By: Margarita Cabrera, Jorge Hinojosa y Samantha Youngeun Shin
from CCAP.
The IPCC report on global warming of 1.5 °C highlighted the urgent need to limit the temperature increase to «well below 1.5 °C» by 2030 to avoid adverse impacts of climate change on people and ecosystems. This requires deep and rapid decarbonization across all sectors and regions, which calls for large-scale financing and investment in climate mitigation. Accordingly, it highlighted the need for collective and strategic actions in the financial and non-financial sectors, and by public and private actors, to achieve the goal using a wide range of financing options.
Latin American countries have many opportunities to reduce carbon emissions in multiple sectors, such as energy, transportation, agriculture and industry, with abundant clean energy resources. Energy (46%) and agriculture (23%) account for the largest share of greenhouse gas emissions in Latin America and the Caribbean.. Furthermore, achieving a carbon neutral region seems plausible with nature-based solutions such as carbon sinks and biodiversity conservation (Latin America and the Caribbean account for 50% of the world's biodiversity). In fact, the region has already made a greater effort to reduce greenhouse gas emissions and chart a path towards net zero levels. However, some challenges related to macroeconomic, financial and institutional risks hinder the NDC implementation process and a higher level of commitment from stakeholders, including the private sector. To overcome these urgent challenges and achieve national climate goals, collective action by the public and private sectors, including financial and non-financial actors, access to climate finance and innovative solutions in line with national climate priorities will be crucial.
In this article, we review the financial instruments currently available to boost the low-carbon economy in Latin America. By analyzing best practices in introducing innovative financial instruments and scaling up public and private sector climate finance in selected Latin American countries - Brazil, Colombia, Chile and Argentina - we aim to provide benchmarks and inspiration regarding climate-related financial instruments to relevant stakeholders.
What financial instruments and mechanisms for green projects apply to Latin America?
To date, the public sector, multilateral institutions and bilateral agencies play a crucial role in providing the necessary finance and enabling green investments by setting norms and standards for financing options. Given the increased scale of finance needed to achieve climate goals, further efforts to unlock climate finance flows and access to more innovative financing solutions are essential. These efforts include de-risking green investments and making them more bankable, while removing barriers in financial markets.
The following is a list of a wide range of financial instruments to promote green investments that currently exist in Latin America.
Table 1. Climate finance instruments and mechanisms
Types of financing | Financial instruments | Mechanisms |
Public flows (national and international) | Public budget expenditure | Climate funds (national and international)
Carbon markets (domestic) |
Traditional loans | ||
Blended finance / Concessional and non-concessional loans | ||
Balance sheet financing, equity and debt | ||
Multilateral and bilateral grants | ||
Guarantees and risk mitigation instruments | ||
Green, SDG and thematic bonds | ||
Private flows (national and international) | Shareholders' equity | |
Impact investment funds | ||
Guarantees and risk mitigation instruments | ||
Subsidies | ||
Green, SDG and thematic bonds |
Sources: Authors, adapted from CPI, 2021
As shown in Table 1, there is a wide range of financial mechanisms and instruments available. However, given that each country has different financial policies, markets and stakeholders, more sophisticated design and financial solutions tailored to country contexts and national priorities are essential to reduce risks while creating synergies between the public and private sectors to achieve climate objectives.
What are the challenges to be overcome to close the financial gaps?
The lack of risk mitigation financial instruments, an immature market, and the lack of institutional and technical capabilities are seen as factors hindering the securing of various crucial and large-scale sources of financing for the transition to decarbonization.
Although several of the financial instruments mentioned above have been considered effective in promoting investments in green projects, economic actors, especially micro, small and medium-sized enterprises (MSMEs), which constitute 99.5% of all enterprises in the LAC region (Herrera, 2020) have had difficulties in adopting such practices due to limited sources of capital and access to financial instruments such as lines of credit, refinancing and guarantees. The percentage of financial resources transformed from the financial sector to the non-financial sector (i.e., the capacity of the financial sector to finance real sector activities) in the LAC region is less than 50%, while that of the United States is around 200% percent (Herrera, 2020). In addition, the lack of local financial market expertise and networks to build a portfolio of viable projects and evaluate climate finance options further hinders access to climate finance. In the case of capital markets, including the bond market, the LAC region still lacks depth and liquidity, so there are only a few markets in the region. By virtue of financial constraints, the financial gap between supply and demand for financing by financial institutions for MSMEs in the region is significant: US$1.8 trillion (Herrera, 2020).
It is important to mention that the lack of updated financial information conveys a low level of transparency to borrowers, has an impact on raising the cost of financing and reducing access to financing (Herrera, 2020); another barrier is the lack of knowledge and development of the institutional framework for innovative financial mechanisms, as it makes it difficult for stakeholders to access additional financing.
To overcome these existing financing barriers for green investments, both from the supply and demand side, some countries in the region have implemented innovative financing solutions.
Best practices in Latin America to promote financial flows towards low-carbon growth
In addition to innovative mechanisms, countries need to integrate climate change into their budgets by creating a specific line item where green investments can be tracked, allowing for an overview of climate finance and decarbonization milestones in each country. Best practices have shown us that each country needs a tailor-made mechanism taking into account specific climate needs, objectives and market conditions. This is essential when climate finance instruments are developed in response to national policies and NDC financing strategies.
Case of Brazil: leading country in green bond issuance in the region
Since its first introduction in Latin America in 2014, the green bond market has grown significantly in Brazil, Chile and Mexico. Notably, the green bond market in Brazil has been largely dominated by non-financial companies. Brazil leads the market with the largest number of non-sovereign (corporate) bond issues (Amundi and CFI, 2021; International Finance, 2020). Since the introduction of new mechanisms for green bond issuance by the Ministry of Mines and Energy, the green bond market has attracted more financial sectors. The first private banking sector issuance was announced in 2020 by the private entity Banco BV; with the objective of fostering the green finance market, the bank issued bonds with a maturity of four years, which will support renewable energy projects and assets (Fatin, 2020).
Success Factor 1: Regulations/protocols: | Several protocols and regulations allow the Brazilian financial sector to incorporate green economy principles into its operations (UNEP FI, 2020), including the framework for the creation and implementation of a socio-environmental responsibility policy, the sustainable banking protocol and guidelines for the issuance of green bonds. In addition to this, since 2018 central banks introduced a new sustainability policy and committee to assess environmental and social risks. |
Success Factor 2: Knowledge/experience sharing platforms: | The Green Finance Council plays a key role in attracting more bond issuers to the market by providing information and guidance on bond issuance requirements. Brazil Green Finance It brings together various stakeholders, including pension funds, public and private banks, insurance companies, local market institutions and private sectors, and promotes market mechanisms to catalyze green investment opportunities (Climate Bonds Initiatives, n.d.) To promote sustainable finance in the country, the Brazilian Development Association, the IDB and the Securities and Exchange Commission, in collaboration with GIZ, launched the Financial Innovation Lab and encouraged representatives from government and society to participate. |
Case of Colombia: effective commitment of international organizations, private financial and non-financial institutions to the successful implementation of the NDCs
The increase in climate finance through the activation of new private climate finance has been internationally recognized as crucial to accelerating the transition to a low-carbon economy. Accordingly, a wide range of members of the international financial community, including multilateral development banks, bilateral agencies and other international organizations, have collaborated to facilitate private investment in green technology and sustainable infrastructure (Bloomberg, 2021).
In a similar vein, the Colombian government established an institutional and regulatory framework for the National Climate Change System (SISCLIMA), led by the Directorate of Environment and Sustainable Development and the National Planning Department, which facilitates the engagement of public and private actors and the implementation of NDCs (GIZ, n.d.; Cisneros, Gómez-Villota and Alvarado, 2021). By incorporating incentives to encourage private sector engagement, the framework contributes to increasing the objectives of the Colombian NDCs [1]. The financial sector is quick to respond to these national climate policies and actions by integrating environmental and sustainability criteria in financial services, for example with the private financial institution BBVA, which introduced a ninety million dollar green guarantee facility The U.S. government is working to build a 100 percent electric public transportation system that will contribute to a significant reduction in greenhouse gas emissions (BBVA, 2020).
Success factor 1: Establishment of a regulatory framework | In collaboration with international experts from multilateral and bilateral institutions, Colombia introduced a private sector participation framework that allows private actors to participate in public green infrastructure projects, while stimulating private sector investments with effective risk management. |
Success Factor 2: Win-win strategy through the introduction of incentives driven by the financial sector | A financial institution contributes to the national climate goal by creating a new banking sector for sustainable finance and exclusively supporting climate-related projects. It enables the private sector to mitigate the business risks involved in implementing green infrastructure projects. |
Case of Chile: creation of a long-term, large-scale financial solution through a partnership between the non-financial and financial sectors
In 2021, IDB Invest decided to provide a financial package of $125 million ($74 million senior loan from IDB Invest, $15 million in combined financing from the Clean Technology Fund (CTF) and $36 million from the Chinese fund) to a private company, ENGIE Energia Chile, which aimed to contribute to the decarbonization of the energy sector (IDB Invest, 2021). By setting a floor price for greenhouse gas emission offsets, the package aims to accelerate clean technology projects, while inducing the closure of coal plants in the region. It is a successful example of joint efforts between financial and private sector actors to support national climate goals.
Case of Argentina: scaling-up approach with a public-private partnership (PPP) model (RenovAr-IFC-WB)
A holistic approach was introduced that creates a pipeline of infrastructure projects with the aim of producing 20% of Argentina's electricity from renewable sources, attracting 1,000 MW of new projects (over 2,400 MW were eventually awarded). The Renewable Energy Auction (RenovAr) agency launched by the Government of Argentina covers the utility's payment obligations. The WB and IFC are involved in consulting on the structuring and implementation of a new bidding process to advance the objectives set forth in the legislation. The WB guaranteed these payments from exchange rate volatility.
Success factor: Enablers such as blended finance or the PPP model to carry out large-scale projects. It is vital to ensure a large scale of investments and minimize investment risks through risk sharing for infrastructure projects that require large upfront capital and a long construction period - especially in the energy sector (e.g., construction of large-scale renewable energy plants, replacement of coal-fired power plants). Chile and Argentina are good examples of the use of the public-private partnership model and joint investments as well as blended finance for the decarbonization of the power sector. |
Conclusion
Climate finance is an essential component of achieving national climate goals. Unfortunately, the current level of investment in sustainable projects is still insufficient to achieve the «well below 1.5°C» target. Therefore, there is an urgent need for more innovative and creative approaches to complement conventional financial instruments, as shown in the case of Chile and Argentina.
Referring to the case of Brazil and Colombia, we learn that institutional mechanisms and agreements, laws and climate policies should be directed to support relevant actors carrying out climate initiatives and projects. The growing role of the private sector, impact funds, and blended finance mechanisms also mean a better financing outlook for SMEs in the region.
The above examples demonstrate that there is no single financial instrument that is perfect and universally applicable. Instead, the introduction of appropriate financial instruments that are aligned with a national climate objective (i.e., an NDC) will be effective in achieving policy objectives. A successful transition to decarbonization requires integrated and cooperative support, including financial and non-financial instruments, along with a tailored instrument that takes into account a country's needs and objectives.
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