The Journal Vol 4. Chapter 3
The Journal Vol 4. Chapter 3
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Ten key themes for financing sustainable development

Financing sustainable development is perhaps the greatest challenge for our generation. But while progress is being made, we have not yet mobilised enough resources to reach the goals set out in either the Paris Agreement on Climate Change or the 17 Sustainable Development Goals. In this piece Aniket Shah from the Financing Sustainable Development Initiative, UN Sustainable Development Solutions Network, outlines 10 key themes that are likely to shape the world of sustainable development.

Ten key themes for financing sustainable development

Ten key themes for financing sustainable development

Aniket Shah, Financing Sustainable Development Initiative, UN Sustainable Development Solutions Network

1. The transition to a low-carbon energy system will be the central global development finance challenge

The Paris Agreement on Climate Change, backed by 195 countries in December 2015, seeks to limit global warming to two degrees Celsius (2°C) above pre-industrial levels. To achieve this goal, the global economy will need to be close to net-zero carbon emissions by 2070.

According to the International Energy Agency (IEA), to get on an energy pathway consistent the 2°C goal (its 450 Scenario), the world needs to almost quadruple investment in low-carbon energy systems from approximately US$250 billion per annum (pa) to US$900 billion, and commit a further US$700 billion pa in improving energy efficiency. This is US$1-1.5 trillion pa more than the IEA’s current energy financing pathway. Without this level of investment, the world could face a global temperature increase of 4-6°C over the next century, with potentially catastrophic effects. [1]

Figure 1: Global investment in low-carbon technologies and energy efficiency in the 450 Scenario

Source: IEA World Energy Investment Outlook 2014

2. The world is on the cusp of an unprecedented infrastructure boom, which will need innovative national economic planning and private-sector investment

Public and private financing of infrastructure will be key for development finance in the years leading up to 2030. If recent studies are anything to go by, spending is set to increase significantly. A 2014 study by Oxford Economics and professional services company PwC suggests global infrastructure spending must increase from US$4 trillion p.a. in 2012 to more than US$9 trillion p.a. by 2025 to meet development needs. In this time, developed economies will need to climate-proof their entire infrastructure stock while the developing world has trillions of dollars of basic infrastructure still to build. According to the New Climate Economy Commission, total infrastructure spending from 2015-2030, globally, is expected to be approximately $90 trillion. But to keep to the 2°C target, total spending will need to be roughly 4% higher than current projections.

Figure 2: Infrastructure capital spend 2015-2030

Infrastructure capital spend is estimated to be around 4% higher in a low-carbon scenario
Global investment requirements: 2015 to 2030, US$ trillion, constant 2010 dollars

Note: Estimates are rounded. Base case estimates include infrastructure requirements for energy, transport, telecoms, water and waste. Energy includes power generation, electricity transmission and distribution, oil, gas and coal, and investment in more energy efficient infrastructure in energy end-use sectors including buildings, industry, and transport (transport engines). Power generation includes fossil-fuel plants and low-carbon technology such as renewables (incl. biofuels), CCS and nuclear. Oil included upstream, refining, and transport investment. Gas includes upstream, T&D, and LNG investment. Coal includes mining investment. Transport includes road, rail, airports and ports. Reduced capital expenditures (CAPEX) from fossil fuels contains lower investment on fossil fuel power generation and on the supply chain. Reduced electricity T&D investment requirements are the result of improved energy efficiency lowering the demand for T&D compared to base case. This efficiency effect outweighs the increased demand for T&D from integrating renewables. Reduced capex from compact cities is the result of infrastructure savings across transport, telecoms, building (energy efficiency), water and waste when cities follow a more compact urban development model. Reduction of operating expenditures (OPEX) was calculated for the low carbon transition of a coal to renewables switch and of a reduction of oil in transport. The reduction is the net result of the increase of OPEX for renewables and low-carbon vehicles minus the reduction of OPEX for fossil fuels.
Source: OECD (2006, 2012), IEA ETP (2012), modelling by Climate Policy Initiative (CPI) for New Climate Economy (forthcoming), and New Climate Economy analysis. For further detail see: New Climate Economy Technical Note, Infrastructure Investment Requirements in a Low-Carbon Economy. New Climate Economy Report 2014 Indicative figures only, high range of uncertainty.

3. The relationship between development banks and global institutional investors will be critical to the investment boom

The basic principal of development banking is that non-commercial capital is often needed to crowd-in private finance for major transitions in an economy. At both the global and national level, it is becoming clear that development banks are essential in supporting the required infrastructure financing. According to a July 2015 report from US think-tank, the Brookings Institution, development banks will need to increase their infrastructure lending five-fold, to US$200 billion over the next 15 years, and then use that capital to leverage with the capital available from institutional investors.

It is this budding relationship between development banks and institutional investors that will be key to creating the levels of investment required: the former having the intellectual and practical experience in infrastructure financing and the latter with a growing pool of investable global savings. These actors are developing new mechanisms, such as infrastructure platforms, to help them work together more closely.

Figure 3: Infrastructure investment commitments in IDA countries by sector (excluding telecoms) 2009-2014

Source: World Bank Private Participation in Infrastructure Database. IDA = International Development Association.

4. More early-stage risk capital in the developing world could unlock a flood of lower-risk capital

Providing developing market companies and infrastructure developers with high-risk capital remains very challenging as private-sector investors are often unwilling to invest and public actors (governments and development institutions) are too fragmented to reach the scale needed for most projects. However, more early-stage capital could unlock hundreds of billions of dollars in available lower-risk capital looking for a home. According to the National Treasury of South Africa, there is an estimated US$25 billion gap in early-stage, high-risk project preparation capital from 2012-2040 that could help unlock over US$300 billion of additional infrastructure financing.

Small and medium-sized enterprises also struggle to find investors. According to the Omidyar Network and the International Finance Corporation, Africa still has a US$140-170 billion credit-financing gap. However, the challenges extend beyond the cost of accessing financing. Many African entrepreneurs do not have the business-servicing skills to upgrade their business ideas and proposals into functioning enterprises.

Figure 4: Survey results for accessing capital in Africa

The cost of Accessing Capital is Prohibitive

Source: Omidyar Network

5. Domestic resources, private investment and Asia will bear the heavy burden of providing additional development finance.

We believe there will be three major additional sources of development finance:

Mobilising domestic resources
Developing countries have rapidly increased the amount of capital available to them by improving tax collection in their growing economies. Between 2000 and 2012, developing countries increased tax collection from US$1 trillion to US$7.7 trillion p.a. (in nominal terms). But there are many other challenges to increasing public sector funds in the developing world, such as illicit financial flows. Low- and middle-income countries still only collect 12% and 17% of GDP in revenue respectively, as opposed to around 30% in high-income countries. [2]

Increasing private investment
In the developing world, foreign direct investment (FDI) and domestic investment is likely to continue to increase despite slower economic growth. According to the United Nations Conference on Trade and Development (UNCTAD), FDI flows reached US$1.5 trillion in 2014 and has extended to more countries. [3] Furthermore, a greater proportion of this investment is expected to come from emerging markets as their savings pools grow. Channelling these savings into the global economy – domestically, internationally; through corporations or governments – will be instrumental in sustainable development.

The increasing importance of Asia
Asia is contributing more public development finance than any other region. The new Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (often referred to as the BRICS bank), both capitalised with US$100 billion, and the substantial increase in lending to the Asian Development Bank, has meant that the region has much of the required international public finance. While the AIIB and BRICS bank may be major initiatives and have great geopolitical importance for China’s role on the global stage, the two institutions combined constitute less than 10% of China’s external infrastructure financing. In contrast, countries such as India and Indonesia have announced multi-year, multi-hundred billion-dollar domestic infrastructure plans.

Figure 5: FDI global inflows, 1995-2014

Source: UNCTAD

6. De-centralisation of international public and private finance

International development finance should continue to become less centralised. With a greater number of official donors (bilateral and multilateral), corporates, private investment companies, national and sub-national development agencies, and other commercial institutions providing development finance, the co-ordination challenges look set to increase. As a result, it will become increasingly difficult for developers to obtain financing at the scale required for transformative projects. Essentially, there needs to be a balance between the requirements of a growing pool of would-be investors and those needed for simple, scalable financial solutions for the recipients of the capital.


Figure 6: Authorised capital stock in AIIB

*Sweden, South Africa, Norway, Austria, Denmark, Finland, Luxembourg, Portugal, Iceland, Malta.
**United Arab Emirates, Pakistan, Philippines, Israel, Kazakhstan, Vietnam, Bangladesh, Qatar, Kuwait, New Zealand, Sri Lanka, Myanmar, Oman, Azerbaijan, Singapore, Uzbekistan, Jordan, Malaysia, Nepal, Cambodia, Georgia, Brunei, Laos, Mongolia, Tajikistan, Kyrgyzstan, Maldives.
Source: Staff Reports/Wall Street Journal.

7. The city becomes the unit of analysis for infrastructure

The size of, and differentiation within, the global economy will require finance professionals to move their frame of reference from a global to a city level. Specifically, there must be a sophisticated approach towards analysing urban development plans and economic growth.

Analysis from McKinsey Global Institute suggests that by 2025, 600 cities will account for 60% of the global economy –the city of Tianjin in China alone, is set to have a larger economic output than Sweden. In the middle of the seventeenth century, less than 5% of people lived in cities. By 2050, that number is likely to hit over 70%. We, like all finance professionals, need to extend beyond using countries as a sole frame of reference and become more granular in our investment approach.

Figure 7: The City 600’s fast growth is fuelled by both GDP per capita and population growth

Source: McKinsey City 600 economic growth; McKinsey Global Institute Cityscope 1.0
Ο= Compound annual growth rate, 2007–25 (%)
1 Predicted real exchange rate.

8. All states are now developing countries, and middle-income countries are in for a difficult time

The Sustainable Development Goals’ framework requires policymakers and investors to view all countries, whether rich or poor, as developing countries, This leaves finance professionals requiring new categories in which to base their analysis around, as all nation states increase public and private investment to tackle the sustainable development challenges most relevant to them, such as energy for developed (or rich) countries and poverty for poor countries.

Within this context, there are two specific elements that are potential causes of concern for middle-income countries. First, these countries are home to the world’s largest proportion of poor people in the world, but as overall income rises, overseas development assistance decreases. The confluence of these two situations causes the so-called ‘middle income trap’, a scenario in which growth slows or stagnates over an extended period.

Second, many middle-income countries will no longer be eligible to receive low-cost international public financing as they reach the next stage in the development process – when GDP per capita reaches US$2,000-$10,000. However, the loss of international financing is unlikely to be offset by an increase in domestic revenue, a process known as the “the missing middle”, which tends to result in challenging financing conditions for middle-income countries (Figure 8).

Figure 8: External flows as a share of GDP by per capita income

Source: World Bank World Development Indicators and OECD Aggregate Aid Statistics.
$1,000 corresponds to a log of 6.9; $4,000 to 8.3; $12,000 to 9.4.
ODA = Official Development Assistance; FDI = Foreign Direct Investment; OOF = Other Official Flows

9. Institutional investors are essential to development

The notion that institutional investors – public pension funds, sovereign wealth funds, insurance funds, endowments and foundations – have a direct role in development finance may be surprising. But there is a now real need for development agencies, governments and urban planning commissions to fully engage with these pools of untapped savings to help fund sustainable development.

This relationship will be difficult to develop, given competing timelines, targets, expertise and compensation structures. However, we are already seeing several European pension funds launch major initiatives intended to work alongside development institutions and deploy capital in major projects that provide strong commercial value and potential return.

10. Sustainable finance is about system design to make the global financial system more sustainable in the long run

A sustainable finance evolution is underway. The UNEP Financial Inquiry has documented five positive steps that financial systems around the world are taking to support greater sustainability in market design:

  1. Enhancing market practice
  2. Harnessing public balance sheets
  3. Directing finance through policy
  4. Transforming culture
  5. Upgrading governance standards. [4]

These transitions are happening quietly, and in unlikely places. China, for example, is taking a leadership role in greening their financial system. And other countries may soon follow in China’s footsteps.

Figure 9: Five approaches to aligning the financial system with sustainable development

Source: UNEP

[1] International Energy Agency. World Energy Investment Outlook 2014. publication/WEIO2014.pdf

[2] The World Bank Group. Financing for Development: Post 2015. October 2013. document/Poverty%20documents/WB-PREM%20financing-for-development-pub-10-11-13web.pdf

[3] UNCTAD. World Investment Report 2015: Reforming International Investment Performance.

[4] UNEP Inquiry into the Design of a Sustainable Finance System. The Financial System We Need: Aligning the Financial System With Sustainable Development. 2015.

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