Public and private sector investment in adaptation

The imbalance in investment in adaptation and mitigation is both well documented and logical. The Multilateral Development Banks, for example, report that 80% of climate finance is tagged as mitigation whilst only 20% is adaptation, and that comes from institutions whose mandate is development. For the private sector, there is no obvious or easy return for investing in technologies that improve public health or air quality, or provide long term flood defenses or irrigation services to subsistence farmers. These are public goods that are traditionally provided by public funds. However, for a developing country, with a limited national budget and more pressing needs for energy, health and education, adaptation projects may have lower priority or be unaffordable. Nevertheless, adaptation projects could be designed smartly to address multiple co-benefits, including for mitigation and sustainable development.

Many (I) NDCs of developing countries and all African NDCs submitted under the Paris Agreement have an adaptation component and emphasize the importance of adaptation. However, some do not specify sufficiently their adaptation ambitions, intended actions and needs for support to attract potential donors. Next to absence of UNFCCC guidance on NDCs, adaptation communications and methodologies for adaptation, some countries may also lack the capacity and tools to quantify adaptation.

As a result, adaptation needs are being very much over-looked in the world’s climate change activities and that spells bad news for Africa, where the need for support is heavily weighted towards adaptation. The GCF has set a target to allocate 50% of its funding to adaptation. Even if successful, a significant gap will remain between needs and support for adaptation.

The Adaptation Benefit Mechanism (ABM), developed by the African Development Bank in collaboration with some African and other developing countries and with support from the Climate Investment Funds and Lancaster University’s Pentland Centre for Sustainable Business, is a deliberate attempt to redress this imbalance. The basic principle behind the design of the ABM is that the Private Sector does not invest in adaptation because there is no price signal for adaptation. Back in the 1990s, the Private Sector did not invest in mitigation either, but the Kyoto Protocol and the EU Emissions Trading Scheme soon changed that. The result of a USD10 per tonne price signal for verified and issued Certified Emission Reductions (CERs) triggered a USD500 billion pipeline of Clean Development Mechanism (CDM) projects.

The mitigation price signal was driven by the Kyoto Protocol which set absolute targets for developed countries. The Paris Agreement does not set such targets – there is no definition of a commodity and the targets are country-driven. There are no quantified targets for adaptation either, so why would any buyer offer a price signal and what would happen if there was a price signal?

The most obvious buyers of Adaptation Benefit Units (ABUs) would be developed country governments who have a target to transfer climate finance, capacity-building and technology to developing countries. The ABM provides an efficient, transparent and credible means for climate finance in return for verified adaptation results. Less obvious buyers would be national and international organizations with Corporate Social Responsibility policies. Purchasing ABUs would offer CSR buyers a fresh and “human” alternative of verifiably helping real people adapt to climate change, whilst also helping host Governments to achieve their NDCs under the Paris Agreement by leaving mitigation and development co-benefits in the host country. Impact investors, nature and culture-based organizations and philanthropists may also find the ABM attractive for the same reasons.

Since the market for ABUs is not a commoditized market, and under the proposed design ABUs are not fungible with one another, the price of an ABU would depend on the cost of creating the units and the project costs for the Project Developer. If a Project Developer were to agree a price and sign an offtake agreement for ABUs with a reputable buyer (for example a Government or a multinational corporation), priced in a hard currency, the contract would represent a new and valuable source of cash flow against which capital could be borrowed from, for example, a development bank or a local commercial bank. With a new source of debt and a now commercially viable proposition, project developers can unlock equity, bring technology and expertise, apply their entrepreneurial skills to overcome barriers and deliver widespread adaptation results in an efficient manner.

These funds could turn a non-viable project, such as connecting households to renewable energy mini-grids in Sub-Saharan Africa into a commercially viable operation that not only delivers adaptation benefits to the households, but also helps the host government to achieve its NDC under the Paris Agreement and deliver on multiple development objectives and the Sustainable Development Goals. Interestingly, mini-grids and many energy projects are traditionally viewed as mitigation projects but, in many developing countries for the individuals concerned, the adaptation and development benefits of connecting a house to a source of electricity far outweigh the mitigation benefits.

This model does not need to be restricted to private sector finance. Public sector and domestic funding can likewise participate in financing adaptation projects under the ABM. Institutional investors may find it a good way of opening up new long-term investment opportunities.

In its simplest terms, the ABM builds upon some of the good experiences with the CDM – the CDM was a transparent and credible way of generating units, which were recorded in a registry and sold to buyers for compliance or voluntary cancellation. The ABM would also achieve transparency and credibility through generating units with a number in a registry. The key difference would be that for ABM there will be no speculation or significant secondary market, which in turn would simplify the process substantially.

The ABM has been programmed for discussion by Parties to the Paris Agreement with a view to its establishment at CoP23. If established, it would be a concrete step towards stocking the (empty) toolbox of mechanisms under Article 6 of the Paris Agreement and a transparent and credible way of transferring public and private sector finance for adaptation to developing countries.