Filling the climate finance gap: holistic approaches to mobilise private finance in developing economies

Bridging the global climate finance gap: drivers and scenarios for 2030

All estimates suggest that trillions of investment capital are needed annually by 2030 to meet Paris Agreement goals but there is no clarity on how to achieve this¹². There is a scarcity of modeling analyses on the amount and aggregation of each financing source needed to bridge the gap, as well as a lack of empirical evidence to reflect differential financing conditions. Based on data and estimates from diverse sources (Method section and Supplementary Table 2), we divide the drivers of finance into public funding, private funding not driven by price-based regulation or public finance, private capital mobilised by public funding, and private capital mobilised by domestic carbon pricing and international compliance markets (Article 6 and CORSIA) and the voluntary carbon market (VCM). We show a projection of each source’s contribution (Fig. 2 and data in Supplementary Table 3).

We present three scenarios for 2030 that illustrate how market-based approaches could help fill the global climate finance gap. We first introduce how we estimate current climate finance leveraged from each source in 2022(Fig. 2a) and 2030 under stated policies and trends (BAU scenario, Fig. 2b). Next, we propose two promising scenarios that integrate new approaches, one is international carbon market (ICM scenario, Fig. 2c) and the other one is a scenario with holistic strategies designed to achieve a high leverage ratio (HLR scenario, Fig. 2d), which represents a potential pathway to almost bridge the funding gap. These are not intended to be accurate predictions or optimal scenarios, instead, aiming to show the potential scale of the mobilisation of finance by each driver and highlight the need to use all instruments to drive finance, including emerging international carbon market. We make certain simplifications to the model and conduct a series of sensitivity analyses on key parameters and assumptions to explore further possibilities (Discussion section and Supplementary Table 4).

The public finance for mitigation (brown bar) includes contributions from governments, state-owned enterprises, multilateral development banks and official development assistance. Public finance is currently about 51% of total climate finance and accounted for USD 660 billion in climate finance for mitigation in 2022^2,32,33, and is projected to grow to nearly USD 1.9 trillion by 2030 under the BAU scenario.

The private capital mobilised without price-based regulation (pink bar) results from the investments becoming profitable as costs fall; from voluntary efforts driven by environmental, social, and governance (ESG) concerns; or as a result of non-price regulatory factors. For 2022, we derived a net value of USD 438 billion for this portion of private finance by subtracting the estimated amount mobilised through public finance and other carbon pricing policies from the total private finance flows as reported by the CPI (2023)¹. Our simple projection for 2030 assumes that private finance will continue to grow at the cumulative average rate since 2011 to reach nearly USD 908 billion in 2030.

The orange bar is private finance mobilised by public finance. Public finance could act as a catalyst in mobilizing private finance through an array of finance instruments, such as guarantees or feed-in tariffs for new technologies. We adopt a public finance leverage ratio of 0.3 from empirical evidence from IEA⁴ and Organisation for Economic Co-operation and Development (OECD)^34,35. In 2022, this particular segment was approximately USD 200 billion. By 2030, under both BAU and the ICM scenarios, it is projected to reach USD 579 billion.

The green bar represents capital mobilised by domestic carbon pricing instruments, such as carbon taxes or emissions trading systems. By adopting a series of assumptions—including carbon price level, coverage, emissions reduction effect, and the carbon price leverage ratio for capital both currently and in 2030 (details in the Methods section)—our estimate indicates that in 2022, existing domestic carbon pricing mechanisms could only mobilise USD 41 billion. In the 2030 BAU case, domestic carbon pricing could mobilise over USD 1 trillion annually in private capital.

The blue bar in Scenario ICM 2030 represents potential capital mobilisation through perfectly functioning international carbon markets enabled by Article 6 of the Paris Agreement. The estimates by Piris-Cabezas, Lubowski and Leslie³⁶ suggest that a perfectly functioning market consistent with meeting a 2 °C target would involve carbon payments between countries of over USD 210 billion annually and therefore might achieve additional annual capital mobilisation of USD 1 trillion by 2030.

The small purple bar is the contribution of the VCM to mobilizing capital. We calculate this by multiplying current payments for VCM credits (around USD 1.3 billion in 2022, according to Trove Research³⁷) by the assumption of capital mobilised per dollar of credit payment. For the 2030 BAU case we use the low estimate from Trove Research³⁸ and World Bank³⁹ that voluntary carbon markets are expected to grow to a size of $10 – 40 billion by 2030, which suggests this market could leverage USD 50 billion after multiplying by carbon price leverage ratio. Here, we adopted the most conservative estimate for the VCM to avoid any overlap with calculations related to the international carbon market.

In 2022, the finance gap amounted to approximately USD 7.1 trillion¹ (Fig. 2a). In the Business As Usual (BAU) scenario in 2030, we project that public finance and private finance leveraged by public initiatives could triple from 2022 levels under the right conditions. Similarly, private finance driven without support from government might double. Continued strengthening and expansion of emissions coverage by domestic compliance carbon pricing policies (including carbon taxes, emissions trading systems) could leverage growth in private finance from USD 41 billion in 2022 to USD 1022 billion by 2030. Voluntary markets may expand, but their impact remains small. Nevertheless, the finance gap would still remain at USD 3.9 trillion (Fig. 2b).

In the International Carbon Market (ICM) scenario (Fig. 2c), potential capital mobilisation to EMDEs of USD 1 trillion by 2030 could be achieved through highly functioning international carbon markets enabled by Article 6 of the Paris Agreement. This international agreement can directly support investment and may also enable an increase in the ambition of domestic carbon pricing in developing countries or provide institutional support⁴⁰. Higher carbon prices in developing countries could mobilise another US$174 billion. However, the gap would still be USD 2.7 trillion.

Understanding how to provide the right incentives is the first step in driving large-scale resource flows. Relying solely on individual carbon credits projects or donations typically do not catalyze the systemic changes necessary for large-scale, long-term mitigation goals. To bridge this gap, it is essential to increase private sector capital leverage ratios of both public finance and carbon pricing policies. In the International Carbon Market and High Leverage Ratio (ICM + HLR) scenario (Fig. 2d), we assume that when host governments successfully implement holistic plans in conjunction with other climate finance sources, we could double the leverage ratio of public finance from 0.3 –0.6 and the carbon pricing leverage ratio from 5 to 10. With these adjustments, the finance gap could be fully addressed, in theory. In the following sections, we delve deeper into these mechanisms and illustrate how a reframed international carbon market and a holistic national plan can work together to drive systemic changes.

Reframed large scale international carbon market

Compared with the business-as-usual scenario, we believe that international carbon markets can play a pivotal role—provided they address concerns about integrity and effectiveness and operate under a reframed, large-scale international agreement. We argue that a large part of previous problems of international carbon market arise from the specific conception of carbon markets as ‘offsets’ which focus on supporting project-scale activities. In a broader interpretation, markets could represent a mechanism for transferring resources, e.g., capital, technology, and capacity, toward those who need these resources to accelerate mitigation while compensating with carbon credits to those who possess them, fostering mutual benefit and enhanced climate ambition.

We propose that international carbon markets could be based on a few, large, bespoke agreements among countries in the way that domestic compliance markets are based on government regulations or laws. Bespoke carbon market agreements at a sectoral or national scale can help ensure that the resources contributed by foreign non-state actors (e.g., companies) in exchange for carbon credits are clearly targeted toward the actions most needed to enable effective, additional mitigation in the specific sector and country⁴¹.

Credits are created and transferred only after successful changes and large-scale reductions have been clearly demonstrated. This large scale ‘results-based’ approach gives hosts and partners a strong incentive to work together to ensure success at the system scale⁴². Under such agreements, buyers or ‘partners’ will fund in advance only activities consistent with delivering reductions through systemic change. This approach also largely resolves two related concerns of partner countries—effectiveness of their contributions in addressing climate change, which matters to their voters and taxpayers, and credit integrity and hence others’ recognition of the credits they claim.

Various initiatives are now exploring and trialing large-scale, or jurisdictional crediting (e.g., the LEAF Coalition, the US Energy Transition Accelerator, Climate Action Teams). Each agreement can involve the creation and sale of large volumes of high integrity credits. For example, the LEAF Coalition addresses these challenges through a coordinated group of buyers joining to generate sufficient scale of demand and a jurisdictional approach, ensuring emissions reductions are accounted for across entire regions to enhance additionality, reduce leakage, and improve transparency⁴³. Supported by over $1.5 billion in buyer pledges, LEAF utilizes the ART-TREES framework to uphold stringent monitoring, accounting, and social safeguards. The state of Pará, Brazil, recently signed a $180 million agreement under LEAF⁴⁴ to support their ongoing efforts to lower deforestation rates⁴⁵. In addition, Ghana has made notable progress in implementing Article 6 frameworks. Ghana plans to use international cooperation under Article 6.2 to achieve up to 55% of its conditional absolute emission reductions, which will require an estimated investment of USD 4.9 billion⁴⁶. In January 2023, Ghana published its framework for international carbon markets and non-market approaches, outlining strategies to minimize overselling risks against its NDC targets. Ghana has also signed MOUs with Sweden, Singapore, South Korea, and Switzerland. Although no Article 6 units had been transferred as of August 2024, Ghana’s institutional readiness and framework design demonstrates a solid foundation for engaging in future large-scale agreements.

Effective governance is vital for achieving systemic mitigation goals. Large-scale electrification initiatives, for instance, call for long-term commitment, clear priorities, strategic planning, and significant upfront funding. Countries such as Vietnam and Indonesia have shown how robust governmental engagement can lead to successful electrification outcomes. In contrast, countries with significant political and administrative challenges may present higher risks for international climate finance, potentially undermining the success of large-scale initiatives.

Innovative supporting finance instruments, as well as reframed contracts, are needed in high-risk investment environments to achieve the potential of international carbon markets. Carbon credit contracts can be structured to make a difference to large-scale capital mobilisation by taking advantage of new risk management possibilities. Risk management in agreements may include provisions for advance payments or commitments (e.g., advance market commitments) or approaches to mitigate and efficiently allocate investment risks from political instability or project delivery uncertainties. Advance payments motivated by anticipated recognition of contributions to global mitigation (such as carbon credits) can be allocated for insurance coverage or as equity stakes, thereby facilitating more conventional private sector investments. Carbon credit contracts can also incorporate pricing mechanisms that share the carbon price risk, mitigating the impact of lower-than-expected prices while still sharing gains in times of high carbon prices.

Holistic strategies and mitigation ‘avocados’

Our model results indicate that the leverage ratios plays a critical role in bridging the finance gap. Instead of addressing issues piecemeal, the host EMDEs have to bear the responsibility to undertake the technically, economically, and socially holistic strategies to scale up the effects of private funding from carbon markets and public funding.

To illustrate a holistic approach more concretely, we propose the concept of a “mitigation avocado”, an analogy based on the avocado’s layered structure (seed, flesh, and skin) to represent a cohesive and mutually supportive package of incentives and resources that spans various levels of the economy—and apply it in the electricity sector (Fig. 3).

Figure 3 uses the “mitigation avocado” framework to illustrate a holistic climate mitigation plan for the electricity sector. In this conceptual model, the “seed” represents foundational mitigation projects like building renewables and phasing out coal. The “flesh” corresponds to the broader economic, political, and social environment, such as regulatory reform and infrastructure management, which underpin successful climate mitigation actions. The “skin” symbolizes overarching visions and coordination. The proportions may vary across countries depending on specific contexts and priorities.

The electricity sector alone could provide about half of the required annual global emission reductions by the year 2030, and reliable and affordable low-carbon electricity is key to decarbonising the rest of our economies⁴⁷. These make it a key area for immediate focus. Decarbonizing electricity involves some discrete projects that can be implemented by the private sector. These projects, which we refer to as the “seed” of the mitigation avocado, include building renewable energy and storage facilities, electrifying buildings and industrial processes, improving the efficiency of fossil fuel facilities that must continue to operate during the transition, and accelerating the closure of unnecessary and inefficient plants.

However, to nurture these ‘seeds’ into sustainable and impactful outcomes, a supportive environment—the ‘flesh’ of the avocado—is essential. For electricity decarbonisation, this entails regulatory reforms that eliminate barriers to profitable renewable electricity generation, and policies, possibly including local carbon pricing, that induce a high level of renewable energy demand and efficient dispatch. It necessitates infrastructure investments and grid management for a more decentralised, reliable, and renewable-focused energy system. Long-term power purchase agreements to reduce transaction costs, stable pricing mechanisms, green bonds, and risk-sharing instruments can improve revenue certainty and lower the cost of capital. Human capital development to provide the skilled labour needed and support for individuals and communities affected by closure of fossil fuel plants, mines, and wells also may be needed to facilitate a just and hence politically feasible transition.

Beyond the “seed” and “flesh”, the “skin” of the mitigation avocado represents the critical institutional framework. Key institutions include climate targets and monitoring, and planning and governance institutions (e.g., Climate Commissions) that coordinate different sources of finance, and technical and capacity support at the national or even global scale, and facilitate social processes to inform and shape the national or sectoral visions for a low emissions future and provide the social licence governments need to act in an ambitious and sustained way. The ‘skin’ is what can support effective international carbon market agreements.

Many OECD countries (for example the European Union, the United Kingdom, Korea, Chile, New Zealand and U.S. states such as California) have already developed integrated plans and created key institutions and are moving ahead, albeit at varying rates, to implement change. However, most EMDEs still lack such frameworks, resulting in ad hoc and piecemeal approaches to climate mitigation whether funded by domestic or international resources. Previous research indicates that technology transfer under the CDM was frequently driven by cost minimisation rather than alignment with host country priorities⁴⁸. Even if host countries were to establish comprehensive plans, and partner countries were to commit to supporting their implementation, the challenge would still be significant. Host countries have to ensure that mitigation efforts are impactful, credible, and equitable among domestic stakeholders, as well as between host and partner countries. For example, Kenya, which scored above the Sub-Saharan African average in government effectiveness, began receiving support from the African Development Bank in 2015 for the “Last Mile Connectivity Project”, aiming to expand electricity access⁴⁹. With local government involvement, Kenya was able to leverage these investments to achieve higher rates of electricity access, showcasing how a holistic national plan can amplify the benefits of climate finance⁵⁰.

Holistic approaches with large-scale international agreements mean a strategy to align different stakeholders’ actions (Fig. 4). Private investors can focus on profitable opportunities in the energy transition, particularly in underexplored markets, while adopting innovative solutions to financing challenges and improving risk assessments. Insurance companies can complement these efforts by offering tailored financial products to mitigate risks associated with climate transitions. Meanwhile, public funders and multilateral development banks can reduce or offset private financing risks through guarantees or subsidies, thus encouraging broader participation. Additionally, international creditors can support debt relief programs linked to results-based transition agreements, enabling countries to secure new private financing for clean investments.

Figure 4 illustrates how international carbon markets can support holistic plans to close the climate finance gap. At the core are International Carbon Market Agreements, linking developed (partner) countries with developing (host) countries through carbon credit transfers, supported by capital, technology, and capacity building. Key actors, including private investors, multilateral banks, insurance companies, and public funds, contribute to mobilizing resources. The icons on the right represent key actions in host countries, such as renewable energy infrastructure, energy efficiency retrofits, building energy conservation, grid management, policy reforms, and workforce training. These holistic plans aim to improve the leverage ratios, enabling public investments and carbon markets to attract more private capital. Credibility mechanisms ensure trust and transparency, aligning efforts with global climate goals and fostering sustainable and equitable outcomes.