Crunch Time: Can Adaptation Finance Protect Against the Worst Impacts From Physical Climate Risks?

Chart 1

The adaptation challenges facing individual countries — and, by association, companies — differ because of the varying frequency and severity of climate hazards, such as storms and wildfires. The vulnerability of assets also differs by location and asset type. Still, adaptation measures can help companies and countries withstand climate risks. Japan, for instance, has avoided large wealth damage even in the face of high climate risks, including typhoons. Lower- and lower-middle-income countries have less ability to cope with and adjust to damaging events, leading to higher and more persistent economic losses. This highlights the importance of international cooperation to support equitable distribution of adaptation investments, particularly given that those most at risk have contributed comparatively little to climate change. A compounding problem is that the finance available to support countries’ adaptation to physical climate risks is severely lagging what is needed. Furthermore, even ambitious investments in adaptation will not fully avoid climate-related impacts.

The Adaptation Finance Gap Continues To Widen and Shows Little Sign of Stopping

Annual adaptation costs for developing countries, accounting for inflation, will be in the range of $160 billion to $340 billion by 2030, and between $315 billion and $565 billion by 2050, according to the United Nations’ Environment Programme (UNEP) Adaptation Gap Report 2022. In contrast, only about $83 billion of climate finance, covering both adaptation and mitigation, was mobilized in 2020, missing the $100 billion-per-year pledge made by developed countries to developing countries under the Paris Agreement on climate change. The picture is similar when looking at global climate finance flows, where mitigation finance dominates, as reported by the Climate Policy Initiative (see chart 2).  

Chart 2

Instruments such as green bonds could partly refocus financial flows toward climate-positive outcomes helped by initiatives such as recent guidance from the Global Center on Adaptation. However, while green bond issuance has increased fourfold since 2018 — surpassing the $3 trillion total issuance mark earlier this year — most green use of proceeds and sustainability-linked bonds are focused on mitigation, with adaptation and resilience accounting for only 4% of green bond spend last year (see chart 3).

Chart 3

The challenges associated with scaling adaptation and resilience finance to the levels required are clear.

• Adaptation tends to be less attractive than mitigation because results and returns are harder to predict and measure. For example, data that describe differences in revenues between resilient and nonresilient assets are not readily available. In addition, some adaptation and resilience investments — such as public infrastructure with a multidecade operational lifetime — may not generate a return for investors.
• There is uncertainty about impacts and necessary responses. Translating the outputs of climate models into specific predictions is not straightforward, even with advances in climate analytics that have improved transparency regarding particular exposures and financial losses.
• Data and standardization, including around investments that should be considered “resilient,” are lacking.
• Building resilience to physical climate risks means addressing a full system, not just an individual company’s assets. This wider approach can be challenging, as it is difficult to secure critical coordination between various stakeholders. The benefits of these adaptation projects also manifest over time, making governments and policymakers less likely to get credit for adaptation efforts, and therefore less likely to pursue them.
• A lack (or perceived lack) of projects appears to be constraining investment. Creating investor awareness of the pipeline of deals in adaptation and resilience is a challenge. Size is also important: Smaller adaptation projects can find it difficult to get on the radar of institutional investors.

New Financial Instruments and Recent Commitments Suggest Improvement

Despite these challenges, there appears to be growing interest from market participants in financing adaptation and resilience projects. Financial instruments such as privately issued climate resilience bonds, debt-for-climate swaps, public-private partnerships and infrastructure investment trusts are likely to go some way toward plugging the growing adaptation gap. Large institutional investors including JPMorgan Chase, Nuveen and Wellington already have dedicated adaptation investments in their climate or impact funds (which exceed $1 billion). In 2022, The Lightsmith Group closed a $186 million private equity fund dedicated solely to adaptation, as reported by Global Adaptation and Resilience Investment (GARI).