Climate Adaptation Finance: The Bankability Challenge
The Context: A Rising Appetite
Climate action has largely focused on mitigation. However, projections are increasingly skeptical that we can limit global average temperature rise to 1.5°C and avoid long-term, severe climate impacts.
As a result, there is growing interest in developing and financing projects that help businesses adapt to climate change. Financing adaptation plays a critical role both in corporate risk mitigation and building competitive advantages in the market.
While mitigation focuses on halting climate change itself, primarily by reducing GHG emissions, adaptation focuses on managing and reducing the adverse impacts.
In other words, mitigation addresses the cause and adaptation measures, like flood walls, manage the consequences.
As the impacts of climate change have become more severe, there has been a rapid push to mobilise capital and fund adaptation projects. Even so, there remains a funding gap of USD $339billion/year to meet adaptation goals in developing countries alone.
The funding that does exist has primarily been provided by the public sector, with institutional investors and commercial banks accounting for less than 3% of adaptation finance. Yet, private actors have an increasingly vested interest in adaptation.
S&P reports estimate that, without significant investments in adaptation, private companies stand to lose up to 28% of their asset value per year.
The Bankability Issue
Despite its importance, adaptation faces significant barriers to accessing private capital.
The issue largely centers on bankability: The ability of a project to attract investment.
Private investors act primarily on financial motives, relying on the ability to quantify benefits in monetary terms and generate profit (not just break-even).
Though there is a growing market for investments that generate positive social and environmental impacts, it accounts for just 1% of the overall UK investing market
The financial motives underpinning most private investment decisions create four major barriers to adaptation bankability:
Difficulty measuring the benefits, lack of a clear revenue stream, scalability, and insufficient institutional capacity.
The Difficulty of Measurement
Measuring the monetary benefits of adaptation is challenging for three key reasons.
First, one of the biggest benefits of adaptation is in avoiding losses. For example, the economic benefit of a flood wall is generated by reducing flood impacts and the associated costs. However, it’s difficult to predict how many floods will occur in order to determine the total cost savings and economic benefits.
Saving money is less tangible than making money and avoided-cost estimates rely on predicting uncertain weather events. Unfortunately, successful adaptation often looks like nothing is happening, which is a difficult business-case to make to investors.
Second, many of the benefits are non-market benefits: They don't have a traditional price-tag or marketplace where you can buy them. What, for example, is the appropriate price for improved air quality? Expressing non-market benefits in monetary terms is still a developing field based on methods that are complex, resource-intensive, and prone to over/underestimation.
Finally, adaptation benefits often come in the form of public goods. Rather than providing benefits that can be captured exclusively by an investor, benefits are disbursed to a broad community. For example, you can’t reasonably track or charge payments for cleaner air. Adaptation can also have co-benefits: Reducing vulnerability while simultaneously contributing to mitigation, social, and environmental goals. However, it is difficult to capture those co-benefits and attribute them directly to an adaptation project.
From an investor perspective, adaptation faces a stark reality: The benefits are challenging to measure, but the costs are easily and accurately quantifiable.
Lack of Revenue Stream
Another key barrier. Adaptation projects rarely create a stream of revenue to ensure a return on investment.
A flood wall will prevent financial loss, but it won't create an income. Many investors rely on a revenue stream to gauge the ability of a borrower to repay the loan and interest.
Without this revenue stream, adaptation projects struggle to guarantee their ability to repay investors and pass standard financial metrics like return on investment.
Adaptation also suffers from a lack of scalability.
Because adaptation needs differ drastically by location, projects are often small-scale and localised. Different from mitigation projects like solar farms, adaptation projects are tailored to specific contexts and cannot generally be standardised or exported at scale.
As such, adaptation typically struggles to meet the minimum investment thresholds and transaction costs required by institutional investors. In short, adaptation projects are too small and localised to interest large investors.
Capacity Issues
Finally, securing private investment often requires the development of complex project designs and proposal pitches detailing how the investor stands to benefit.
Projects need to be rigorously planned and constructed to appeal to the financial logic of private investors.
Even if their project is viable, companies and governments alike often lack the capacity to develop the metrics and business proposals to entice private capital.
Together, these barriers threaten the ability of private companies to manage climate impacts and require novel solutions to overcome.
How do Barriers Impact Private Companies
One climate disaster, such as a severe flood, can disrupt supply chains and business operations, damage assets, and lead to insurance coverage retreats or premium hikes. Though climate disasters impact companies in different ways, they all pose significant threats to a business's ability to operate and generate profit.
While some companies manage these risks through private adaptation, others rely on spillover-benefits from public adaptation. Flood walls, for instance, are often public projects. However, they protect both public and private assets.
In this context, barriers to adaptation finance can have severe consequences for companies. Directly, barriers can prevent companies from developing their own adaptation projects or force them to take out traditional loans at higher cost to finance them. Indirectly, barriers can prevent companies from capturing the benefits of public adaptation.
How Can Companies Address These Barriers
Two specific actions can help businesses address barriers to bankability: aggregating project proposals and partnering with public institutions.
Rather than seeking finance for an individual project, companies can combine projects into larger, more diverse investment proposals. Pairing adaptation with revenue-generating mitigation projects, for example, dilutes risk and caters to the financial logics governing private investment decisions.
Companies can also partner with each other to bundle projects together, increasing the investment scale to meet the minimum requirements of institutional financiers.
Partnering with public institutions is another effective solution. Since adaptation often has spillover benefits, there are opportunities for governments and companies to partner on projects that benefit them both.
Private companies benefit from the higher credit ratings of public institutions (which makes the project less risky for investors) and both benefit from sharing the cost-burden of the project. Public and private partnerships also benefit from capacity sharing that aids the development of investor-attractive projects and proposals.
Looking Forward
While the current case for adaptation is risk mitigation, the future case will be competitive advantage.
As climate impacts increase, company value will be assessed in terms of resilience, with marketplaces rewarding the most reliable.
While early movers on adaptation experience minimised disruptions, latecomers will face an uphill battle to compete.
At the end of the day, solving the bankability problem is not just for B-Corps or sustainability-minded companies. It’s just good business.
