Quiz | Innovative Financial Instruments for Climate Change Adaptation

By Deborah Murphy, Senior Associate, NAP Global Network Secretariat (IISD)

Significant financial resources are required now and in the coming decades for people and systems to adapt to a changing climate. Developing countries need about USD 212 billion per year up to 2030 to address their adaptation needs, yet adaptation finance flows were only USD 56 billion in 2021-2022.1 Private sector investment has a pivotal role to play in addressing the gap in financing for adaptation, but effort is needed to scale up financing from the private sector, which was less than 3 percent of total finance for adaptation activities globally from 2019 to 2022.2

Innovative financial instruments have been highlighted as a means to spur greater private sector investment in climate adaptation. The NAP Global Network’s inventory of innovative financial instruments for climate change adaptation explores 26 financial instruments and mechanisms that could help to attract private investment for adaptation action. Take our quiz to learn more about these instruments.

Innovative financial instruments for climate change adaptation include mechanisms and approaches that can be used to acquire, structure, govern, and allocate financial resources toward adaptation priorities. These can enable access to financial resources from financial institutions, private investors, institutional investors (such as pension funds), impact investors, foundations, and other philanthropists and may be blended with traditional sources of financing.

Source: NAP Global Network, 2024.

  • What green debt instrument is used to raise funds for environmentally sustainable projects from a bank or private operation?

    You’re right. Green Loans are used by borrowers to finance or refinance green projects, which can include climate change adaptation projects such as climate observation and early warning systems, climate-smart agriculture, and protection of coastal environments. Green loans are similar to green bonds in that they raise capital for environmentally sustainable projects, but green loans come from a bank or private operation, while funds for green bonds come from the investor market, and the amounts raised for green loans tend to be smaller than for a bond.

    No. Funds for Green Bonds come from the investor market while funds for green loans come from a bank or private operation. A bond is a type of loan in which the issuer (which can be a government, corporation, not-for-profit organization, financial institution, or renewable energy company) borrows money from the buyer of the bond. The issuer of a green bond commits to investing the proceeds of the bond issuance in projects with environmental benefits, which can include climate change adaptation, such as early warning systems and making infrastructure more resilient to climate change impacts.

  • What type of Green Bonds dedicate a portion of the proceeds to climate change adaptation and resilience-related assets, projects, and activities?

    You got it. Climate Resilience Bonds dedicate a portion or all of the proceeds of the bond issuance to investments that support climate change adaptation and resilience-related assets and activities. The issuer of the bond must demonstrate that they understand the climate risks and how the activity or project addresses those risks. This is an emerging instrument, with the first climate resilience bond launched by the European Bank Reconstruction and Development in 2019.

    You’re right that Blue Bonds can support projects and activities with adaptation benefits, such as coastal climate resilience and mangrove rehabilitation, but they are focused on the betterment of marine resources. The first blue bond was issued by the Government of the Seychelles in 2018, and the most common objective to date is the financing of marine and ocean projects.

  • What type of bonds can be used to raise funds for a firm’s general operational activities that have explicit sustainability targets, including climate change adaptation targets?

    Yes. Sustainability-linked bonds are linked to the issuer’s achievement of climate change or broader sustainability goals through adjustments in general operations, rather than being earmarked for financing particular projects. They have typically been used by corporations to further their overall sustainability strategies and can be used to finance climate change adaptation projects, such as flood protection.

    Not exactly. Sustainability bonds are a type of green bond where the proceeds are applied to financing specific green and social projects, rather than being used for the general purposes of a firm. These use-of-proceeds sustainability bonds offer flexibility in regard to the types of projects to finance, and can be used for climate change adaptation projects, such as management of coastal areas, flood management, and sustainable management of natural resources.

  • What tested, mature financial instrument for conservation efforts can be used in a way that provides climate change adaptation benefits?

    Correct. Payments for ecosystem services have been used as a conservation and resource management tool since the early 1990s and have been implemented on all continents. They use a “beneficiary pay principle” to transfer payments to providers that are linked to the successful protection of ecosystem services. These schemes can be structured to provide adaptation benefits, such as flood abatement.

    Not quite. Conservation impact bonds are an emerging instrument, with a prototype launched in Canada in 2020. They provide funds for conservation and nature-based solutions, and can be structured to provide adaptation benefits, such as restoring waterways and growing native plants.

  • What instrument is used by multilateral development banks, bilateral development partners, and government entities to incentivize more lending and investment in sectors and countries in which lending from financial institutions is constrained, including for climate change adaptation initiatives?

    Both are correct. Credit Guarantees are an instrument whereby a third party – the guarantor – pledges to repay all or part of a loan if the borrower defaults. Guarantees in developing countries are most popular in structuring financing in which a multilateral development bank, bilateral development partner, or government entity guarantees the repayment of a loan taken by a project developer. Guarantees can be helpful in raising investment for adaptation projects that have less of a track record and are unfamiliar to investors, or adaptation projects that are predicted to have lower or more volatile returns on investment.

    Both are correct. Pooled Investment Funds are financial vehicles that combine capital from different entities and then deploy that capital to projects/initiatives. When public funds (e.g., from multilateral development banks, bilateral development partners, and government entities) are combined with private finance, the resulting pool of resources is a blended finance investment fund. The public funds help to lower the risk/return trade-off for other co-investors, which helps to attract private investment to projects that otherwise would not have receive commercial capital, such as adaptation projects.

  • What public investment mechanism was developed and used by South American governments to enable private firms to prepay a portion of their taxes in the form of public works?

    You’re right. The Government of Peru devised the Works for Taxes Scheme in 2008 to encourage joint work between the public and private sectors to reduce the country’s infrastructure gap. The private companies assume the upfront costs of new infrastructure projects while the government accepts the projects in lieu of future tax payments. Colombia replicated the program in 2017 and included climate change and climate risk management as one of the priority areas for project development.

    No. Tax Increment Financing (TIF) has been used for over 50 years by municipal governments in the United States, with some application in Australia, Canada, Hong Kong, New Zealand, and the United Kingdom. TIF schemes are a form of land value capture financing, where it is assumed that land value will increase as a result of redevelopment or revitalization of public infrastructure projects that are financed by municipal governments.  The expectation is that, after completion, the taxation authority will receive higher tax revenue as a result of an increase in land values. This incentive mechanism has been used to encourage investments in adaptation, including green roofs and stormwater management.

  • What pay-for-success instrument provides upfront capital from private investors for one environmental project or initiative, with repayment tied to the revenue or cost savings generated by the successful initiative?

    Correct. Environmental Impact Bonds are used to pilot riskier investments or to scale up solutions that have been tested in a pilot project. Borrowers, such as public entities, repay investors based on the achievement (or not) of agreed environmental outcomes, meaning that the borrower could repay more or less than the original amount of the loan depending on the results, as defined in the environmental impact bond contract These bonds tie repayment to the revenue or cost savings generated by the successful project, while traditional bonds are often repaid from the general revenue of the bond issuer. Environmental impact bonds can be useful in cases where a project delivers climate change adaptation benefits, such as wildfire risk reduction and stormwater management, but lacks traditional revenue streams to attract investors interested in both a financial return and environmental impact. 

    No. Green Bonds, like traditional bonds, are typically used for multiple investments and are repaid with the general revenues of the issuer of the bond. A core component of a green bond is the use of its proceeds for projects with clear environmental benefits that should be assessed, and where possible, quantified by the bond issuer. Climate change adaptation is an eligible project category under the Green Bond Principles.

  • What innovative financial instrument links individual private investors with projects and entrepreneurs that need capital to start or scale up their adaptation-related initiative?

    You’re right. Crowdfunding and investment platforms aggregate capital from multiple investors (small private investors, investment funds, donors—each of whom provides a relatively small amount of money) and channel the capital into multiple projects and businesses seeking investment, which can include adaptation projects. Project selection (eligible borrowers), risk assessment, and due diligence are done by the crowdfunding platform provider or a partner company. These platforms typically operate as an Internet-based platform and often function without standard financial intermediaries. 

    Not exactly. Green Revolving Funds are typically established with funding from   public sources and provide funding for sustainability projects that generate cost savings. A portion of the savings is used to replenish the fund, which ensures a repeated cycle of loans and repayments. Several U.S. states have used these to finance adaptation-related projects, including stormwater infrastructure; and revolving funds have been used to support small projects in developing countries including for adaptation.

Using Innovative Financial Instruments: What makes an instrument “innovative”?

Innovative financial instruments can help to scale up private sector investment for climate change adaptation; however, it is important to recognize the limitations of these instruments and be judicious in identifying opportunities. IISD research determined that innovation lies with the way the instruments – which are not necessarily new – are used. The instruments can be innovative in how they are combined to incentivize private investors to increase investment flows to adaptation projects. In addition, they can be innovative by applying a tested financial mechanism or arrangement to a new issue, such as climate change adaptation; or applying the instruments in a sector or country in which they previously have not been used. Blended finance arrangements that bring together grant and concessional public finance with private capital have been and will continue to be the means through which private finance supports many adaptation projects.

Importantly, efforts to use innovative financial instruments to scale up investment in climate change adaptation should be focused on those sectors and regions where there is the greatest opportunity to meet the revenue expectations of private financiers. A realistic assessment recognizes that some adaptation interventions – particularly those that reach the most vulnerable communities, people, and ecosystems – will not provide an adequate return on investment to attract private finance, and should be prioritized for grant and concessional finance from a public entity.

Start Over

Read more:

Gouett, M., Murphy, D. & Parry, J.  (2023). Innovative financial instruments and their potential to finance climate change adaptation in developing countries. Winnipeg: IISD. https://www.iisd.org/publications/report/financial-instruments-climate-change-adaptation

NAP Global Network. (2024). Inventory of Innovative Financial Instruments for Climate Change Adaptation. https://napglobalnetwork.org/innovative-financing/?category=financial-risk-management&instrument=green-revolving-fund

 

  1. Climate Policy Initiative & Global Center on Adaptation. (2024). State and trends of climate adaptation finance 2023. Page 4.  https://www.climatepolicyinitiative.org/wp-content/uploads/2023/12/State-and-Trends-in-Climate-Adaptation-Finance-2023_.pdf
  2. Ibid., page 13.

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