Bridging the Gap How to Finance the Net Zero Transition 2025

Executive summary This white paper addresses the funding gap in the transition to net zero. It aims to define the climate finance gap and explore its drivers, including the fragmentation in both climate policy-making and the global financial services sector. It explores how the gap affects developing and developed countries differently and the role of “common but differentiated responsibilities and respective capabilities” in potentially ameliorating the developing-developed country divide. Additional factors contributing to the climate finance gap include insufficient public funding, limited private sector engagement, high costs of capital in developing economies, political and regulatory uncertainty, inadequate project pipelines and the complexity of climate finance mechanisms and initiatives. The paper reviews the financial and economic mechanisms for addressing the funding gap. It specifically considers: –Use of strategic policy levers to effectively mobilize transition finance. –Market-based instruments to address the negative externality effects of climate change and eliminate the market failure it engenders. –Hybrid mechanisms that combine non-market and market principles to mobilize finance. Furthermore, it discusses specific flagship hybrid instruments from the European Union (EU), including the European Green Deal, EU Emissions Trading Scheme (EU-ETS) and the Carbon Border Adjustment Mechanism (CBAM), as well as the US Inflation Reduction Act. It describes and critically reviews the essential elements of these mechanisms, outlining the challenges they may face in achieving their stated objectives. Against the backdrop of this analysis, the report concludes by outlining a set of principles for the design of instruments to address the climate finance gap. It argues for policy-makers to exploit the expansion in economic, financial and other data generation in an increasingly digital world to craft innovative instruments that eliminate risk factors impeding the flow of critical capital to low-carbon innovation and climate projects. It further advances an ambitious agenda that establishes coherence, clarity, fairness and appeal at the heart of climate change policy instruments’ design. Gbenga Ibikunle Professor and Chair of Finance, The University of Edinburgh; Founding Director, Edinburgh Centre for Financial Innovations, United Kingdom Bridging the Gap: How to Finance the Net-Zero Transition 4