Financial Innovation for Climate Adaptation in Africa
Global Center on Adaptation
Current adaptation finance flows to Africa are insufficient to meet growing the climate adaptation needs on the continent.
This report provides an overview of existing adaptation finance flows in Africa and identifies opportunities to increase the volume and efficacy of that finance. The core objectives of this report are to:
Assess the state of adaptation finance and risk-finance mechanisms already available and in use in Africa.
Analyze African financial market readiness for climate adaptation finance and risk finance mechanisms.
Identify gaps where climate risk exists yet there is insufficient finance to address it, as well as the barriers to implementation.
Propose solutions to increase the volume and variety of capital available for adaptation finance and risk transfer mechanisms in Africa and to enable pipelines for adaptation and dual benefits projects in the region.
More than half (27) of the world’s 40 most climate-vulnerable countries are in Africa and climate-related disasters are increasingly common: Southern Africa has been exposed to prolonged drought conditions since 2018, cyclones impacted 3 million people in Mozambique, Malawi, and Zimbabwe in 2019, and locust swarms in 2020 caused severe crop destruction across Ethiopia, Somalia, and Kenya, compounding existing food insecurity and economic pressure from the COVID-19 crisis. The COVID-19 pandemic has resulted in Africa’s worst recession in more than half a century. Real GDP contracted by 2.1% in 2020 and lasting impacts of the pandemic could drive 40 million additional people into extreme poverty. Amidst this prolonged economic challenge, the increasing intensity and frequency of extreme weather events and chronic climate-related stressors continues to threaten livelihoods, ecosystems, and communities, reversing progress made on sustainable development goals.
Financial Flows to Adaptation in Africa Fall Far Short of Needs
There is a pressing need to increase investment in climate change adaptation. While only six countries have submitted National Adaptation Plans (NAPs) to date, all African countries, with the exception of Libya, have submitted nationally determined contributions (NDCs), all of which include an adaptation component. Based on these NDCs, the top three priority sectors for adaptation across all African regions were 1) agriculture, 2) water, and 3) either health or forestry, land-use, and ecosystems. 40 African countries provided estimated investment needs for adaptation, totaling roughly USD 331 billion through 2030. Fifteen countries provided a breakdown of conditional vs unconditional cost estimates, with an average ratio of 80:20. An average 80:20 ratio indicates that of the USD 331 billion estimated investment need (or USD 33 billion annually), countries expect to contribute around USD 66 billion (or 6.6 billion annually) from their national budgets, while the remaining investment gap of USD 265 billion (or 26.5 billion annually) must be met by international donors and domestic and international financiers.
Globally, an annual average of USD 30 billion in adaptation finance was tracked for 2017 and 2018, mostly provided by public actors (DFIs alone accounted for 67 percent of the total). Due to data limitations, nearly all flows tracked are from international public finance. Just over USD 6 billion was tracked in adaptation finance to Africa in that period. If this trend continued through 2030, total finance from 2020-2030 would only amount to USD 66 billion, far short of the USD 331 billion (or approximately USD 33 billion annually) in estimated needs per stated cost estimates in NDCs. Adaptation finance is therefore scaling too slowly to narrow the gap while the costs of climate impacts rise.
Of the USD 6 billion in adaptation finance tracked, grants and concessional debt accounted for approximately 90% of financial flows to adaptation in Africa. Two sectors – agriculture, forestry, land-use, and natural resource management; and water and wastewater management – combined to receive 62% of total adaptation finance in 2017-18. These results are consistent across African sub-regions. The majority of finance flowed from Development Finance Institutions (DFIs) both from the region and external to Africa: multilateral, national, and bilateral DFIs contributed and managed 67% of total adaptation finance flows to the region, followed by bilateral government flows at 19%. The most vulnerable countries in Africa have not been recipients of proportionally high volumes of adaptation finance. There is limited to no correlation at the country-level between climate vulnerability and adaptation finance overall or per capita.
Impacts of the COVID-19 Pandemic on Adaptation Flows
The COVID-19 pandemic creates significant uncertainty in future adaptation flows, as well as opportunity to catalyze resilient recovery. A comprehensive dataset for 2019 and 2020 is not yet available. In particular, the impact of COVID-19 on adaptation finance is not yet well understood. Key factors likely to impact the volume of 2020 adaptation finance flows and in future years are as follows.
Inclusion of resilience in stimulus packages is limited. In an upcoming study, the World Resources Institute reviewed 66 countries’ – including all G20 and V20 countries – 2020 fiscal stimulus packages for whether and how they included climate resilience. Less than one-third (18) of the countries’ responses that were examined were found to integrate physical climate risk awareness and resilience components – including just two African countries: Niger and Kenya. This limited inclusion of resilience in stimulus packages suggest that there is a potential missed opportunity to ensure that climate risks are considered in new funding allocations. Beyond the limited inclusion, the overall size of stimulus packages in developing economies has been much smaller than those in developed economies, with middle income countries spending 6% of GDP and low-income countries spending 2%, vs 24% of GDP spent in high income countries, in 2020.
Private sector investment has declined in the short term. Although capital outflows stabilized relatively soon after hitting record lows in March 2020, foreign direct investment (FDI) declined 16% in 2020 in Africa, to USD 40 billion, a decline to 2005 levels of investment. Liquidity support for firms was also largely not conditional on adopting any climate resilience measures. Given the potential for private sector investment in adaptation activities, robust flows of foreign direct investment and domestic private investment are critical to maintain a high baseline for potential adaptation mainstreaming.
The COVID-19 pandemic continues to severely impact developing economies. Just over 50 million doses of COVID-19 vaccine have been administered across a continent with a population of 1.3 billion. As of June 2021, less than 1% of Africa’s population had been fully vaccinated. Adaptation finance flows in future years will depend heavily on vaccine distribution speed and equitability to enable recovery of sectors critical to Africa’s macroeconomic prospects including international trade and tourism.
Multilateral Development Bank (MDB) adaptation finance commitments to Africa increased substantially in 2020 from 2019 levels. The group of MDBs reported USD 4.7 billion in adaptation finance committed to Sub-Saharan Africa in 2020, vs USD 3.6 billion in 2019. For Middle East-North Africa, USD 1.4 billion was committed in 2020 vs USD 1.0 billion in 2019. It is not clear if this increase is sustainable without re-capitalization or replenishments of MDB funding, which was spent quickly to counter the effects of the pandemic. For example, the 32% increase in adaptation finance commitments across the two regions is roughly proportional to the total increase in MDB commitments in 2020, estimated at 39%.
MDB climate finance targets are increasingly targeting adaptation. In 2019, nine MDBs announced a collective commitment to double their total levels of adaptation finance provided to clients by 2025, to USD 18 billion annually. Towards that end, the World Bank announced a 35% target for climate finance as a proportion of total finance from 2021-2025, of which at least 50% will support adaptation. The African Development Bank (AFDB) has committed to a target of at least 40% for climate finance by 2025, a doubling of climate finance to USD 25 billion between 2020 and 2025 and to prioritizing adaptation finance.
The IMF is firmly committed to deal with climate risks by integrating climate in their economic and financial services. In addition, a proposed allocation of Strategic Drawing Rights (SDRs) of $650 billion would benefit all IMF members, including in Africa, and could support a global green and resilient recovery. A group of Development Finance Institutions is collectively advancing adaptation finance efforts. Under the Adaptation & Resilience Investors Collaborative, members are advancing a set of actions to accelerate finance to adaptation and resilience. The group has made commitments including to pursue a substantial increase in investments in adaptation and resilience, to move towards ensuring all investments made have assessed and are resilient to climate risks, and to increase support and collaboration to shape markets and build pipelines of bankable investments in climate adaptation.
New innovative models are being launched to address the gap. For example, the Global Center on Adaptation (GCA) and the AfDB have jointly developed the African Adaptation Acceleration Program (AAAP). The AAAP was launched at the Climate Adaptation Summit in January 2021 and aims to mobilize USD 25 billion towards adaptation activities in Africa by 2025. AfDB has committed USD 12.5 billion to the AAAP with the remaining USD 12.5 billion to be mobilized through partnerships and domestic resource mobilization through national governments and the private sector and will be centered on four action areas:
Innovative financial initiatives to enhance access to finance and mobilize new investment in adaptation activities through support to the development of debt instruments in viable markets and training programs to increase technical capacity in climate risk assessment and financial structuring.
Climate smart digital technology for agriculture and food security to help smallholder farmers increase yields and drive climate resilience in the agriculture sector.
An African Infrastructure Resilience accelerator to mobilize investment in climate resilience infrastructure through project preparation initiatives and innovative finance mechanisms including debt-for-resilience swaps.
Youth empowerment in entrepreneurship in climate adaptation and resilience with the aim to generate climate resilient jobs for youth and to strengthen your entrepreneurship via an incubator program and training programs.
With appropriate policy approaches, there is substantial potential for a green and resilient recovery. There are efforts underway to drive a resilient recovery to COVID-19 in Africa – including through the Debt Service Suspension Initiative, the Access to COVID-19 Tools Accelerator, and through moves to issue and allocate new Special Drawing Rights. These efforts all have potential to help facilitate a resilient recovery and additional investment in climate adaptation. A resilient recovery also has potential to address challenges Africa faced prior to COVID-19 including youth unemployment, high climate risks, poor infrastructure, and weak governance. Investment in climate resilient infrastructure, nature-based solutions, technology, and other sectors has significant potential to address underlying climate risks and respond to pre-COVID-19 challenges.
Diversifying Finance Sources for Adaptation Investment
Future adaptation finance for Africa is expected to more than double by 2025 based on announced commitments discussed above. However, even if many of the main DFI actors adopted best practice commitments (similar to World Bank’s commitment to dedicate 35% to climate finance, of which 50% to adaptation) and if currently announced private sector mobilization efforts are successful (assuming at least 20% of MDBs’ USD 40 billion private sector mobilization target goes to adaptation in Africa), annual adaptation finance flows may still not meet minimum estimated investment needs by 2025.
To mobilize further investments and to increase the impact of investments in terms of building resilience, a wider variety of sources of finance need to be tapped. Public spending alone cannot meet the adaptation finance gap, so private sector investment must scale alongside public investment to supplement limited public resources. These actors offer financing along a spectrum of terms, ranging from highly concessional terms (lower return expectations and/or longer tenors) to commercial terms (market returns and tenors expected). Concessional capital is intended to fill a gap where the private sector (commercial capital) would not otherwise invest.
Barriers to Investment in Adaptation
There are cross-sectoral barriers as well as sector-specific barriers hindering investment in adaptation activities. These include:
Inadequate risk-adjusted returns
Complexity of project due-diligence
Limited capacity to collect and analyze relevant climate data
Lack of municipal/subnational implementation capacity
Policy and regulatory barriers
Limitations in aggregation
Variability of climactic conditions within a single project
Public sector nature of the sector
Need for regional coordination
Risk attitudes of decision-makers
Lack of subnational fiscal autonomy
Multi-stakeholder solutions can create complexity for channelling funding
A Three-Pronged Investment Strategy
Mainstream Resilience into Investment Decision-making
Many investors are already engaged in investment that has significant relevance to adaptation goals – but their investments are not yet climate resilient. For example, a multinational corporation investing along an agricultural supply chain or an infrastructure investor building a water treatment facility will be operating in a sector with substantial climate risk but may not be screening for climate risk nor mitigating that risk. For example, the Infrastructure Consortium for Africa (ICA) finds that water infrastructure sector commitments totaled USD 13.3 billion in 2018 in Africa. This compares to the USD 1.2 billion tracked in adaptation finance to the water sector in the same year – suggesting that a significant proportion of finance to the sector is not climate resilient – or at least has not been rigorously assessed for physical climate risks or only is MDB finance that does not meet the MDB definition of adaptation finance.
To enable financial institutions to mainstream resilience into the investments they are making, the following steps are critical:
Increase access to robust climate data: There is a critical lack of climate data in many parts of Africa which limits adaptation projects and leads to uncertainty about the optimal approach. The poorest countries have the most significant lack of climate data: either they are post-conflict or fragile states, or simply do not have the funding and technical resources to develop climate data such as groundwater baseline data, 24–48-hour precipitation data, and forward-looking climate projections. Lack of past and current hydromet data particularly hinders design of some types of adaptation activities and finance instruments. Resilience bonds or results-based performance instruments for example, require disaggregated data across hazards, exposures, and vulnerabilities to accurately inform risk assessments and track impact. Concessional funding and grants are needed to increase climate information collection, accessibility, and technical capacity to utilize the information. The ability to access and use climate information is critical for project implementers seeking funding for climate adaptation projects. Without robust climate information on hazards, exposures, and vulnerabilities, implementers in Africa are stuck in a vicious cycle where they cannot prove the adaptation-relevance of a project – and are also unable to access finance that would help them collect and utilize that climate information. More targeted concessional finance and grants, from DFIs, donor governments, and foundations are needed to support policy makers and other implementers in collecting and providing access to sufficient data, as well as support collaboration and training on open-source models that can utilize the data. Across the board, there should be an emphasis on increasing access to high resolution climate data at low cost so that implementers may undertake climate risk assessments as a basis for future adaptation planning.
Incubate technical expertise in financial structuring: Adaptation work requires blending of public, private, domestic, and international finance and therefore calls for substantial financial engineering expertise. Donors are also increasingly requesting quantitative adaptation metrics, including data on physical infrastructure. It is very difficult to assess what volume of adaptation finance is needed and where it should be directed, due to the shortcomings of our current approach to aggregating adaptation finance flows. Policymakers should prioritize development of frameworks for measuring adaptation progress at the global level. This step will be especially critical to drawing in the private sector and to developing a more robust analysis of investment gaps in terms of direct impact on resilience outcomes.
Pension funds should be engaged through appropriate financial instruments: Pension funds are instrumental in mobilizing long-term saving and can support long-term investments. However, traditionally they have low risk appetite due to liquidity requirements. The percentage of people covered by pension schemes has reached about 80% in some North African countries while it is still as low as 10% in Sub-Saharan Africa. Pension funds are especially strong in South Africa, Botswana, and Namibia per their assets-to-GDP ratio. Total assets under management in 12 emerging markets in Africa are close to USD 400 billion. Reports suggest that the assets-under-management of African pension funds were expected to rise to USD 1.1 trillion by 2020.
Build capacity of African financial institutions and government entities to evaluate and act on climate risks: A concerted effort should be made to increase membership of Pan African Banks, locally based pension funds, and national development banks in international financial initiatives such as the UN Principles for Responsible Investment and Banking, and the International Development Finance Club – and to provide these institutions with the resources to participate actively. Capacity building is also crucial to strengthen African financial institutions’ capacity to access finance from Climate Funds through pre- and post- accreditation support. National Designated Authorities (NDA), Direct Access Entities (DAEs) and the other Accredited Entities (AEs) also require technical and institutional capacity building to build project pipelines and proposals to the GCF. These needs are especially acute in the most vulnerable countries where access to international climate finance is also difficult. The support of International Accredited Entities and readiness programming is crucial in strengthening the DAEs and NDAs to achieve the goal of bottom-up, country-driven approach of mobilizing adaptation finance.
Require disclosure of climate risks – via national legislation and/or via DFI on-lending. Domestic financial regulators in Africa should consider requiring financial institutions to disclose climate-related risks in line with the Task Force for Climate-related Financial Disclosures recommendations. Moody’s has found that the 49 banks it rates across Africa have more than USD 200 billion in lending across sectors with high potential climate risk, so disclosure of climate risks is critical.
Support small and medium-size enterprises (SMEs) that are offering adaptation-relevant products and services. There should be increased attention on the considerable potential value that SMEs hold in unlocking climate adaptation solutions and engaging the private sector. There are 100s of SMEs across Africa that have valuable adaptation solutions and have developed viable business models to implement those solutions. Significantly more focus and finance are needed in this space to support the number of SMEs with potential to deliver adaptation solutions.
Build the Enabling Environment for Adaptation Investment
The enabling environment in a country will help determine the viability of certain types of instruments. In some cases, lack of financial sector development or lack of commitment to a particular climate adaptation priority will make certain investments difficult to implement. In these instances, there may be a stronger role for concessional capital from DFIs or foundations to facilitate the effective deployment of an investment. Countries’ readiness for adaptation finance may be assessed via several factors across categories of policy environment, market environment, and stakeholder environment. Enabling environment priorities to mobilize investment include the following:
Articulate investment-ready NAPs and mainstream climate resilience in government procurement: Having a nationally articulated strategy for adaptation is critical for establishing long-term expectations, identifying priority actions across sectors, and indicating areas for private sector participation. Only six countries in Africa have submitted NAPs to date while 34 other countries have received funding or have submitted proposals to access funding from GCF and LDCF for NAP development. Policymakers should ensure that adaptation planning is incorporated and mainstreamed into all relevant policy and procurements plans. An increased focus on climate adaptation mainstreaming within procurement plans, in particular, is critical to ensure that international infrastructure investment must screen for and build in resilience.
Build capacity to develop science-based policy and projects: For much international public climate finance, there is a need to establish attribution between a climate impacts and the corresponding action/measure that aims to mitigate that impact. This attribution is challenging, requires substantial quantitative and science capacity and is often a critical factor for mobilizing adaptation finance. There is a substantial need to increase capacity to translate science into policy, and to translate policy into investment needs, for instance by utilizing climate resilience indicators to prioritize budget allocations. Resilience outcomes are also difficult to track against a moving baseline—for example, other development projects may have also contributed to improved social outcomes in a given region.
Improve macro-economic environments and adopt a multi-faceted approach to address debt burdens faced by African countries: Even before the pandemic, external debt averaged 40% of GDP across the African continent. Gross debt-to-GDP ratios across Africa are projected to have increased by around 8 percentage points in 2020, and by over 20 percentage points in the Republic of the Congo, Seychelles, Sudan, and Zambia. Four countries are already in debt distress, while 15 other countries are at high risk of external debt distress. Absent substantial global efforts to help reduce the debt burden, many countries are not able to take on additional debt to address climate risk. Overall, African countries have low sovereign credit ratings from the three major credit rating agencies (CRA): Moody’s, Standard & Poor’s (S&P), and Fitch. Just two countries – Botswana and Mauritius – have investment grade ratings from Moody’s while all other countries are either sub-investment grade (19 countries) or do not have a rating (26 countries). A low sovereign credit rating or lack of a rating raises the cost of debt and makes attracting foreign direct investment more challenging. Already low sovereign credit ratings are put further at risk by increasing climate-related risks as CRAs begin to incorporate such risks into their ratings. Moreover, increasing climate impacts and a lack of adaptation action pose significant risk to sovereign credit ratings across the region. African finance ministers have called for external assistance of USD 100 billion annually over the next three years to close a financing gap of USD 345 billion to achieve a sustainable recovery. The participation of private creditors will be critical to relieve existing debt burdens, requiring innovative financing models that set clear incentives. Additional actions that should be considered to address debt challenges in African countries include:
Advance efforts to link credit ratings with reductions in climate risk to incentivize resilience and lower the cost of debt.
Continue implementation of the Debt Service Suspension Initiative (DSSI) program and seek as many avenues as possible for alleviating debt strain on African countries as a key strategy to increase domestic adaptation finance.
Develop sovereign bonds with an adaptation component (i.e., Ghana’s 2030 bond with an IDA guarantee of 40 percent) and scale up sovereign debt-for-adaptation swaps to countries where conditions are viable.
Deploy Innovative Finance Instruments
There is a wide array of available investment instruments, risk finance mechanisms, and broader finance-relevant solutions that financial actors are already mobilizing in support of climate resilience across Africa. The level of “concessionality” required for certain instruments will vary by market or policy environment. Financial instruments can be used to finance activities that build physical resilience to climate change impacts (reducing physical risk) and are also useful in responding to risks where physical climate impacts cannot or have not been eliminated (through risk transfer and risk reduction instruments).
It is critical to carefully select a financial instrument or structure that meets the conditions and activities targeted. Selection of appropriate financial instruments must be informed by the sectoral focus of the adaptation activity, underlying country-level policy and market conditions, and the stakeholders and actors engaged. Instruments will only function successfully when they target an appropriate context. Key factors that must be considered when designing an instrument include currency stability, strength of project pipeline, strength of debt capital markets, presence of strong policy environment, existence of a sovereign credit rating, existence of corporate bond market, robustness of climate information, and engagement/existence of a domestic private sector.
In sum, African countries are among the most at risk of increasing frequency and severity of climate-related shocks and stressors. There is a pressing need to invest in climate change adaptation to support individuals, SMEs, municipalities, corporations, financial actors, and governments in building resilience to climate impacts. To date, climate adaptation finance is scaling far too slowly to build climate resilience while the costs of climate impacts rise.
To mobilize the levels of investment needed and to increase the resilience impact of these investments, a wider variety of sources of finance must be tapped. A three-pronged strategy is needed to tap the wide range of potential actors: 1) mainstream resilience in investment decisions making, 2) build the enabling environment for adaptation investment, and 3) aggressively deploy innovative finance instruments at scale towards adaptation activities. Action taken now across the full range of potential adaptation finance sources will be critical to determining the course of Africa’s capacity to respond to present and oncoming climate impacts and to building a more climate-resilient and livable future.
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