Economics for the Earth Blog

A Struggle for the Soul of the GCF

Posted Nov. 20, 2012 / Posted by: Karen Orenstein

Existential crises usually kick in mid-life, as one wakes and wonders: what is my purpose in life? Why am I here, and where am I going? Though still in its infancy, the Green Climate Fund, a new institution of the United Nations Framework Convention on Climate Change, is confronting such profound questions.

As board members of the Green Climate Fund roll up their sleeves to begin critical preparatory work ahead of their first meeting in 2013, they will have to very soon answer a key question to define the soul of the GCF: Is the primary purpose of this new institution to best serve the needs of peoples in developing countries, and their environment, as the world heads full throttle into a climate crisis? Or is its purpose to attract high levels of private finance, given the magnitude of the climate problem? To be sure, these goals are both important. And though they are not always mutually exclusive, they are also certainly not the same.

This fundamental question about the vision of the GCF has still to be thoroughly debated, let alone resolved. Yet the Board has already placed the private sector facility at the top of the agenda for its next meeting, and the facility is among the top two indicative priority issues in the fund’s work plan through 2013.

For those unfamiliar with what is meant by “private sector facility,” you are not alone. At this point, the only parameters to go by are a few sentences in the GCF’s governing instrument:

The Fund will have a private sector facility that enables it to directly and indirectly finance private sector mitigation and adaptation activities at the national, regional and international levels. The operation of the facility will be consistent with a country-driven approach. The facility will promote the participation of private sector actors in developing countries, in particular local actors, including small and medium-sized enterprises and local financial intermediaries. The facility will also support activities to enable private sector involvement in SIDS [small island developing states] and LDCs [least developed countries]. The Board will develop the necessary arrangements, including access modalities, to operationalize the facility.

What the private sector facility will be, in practice, is very much up for debate.

A Misalignment of Needs

The argument -- made by some -- that the GCF should serve primarily as a scale-up tool to help mobilize a trillion-plus U.S. dollars in private finance is misaligned with the need of the GCF to serve those who are most vulnerable to the impacts of climate change.

Adaptation -- an area rich in helping the most vulnerable but poor in attracting for-profit ventures -- would likely be seriously sidelined were attracting private finance the primary objective of the GCF. Without rigorous intention to prioritize adaptation, which already only receives a pittance, we would see an even greater neglect.

There may be more money to be made in mitigation, but low income countries are far less likely to have high mitigation potential (least developed countries have among the world’s lowest per capita greenhouse gas emissions) and economies of scale big enough to attract much private finance. Thus, a private finance-focused GCF would largely bypass the energy needs of low income countries.

And where would “loss and damage” in developing countries stand if a premium were to be placed on leveraging private finance? (Loss and damage refers to the swath of permanent loss caused by the impacts of climate change.) The incredible price tag resulting from “natural” disasters, now front and center in the aftermath of tens of billions of dollars of damage caused by superstorm Sandy and the large government -- i.e. public -- response needed to address its carnage, should give us all pause.

Deciding how to channel tens of billions of dollars that will hopefully one day flow through the GCF is a process that needs to start with the question of what people in developing countries need most. The chair of the Least Developed Countries Group recently elaborated some of these needs in an open letter to U.S. President Obama. Priorities include:

… moving drinking water and irrigation wells away from coasts, where saltwater is intruding into aquifers; it includes developing drought-resistant crops and helping small farmers in fragile, semi-arid regions survive. We have to prepare roads and cities, villages and farms for floods, hurricanes and heat waves. We need to equip people with the weather prediction, early warning systems and emergency response that citizens of the developed countries take for granted.

To answer questions around what the business model for the GCF should be, and what role the private sector facility should play, the Board should start by asking how the GCF can serve the waste picker in Bangladesh, the slum dweller in Kenya, the farmer in Bolivia and the fisherfolk in the Caribbean.

This approach does not necessarily leave out the private sector, but it doesn’t assume that the private sector will be at the center. It is thus unwise to put leveraging private finance at the heart of the GCF, and it seems especially unwise to launch a private sector facility with its own governance structure, separate from the Board of the GCF, that would include board seats with voting rights for the private sector, as some have suggested.

And here’s why shooting the private sector facility up to the top of the GCF’s agenda is especially worrying:

An Inconvenient Truth: Lessons from past attempts to mobilize private finance

Extensive evidence is lacking -- in the fields of development finance and carbon finance -- to demonstrate the private sector’s efficacy in generating pro-poor, climate friendly investment. After all, private finance is motivated first and foremost by profit. Thus, larger projects in middle income countries are the most likely to garner private investment. This is evident in the investment patterns of the International Finance Corporation, the private sector lending arm of the World Bank Group, which has been held up by some as a model for the GCF. In 2012 less than 29 percent of IFC investment went towards the poorest countries (i.e. IDA countries, those targeted by the World Bank’s lending window for the poorest countries).  Indeed, 37 percent of all investment in 2009 went to Brazil, India, Russia, China and Turkey alone. The World Bank Group’s own Independent Evaluation Group found that of the IFC projects it examined, only “13% of projects had objectives with an explicit focus on poor people."

Similarly, over 75 percent of all projects in the pipeline of the Clean Development Mechanism, which is supposed to generate climate-friendly development, in 2012 were located in China, India, Brazil and Mexico. Not surprisingly, the CDM is strongly biased towards large-scale projects that produce large numbers of credits. Smaller-scale projects, which would be more likely to have sustainable development benefits, would not generate offsets as cheaply.

It is thus difficult to drive private investment towards poorer countries and towards marginalized communities within middle income countries, where there is generally higher risk but also higher need. It is especially challenging to direct private investment toward local companies in low income countries. If the GCF were to adopt an IFC model, as some have suggested, the Board would have to think carefully about whose economies the GCF would be growing. Though small and medium enterprises in poorer countries are most subject to credit scarcity and high borrowing costs, they are also traditionally the least served by the IFC. Of that institution’s investment in low income and lower-middle income countries from 2006 to 2011, only 2.4% went to small and medium enterprises, and all of that money was channeled through financial intermediaries. The European Investment Bank fared even worse, with only 0.4 percent of investment in non-European countries directed to small and medium enterprises from 2007 to early 2012.

Furthermore, experience at the IFC strongly suggests that efforts to crowd in private finance will result in the prolific use of financial intermediaries, which is likely to undercut the implementation of environmental, social, accountability and fiduciary standards. (Financial intermediaries may include, for example, commercial and investment banks, private equity and venture capital funds, microcredit institutions, insurance and other financial institutions which, in the case of the GCF, would ostensibly invest money in developing countries in climate-friendly sub-projects.) At the IFC, the financial intermediary usually assesses, monitors and reports on itself. Neither the IFC nor the financial intermediary provides much public information about high risk sub-projects; information about the locations, sectors and names of the projects is shared once a year. Further, no information is made public about medium-risk projects. The outsourcing of development finance through financial intermediaries has led to a deterioration of transparency, civil society and community consultation and consent, as well as the implementation of environmental, social and fiduciary safeguards.

The take-home lesson for the GCF is that the greater the use of financial intermediaries, the more intrinsically difficult it will be to ensure implementation of and compliance with environmental and social standards. Similarly, the financial sector’s desire for less disclosure, liability and accountability for the environmental and social outcomes of their transactions will pose a significant challenge for GCF efforts to promote sustainable development and climate effectiveness in the use of climate funds.

You can read more about this here -- Leveraging Private Finance: Lessons for Climate and Development Effectiveness

Photo: President of South Korea addresses a reception at the Green Climate Fund Board meeting, October 2012.

Leveraging private finance: Lessons for climate and development effectivenesss (Factsheet)

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