Negative energy pricing is one of the unintended consequences of many of the initiatives designed to boost renewable energy generation. Substantial declines in emissions from energy generation also depress CFI prices on EU-ETS platforms, thus potentially rendering the EU’s flagship climate change instrument ineffective. The EU-ETS is only effective if its price signals are high enough to drive low-carbon innovation and discourage emissions production. Consequently, there needs to be an emphasis on policy coherence in the development of climate change policy instruments. The EU-ETS is discussed at greater length in Chapter 3.2. Sustainable debt instruments According to the Climate Bonds Initiative, the sustainable debt market reached a cumulative size of $4.4 trillion in 2023. Sustainable debt instruments include the following: –Green bonds: these have thrived due to increasing climate commitments and growing investor demand for sustainable assets.112 Green bonds were the largest category in 2023, at $2.8 trillion in issuance. –Social bonds: these have also gained in prominence, particularly in the context of the post-pandemic drive to address socio- economic disparities.113 Social bond issuance totalled $821 billion in 2023. –Sustainability bonds: these offer a comprehensive approach, funding projects with dual environmental and social benefits. They incentivize issuers to meet specific sustainability targets, reflecting a trend towards outcome- driven finance. Sustainability bond issuance totalled $768 billion in 2023. Despite the strong growth observed in the sustainable debt market, 2023 saw substantial declines in some instruments. Sustainability bond issuance fell by 31% and development bank issuance declined by 71%, reflecting market challenges amid global economic uncertainty.114 However, emerging markets continued to demonstrate resilience, with new issuers such as Saudi Arabia entering the social bond market.115 Sovereign issuances, especially from Mexico and Thailand, played significant roles, while the Latin America and Caribbean region led in sustainability bonds issuances in 2023.116 Nevertheless, the overall plunge in issuances underscores challenges faced in raising climate financing in the presence of inflationary pressures and highlights the need for stronger market incentives and policies to maintain growth. Improving broader economic conditions, comprehensive policy and regulatory frameworks, standardization and transparency will be needed to sustain the market’s growth, maintain investor confidence and market integrity and address other challenges ahead.117,118 Performance-based finance mechanisms Performance-based financing mechanisms enhance accountability by directly tying financial rewards and compensation to the achievement of defined and measurable outcomes, funding recipients incentivized to meet environmental or other targets. Existing performance-based instruments leverage market principles to promote renewable energy, sustainable practices and environmental conservation. Instruments such as power purchase agreements (PPAs) and investment tax credits provide financial incentives linked to measurable outcomes, encouraging efficiency, innovation and investment across various sectors. Collectively, they demonstrate how performance-based approaches can align financial incentives with sustainability goals. Performance-based incentives have been successfully implemented to promote renewable energy and sustainable projects. For example: –Germany’s market premium scheme under the Renewable Energy Sources Act (EEG) provides renewable energy producers with a performance-based premium, incentivizing them to compete to optimize energy generation in line with market demand. –India utilizes solar PPAs with performance- based incentives to drive the scale-up of solar energy. –In the US, California and other states offer performance-based incentives within renewable portfolio standards, rewarding generators for renewable energy output. –South Africa’s Renewable Energy Independent Power Producer Procurement Programme (REIPPPP) ties financial rewards to energy output, to enhance competition and efficiency in the renewables sector. –Chile and Brazil have implemented auction systems where developers bid to supply renewable energy, reducing costs and increasing investment in renewables.119 These examples indicate how performance- based finance can play a transformative role by directing capital towards projects that deliver measurable environmental or social outcomes, thereby enhancing the impact of limited financial The sustainable debt market reached a cumulative size of $4.4 trillion in 2023. Bridging the Gap: How to Finance the Net-Zero Transition 18

Bridging the Gap How to Finance the Net Zero Transition 2025