Laudes Foundation Finance Dialogue: Multilaterals and the climate change challenge

We are living through a series of interrelated crises – food insecurity, climate, inequality, migration and energy. This already tough environment is being further challenged by a deteriorating economic and geopolitical context. 

Brave and bold action is needed to solve these challenges. Multilateral development banks are ideally suited to lead this action, having been initially set up to assist the post-world war two economic reconstruction. They have long proven their ability to deal with global challenges, most recently during the pandemic, and have initiated multiple sustainable finance initiatives to unlock capital flows and leverage impact. 

So they clearly have the ability to be ambitious, but are they doing enough?

For the latest Laudes Finance Dialogue, a virtual event series to discuss new economic and finance ideas, we invited former Vice President and Treasurer of the World Bank, Jingdong Hua, to share his thoughts on what it will take to get capital flowing to the places where it’s needed most. 

Jingdong’s personal experience is the perfect illustration of the power of capital markets. He was born in China in 1963, when it was a poor country. During his lifetime he has witnessed China’s incredible development transition  to the point where it is now, on the verge of being classified as a high income country, a journey that has seen 800 million citizens move out of poverty. 

He says, “capital markets played a central role in this journey… Only by building a deep, liquid, open, vibrant capital market can a country effectively grow and recycle its domestic savings as a primary source of financing.” In his view, China’s economic transformation is the validation of why finance is central to development, and also for tackling climate change. 

When taken in aggregate, there is ample capital within the global financial system to address climate change. According to Jingdong, around USD 4 trillion a year is needed to limit global warming within 1.5-5 degrees so while “the world has enough wealth to solve every development and humanitarian crisis or challenge, we have not yet come up with the innovative financing that will make this happen.”

This is where multilateral institutions come in – global crises need global solutions. Jingdong has led the field by contributing to the launch of many innovative financial products during his time at the World Bank; all of which have made a real difference to unlocking global savings and generating impact.  

Jingdong led the world’s first sustainability-orientated thematic bond issuances, which included bonds focusing on water, forests, gender, food loss and waste. He says, “such bonds draw attention to social and development issues but also serve as pilots to test whether such finance models will work.”

The model favoured by multilateral banks leverages their AAA credit rating and stable reputation to raise funds in international capital markets at significantly cheaper rates than is possible through domestic markets. 

Jingdong cites the World Bank’s first issuance of Rwandan franc denominated bonds as an example of how powerful these events can be for developing countries. He explains, “this kind of pilot can draw [positive] attention to a country and raise a flag. This has a catalytic impact of putting the country on the map of international capital markets.”

A similar bond structure has also been used to support wildlife preservation efforts – such as breeding programmes for black rhinos in South Africa. Jingdong states that if an Environment, Social and Governance outcome can be quantified – in this case growing the rhino population by 5% – then a bond can be created to incentivise it. Such bonds also have the benefit of protecting developing economies from the burden of failure, as this risk is passed on to the private sector and public money only pays for success. 

Through Jingdong’s leadership, the World Bank has developed other financial structures to support development and sustainability. Catastrophe bonds have been structured to provide financial protection in the wake of damage caused by hurricanes and earthquakes in areas such as the Philippines and the Caribbean. Jingdong believes these fixed income tools can often be more attractive to vulnerable regions than traditional insurance because if a pre-defined disaster strikes, it’s possible for the pay-out to be rapidly deployed.

Importantly, he also believes such structures can be scaled exponentially; from the $5-6 billion currently trading to up to $500-600 billion, as they are increasingly attractive to institutional investors. He says, “Investors are firstly interested in the higher coupon, but secondly – from a fixed income portfolio management point of view – they offer strong diversification as crisis risk is uncorrelated with interest rate risk or foreign exchange risk.” 

However, despite these innovations, multilateral development banks have recently come under criticism for not doing enough to unleash the trillions necessary to support the Just Transition, particularly in emerging markets. A report commissioned by the Group of 20 major economies suggested that the desire to protect their AAA credit ratings prohibits MDBs from relaxing their strict capital requirements, which, in turn, restricts the amount of capital flowing towards development projects. 
While not addressing this point during our session, Jingdong did acknowledge that multilateral banks could be doing more to power capital markets into solving global issues. “Two years ago the World Bank passed the milestone of having issued a US 1 trillion bond…  Of that USD 1 trillion, about USD 800 billion went to direct resource development for poorer countries… We need to power capital markets to solve global issues; if we can work together to unlock more of this innovation it can be a powerful way forward.” 

He also suggested that philanthropic foundations were another effective tool for bringing new solutions to the table. Given their smaller size, foundations could help support the projects that are too small in scale for the multilaterals. “If you have a space where 1,000 flowers can bloom. Some blooms will be big, some will be small and some will perish. Philanthropic foundations enable all sorts of ideas to surface which is already very impactful. Through iterative processes those ideas with promise can be identified and supported.”

At Laudes Foundation, our efforts to accelerate the Just Transition are resolutely practical. We support action, seek to catalyse new ideas and enable innovative projects to flourish. We also support action that challenges industry, holds it to account and incentivises change. 

The work of multilateral development banks has been invaluable in identifying the potential for impact investing to scale by piloting new sustainable financial structures. Yet, the desire to maintain their AAA credit ratings also inhibits these institutions from taking the risk necessary to catalyse further impact and investment into the Global South. In order to achieve the goals of the Paris Agreement, keep people out of poverty and develop better livelihoods, these institutions must explore options to increase their lending capacity, including less restrictive capital requirements and the potential to drop down a notch in terms of credit ratings. 

In order for us to successfully mobilise the necessary capital to fight these challenges, multilateral ambitions must be ratcheted up.