the IMF ‘advanced economies’, all in the Global North, with the highest debt-to-GDP ratios. The analysis showed that the HIPC all had junk ratings despite having lower debt-to-GDP ratios than the top 10 indebted Global North countries, indicating that the HIPC countries are more likely to be able to repay their debts. A junk grade for these countries will increase their cost of borrowing and prevent them from accessing global financial markets and investing in climate mitigation. All the Global North countries, apart from Greece, met investment grade, despite having higher debt ratios. While CRAs consider a multitude of other factors when making sovereign rating assessments, the data shows that countries in the Global South are potentially being held to a different standard than countries in the Global North.

Fig. 1: Sovereign ratings for Global North and HIPC countries with highest debt-to-GDP ratios
Lack of transparency and unsolicited ratings

Researchers have also raised concerns over the lack of transparency in the CRA’s method of assigning ratings. One study by Belgian researchers highlighted that CRAs are not fully transparent in how they assign ratings, and their models often rely on incomplete data for emerging markets, leading to biased results. This creates uncertainty and forces countries into lower-rated categories than they may deserve.

Countries in Africa have also faced downgrades in assessments they did not request or pay for, with unsolicited downgrades adding to their financial burdens. Ghana’s government has raised concerns around unsolicited downgrades by Moody’s and Fitch. The country’s finance ministry said it was “gravely concerned about what appears to be an institutionalized bias against African economies.”

Exacerbate fiscal vulnerabilities during crises

The inability of CRAs to foresee the crises of the 1990s and their downgrades of sovereign credit ratings afterwards led some researchers to argue that they may have exacerbated those crises. The Mexican economic crisis in 1994-1995 “produced the sentiment that rating agencies react to events rather than anticipating them and raised questions about how seriously investors should take sovereign ratings on developing countries,” according to the OECD. A group of researchers found that credit rating agencies may have contributed to worsening the East Asian crisis in 1997–1998 by issuing excessive downgrades, which increased borrowing costs for the affected countries and helped to create a self-fulfilling prophecy. 

Covid-19 Pandemic 

During the COVID-19 pandemic, developing countries experienced over 95% of credit rating downgrades. This is despite Global North countries taking on significantly larger increases in debt and their economic output contracting at more than twice the rate of output contraction in emerging markets and developing economies. Fear of potential downgrades may have deterred some developing countries from participating in official debt relief programs during the pandemic, impacting their long-term debt sustainability, according to the UN.

Fig. 2: Share of the three CRA’s portfolio of rated sovereigns downgraded by at least one notch (Jan 31, 2020 – Feb 28, 2021)

In Latin America, 12 of 18 countries that are rated were downgraded during the pandemic, while four were given negative outlooks.2The 18 countries rated sovereigns by Fitch in the region include Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Suriname and Uruguay. 11 out of the 16 climate-vulnerable Small Island Developing States that are rated also experienced a downgrade or a negative credit outlook from at least one of the major CRAs during the pandemic. 

In Africa, downgrades continued to play a role in post-pandemic economic recovery. In the first half of 2023, 13 negative rating actions — seven downgrades and six negative outlook revisions — were applied to 11 African countries. The CRAs attributed their downgrades, among other things, to a shrinking amount of foreign currency or reserves, increasing debt service costs, and rising interest rates on Eurobonds – making it too expensive for African governments to borrow money internationally. The actions reversed optimism among international investors that African economies were recovering from the pandemic.

Lack of competition and conflicts of interest

S&P, Moody’s and Fitch hold more than 95% of the global credit rating market, leaving little room for competition. This near-monopoly makes it difficult for alternative, regional CRAs to gain traction or offer differing perspectives, particularly in the Global South. Moody’s takeover of Global Credit Rating Company, which has operations across Africa, in July further reduced the diversity of rating perspectives in African markets.

According to a study by researchers in Belgium, there are several potential biases stemming from the business models of the top three CRAs:

  • CRAs used to make money by selling assessments to investors or anyone who paid. But as demand grew for them to cover more regions and do assessments more often, this business model became less profitable. The shift from an “investor-pays” to an “issuer-pays” model, which took place in the 1970s, introduced several risks. In the “issuer-pays” model, bond issuers, who are the clients of CRAs, cover the costs of credit ratings. This can create a conflict of interest, as CRAs might feel pressured to issue more favourable ratings to retain these paying clients. Issuers could threaten to switch agencies or demand better terms if they receive negative ratings, incentivising CRAs to provide ratings that are more positive than they should be. 
  • The ownership structure of CRAs adds another layer of potential bias, as the parent companies of CRAs are sensitive to the investment incentives of their major shareholders and bondholders. CRAs and their parent companies might be motivated to issue upward-biased ratings to benefit their key investors, compromising the objectivity of their assessments.

How to make ratings more holistic and equitable

World leaders are rallying behind international financial system reform to make the system fairer for developing countries ahead of the G20 summit in November in Brazil. The current credit rating system puts Global South countries at a disadvantage, and reforms could provide a more level playing field, according to the UN. Looking forward, climate change could increase annual interest payments on sovereign debt by USD 22 billion–33 billion by 2100, even if global temperature rise is limited to below 2°C.

Incorporating climate risks in a just way

Climate change is already impacting sovereign ratings, with CRAs starting to incorporate climate-related risks and environmental, social, and governance (ESG) factors into their rating assessments. For the Global South, climate and environmental considerations are largely having a negative impact on their ratings, since CRAs do not positively account for investments in climate mitigation. In 2020, Moody’s reported that ESG considerations negatively impacted 60% of its sovereign credit ratings for Global South countries. 

S&P said that future modifications in ratings due to climate change factors would be negative in most cases. These downgrades or negative outlooks could make it difficult for countries to invest in climate mitigation, particularly as CRAs tend to exclude the positive impacts of climate resilience investments in their rating assessments. 

In response to these growing risks, the UN has called for the development of ratings that account for long-term factors on a country’s debt sustainability such as climate change and demographic trends. The ratings should positively reflect developing countries’ investments in sustainability or a robust climate mitigation, according to the UN, since investing early in climate mitigation and adaptation can strengthen long-term fiscal stability and reduce borrowing costs for corporations. “Failing to invest in making economies and societies more climate-resilient undermines future growth, wellbeing, and sovereign creditworthiness,” the UN said.

Global and regional regulation of CRAs 

There is currently no global body that regulates CRAs, and the UN has called for the establishment of a global regulator to ensure rating comparability, enforce transparency and evaluate analysts’ expertise. The global watchdog, which would have adequate representation for emerging and developing economies, should complement national regulators, according to the UN. 

The IMF has also said that “well-crafted” regulation of CRAs could increase investor confidence and boost capital flows and economic growth, adding that a regulatory framework across jurisdictions could promote transparency around rating decisions. Regulation that requires CRAs to publicly disclose their criteria and methodologies for assigning and updating ratings could improve investor decision-making and allow them to assess the reliability of an agency’s analysis. Some progress has been made on the national and regional levels, such as the EU’s rules on CRAs adopted in 2009 in the wake of the financial crisis.

Spotlight on Africa

The United Nations Economic Commission for Africa (ECA) said there is a pressing need for African regulators to develop mechanisms to oversee the work of the CRAs within their jurisdictions. This is especially important, as a United Nations Development Programme study suggests that fairer ratings could save African countries up to USD 74.5 billion, aiding in managing debt and allocating resources for development. 

The ECA highlighted a concerning trend: despite positive economic projections, sovereign credit ratings for African countries are deteriorating. “Moody’s, Fitch and S&P continue to make significant errors in their ratings, yet they continue to influence global financing decisions and flow of capital,” the ECA said. The commission suggested increasing the presence of analysts based in Africa who understand the domestic environment – which could help tackle the challenges around foreign-based assessments. S&P has two offices in Africa – in Cape town and Johannesburg, Moodys’ has one – in Johannesburg, while Fitch has none, according to the CRA’s websites. Johannesburg and Cape Town are among the top three African cities with the most wealthy residents. However, having analysts based in these cities does not necessarily provide the on-the-ground approach necessary to fully understand the socio-economic and risk factors across African countries, which often have vastly different characteristics. Research shows that issuers with analysts located in more distant offices tend to receive more conservative ratings than those with analysts located closer.

The African Union is in the process of establishing a regional credit agency which will aim to provide more relevant and detailed ratings tailored to the continent’s unique economic contexts and support the development of domestic financial markets. It is unclear how effective establishing an African credit rating agency would be in attracting capital, as “target investors tend to assign more weight to reports from the established Big Three agencies” despite claims of bias. However, it offers an alternative for the 22 African countries without international ratings that can’t afford the cost of maintaining ratings from one of the international rating companies.

Lending during crises

To address concerns around CRA’s exacerbating crises by issuing “excessive” downgrades, the UN suggested mechanisms to support countercyclical lending. For example, international financial institutions could provide more favorable lending terms during crises, even if CRAs downgrade a country. It also suggested a more nuanced rating grade, that would soften the sharp divide between investment and speculative to reduce the risks of massive outflows of capital when a country is downgraded.

  • 1
    The sovereign spread is the difference between the interest rate on a US treasury bond and a similar bond of another country. This measure is related to country risk: A higher spread implies higher perceived risk.
  • 2
    The 18 countries rated sovereigns by Fitch in the region include Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Suriname and Uruguay.

Principles for just and equitable oil and gas phase out

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This paper was produced in collaboration with Strategic Perspectives.It intends to contribute to the next steps of the global debate of how to transition away from fossil fuels as agreed at COP28 by proposing scenarios, recommendations and reflections on targets for phasing out the extraction of oil and gas.

Upcoming meetings of the G7 and G20 can discuss what a fossil fuel phase out in “a just, orderly and equitable manner” means, building momentum for countries to include fossil fuel phase out commitments in their updated climate targets, ahead of the climate summit in Brazil in 2025.

Key points:

  • Feasible 1.5°C scenarios require both oil and gas production to decline by 65% by 2050 compared to 2020 levels, but current projected production is set to be 260% and 210%, respectively, above what would be required to keep warming below this.
  • Orderly transition plans for the sector are long overdue, but are the natural next step after the COP28 consensus to transition away from fossil fuels in Dubai.
  • Countries and companies aiming to fully use their oil and gas resources chase diminishing returns and risk USD 1.4 trillion in stranded assets.
  • By delaying a managed decline of fossil fuel production, countries are increasing the costs of achieving a just and equitable transition.
  • Instead of competing for the perceived benefits of oil and gas extraction, countries can collaborate to agree on principles for a just and equitable fossil fuel phase out that reduces the economic and social impacts of any delays.
  • Multilateral forums such as the G7 and G20 are best placed to provide the vision and leadership on how to phase out oil and gas production. COP30 can become a significant milestone to show what a just and equitable transition looks like at a global level.
  • Most approaches to achieve a fossil fuel phase out share significant commonalities around the principles of justice and alignment with the Paris climate agreement and climate science.
  • With USD 2.4 trillion green transition investment required annually through 2030 in emerging and developing economies (other than China), climate finance is the key enabler of phase out planning.
  • All countries should halt the opening of new oil and gas fields while a coordinated global phase out of fossil fuels is negotiated.

The scientific urgency to act

The scientific evidence is unequivocal, the next years are crucial to keep the 1.5°C temperature goal enshrined in the Paris Agreement within reach. The UN’s Intergovernmental Panel on Climate Change (IPCC) has stated clearly that global greenhouse gas emissions need to peak before 2025 and be reduced by 43% by 2030.

Fossil fuels are the major contributors to global warming, a fact finally recognised by all countries at COP28, which agreed to “Transitioning away from fossil fuels in energy systems, in a just, orderly and equitable manner, accelerating action in this critical decade, so as to achieve net zero by 2050 in keeping with the science”.1UNFCCC “Decision CMA.5, Outcome of the First Global Stocktake.” UNFCCC, 2023.

There is a clear urgency to set transition pathways to drastically reduce fossil fuels: Projected cumulative future CO2 emissions from existing fossil fuel infrastructure would already exceed the remaining 1.5°C carbon budget, unless they are abated.2IPPC, “Climate Change 2023: Synthesis Report: Summary for Policymakers.” IPCC, 2023.

Business as usual is thus not an option. To stay within a 1.5°C carbon budget, 40% of ‘developed’ reserves of coal, oil and gas would need to be left unextracted. Developed oil and gas fields alone account for more than four fifths of the 1.5°C budget.3Trout, K. et al. “Existing fossil fuel extraction would warm the world beyond 1.5°C.” Environmental Research Letters, 17, no. 6 (2022).

Oil and gas production should decline by 15% and 30%, respectively, by 2030 and 65% by 2050, compared to 2020 levels, according to analysis of feasible 1.5°C scenarios by the International Institute for Sustainable Development.4Bois von Kursk et al, “Navigating energy transitions: Mapping the road to 1.5°C.” IISD, 2022.

Fig. 1: Oil and gas production from new and existing fields vs a 1.5°C aligned pathway

Existing fossil fuel extraction projects are already sufficient to meet demand in scenarios where warming is limited to 1.5°C.5Green F.et al. “No new fossil fuel projects: The norm we need”, Science, May 2024. Any new oil and gas extraction projects would exceed this, putting the temperature goal of the Paris climate agreement at risk.

Unless meaningful policy measures and finance decisions are taken, governments could produce around 110% more fossil fuels in 2030 than would be consistent with limiting warming to 1.5°C.6SEI, Climate Analytics, E3G, IISD, and UNEP. “The Production Gap: Phasing down or phasing up? Top fossil fuel producers plan even more extraction despite climate promises.” UNEP, 2023. This makes it evident that current trajectories for oil and gas production are completely incompatible with the goals of the Paris Agreement. Instead, all countries can be encouraged to set out their plans to transition away from fossil fuels in their next round of updated Nationally Determined Contributions (NDCs), due in 2025.

Without action, oil and gas production is forecast to be 29% and 82% higher, respectively, than the median 1.5°C pathway in 2030. By 2050, the respective percentages will grow to 260% and 210%.

Fig. 2: Oil and gas production forecasts and scenarios

Defining just, orderly and equitable transition pathways is thus imperative. This discussion is happening at a time when extreme climate events are breaking records, making it evident to citizens and leaders that climate action is inevitable and urgent. These extreme climate events affect vulnerable communities the most and become a great obstacle in reducing inequalities.

The economics continue to be made to favour oil and gas production and consumption. Global fossil fuel subsidies amounted to USD 1.6 trillion in 2022, according to the OECD and IISD.7OECD & IISD “Fossil Fuel Subsidy Tracker.” Accessed June 2024. It is high time to implement the agreement at COP28 to “Phasing out inefficient fossil fuel subsidies that do not address energy poverty or just transitions, as soon as possible”.8UNFCCC “Decision CMA.5, Outcome of the First Global Stocktake.” UNFCCC, 2023.

A transition away from fossil fuels is still hindered by countries each trying to benefit from their resources the longest rather than working towards a collectively managed transition. But this approach is misguided as the economic benefits of fossil fuel production will be limited and diminishing as the energy transition accelerates. If all countries seek to maximise oil and gas production in the face of falling demand, the economic and social costs of the transition will increase.

Oil firms and investors also face significant risks from the energy transition, with the total value of stranded assets under a scenario where warming is limited to 2°C estimated at USD 1.4 trillion.9Semieniuk, G., Holden, P.B., Mercure, JF. et al. “Stranded fossil-fuel assets translate to major losses for investors in advanced economies.” Nat. Clim. Chang. 12, 532–538 (2022).

Instead of competing for the perceived benefits of oil and gas extraction, countries can collaborate to agree on principles for a just and equitable fossil fuel phase out that reduces the economic and social impacts of any delays. Without coordination and effective policies, these climate impacts will end up being disproportionately borne by the poorest, most marginalised and least able to transition. Some initiatives such as the Beyond Oil and Gas Alliance and the Fossil Fuel Non-Proliferation Treaty have proposed approaches to this end.

Multilateral forums such as the G7 and G20 can discuss what a fossil fuel phase out in “a just, orderly and equitable manner” means, building momentum for countries to include fossil fuel phase out commitments in their updated climate targets, ahead of the climate summit in Brazil in 2025. Following the scientific evidence would require immediately halting the opening of new oil and gas fields as a first step.

Methodologies to define a just and equitable transition

A variety of approaches have been identified to achieve a fossil fuel phase out, many of which share significant commonalities around the principles of justice, fairness and alignment with the Paris climate agreement and climate science.10While broad agreement on the importance of an equitable phase out between countries, different methodologies have been proposed for assessing the responsibilities and capabilities of individual countries. Proposed criteria include each country’s development according to the Human Development Index, accrued benefit from past fossil fuels production, historical cumulative per-capita production, GDP per capita, and share of GDP per capita derived from non-oil and gas sectors. See Calverley, C. & Anderson K. “Phaseout Pathways for Fossil Fuel Production Within Paris-compliant Carbon Budgets”, University of Manchester, 2022; Civil Society Equity Review, “An Equitable Phase Out of Fossil Fuel Extraction”, Civil Society Equity Review, 2023; Muttitt, G. and Kartha, S. “Equity, climate justice and fossil fuel extraction: principles for a managed phase out”, Climate Policy, vol 20 (2020); Pye, S. et al “An equitable redistribution of unburnable carbon”, Nature Communications, volume 11 (2020). The majority cite one of the foundational principles of the UNFCCC process – that of common but differentiated responsibilities and respective capabilities.

As an example, assessing countries by their ability to finance the transition – measured in GDP per capita and the extent to which government income comes from oil – shows that countries like the UK, US and Canada would face relatively low challenges to transition (according to these criteria) and have significant financial capacity for it. Whereas countries like Iraq, Congo and Equatorial Guinea face significant challenges and have little financial resources to mitigate the impacts of the transition (see Figure 3).

Fig. 3: Transition capacity of selected countries by GDP per capita and oil share of government revenue

A recent study, endorsed by over 200 organisations including Climate Action Network International and the International Trade Union Congress produced a comprehensive approach to assess which countries are least socially dependent on fossil fuel extraction. The study – the Civil Society Equity Review11Civil Society Equity Review, “An Equitable Phase Out of Fossil Fuel Extraction.” Civil Society Equity Review, 2023. – identifies three criteria:

  1. the share of primary energy consumption that is met from domestically extracted fossil fuels,
  2. the share of government revenues that comes from fossil fuel extraction, and
  3. the share of the workforce employed in fossil fuel extraction.

Underpinning this analysis is the principle that the pace of the phase out should be driven by reducing the social costs and maximising the social benefits of transition, rather than purely by a country’s stage of development or historic responsibility.

The two tables below highlight options of what just, orderly and equitable transition pathways could look like. They can form the basis for a discussion in multilateral forums such as the G7 and G20 and UNFCCC on what criteria should be used to assess a just phase out of fossil fuel production.


Table 1: Equitable oil and gas phase out assessed on country’s non-oil and gas GDP per capita
Table 2: Equitable oil and gas phase out using the Civil Society Equity review framework (selected countries)

The role of financing in the transition

As well as defining what just and equitable approaches mean, agreement on the financial support to get there would be critical to a successful implementation. Multilateral conversations can therefore focus on developing principles and pathways that are just and equitable, matched by financial support for those countries that need it. This would reflect countries’ capacities and constraints, the necessity to provide finance, as well as predictability for workers and communities.

A range of proposals are on the table on climate finance, among them the necessity for Developed Countries (defined as Annex I countries under the UNFCCC) to provide support and the suggestion that countries with the greatest ability to pay (defined as those with per capita capacity above the global average) contribute. More recently, there have been calls for the fossil fuel industry to pay for climate finance, as proposed by the EU, and the idea of a fossil fuel levy by incoming COP29 presidency Azerbaijan.12John Ainger, Jennifer A Dlouhy and Akshat Rathi, (2024, May 30) “COP29 Host Azerbaijan Working on Proposal to Levy Fossil Fuels.” Bloomberg News.

A broader reform of financial systems that includes the international financial institutions is also under way – and will be critical – but progress has been too slow given the resources needed. The economic and financial opportunities resulting from a transition to climate neutrality can only be unlocked in low-income countries with access to sufficient finance and if debt no longer stands in the way of sustainable development.

The scale of existing climate finance is estimated at USD 1.3 trillion annually, according to the Climate Policy Initiative.13Buchner, B. et al, “Global Landscape of Climate Finance 2023.” Climate Policy Initiative, 2023. This is still less than the USD 1.5 trillion paid in direct fossil fuel subsidies among 82 of the largest economies in 2022 (OECD).14OECD, “Cost of Support Measures for Fossil Fuels Almost Doubled in 2022 in Response to Soaring Energy Prices.” OECD, 2023. It is also just over half of the USD 2.4 trillion green transition investment required annually through 2030 in emerging and developing countries (other than China), according to the UN’s high level expert group on climate finance.15Independent High-Level Expert Group on Climate Finance, “Finance for climate action: Scaling up investment for climate and development.” LSE, 2022.

The G20 and G7 can play important roles in the process of creating financial mechanisms to allow low-income and vulnerable countries to decarbonise their energy systems and adapt to the impacts of an increasingly extreme climate. COP29 should result in a new collective quantified goal (NCQG) on climate finance that addresses mitigation, adaptation, and loss and damage.16UNFCCC, “From Billions to Trillions: Setting a New Goal on Climate Finance.” UNFCCC, 2024.

Timelines for planning the energy transition

Managing local needs and collective action requires a combined bottom-up and top-down approach to define a just, orderly and equitable transition away from fossil fuels. The run-up to COP30 is the time to make progress on setting out pathways to transition away from fossil fuels. The G7 and G20 summits in June and November 2024, respectively, offer key touchpoints to lay the foundations for global action on the transition away from fossil fuels. These summits offer the opportunity for major economies to signal their intent to phase out oil and gas production, and begin building international consensus around how to ensure that it is just and equitable.

Agreements at these summits could lay the groundwork for a bottom-up approach, where countries commit to end the expansion of oil and gas extraction, set fossil fuel phase out dates as well as demand reduction goals for 2035 in their next NDCs, to be submitted 9-12 months ahead of COP30.

The top-down approach can be guidance on what “just, orderly and equitable” means internationally, building on the progress made through countries’ individual commitments. It is vital that new, fossil-free economic models are established globally and alternative income sources found for fossil-dependent economies. This approach should also aim to address any shortcomings in bottom-up targets and ensure these are aligned with what is required to limit warming to 1.5°C and achieve a just transition.

The G7 and G20 have an opportunity to give an impetus to this debate, not least as the high-income countries among their members have a historic responsibility to lead on emissions reduction and provide financial support. Their leadership could pave the way for a broader debate and action in the UNFCCC context.

Leadership needed from the G7 and G20

Widespread support for immediate government action to address climate change exists in most countries, with 71% of people in G20 countries agreeing that action is necessary. Concerns about escalating weather extremes, care for future generations, and dissatisfaction with government inaction are significant elements of messages that drive support for climate action. Research indicates majority support for policies like ending fracking (61%) and phasing out fossil fuels (56%) across G20 countries.17Potential Energy “Later is Too Late.” Potential Energy, 2023.

With sufficient global leadership, societal support can be built on the imperative of phasing out fossil fuels to avert current and future climate impacts to protect people and nature. Progressing the debate will be facilitated by global leadership on:

  • Affirming the scientific finding that any new oil and gas projects are incompatible with and threatening the 1.5°C warming goal.
  • Highlighting that both supply-side and demand-side policies need to contribute to a transition away from fossil fuel use, in line with science.
  • Recognising the IEA Net Zero Emissions scenario findings that a number of higher-cost projects would need to be retired before the end of their commercial life due to falling demand in the 2030s.18IEA “Net Zero Roadmap: A Global Pathway to Keep the 1.5°C Goal in Reach.” IEA, 2023.
  • Acknowledging that the UNFCCC must play a vital role in agreeing on terms for a just, orderly and equitable transition away from fossil fuels, in line with climate science, based on principles of common but differentiated responsibilities and respective capabilities; supporting just transitions for workforce; reducing extraction fastest where social costs of transition are least and ensuring respect for human rights and biodiversity.

Furthermore, in terms of practical steps, the G7 and G20 can play a crucial leadership role by committing to:

  • Ending the licensing of new coal, gas and oil projects,
  • Setting clear end dates for coal, gas and oil use per sector,
  • Committing to phasing out coal by 2030 (G7) or 2035 (developing countries) and setting out how much demand and supply will be reduced for coal, gas and oil by 2035 in their upcoming NDCs,
  • Supporting other countries on their just and orderly transition away from fossil fuels,
  • Phasing out fossil fuel subsidies as soon as possible, as agreed at COP28,
  • Showing leadership as the G7 on the overall finance reform to accelerate a just energy transition in low-income countries, especially through access to renewable energy,
  • Using the G20 to set out concrete steps on the financial reforms and financing mechanisms required to share the costs of the transition fairly, committing to scaling up finance as a matter of urgency with tangible outcomes, including through innovative sources of finance such as a tax on fossil fuel companies’ revenues.

Loss and damage funding for Africa will be back on the table at COP28

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Key points:

  • A landmark decision was reached last year at COP27 to create a loss and damage fund to provide financial assistance to countries most vulnerable to climate change.
  • Key details for the fund still have to be agreed on at COP28, and the main hurdle will be ensuring adequate financing is available for vulnerable countries.
  • African countries are disproportionately affected by climate change, with many facing extreme weather events, such as heatwaves and floods, that are increasing in frequency and severity.
  • Weather, climate and water-related hazards in Africa caused more than USD 8.5 billion in economic damages in 2022.
  • Low-income countries can become trapped in a cycle of borrowing and debt that prevents investments in climate resilience and economic development.
  • Malawi faced significant destruction from Tropical Cyclone Freddy in March 2023, with reconstruction costs topping USD 680 million.
  • Climate change impacts in Malawi could result in annual GDP losses as high as 20% by 2040.

Loss and damage fund

At COP27 last year in Egypt, a milestone achievement was reached with an agreement to establish a new loss and damage fund. The fund is aimed at assisting “developing countries that are particularly vulnerable to the adverse effects of climate change”. A committee of developed and developing countries has begun work on the fund, and key details will be discussed during COP28 later this year in the United Arab Emirates. In their last meeting in early November, the committee agreed on a draft proposal for consideration at COP28, that would see the fund housed under the World Bank, with only voluntary contributions.

The debate on what is considered loss and damage, as well as who should compensate for it and how, has been ongoing for decades. While high-income countries are responsible for the majority of carbon dioxide emissions, they have been reluctant to commit to loss and damage funding due to concerns around legal liability.

What is loss and damage?

Loss and damage refers to the inevitable impacts of climate change experienced by the Global South that have not been avoided through mitigation and adaptation due to socio-political or economic constraints, or that cannot be avoided because it is impossible to do so. It may include circumstances such as:

  • Extreme weather or rapid-onset events, such as storms, cyclones, heatwaves and floods
  • Slow-onset events, such as drought, desertification, increasing temperature, land degradation and sea level rise
  • Non-economic impacts, such as loss of cultural heritage, animals, plants and tradition
  • Economic impacts, such as loss of lives, livelihoods, homes, agriculture and territory

Some of these risks can be addressed through adaptation measures. If the measure is not yet available but could become available in the future, the risk is considered to be a soft adaptation limit. An example of this might be the development and implementation of an early warning system for floods in a region that is becoming increasingly flood prone. However, some risks have a hard adaptation limit, meaning the available technologies and actions for averting this risk are not feasible. An example is when an island becomes uninhabitable because of sea-level rise.

It is helpful to think about climate risks as being situated along a continuum of risks that have or will be avoided through mitigation, unavoided risks that cannot presently be avoided or reduced due to socio-economic constraints, and unavoidable risks with hard adaptation limits (see Figure 1).1Adapted from Finance for loss and damage: A comprehensive risk analytical approach. Loss and damage is centered around unavoided and, particularly, unavoidable risks.

Fig. 1: Climate risks along a continuum of avoided, unavoided or unavoidable risks
Source: An introduction to loss and damage, Zero Carbon Analytics, 2022.

Loss and damage in Africa

Despite Africa being responsible for just 3% of all carbon dioxide emissions since the industrial revolution, it is the most vulnerable continent to the impacts of climate change. Nine of the 10 countries ranked as most vulnerable to climate disruptions are in Africa.

The loss and damage costs in Africa are estimated to range between USD 290 billion and USD 440 billion between 2020 and 2030, depending on the level of warming.

In 2022 alone, weather, climate and water-related hazards in Africa caused more than USD 8.5 billion in economic damages. More than 110 million people were affected by weather, climate and water-related hazards in Africa in 2022, and 5,000 deaths were recorded. However, the true toll is likely to be much higher due to underreporting.

Africa is already losing between 5% and 15% of its per capita economic growth due to climate change and related impacts, according to the African Development Bank.2Gross domestic product per capita measures a country’s economic output per person and is calculated by dividing the GDP of a country by its population. Studies estimate that African countries may face a 34% reduction in gross domestic product (GDP) per capita by 2050 on average even if warming is limited to 1.5°C.

The costs from climate change come in addition to the large amounts of funding African countries need for development and debt repayments. “The disasters triggered by the growing climate-related hazards threaten to undo decades of development gains and push millions back to poverty,” according to the United Nations Office for Disaster Risk Reduction.

Malawi’s vulnerability to climate change

Malawi is one of the poorest countries in the world, with over 50% of its population living below the national poverty line, and about 15% of its population experiencing acute food insecurity.3A national poverty line represents the cost of basic needs in a country, while an international poverty line represents the average national poverty line for the poorest 15 countries. The World Bank estimates 72% of Malawi’s population live under the international poverty line of less than USD 2.15 a day.

The southeast African country has contributed less than 0.01% of cumulative global carbon dioxide emissions associated with human activities, but is extremely vulnerable to climate impacts. This is partly because Malawi’s economy is heavily reliant on the agriculture sector, which employs up to 80% of the population. Around 90% of people live in rural areas and are mostly reliant on rain-fed and smallholder farming, which is vulnerable to changes in rainfall patterns and extreme weather.

Tropical Cyclone Freddy

In March 2023, Tropical Cyclone Freddy broke records as the longest-lasting cyclone since weather records began, according to the World Meteorological Organization. Malawi received six months’ worth of rain in six days. The government of Malawi estimates that about 2.3 million people were affected, with 659,000 people displaced, 669 killed and over 500 people declared missing by mid-March 2023.

The housing and transport sectors suffered the worst damage, with more than 260,000 houses affected and damage to road networks limiting relief and recovery efforts. The agricultural sector was also significantly affected, with the loss of crops and expected reduction in output having serious impacts on peoples’ livelihoods and worsening food insecurity.

A post-disaster needs assessment estimated the total cost of damage at USD 507 million, while the total cost of recovery and reconstruction came to USD 680 million – equivalent to almost 6% of Malawi’s GDP. The amount of climate finance received by Malawi – estimated at USD 130 million in 2021 – does not come close to the amount of funding needed for the country to recover and rebuild.

The assessment also highlighted many non-economic impacts, such as the destruction of fragile ecosystems in the districts of Zomba, Chikwawa and Nsanje and damage to cultural heritage sites, including the Mbona Sacred Rain Shrines.

Cumulative impacts

Cyclone Freddy is not a stand-alone event. Climate change induced extreme weather events in Malawi are becoming more frequent and causing losses and damages faster than the country is able to recover from them. Cyclone Freddy was the third extreme weather event to hit Malawi in just over a year, following Tropical Cyclone Ana and Gombe in 2022. The cyclones, as well as Cyclone Chedza in 2015 and Tropical Cyclone Idai in 2019, all led to significant loss of life, livelihoods and damage to infrastructure.4See here for additional case studies on the impacts of tropical cyclone Ana in Mozambique and Malawi.

The cumulative costs of damage and losses from these events came to well over USD 1 billion (Figure 2). When Cyclone Freddy hit, Malawi was still yet to recover from these disasters – alongside the lingering effects of the COVID-19 pandemic, Russia’s invasion of Ukraine, which disrupted supply chains and raised prices, and the deadliest outbreak of cholera in the country’s history.

Fig. 2: Costs of recent extreme weather events in Malawi
Source: Government of Malawi, 2023.

The urgent need for emergency response and rehabilitation efforts in the aftermath of disasters can divert resources away from long-term recovery and development efforts. Frequent and consecutive disasters, like those experienced by Malawi, can deplete financial and natural resources. The government of Malawi said that climate-induced shocks are worsening macroeconomic instability and “making it harder for Malawi to break the cycle of vulnerability”.

The government estimates suggest the country loses an average of 1.7% of its GDP every year as a result of climate change-related disasters. Climate change impacts could result in annual GDP losses as high as 20% by 2040 if Malawi remains on its current low-growth development trajectory, and are likely to exacerbate existing social and economic inequalities, particularly for vulnerable groups. National data has shown that households in Malawi are 14% more likely to fall into poverty after a climate shock.

Debt spirals and climate vulnerability

Analysis by ActionAid found that 93% of countries at the forefront of climate disasters “are drowning in debt”. When countries are hit with natural disasters and do not have the resources to respond and recover, they must borrow money. Finance is largely provided through loans, not grants, resulting in more debt. This often comes on top of existing loans that have to keep being paid back, which can push countries into a costly debt spiral. Borrowing money is expensive due to the perceived risk of lending to countries in crisis. The average cost of borrowing for the group of 58 climate-vulnerable nations is 10.5% – much higher than borrowing costs for developed countries, which is around 3.5%.

Currently, 38 out of the 63 most climate-vulnerable countries are spending so much on debt repayments that they are likely cutting spending on public services. Malawi is no exception – borrowing with high rates has “not only increased debt service costs but has also exacerbated vulnerabilities in public debt and pushed it to unsustainable levels”. Public debt in Malawi reached around 60% of GDP in 2022. Reserving a large part of the budget for debt servicing and disaster response threatens the allocation of funding for building climate resilience and slows progress towards development goals.

Next steps

Key details for the loss and damage fund that still need to be resolved at COP28 include:

  • Where the fund will sit: At its meeting in early November, the transitional committee agreed on a draft proposal that would see the fund sit under the World Bank for at least four years. Developing countries want the fund to be an entirely new mechanism in the hope that this would avoid institutional challenges they face when attempting to access funds. However, developed countries have suggested that housing the fund in an existing entity would avoid delays and the further fragmentation of climate finance.
  • Purpose of the fund: Developing countries agree that the fund should be demand-driven and cover all types of economic and non-economic losses. Some developed countries, such as the US and New Zealand, have suggested a more limited scope: that finance only covers slow-onset events, such as sea level rise, and that it should only cover non-economic loss and damage, such as loss of heritage.
  • How funds will be sourced: The committee’s draft proposal states that contributions towards the fund would not be obligatory. Wealthy countries that have historically contributed the most greenhouse gas emissions would pay into the fund, but there is disagreement over whether other major polluters, such as India and China, and high-income oil-producing states should also contribute. Developing countries agree that loss and damage finance needs to be “new, additional, predictable and adequate” as well as “grants-based”. Ensuring that these funds are not drawn from existing climate financing or overseas development assistance is also a priority.
  • Who will receive funds: Countries agreed at COP27 that the fund is intended to support “developing countries that are particularly vulnerable” to climate change. However, some countries want all developing countries to benefit from the fund while others claim only specific nations, such as Least Developed Countries and Small Island Developing States, should benefit.
Scaling up funding

The key hurdle will be ensuring adequate levels of funds are available to deal with the scale of current and future loss and damage. Estimates of total global costs of loss and damage by 2050 range from USD 500 billion to USD 4 trillion, depending on the level of warming. In 2020, developed countries provided and mobilised a total of USD 83.3 billion in climate finance, with only a quarter of that going to African countries.

Developing countries have proposed that the fund should provide at least USD 100 billion by 2030 as a “minimum”. So far, seven United Nations member states as well as the government of Scotland and the Belgium region of Wallonia have pledged financing, amounting to around USD 294 million, with about 61% of that coming from Germany. Some of this funding comes from existing commitments. 

Previous climate finance agreements, such as the 2009 goal to raise USD 100 billion in climate finance each year by 2020, have fallen short. It is critically important that the global loss and damage fund attracts adequate levels of funding to reinstill trust in international climate negotiations.

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