In the lead up to COP27 in Egypt, all eyes are on the region. The acceleration of the global energy transition poses critical challenges for the Middle East and North Africa (MENA), with the transformation evolving into an all-encompassing economic, social, and political project for the region. Exacerbating this shift are two main factors: the over-dependence on hydrocarbons, coupled with ongoing diversification drives and ambitious reform programs aimed at widening the economic base. MENA is one of the most climate-vulnerable regions, facing extreme high temperatures, worsening droughts and floods and sea-level rise. Importantly, given that climate change is a threat multiplier impacting the region’s growth and development, a proper response would require a multi-pronged approach, including policy, regulatory frameworks and sizeable financing. This piece primarily will focus on financing and on the role of existing international financial institutions (IFIs) and international organizations addressing this.
The need for diverse financing
Over the latest decades, climate disasters in the region have adversely impacted growth, fiscal (government) space and the external sector (exports, imports, financial flows). This has disproportionally affected fragile and conflict states, including communities at risk, aggravating poverty and inequality, and contributing to social tensions, migration and conflict. Therefore, to help MENA countries boost climate resilience, measures to promote climate adaptation and mitigation are a priority. More specifically, financing is needed to help scale interventions, from domestic to external sources, including the public sector, private and international sources.
Domestically, fiscal budgets need to incorporate climate adaptation- and mitigation-related investments, including adequate buffers to react to climate shocks, while simultaneously preserving debt sustainability. Governments in the region have benefited from financial solutions to meet their need for sustainable investments. In September 2020 and in an emblematic transaction, Egypt issued its first-ever green sovereign bond in the region, valued at $750 million, with a tenor of 5 years and an interest rate of 5.25%. Proceeds were earmarked for financing clean transportation, renewable energy, pollution prevention and control, sustainable water and wastewater management, energy efficiency and climate change adaptation. On the heels of this investment, preliminary data in 2022 suggest that Egypt is on track to achieving its Vision 2030 goal of increasing the proportion of green projects in its investment budget, from 14% in 2020 to 30% in 2022.
However, climate initiatives also require the mobilisation of private capital as a critical complement to that of the public sector. While banking systems in the Gulf remain well-capitalised, those in other countries remain weak, as in Algeria, Iraq and other fragile countries. Financial institutions in the region are characterised by concentrated lending to sovereign or government-led projects, reflecting the outsized role of the state, including exposure to national oil companies, through syndicated bank loan financing, which will squeeze local liquidity.
Leveraging international financiers and multilaterals
One way the international community provides climate financing to MENA is through multilateral, predominantly non-concessional terms and debt instruments, and through bilateral finance, primarily on concessional terms. Key contributors include European countries, with France (through Agence Française de Développement [AFD]) and Germany (through KfW or the German Agency for International Cooperation [GIZ]) taking the lead on individual country and regional programs – and a host of other peer nations, including Japan, contributing through other channels such as the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB) and multilateral climate funds (notably, the Clean Technology Fund and the Green Climate Fund). The Islamic Development Bank also plays a role in climate change initiatives, co-financing projects with the EBRD and others.
Other forms of IFI financing include senior or mezzanine debt or equity and can take on hybrid forms, such as blended finance. This is when an IFI’s own account finance (from its balance sheet) and/or commercial finance from other investors is ‘blended’ with concessional finance from donors, or third parties, to develop private sector markets. Indeed, a climate project is not fully commercial on a standalone basis and needs a temporary subsidy to enable its high-impact, without which it would not otherwise materialise.
In addition, there are 12 climate funds active in the MENA region (see Table 1)
The largest contributions are from the Clean Technology Fund, one of the two multi-donor trust funds under the Climate Investment Funds framework, with an estimated pool of $5.4 billion in funds. More broadly, amongst the various climate funds, between 2003 and 2022 an estimated $1.6 billion of financing was approved for over 139 projects, whose scope was largely centred on mitigation efforts, despite pressing adaptation needs in the region, especially for water conservation and food security measures. Out of the total funding approved for the region, $560 million (approx. ~30%) has taken the form of grants. The two top recipients, Egypt and Morocco, have respectively received 29% and 19% of the total approved climate finance in the region.
Capital market instruments
Green and blue bonds, including Islamic green Sukuk, can help attract financial flows for climate change. These are fixed income (debt) instruments, whose issuers exclusively use the proceeds to finance investments in climate and environmental projects. Since the first green bond issuance in 2007 by EIB, under the label Climate Awareness Bond, various assets have been identified to qualify for green. Initially, only Multilateral Development Banks were issuing green bonds, until 2012, when the first private transaction was completed. The growth of the international green bond market serves to showcase how capital markets can channel private capital to address climate change. For example, in August 2021, Egypt’s Commercial International Bank issued a $100 million Green bond with the International Financial Corporation (IFC), the private sector arm of the World Bank, subscribing to the full value of the issue.
The rising market of blue finance emerged in 2014. In the same way, the green space developed in response to increased carbon emissions, the premise of blue being centred on contributing to ocean protection and improved water management – an ever-growing challenge in water-poor MENA. In January 2022, IFC released its Guidelines for Blue Finance, which delineated how to structure, evaluate and monitor blue bonds and loans. This framework is supported by The International Capital Market Association (ICMA), which acts as a repository for promoting internationally accepted standards of practice.
For both green and blue assets, external second party opinion providers and third-party verification is becoming increasingly important, especially in bonds and capital markets, to address risks of ‘greenwashing’–that is, portraying an asset, investment or initiative as Environmental Social Governance-aligned where no real sustainability impacts exist–and similar risks resulting from ascertaining what qualifies as blue, to ensure the use of proceeds are being properly directed.
Given the region’s level of water stress means blue finance may provide an innovative financing solution in the region, to address not only more sustainable practices in wastewater and sanitation services, but also coastal resilience and interventions, especially in countries like Algeria, Egypt, Morocco and Tunisia, where erosion and increased flooding–together with overfishing in the Mediterranean–present a few challenges. The World Bank is currently engaged in the region through MENA Blue, whose program is designed to strengthen physical, social and economic resilience, through technical assistance and the mobilisation of climate finance.
Such developments, together with the growing trend of investors demanding more transparency and accountability, will ultimately dictate where capital goes, impacting financial flows and growth within these economies.
Galvanising regional momentum
As COP27 inches closer, in a part of the world where climate change is acutely felt, the MENA region is facing a tremendous opportunity to benefit from, and contribute to, the global energy transition. Despite the country-specific idiosyncrasies, the region has been able to innovate and experiment with new technologies and financial approaches, supported by the state, and regulatory frameworks.
Ultimately, as climate vulnerabilities continue in intensity and frequency, thereby increasing loss and damage, countries in the region need to obtain diverse sources of funding to tackle adaptation and mitigation, to determine how best to rebalance transition risk, while ensuring long-term economic viability moving forward.