Climate finance innovations: 5 transformative approaches
· 14 min read
As the urgency to mitigate climate change and adapt to its impacts intensifies, the world faces a critical challenge: mobilising sufficient capital to finance the ecological transition. This necessitates innovative solutions that can bridge the gap between traditional finance and the unique needs of more climate-conscious projects.
This two-part article, collaboratively drafted by BASE’s specialists of diverse backgrounds and experiences, looks into five transformative climate finance innovations poised to play a pivotal role in unlocking new sources of funding for green, blue and, more generally, sustainable projects. From sustainability-linked loans and bonds to impact investment funds and blue finance, these approaches offer a glimpse into the future of climate finance, where innovative financial instruments and strategic partnerships pave the way for a more sustainable and resilient global economy.
This first chapter features a detailed introduction to three of these innovations:
The size of the impact investing market currently stands at USD 1.16 trillion in assets under management, of which just under 40 percent is directed to developing countries. In comparison, the financing gap to achieve the Sustainable Development Goals (SDGs) targets in developing countries amounts to about USD 4 trillion. Current funding for climate mitigation and adaptation remains well below the scale needed to meet the current and future challenges of the environmental crisis, but impact investors can play a key role in mobilising capital for climate change solutions in developing countries.
An impact investment fund is a type of investment vehicle that seeks to generate positive social or environmental impact alongside financial returns. Impact investing aims to allocate capital to projects, companies, or organisations that address sustainable challenges while making a profit. Social goals typically include poverty alleviation, affordable housing or healthcare access, while environmental objectives can be related to sustainable agriculture, energy access, or cleaner energy technologies. Assessing the effect of financing is a core aspect of impact investing, and funds utilise various methodologies to track their contributions and measure the potential benefits created. This type of facility brings together individual and institutional investors pursuing both financial returns and a positive impact.
Impact funds help mitigate investment risks associated with sustainable solutions by leveraging their expertise, conducting thorough due diligence, and maintaining diversified portfolios. Indeed, these firms specialise in evaluating sustainability-focused investments, considering both financial viability and impact potential. By spreading investments across sectors, geographies, and asset classes, impact funds reduce the risk of any single investment underperforming. Furthermore, they usually prioritise impact measurement and reporting, establishing clear metrics to assess the social and environmental performance of their portfolio companies. Such transparency enables investors to monitor progress, make informed decisions, and manage risks effectively. Additionally, impact funds often provide valuable support, including mentorship and access to networks, to their portfolio companies.
Impact funds can act as “anchor investors” and help to mobilise other investors by demonstrating trust in the projects. This can be especially important in developing countries, where perceived risks may deter investments.
By combining public and philanthropic funding with private capital, blended finance can bring multiple benefits to impact investment funds. It can significantly contribute to de-risk investments by providing guarantees, hence unlocking new capital by attracting hesitant private investors. Moreover, as public and philanthropic funding is generally impact-focused and subject to strict management transparency requirements, it helps ensure investments’ impact and focus on delivering positive outcomes.
Sustainability-linked loans and bonds (SLL/Bs) are innovative sustainable finance products that allow borrowers to access more affordable financing against the condition they pursue and successfully achieve sufficiently ambitious and quantifiable environmental and social impact. Indeed, under SLL/Bs, the price of financing (i.e., the margin or coupon) depends upon the reach of predetermined sustainability performance targets (SPTs) measured using one or more key performance indicators (KPIs).
Such ‘sustainability-linked’ products are distinct from ‘use of proceeds’ products, such as Green bonds or social loans, which offer funding exclusively directed towards either or both green and social projects. In the case of SLL/Bs, the financial resources can be applied indistinguishably, and beneficiaries can unlock benefits in the interest rate if specific milestones related to sustainability are met in the determined period. Therefore, the scheme offers affordable finance and flexibility to the borrowers regarding the use of the provided funding. For private financial institutions, offering SLL/Bs represents an effective tool to transition their portfolio of investments towards ESG goals while creating a new revenue stream and contributing to readiness towards future sustainable banking regulations.
SLL/Bs are also proving to represent an effective tool to finance sustainability-related endeavours. In such a case, since the financing is not tied to a specific project, this flexibility empowers borrowers to determine the most effective means of achieving their goals. For instance, if a company requires a loan to enhance the energy efficiency of its operations up to a measurable KPI, an SLL allows its management to investigate and decide whether upgrading equipment, reinforcing insulation, improving processes or any other measures would represent the best solution to improve performance. In this respect, SSLs also promote a technology-agnostic approach and, more generally, foster openness to a diverse range of solutions when employed for sustainability actions.
Moreover, by offering SSLs instead of conventional loans, financial institutions empower companies to make environmental or social progress, stimulating a transition in the case they were not initially focused on attaining such objectives. Indeed, the possibility of reducing the interest rate provides a strong incentive to pursue sustainable practices and obtain tangible outcomes. In the experience of BASE, SLLs granted to private financiers by multilateral institutions act as strong levers for actions aimed at enhancing organisational strategic transformation that has an impact on their portfolios, activities, clients, and therefore the real economy.
For these reasons, and due to the increasing demand for sustainability impact reporting, SLLs are gaining significant attention in the financial sector. The main risks inherent to this model revolve around a failure to achieve the predetermined targets, which results in a credit cost increase for the borrower, and a lack of transparency on the measurement and communication of KPIs, which can cause friction between both parties and generate reputational damages. To address these, lenders typically hire external validation firms to develop credible and robust targets measurable against an assessed baseline. Such external reviewers are also in charge of verifying the indicators on a regular basis.
Our oceans and waterways are some of the lifeblood of our planet. They generate over half the oxygen we breathe and are considered “the world’s greatest ally against climate change” by the UN as they represent the largest carbon sink on Earth. Additionally, they constitute vital resources for food and medicine. However, human activities like pollution, overfishing, and global warming are pushing our oceans to a tipping point.
In this context, the Blue Economy, and more particularly Blue Finance, constitutes an emerging field of climate finance gaining significant attention from global investors and international organisations. It presents interesting opportunities to protect clean water access, preserve underwater environments, and foster a sustainable water economy. The ocean economy is projected to double to USD 3 trillion by 2030, generating employment for 40 million people. Innovative financing solutions, such as Blue Bonds and Blue Loans, can play a crucial role in supporting various initiatives aimed at protecting, restoring or sustainably managing water resources and their ecosystems.
Blue Bonds and Blue Loans are pioneering financial instruments that raise funds specifically earmarked for investments in areas such as water and wastewater management, reduction of ocean pollution (including plastic and chemicals), marine ecosystem restoration, sustainable shipping, blue food production and trade, eco-friendly tourism, and offshore renewable energy. Providing clear guidelines and criteria to assess the impact of projects is key to making investments as beneficial as possible.
To this aim, organisations such as the International Finance Corporation (IFC) are developing guidelines and taxonomies to promote transparency and integrity in financing blue economy projects. Drawing upon the Green Bond Principles (GBP) and the Green Loan Principles (GLP), which set such recommendations for projects focusing on fostering “a net-zero emissions economy and protecting the environment”, the IFC produced the Guidelines for Blue Finance, providing an additional framework focusing on the blue economy. To qualify as ‘Blue Eligible’ according to IFC’s standards, an activity must not only align with the above-mentioned green bonds and loans principles but also contribute to one or both of the SDGs related to water resources: SDG 6, “Clean Water and Sanitation,” and SDG 14, “Life below Water.” Additionally, it should present minimal risk of hindering progress on other SDGs.
Development banks and agencies are already working with various stakeholders in all geographies to develop a systematic global blue economy finance market. By offering technical assistance to private banks, working with national regulators to create new financial products, and setting standards to identify opportunities, multilateral organisations are paving the way to realise the potential of investments to have a meaningful impact on our planet’s waters.
Taxonomies are classification systems that categorise economic activities, assets, or investment projects, based on their alignment with sustainable objectives, such as the SDGs, national goals (i.e. the Nationally Determined Contributions (NDCs)), or the Paris Agreement. Taxonomies establish eligibility criteria, developed by sector specialists and industry experts, to ensure that any particular activity substantially contributes to at least one of its goals (e.g. climate change mitigation, climate change adaptation, biodiversity, circular economy, etc.) while not significantly harming any other. A Green Taxonomy focuses on climate and environmental objectives while a Sustainable Taxonomy includes objectives beyond green and encompasses social objectives.
Such tools bring certainty and transparency to financial markets, encouraging investment in sustainable activities and enabling better tracking of financing flows for sustainability. By offering precise and consistent definitions, Sustainable Taxonomies aim to create reliable, legitimate, unified, and science-based classification systems, reducing the risk of greenwashing and ensuring that sustainability claims are substantiated.
The development trajectory of taxonomies for sustainable financing has focused first on climate change mitigation, with the development of so-called ‘Green Taxonomies’. Since then, additional eligibility criteria have been added progressively to cover all the other aspects of the environmental crisis. For instance, BASE was involved in the development of categorisation systems facilitating investments in local projects contributing to the circular economy in Colombia, Peru, and expanding its work to include Chile, Costa Rica and Uruguay. The transition from a linear to a circular economic system not only contributes towards reducing emissions but also helps address the pressing issue of waste pollution while bringing economic and social positive impacts.
By 2023, more than 35 green and sustainable taxonomy projects have been initiated worldwide, as reported by the United Nations Environment Programme Finance Initiative (UNEP FI). China became in 2015 the first country to adopt a green taxonomy, which currently provides a “white list” of activities and asset types considered “green”. Other influential taxonomies include the Climate Bonds Initiative’s (CBI) Green Bond Taxonomy, the Sustainable Taxonomy of Mexico, and the EU Taxonomy for Sustainable Activities. While these taxonomies can present some differences, they typically share a common foundation.
For example, the CBI Taxonomy, initially published in 2013, offers a general description of sectors and activities, employing a traffic light system to indicate which activities, assets, or projects automatically comply with the taxonomy based on specific criteria. The EU Taxonomy follows a comparable approach, although it uses quantitative metrics and screening criteria. In 2022, Colombia became the first country in the Americas to publish a Green Taxonomy, which includes land management as a notable innovation. Mexico’s Taxonomy, published in 2023, distinguishes itself by considering social objectives alongside environmental objectives, encompassing gender equality and access to basic services related to sustainable cities.
As common denominators, these taxonomies typically share: 1) accelerating the growth of green finance as the primary objective; 2) banks, financial institutions, financial regulators, policymakers and investors as main users; 3) sectoral scopes tailored to the specific needs of the target users; and 4) addressing local environmental objectives in addition to climate change.
To better support the development of such instruments, frameworks building on the common characteristics of already developed taxonomies can be created. To tackle the lack of comparability between national taxonomies in the Latin American region, UNEP FI created the “Common Framework for Sustainable Finance Taxonomies for Latin America and the Caribbean”, that aims to ‘serve as a catalyst for progress towards sustainable finance implementation, providing LAC member states a regional alignment approach to unlock opportunities and financing for long-term value creation, shared prosperity, and sustainable development in the region.’ The Guide to Developing National Green Taxonomy developed by the World Bank serves as another main reference.
Taxonomies serve as a shared language, defining terms related to sustainability and providing a common understanding for investors and companies alike. Disclosure standards, on the other hand, build upon this language by specifying the information companies must report. This allows investors to assess the climate-related risks and opportunities associated with a company’s activities. In simpler terms, taxonomies are the building blocks, while disclosure standards are the instructions that ensure investors get a clear picture of a company’s sustainability efforts. Together, these tools play a vital role in promoting transparency and facilitating informed investment decisions.
In 2015, the Task Force for Climate-related Financial Disclosures (TCFD), founded by the Basel-based Financial Sustainability Board (FSB), emerged as a game-changer. This voluntary framework provides a set of recommendations for investor-grade risk disclosures on climate change. Designed for use across all industries and jurisdictions, the TCFD promotes consistent and comparable climate-related disclosures by companies. This focus on consistency aimed to push companies to dwell on their climate-related risks and opportunities, and accordingly account for these factors into risk management, strategic planning, and decision-making.
The benefits of disclosures have a ripple effect beyond a company’s internal functioning and reputational value. As both companies and investors gain a deeper understanding of the financial implications of climate change, markets become better equipped to channel investments towards sustainable solutions, resilient business models, and emerging opportunities. The TCFD framework outlines 11 recommended disclosures categorised under four key areas: Governance, Strategy, Risk Management, and Metrics and Targets.
Financial institutions shoulder an additional, crucial responsibility. Beyond disclosing their own climate risks, they must also consider the climate risks associated with the companies they invest in.
In 2020, a consortium of five standard-setting organisations—the Carbon Disclosure Project (CDP), Climate Standards Disclosure Board (CSDB), Global Reporting Initiative (GRI), International Integrated Reporting Council (IIRC), and Sustainable Accounting Standards Board (SASB)—signalled their intention to work towards enhancing corporate reporting to complement financial reporting regarding sustainability. Notably, during these early years, the primary focus of sustainability information was to enhance economic decision-making for enterprise value creation. However, over the past four years, the conversation has rapidly evolved to encompass a broader perspective. Now, it not only considers economic impact but also the environmental and social impacts of an organisation (often referred to as “double materiality”) and its contribution to achieving sustainable development.
These organisations spearheaded efforts to push for robust sustainability reporting alongside financial disclosures. They pursued this goal through both independent research and collaborative initiatives. A key milestone was the merger of SASB and IIRC to form the Value Reporting Foundation (VRF):
Another significant development was the Corporate Reporting Dialogue, which included CDP, CSBD, GRI, ISO, SASB, and IIRC (detailed timeline available here). Ultimately, these efforts culminated in the establishment of the International Sustainability Standards Board (ISSB), now a reference. This comprehensive and globally relevant body aims to provide a standardised baseline for sustainability disclosures within capital markets through its IFRS Sustainability Disclosure Standards.
This standardisation directly addresses the prior issue of fragmented frameworks, often referred to as the “alphabet soup,” which caused confusion regarding adoption and implementation. In essence, the IFRS standards represent a harmonisation of existing frameworks, rather than an erasure of previous work. As a result, companies and capital markets will face reduced complexity and lower costs when applying and using sustainability-linked information.
Before delving into how they facilitate interoperability with other sustainability reporting frameworks, let’s first examine what the IFRS standards entail. This will provide a foundational understanding before we explore how they assist companies in streamlining their sustainability reporting processes and disclosures. As of now, the IFRS sustainability standards consist of two parts: IFRS S1 and IFRS S2.
How, then, does IFRS build upon its predecessors? Notably, IFRS S2 mandates industry-specific disclosures, where it leverages illustrative guidance derived from the SASB Standards. These industry-specific climate-related metrics enhance comparability for investors by aligning with existing industry benchmarks.Furthermore, companies adhering to the IFRS automatically fulfil, and often exceed, the recommendations set forth by the TCFD. One example of how IFRS surpasses TCFD recommendations lies within the “Risk Management” category. While TCFD focuses on a general description of risk identification processes, IFRS S2 delves deeper. It mandates the disclosure of detailed information regarding these processes, including specific data sources, assumptions employed for risk identification, and the role of climate-related scenario analysis. Additionally, companies must report changes made to their risk identification and management processes compared to the previous year. This increased level of granularity provides investors with a clearer picture of a company’s approach to managing climate-related risks. Moreover, companies transitioning from TCFD can seamlessly integrate their existing efforts with IFRS by utilising the IFRS-TCFD interoperability guide.
This article is also published on energy-base.org. illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.
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