Policy Brief: Climate Finance and African Development Finance Institutions

THE AfCFTA AND TRANSFORMATIVE INDUSTRIALISATION ROUNDTABLE SERIES

CLIMATE FINANCE AND AFRICAN DEVELOPMENT FINANCE INSTITUTIONS POLICY BRIEF 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.

Introduction............................................................................................................................................ 2

2.

Context and Background..................................................................................................................... 3 2.1 Green Finance in Africa ................................................................................................................. 5 2.1.1 Sustainable banking .......................................................................................................... 5 2.1.2 Regional green finance initiatives.................................................................................. 5 2.1.3 International financial institutions and green finance in Africa............................... 5 2.2 African DFIs and Climate Finance for Africa ........................................................................... 6

3.

Key Recommendations ....................................................................................................................... 7

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1. Introduction The Nelson Mandela School of Public Governance (The Nelson Mandela School) 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. The policy recommendations below are based on suggestions from researchers and practitioners who participated in the webinar, and insights from the Africa Delivery Exchange (ADX) event held by the Tony Blair Institute and The Nelson Mandela School in September 2022. The primary focus of the event was to build a coherent narrative for Africa on climate change in preparation for COP27. Climate finance was one of the four thematic areas that were discussed extensively, and some of the commentary and insights presented are included in this policy brief.

The Nelson Mandela School has established a climate change research programme that explores the impact of climate change on Africa’s development. It specifically focuses on agricultural adaptation measures and

food security, developing renewable energy regional value chains, green industrialisation, and trade and climate change. The School’s Climate Finance and Africa research is part of its research programme on the Role of African Development Banks in Green Structural Transformation and Developmental Regionalism.

This research programme is led by Professor Nimrod Zalk, who has published extensively on the topic. His article, titled African development banks need scale, urgently. Here’s how it can be done argues that “the scaling up and consolidation of African development banks offers the most promising route to attract long-term private finance to achieve [Africa’s] sustainable development goals and structural transformation.”1 The School’s research on climate finance primarily focuses on strengthening African development banks’ capacity to play a more active role in closing the continent’s climate finance gap.

The first part of this brief provides a detailed overview of climate finance in Africa and the role of the continent’s development finance institutions (DFIs). The second section outlines key policy recommendations for consideration.

1 Nimrod Zalk. (2021, 26 November). African development banks need scale, urgently. Here’s how it can be done.

The Conversation. https://theconversation.com/african-development-banks-need-scale-urgently-heres-how-it-can-bedone-172178

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Climate Finance and African Development Finance Institutions • POLICY BRIEF

2. Context and 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, past and current climate finance pledges 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 channelling USD 100 billion a year to developing economies towards climate adaptation and mitigation. This was confirmed in the Paris Agreement at COP21 in 2015, and again at the COP26 held in Glasgow in 2021. This target has, however, never been reached despite the adverse impacts of climate change being more prevalent in Africa.

The African Development Bank (AfDB), in its African Economic Outlook Report (2022)2, estimates that the cumulative financing needs

for Africa to respond appropriately to climate change range between USD 1.3 trillion and USD 1.6 trillion, averaging USD 1.4 trillion in 2020– 30. Broken down annually, USD 127.8 billion is needed. However, this is hardly sufficient as adaptation costs alone are estimated at USD 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 between USD 166 billion and USD 260 billion in 2020–30.

Although international climate finance is increasing steadily, only USD 79.6 billion of the USD 100 billion committed by developed countries was mobilised in 2019, two-thirds of which was for mitigation. Moreover, the USD 100 billion pledged does not reflect the estimated financing needs in Africa to reach the net-zero transition by 2050. Aware of the climate finance shortfall, developed countries,

2 African Development Bank (AfDB). (2022). African Economic Outlook 2022: Supporting Climate Resilience and a Just Energy Transition in Africa. https://www.afdb.org/en/documents/african-economic-outlook-2022

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through the Glasgow Climate Pact, pledged to double funding provided to developing countries for adaptation by 2025, increasing the annual figure to approximately USD 40 billion.

However, although this pledge is commendable, it remains to be actualised.

Africa’s share of international climate finance flows is minimal compared to other developing regions such as Asia. Africa’s climate-related investment needs are estimated at USD 2 trillion over the next 30 years. Investments in adaptation are significant, ranging from USD 259 to USD 407 billion between 2020 and 2030, representing an annual average requirement of between USD 26 and USD 41 billion (AfDB 2022). The Global Commission for Adaptation (GCA)3 found that even if the Paris Climate Agreement goals are achieved, the economic costs of climate change in Africa will be most severe (as a % of GDP) compared to other regions globally.

The continent’s share of global climate finance flows increased from 23% (between 2010 and 2015) to 26% (between 2016 and 2019), representing a mere 3% improvement. Between 2016 and 2019, African countries received approximately USD 73 billion in climate-related development finance, with an annual average of about USD 18 billion. Total climate finance due to Africa to compensate for historical and future emissions is estimated between USD 4.76 trillion and USD 4.84 trillion through to 2050; this translates into an annual figure of between USD 163.4 billion and USD173 billion for 2022–50 (AfDB 2022). Insufficient climate finance means that most African countries will not meet their conditional Nationally Determined Contribution (NDC) targets.

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, debtbased lending, US-dollar-based lending (with a few options for local currency lending); the complexity of administrative and regulatory processes; poor creditworthiness of many

3 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.

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Climate Finance and African Development Finance Institutions • POLICY BRIEF

African countries; lack of climate data and information on exposure to climate risks; insignificant debt reforms or restructuring.

Since it is challenging for the region to access international climate finance, African countries must strengthen the capacity of their regional development finance institutions. Increased 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 China’s 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 the AfDB and Afrieximbank, play a notable role in contributing to climate finance for the continent. There is, therefore, a pressing need to scale up and consolidate African development banks’ 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.

2.1 Green Finance in Africa 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 institutions to benefit from more favourable financing rates.

2.1.1

Sustainable banking

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 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. The Rwandan government also developed the Rwanda Green Fund, an investment facility that provides loans and credit lines to commercial banks for green projects across various sectors.

2.1.2 Regional green finance initiatives African economies have 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 aim to accelerate the scaling up of green finance. International organisations are crucial in providing guidance on and defining green finance. Many African financial institutions have partnered with international financial organisations. In 2021, the African Development Bank (AfDB) and the Global Centre of Adaption launched the African Adaption Acceleration programme. 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 now members of the United Nations Environment Programme Finance Initiative (UNEP FI).

2.1.3 International financial institutions and green finance in Africa International institutions are also partnering with African commercial banks to finance large investments in green infrastructure and

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small investments in small and medium-sized enterprises (SMEs). For example, in 2020, the International Finance Cooperation (IFC) and the Dutch Entrepreneurial Development Bank (FMO) provided USD 225 million to First Rand Bank in South Africa to finance the development of climate-friendly infrastructure involving SMEs. The IFC also invested USD 200 million in Standard Bank’s (another South African Bank) green bond placed on the London Stock Exchange in 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 USD 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 an MoU with the Kenya Bankers Association in 2017 to advance environmental and social risk management and sustainable financing practices in the country’s banking sector.

2.2 African DFIs and Climate Finance for Africa Africa has a plethora of development finance institutions, totalling approximately 102 institutions with an estimated USD 188 billion in assets, of which 13 are multilateral development banks (MDBs) whose volume of assets matches all national institutions’ assets combined. It is, however, difficult to determine the exact amount of funds that African DFIs – including MDBs, national DFIs, and funds – spend on addressing climate change as a centralised database does not exist, and

different research methodologies produce varied results. Between 2016-2020 the African Development Bank (AfDB) spent about USD 13 billion between 2016 and 2020 on climate projects, and over the next five years (up to 2025), they aim to spend USD 25 billion, increasingly prioritising adaptation projects.

Determining the specific financing needs of each African country is critical to identifying financing gaps and opportunities for African DFIs to effectively assess, allocate, and mobilise climate finance. In this regard, “51 out of 53 African countries that submitted Nationally Determined Contributions have provided data on the costs of implementing their NDCs. Collectively, they represent more than 93% of Africa’s GDP. Based on this data, it will cost approximately USD 2.8 trillion between 20202030 to implement Africa’s NDCs.”4 African governments have contributed about USD 264 billion of public resources, covering only about 10% of the total cost.5 International financial support, required beyond national sources, is defined as a “climate finance need.”6 While most African countries have expressed high needs, “these could be underestimated due to a lack of data from subnational governments and vulnerable communities.”7 “Robust estimations of climate finance needs can be an important driver of financing and policy decisions. While most African countries have taken steps to understand their climate finance needs, there is significant scope to improve the quality of those estimates and translate them into clear financing road maps – both national and international – that can underpin NDCs and ultimately [the] implementation of the Paris Agreement.”8

4 Sandra Guzmán, Greta Dobrovich, Anna Balm, and Chavi Meattle. (2022). The State of Climate Finance in Africa: Climate Finance Needs of African Countries. Climate Policy Initiative. https://www.climatepolicyinitiative.org/wp-content/ uploads/2022/06/Climate-Finance-Needs-of-African-Countries-1.pdf 5 Sandra Guzmán, Greta Dobrovich, Anna Balm, and Chavi Meattle. (2022). The State of Climate Finance in Africa: Climate Finance Needs of African Countries. Climate Policy Initiative. https://www.climatepolicyinitiative.org/wp-content/ uploads/2022/06/Climate-Finance-Needs-of-African-Countries-1.pdf 6 Sandra Guzmán et al. (n.d.). The State of Climate Finance in Africa: Climate Finance Needs of African Countries 7 Sandra Guzmán et al. (n.d.). The State of Climate Finance in Africa: Climate Finance Needs of African Countries 8 Sandra Guzmán et al. (n.d.). The State of Climate Finance in Africa: Climate Finance Needs of African Countries

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Climate Finance and African Development Finance Institutions • POLICY BRIEF

3. Key Recommendations • African finance institutions need support to deepen their engagement with green finance. For instance, they need to develop specific green financial products for their respective regions and also improve communication with their clients about green finance products; what they could be used for, and the expected returns. 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.

• African DFIs need to cooperate to scale up climate finance for Africa. Given that there are close to 100 DFIs in Africa, a cooperation agreement must be established to coalesce these institutions to work together to provide climate finance. By creating a collaborative mechanism or framework, DFIs can draw on their experiences and knowledge to induce collective action and learn to finance climate mitigation, adaptation, and resilience projects.

• African policymakers need to explore how to combine adaption-focused public funds with private funds in novel and innovative forms. For example, Gabon, the world’s second most forested nation, is planning to release a record 90 million carbon credits onto the voluntary carbon market to finance the conservation of its carbon-absorbing forests. The country has created credits via the United Nations Framework Convention on Climate Change’s REDD+ mechanism.

The carbon credits will be “marketed by the country’s sovereign wealth fund and sold

via a new platform, redd.plus, a collaboration between S&P Global’s IHS Markit, CBL commodity exchange, and the Coalition for Rainforest Nations.”9 Priced between USD 20 and USD 30 per credit, the plan could earn Gabon about USD 1.8 billion. The government plans to use the revenue from sales for a biodiversity fund, a community development fund, to refinance debt, and expand its sovereign wealth fund to invest in climate-resilient infrastructure.10 • Public funding for adaptation measures needs to increase. Adaptation investments can reduce the hardship incurred by climate change in Africa. Adaptation costs for Africa are estimated at approximately USD 20-30 billion per annum over the next 10 to 20 years.11 However, to date, only USD 130 million of the USD 350 million adaption funding approved for Africa has been disbursed.12 There is a need to focus energies on securing funding for adaptation measures from the public sector. This can be done through sector-specific national adaptation plans (NAPs), especially for climate-sensitive sectors such as agriculture, health, water, and energy. These plans also need to be clearly articulated – identify the climate risks and adaption measures, and also outline strategies to accrue public finance and implement the identified adaption measures.

• Improve the technical capacity of state agencies. The limited capacity of some state entities to prioritise projects and present proposals affects a country’s ability to access climate-related finance. Some state agencies also do not have adequate project appraisal and procedures in place to evaluate whether a project meets external funders’ requirements. As such, there is a huge need for professional and technical upskilling, especially for public sector

9 Michael Kavangh. (2022, 14 October). Carbon Credits Seen Fetching as Much as $35 a Ton. Bloomberg. https://www. bloomberg.com/news/articles/2022-10-14/gabon-carbon-credits-seen-fetching-as-much-as-35-a-ton?leadSource=uverify%20wall 10 Michael Kavangh. (n.d.). Carbon Credits Seen Fetching as Much as $35 a Ton. 11 African Development Bank (AfDB). (2011). The Cost of Adaption to Climate Change in Africa. https://www.afdb.org/ fileadmin/uploads/afdb/Documents/Project-and-Operations/Cost%20of%20Adaptation%20in%20Africa.pdf 12 AfDB. (n.d.). The Cost of Adaption to Climate Change in Africa.

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employees – ongoing technical capacity training is also imperative for improving the effectiveness of state agencies in lobbying for climate finance. Training and courses should focus on project preparation, procedures, and evaluation to help with project prioritisation and the production of proposals.13 Simultaneously, trainees must also be taught about data gathering and selection skills that can support project justification.14 • Knowledge building to help attract financing. A lack of (or access to) data significantly hampers African agencies from accessing available climate financing options. African countries need to either, at a regional or continental level, curate available data into a single database, making it easier for all public, private, and international stakeholders to access data that can inform decision-making and consequently help determine available financing options.

A major African DFI, either the African Development Bank or AfriExim Bank, could spearhead the development of such a database.

• Developed countries can be more active in helping developing economies secure climate finance through energy transition partnerships. South Africa’s Just Energy Transition Partnership (JETP) with some Global North donor countries is an apt case study. Through this JETP, South Africa mobilised USD 8.5 billion in climate finance.

“The concept of JETPs as country platforms for the support of energy transitions in developing economies has attracted significant interest from across development and climate finance communities.”15 As such, various questions have emerged:16 Can JETPs provide an effective model for financing low emissions and climate-resilient development? What can be learnt from the South African experience? Can JETPs work for Africa at large, and if so, how? The South African JETP needs to be thoroughly examined and critically analysed to answer some of these questions.

13 African Policy Research Institute (APRI). (2022). Climate Finance in Africa : Needs, challenges and opportunities to deliver the financial resources required to drive low-carbon and climate resilient development. https://afripoli.org/projects/ climate-finance/climate-finance-in-africa-flagship-report 14 APRI. (n.d.). Climate Finance in Africa : Needs, challenges and opportunities to deliver the financial resources required to drive low-carbon and climateresilient development.

15 Emily Tyler and Lonwabo Mgoduso. (2022). Just Energy Transitions and Partnerships in Africa : A South African Case Study.

Meridian Economics. https://www.iddri.org/sites/default/files/PDF/Publications/Catalogue%20Iddri/Rapport/202211-Ukama-JETPs-ZAF.pdf 16 Emily Tyler and Lonwabo Mgoduso. (n.d.). Just Energy Transitions and Partnerships in Africa : A South African Case Study.

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