Innovative funding models to boost climate finance
The Energy Consortium - IIT Madras
Accelerating Net Zero - through a global academia-industry-government partnership effort!
Climate change is here, and now. It can be seen in the rise of extreme weather changes across the world. In India, around 600 mn people are at risk from impact of climate change brought by flood, heat waves and wildfires. Inaction on such a threat has the potential to erode around $1.12 tn of India’s GDP by 2050.[1]
Thus, as the window of opportunity to secure a sustainable future is narrowing, there is a need for an effective climate action enabled by international co-operation coupled with ?access to finance and technology. It is in this context that several policy announcements (National Green Hydrogen Mission in India, Hydrogen Hubs in USA), laws (Carbon Credit, Green Credit), Net zero pledges are coming up in various parts of the world. These policy pronouncements by both Government and industry are reflective of a sense of urgency to address climate change.
While pledges at the global forum might not lead to an immediate shift in policy, they do influence businesses to align their goals with such international commitments. In India, post COP26 announcement, there has been a growing momentum towards incorporating sustainable practices in businesses’ operations. Around 180 Indian companies have adopted decarbonisation targets verified by the Science based targets initiatives.[1] India’s stated goal of net neutrality by 2070 is expected to initiate a series of policy actions.
A multi-pronged approach of incentives, policies, monitoring is required to create an ecosystem for building the structural and operational foundations for India’s journey to net zero. Over the last few years, a growing number of policies and regulations have come up to create the foundations for India’s journey to net zero. Some of these are industry specific such as PLIs, FAME, Sight for green hydrogen, while others are broader in application – ESG. ?
Amongst these, ESG has emerged as an important enabler across industries. ESG Reporting landscape has undergoing a rapid change in the past two years and currently focuses on redefining the corporate purpose with increased focus on all the 3 dimensions of ESG. Here, businesses have two options – doing the bare minimum compliance required vs going beyond compliance to find opportunities to create value. [1] To achieve the latter, businesses have to put a concerted effort towards building scalable solutions for emissions reduction and material circularity. This has to be supplemented with ambitious targets for scope 3 emissions and support for both customers and suppliers in adopting sustainable practices as their business priority to ensure development of a sustainable value chain.
Increasing in scale would require more industry alignment, cross value chain partnerships, collaboration amongst government, private players and industry bodies. For each of the above requisite, an effective economic model is essential.
How will the transition be funded?
This takes us back to the fundamental question of understanding the economic impact of the transition to a sustainable and environment friendly future. Though the government incentives will certainly provide an impetus to start this journey, commercial viability and demand security would be essential for the industry commit to capital expenditure to scale up so as to make a significant impact on the reduction of the carbon footprint. Here, large corporates might still be able to deal with the costlier impact of these alternatives in the early stages, but what about the small and medium enterprises? Transition to new science based solutions to lower climate change impact will go through a phase of evolution wherein in early stages technologies to aid such transition may prove to be expensive, before such technologies are proven and reach industrial scale to be affordable. Besides, it will also impact the end consumer as goods and services in the short to medium term may see increase in prices thereby causing a predictable inflation for a period of time. A key watch out though is how the entire value chain especially small and medium enterprises are able to access financing and are able to either partially absorb or pass on the costs to consumers.
Thus, moving to greener products and environmentally sustainable operations with increased compliances and disclosures will mean additional costs. As its an imperative, the question is not who but how will the additional cost burden be taken care of? This will require more than just political will and commitment. A continued focus and unflinching commitment through global and political turmoil will be key for this train to stay on track.
Where are we on climate finance?
Globally, climate finance has reached $1.3 tn average in 2021/2022 wherein most of the growth is due to the increase in mitigation finance.[1] However, growth is not consistent across regions.
India will need around $7.2 tn - $12.1 tn in investments until 2050 for its decarbonisation journey. Around 50% of the investment would be needed till 2040.[2] At same time, decarbonisation could decrease operating costs by $2.1 tn by 2050. Currently, India is only able to meet 10%-12% of the investment demand (in an accelerated scenario).[3] Despite the positive returns, financing is constrained due to risks such as payment risks, technology risks, project execution risks and structural constraints such as investor expectation mismatch, limited banking participation etc.
Further, transition to clean energy intensifies the demand for critical minerals such as lithium, nickel, cobalt, graphite, copper, and aluminium. Demand for these critical minerals is expected to more than double by 2030 and further increase by 3.5 times by 2050. While having an alternate supply chain is critical, building one would require time and economies of scale to make these products available at affordable prices.
Therefore, we have an important question before us: how can we help close the gap between ambition and impact and start balancing the near term costs with the long term benefits of climate initiatives.
Currently, various governments are incentivizing development of an ecosystem for various products to substitute existing fossil fuel-based applications. These incentives will provide the necessary impetus, however, for these transitions to gain an industrial scale and commercial competitiveness, a a stable financing model is needed. But how do we build a source for such funding?
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While obvious temptation is to introduce additional taxes but given the fact that 2% of CSR contribution is already in place anything additional will impact the cashflows and constrain further investments. Alternatively, can we look at diverting a portion from the existing CSR funds towards creating an investment pool with “pay and forget” contributions. The investment pool can attract an equal contribution from the government and provide the necessary push for initial investments. It can then be leveraged to build a corpus for financing through various debt or other instruments.
While the governance of the corpus can have representation from both industry and government, we can have appropriate mechanisms for utilisation and disbursement of funds for the intended use Currently the annual CSR amount is Rs. 14,600 crores and if half of the funds are made to spend on specific initiatives on climate change, it will create the necessary initial pool of funds.
The benefit of building this corpus is multifold: ?Firstly, it will provide the initial momentum to attract industries towards taking up decarbonisation activities on scale. Secondly, it will generate employment and create consumption of decarbonised products. ?Thirdly, the taxes which are then collected either indirectly or directly will help to provide a satisfactory payback to the government. Meanwhile, as the consumption pattern for such products increase, there will also be a simultaneous increase in the taxes on consumption. ?This can be further supported with investment from international and regional agencies.
Thus, to successfully navigate through the journey of addressing climate change, we have to continually think of similar models which might provide a multiplier effect for the community at large. ?While climate change is one of the biggest existential crises before us, availability of adequate financing models will be a critical enabler especially for developing nations. We might not have answers to all the challenges posed by climate change, solving the finance piece of puzzle will be a good starting point. And it is imperative that the industry, policy maker and the academia work together to build such working models.
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