Building an Ecosystem to Save an Ecosystem: How Facilitating Climate Finance for MSMEs Can Fight Global Climate Change
For any micro, small and medium enterprises (MSMEs) or start-ups working on climate solutions, “climate finance” is a buzzword. But it has become increasingly clear that we need to reimagine the entire ecosystem if we want to get MSMEs to actively and effectively engage in the delivery of climate solutions – as well as saving them from the negative impacts of climate change. (Yes, the MSME sector is quite vulnerable to climate change and extreme weather events.) So what’s the best way to effect this ecosystem-wide change? Let’s start by defining the terms of the discussion.
What is Climate Finance?
Climate finance remains a bit cryptic to the majority of MSMEs and start-ups. There is no standard agreement about what types of finance qualify, and this leads to several issues in understanding, measuring, reporting and verifying it. The United Nations Framework Convention on Climate Change’s Climate Finance Flows Report offers the following definition: “Climate Finance aims at reducing emissions, and enhancing sinks of greenhouse gases and aims at reducing vulnerability of, and maintaining and increasing the resilience of, human and ecological systems to negative climate change impact.” This definition is quite comprehensive and could encompass a whole gamut of financial instruments. Yet most MSMEs are familiar with only a few such instruments, such as carbon credits, Certified Emission Reductions, grants, etc.
For the purposes of this article, let’s define climate finance as any national, transnational or local financing from public, private and alternative sources to support solutions addressing climate change mitigation and adaptation. Climate finance may focus on significantly reducing carbon emissions (mitigation), or on adapting to the adverse effects of a changing climate (adaptation). Climate change mitigation includes the funding of projects focused on renewable energy, energy efficiency, forestry and land-use, sustainable urban transport, etc., while funding for adaptation is geared towards enhancing resilience to the impact of climate variability.
Who are the providers and how do they work?
There is a huge gap between the demand for climate finance and its supply. According to the World Economic Forum, by 2020, a US $5.7 trillion investment in green infrastructure will be needed each year to support climate change mitigation and adaptation, mostly in the developing world. However, according to a Climate Policy Initiative report (2018), the total global expenditure on climate change mitigation and adaptation ranged from roughly just US $450-550 billion a year in 2016/2017.
One of the biggest challenges in taking advantage of climate finance is its convoluted route. Climate finance flows from public, private, alternative or blended sources through national, regional and/or international channels. Developed countries like Australia, Canada, the US, the UK and others have a mandate, as part of the Paris Agreement, to provide support to developing countries. There are country-specific bilateral institutions such as DFAT, CIDA, GIZ, JICA and others which are responsible for ensuring the flow of climate finance to developing countries. These institutions provide capital to climate change-specific funds such as the Green Climate Fund, the Adaptation Fund and the Climate Investment Funds, among others, which are managed by multilateral institutions such as the World Bank and the UNDP.
These funds then appoint National Implementing Entities (NIEs) in developing countries, such as India’s National Bank for Agriculture and Rural Development, Rwanda’s Ministry of Environment and Namibia’s Environmental Investment Fund, which are responsible for the disbursement and management of climate finance to MSMEs. MSMEs and other enterprises apply for funds from these NIEs, which follow a pre-determined process for awarding and transferring the funds.
Why do MSMEs not get access to climate finance?
In spite of the availability of these resources, there are several impediments that prevent MSMEs from fully leveraging them. For instance:
- Limited communication between financial institutions and MSMEs results in a lack of awareness about climate finance opportunities for these enterprises.
- The complexity of applying for access to climate finance (especially the paperwork required) is a major challenge for MSMEs that lack an understanding of the procedures, eligibility requirements and reporting criteria involved.
- Climate finance also requires strong implementation and a solid track record, the absence of which makes it difficult for MSMEs to access this funding. The existing funding instruments and channels are not optimised for catering to the MSME sectors. For example, the Green Climate Fund requires that every dollar it contributes should leverage four dollars of commercial capital. Furthermore, many lenders expect a higher share of equity from MSMEs, as well as established credentials – and unfortunately, the majority of MSMEs struggle to meet these expectations. Also, MSMEs need more capacity building support and technical assistance grants, but due to their small project sizes, they find this support to be insufficient.
How to support the flow of climate finance to MSMEs?
There are several ways the global development community can help overcome these challenges and open new avenues to climate finance for MSMEs. To take just a few examples:
- There is a dire need for a dedicated ecosystem for enabling climate finance to the MSME sector. Financial institutions need to calibrate their offerings with a nuanced understanding of MSMEs’ needs in different climate change sectors. Additionally, government institutions and policy makers need to make additional efforts to create a regulatory environment that’s conducive to climate finance.
- A new mechanism for risk mitigation needs to be developed, in which risk is mitigated by development finance institutions and not left to be mitigated by the MSMEs, which do not have capacity. The newly launched Invest4Climate shows promise, but would benefit from a dedicated focus on MSMEs.
- The sector also needs simplified processes for ensuring a smooth flow of climate finance, and dedicated agencies for capacity building at the national as well as sub-national levels. Online resources and tools that help MSMEs to check their eligibility for different types of climate finance, and that explain how they can obtain it, could be a great value add.
If these measures are taken as part of a broader effort to boost the climate finance ecosystem, the benefits will be substantial – not just for MSMEs, but for both national economies and the global environment.
Photo courtesy of Franz Jachim.