Comparable with the size of global environmental challenges, the financing available for environmental projects is small. Climate change solutions could require $93 trillion in investment by 2030, but outstanding climate-aligned bonds total only $700 billion.
The world of “green finance” seeks to address this problem by financing investments that benefit the environment and foster sustainable development. But although many consider all green finance innovative, most instruments are conventional and could be improved by a heightened emphasis on results.
Several platforms and initiatives are leading the effort to identify, develop, and pilot new approaches to climate and environmental finance, from simply redirecting capital to green projects to more innovative instruments that take a results-based approach and tie financing to outcomes. Earth Day provides an opportunity to reflect on tools being used in this endeavor.
Although some instruments in green finance show promise, many remain traditional in form. Green bonds, first launched in 2007 by the European Investment Bank and followed in 2008 by the World Bank, raise money through debt capital markets the same way as traditional bonds, but use the proceeds to fund projects with explicit climate or other environmental benefits.
Structuring green bonds like regular bonds has enabled the product to attract significant interest and expand rapidly. Last year, just under a decade after their launch, green bond issuances topped $81 billion. Although there are voluntary standards and certifications that help reach consensus on what qualifies as a green bond, the focus remains on what activities the bond will fund, not the outcomes it will achieve.
Steps have been made to outline and measure certain outcomes, and investors increasingly expect such reporting, but investor repayment is not contingent on attaining rigorously verified beneficial impacts.
New models do more to elevate results
Efforts are under way, however, to bridge this gap and tie the financing directly to outcomes. One approach that has attracted attention is the pay for success (PFS) model. Used exclusively for social interventions until recently, PFS raises up-front capital from new investors (private or philanthropic) to fund a project with specific, measurable outcomes. If a rigorous evaluation finds that the project meets those outcomes, investors will be repaid by the traditional funder (typically government) with interest.
Ensuring the rigorous evaluation of outcomes (did the project achieve the impact it aimed for?) and making repayments contingent upon achieving those outcomes are both in the public interest. In 2016, DC Water launched the first PFS project with an environmental focus. Its Environmental Impact Bond raised capital for the construction of green infrastructure to reduce storm water runoff.
Other projects are in the planning or exploration phases. Blue Forest Conservation is developing a Forest Resilience Bond to raise capital for forest restoration projects using a PFS approach. Its project would create benefits for local communities (e.g., lives and homes saved), the US Forest Service (decreased firefighting costs), and utilities and water-dependent companies (improved water yield) and seek to repay investors based on these benefits. At the federal level, the US Department of Agriculture’s annual grant-funding opportunity for conservation-focused projects regularly includes PFS as a focus area.
Despite these developments, this model’s replicability is a major question. So far, despite earnest interest from investors and others, DC Water’s effort remains the only environmentally focused PFS project. And yet, it’s not hard to see the appeal of PFS or other results-based financing instruments to address environmental challenges.
Investors are increasingly interested in impact investing opportunities and in improving the measurement of impact. Governments, foundations, and other stakeholders have a complementary, growing interest on results and evidence. With these tailwinds, it’s likely we’ll see more innovatively financed green projects.