Potentials and limitations of private climate finance: An overview of current debates

Der Beitrag der mobilisierten privaten Klimafinanzierung muss besser definiert werden. Photo: shutterstock

With the upcoming COP31 in Turkey, private climate finance mobilisation is high on the agenda of the international negotiations. While governments are increasing the share of private climate finance and private sector actors are increasingly involved in new climate funds and initiatives to foster implementation, civil society actors are highlighting the limitations of private finance for funding especially climate change adaptation and demand an increase of public climate finance. This is a good time to shed some light on the role of private finance in the current climate finance landscape and its potentials and limitations.

Key instruments for private finance mobilisation

Unlike loans provided by developed countries that originate from public budgets and that are provided directly to counterparts in developing countries, mobilisation private finance describes the use of public funds to bring in private investments for financing climate-related activities. Public finance are used to reduce risk or set incentives to reduce barriers for private investment. Mobilisation can happen at two levels:

• at individual investment level, i.e. through direct investments in companies (DIC), syndicated loans (i.e. loans combining public and private funds) or guarantees (using public funds to cover possible losses thus making projects attractive to institutional investors).
• as collective investment vehicles (CIV) such as joint guarantee programmes, blended finance facilities combining public and private capital or thematic bond issuances. These approaches aim to move beyond single-instrument approaches to achieve greater scale and efficiency.

It is also important to understand that private finance mobilisation uses different instruments that follow different logics and objectives. These can be broadly clustered in four clusters:

• Grants and technical assistance aim to support activities that strengthen the programmatic approach, improve the risk and return profile and support the other instruments Examples are project preparation facilities, market research or trainings financed as part of a direct investment or guarantee programme.
• Outcome funding, impact bonds and impact-linked finance that connect impact with financial returns (results-based financing). Most of these instruments are smaller and need a verifiable result to trigger payments. An example in climate finance are REDD+ schemes and debt-for-climate swaps.
• Equity and debt are well-established instruments in which public investors provide capital to private investors for climate-related investments. Equity investments provide companies with capital needed to attract additional capital, thus often supporting them in starting up. Both instruments are often used to support market development and bring in private capital for climate-related investments. In both cases public investors expect a return on their investments, although equity investments can take on a higher risk in covering eventual losses.
• First loss capital and guarantees are used to de-risk investments in which public investors absorb the first set of losses of an investment. Unlike equity and debt, it usually does not aim to preserve capital or expect a financial return on the investment. It aims bring in investors which would not otherwise engage, i.e. institutional investors like pension funds.

Private finance is increasingly used to fulfil climate finance pledges

The recent numbers of the 2026 OECD report on developed countries provision of climate finance highlight that, in 2023 22.9 of 132.8 billion US$ (16.7%) in the reported numbers were mobilised private finance which increased to 30.6 of 136.7 billion US$ (22.4%) in 2024. The most recent OECD report on private finance mobilisation through official development aid (ODA) shows that between 2021 and 2024, mobilisation levels increased constantly and amounting to 77 billion US$ in 2024. Multilateral Development Banks (MDBs) provide the bulk of mobilised private finance (71% overall) while bilateral donors also play an important role. 40% of all mobilisation is counted to climate action, with 70% of climate related mobilisation allocated for mitigation, 22% on cross-cutting projects (i.e. mitigation and adaptation) and only 8% to adaptation projects. The most common instruments used are DICs mobilising 27% of private climate finance, syndicated loans (23%) and guarantees (19%).

Mobilised private climate finance has thus followed an upward trend in recent years, but its overall volume and contribution to climate finance commitments still remains modest. Nevertheless, donor countries perceive private capital mobilisation as an important cornerstone to fulfilling their climate finance obligations and to increasing the overall amount for climate change mitigation and adaptation as well as biodiversity conservation.

Potential and limitations of private climate-related investments

The largest potential for private climate-related investments is where there is a potential for a commercially viable investment with a clear return on the investment. Blended finance vehicles also need to consider and bridge different priorities of public and private investors: the focus on development goals by the public investors that de-risk the investment and the interest in commercial viability for the private investors that bring in a large share of the capital. This influences the type of activities that are suitable for private capital mobilisation as well as its limintations.

Private investment is most prominent in climate change mitigation, in particular renewable energy, energy efficiency and transport. Private climate flows in 2023 show that 96% of investment are directed for mitigation and 75% are allocated to the energy sector, followed by buildings and infrastructure (11%) and transport (8%). These investments offer proven business models with predictable cashflows as well as access to risk-sharing with public co-finance. A more recent field of investment is the decarbonisation of industry which has not yet received a large share of private investment (1% in 2023), but in which recent high-level public initiatives like the Climate Club have been launched to create more enabling conditions for private investments.

In contrast, there are clear limitation for private capital mobilisation for climate change adaptation. Estimates of adaptation needs in developing countries amount to a range of approximately US$320 billion to US$400 billion per year in developing countries by 2035 in adaptation funding. The large gap to current private investments underlines that limited role that private finance plays for adaptation. The OECD itself highlights some of the underlying reasons for the limited private finance for adaptation. Many adaptation needs require answers that are local and diversified and do not generate a commercial return. They mostly generate public benefits which can also occur over a long time frame. All of these factors limit the potential for private investments in adaptation.

The largest potential for private investments in adaptation can be considered where there are new goods and services at the local level or where revenue can be generated or costs reduced through adaptation. This is the case mostly for agriculture where innovations such as research into drought-tolerant research, water management, early warning services or investments into agriculture techniques and machinery or post-harvest production and storage are of high relevance for the private sector to make their value chains more climate-resilient. While there are options for blended finance vehicles to support investments, there is also the risk that public funds are funding activities that the private sector would introduce without public support and that it does not reach smallholder farmers that comprise a large proportion of poor and vulnerable population groups worldwide. It is also important to see that the level of public benefits and direct returns for farmers and private investors varies between the different types of investments.

The potential for private capital mobilisation for adaptation in infrastructure depends on how the investments are typically financed in developing countries, e.g. by public finances or user-pay models and whether there is an expected return or profit for private investors from protecting infrastructure against climate risks. There are first examples, e.g. in the urban context where incentives for climate resilient infrastructure are linked to lower insurance premiums. Investments in water infrastructure offers different entry points for private sector involvement such as investments in water infrastructure, wastewater treatment or land restoration through public-private-partnerships (PPP), bonds or micro-credit. But in practice there are challenges related to long payback periods, tariffs that are often below real cost, and the absence of a pipeline of investable projects which has reduced private sector investment.

Nature-based solutions (NbS) are perceived as generating high economic benefits and potential returns, with a range of options for private capital mobilisation. This includes performance-based schemes such as REDD+ or the issuance of thematic bonds or blended finance vehicles like the Tropical Forest Forever Facility (TFFF). However, there are also major concerns regarding the potential of these initiatives to generate substantial results for biodiversity conservation and the risks that they pose to the rights of Indigenous Peoples and local communities living from these resources.

The different priorities of public and private investors also influences the level of risk that is associated with the climate-related investments. There is a clear trend that private capital mobilisation remains concentrated in markets perceived as less risky. Upper middle income countries are the main beneficiaries of mobilised private climate finance (46% between 2021-2024), followed by lower middle income countries with 32%. For adaptation finance, estimates for the potential for private sector for adaptation funding needs amount to 15% of developing country needs and for Least Developed Countries (LDC) only 5%. This means that adaptation finance if often not directed at the most vulnerable countries.

A more targeted use of the role of private finance in the climate finance landscape

Private finance has an important role to play in shifting to clean energy, but its role in financing adaptation is limited and even less prominent for Loss and Damage. Here, grant-based finance provided by donor countries and multilateral climate funds remains crucial, especially for highly vulnerable countries affected by a combination of climate impacts, poverty and conflict. In addition, increasing mobilisation of private finance does not come for free. It requires public funding which can then not be used for the provision of grant-based support which is needed to fulfil the climate finance commitments under the NCGQ and in particular the goal of doubling adaptation finance. It also needs a clear understanding of where public funds can be used to support much needed private investments in ambitious climate mitigation that would not happen without the willingness of public funders to take on risk and where it runs the risk of supporting investments which would have taken place without public support.

In times of reduced public budgets for climate finance to achieve multilateral obligations, it is thus vital to keep this in mind and make a careful selection of where to spend public funds and on which goals. Mobilised private finance can play a role for ambitious climate action, but it is not the silver bullet to tackle all challenges brought on by the climate crisis. It is vital to continue public funding for adaptation and for reaching the most vulnerable and high-risk countries.

Christine Lottje