A blended finance and partnership structure to increase climate-resilient economic growth
The Dutch Fund for Climate and Development
In recent years, investments by commercial investors in solar panels and wind energy have accelerated - including in developing countries. These are projects that focus on mitigation: combating climate change by limiting the amount of greenhouse gases emitted into the atmosphere. But commercial investment in adaptation is lagging.
Research by the Global Commission on Adaptation even estimates that investing USD 1.8 trillion in climate adaptation over the next decade will save USD 7.1 trillion by 2030. In other words, failing to seize the economic benefits of climate adaptation would undermine trillions of dollars in potential growth and prosperity. So far, governments and private markets have failed to act on this opportunity. The reason that private investments in climate adaptation are lagging is not only that there is not enough money: there are also not enough adaptation projects to finance with private money. The projects that do exist have too low returns and are too risky for commercial investors.
The Dutch Fund for Climate and Development (DFCD) contributes to closing this gap by developing new adaptation projects and mobilizes private money to finance them. The EUR160 million climate fund is managed by a unique consortium of Dutch development bank FMO (lead manager), SNV Netherlands Development Organisation, World Wide Fund for Nature (WWF) and Climate Fund Managers (CFM) and is funded by the Dutch Ministry of Foreign Affairs.
“Global actions to slow climate change are promising but insufficient. We must invest in a massive effort to adapt to conditions that are now inevitable.” – Global Commission on Adaptation, November 2019
An interview with Aart Mulder, fund manager of the DFCD at FMO
What does this partnership between two NGOs, a development bank, and a climate investor try to achieve?
“The goal of the climate fund is to promote "climate-resilient economic growth", says Mulder. “It is about both climate adaptation and mitigation, but the main part must be adaptation. In particular, the fund should improve the resilience of vulnerable groups towards climate change. The fund intends to enhance the well being, economic prosperity and livelihoods women and children in particular. Next to this, it aims to protect ecosystems such as river basins, tropical rainforest, swamps and mangroves. Preservation of these ecosystems must better protect the communities that live in or nearby against the consequences of climate change.”
How would you describe the difference between climate adaptation and climate mitigation projects?
“Mitigation is the act of reducing GHG emissions into the atmosphere, or sequestering GHG emissions from the atmosphere. A good example of a mitigation project is a solar plant which delivers clean energy to a community that used to be dependent on greenhouse gas-emitting fossil fuels like coal, oil, and gas.
Adaptation is defined as the process of adjustment to actual or expected climate stimuli and its effects. It’s doing what we can to live with and minimize the destruction and suffering that comes from climate change. Climate adaptation projects include, for example, climate-smart agriculture: seeds from crops that are more resistant to drought, or training farmers on how to deal with drought. But it can also involve the construction of a dam, or the conservation of mangrove to protect the coast against a rise in the sea level.
Climate adaptation interventions are a lot more context specific than mitigation measures. Adaptation projects require investors to understand the climate risks inherent in a region. Not every region faces droughts, flooding or reduced agricultural productivity due to salinization or changing temperatures. The DFCD consortium plays into the strengths of SNV and WWF - the fund’s ‘origination partners’ - that bring together local stakeholders to help identify the climate-related issues they face through a landscape strategy.”
Most climate finance experts agree that climate adaptation projects are harder to finance and scale than mitigation projects. How does the fund overcome this difficulty?
The DFCD is structured in three facilities. Each facility has its own thematic focus, governance structure, and pre-allocated budget. WWF and SNV manage the € 30 million origination facility that identifies and develops bankable business cases for a possible investment thereafter via the other 2 facilities.
"These NGOs have knowledge and skills in this area," says Mulder, "and they know the situation in the field well. There are many project ideas, but they have to be developed into revenue models or need to develop a track record to acquire (commercial) financing. There are innovative projects in the areas of adaptation and mitigation, but they are not yet bankable, which means that the risk for investors is still too high.”
SNV and WWF support these projects in creating a solid earnings model and business plan and guide them in scaling up. The fund uses technical assistance and grants for this. As soon as a project is eligible for commercial financing, this part of the fund is ready, and the project moves on to the next stage.
The second and third facilities of the climate fund are operated by FMO and Climate Fund Managers, and each has their own facility. This part is dedicated to investments that are intended to make a financial return and is about attracting as much commercial capital as possible for climate finance.
Blended Finance Solutions "There are still few commercial investments in climate adaptation," says Mulder, "because the risk of these types of projects is high, especially in developing countries. That is why we will use the money from the Ministry of Foreign Affairs as risk capital, in order to attract more commercial money. "
This is done through a so-called blended capital structure. The government money and the money of a commercial party are put together, and a project is financed from this, However, the public party bears more risk than the private one. The climate fund takes the "first loss".
"This means we give a risk buffer to the commercial party. With this you make smart use of the different degrees to which parties expect returns and can and want to bear the risk. By setting up this fund, we combined those two parties and as a result, with 160 million euros, we can ultimately make many more investments.” The fund aims for a total investment value of between 500 million and 1 billion euros.
Part of the investment is dedicated to water projects (EUR 75 million). The water facility is led by Climate Fund Managers, which established the Climate Investor One fund a few years ago. Through this it raises commercial capital and invests in renewable energy in emerging economies and developing countries. The water facility under DFCD is called Climate Investor Two and provides equity solutions for water projects worth several tens of millions of euros, in for instance coastal protection, industrial water treatment, distribution of potable water or sanitation. These projects must contain a revenue model. For example, industrial wastewater treatment can save money for the industry, while more efficient use of water makes the area more economical with water - and thus more resilient to droughts caused by climate change.
FMO itself is in charge of the land use facility (EUR 55 million). Mulder: “In the same way as Climate Fund Managers, we make commercial investment more attractive with public funds, but in projects of between 1 and 10 million euros in the field of (forest) agriculture: forest conservation in agricultural areas where residents have a source of income from the forest, for example, or use of climate resistant seeds, or smarter irrigation by farmers.”
The land use facility finances projects by providing debt, equity or mezzanine solutions. “A challenge of blended finance is not to distort markets, but rather to create new markets,” explains Mulder. “For the DFCD this means that we help develop a market for climate adaptation projects. Our finance needs to be additional, meaning that if private capital is already available to (completely) fund the project, the DFCD will not provide any financing. However, the facility can provide subordinated capital to mobilize other financiers, which can be refinanced once the project is de-risked after a couple of years, i.e. when it generates sufficient cash flows. The challenge lies in providing the minimum amount of public blended finance capital to still ensure that a project will have sufficient finance to be implemented.”
Collaboration in landscapes The climate fund works within landscapes, which stimulates cooperation between the various managers of the fund - FMO, SNV, WWF and CFM. Rather than focusing on countries, the fund looks at landscapes - basically, a landscape is a unit that has to deal with the same climate effects, for example a river bed or a dry region.
"We have already chosen a number of landscapes," says Mulder. “An example is the Kafue Plain in Zambia , in the Zambezi River basin. Electricity is generated by the river for half of the population, and it is also important for drinking water. WWF is in general leading in choosing the appropriate landscapes. We do not limit ourselves to the landscapes already identified, however. If we are approached with a good climate project, we will endeavour to build a landscape approach around it”.
"We strive for a combination of commercial and public presence in a landscape. With a public investment, a private project can be made possible via DFCD and vice versa: private investments can boost the public investment agenda in a landscape. The landscape approach shows that improvements are being made throughout the area, including in the administration."
“The challenge for us lies in the different lenses of the DFCD’s consortium partners,” explains Mulder. “For a development bank, finding investments in a pre-determined landscape can be difficult. Typically, investors favor a broad mandate, so they can pick the best project from a long pipeline of potential portfolio companies. By narrowing yourself to specific landscapes, we are looking to help projects through grant funding and technical assistance that are often a little less advanced. At the same time it is extremely inspiring to overcome this challenge and protect crucial ecological landscapes and communities for a more climate resilient world!”
Climate resilient black tiger shrimp farming in the Ganges Delta
The Ganges Delta in Bangladesh is one of the most climate vulnerable places in the world. With the sea level rising, there is a serious risk of flooding within the low-lying delta. Such saltwater intrusion is leading to the destruction of farmland and poor availability of safe drinking water. Due to heightened soil and water salinity, millions of smallholder farmers face grave risks to their livelihoods. Salt-tolerant alternatives to rice production, like shrimp farming, have become important for this vulnerable group to sustain themselves and their families. However, low farm productivity coupled with lack of market integration are undermining the sustainability of this sector.
Training and financing smallholder farmers
ACI Agrolink, one of the leading agricultural conglomerates in Bangladesh, wants to improve the situation in the shrimp industry and is looking to build a climate resilient, sustainable supply chain. By training smallholder famers the company increases product quality, production, farmers’ income, access to finance, and knowledge on how to operate a farm without negative impact on the environment. Smallholders are taught how to sustainably deepen their ponds to increase production, and how to farm the high-quality black tiger shrimps for which they can get internationally recognised certificates – and thus more money for their yield.
Salt-tolerant alternatives to rice production, like shrimp farming, have become important for this vulnerable group to sustain themselves and their families.
SNV, as one of the Dutch Fund for Climate and Development’s origination partners, is supporting ACI Agrolink in this project. SNV provided grant funding and technical assistance to introduce a new contract farming model to Bangladesh. This model improves access to inputs and output markets as well as extension support through contract growing with private companies.
Over the next few years, this project is seeking to bring 18,750 hectares of farmland under sustainable management, increase smallholder farmer income by 15%, create 10,000 jobs and indirectly benefit 30,000 people in the Delta. Additionally, ACI Agrolink opens up the Bangladesh shrimp industry to international markets, making the country less dependent on the garments industry.
Through the DFCD’s Origination Facility, SNV is working to make this project ‘bankable’: collecting proof that this actually is a sustainable business case, which could serve as a guide for other investors. A little bit more down the road, FMO, which manages the DFCD’s Land-Use Facility, might then invest in this project as well.
Scaling up ecosystem-based adaptation
The Ganges Delta is one of the most densely populated areas on earth, and it is also home to ecologically important mangrove forests, as well as several endangered and threatened species such as the Bengal tiger, Irrawaddy river dolphin, and Indian elephant. SNV and its DFCD origination partner WWF are exploring how ACI Agrolink’s sustainable shrimp farming program can have a positive ‘trickledown effect’ on other vulnerable areas in the Ganges Delta landscape. Through education and increasing farmers’ income, the organizations hope to be able to protect areas like the Sundarbans. This highly biodiverse mangrove forest is a natural barrier against storms, sea level rise and erosion, and has a high potential to store and sequester carbon.