Key points
In the article, climate finance is defined as: “the provision of financing by private actors for projects intended to decrease carbon emissions or make cities more resilient to the impacts of climate change.”
The author first explains that:
- “grants and fiscal transfers are an important part of any comprehensive climate change financing plan” but they will not be sufficient, and
- some innovative funding solutions, such as carbon taxes or carbon-related user fees are limited for legal and political reasons.
The analysis starts with an overview of advantages and disadvantages for municipalities to use debt financing:
| Advantages | Disadvantages |
| “borrowing for infrastructure investment can indirectly contribute to economic and revenue growth” | “although the municipal officials involved in the decision-making process are ultimately accountable to city councils and voters, borrowing can be less transparent than raising taxes” |
| “borrowing can be a fairer way of paying for climate infrastructure from an intergenerational perspective” | “debt financing may not be a solution for smaller municipalities, which might have limited experience, know-how, and resources to issue debentures or maintain a good credit rating” |
| “debt payments can be more easily aligned to the lifecycle of an asset” | “current taxpayers also benefit from infrastructure investments; moreover, they have more control over how the money is invested and which types of projects get funded, sometimes to the detriment of future taxpayers” |
| “borrowing can help municipalities accelerate climate infrastructure investments; climate financing is a logical choice for complex capital projects with large upfront costs that require significant investments at once” | “risk aversion on the part of the investors may also affect which projects or technologies attract financing, as investors tend to prefer mature infrastructure projects and tested technologies” |
| “it may be politically easier for Ontario municipalities to issues debt than to raise taxes or charge user prices” | “debt servicing is a claim on future budgets and can limit spending flexibility” |
| “debt financing can be financially advantageous, as the low interest rates prevailing in international and domestic markets at present make borrowing a relatively cheap option for municipalities” | “there may be a mismatch between the characteristics of many climate projects and the incentive structure of financial markets” |
| “there are also regulatory and practical challenges to some of these instruments, although they are not insurmountable” |
Then, each of the four instruments’ advantages and disadvantages are analysed for implementation at the municipal level:
Green bonds are defined as “debentures, the proceeds of which are earmarked for projects with an environmental benefit:
| Advantages | Disadvantages |
| “Green bonds may provide reputational gains for their issuers who thereby associate their brands with environmental goals” | “Green bonds may create reputational risks if investors or the public perceive they are being used to ‘greenwash’ business-as-usual projects with no or minimal environmental benefits” |
| “Green bonds offer an opportunity for investors to fulfil their environment investment mandate with adequate risk/reward ratios” | “Many municipalities that could benefit from climate projects may not be rated by credit rating agencies and may not have easy access to financial markets.” |
| “Green bonds tend to be more transparent than regular municipal bonds, as they can be subject to the external monitoring of the use of proceeds” | “Green bonds are still a very small portion of the total global bond market.” |
| “Since compliance with standards is voluntary, investors may require the intermediation of third-party service providers to monitor and verify that the proceeds are being applied in accordance with the purposes of the green bond” | |
| “The proceeds from green bonds may not be used in projects with real environmental benefit, partly because of the lack of information, and partly because the risks of less mature technologies are harder to assess, since performance data is scarce” |
Environmental impact bonds (EIBs) are defined as “an adaptation of social impact finance instruments to environmental purposes. They are not debentures per se, but a complex web of contractual relationships that include the issuance of debentures for financing environmental projects or providing environmental services by third parties.”
| Advantages | Disadvantages |
| “SIBs and EIBs can align the interests of investors, local governments, and service providers behind a social or environmental objective.” | “SIBs and EIBs may subordinate the public good to financial considerations and the incentives of private investors.” |
| “SIBs and EIBs allow local governments to tap into private capital, transferring performance risk to capital markets and engaging private investors in monitoring the quality and provision of environmental services” | “Despite their potential to generate savings, EIBs may be costly to the issuer, depending on their structure.” |
| “EIBs allow for flexibility in their financing structure.” | “EIBs may not be financially attractive to market investors.” |
| “There is a risk that the service providers may achieve the projected results but external and unrelated factors created additional costs for the government on top of the payment due to the investors according to the terms of the EIB” | |
| “It may be impossible or inappropriate to use a standardized, rigid metric to measure the outcomes of certain interventions” | |
| “The emphasis placed by proponents of SIBs and EIBs on ‘proven’ interventions can deter innovation.” |
CAT bonds are defined as “more complex than regular debentures and involve the creation of a special-purpose vehicle (SPV) to serve as the intermediary between the beneficiary of the CAT bond and private investors.”
| Advantages | Disadvantages |
| “CAT bonds can help governments transfer to capital markets risks that would not be regularly covered by insurers.” | “CAT bonds are designed to complement insurance instruments, not to provide capital for infrastructure investments.” |
| “CAT bonds can help municipalities and other local public agencies improve their fiscal and financial resilience” | “CAT bonds may contribute very little, if anything, to the social or economic resilience of communities after a disaster strikes, including social cohesion, long-term economic wellbeing, and employment opportunities for their residents.” |
| “CAT bonds are less transparent than green bonds and there is no legal precedent for their use by Ontario municipalities.” |
Green banks are defined as “financial institutions specialized in the provision of financing for projects with environmental benefits”
| Advantages | Disadvantages |
| “Financial aggregators can lower borrowing costs and increase market access for municipalities.” | “Financial aggregators may compete with commercial banks and other lenders (such as infrastructure banks) as a source of financing for capital investments.” |
| “Depending on their mandate, green banks may cater to underserved municipalities and sectors of the economy.” | “If financial aggregators are publicly owned, or if they implement public policy or operate in accordance with public plans, they may be seen as ‘picking winners’ or caving in to political influence in their lending activities.” |
| “Financial aggregators can provide a range of financial services to municipalities, from managing and maintaining deposit accounts to more specialized services, such as credit enhancements, assistance with project design and financial modelling, assistance with bond issuance, and financial or policy risk insurance.” | “On the other hand, if they operate according to commercial or industrial standards, they may rely too much on short-term credit […] and may not serve smaller municipalities or sectors of the economy that need capital the most but cannot easily access private capital markets.” |
| “Green banks can have a flexible, dual role in lending to both the public and private sectors.” | |
| “Green banks and other financial aggregators can help local governments leverage private capital by using their own resources in support of private lending for climate projects” |