Blog: Risk and Reward – Leveraging Risk Management Structures to Mobilize Climate Finance in SIDS

Although small island developing states contribute less than 1% of global carbon emissions that drive climate change, they are among the hardest hit, due to a lack of action.

By Sagar Joshi, Commonwealth National Financial Advisor for the Maldives

For the second year in a row, climate action failure is ranked number one overall risk by the World Economic Forum, while four of the other risks listed in the top 10 are also induced by climate change.

Small Island Developing States (SIDS) are usually the first to suffer the adverse effects of climate change. Adverse effects range from a high frequency of climate-induced natural disasters impacting livelihoods and the economy, to the existential threat of sea level rise. Expected losses due to climate change in some SIDS are estimated at 6.5% of annual GDP, compared to a global average of 0.5%.

Closing the investment gap

These challenges require an immediate response from affected countries as well as the global community to build the infrastructure and resilience needed to combat climate change. This would require substantial investments in climate change mitigation and adaptation.

An analysis of the current climate investment landscape in SIDS shows that the investment gap is already large and continues to grow. It is also observed that the scale of international climate finance in SIDS must be multiplied by more than five if the set climate objectives are to be achieved.

Climate finance in most SIDS has remained limited due to several factors including, but not limited to, over-leveraged debt, uninvestable credit ratings, underdeveloped financial markets as well as a lack of financial mechanisms. government-backed investment. Addressing these challenges will require structural changes that may take years to embed and may not match the urgency of climate investments.

Risk mitigation – an immediate solution

An immediate and effective solution would be to have risk mitigation interventions, such as credit enhancement and credit guarantees. These interventions could structure development capital to absorb some of the country and project level risk, making it attractive to financial institutions.

Credit enhancement is a risk mitigation mechanism that could improve the credit profile of climate projects in SIDS, by increasing access to capital. A credit enhancement trust could be created using grants and concessional capital from international development finance institutions (DFIs), bilateral financing institutions, or philanthropic organizations.

This trust can invest directly in climate projects, occupying a junior position, thus allowing the private funder to occupy a less risky senior position. This mechanism could support climate-resilient infrastructure and energy projects in SIDS, by government or public-private partnerships, and can unlock long-term capital.

Maximize impact

Another effective risk mitigation mechanism could be a credit guarantee mechanism. A guarantee mechanism creates a bilateral loss-sharing agreement between a credit guarantee fund, financed by development capital, and international lending institutions.

The guarantee fund would have several pools of losses which could be called upon to compensate credit institutions in the event of a delay in debt service and for part of the losses incurred due to default by the borrower. Guarantees can be structured to address both project level and sovereign risk.

Credit enhancement and guarantee structures have been implemented in several countries in the past with some success, improving access to capital for its beneficiaries. An analysis of past interventions of this type shows that if implemented effectively, these structures can multiply investments by 10 times from different sources.

Risk mitigation measures use development capital strategically, attracting investment from multiple sources and maximizing impact.

It also diversifies and strengthens the financial support available for the climate sector in SIDS countries while building investor confidence in the economy and boosting financial support for climate action.

Learn more about how the Commonwealth Climate Finance Access Hub helps small states mobilize finance for climate action

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Media contact

  • Josephine Latu-Sanft Senior Communications Officer, Communications Division, Commonwealth Secretariat
  • +44 20 7747 6476 | E-mail

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