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Financial Innovation and Capital Efficiency

Updated: Feb 16, 2023

Recent deployments of venture capital into climate startups suggest that the long-established gap in climate funding is finally being bridged and that there are ample funds to support the innovations that will drive the green transition. While similar funding increases have been seen across climate-friendly assets, a deeper look suggests both that a significant capital gap remains and that there is the need for financial innovations to drive capital efficiency to meet national and global climate goals.

Globally, leading estimates suggest a need for an additional 90 trillion USD in funding by 2030 and 275 trillion USD by 2050, exclusive of adaptation and resilience funding. In India, Climate Policy Initiative (CPI) estimated a required 170 billion USD per year to achieve the NDCs. The IPCC estimates the average annual investment required by 2030 is between three to six times greater than current levels across all sectors, stages, and regions. Despite these requirements, even the 100 billion USD per year committed to developing nations by 2020 in the Paris Agreement has still not been delivered.

These figures paint a picture far grimmer than recent funding would suggest, yet the truth lies beyond.

Estimates of climate finance needs are based on existing financial products and related adoption costs and timelines. Applied to the current context, the old Wall Street disclaimer, “Past performance is not indicative of future results,” becomes less warning and more pathway to something better.

Whether for corporations, SMEs, governments, or startups, the global economy has access to a far more robust set of financing tools and instruments to mitigate or distribute risk and facilitate funding than is currently available for climate investment.

This difference is particularly pronounced in India, where climate finance is deployed from a limited pool of capital and via limited financial instruments. Often these investment structures are not best suited to the technology, business models, or market needs of the sector.

Forays into blended finance, carbon credits, and green bonds have all been good starting points, but India needs a broader set of financial tools and capital. Project finance, invoice discounting, prepaid contracts, asset securitization, OTC marketplaces, insurance, and certain types of structured products with varied risk-reward profiles (just to name a few) need to be made available to fund assets and attract larger pools of capital.

To drive the adoption of climate technologies, newer business models that leverage financial innovation are often required and nearly always require access to appropriate capital sources. Customer financing, whether through EMIs or more innovative models such as ESCO, PayS, _(product)_ as a service, or other models increases access and reduces friction. During the Covid lockdowns, business came to a stop and a review of small and midcap companies revealed an average of only 2 months of cash on hand. Credit-based or opex models are necessary for large swathes of the economy to transition.

Often, businesses need multiple types of capital, and rarely can one source provide all. Capital providers can further enhance market efficiency and support their investments by working with other capital allocators to align funding strategies and build a consistent value chain. The continuity of capital across growth stages is essential for businesses and investors to optimize results.

Not all of the financial tools listed above are relevant for every (or even necessarily many) situation(s); but applied judiciously, they have the ability to accelerate the speed and scale at which climate technologies and solutions are adopted and the efficiency with which capital is utilized.

The more efficiently capital is deployed, the higher the return -- on the investment and the environment. On average, an investment of 1 USD towards a green economy yields 4 USD in benefits. India is well-positioned to catapult its economic and environmental growth by strategically leveraging capital efficiency and building on the associated returns.

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