Giving Compass' Take:

• The United Nations Environment Programme highlights the need for upstream changes to global financial systems in order to direct sufficient capital towards the Sustainable Development Goals. This document lays out opportunities for improvements. 

• How can philanthropy help instigate these upstream changes? How can companies take steps to redirect their processes to align with the SDGs? 

• Learn how to leverage blended finance for the SDGs. 

Financing the SDGs and the Paris Agreement commitments on climate requires investments amounting to trillions of dollars per year for the coming decade and beyond. It is now widely accepted that much of the finance needed will have to come from private sources, given both the scarcity of public finance and the potential for some public goods to be financed profitably.

Yet today, inadequate private capital is being deployed in ways that are aligned to these goals and commitments. Much can, and is being done, to incentivize private finance. Notable are the wealth of innovative financing mechanisms that in diverse ways blend in public finance, variously to offset risks, and to subsidize and incentivize private lending, investment and insurance. Internationally, development finance institutions, working with other sources of development cooperation finance, are increasingly using their balance sheets to leverage private capital, alongside measures to de-risk investments by encouraging wide-ranging policy and institutional developments.

Such downstream financial innovations are vital, and are the subject of much research, experimentation, and growing practice. However, the rapid scaling of blended financing is constrained, not least by limits to the volume of public finance that can be redirected to this purpose. Reforms in the real economy complement such financing mechanisms, as policy, market and technological developments change the relative prices, risks and returns to sustainability-aligned financing, hopefully for the better. Yet again, although some of these changes are visible and dramatic, such as the falling cost of clean energy systems, the scale of redeployment of private capital remains wholly inadequate.

Conventional wisdom tells us that if the problem concerns real economy externalities, such as environmental damage, then the ‘firstbest’ solution is to intervene in the real economy. Often, this is exactly right. Effective building codes and incentives for renewable energy, for example, all provide important signals to the financial system. Pricing the negative effects of greenhouse gas emissions into markets for products and services is without a doubt a key to addressing climate change.

Equally, there are legitimate reasons for providing what are effectively subsidies to private capital so that it provides finance for investments delivering public goods that the private owners of capital should not be asked to pay for. Bringing forward the deployment of renewable energy is a case in point, where improved returns to private capital have been secured through direct public subsidies, or by imposing surcharges on electricity consumer prices.

In many instances, this is a matter of correcting policy failures. The IMF, for example, calls for an end to fossil fuel energy subsidies that it estimates at US$5.3 trillion annually, or about 6.5% of global GDP. Such subsidies, the IMF argues, are made up of both policy and market failures – policy failures including continued direct fossil fuel subsidies, and market failures including the externalized societal costs of negative health effects of carbon-intensive energy production. The Inquiry was established with a view that these two tracks needed to be supplemented by a third – one that would address policy and market failures within the financial system itself.