Last month, leaders from economies large and small met in Paris for a climate finance summit to help to bridge the gap between current levels of green investment and what is needed to meet international climate goals. The outcomes were modest, but ambitious ideas were put on the table.
One concept — proposed as part of the “Bridgetown Initiative” advanced by Prime Minister Mottley of Barbados — is a new facility that would issue $100 billion per year in coverage of local currency depreciation risk for green investments in developing countries.
While the $100 billion number may seem large, it pales in comparison to what analysts project is required to avoid dangerous levels of climate change. For example, a new report by the International Energy Agency and the International Finance Corporation indicates that annual clean energy investments in emerging economies (outside China) and other developing countries, which currently total $260 billion, need to rise to over $1 trillion within five years to meet our global climate goals. A substantial (albeit, minority) share of this investment will need to be sourced from international capital that remains wary of the risk of local currency depreciation.
How to overcome this barrier to clean energy investment?
One possibility is to leverage the depreciation coverage of the Bridgetown Initiative through the Energy Transition Accelerator proposed by the U.S. special presidential envoy for climate, John Kerry, to mobilize carbon market revenues and private capital that funds them.
The proposed Bridgetown currency risk coverage would take advantage of and partially correct for the tendency of hedging markets to overestimate — and overprice — the risk of depreciation of emerging market currencies against the dollar. The proposal’s originator, Professor Avinash Persaud, has analyzed what the market has charged versus actual depreciation and found a systematic overpayment, effectively a penalty imposed on developing country investments. The new entity would avoid this overpayment, enabling currency coverage at a discounted price, lowering the cost of capital, catalyzing more green projects in developing countries, and thus, reducing greenhouse gas emissions.
While various potential sources of funding for the agency have been enumerated, notably international public sector sources, there is one important potential source that merits special attention: private capital mobilized through carbon markets. Secretary Kerry, in cooperation with the Rockefeller Foundation, the Bezos Earth Fund and others, has launched the Energy Transition Accelerator to mobilize capital for mitigation through carbon market mechanisms. Combining the private capital of the Energy Transition Accelerator with the Bridgetown proposal (what might be termed “Bridgetown+”) would provide for an even greater impact.
This type of combination was contemplated by the Exchange Rate Coverage Facility, a proposal developed by our team from Columbia University’s Center on Global Energy Policy, the World Economic Forum and the World Bank’s carbon markets team that also targets this critical impediment of currency depreciation risk.
Like the Bridgetown structure, the Exchange Rate Coverage Facility would be funded by international public financial institutions, as well as governments, philanthropies, sovereign wealth funds and others interested in reducing global emissions by supporting clean energy investments in developing countries.
However, in contrast to Bridgetown, the funding source to be tapped first to cover any depreciation (what can be termed “first loss”) would be carbon market-type revenues generated by the green project’s own emissions reductions — revenues provided by private sector investors in carbon markets that are seeking the benefits of supporting certified emissions reductions. This constitutes a potentially large additional resource that would significantly expand the amount of depreciation coverage contemplated by the Bridgetown proposal.
The initial modeling for the Exchange Rate Coverage Facility indicates that many renewables projects would generate, at a relatively modest carbon price (about $20/ton of CO2), sufficient carbon revenues to cover the first 30 percent or so of currency depreciation, with a margin that would leave developers with an upside (based on assumptions regarding the project’s financing plan, the construction cost of renewables and the amount of avoided carbon given the grid’s emissions factor). These additional resources could be paired with the coverage offered by the Bridgetown agency.
For example, if local currency revenues from a project lose up to 20 percent of their value, the deficit (“first loss”) for repayments to the project’s international lenders would be funded from carbon revenues. In the event of a depreciation exceeding 20 percent, the resulting “second loss” would be funded by the Bridgetown agency.
In order to mobilize those carbon revenues, a successful Energy Transition Accelerator will be needed to remove uncertainties that currently undermine the ability of carbon markets to mobilize private capital for mitigation. Additionally, the combination proposed here would support the Energy Transition Accelerator’s own objective of better-using carbon markets for mitigation (particularly for renewable energy) by effectively leveraging them with public sector and other resources through the Bridgetown structure.
To protect against increasingly extreme climate events, we must tackle the emissions problem. This task requires massive amounts of investment in green projects in developing countries. Fortunately, the international private sector has the resources to contribute its share to meet that challenge, but it will require help to address currency risk.
The Kerry Energy Transition Accelerator is part of the answer. Using the carbon markets it is designed to catalyze can augment the impact of the Bridgetown currency proposal to provide a powerful new tool to raise the private capital we need to meet our global climate goals.
Philippe Benoit is an adjunct senior research scholar at Columbia University’s Center on Global Energy Policy focusing on climate finance and emerging markets and is also research director at Global Infrastructure Analytics and Sustainability 2050.
Jonathan Elkind is a former assistant secretary of Energy and a senior research scholar at Columbia University’s Center on Global Energy Policy.