VIEWPOINT

2024

E M B E D D I N G C L I M AT E
FINANCING WITH
NET ZERO FOCUS
Collaborative priorities for businesses,
financial institutions & government

AUTHORS
Arjun Vir Singh

One of the biggest challenges for delivering on

Martin Rauchenwald

the world’s climate change commitments is how toDaniel Fabischfinance the huge costs involved. As climate-tipping
points approach ever closer, there is a pressing
need to embed climate change–related issues
into investment and funding decision-making,both public and private. In this Viewpoint, we lookat what this entails and set out some priorities forbusinesses, financial institutions, and government —working collaboratively — to narrow the funding gap.

Rick Eagar

ARTHUR D. LITTLE

VIEWPOINT

THE CLIMATE CHANGE
FUNDING GAPDEVELOPING COUNTRIESIN AFRICA AND THE
M I D D L E E A S T H AV E
THE LARGEST A&R
FINANCING GAP“The era of global warming has ended; the eraof global boiling has arrived.”— UN Secretary-General Antonio Guterres
As the urgency to address climate change
intensifies, one of the biggest challenges

Around $3.4 trillion in mitigation finance isfor the world is how to pay for the required
mitigation and adaptation activities, such as thetransition to renewable energy, new technology

needed annually in the current period 2020–2025. The shortfalls extend across all sectors,
although power makes up for nearly 60% of thedevelopment, and building adaptation andshortfall. Developing countries in Africa and theresilience (A&R). A report by the Rockefeller

Middle East have the largest A&R financing gap

Foundation from the 2022 United Nations

as a percentage of GDP (2.05%-2.2%) and the

Climate Change Conference (COP27) estimatesgreatest unmet needs. Excluding China from thethat investments required to meet the Unitedcomputation, emerging markets and developing

Nations Sustainable Development Goals (UNSDGs), outlined in the Paris Agreement, will be in
the trillions of dollars over the next few decades.
These investments have a predicted average

economies will require about $1 trillion in climate
finance per year, representing about a third ofglobal need (not shown in Figure 1). According
to BloombergNEF, only about 16% of climate

annual funding gap of around US $2.8 trillion in

finance needs are currently being met. Critical

the period 2026–2030 if investment flows don’t

decarbonization levers such as carbon capture/change from today’s levels (see Figure 1).

sequestration and fuel cell technology are
significantly underfunded.

Figure 1. Climate change investment needs & flow, 2020–2025
Figure 1. Climate change investment needs & flow, 2020–2025
Data confidence

in US $ billions~$4,110$660$1,930

$400
$260

$380
$240
$140

$340
$230
$110

$50
$40 $10$3,360~$2,800$2,050$1,180Includes climate finance, transition
finance & other categories of financewith climate impact

$750
Power

Buildings

Transport

2020–2025 average annual gap

Agriculture &nature-based
solutions12020 flows

Industry$1,310$1,3102020 total

2026–2030
averageannual needs

2026–2030 approx. average annual gap

Note: (1) Based on estimates that include operating expenses and dual-mandate projects with A&R benefits; investment needsin agriculture and nature-based solutions use a 2020–2050 average rather than a 2020–2030 average, as other sectors do
Source: Arthur D. Little, International Energy Agency (IEA), Rockefeller Foundation

EMBEDDING CLIMATE FINANCING WITH NET ZERO FOCUS

Note: (1) Based on estimates that include operating expenses and dual-mandate projects with A&R benefits; investment needs in agriculture and nature-based

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ARTHUR D. LITTLE

VIEWPOINTWith such a huge requirement, it is perhaps not
surprising a shortfall in funding exists. However,various factors are contributing to its scale, which

WHAT EMBEDDING CLIMATEFINANCING ME ANS

need to be addressed if the gap is to be narrowed:

Embedding climate financing into business and- Economic barriers. Compared to othercommerce refers to the integration of climate

non-green investment projects, manysustainability projects deliver low or uncertain
returns. This is typically associated withlong payback periods and/or high risks anduncertainties (e.g., due to technologicallimitations, unclear or undeveloped businessmodels and markets, and regulatory risks
such as changes in subsidies and future
performance obligations). These barriers
are especially applicable for private sector
investment.

- Operational barriers. Even when funds

are available, operational challenges likebureaucratic hurdles, lack of local expertise,or inadequate infrastructural readiness can
impede the execution of climate projects.

-

Standards barriers. The absence ofuniversal and standardized metrics forgreen investment and accounting leads todisparities in how funds are allocated anddifficulties in establishing the business case.
Without clear metrics, there is a continued riskthat funds might not be directed toward themost effective or needed climate initiatives.

- Allocation barriers. While substantial

sums are directed toward climate financeglobally, a large portion of these funds is
not necessarily reaching the most vulnerable
regions or sectors. Developing nations, inparticular, face challenges in accessing thecapital needed to drive their sustainabletransitions.

change–related issues into investment andfunding decision-making, both public and private.
Embedding climate financing aims to ensure that
low-carbon and climate-resilient pathways are
better financed, that investments are diverted
away from fossil fuel–intensive sectors, and thatbusiness models align better with the goals of theParis Agreement. Looking holistically at the typesof activities into which climate financing needs tobe embedded, we can identify four broad areas:
1. Technology and R&D. There is a critical needfor technological development and innovation
across a vast range of potential applications
relevant to climate change mitigation andadaptation. This includes activities along theentire innovation cycle from research andearly-stage concept development to scaleup, adoption, and performance improvement.
In addition to financing technology and R&D,
as we discuss below, financial institutions
themselves can conduct R&D to come up
with innovative financial products that foster
sustainable growth and address the growing
demand for green financing.
2. Green transition. Financially supporting
industries in their transition to becoming
green(er) is vital for a sustainable future (e.g.,
the automotive transition to electric vehicles).
Transitioning is ultimately the biggest costfor industries to achieve net zero. While
withholding capital from poor-performing“brown” industries can, in some cases, act asa lever to improve sustainability performance,

In the remainder of this Viewpoint, we examine

financially supporting them in their transition,

how financial institutions and businesses,with suitable conditions attached, iswith the support of governments, can improve

essential for accelerated progress. This also

how they go about addressing climate change

allows financial institutions to discharge

financing to start overcoming some of thetheir obligations to contribute actively tobarriers and, eventually, narrow the funding gap.

sustainability improvements.

EMBEDDING CLIMATE FINANCING WITH NET ZERO FOCUS

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ARTHUR D. LITTLE

VIEWPOINT

3. Resilience building. As well as mitigation,
adaptation efforts also need financing. This- Green infrastructure. Sustainable urban

planning, green transportation, and energy-

includes investing to safeguard against

efficient buildings present much-needed

physical risks, such as in infrastructure

investment opportunities. According to athat can withstand the impacts of climate

study by the European Commission, more thanchange (e.g., flood barriers, drought-resistant

35% of the EU’s total waste generation stems

crops); securing raw materials sourcing (e.g.,

from the construction sector, highlighting theadapting supply chains, alternative materials);large room for improvement in this sector.

and investing in business models andmanufacturing processes that are suitable
for the future and robust enough to transition
risks (e.g., climate regulations that disrupt“business as usual”).
4. Policy advocacy. Financial support should- Carbon capture, usage, and storage(CCUS). Technologies that absorb and store
emitted CO2 can bridge the gap between
current emission levels and net zero targets.
Although CCUS has been under development
for decades, poor economics have greatly

also be provided for policy-advocacy

hindered adoption. However, net zero targets

initiatives that promote favorable regulations

and the realization that CCUS may be theand incentives for green businesses andonly solution for certain industries (e.g., steel

projects. Joining coalitions like the Net-and cement) have provided a new impetus.

Zero Banking Alliance and committing to

For example, the Chinese Sinopec Group hassustainability frameworks such as the UN

invested significantly in this area. According

Principles for Responsible Banking canto the company, its Qilu-Shengli Oilfieldsignal that financial institutions are ready

CCUS project, which aims to capture, purify,to (financially) support climate regulations.

and reuse CO2 in production processes, is
expected to reduce annual CO2 emissions

WHERE CLIMATE FINANCING
IS MOS T NEEDED
While there are financing requirements acrossthe whole range of climate change mitigation andadaptation activities, some of the greatest needs
and opportunities are in the following areas:-by 1 million tons.

- Sustainable agriculture. According to the
Food and Agriculture Organization of theUnited Nations (FAO), by 2050 a 60% increasein food production will be required to sustain
the growing global population. Sustainable
farming practices, which both mitigate

Transition to renewable energy. The switch

and are resilient to climate change, offerfrom fossil fuels to renewable sources

substantial investment avenues. AlphaMundi

like solar, wind, and hydro offers significant

Group, for example, introduced an impact debt

investment prospects. According to Statista, thefund (SocialAlpha investment fund) that offers

global investment in renewable energy reachedcredit tailored to the harvesting season of fairaround $495 billion in 2022, representing a 17%

trade–certified fruits. The fund allows farmers

increase from the previous year. Global giants

to be paid in real time (rather than after

like Google have made pledges to rely purely on

harvest) and aims to encourage sustainablecarbon-free energy by 2030.

practices like the protection of biodiversity.

EMBEDDING CLIMATE FINANCING WITH NET ZERO FOCUS

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VIEWPOINT- Sustainable packaging. The global

sustainable packaging market is worth around$380 billion today and is expected to growat more than 5% CAGR in the coming years.
Major online retailers are transitioning tosustainable packaging, reducing waste, andpromoting recycling. Amazon’s Frustration
Free Packaging initiative is one such example.

- Sustainable sourcing, supply chain,circularity. Managing sustainability along
the supply chain from source to end of life isa major challenge, especially for sectors suchas chemicals and manufacturing. Investment
in digital technologies, such as the Internetof Things, artificial intelligence, simulation,and data analytics, will be a key part of thesolution. Similarly, consumer brands are
sourcing sustainable materials, promoting
circular fashion, and using technologies toreduce water consumption. For example,
companies like Patagonia are pioneering
recycled polyester clothing, emphasizing
repair over replacement.

MANAGING & MITIGATINGTHE CHALLENGES
What businesses can do
To overcome the funding gap, businesses needto do more to embed climate change issues into
investment and funding decision-making, taking
into account the range of challenges and barriers(see Table 1).
Economic barriers may be the hardest to
overcome, especially for smaller businesses.
The higher risks and uncertainties of many green
investments may sometimes require blended
sources of finance to offset risks. Adopting amanaged portfolio approach can help ensurethat higher-risk/higher-return projects arefinanced alongside lower-risk projects. Scenario
planning can also be valuable in identifying “noregret” green investments, “strategic insurances”(i.e., investments to mitigate possible futurehigh-adverse-impact events), and the costsof “do nothing.” Partnerships and ecosystemdevelopment are valuable for risk and reward
sharing. Small businesses can also be encouraged
to take advantage of the volume discounts andshared costs found in cooperative purchasing
and bulk buying.

Table 1. How businesses can better embed climate finance
Table 1. How businesses can better embed climate finance
BARRIER TYPEBARRIERMITIGATION & MANAGEMENT

Economic

Perceived high risk

Consider blended public/private finance, adopt managed portfolio approachLong payback periods

Shift paradigm to better value long-term sustainability, conduct scenario planningHigh initial costs

Explore partnerships, exploit regulatory incentives, consider financing

Lack of know-how & expertise

Build capacity/training, leverage ecosystem

Poor follow-up on ESG commitments

Integrate ESG better into KPIs & incentives, join ESG alliances, conduct ESG audits

Lack of standards

Align with emerging global standards & certifications

Poor ESG data

Improve consistency & accuracy of ESG data monitoring & reporting

Operational

Standards

Source: Arthur D. Little

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VIEWPOINT

BUSINESSES NEED TO
DO MORE TO EMBED
C L I M AT E C H A N G E I S S U E S
INTO INVESTMENT
AND FUNDING
DECISION-MAKING- Develop innovative green financial

products. Targeted products such as green
bonds and sustainable loans, earmarked tofund environmentally friendly projects or
to meet ESG criteria, facilitate the flow ofcapital toward sustainability initiatives. They
also provide investors with the assurance
that their investments will only go towardspecified (climate-related) activities.

For example, small-scale wind energy producers
in Denmark often form cooperatives to share thehigh initial costs and risks associated with windturbine installations, demonstrating the powerof collaborative investment. Finally, manysustainable technology suppliers offer financing
or leasing options, allowing small businesses toaccess the necessary equipment without bearing
the full up-front costs.
Many businesses need to address operational
barriers preventing environmental, social, andgovernance (ESG) commitments from being
realized in practice (e.g., through training,
capacity building, and integrating ESG fully
into corporate and personal KPIs and incentives).
To address the problem of lack of standardization,businesses can proactively align with, andin some cases, influence emerging global
standards and certifications. The availabilityof reliable ESG data is an important prerequisite
to being able to properly assess business cases
for ESG investment. Overall, new financial tools,
strategies, and structures must be designedwith a net zero target in mind, including better
reporting on brown financing (i.e., financing ofcarbon-intensive activities).
Role of financial institutions

Sustainability-linked loans allow borrowers
to use the proceeds for general businessactivities, but the terms of the loan are linked
to sustainability performance. Investment
management companies can create ESG
funds, mutual funds, or exchange-tradedfunds focused on ESG-compliant companies.
Climate-focused venture capital — investingin start-ups with innovative solutions toclimate change — is also gaining traction.
Beyond Meat’s plant-based protein or Carbon
Engineering’s Direct Air Capture technology
are two of many examples.

- Integrate climate into due diligenceand risk assessment. ESG factors can beincorporated into credit-rating models tobetter recognize that companies with robust
ESG practices should have better long-termrisk profiles. ESG screening is increasingly
being integrated into due diligence before
making investment decisions or providing
loans to identify potential risks andopportunities. This process can include both
positive screens to identify sustainability
leaders that receive capital at more favorable
terms as well as negative screens to identify“bad actors” that are excluded from financing
or only receive capital at more unfavorable
terms. The use of big data analytics can help

Banks and other financial institutions have anassess the ESG performance of potential

important role to play in working with businesses

investment opportunities, providing a clearer

and governments to overcome the funding gap.

picture of their true long-term value.

The two key success factors here are to embraceinnovation and to engage more collaboratively
with business customers. The following areparticularly important:

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ARTHUR D. LITTLE

VIEWPOINT- Offer capacity-building and advisory

services, including technology and data
analytics. Financial service providers canhelp improve their risk exposures and likely
returns by offering training, workshops, andadvice on ESG best practices to their businesscustomers, especially small and medium
enterprises (SMEs). Consulting services can

THE T WO KEY SUCCESSFA C T O R S A R E T O
E M B R A C E I N N O VAT I O N
AND TO ENGAGE MORE
C O L L A B O R AT I V E LY W I T H
BUSINESS CUSTOMERS

include, for example, how to develop andimplement effective ESG strategies and/or
how to transition toward more sustainablebusiness models. Data is a critical enabler
for companies to manage ESG. Financial
institutions can advise clients on data
management, and create digital platforms
where SMEs can access resources, tools,
and funding options to aid their ESG journey.
These platforms can also allow SMEs to better
aggregate ESG information, understandtheir clients’ ESG performance, and identify
learnings to help them improve.

-- Develop specialized financing forSMEs. SMEs face the biggest financing
challenges for making the green transition.
Financial institutions play a huge role for
SMEs, including offering microfinancing
loans to help them invest in sustainableinfrastructures and technologies, andcollaborating with international bodies,governments, or NGOs to connect small
businesses with grants or subsidies designed
for sustainable initiatives. Green loans for
SMEs often include lower interest rates,

Develop collaborative partnerships

extended repayment periods, and reducedon green finance. Collaborations withcollateral requirements. For example, thegovernments and public sector agencies on

European Investment Bank provides green

cofinancing green projects (e.g., public-privateloans to small businesses for projects that

sector partnerships [PPPs)] can help achieve

have a positive impact on the environment,

greater scale and impact as well as sharing

offering favorable terms and expert technicalrisks and improving returns, leveraging the

support. Crowdfunding platforms dedicatedstrengths of both parties. Collaborations

to sustainability projects are also increasing,with nongovernmental organizations (NGOs)

building on the growing community of impact

and think tanks can also be valuable as theseinvestors who seek both financial returns andorganizations often possess deep insights into

positive social and environmental impacts. For

local environmental and social challenges andexample, StartSomeGood is a crowdfunding

can provide valuable expertise and guidance.

platform exclusively for social change initiatives,

For example, the asset management division

where small businesses with environmentalof the European bank Erste Group works

projects can raise funds from like-mindedwith the NGO World Wildlife Fund to identify

individuals and investors.

green companies for some of its investment
funds’ portfolio firms. Such partnerships canalso help improve credibility and mitigate
greenwashing concerns. Creating and/or
participating in climate finance markets,
specifically tailored for green financial
products, is also an effective strategy.

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VIEWPOINT- Promote transparency and reporting.

Financial institutions need to adopt and- Tax incentives. These include credits,

deductions, or exemptions for investments inpromote a standardized ESG reporting

sustainable technologies and practices. For

mechanism, like the Task Force on Climate-example, the US federal government offers

Related Financial Disclosures (TCFD)

a business energy investment tax credit

recommendations, making it easier forthat allows businesses to claim a credit ofbusinesses to report and for stakeholders to

up to 30% of expenditures on solar energy

interpret. Better terms or rates can be offeredinstallations.

to companies that regularly and transparently
report their ESG performances, promoting aculture of openness.

- Change internal policy and culture.

- Technical assistance and capacity building.
For example, the UK’s Carbon Trust provides
small businesses with free energy audits,
advice on low-carbon technologies, andFinancial institutions also need to embedsupport in developing a comprehensive

sustainability into their own policies,

energy-saving strategy.

practices, and culture. This means, forexample, developing a comprehensive ESG
strategy that integrates ESG into everyday
decision-making and providing in-housetraining, education, and capability building.
Aligning compensation with ESG goals isa key aspect, ensuring that compensation
structures, especially for top management,
reflect the institution’s ESG priorities. Climate
risks also need to be embedded into lending
and investment assessments, accounting
for both physical risks (e.g., extreme weather
events) and transition risks (e.g., changing
regulatory landscapes).
Role of governments
By working collaboratively with both businesses
and investors, governments and internationalorganizations can help overcome climate-funding
challenges. With a focus on supporting business,
especially SMEs, governments can offer:- Direct grant and subsidy programs.
An example is the US Small Business

Innovation Research program, which offers
grants to businesses engaged in the R&Dof environmentally friendly technologies.
Another example is in India, where the- Innovation competitions and awards. For

example, the H&M Foundation’s Global ChangeAward supports early-stage innovations
that present new circular approaches for the
fashion industry, providing both grant funding
and a one-year innovation accelerator.

- Risk-guarantee programs. For example,

the World Bank’s partial credit guarantee isan instrument designed to encourage lending
to small businesses by taking on a portion of
the lenders’ risk, making it easier for thesebusinesses to secure loans for sustainability
projects.

- PPPs. As mentioned earlier, collaborations

like PPPs can help achieve greater scale andimpact as well as sharing risks and improving
returns, leveraging the strengths of bothparties.

- International programs and cooperations.
Adopting a global perspective is vital.

Governments play a key role in addressing
some of the global and regional imbalancesthat are apparent today, especially in seeking
to rebalance the allocation of resources
toward those countries and regions that are
most in need.

government partnered with private companies
under the Jawaharlal Nehru National Solar
Mission to significantly increase the country’s
solar power capacity, providing subsidies andincentives for private investment.

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ARTHUR D. LITTLE

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CONCLUSIONP U T T I N G C L I M AT E F I R S T

N A R R O W I N G T H E C L I M AT E F U N D I N G G A P W I L L
R E Q U I R E C L O S E C O L L A B O R AT I O N B E T W E E N
GOVERNMENTS, FINANCIAL INSTITUTIONS,AND BUSINESSESAs the ramifications of climate change grow increasingly clear, so does
the importance of climate financing in guiding the world toward asustainable net zero future. The climate funding gap is one of the biggest
barriers to achieving this goal. The concept of the triple bottom line —planet, people, and profit — has been with us for decades but has still
not been properly integrated. Narrowing the climate funding gap will
require close collaboration between governments, financial institutions,and businesses, aimed at embedding climate considerations into every
financial decision, investment, and strategy:1	Businesses must take positive steps to overcome the economic,
operational, and standards-related barriers toward embedding
climate finance.
2

Financial institutions play a key role in embracing innovation in
their products and services and engaging more collaboratively
with business customers.

3

Governments must make the most of the range of policy andregulatory instruments at their disposal, encouraging and enabling
as well as enforcing.

4	By addressing the challenges head-on, and in close collaboration,
we have the ability finally to steer our planet toward a moresustainable trajectory.

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