Mapping the Financing Landscape for Climate Adaptation
As population growth, urbanization, and climate change continue to strain water resources, effective water management has become increasingly critical. Fortunately, cities and countries around the world are leveraging innovative financing mechanisms to enhance the resilience of their water systems and ecosystems.
One such approach gaining traction is the use of environmental impact bonds (EIBs). These bonds connect investors with public entities to fund green infrastructure projects that manage stormwater, mitigate flood risks, and restore natural environments. By linking financial returns to measurable environmental outcomes, EIBs foster a collaborative approach to urban water management. For example, the District of Columbia Water and Sewer Authority used an EIB to build green infrastructure that improved water quality, boosted resilience, and restored local ecosystems.
Another innovative financing tool is stormwater fees. By imposing fees based on a property’s impervious surface area, municipalities encourage owners to adopt green solutions like rain gardens and permeable pavements. These decentralized, nature-based approaches alleviate the strain on aging infrastructure and support more resilient, sustainable water management. The city of Berlin’s strategy for biodiversity preservation, which promotes these types of nature-based solutions, is one successful example.
Green bonds have also emerged as a way for water utilities to fund nature-based solutions that tackle water supply and quality issues. These bonds finance projects like wetland restoration, riparian buffers, and reforestation, helping utilities reduce their dependence on traditional, costly gray infrastructure and adapt better to climate change. Anglian Water, for instance, issued the first public sector green bond to fund innovative water management and ecosystem restoration initiatives.
Harnessing the Power of Catastrophe Bonds
Another innovative financing instrument making waves in the water and climate resilience space is the catastrophe bond (CAT bond). These high-yield debt instruments allow insurance companies, governments, and other entities to protect themselves against the impacts of natural disasters. CAT bonds provide immediate liquidity when a predefined catastrophic event occurs, such as a hurricane or flood.
The World Bank has issued CAT bonds that provide insurance against natural disasters and weather events in countries like Mexico, the Philippines, and Jamaica. Similarly, the African Risk Capacity (ARC) has been working to establish an Extreme Capacity Facility (XCF) that will issue CAT bonds to blend private capital for climate change adaptation and resilience projects in eligible African countries.
The use of CAT bonds is not limited to the public sector. In 2021, USAA Insurance, which provides financial services to U.S. military veterans, issued a $300 million CAT bond to reinsure against losses from a range of climate-related perils, including tropical cyclones, severe thunderstorms, and wildfires.
Unlocking Adaptation Finance through Innovative Mechanisms
Alongside CAT bonds, a variety of other innovative financing mechanisms are emerging to support climate adaptation efforts. One such mechanism is the Adaptation Benefits Mechanism (ABM) being piloted by the African Development Bank. This program enables project developers and governments to certify the benefits of their adaptation activities, which can then be traded with donors or climate change financiers, providing an additional revenue stream and collateral for securing upfront investments.
Biodiversity credits represent another innovative approach. These tradable units of restored or preserved biodiversity can incentivize private sector investments in nature-based solutions that enhance climate resilience. While no existing schemes have explicitly targeted adaptation outcomes, the link between biodiversity and climate change adaptation means that such credits could emerge in the future.
Blue bonds are another growing area of innovation. These green bonds focus specifically on financing projects that improve marine and coastal resources, including activities that enhance climate adaptation, such as mangrove restoration and improved water management. The Republic of Seychelles launched the world’s first sovereign blue bond in 2018, raising $15 million to support marine conservation and the development of the country’s blue economy.
Blending Public and Private Capital for Climate Resilience
As governments and communities seek to enhance the resilience of their water resources, climate resilience bonds have emerged as a promising financing tool. These green bonds dedicate proceeds to investments that support climate change adaptation and resilience, with the Climate Bonds Initiative’s Climate Resilience Principles providing guidance on integrating adaptation criteria.
In 2019, the European Bank for Reconstruction and Development issued the first-ever dedicated climate resilience bond, raising $700 million to finance the bank’s existing and new climate-resilience projects. More recently, Mexico’s FIRA development bank issued the first green bond linked to climate resilience, with proceeds allocated to building the resilience of the country’s food and agriculture sector.
Another innovative approach is the use of conservation impact bonds (CIBs). These pay-for-success structures connect conservation stakeholders with impact investors, transferring the risk of funding conservation efforts from governments, communities, and donors to the private sector. CIBs can support projects that enhance the ability of natural systems to adapt to climate change, such as restoring watersheds and implementing nature-based solutions.
Harnessing the Power of Blended Finance
The water and sanitation sector is also benefiting from the growing trend of blended finance – the strategic use of public and philanthropic funds to mobilize private capital for development and adaptation initiatives. For example, the recently launched ARCAFIM mechanism combines international public funds with a commercial bank’s risk-sharing to provide climate adaptation loans to smallholder farmers and rural enterprises in East Africa.
Similarly, the proposed GAIA platform, led by MUFG and FinDev Canada, will blend commercial and concessional capital to finance long-term loans for climate adaptation and mitigation projects in developing countries. Seventy percent of the portfolio’s expenditure will be dedicated to climate adaptation, with a focus on least developed countries and small island developing states.
Philanthropic and donor-backed initiatives like the Landscape Resilience Fund are also leveraging blended finance to support sustainable adaptation solutions for vulnerable communities and small- and medium-sized enterprises. By combining public, private, and philanthropic capital, these funds can create a self-sustaining tool for financing climate adaptation.
Innovative Financing for Water and Sanitation Infrastructure
Governments and development partners are also exploring innovative financing mechanisms to enhance the resilience of water and sanitation infrastructure. Public-private partnerships (PPPs) are one such approach, with the World Bank and Global Center on Adaptation highlighting their potential for integrating adaptation and resilience considerations.
For example, the Development Bank of Jamaica, with support from the Inter-American Development Bank, has strengthened the country’s PPP framework to include climate resilience at each stage of the process. Similarly, the Santiago Water Fund in Chile brings together the regional government, a local water utility, multinational corporations, and an international NGO to invest in watershed protection and restoration, enhancing the resilience of the capital city’s water supply.
Revolving funds represent another innovative financing mechanism for water and sanitation infrastructure. In the United States, federal-state partnerships support water-related revolving funds that can be used to reduce risks from natural hazards and climate change, including purchasing backup generators, constructing flood barriers, and conserving source water areas.
The Maryland Shore Erosion Control Revolving Loan Fund is one such example, providing zero-interest loans to households, businesses, and municipalities for nature-based shore erosion control projects. Similarly, the Adaptation Window of Antigua and Barbuda’s Sustainable Island Resources Framework Fund offers low-interest loans to vulnerable homes and businesses for adaptation measures like rainwater harvesting and water efficiency retrofits.
Unlocking Private Capital through Securitization
As governments and communities seek to scale up investment in climate-resilient water infrastructure, securitization offers a promising approach to unlock private capital. By pooling loans or other financial assets into a new, sellable product, securitization can increase the liquidity of existing assets and attract investment from a broader range of sources.
Green securitization, where the underlying cash flows are derived from low-carbon assets or the proceeds are earmarked for such projects, can support climate adaptation efforts. For example, the Beijing Enterprises Water Group in China has issued green asset-backed securities (ABS) to finance water infrastructure projects that address pollution prevention, resource recycling, and climate change adaptation.
Payments for ecosystem services (PES) represent another innovative financing approach that can support climate adaptation. By compensating landowners and stewards for the provision of regulating services like watershed protection and flood control, PES schemes can incentivize the conservation and restoration of natural systems that enhance resilience.
The CompensACTION initiative, launched by the Government of Germany, aims to scale up PES programs that compensate smallholder farmers for their contributions to preserving ecosystem services, including those that build climate resilience. Similarly, Switzerland’s agricultural policy framework includes direct payments to farmers for efforts that enhance landscape quality and water-use efficiency, providing a model for integrating adaptation into PES schemes.
Innovative Financing for Sustainable Development
As communities worldwide grapple with the growing threats of climate change, innovative financing mechanisms are emerging as a critical tool for enhancing the resilience of water resources and related infrastructure. From environmental impact bonds and stormwater fees to catastrophe bonds and blue bonds, these cutting-edge approaches are mobilizing public, private, and philanthropic capital to support sustainable, climate-resilient solutions.
By harnessing the power of blended finance, conservation impact bonds, and public-private partnerships, water sector stakeholders can unlock the resources needed to protect vital freshwater supplies, restore natural ecosystems, and build community resilience. And as countries and cities continue to explore new financing avenues, such as securitization and payments for ecosystem services, the potential to scale up adaptation efforts has never been greater.
The Joint Action for Water blog is at the forefront of these exciting developments, sharing insights and best practices from around the world. Join us as we explore innovative financing mechanisms that are transforming the water and sanitation landscape, empowering communities to thrive in the face of climate change.
