Climate Finance and African Development Finance Institutions – Summary Report

THE AfCFTA AND TRANSFORMATIVE INDUSTRIALISATION ROUNDTABLE SERIES

CLIMATE FINANCE AND AFRICAN DEVELOPMENT FINANCE INSTITUTIONS SUMMARY REPORT 2023 Cape Town

Linkoping House 27 Burg Road Rondebosch 7700 Cape Town T +27 (0) 21 650 1420 F +27 (0) 21 650 5709 E nelsonmandelaschool@uct.ac.za www.nelsonmandelaschool.uct.ac.za Design: Mandy Darling, Magenta Media

Contents 1.

Background ........................................................................................................................................... 2 1.1

Objectives of Session 2 ............................................................................................................. 3

2.

Speaker Biographies ...........................................................................................................................4

3.

Presentations......................................................................................................................................... 6 3.1

The International Climate Finance Landscape and Africa.................................................. 6

3.2

Debt, Climate Finance, and Development Finance Institutions in Africa........................ 7

3.3

African DFIs and Green Finance............................................................................................ 10

3.4

Lessons from Brazil’s Banco Nacional de Desenvolvimento Econômico e Social (BNDES) for African DFIs.......................................................................................... 11

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The Nelson Mandela School of Public Governance at the University of Cape Town (UCT) hosted a webinar titled Trade Facilitation, Climate Finance, and Strengthening Africa’s Development Finance Institutions on 31 August 2022. This webinar was part of The School’s African Continental Free Trade Area (AfCFTA) and Transformative Industrialisation Webinar Series. Participating practitioners and researchers in session two of the webinar series explored how African development finance institutions (DFIs) can be capacitated and scaled up to contribute more to meeting the continent’s climate financing needs.

1. Background Climate change is a significant challenge to Africa’s sustainable development. Addressing it requires increasing climate finance from national, regional, and international organisations. However, previous and current pledges towards climate finance do not meet expectations and financing requirements. At the 15th United Nations Climate Change Conference of the Parties (COP15) in Copenhagen, Denmark, in 2009, developed economies committed to

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channelling US$100 billion a year to developing economies for climate adaptation and mitigation. However, how much the financing would be split for each was not clearly outlined. This commitment was confirmed in the Paris Agreement at COP21 in 2015 and COP26 in Glasgow (2021). However, this target has never been met despite the adverse impacts of climate change becoming more prevalent in Africa.

Climate Finance and African Development Finance Institutions • SUMMARY REPORT

The African Development Bank (AfDB), in its African Economic Outlook Report (2022), estimates that the cumulative financing needs for Africa to respond appropriately to climate change range between US$1.3 trillion and US$1.6 trillion, thus averaging US$1.4 trillion in 2020–30. Broken down annually, US$127.8 billion is needed, which is hardly sufficient when adaptation costs alone are estimated at US$259–407 billion. Furthermore, if the international-to-domestic commitment ratio of 2020 remains constant, the adaptation financing gap in Africa from international sources will range from US$166 billion to US$260 billion in 2020–30.

Even though international climate finance is increasing steadily, only US$79.6 billion of the US$100 billion committed by developed countries was mobilised in 2019, two-thirds of which was for mitigation. Moreover, the US$100 billion pledged does not reflect the estimated financing needs in Africa to reach the net-zero transition by 2050. In recognition that more climate finance needs to be channelled towards adaption measures, developed countries agreed, through the Glasgow Climate Pact, to double their commitment from the 2019 value of US$20 billion to US$40 billion by 2025. Although this pledge is commendable, it, however, remains to be actualised.

the AfDB and Afrieximbank, play a major role in contributing to climate finance within the continent. There is a pressing need to scale up and mobilise African development banks to play a significant role in addressing the continent’s climate financing needs. This offers the most promising route to building an African arsenal of strategies and institutions that can implement an African-driven climate-resilient development agenda.

1.1 Objectives of Session 2 Session 2 of the webinar series was titled Unlocking Climate Finance: The Role of African Development Banks. The primary objectives of the session were: • To outline the international climate finance landscape and Africa’s position; • Explore various innovative ways of expanding the capacity of African development banks to supply climate finance; • Explore how African development finance institutions (DFIs) can contribute to building the continent’s green finance sector; and, • Identify lessons or experiences that African countries could learn particularly from Brazil’s BNDES’s experience with climate finance and green investments.

Africa’s share of international climate finance flows is minimal compared to other developing regions such as Asia. Insufficient climate finance means that most African countries will not meet their conditional Nationally Determined Contribution (NDC) targets. Because it is challenging for African states to access international climate finance, the region must strengthen the capacity of its development finance institutions.

Far more effort is needed to capacitate African development banks to mobilise public and private financing for climate mitigation, adaptation, and resilience projects. Elsewhere in the world, other development banks have played a significant role in climate financing. Examples include Germany’s Kreditanstalt für Wiederaufbau (KfW), Brazil’s Banco Nacional de Desenvolvimento Econômico e Social (BNDES), and the China Development Bank, China Eximbank, and the Industrial and Commercial Bank of China. Although Africa has many development banks – 95 in total – only a few, such as

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2. Speaker Biographies Richard Sherman is the substantive lead for the climate finance programme at the Cape Town-based NGO, South-South North (SSN). Richard is a member of the South African delegation to the United Nations Framework Convention on Climate Change (UNFCCC), where he also serves as one of the African Group lead coordinators on climate finance negotiations, and where he coordinates the African Board members of the Green Climate Fund and serves as lead adviser to the developing country Co-Chair of the Board. He was also one of the African representatives on the Standing Committee of Finance between 2014 and 2018, which is mandated to oversee coherence between the funds under the financial mechanism of the Convention.

João Carlos Ferraz is a Professor at the Instituto de Economica housed at the Federal University of Rio de Janeiro, Brazil. He served as Vice-President and Executive Director of the Brazilian Development Bank (BNDES) between 2007 and 2016. Previously (2003-2007), he was Director of the Division of Productive Development of the United Nations Economic Commission for Latin America and the Caribbean (UN / ECLAC) in Chile. His areas of expertise cover business strategies and competitiveness, industrial and innovation development, technology foresight, development finance and industrial and innovation policies.

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Penelope Hawkins is a published economist with a PhD in economics from Stirling University, Scotland. She is a Senior Economic Affairs Officer in the United Nations Conference on Trade and Development’s (UNCTAD) Debt Analysis and Finance Division on Globalisation and Development Strategies.

Her research focuses on external and public country debt, finance for development, illicit financial flows, financial inclusion, and how development finance can contribute to structural transformation and addressing climate change.

Alberto Lemma is a Research Fellow at the Overseas Development Institute in London. He works as a researcher and economist in the organisation’s International Economic Development Group. Alberto specialises in private sector development, specifically in access to finance, business partnership programmes and the interplay between the private sector and climate change adaptation and mitigation. His work on finance focuses on Development Finance Institution impact assessment and the role of DFIs in development, small and medium-sized enterprises (SME) finance and access to innovative sources of finance such as crowdfunding or alternative financial mechanisms for SMEs.

Climate Finance and African Development Finance Institutions • SUMMARY REPORT

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3. Presentations 3.1 The International Climate Finance Landscape and Africa Richard Sherman provided a comprehensive background on the international finance landscape and Africa’s position, especially within the context of the UNFCCC and the Paris Agreement. Below is a summary of the main points of Richard’s presentation: • Under the UNFCCC, developed countries agreed to provide financial support to help developing country members implement climate adaptation and mitigation measures.

Beyond the UNFFCC, developed country members are encouraged to provide financial assistance either bilaterally or multilaterally to help developing countries implement the Convention. There are various climate financing mechanisms, including (but not limited to): those linked to the UNFCCC, specialised funds, funding from multilateral development banks, development finance institutions, the private sector, and national funding.

• Africa’s receipt of international climate finance is marginal compared to other developing regions. The continent’s share of global climate finance flows rose from 23% (between 2010 and 2015) to 26% (between 2016 and 2019), representing only a mere 3% increase. Between 2016 and 2019, African countries received approximately US$73 billion in climate-related development finance; an annual average of about US$18 billion. The total climate finance required to fund Africa’s historical and future emissions is estimated between US$4.76 trillion and US$4.84 trillion through to 2050; this translates into an annual figure of between US$163.4 billion and US$173 billion for 2022–50 (AfDB 2022).

• Investments towards adaptation are significant, ranging from US$259 to US$407 billion between 2020 and 2030, representing an annual average need of between US$26 billion and US$41 billion (AfDB 2022). The

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Climate Finance and African Development Finance Institutions • SUMMARY REPORT

Global Commission for Adaptation (GCA)1 found that even if the Paris Climate Agreement goals are achieved, the economic costs of climate change in Africa will have higher relative impacts (as a percentage of GDP) than most regions globally.

• There are numerous challenges and barriers for African countries to access international climate finance. These include (but are not limited to): a lack of political commitment from developed countries; the maturity and depth of local capital and financial markets, debt-based lending, US-dollar-based lending (with a few options for local currency lending); the complexity of administrative and regulatory processes; poor creditworthiness of many African countries; lack of climate data and information on the level of exposure to climate risks; insignificant debt reforms or restructuring.

3.2 Debt, Climate Finance, and Development Finance Institutions in Africa Penelope Hawkins outlined debt sustainability in Sub-Saharan Africa (SSA); highlighted the International Monetary Fund (IMF) Special Drawing Rights (SDR) Issue of August 2021; looked at mobilising African DFI’s for climate finance; assessed whether SDRs could be a game changer in the climate finance space; and, she touched on the multilateral rules for debt and climate finance. The main points of her presentation are summarised below: • Although the external debt stock of SSA accounts for 10% of low-and-middle-income developing countries (excluding China), it is the most unmanageable. Using two metrics – external debt stocks to exports ratios and public and publicly guaranteed (PPG) debt service to government ratios – Penelope painted a grave picture of SSA debt. As of 2020, SSA had the highest ratio of external debt stocks to exports. Nineteen SSA countries have a ratio above 250%; that is their debt stock is 2.5 times the value of their exports. In 2020, 31 SSA countries spent

more than 5% of government revenue on PPG debt servicing.

• In addition, given the unpredictable nature of the COVID-19 pandemic, developing countries experienced a shortage of resources to effectively address pandemic-related economic and healthcare challenges. Consequently, on 02 August 2021, the IMF announced that a massive allocation of special drawing rights (SDRs) worth US$650 billion was to be approved from 23 August 2021. SDRs are an IMF reserve asset designed to bolster government reserves and help ease liquidity crunches during crises. SDRs are not cash but can be used to pay debts, strengthen countries’ financial positions, or make exchanges for hard currency. The primary motivation for the allocation in August 2021 was to support low-and-middle-income countries dealing with the economic fallout of the COVID-19 pandemic. However, the IMF’s allocation of funds by its quota system seriously disadvantaged developing countries (36 advanced countries received US$398 billion while Africa received US$33 billion or 5%, and 54 of the V202 countries only received US$26 billion). This resulted in developing regions calling for the re-channelling of SDRs, which could result in a possible redistribution of US$100 billion from developed countries to the developing countries that need the funds the most. The significance of this would be immense, as it would far exceed the collective concessional lending by multilateral development banks in 2018.

• Africa has a plethora of development finance institutions, totalling approximately 102 with an estimated US$188 billion in assets, 13 of which are multilateral development banks (MDBs). It is difficult to determine the exact amount of funds that African DFIs – including MDBs, national DFIs, and funds – spend on addressing climate change since a centralised database does not exist, and the different research methodologies undertaken within the institutions produce varied results. Between 2016 and 2020, the African Development Bank (AfDB) spent about US$13 billion on climate projects and

1 CGA is hosted by the Netherlands. It is an international organisation that engages in policy development, advocacy research, communications, and technical assistance to the government and private sector.

2 V20 stands for The Vulnerable Twenty (V20) Group of countries. More information on this establishment can be found here: https://www.v-20.org/about

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aims to spend US$25 billion over the next five years (including 2025), placing top priority on adaptation projects. DFIs are a vital component of the multilateral development system and an essential source of reliable long-term finance; providing favourable terms to support development. But they need sufficient and reliable sources of capital. Some suggestions to increase access to capital include, but are not limited to: taking on additional members to raise more capital; revisiting the AAA credit rating requirements to allow DFIs to hold smaller cash reserves; and, possibly increasing the capital contribution from existing government members.

• Rechannelling SDRs to MDBs is, however, a tricky issue as re-channelling transforms the nature of SDRs. Essentially, they are converted to loans that must be repaid (although at concessional terms). As

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prescribed holders, MDBs could use SDRs as a financial asset on their balance sheet and as a means of exchange. Two options to consider are: 1) MDBs could on-lend SDRs. With this approach, MDBs could maintain the reserve asset status of SDRs by mimicking the IMF’s Poverty Reduction and Growth Trust (PRGT) and operating an encashment regime, whereby a portion of available funds would be held as reserves to meet encashment calls by developed country creditors in case of balance-of-payments or reserve difficulties. 2) Countries could use their excess SDRs as capital injections to MDBs that, being banks, would be expected to leverage their equity and multiply the impact of a single re-channelled SDR three to four times. This latter approach is riskier since using SDRs for longer-term developmental purposes requires some degree of maturity transformation, i.e., transforming a liquid asset into a longer-term investment.

Climate Finance and African Development Finance Institutions • SUMMARY REPORT

• The re-channelling of new SDRs could therefore provide a much-needed funding alternative for climate finance. The IMF has proposed re-channelling SDRs into a Resilience and Sustainability Trust (RST).

The re-channelling of new SDR issuances into such a trust could form a vital part of developing countries’ climate and development finance landscape. Independently of the IMF, MDBs, could set up similar trusts with the objective of amassing private investments. A well-designed climate trust would provide the capacity for countries to respond to climate change without incurring significant increases in their debt burdens.

It would catalyse low-cost financing and capacity building for poorer, climate-vulnerable countries to build climate-resilient and adaptation strategies, and it would improve the ability of developing countries to mobilise long-term financing for just energy transitions.

• The debt-climate link requires a multilateral approach. Debt relief and debt cancellation for developing countries should be on the international climate agenda. What is needed is the establishment of a multilateral legal framework for debt restructuring to facilitate timely and orderly debt crisis resolution with the involvement of all official (bilateral and multilateral) and private creditors. A UN commission of experts could be created to explore the different design options for this framework. UNCTAD Principles of Responsible Sovereign Borrowing and Lending (PRSBL) should be revitalised as they delineate the co-responsibilities of both lenders and sovereign borrowers, covering all debt instruments used by sovereigns. Therefore, the UNCTAD Principles are designed not only to prevent a debt crisis but to also increase debt transparency.

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3.3 African DFIs and Green Finance Alberto Lemma provided an overview of African DFIs and green finance. He outlined examples of African DFI’s adopting green finance principles and collaborating with international institutions on green projects. Alberto also suggested how African DFIs can build the continent’s green finance sector. Some of the key points of his presentation are summarised below: • Over the last decade, numerous African governments have either developed sustainable banking principles or joined sustainable banking initiatives. For example, South Africa’s National Treasury published a technical paper titled Financing A Sustainable Economy in 2020; the Bank of Ghana launched the Ghana Sustainable Banking Principles in 2019; the Kenya Bankers Association adopted Sustainable Finance Guiding Principles in 2015; and, Nigeria established the Sustainable Banking Principles in 2012.

African countries also use national development banks and other public financial institutions to raise and channel green finance.

For example, the Development Bank of Southern Africa, a state-owned bank in South Africa, became a green development bank in 2021 and launched two green bonds in the same year. In addition, the Rwandan government is developing the Rwanda Green Fund, an investment facility that will provide loans and credit lines to commercial banks for green projects across various sectors.

• African economies have both established regional initiatives and joined international initiatives to increase private and public flows of green finance. Several African states’ central banks and supervisory authorities are members of the Network for Greening the Financial System, an international group of central banks and financial supervisors that aims to accelerate the scaling up of green finance. International financial organisations are crucial in providing guidance on and defining green finance, therefore several African financial institutions have formed partnerships with them. In 2021, the African Development Bank (AfDB) and the Global Centre of Adaption launched the African Adaption Acceleration programme.

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Climate Finance and African Development Finance Institutions • SUMMARY REPORT

The AfDB also established the African Alliance for Climate Change which links stock exchanges, sovereign wealth funds, central banks, and other institutions across the continent that aim to mobilise capital and shift portfolios towards green investment.

In addition, 34 African financial institutions across nine African countries (Nigeria, Egypt, Morocco, Ghana, Togo, Kenya, Namibia, South Africa, and Mauritius) are a part of the United Nations Environment Programme Finance Initiative (UNEP FI).

• International institutions are also partnering with African commercial banks to finance significant investments in green infrastructure, as well as small-scale investments within SMEs. For example, in 2020, the International Finance Cooperation (IFC) and the Dutch Entrepreneurial Development Bank (FMO) provided US$225 million to First Rand Bank in South Africa to finance the development of climate-friendly infrastructure involving SMEs. The IFC invested an additional US$200 million in Standard Bank’s (another South African Bank) green bond, which has been listed on the London Stock Exchange since March 2020. It was Africa’s largest green bond and South Africa’s first offshore green bond issuance. In addition, the European Bank for Reconstruction and Development (EBRD), in partnership with the Climate Investment Funds and Global Environment Facility, created a US$250 million funding framework for private-sector renewable energy development in North Africa and the Middle East. Bilaterally, DFIs are also supporting the greening of Africa’s finance sector. For example, the Dutch FMO signed a Memorandum of Understanding with the Kenya Bankers Association in 2017 to advance environmental and social risk management and sustainable financing practices in the country’s banking sector.

• Africa’s green finance sector is relatively underdeveloped compared to other regions, such as Asia. Support for developing green bond market investments can induce the catalysation of larger funding volumes to provide more opportunities for DFI investments and commercial investments. In addition, recognised green financial principles and stronger transparency standards, domestically and internationally, could boost investor demand for green finance products in Africa, enabling financial insti-

tutions to benefit from more favourable financing rates. This is where regional and continental forums such as the AfCFTA could play a critical role in coordinating and encouraging African DFI’s to adopt green financing principles and sound transparency practices.

• African finance institutions need support to deepen their engagement with green finance. For example, they need to develop specific green financial products for their respective regions and even improve communication with their clients about green finance products – their objectives, what they could be used for, and what kind of returns could be anticipated. African governments can also play a key role in encouraging and facilitating the allocation of domestic financial resources to green investments. Regional collaboration mechanisms should also be established to identify priority transnational climate-friendly projects. African DFIs need to enhance their collaboration with governments to support national innovation systems, including trade facilitation, competition policy, and the promotion of better state-business linkages.

3.4 Lessons from Brazil’s Banco Nacional de Desenvolvimento Econômico e Social (BNDES) for African DFIs João Carlos Ferraz stressed that African development banks must take a collective approach to climate finance and outlined the need for adaptive and innovative financing approaches.

To highlight his points, he drew on two examples – the Banco Nacional de Desenvolvimento Econômico e Social’s (BNDES) Amazon Fund and how, through strategic investment, it played a significant role in building Brazil’s wind industry. The main points of Joao’s presentation are discussed below: • Given that there are over 100 DFIs in Africa, Joao suggested that a type of cooperation agreement be established to coalesce African DFIs to work together to provide climate finance. By creating a collaborative mechanism or framework, DFIs can draw on their various experiences and knowledge

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to induce collective action and learning to finance climate mitigation, adaptation, and resilience projects.

• An example that is often cited of how a nationally owned and managed inclusive climate change fund can be established is The Amazon Fund (Fundo Amazônia), which was created in 2008 and became operational in 2009. It is a performance-based payment fund managed by the BNDES to finance projects that contribute to reducing the Amazon Forest’s deforestation and promoting the biome’s sustainable development. A variety of stakeholders are included in its decision-making committees. The fund has attracted significant attention for its design and operation - a major innovation being its pay-for-performance fundraising model. Based on this setup, international donors (such as Norway) provided financial support to deliver the fund’s objectives equivalent to the emission reductions achieved.

• The BNDES has played a significant role in building Brazil’s wind energy sector. Its free energy industry investments are aligned with the National Plan on Climate Change (PNMC) efforts to reduce greenhouse gas emissions. As of 2021, more than 600 wind farms have already been implemented in Brazil, totalling 15.4 GW in installed capacity.

As a result, the electric energy from wind sources now ranks second in Brazil’s electric matrix. The BNDES grew the wind power industry through significant strategic investment. In addition to offering competitive loans and interest rates, it stipulated that developers use domestic equipment and suppliers. This strategy supported the development of the domestic wind industry and ensured that imported turbines would struggle to compete in Brazil in the future.

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Climate Finance and African Development Finance Institutions • SUMMARY REPORT

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