Climate change is a global challenge affected by GHG emissions from anywhere. We need to reduce emissions from coal power generation and that requires some program to encourage and entice owners to shutter their plants. A global auction, conducted by the United Nations or a similar international organization, would help to identify opportunities where willing plant owners and interested funders can make a deal.

Philippe Benoit

Chandra Shekhar Sinha

 after report highlights that we can only achieve the greenhouse gas (GHG) emission reductions required by the climate goals of the 

 if much of the existing coal power generation capacity is retired early. To this end, one concept that deserves greater consideration is conducting an auction for early retirement of coal power plants worldwide: a global coal retirement auction. This article sets out the broad outlines of how this global auction might operate.

The International Energy Agency (IEA) has estimated that there are 

over 8,500 coal power plants in the world

, with over 2,100 GWs of capacity. Although these plants are concentrated in a limited number of countries (notably 

over 100 countries with over 2,000 owners

level of emissions from coal is incompatible

“well below 2oC” or the more ambitious ”1.5oC”

 temperature targets set out in the Paris Agreement.

Accordingly, climate/development organizations, like the 

, are exploring programs to effect the early retirement of these coal plants.

But closing these plants presents two important challenges. First, retiring these plants removes electricity production that many countries rely upon for their economic development … production that would need to be replaced with preferably low-carbon sources. Second, owners are generally unwilling to shutter revenue-generating plants and want financial compensation for the returns they would forego from the premature retirement of their asset. This article addresses this second constraint.

There are various regulatory mechanisms that can be used to push early retirement, such as mandating closure of plants or imposing a carbon tax or other cost that makes operating the plant uneconomic.

A completely different tack is to entice closures by paying the owners to do so. This is the premise of, for example, the 

ADB’s innovative Energy Transition Mechanism

But what’s a fair price? Perhaps, however, that’s not the right question. Rather, at what price are the owners willing to shutter their plants? Given that there are more than 8,500 coal power plants operating with different technical and revenue characteristics, and over 2,000 plant owners in diverse financial situations following distinctive corporate strategies (including numerous state-owned enterprises), the answer will vary.

A technique that has been used in this type of context of multiple actors is an “auction”. While in the traditional context, a seller looks to get the highest price from multiple possible buyers through an auction, in this case, we have a buyer that is interested in paying the lowest price to different plant owners (i.e., the sellers) for the retirement of their coal plants.

, at low prices, and specifically in the climate context 

to attract cost-effective investments that reduce methane emissions

The reverse auction mechanism could be used to solicit proposals from coal power plant owners as 

to the price at which they would be willing to close their plant

. Conceptually, this could be done on the basis of MWs of installed power generation capacity. Under the auction, an interested coal plant owner would offer to sell — more specifically, to shutter — their MWs of plant capacity by a fixed time at a proposed price.

Importantly, the climate benefit sought by the auction is not from the decommissioning of MWs of capacity itself, but rather from the GHG emissions that would be avoided by retiring that capacity. Accordingly, for any coal retirement tender, it will be necessary to estimate the level of emissions that would be avoided.

This determination will be based on several factors, including the particular plant’s efficiency, remaining operational life and other technical characteristics, the type of coal used, and the amount of electricity production projected to be foregone through early retirement given the power system’s expected demand for electricity from that plant.

Tenders should include sufficient information to evaluate these items and, by extension, the level of avoided emissions and related climate benefit to be produced from the proposed retirement. This, in turn, will drive how much the auction buyer should be willing to pay for the tender.

Moreover, because it would be largely counter-productive from a climate perspective to pay to retire existing coal plants to see that money used directly (or indirectly) to build new fossil fuel generation, the tender by the plant owner would need to be accompanied by an undertaking not to reinvest in new fossil fuel generation.

As has been repeatedly explained, CO2 emissions have a global impact that is essentially unaffected by the geographic location of the emitting plant. Given this global nature of emissions, the auction would likewise be conducted at a worldwide level as a global auction. From India to Indonesia, from South Africa to South Korea, from Poland to Australia, any plant anywhere would be eligible to participate in the global auction.

Given this scope, an international organization like the United Nations or a multilateral development bank would be well positioned to provide the platform for this auction. One could imagine a system where the auction bidding process sets out eligibility criteria for projects, the methodology for estimating GHG emission reductions, and other key bid-submission parameters.

Significantly, while the bidding process would be managed on an integrated basis, the funding and selection of winners need not be. Rather, a system that allows for the matching of interested coal retirement buyers with individual plant owners could be used.

For example, buyers and their funding could be mobilized on a plant-by-plant basis based on information submitted by the plant owner through the auction process. Indeed, many potential funders have areas of focus that could lead them to be attracted to retiring coal assets only in certain countries (e.g., funders interested in a targeted set of developing countries). The proposed auction structure could accommodate these preferences. Moreover, the global auction could also operate 

in association with country-specific approaches

One potential source of funding for coal retirements tendered under the auction is the potentially large amounts of capital to be mobilized through expanded carbon credit mechanisms under development. Tapping into these mechanisms might require establishing defined project eligibility criteria, frameworks for calculating GHG emissions reductions, and associated monitoring and verification systems to enable payments for emission reductions at the time of decommissioning based on a price for emission reduction (“carbon”) credits.

It is also important to recall the first constraint noted earlier, namely that countries, and particularly developing countries, will need more electricity to power further economic and social development. Accordingly, any global auction to retire coal plants needs to be coupled with a program to fund new renewables electricity generation.

. Illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.

Early Coal Retirement: How about a Global Auction

With COP 27 approaching, pressure is mounting on wealthy countries to increase their support to poorer ones in the face of climate change. The recent floods in Pakistan have amplified this issue. China, as the world’s second largest economy, will similarly face increasing pressure to help other developing countries on climate. 

With COP 27 approaching, pressure is mounting on wealthy countries to increase their support to poorer ones in the face of climate change. The 

recent floods in Pakistan have amplified this issue

. China, as the world’s second largest economy, will similarly face increasing pressure to help other developing countries on climate.

At last year’s COP, the Asian Development Bank (ADB) unveiled an innovative program to fund the 

capital to buy-out the investors in these plants

. This approach has an interesting, and potentially even easier, application to the coal plants financed by China in Pakistan and elsewhere overseas under its 

 (“BRI”). The key to unlocking this, somewhat surprisingly, lies in the dominance of China’s state-owned companies in BRI transactions.

In 2015, Beijing and Islamabad launched a program under the BRI to build a series of new power plants in Pakistan. Over the next five years, 

 were commissioned and there are currently an additional 

developed by Chinese energy firms with loans from Chinese banks

 and financiers … companies that are all mostly owned by the Chinese Government.

criticized for the BRI’s funding of new coal power plants

 considered to exacerbate the climate vulnerabilities of the countries where these projects are being built, like Pakistan. Even as President Xi 

pledged last year to stop building new coal-fired power plants abroad

, there has been an increasing understanding that achieving the temperature goals of the Paris Agreement — and reducing the type of 

climate devastation experienced by Pakistan

 – requires not only slowing new construction, but also 

retiring existing coal power plants early

In response to this challenge, the ADB announced the 

buy out existing coal investors to shutter their plants early

 and thereby avoid the attendant future emissions. Typically, this would involve mobilizing international financing from multilateral development banks, climate funds, etc. to compensate the private sector investors in these plants.

Interestingly, the dominance in the BRI’s overseas projects of China’s state-owned companies creates the opportunity for the Chinese Government to apply the ADB mechanism in a streamlined manner — under what could be called the “BRI Clean Energy Transition Mechanism”. How might this work? Some initial ideas follow.

As noted above, Chinese state-owned financial institutions are the major lenders to the BRI coal power projects in Pakistan. Similarly, Chinese government-owned energy firms are the dominant coal plant owners. It is the financial interests of these various Chinese state-owned lenders and other enterprises (SOEs) that would be affected adversely by any early retirement.

Consequently, under the proposed mechanism, China would be compensating its own SOEs for the revenues they would lose in the future from the early plant retirements in Pakistan. In essence, China would pay itself. This is a unique feature of this BRI coal retirement program that flows from China’s reliance on its own SOEs … and it presents several operational and financial advantages.

The financial arrangements for early retirement should be easier to negotiate and execute since the parties are all affiliated — i.e., the Chinese government, its state-owned banks and other SOEs. This should also reduce transaction costs.

In the ADB’s early retirement context, private sector investors would typically insist on some compensation being paid today for the loss of projected future revenues. In contrast, because the BRI context would involve compensation from the Chinese Government to its own SOEs, the Government could reasonably delay payments till the point at which the SOEs would actually be foregoing revenues. So, for example, if we assume early retirement in 2030 — an interval that would give Pakistan the time to replace the retired coal electricity generation with renewables in an orderly manner (see discussion below) – then the payments by the Chinese Government to its SOE lenders and energy firms could similarly be deferred till that time.

The Government would also, as a practical matter, enjoy significant discretion regarding the level of compensation to be paid to its SOE lenders and energy firms in 2030 and beyond. Notably, the Government could impose a discount on these future payments — especially if it has implemented by that time financial disincentives targeting coal generation (e.g., a carbon price) to 

support its own carbon peaking and neutrality goals

The proposed BRI mechanism would resemble in various ways a debt-for-nature swap, notably from the perspective of China as a creditor/donor country. In this BRI “debt-for-coal” swap, China would forego the payments due its SOEs in the future from the operation of these Pakistan coal plants in exchange for the reduced emissions generated by their early retirement. Significantly, this mechanism would produce emissions avoidance benefits without China providing any new overseas funding.

What are some possible motivations for Beijing to launch this type of initiative?

First, it provides a mechanism for China to respond to 

the increasing pressure it is facing as the world’s second largest economy to help poorer developing countries

 meet their climate and sustainability challenges. China’s status as the world’s largest emitter of greenhouse gases amplifies this pressure.

Second, the ability to launch an international climate program that does not require China to disburse funds for the next several years — and, when it does so, to pay its own SOEs — may appeal to the Government, particularly given the current 

 advanced by other donor countries where the financial cost to the donor is from foregone revenues, not new funding.

Moreover, the loss in revenues for China and its SOEs from the early BRI coal plant retirements would only take place in 2030 when China’s economy should be markedly larger and more capable of absorbing the expense.

Finally, there is an argument that to the extent the ADB and BRI approaches retire the same type of coal capacity with the same climate benefits, China’s inducements to its SOEs to retire BRI coal assets early should be counted as international climate financial support (e.g., a type of “synthetic carbon credit”) just as actual 

monetary transfers to private sector investors would be recognized with respect to an ADB coal retirement transaction

Importantly, Pakistan and other BRI developing countries will 

need even more electricity to power their economic development

. Consequently, the BRI Clean Energy Transition Mechanism needs to include additional funding for new renewables power generation capacity (as is the case under the ADB’s approach).

Helping BRI-recipient countries to transition from coal to renewables would also support international efforts to reduce emissions — efforts whose 

importance for Pakistan and various other developing countries has been made abundantly evident

 by the devastating weather they have been experiencing.

The extreme climate events of 2022 have increased awareness regarding the vulnerability of poorer countries to climate change and the 

consequent importance of reducing future emissions

. This article sets out a proposal for how China could retire BRI coal plants early in Pakistan and elsewhere that capitalizes on its use of state-owned companies, while supporting more renewables in these countries to reduce the climate change threat and promote sustainable economic growth.

How China Can Retire Coal Early in Pakistan and Elsewhere Through the BRI

Transitioning to a low-carbon energy future consistent with the goals of the Paris Agreement requires trillions of dollars of additional investment in the Global South. Most of this investment will need to be in domestic-oriented projects, generating local currencies and creating domestic development opportunities. However, local capital alone will not be enough, and significant amounts of foreign investments in the form of debt or equity will play a critical role.

Jonathan Elkind

Leonardo Beltran

Justine Roche

Espen Mehlum

Olivier Lelouch

Transitioning to a low-carbon energy future consistent with the goals of the Paris Agreement requires trillions of dollars of additional investment in the Global South. Most of this investment will need to be in domestic-oriented projects, generating local currencies and creating domestic development opportunities. However, local capital alone will not be enough, and significant amounts of foreign investments in the form of debt or equity will play a critical role. Exchange rate risk—the possibility that a local currency (LC) loses value relative to the foreign currency (FC) in which a loan is denominated—is a major impediment to large foreign capital flows for clean energy projects, increasing the cost of capital and at times hindering investments altogether while creating financial exposure issues for domestic sponsors. While currency hedging and other options exist, they can be expensive and are lacking for many developing country currencies, particularly at the long tenors, low cost, and large scale required to support the needed clean energy investments.

Addressing exchange rate risk should therefore be a priority for climate- and development-focused policy makers, financial executives, clean energy investors, and civil society advocates. While this issue is important regardless of economic cycles, it is vital in times of rising interest rates and cost of capital—particularly in many emerging and developing markets, which are often seen as riskier by investors in times of global economic uncertainty.

This policy note sets out a possible structure that could alleviate exchange rate risk for clean energy projects. It outlines a facility, supported by a combination of domestic and international resources (including carbon credits, official development assistance, and international private capital), that could issue currency exchange risk protection to international lenders to catalyze financing for clean energy projects in developing countries.

Critical features of the facility would include the following:

—the facility would cover any and all shortfalls, even those resulting from an extreme depreciation.[1]​ 

Protection for both foreign investors and local stakeholders

—the facility would provide a creditworthy offshore guarantor for foreign lenders and reduce the corresponding exposure of host-country stakeholders (with the facility absorbing this risk with respect to the FC loans).

—the facility would be funded from a variety of sources, including potentially multilateral development banks, development finance institutions, philanthropic impact investors, sovereign wealth funds, private investors, and host-country stakeholders.

—critical funding of the coverage would come from monetizing a share of the carbon credits generated by the clean energy project and assigned to the facility.

—the facility is designed to be able to expand in size and coverage over time.

—the facility would complement commercial currency hedging products to create a seamless coverage for the long tenors required by clean energy infrastructure projects.

—the facility would be housed within an appropriate, existing institution (likely a multilateral finance organization) and would draw on existing currency exchange rate expertise.

The facility, as conceived by the authors, would generate several benefits for project owners, host countries, and international investors, including by:

catalyzing additional foreign financing for clean energy projects in developing countries, targeting in particular high-impact climate projects, such as those that add zero-carbon capacity to carbon-intensive grids.

absorbing currency depreciation risk, which could insulate (to some extent) consumers and other local stakeholders against the currency exchange rate risk, including by guarding against the prospect of dramatically rising electricity prices if the LC devalues;

reducing the cost of foreign-financed clean energy projects by enabling projects to access international finance at international lending rates.

providing a vehicle for climate-engaged funders and donors to leverage their financial contributions into larger investments in clean energy projects in developing countries.

facilitating the growth of markets for high-integrity carbon credits, which are likely to be in high demand as diverse jurisdictions and companies around the globe seek to implement net-zero pledges.

providing the flexibility to aggregate smaller projects or to cover other specialized projects, such as projects in “small island developing states.”

The facility outlined in this policy note reflects extensive analysis and consultations conducted by the authors. While it is possible that this specific concept could become a reality, the primary objective of this piece is to catalyze intensified discussion on potential solutions that can increase the flow of climate finance to developing countries by addressing the constraint of currency exchange rate risk.

Efforts to address the climate crisis face a range of challenges—political, geopolitical, economic, technological, financial, and more. One of the most persistent challenges is the difficulty of mobilizing sufficient capital to enable developing countries[2] to continue developing while simultaneously accelerating their clean energy transition.

To deliver clean energy consistent with the terms of the Paris Agreement, it is estimated that finance for clean energy infrastructure in developing countries, even without including China, needs to grow massively. Analysis produced by the International Energy Agency in cooperation with the World Economic Forum estimates that, depending on whether one aims to limit global warming to “well below” 2.0o Celsius or to 1.5o Celsius, such investments must grow from roughly $150 billion per year currently to either $600 billion or over $1 trillion in 2030.[3] Advanced economies pledged to mobilize $100 billion annually for clean energy investment in developing countries but have fallen short, only meeting 80 percent of that.[4]​ 

A key to achieving these goals is addressing the currency exchange risk that occurs between foreign-denominated financing and the local currency (LC) revenues of clean energy projects in emerging economies and other developing countries. This policy note sets out a possible structure to address this constraint and is organized as follows:

This policy note is the result of a collaboration among scholars at Columbia University’s Center on Global Energy Policy, working with the World Economic Forum’s “Mobilizing Investment for Clean Energy in Emerging Economies” initiative[5] and the World Bank Group’s Climate Change program “Invest for Climate.”[6] The piece reflects the authors’ analysis and research, including information gathered through discussions with investment and commercial bankers, private investors, multilateral bank executives, development finance authorities, development advocates, clean energy project developers, foreign exchange experts, and policy stakeholders.

Part One: The Global Need For Clean Energy Investments in Developing Countries

In order to achieve the global climate goals set out in the Paris Agreement while also meeting rising demand for energy to fuel economic growth, developing countries need much more clean energy investment. Numerous analyses estimate the scale of need. As noted earlier, the International Energy Agency (IEA) has published seminal analysis that projects a need for fourfold to sevenfold increases in investments.[7] That analysis also estimates that 30 percent of the needed funding could come in the form of foreign capital.[8] This is due to the comparatively small scale of gross domestic product, less developed capital markets, and competing priorities for domestic funds (such as education and health services). Moreover, a portion of the required equipment will need to be sourced from abroad in foreign currencies (FCs). Foreign capital will need to play a significant role.[9]​ 

Adding complexity, capital for clean energy finance tends to be available in advanced economies rather than in developing economies.[10] Investment in developing countries grew at only 2 percent per year for most of the period since 2015, the year when the Paris Climate Agreement was achieved.[11] Developing countries comprise two-thirds of the global population but have attracted only one-fifth of clean energy investment since 2016.[12] Available finance is a key missing link to accelerate clean energy deployment in developing economies.

Clean energy technologies often require large up-front capital expenditure. Their overall lifetime costs (initial capital expenditures plus operations, maintenance, and financing costs) may be lower than those of legacy energy systems, but the capital intensity of clean energy poses its own burdens, especially in capital-constrained developing countries. This means that building clean energy in developing countries requires effective management of a range of different risks—the creditworthiness of purchasers, possible regulatory and political uncertainties, unfamiliar technologies, and where foreign debt is involved, currency exchange rate risk.

Two additional important dynamics are relevant in financing clean energy projects to meet climate goals. First, greenhouse gas (GHG) emissions are projected to rise in emerging economies and other developing countries as a result of demographic, development, and energy demand reasons. Over the coming decade, countries currently classified as low and middle income by the World Bank[13] will grow to constitute roughly two-thirds of total global energy demand, a stark shift from the beginning of the century when the majority of global energy demand was in advanced economies.[14] Similarly, energy emissions in developing countries are currently projected to grow by 5 Gt by 2040, while over the same period they plateau in China and shrink by 2 Gt in advanced economies.[15] These projections highlight the importance of reversing emissions trends in these developing countries, which must simultaneously continue to develop their energy systems to raise inadequate standards of living. This emissions-reduction outcome requires a massive increase in clean energy investment in developing countries.

Second, as described in more detail in the next section, the majority of these clean energy investments need to be made in power and other infrastructure projects designed to meet local demand; they therefore generate local currency revenues. In addition, they tend to earn modest returns that require long return periods. They thereby contrast to the high-return foreign currency generating export projects that have, to date, attracted much of the international capital to energy investments in developing countries.[16]​ 

Currency Exchange Risk in Clean Energy Investments

Most clean energy projects—such as solar or wind power plants, investments in public transit systems, building efficiency retrofits, and electric vehicle charging stations—generate revenues in local currency. Traditionally, local borrowers are required to repay any foreign debt finance on agreed terms in the foreign currency, such as US dollars, euros, or yens. If the local currency loses value relative to the foreign currency during the life of the loan, a common circumstance with many developing country currencies, the project’s investors are exposed to a material risk.

Often, this risk is borne by host-country participants through, for example, host-government guarantees or by denominating the loan and other returns to foreign investors in dollars or other foreign currencies. As a result, as one expert analysis states, “When local currencies depreciate, the consequences [for host developing countries] range from bad to disastrous; including insolvency, job losses, recession, increases in non-performing loans, decreases in investment flows and economic crisis.”[17] In addition, foreign investors are often unwilling to invest without access to coverage beyond what the host government provides, thereby limiting the supply of capital for clean energy investments.

Two other factors compound the currency exchange rate risks for clean energy investment in developing countries. First, as noted above, most such projects are not major cash generators; they provide utility-scale returns. Second, the debt service terms may extend for 15 years or more, during which currency depreciation can be large while slim margins make it more difficult to absorb.[18]​ 

Importantly, developing countries can be on the losing end of exchange rate fluctuations for a variety of reasons—some having nothing to do with their own policies or practices. For example, in early 2022, global investors worried about the macroeconomic impacts of Russia’s war in Ukraine, and many investors shifted to traditional “safe” stores of value. They wanted to hold wealth in US dollars or gold, for example.[19] Many other currencies—especially those in the developing world—suffered losses as a result.[20] Other factors also adversely affected them, such as the sharp increase in energy import prices and the impact on their currency reserves.

Problematic domestic policies can also drive down the value of local currencies. At times it is difficult to identify the exchange rate impact of individual factors, especially over the short term, but as a general proposition the local currencies of many emerging economies have depreciated significantly relative to the dollar over the last 20 years. The LC values for Indonesia, India, Egypt, and South Africa relative to the US dollar are shown in Figure 1.[21]​ 

Certain existing tools and mechanisms can help manage exchange rate risk, but they have specific implications for costs, tenor, and scale. One such mechanism, host-government guarantees, covers the gap between the value of the local currency revenues and the debt service (and potentially equity payments) owed to foreign investors. Such guarantees require that the host government has fiscal space and can often create macroeconomic and budgetary stresses—a particularly salient issue given the trying macroeconomic environment of the past two years.

Another approach is for the debt obligation to be denominated in the FC, which results in the project developer—often a state-owned enterprise—bearing the responsibility to cover a depreciation-related debt service shortfall and often then turning to the government owner for compensation.[22] Clean energy investment in developing countries will not be able to proceed at pace and scale if all projects must rely on host-government compensation or guarantees—not only because these governments lack the financial capacity to do so, but also because doing so may not be wise from a macroeconomic management perspective.

Another tool used for certain projects—price indexation—has different implications. In this case, the project developer would raise the price it charges for the clean energy if the local currency loses value over time.[23] Such an arrangement can present major political and social problems if it results in significant tariff increases for consumers. As a result, this may translate into an accommodation in which the government once again steps in to pay the required amounts without passing the costs onto consumers.

Domestic private companies developing clean energy projects often do not have the option to turn to the state for compensation or have the financial muscle to cover potential large losses due to currency fluctuations. Even international companies investing in many markets with greater financial solidity and ability to diversify risks across different markets and currencies are exposed to LC depreciation risks over time, which can make investments that would otherwise be financially viable riskier and, hence, less attractive or even impracticable.

Importantly, the market can also provide protection—at a price and under certain conditions and limitations. Exchange rate swaps and hedges can be purchased in the commercial market to protect against currency risks, but hedges and swaps are only available for certain currencies, and they are not generally available for the long-tenor obligations that characterize the financing for clean energy investments. They can also be costly.[24]​ 

Recognizing the limitations of currency hedging products for many developing country currencies, various donors, together with multilateral financial institutions, established The Currency Exchange Fund (widely known as TCX). TCX aims to facilitate sustainable development in emerging and frontier markets by providing currency hedging services for project developers and borrowers in these markets.[25] In the 15 years since its inception, TCX has de-risked $1.4 billion in loans to developing countries, including $53 million in energy projects.[26] While an important addition, there remains significant room for more financial innovation.

Risk-adjusted returns matter for domestic and foreign investors, and the FC risk is an important element in that determination. The financial products currently available to catalyze clean energy investments by addressing currency exchange rate risk are insufficient to deliver the needed volume of foreign investment, particularly on terms that are affordable and consistent with other development needs. Consequently, there is not only room but need to do more in this area. The following section sets out a possible new facility to help fill this gap.

Part Two: An Illustrative Exchange Rate Coverage Facility

One possible approach to manage exchange rate risk is through the creation of a Clean Energy Exchange Rate Coverage Facility (ERCF). The structure and design presented here by the authors are not the only form that such a facility could take. Rather, this proposal provides an indicative structure with certain features that can be debated, amended, and improved. In order to facilitate the basic design task, certain parameters of the proposed facility have been simplified.

The Clean Energy Exchange Rate Coverage Facility is intended to increase funding for clean energy investments in developing countries[27] by protecting FC lenders (including those supplying commercial loans and buying bonds) against depreciation of LC payments, while also helping to protect domestic sponsors against this exposure. The facility would do so by absorbing this risk, which is distributed among its various funders (as described below). The facility would provide foreign lenders for clean energy projects with an offshore, creditworthy financial guarantee against foreign currency exchange risk and also help project sponsors access FC loans at lower rates than would otherwise apply.

In general, the following guiding principles have informed the development of this illustrative structure to respond to potential concerns of investors, local stakeholders, and international financiers, including multilateral development organizations:

—The facility aims to attract (“crowd in”) additional funding to support the significant scaling-up of affordable clean energy in developing countries, targeting in particular high-impact climate projects that can generate carbon credits (such as those that add zero-carbon generating capacity to carbon-intensive electricity grids).

—The facility would cover the gap that results if and when, as a result of currency depreciation, the value of the LC payments due by the clean energy project falls below the corresponding FC-denominated debt payments. The facility would cover any and all shortfalls, even from an extreme depreciation (i.e., where the LC is worth a tiny fraction of its original value).

rotection for both foreign investors and local stakeholders

—The facility would provide a creditworthy coverage for foreign lenders while also reducing the corresponding exposure of host-country stakeholders—with the facility absorbing this risk with respect to the FC loans.

—The proposed facility would mobilize concessional funding while providing for burden sharing among three different classes of economic actors—host-country stakeholders, international development community, and international capital.

Climate impact through leveraging of funding

—The facility’s FC loan coverage would leverage financial contributions into larger amounts of capital investment in clean energy investments by mobilizing larger amounts of other investments such as complementary equity investments and LC loans. The facility’s financial structure itself, comprising individual funding contributions, should also catalyze funding from others (e.g., carbon credits catalyze multilateral development bank [MDB]/development finance institution [DFI] support and vice versa).

—The facility is designed to be able to expand in size and coverage, thereby enabling it to catalyze increasing amounts of clean energy investment.

—The facility would provide coverage of a creditworthy offshore guarantor.

—The facility product would be structured to complement existing commercial hedging products, helping to create seamless coverage over the long tenors required by clean energy infrastructure projects without crowding out current market services. It could also complement existing currency inconvertibility coverage.[28]​ 

—For each project considered by the facility, decision-making and deployment procedures for the exchange rate coverage would be as straightforward and simple as possible.

the World Bank guarantee program, notably by enabling local sponsors, with the support of the host government, to attract financing at sound rates by providing creditworthy third-party offshore protection to international lenders,

concessional funding by the International Development Association, achieved through concessional capital provided by development agencies and climate-focused philanthropies,

contributions by the host government (e.g., through any required counterguarantees in respect of MDB guarantees to the facility) and also from local stakeholders (through the assignment of the project’s carbon credits).

The ERCF would cover the entire FC loan repayment against any shortfall resulting from depreciation of the LC relative to a contractually defined exchange rate, referred to herein as the “Reference Exchange Rate.” This coverage would include minor depreciations (e.g., the LC is worth 99.9 percent of its original value), as well as extreme depreciation (e.g., the LC is worth a tiny fraction of its original value), and all levels in between.

The ERCF’s coverage would be issued to support the debt service payments due to the FC lender of a project. The facility would be established and operate “offshore”—that is, outside the project host country—and would make its shortfall payments in FC directly to the FC lender (as depicted in Figure 2). The FC loan would be issued by the foreign lender to the project borrower; the coverage would be issued by the facility to the foreign lender. When there is a shortfall in the LC contracted amount relative to the FC debt service payment,[29] the ERCF would pay the dollar amount of that shortfall directly to the foreign lender.

This coverage is illustrated in Table 1, which depicts how the shortfall would have applied to a 10-year,[30] dollar-denominated loan using the historical exchange rate for the Indonesian rupiah/US dollar from 2012 to 2021. The exchange rate average for 2011 of 1:8,770 is used as the Reference Exchange Rate. The ERCF coverage would, as reflected in Table 1, have paid the FC lenders $0.7 million in 2012, rising to $4.0 million in 2020, and a total of $30.9 million over the 10-year term.

The ERCF is not designed to cover traditional credit, operational, technological, or other risks, which fall within the usual due diligence remit of project investors. However, consistent with its climate and development orientation, the product would conceptually be structured such that the facility’s shortfall currency protection is triggered if the project produces the clean energy (which in turn produces the carbon credits) and the borrower makes the contracted LC payment.

The facility’s product could potentially be used to mobilize additional funding from foreign lenders to domestic banks to increase the capacity of these banks to provide local currency loans for these projects. The facility could also explore potential specialized product windows, for example aggregating smaller projects from small island developing states. In addition, consideration could be given to providing some complementary protection for equity investors. Finally, the facility could be structured to receive any “surplus” in the event of an appreciation of the LC relative to the Reference Exchange Rate.

This section describes the sources of funding for the facility, the facility’s potential exposure, the proposed funding structure to meet that exposure, and other possible financial management and operational considerations.

The ERCF would draw on funding from three types of sources: (i) carbon credits; (ii) multilateral development banks (MDBs), development finance institutions (DFIs), and others in the international development/climate community; and (iii) other sources of international capital. The result is a “blended finance” facility:

 An agreed share of the carbon credits generated by the clean energy project would be transferred to the facility by their nominal owners in return for the currency exchange coverage used to help mobilize the project’s FC loans. The credits would then be monetized into hard currency resources of the facility through a long-term carbon credit purchase arrangement backstopped, for example, by one of the carbon funds operated by the MDBs,[31] which would also provide a guaranteed price floor (so as to generate the required revenues for the ERCF). Under the illustrative structure, these revenues would be divided into two installments: an initial one covering up to 20 percent of currency depreciation (i.e., if the currency loses value down to 80 percent relative to the Reference Exchange Rate), and a second one covering the unlikely prospect of a depreciation of 81–100 percent (i.e., if the LC effectively falls to near zero in value). Unused carbon credit revenues (or a portion thereof) could, potentially, be rolled over to reduce the next year’s funding requirements (notably with respect to the “81–100 percent” coverage, which is unlikely to be required for most years under most loans).

Multilateral development banks and other similar bilateral agencies.

 The second source of financial support would be from climate- and development-focused multilateral and national development agencies. Under the illustrative structure, they would provide financing to cover the second slice of depreciation, from a level of 21 percent to 50 percent (i.e., when the LC value falls to between 79 percent and 50 percent of its original value). This second slice would be divided in two, with a currency depreciation from 21 percent to 35 percent being funded through an MDB guarantee, which is in turn counterguaranteed by the host country. This counterguarantee would create a financial disincentive for the host-country government, but the host country would have no financial exposure to the facility beyond this counterguarantee. Funding for a depreciation of 36 percent to 50 percent would be provided by these organizations either through guarantees to the facility (this time without the host-country counterguarantee) or paid-in contributions.

nterested international capital, including philanthropies, sovereign wealth funds, and private-sector financial institutions.

 Under the illustrative structure, they would provide financing to cover the third slice of currency depreciation, from a level of 51 percent to 80 percent (i.e., when the LC value falls to between 49 percent and 20 percent of its original value). This would notionally be in the form of grants from philanthropies, while other funders would receive some level of renumeration (notionally, concessional to some extent). It is anticipated that multiple institutions would contribute only a portion of the required funding. Moreover, the coverage being funded would in essence constitute a form of “third loss,” following on the exposure absorbed through the carbon credits (“first loss”) and the MDBs/DFIs (“second loss”) slices.

These various funding sources are depicted in Figure 3.

In order to illustrate how a clean energy project, its FC loan, the ERCF coverage, and the illustrative facility funding structure interact, the authors have developed a model clean energy project and related FC loan. They assume the following:

A $200 million capital investment in a utility-scale solar project

A debt-equity ratio for the capital investment (excluding financing costs) of 70:30

Sixty percent of this debt for the capital investment (i.e., $84 million) provided through the FC loan to be protected by the facility

The FC loan has the following attributes:

A fixed interest rate of 5.5 percent per annum (e.g., underlying variable rate loan swapped into a fixed rate one)

$7 million capitalized into the loan to cover interest during construction (IDC)

A levelized repayment structure of 13 equal payments

The resulting total FC loan amount, including IDC, is $91 million. The debt is repayable in 13 annual equal installments of $10 million, for total repayment over the life of the loan of $130 million. As a consequence, each 10 percent LC depreciation relative to the Reference Exchange Rate in any given year generates a shortfall of $1 million for that year and, if repeated for the entire life of the loan, a total shortfall of $13 million.

The maximum exposure of the facility (i.e., assuming a complete collapse of the local currency through the term of the loan) would equal $130 million payable over the 15-year loan period. The facility would need to be funded to pay any and all shortfalls, up to the maximum of $130 million—an extremely unlikely scenario but nonetheless a scenario for which lenders would seek comfort. To meet this contingent obligation, the facility would draw on the following contributions:

The first 20 percent currency depreciation: $26 million, funded by carbon credits, with $2 million drawable in any given year[32]​ 

The second slice covering 21 percent to 50 percent currency depreciation: $39 million, split between $19.5 million of MDB guarantee with a host-government counterguarantee, and the balance through other MDB/DFI/bilateral support

The third slice covering 51 percent to 80 percent currency depreciation: $39 million, funded through a combination of philanthropies, sovereign wealth funds, and other investors

A final slice, covering a severe depreciation of 81 percent to 100 percent: $26 million, funded by carbon credits

Policy Note | Scaling Clean Energy through Climate Finance Innovation

 One third of Pakistan is now under water. The scope of the destruction is difficult to fathom, not just the enormity of the devastation its people are facing today, but also the damage to its infrastructure, its buildings, and its economy that will weigh heavily on the country for months and even years to come.

. The scope of the destruction is difficult to fathom, not just the enormity of the devastation its people are facing today, but also the damage to its infrastructure, its buildings, and its economy that will weigh heavily on the country for months and even years to come.

While experts may debate the extent to which 

greenhouse gas emissions impacting Pakistan’s weather patterns may be to blame

, the scale of this devastation shows the shortcomings of invoking notions of “adaptation” as a meaningful strategy to respond to climate change’s destructive force.

Pakistan is facing the type of large-scale destruction that is seen in wars — and not just any war, but total warfare that consumes entire regions and countries. This is what many countries suffered in World War II and others in more recent conflicts. In Pakistan, the cause isn’t an army, but a changing climate fueled at least in part by the greenhouse gas (GHG) emissions clogging our atmosphere.

A core strategic element of the international effort to address climate change is “

to respond to the impacts of climate change that are already happening, as well as prepare for future impacts

” which focuses on reducing GHG emissions.

Because our historical and future GHG emissions will produce some degree of climate change, we indeed do need to fund measures to respond to the inescapable changes in weather patterns and climate more broadly – even as, through mitigation action, we seek to lower our GHG emissions to limit how much our climate will change.

Yet, the recent events in Pakistan illustrate the shortcomings of an adaptation strategy in the face of widespread devastation. Any notion of “adapting” to these events is tragically misplaced. We cannot, just as countries cannot adapt to the destruction of war. They can resist, fight, look to recover, but the tragedy they suffer cannot be undone.

And while the number of lives lost because of climate change arguably may presently be smaller than that wrought by war, the capacity of both to destroy property, livelihoods and economies is similar.

The goals and elements proposed by the experts within the “adaptation” effort are the right ones. We must look to limit the losses generated by changes in our climate, to accelerate the recovery from extreme climate events, and 

We must invest in climate resilient infrastructure, drought-resistant crops and other strengthened agricultural practices, better weather forecasting capacity, tools to reconnect power supply more quickly, and in a multitude of other measures. And these efforts need to be adapted to the changes in our climate. Moreover, as climate specialists and others advocate, many more resources need to go into this area.

But while technocrats and politicians of the past landed on this terminology of “adaptation”, what today’s events in Pakistan show is that you cannot truly adapt to climate change and its potential for widespread devastation — especially developing countries that do not have the financial resources to counter extreme weather events.

Even at a smaller scale across both developing and wealthier advanced economies, the rising number and severity of localized wildfires, heatwaves and floods are causing irreparable damage. People suffer loss. Although they might recover and rebuild their homes or businesses, there has still been harm and too often tragedy. People die because of climate change. Too much is lost forever.

There has been growing discussion in the international climate arena around payments for 

 caused by climate change. This type of funding, including for additional adaptation measures, can help — but it will not remedy the problem, especially given 

the potentially massive magnitude of the destruction

Pakistan cannot be expected to adapt to having one third of its country under water. Families should not be expected to adapt to the tragedy climate change can inflict.

Let’s find another term that better conveys what is truly within our reach in responding to climate change so that we can have a clearer appreciation of the climate threats we face. The global community can indeed work to reduce the loss people will suffer and do a better job at helping them to recover and rebuild. But truly “adapting” to the devastation that climate change can cause is a dangerously misleading notion.

Yes, there must be additional funding for adaptation and to help poorer countries respond to climate disasters. But what the events in Pakistan show is that so much more needs to be done to reduce GHG emissions and thereby limit the degree of climate change and accompanying destructive forces people will need to face.

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Philippe Benoit

Philippe Benoit

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