Beijing, June 19, 2023

Addressing the Climate Finance Shortfall: The Role of Multilateral Development Banks, Institutional Investors and Insurers

Photo shows how AIIB's Gujarat Rural Roads (MMGSY) project improved rural road all-weather connectivity to 4,000 villages in all 33 districts of Gujarat. Other international financing institutions like the World Bank and the Asian Development Bank also gave India financing support to improve its road infrastructure in other rural areas.

Between now and 2040 the world requires an estimated USD84.5 trillion in investment in infrastructure. Included in this is a projected USD16 trillion gap in required sustainable infrastructure financing.[1] A 2022 report by the Independent High-Level Expert Group on Climate Finance[2] estimated that USD1.2-1.7 trillion of investment in sustainable infrastructure is required per year by 2030, which is double the approximately USD600-USD800 billion that is contributed annually at the present time.[3] Closing this substantial financing gap will require mobilizing private capital and a pipeline of bankable projects at a scale never previously accomplished. To do so, the combined resources of multiple sectors of the global financial services sector will be necessary.

While multilateral development banks (MDBs) have been deploying their substantial resources to make a dent in the gap, they have made limited progress. Part of the reason is the absence of bankable projects around the globe, but another important component is that the MDBs have failed to jointly marshal their resources—operating in silos rather than collectively. That is gradually changing as multilateral initiatives are impacting the climate finance landscape.

But other important factors are contributing to the shortfall in climate finance. A misalignment of interests between investors, lenders and risk takers, along with a general hesitancy among climate financiers to assume greater levels of risk, have prevented more progress from being made. Some investors and lenders have never before worked with MDBs, in part because they either are generally unfamiliar with what the MDBs do or prefer to steer clear of public sector institutions because of the perception that they are slow, cumbersome, and difficult to work with. Yet, as the timelines of project finance is often years rather than months, if MDBs are engaged at the beginning of the financing process rather than in the middle or toward the end, processing timelines may not be misaligned.

Some MDBs have already acted upon, or are in the process of acting upon,  such concerns by creating programs specifically intended to engage more effectively and creatively with the private sector and institutional investor communities. While the programs have generally been well received and utilized, clearly, more needs to be done to unlock the billions of dollars of capital waiting to be unleashed by institutional investors in the infrastructure (and other) sector(s) in the developing world.

Among the most important things the MDBs can do are to:

  1. Combine their resources instead of working independently to create larger pools of equity, loans, and guarantees;
  2. Pre-package infrastructure financing instruments that offer investors AAA-rated products that are readily available and easy to deploy;
  3. Produce standardized loan, syndication, guarantee, and other documentation in a format pre-approved by the private marketplace that can be quickly and easily deployed;
  4. Create a collective first-loss credit enhancement product; and
  5. Assume the risks other sources of private capital mobilization are not typically willing to assume and do so with greater frequency.

This will of course be easier said than done, but the MDBs are one of only a few sources of capital and de-risking that are in a position to move the needle to fill the infrastructure and climate finance gap. They are moving in this direction, but doing so should become a recurring priority of the MDB sherpa group to keep this issue at the top of their collective list of priorities.

There is another important piece of the puzzle that is missing and would help close the climate finance gap: institutional investors, which have mostly held back from supporting climate-friendly infrastructure investment at scale in developing countries. Among the reasons commonly cited by these investors are the scarcity of bankable projects, lack of appropriate financing vehicles/ instruments, maturity mismatches between private equity funds and infrastructure requirements, regulatory barriers/instability, market fragmentation, high bidding costs, an absence of local expertise, a shortage of reliable data, and a lack of transparency. These investors are ultimately looking for a reason to say “yes” to investing in sustainable infrastructure in developing countries, but they must believe that there is meaningful risk sharing with the MDBs and other de-risking partners.

The other most important potential partners in terms of de-risking and additional sources of capital are insurers, which have the resources, global reach, and gravitas to make a real difference. With approximately USD33 trillion in assets under management, insurers rank alongside pension funds as the world’s largest long-term investors. Historically, insurers invest less than 2.5% of their portfolio in infrastructure, even though infrastructure offers an attractive investment opportunity because it can deliver predictable and stable cash flows that match insurers long-term liabilities while also generating an illiquidity premium. Additionally, insurers are well-positioned to understand physical climate risks and the advantages of investing in infrastructure that is low carbon and resilient to climate change. The virtuous cycle between investment and underwriting makes insurers exceptionally well-positioned to lead the way on climate-smart investments.[4]

A number of UN-sponsored initiatives have been created in recent years to further develop regulatory guidelines and foster greater involvement of insurers in climate finance, but most insurers have chosen to chart their own path. While some insurers have been innovative and are heading in the right direction, to date there has been little meaningful progress made in crafting a collective solution to the climate finance shortfall from the insurance community. If insurers want to help move the needle, they will need to combine their resources to help catalyze hundreds of billions of dollars in sustainable infrastructure in the near future. Hundreds of millions won’t be enough.

Investors and lenders naturally have a range of legitimate concerns about perceived risk, governance, corruption, transaction size and structure, and a relative lack of risk and return data, among other issues. However, there is plenty of private capital sitting on the sidelines waiting to be invested. Investors will continue to rely on MDBs and similar organizations to identify and support bankable projects that have been well vetted to give them the confidence they need to proceed to commit their capital in projects and in places where they may not otherwise wish to do so.

When institutional investors better understand the MDB value proposition and the many ways in which the MDBs can catalyze investment in the infrastructure sector in many of the world’s least developed countries, it can result in increased investment in the countries that need it the most. However, that will depend in large part on the extent to which MDBs are successful in mitigating risk and creating an investment climate conducive to a much greater volume of infrastructure investment.

Similarly, host governments must do their part to make resources available to MDBs and investors, and create an enabling environment conducive to successful cross-border infrastructure investment. The same can be said about domestic funding sources – whether pension funds, sovereign wealth funds, or commercial banks – which in many instances hold the key to whether domestic resources are catalyzed in a similar manner. But, in the end, it is the institutional investors themselves that must demonstrate a willingness and capacity to invest. Given the right set of financing tools and safety mechanisms, that, too, should come in time.

MDBs are in a unique position to play a catalytic role in incentivizing many forms of investment throughout the developing world. The lengthy list of recommendations referenced here are achievable. The question is, will the MDBs, institutional investors and insurers commit to making them a reality and will they agree to work together to produce a more harmonized operational landscape? To do so will require turning the pyramid upside down and looking at the climate finance universe in a wholly different way. That will require a willingness to press against the conventional operational boundaries that exist, agree to work together and arrive at a collaborative path forward.

This article was first published in Refintiv Project Finance International (PFI) magazine.

[1] (from 2020 onwards, inclusive of the UN’s Sustainable Development Goals).






Daniel Wagner

Senior Portfolio Officer, Resource Mobilization, AIIB (seconded to COP28 through 2023)

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