What the Cop27 financial reform agreement could mean in practice

A deal struck at the UN Cop27 climate summit calls for rapid and far-reaching changes to the world’s financial system to fund the transition to a low-carbon economy.

“Delivering [the necessary investments of at least US$4-6tn a year] will require a swift and comprehensive transformation of the financial system and its structures and processes, engaging governments, central banks, commercial banks, institutional investors and other financial actors,” says the agreement, known as the Sharm el-Sheikh Implementation Plan.

Although the agreement does not stipulate the precise nature of the proposed reforms, discussions alongside the summit focused on the future of the World Bank, the distribution of special drawing rights (SDRs), and a proposal for “debt-for-climate swaps”, whereby creditors cancel some debt from poorer countries on the basis of commitments to undertake climate projects.

World Bank overhaul looks increasingly likely

Momentum has been growing behind a move to revamp the business model of the World Bank so it can provide long-term support for climate adaptation and mitigation.

The call was the centrepiece of a keynote address at Cop27 made by Barbados prime minister Mia Mottley. Mottley has emerged as a champion of small and developing nations which say they are fed up with borrowing at high rates to pay for climate impacts they didn’t cause.

Reforms could see the World Bank offer more concessional finance and grants to developing countries for climate projects. Concessional finance means finance on better terms than is available commercially.

There is also a push to increase the bank’s lending capacity by reducing the amount of capital lenders are required to hold against loans to developing countries. An independent review commissioned by the Indonesian presidency of the G20 found the World Bank and other multilateral development banks (MDBs) could leverage an additional $1tn for climate and development finance through such a policy.

The report also recommended changes to how ratings agencies assess risks to climate projects, suggesting they are currently unnecessarily risk averse.

The World Bank has received criticism under the current leadership of David Malpass for lagging behind other development banks in the share of funding it dedicates to climate and for failing to align its overall lending portfolio with the Paris Agreement goals.

Malpass recently caused consternation when he declined to say whether he accepts the scientific consensus on global warming. He has said he opposes reforms to the World Bank’s capital regime, although would work to implement them if demanded by shareholder governments.

Al Gore, the former US vice president, expressed optimism that fundamental reform of the World Bank could be completed within a year, and called for the institution to refocus its mission on supporting green energy.

Call for SDRs to be used for climate mitigation

Mottley has pushed for SDRs from the International Monetary Fund (IMF) to be allocated towards helping developing countries invest in the low-carbon transition.

SDRs are a reserve asset issued by the IMF which can be exchanged for the currencies of the fund’s members. A proposal supported by Mottley would see $650bn worth created to establish a climate mitigation trust. A further $100bn could be rechanneled away from rich countries in whose possession they are not currently being used.

The plan’s backers say this fund could be used to borrow a further equivalent amount from the private sector, which could be lent out at low rates for investment in green infrastructure projects.

The architects also say such a trust would lend directly to projects rather than to governments. The loans would therefore become an asset of the trust and a liability of the project, taking climate mitigation off government balance sheets.

Civil society groups have said that, although SDRs are immensely valuable to low-income and vulnerable countries, they have historically been allocated to advanced economies which do not need them.

Global financial institutions interested in climate debt swaps

A further proposal championed by Mia Mottley is for increased use of green debt swaps. This involves creditors agreeing to renegotiate a portion of poorer countries’ debt on the basis that the borrower agrees to undertake some form of climate investment.

The use of such mechanisms has ballooned in recent years and the idea has won some support from the IMF and World Bank.

Kristina Kostial, the IMF’s deputy director, warned during Cop27 that climate-vulnerable countries with large debt burdens are losing even more capital due to climate shocks. She said they therefore had more limited fiscal space to undertake climate mitigation investments.

An IMF working paper published earlier this year found that climate vulnerabilities and fiscal risks are closely correlated, and recommended climate debt swaps as a way to support poorer countries’ climate spending when grants or more comprehensive debt relief are not on the table.

Debt justice groups agree that debt swaps have a role in supporting climate-friendly development, but argue it should be alongside much more comprehensive debt relief than richer countries and financial institutions are currently offering. They say there is a danger that such agreements will legitimise odious or illegitimate debt which should never be repaid.

In a separate move, French president Emmanuel Macron has called for the rules of the IMF, the World Bank and other major lenders to be changed to make clauses that halt debt repayments in the event of a disaster far more common.