Financial Mechanisms

This page includes three sections —
  • About the Paris Agreement obligation for rich countries to provide financial support to less developed countries, in order to increase ambition in their NDCs
  • About key forms of climate finance, including grants, loans, and ‘market mechanisms’
  • About key sources of climate finance, including bilateral aid, private sector, or through the Green Climate Fund.
Climate Finance Commitments

Article 9.1 of the Paris Agreement states that “developed country Parties shall provide financial resources to assist developing country Parties with respect to both mitigation and adaptation in continuation of their existing obligations under the Convention.” In a decision that even predates the Paris Agreement, rich countries pledged USD 100 billion a year by 2020 in climate finance. But current pledges are not even close to this level of annual support. Support for adaptation lags still farther behind.

Under the Least Developed Countries Fund (established 2001) and the Green Climate Fund (see below), Least Developed Countries (LDCs) and Small Island Developing States (SIDS) should be prioritised. These most vulnerable countries cannot attract enough private investment and face challenges in self-funding, and so many are heavily reliant on funds from developed countries to enable them to cope with a situation they did little to cause. Those same countries bear the impacts of climate change — flooding, droughts, fires, disease problems, and deteriorating food security. These factors combine to create a situation from which it is very difficult to escape without external support.

It is important for developed countries to focus on funding adaptation much more than they have done to date, and to shoulder the financial burden which is their responsibility in the context of anthropogenic climate change. Providing money to the LDC Fund (see below) is one of the most positive actions that developed countries can take.

Heinrich Boell Foundation and the Overseas Development Institute maintain a very useful database of information the different climate funds here.  You can read short briefings about the individual funds, and get a sense of what funds are flowing to what countries for what purposes.

Key Forms of Climate Finance
Grant Support

The Least Developed Country Fund was established by Parties to the UNFCCC in 2001 and is overseen by the Global Environment Facility. It provides grants to the states which need them the most, with a focus on adaptation. Through National Adaptation Programmes of Action (NAPAs), the LDCF aims to help countries adapt to current climate impacts — including through climate-resilient agriculture and agroforestry systems. The LDCF also invests in ‘early warning systems’ that can reduce the impact from extreme weather events, including drought.  The Fund holds USD 1.3 billion of voluntary contributions. It focuses on the most vulnerable sectors in each country, including agriculture and water sectors. Denmark, Germany, the Netherlands and Sweden pledged a combined total of USD 160 million to the LDCF in 2019, but many more developed countries haven’t yet contributed their fair share. 

Loan Support

Loans granted by EU institutions or through the Green Climate Fund make up most of some countries’ (especially developed countries’) climate finance support (this is the case with France, for example). Even when loans are given at ‘concessionary rates’, they still must be repaid.

Loans are overwhelmingly concentrated in mitigation projects — adaptation efforts may not generate revenues that allow for loan repayments. Concessional loans may be packaged with grant finance, improving the financial viability of particular projects. (In some cases, ‘capacity building’ support can come in grant form, while support for infrastructure development requirements repayment.) Some argue that loans should not be counted as ‘climate finance’ at all, if loans taken out to address climate change increase overall indebtedness.

‘Market Mechanisms’

The under-two-degrees temperature limit goal of the Paris Agreement implies a ‘cap’ on total global emissions, to stay within a ‘global carbon budget’. So to reach this goal, all countries should use their NDC to propose a cap on their emissions by ‘date certain’ — and after that, a continued decline in emissions. (This is called ‘cap and decline’.)

But another approach has been proposed, and that is ‘cap and trade’. This means that if a country has good success in reducing its emissions — below the level indicated in the target cap — then the country could trade emission credits. Countries that can’t reduce their emissions enough to meet their own targets could then buy credits from those other countries who did meet their targets and have ‘unused’ credits. Each credit, or unit, amounts to one ton of CO2, and must only be used, and counted, once. If accounting is then accurate, the effect on the atmosphere over all should be the same, regardless of who created or reduced the emissions.

An earlier agreement made at the UNFCCC — called the Kyoto Protocol — created two project-based ‘flexibility mechanisms’, Joint Implementation and the Clean Development Mechanism. We won’t go into detail about these mechanisms, because it isn’t clear how much of their structure or function will continue after 2020. But under these flexibility mechanisms, countries (or businesses) could propose projects that earn carbon credits, based on the difference in emissions between business-as-usual (no climate-mitigation project), and the new situation where the project is reducing emissions. Developing countries have used these mechanisms to finance clean cookstove projects, renewable energy installations, and methane capture from waste treatment.

Market mechanisms can operate on a national or international scale. They can be an attractive way of increasing the ambition within an NDC, because they can support technology transfer, encourage the development of expertise in certain projects, and help achieve additional benefits from sustainable development. They are also effective at encouraging the implementation and quantification of mitigation outcomes across a number of sectors, stakeholders and countries, who learn from each other via knowledge sharing.

But the ‘flexibility mechanisms’ can also cause ‘market failure’ in cases of improper carbon accounting, or weak governance. Some would also argue that they allow rich countries to ‘buy their way’ out of the problem by purchasing carbon credits, rather than making a more serious effort to reduce emissions at home. And of course because emission reductions are only supposed to be counted once, an important question arises — who gets to take credit for the emissions? In the current system, the purchaser of the carbon credits gets 100% of the value of those credits. But that could make it harder for developing countries to reach their own NDC goals, if some of the better mitigation opportunities are pulled into the trading system.

A number of CLARA members recently published a note, ‘recommendations on forests in voluntary carbon markets’.  At a minimum, carbon credit from forests must demonstrate compliance with strict and comprehensive safeguards that advance the rights of the people who live there, while protecting the ecological integrity of the forests.  See note here.

Transparent accounting is essential in order to gain a picture of the global impact of all actions combined, and to avoid ‘double-counting’; but the question remains whether these ‘flexibility mechanisms’ are consistent with principles of climate justice. Article 6 of the Paris Agreement covers market mechanisms, but the rules for implementation of Article 6 are still under negotiation.

Non-Market Mechanism

Countries agreed to the launch of both market and non-market mechanisms at the Glasgow Conference of Parties (COP26, November 2021).  The ‘non-market mechanism’ found at Article 6.8 of the Paris Agreement is now ready to be implemented.   CLARA members worked to ensure that non-market approaches were included in Article 6 outcomes.  In a 2021 submission to the UNFCCC, CLARA argued that the non-market approach is most aligned with the principle of climate justice.  CLARA further notes that non-market approaches create greater ambition while reducing the need for expensive monitoring and evaluating of climate actions.  It is also better for combining mitigation and adaptation approaches and for combining biodiversity and climate mitigation.  See here for a discussion on ‘Joint Mitigation Adaptation’ approaches to protect forests.

Discussions about financing Article 6.8 non-market approaches are ongoing in 2022; see here for CLARA’s most recent submission to the UNFCCC on this topic.  Look and here for commentary about the place of Article 6.8 in climate finance.

Green Climate Fund

The Green Climate Fund was created by the UNFCCC in 2010. It is mentioned in many draft NDCs as the most important mechanism for providing international support to developing countries. The Green Climate Fund supports programs, projects, and portfolio investments designed to respond to climate impacts, to speed up ‘green’ (low-carbon) development, and also for adaptation purposes. The Green Climate Fund supports projects across a wide range of areas, for instance climate-resilient agriculture, flood management, transport energy efficiency, and natural carbon sink management and stewardship. The GCF is dependent on the fulfillment of financial pledges by countries, primarily (but not only) developed countries.

At present, most GCF funds flow to multilateral development banks (Asian Development Bank, African Development Bank, etc.) as well as United Nations agencies (UNEP, FAO, UNDP, etc.). However, funds can go directly to national and regional organisations, rather than going through an international intermediary. This ‘direct access’ approach has very much been favored by developing countries.

In order to be eligible, country NDCs must fulfil the GCF investment criteria. Each part of the NDC for which funding is sought must then be shaped into a coherent funding proposal — and either submitted directly to the Green Climate Fund, or via an international intermediary.

Private Finance

Public finance mechanisms generally measure ‘return on investment’ in terms of improved public and community welfare. But private finance requires an adequate financial returns from any investment — and what is considered ‘adequate’ depends on the level of country or project risk, and the time period for the investment. Investors may also back away if they perceive technology or foreign-currency risks. These are among the reasons that it can be particularly difficult for less developed countries to attract private investment.

However, countries may choose to involve ‘the private sector’ in implementation of its NDC. As part of an NDC, then, the country may identify both barriers to private investment they might change in order to attract private-sector climate finance; while also providing guidelines about what kinds of projects, and even what sectors, will be open to the private sector. Governments can: take advantage of capacity building support to facilitate knowledge transfer; commit to using loan or grant support, or insurance, to increase the financial viability of projects, thereby ‘bailing in’ the private sector; apply tax-breaks to technologies that fit the criteria for effective climate action. It’s important that those in government responsible for developing the NDC also have a good relationship with officials in the finance ministry; that dialogue is very important for success in interacting with the world of private finance, and ensuring that private-sector support is aligned with NDC programs and goals. It is important that an NDC that calls for private finance demonstrates consideration of these elements.

Debates also exist over whether private investment should even be counted as ‘climate finance’, due to its preference for funding mitigation over adaptation.

What To Ask For
  • Where market mechanisms are to be employed, is double-counting of emissions being avoided via clear carbon accounting rules?
  • Are sustainable development outcomes detailed separately to emissions reductions and are any trade-offs acknowledged?
  • Is adaptation prioritised over mitigation?
  • If you are in a developed country, does the NDC highlight pledges to help developed countries?
  • Are key roles defined at the national level in relation to climate finance? Is it clear which working group(s) will act to coordinate on climate finance?
  • Is climate action mainstreamed into national budgeting, for a positive impact on existing as well as new projects?
  • Are projects divided into sub-actions (e.g. human resources, training, surveying, research) which are individually and realistically costed?
  • Does the NDC demonstrate understanding of the barriers to climate finance, and propose measures to overcome these?
Good Practice 

CIDSE recently published a report that makes the case for reforming the way agriculture and food systems development is financed, to achieve the transformation to low-emission food production.  The report focuses on funding for agroecology – which is vital for the transformation, and most suited to family farmers. 

Further Resources

Library Resources

NDC Guidance on Finance

  • CDKN Planning