Bridging the Gap How to Finance the Net Zero Transition 2025

Developed countries fulfilled their pledge to mobilize $100 billion in climate finance for developing nations in 2022.9 Nevertheless, the scale of the financing required for mitigation and adaption efforts, limited government budgets and competing priorities imply that public funding alone is inadequate for addressing climate change challenges in middle- and low-income countries. Enhanced public financing mechanisms are crucial, but so is the engagement of the private sector. Unfortunately, private investors often hesitate to commit capital to climate projects due to perceived risks, uncertainty regarding returns and insufficient policy support.10 This reluctance is compounded by high capital costs, political and regulatory unpredictability and the complex landscape of climate finance, which includes inadequate project pipelines and fragmented financial systems.11,12 Nevertheless, investors prioritizing short-term returns over long-term sustainability goals remain, perhaps, the most significant impediment to investments in climate-friendly projects, including innovative or unproven yet promising technologies. To make long-term commitments, investors require stable and predictable policies, which are often lacking in many developing countries and regions. Pervasive institutional weaknesses in some developing countries can lead to higher perceived risk, thus deterring private sector investment in otherwise impactful climate-related projects. Although this is not an issue plaguing only developing countries, the effects in this context are more acute when considered in tandem with other socio-economic challenges they may face. In addition, while many developing countries have broad targets in their Nationally Determined Contributions (NDCs), they lack specific plans and detailed energy transition strategies to achieve them. Absence of clarity in national plans and stable regulatory frameworks make it difficult to attract international investment and secure long-term private sector engagement. Private investors willing to engage in projects with higher risk profiles require higher rates of return – and this could ultimately make such projects unviable when assessed using conventional mean-variance optimization assessment methods. For emerging economies with other and arguably more pressing priorities, this almost certainly limits the availability of funds for both mitigation and adaptation initiatives, exacerbating the challenge of attracting sufficient investment to address climate change where the need is greatest. The challenges posed by these issues are reflected in the shortage of well-conceived and bankable projects that can attract investment. Reports suggest that many projects lack necessary feasibility studies, technical assessments or clear business models, making it difficult even for donor organizations to commit funds.13,14,15 There is a dearth of the institutional capacity and technical expertise required to design and implement bankable climate projects in some developing countries. Even when commitments for provision of financial assistance, technology transfer and capacity- building support from donor organizations are a near-certainty,16,17 the lack of proficiency in project preparation and knowledge of how to access and utilize climate finance remain concerns. Furthermore, the disjointed global financial system – arising from geopolitical constraints and lack of coordination among funding sources – creates inefficiencies, particularly for developing countries. Lack of coordination among multiple potential funding sources can cause difficulty in mobilizing and deploying funds effectively, resulting in underinvestment. This fragmented climate finance landscape also suffers from a lack of standardized metrics and methodologies for measuring and reporting financial flows, introducing unhelpful opacity and unaccountability. This complexity, combined with insufficient expertise to navigate the landscape, can constrain private sector investment and impede the effective leveraging of resources.181.2 What are the drivers of the climate finance gap? There is a dearth of the institutional capacity and technical expertise required to design and implement bankable climate projects in some developing countries. The climate finance gap between developed and developing countries is striking. Developed nations benefitted from 44% of the total tracked capital in 2021-22 while emerging markets and developing economies (EMDEs), excluding China, received only 14%, according to the Climate Policy Initiative’s Long-Term Climate Risk Index. Although the investment in EMDEs has increased sharply in recent years, the 10 most climate change- vulnerable developing countries received just $23 billion between 2000 and 2019, less than 2% of the total capital outlay.19 1.3 Developed versus developing countries: an enduring gap in fortunes Bridging the Gap: How to Finance the Net-Zero Transition 6