Dissecting the current urban landscape and why we need climate finance in cities

Why urban climate finance is needed 

Cities, with their immense potential to drive global climate action, should serve as a beacon of hope. They bear the responsibility for 70% of global emissions, and 56% of the world’s population resides in cities, a number projected to increase to 68% by 2050. Two-thirds of the 169 SDG targets are to be implemented at the subnational level, primarily in cities. However, the lack of enabling environments from national governments currently hinders the delivery of financing to urban areas.

Given the pressing urgency of the situation, cities urgently need climate financing. They have been grappling with inadequate capital levels for climate adaptation and mitigation. This includes instruments such as green bonds, social bonds, sustainability-linked loans, and other financial structures conducive to fostering more climate-friendly cities. 

Financiers and MDBs have a key role to play in urban climate finance 

Multilateral development banks (MDBs), as key players in the global financial system, have a crucial role in shaping the direction and scale of climate finance for cities. In an open letter to the presidents of 10 MDBs, 40 city leaders have recently emphasized the need to mobilize climate capital for cities, particularly from MDBs themselves. This underscores the potential influence and responsibility of MDBs in urban climate finance. 

The launch of the Coalition for High Ambition Multi-Level Partnership (CHAMP) during COP28 was a significant step towards mobilizing climate capital for cities. CHAMP, a global initiative, recognizes the pivotal role of cities in global climate efforts and aims to provide the necessary resources and financing to support their climate strategies. The endorsement of the CHAMP agreement by over 70 national governments at COP28 further underscores the importance of prioritizing climate investments in subnational projects. This initiative serves as a platform for collaboration and knowledge sharing, aiming to accelerate urban climate finance. 

CHAMP aims to work closely with subnational governments in planning, financing, implementing and monitoring climate strategies to maximise climate action. 

A recent report by C40 Cities highlighted how the proportion of financing from MDBs committed to urban-related finance in Low and Middle-Income Countries (LMICs) has plateaued at 21% across 2015-2022, despite climate finance increasing at rapid rates across the rest of the world. This seems counter-intuitive, as the report points out that 'climate-related opportunities in LMICs ', which refer to the potential economic, social, and environmental benefits of climate action, are projected to exceed US$29.4 trillion by 2030. These opportunities, if harnessed, can significantly contribute to urban climate finance, underscoring their importance in the urban climate finance landscape. 

Out of the $287 billion MDBs invested in climate-related finance between 2015 and 2022, $62 billion was invested in urban climate financing. When looking at all global climate financing, between 2017 and 2018, cities worldwide received an average of USD 384 billion in climate finance per annum—only 7-8% of the annual global climate finance requirement. This lack of investment particularly stood out in LMICs. 

Developing quality and sustainable urban infrastructure is undoubtedly one of the most pressing challenges for cities, yet one of the most appealing opportunities. It is estimated that $4.5-5.4 trillion per year is needed for urban infrastructure upgrades, with actual investment levels being $350 billion per year less than what is required. However, the potential benefits of such investments are immense, including job creation, improved quality of life, and reduced climate risks. This underscores the importance and potential of urban climate finance. 

What obstacles are there? 

Obstacles to unlocking urban climate finance include issues such as: 

• Poor creditworthiness - Only 5% of 500 large cities in developing countries possess credit ratings acknowledged by international capital markets.

• Limited fiscal decentralisation within countries forces cities to be responsible for much but possess limited financial capacity to act on their responsibilities. 

• Tax revenue uncertainty at the city level

• Restricted access to capital markets for city governments, partly due to their lacklustre creditworthiness. 

In addition, political misalignment across different levels of government and municipalities' inadequate institutional capacity act as substantial barriers. 

It is crucial to note that those controlling the Global Financial Architecture must be willing to make critical reforms. These include expanding MDB financing in cities and providing funding to encompass local capacity-building, including building municipal creditworthiness. A culture shift in financial institutions and Treasury departments is essential to overcome these obstacles.

Additionally, the more modest scale of urban climate infrastructure can off-put possible investors. Trying to generate an adequate return on investment from urban climate infrastructure projects is difficult, as there is often no clear revenue stream being generated by these projects or complex, nascent financing arrangements, such as Environmental Impact Bonds (EIBs) and Sustainability-Linked Loans (SLLs), are necessary. 

In turn, many nations are reluctant to make the necessary legal and policy reforms to equip subnational governments to implement the SDGs and climate change commitments.

…and how can they be overcome?

Working groups, such as the G20 Independent Experts Group, and movements like the Bridgetown Initiative have called for reform. They have ideated how to make MDBs more ‘fit-for-purpose’ to tackle the most pressing emerging challenges, including sustainable development, rising debt levels, pandemics, and climate change. This concept of 'fit-for-purpose' refers to the need for MDBs to align their strategies, operations, and governance structures with the evolving needs and priorities of their stakeholders, particularly in the context of climate change and sustainable development. This alignment is crucial for MDBs to effectively support urban climate finance. 

High-level solutions may involve: 

• Better reflecting climate considerations in MDB mandates and strategies. 

• Expanding the sources and quantity of climate funding, especially those with a higher volume and certainty of return on investment, is a key solution. This likely involves creating new financing instruments and vehicles for urban climate and sustainability financing, such as Green Bonds, Social Bonds, Sustainability-Linked Loans, and other innovative financial structures that can attract private sector investment and support the transition to more climate-friendly cities. The private sector's involvement in urban climate finance is crucial, as it can bring in significant capital and expertise, highlighting its role in the urban climate finance landscape. 

• Creating better financial instruments for improved debt sustainability and private capital mobilisation, including certain types of bonds and underwriting, particularly from Treasury departments.

• Mobilising capital for loss and damage financing is a goal of the Bridgetown Initiative. 

Under these efforts, in June 2023, at President Emmanuel Macron’s Summit for a New Global Financial Pact, the Mayor of Paris, the Mayor of Rio de Janeiro, and Jeffrey Sachs launched the Global Commission for Urban SDG Finance. This commission, a global platform for knowledge sharing and policy dialogue, aims to promote and instill a suite of recommendations determining how to unlock SDG financing for cities best. Its work is expected to significantly contribute to the advancement of urban climate finance. Establishing this commission marks a significant stride in advancing urban climate finance, fostering global collaboration and knowledge exchange.

The Commission’s six task forces address the following problem areas: 

• Reforming the multilateral development banks.

• Expanding existing and creating new funds or institutions.

• Attracting private sector participation.

• Developing an advocacy strategy.

• Recognising geography and context.

• Balancing mitigation and adaptation.

So, while there are many challenges to promoting urban climate finance, there is a substantial groundswell for discussion and solution ideation. The discussions regarding urban climate financing are nascent but becoming more mainstream. 

Many of the proposed solutions necessitate a culture shift in financial institutions, Treasury departments, and for LMICs, MDBs. Your role in this shift is crucial. These financiers must become more comfortable with the uncertainty and risk surrounding climate financing, including physical and financial risks. 

This 'culture shift' in financial institutions and Treasury departments refers to a fundamental change in their attitudes, practices, and decision-making processes to better align with the needs and priorities of urban climate finance. This shift will be easier as more innovative financing instruments and vehicles become available. While the exact timeframe for this shift remains uncertain, contemporary discourse suggests it’s a question of when, not if.