Bridging the climate finance gap: the big picture4 Three principles can help guide the successful deployment of market mechanisms as consumer behaviour- altering instruments: coherence, fairness and appeal. An emerging conclusion in this paper is that meaningful action on bridging the climate finance gap will require an innovative integration of market and non-market instruments. It demands the design of policies that can mobilize private and public sector funding as part of an ambitious agenda to equitably reduce global dependence on emission- intensive consumption with little to no adverse economic effects. This is a tall order. The scale of the challenge suggests that the majority of the financing to drive meaningful action on climate change must be mobilized from the private sector by deploying incentive-based market instruments that eliminate or significantly reduce the risk associated with climate projects. However, the strategic allocation of public funding also plays a critical role. Carbon pricing instruments, such as the EU-ETS and CBAM, appear to be effective examples – yet these instruments need to be resilient enough to address the often-overlooked misattribution challenge affecting such incentive- based tools. For example, in theory, cap-and-trade – the most significant market instrument currently deployed globally (e.g. China ETS, EU-ETS) – streamlines the vital features that make the implementation of carbon pricing workable. Nevertheless, even if the process generates an “accurate” price signal that can impact consumption patterns significantly enough to achieve policy goals, product price signals by themselves are unlikely to offer the information consumers need to change their behaviour over the long term. This is because the evolution of prices may be due to factors not directly related to the emission-intensity of products, preventing consumers from being able to accurately assess the reasons for price changes in their consumption decisions. This is a crucial issue, because addressing climate change requires consumers to accurately infer the emission-driven costs of their consumption decisions. When this happens, consumers will gravitate towards lower-emission consumption, thus imposing higher risk on emission-intensive production activities. This paper proposes a set of principles that could be applied in developing instruments that can help accelerate the arrival of this future. At the core of the proposed principles is an acknowledgement of the opportunity presented by the combination of a data-rich economic environment, which has emerged in recent years, and an improved understanding of human behaviour. These two factors can help address the practical issues of price discovery, information transmission and consumer engagement. To address these issues, some jurisdictions are considering augmenting their existing upstream carbon pricing schemes with features that engage consumers more directly, or have already done so. Germany introduced a de facto tax of €25/ tCO2e on petrol, diesel, heating oil and gas to ramp up the cost of dirty energy and incentivize greener ways of living, while Canada is examining the implementation of personal low-carbon savings accounts which consumers pay into each time a hydrocarbon-based fuel is purchased. Incentive-based schemes that are well-designed and elicit the expected response from consumers can be expected to lead to an intensification of capital flow towards low-carbon innovation as a result of the elimination of the negative externalities that make low carbon projects financially unfeasible. Germany introduced a de facto tax of €25/ tCO2e on petrol, diesel, heating oil and gas to ramp up the cost of dirty energy and incentivize greener ways of living. Bridging the Gap: How to Finance the Net-Zero Transition 26

Bridging the Gap How to Finance the Net Zero Transition 2025