The United Nations Climate Change Conference (COP) 28 in the UAE in 2023 marked a significant milestone in global climate finance with the announcement of the Fund for Responding to Loss and Damage under the United Nations Framework Convention on Climate Change (UNFCCC) with its headquarters in Bonn, Germany. This new fund addresses the long-standing issue of climate-related loss and damage, particularly in vulnerable nations, creating a formal mechanism for financial assistance to countries that are bearing the brunt of climate change but contributing the least to its causes. On 11 June 2024, the World Bank‘s board approved a plan for the bank to act as interim host of a fund that will provide financial support to developing countries impacted by climate change. Richer nations had been concerned that creating a fund to help cover the impact of extreme weather events – such as floods and droughts – would mean they have conceded liability for causing damage to the climate with their carbon emissions.
On 9 July 2024, at the second meeting of the Board of the Fund for responding to loss and damage, the Board decided to select the Philippines as the host country of the Board of the Fund. For stakeholders like Pathways Capital, this fund is not just a critical development but an opportunity to engage in the next frontier of sustainable finance.
Fund for responding to Loss and Damage: Why Loss and Damage?
While mitigation and adaptation have been the focus of climate finance for years, loss and damage acknowledges that there are limits to what these approaches can achieve. For many nations—especially small island states and least developed countries—climate change is already causing irreversible harm. Rising sea levels, extreme weather events, and prolonged droughts are not just future risks but current realities, resulting in loss of lives, livelihoods, homes, and ecosystems.
The financial mechanisms for addressing these issues, however, have been insufficient or non-existent. The creation of a dedicated Fund for responding to Loss and Damage fills this gap by acknowledging that the countries most affected by climate change need resources not only to adapt but also to recover from damage that can’t be undone.
The Structure of the Fund for responding to Loss and Damage
The Fund for responding to Loss and Damage is envisioned as a pooled financial instrument within the broader framework of climate finance, potentially funded by a variety of sources:
- Developed nations’ contributions based on historical responsibilities for carbon emissions
- Innovative financial mechanisms, including levies on high-emission industries or international aviation
- Private sector contributions, particularly from industries most linked to environmental degradation
While the fund’s final details are still being shaped post-COP, it is expected to have a multilateral governance structure ensuring that vulnerable nations have a say in how funds are allocated. This inclusive structure will ensure that the most affected communities receive targeted and efficient support.
A coalition of developed nations, led by Germany, Canada, and the United Kingdom, pledged $50 billion over the next five years, aimed specifically at assisting vulnerable countries. These nations are contributing to what is being called a “Global Solidarity Package” to kick-start the fund.
Moreover, innovative financing mechanisms have emerged, with several countries proposing innovative ways to expand the fund’s resources. Notably, France and Denmark have spearheaded discussions around taxing carbon-intensive industries, while New Zealand proposed a levy on international aviation and shipping, sectors notoriously difficult to decarbonize. These measures are expected to raise an additional $25 billion by 2030.
Developing nations and small island states like Fiji and Maldives, on the frontlines of climate change, have gained a significant voice in the governance of the fund. They now have direct influence over how the funds are allocated, ensuring that the most vulnerable communities receive timely support for both immediate disaster recovery and long-term resilience building.
Financing Loss and Damage: What It Means for Capital Markets
For capital markets, this development opens new channels for sustainable investment and green bonds designed around loss and damage. There are multiple pathways through which financial actors can play a role:
- National Contributions: Countries most responsible for historic emissions are expected to contribute the lion’s share of the fund, with allocations based on GDP and emissions.
- Sovereign and Sub-Sovereign Bonds: Countries vulnerable to climate-induced disasters can issue bonds backed by the Loss and Damage Fund or other similar initiatives, creating new opportunities for investors focused on impact finance.
- Parametric Insurance Models: These innovative insurance instruments pay out quickly when specific conditions (e.g., a hurricane of a certain strength or sea level rise) are met. Tying these to loss and damage recovery efforts could attract investment in climate-resilient financial products.
- International Levies: Taxes on high-emission sectors, such as aviation, shipping, and fossil fuel industries, are earmarked to fund loss and damage initiatives.
- Debt Restructuring Linked to Climate Resilience: Climate-vulnerable nations often face the dual challenge of recovering from disasters while managing high debt burdens. Financial instruments tied to the Loss and Damage Fund could include debt-for-climate swaps or resilience-linked debt restructuring options, alleviating the financial pressure on these nations.
- Green Sukuk Bonds: As part of the Islamic finance framework, Green Sukuk bonds have emerged as an innovative tool to fund loss and damage efforts in Islamic nations. These bonds, which comply with Sharia law, enable countries to raise capital for climate resilience projects while adhering to ethical financial principles. In Indonesia and Malaysia, for example, Green Sukuk has been proposed as a solution to fund climate resilience infrastructure in flood-prone regions.
- Climate-Resilience Linked Bonds (CRLBs): CRLBs are a new class of bonds that link payouts to specific climate resilience metrics. These bonds provide financing upfront, with interest rates and repayment terms adjusted based on the progress of climate resilience initiatives, such as coastal defense systems or reforestation projects. This incentivizes nations to prioritize climate adaptation while providing capital to recover from existing damage.
- Impact Bonds Tied to Coastal Ecosystem Preservation: A new class of impact bonds aimed at preserving coastal ecosystems is gaining traction in 2024. These bonds are designed to finance projects that restore mangroves, coral reefs, and other critical coastal ecosystems that provide natural protection against storm surges and rising sea levels. Investors receive returns based on the ecological and economic benefits generated, such as improved fisheries and tourism.
The Role of the Private Sector
The private sector is expected to play a pivotal role in scaling the Loss and Damage Fund through public-private partnerships (PPPs). Institutional investors, pension funds, and even tech companies are increasingly looking to align with climate goals. By participating in the fund, they can contribute to long-term resilience projects while gaining exposure to impact-driven investment opportunities.
Blended finance models are seen as the key to unlocking private sector engagement. Public funds can be used to de-risk climate-resilience projects, making them more attractive to private investors. Additionally, the use of guarantees and insurance mechanisms within the Loss and Damage Fund is expected to create a stable investment environment for projects in high-risk regions.
The Path Forward
The Loss and Damage Fund represents an opportunity to innovate within the sustainable finance space.
In addition, as the fund evolves, there will be new opportunities to collaborate with governments and multilateral institutions to develop tailor-made financial solutions that help vulnerable nations recover and build resilience. Whether through the issuance of sovereign climate bonds or the structuring of debt-for-climate swaps, Pathways Capital can play a role in shaping the future of climate finance.
