Unlocking funding solutions for climate-vulnerable communities (SIDS, LDCs and EMDEs)
Climate change imposes irreversible impacts on vulnerable nations, particularly Small Island Developing States (SIDS), Least Developed Countries (LDCs), and emerging market and developing economies (EMDEs), where adaptation measures fall short. Extreme weather events like cyclones and floods, alongside slow-onset events such as sea-level rise, ravage infrastructure, agriculture, and ecosystems while eroding cultural heritage and biodiversity, intensifying vulnerabilities for 3.6 billion people globally. These non-economic losses compound economic damages, estimated at over US $200 billion annually worldwide, with indirect costs like health and livelihoods pushing totals toward US $2.3 trillion yearly. Additionally, World Health Organisation (WHO) estimates 250,000 deaths yearly from 2030-2050, with 37% of heat-related deaths tied to human-induced climate change.
To address this, a Fund for Responding to Loss and Damage (FRLD) was established at COP28 to aid the SIDS, LDCs and EMDEs after decades of negotiations on grants and concessional financing. The push for Loss and Damage (L&D) fund began in 1991 when Vanuatu as part of the Alliance of Small Island States (AOSIS) under UNFCCC, called for an international insurance pool to compensate historic pollution by affluent nations. Talks on the fund evolved through Kyoto Protocol, COP11 (Montreal), COP19 (Warsaw), Paris Agreement, COP25 (Santiago Network), COP26 (Glasgow dialogues), and breakthrough at COP27 (Sharm El Sheikh), which set up a Transitional Committee. COP28 operationalised it with the World Bank hosting coordination and UNDP as the technical support unit. As a recent development, COP30 in Belem advanced the third Warsaw International Mechanism (WIM) review, mandating regular loss and damage gap reports and knowledge products. This helps build global solidarity with non-debt support where adaptation fails.
Challenges faced by L&D
Despite this progress, the fund faces various shortfalls and structural hurdles. Natural disasters have caused US $250 billion in annual losses since 2013, and L&D pledges stand at just US $ 759 million. The New Collective Quantified Goal (NCQG) calls for US $1.3 trillion yearly by 2035, with at least US $300 billion earmarked for adaptation and loss and damage, according to UNEP’s Adaptation Gap Report. This reveals how financial needs in developing countries exceed available funds from all sources, creating a massive finance gap. Given this, there is a need to innovatively finance L&D in LDCs, SIDS and EMDEs. However, the fund faces some major challenges making it difficult to finance such as:
- Voluntary pledges raise liability concerns: Loss and Damage Fund’s voluntary nature of contributions weaken its main goal of covering climate impacts from past emissions. Unlike required payments, pledges from richer countries in the voluntary model are unpredictable, leading to debates on who is responsible. This shifts attention from helping vulnerable countries and reduces confidence in the fund
- Attribution issues slow down payments: Proving which losses come from climate change is hard, as weather events mix natural causes with human effects. Deciding what gets funded and by whom demands complex models, but countries disagree on clear rules and criteria to establish the climate link. This holds up aid for small islands and poor nations during emergencies indefinitely
- Ambiguous eligibility criteria for beneficiaries of the fund: There is a lack of clear details, such as precise definitions of “vulnerability” or required minimum loss thresholds. These rules fail to specify whether growing economies qualify alongside the poorest nations, creating inconsistencies in access. Without standardised guidelines, decision-making processes go on indefinitely as observed after COP28 heightening risks of unfair distribution and delays in delivery
- Difficulty in accounting non-economic losses: Assigning monetary value to intangible losses such as cultural sites, biodiversity, or human lives proves far more challenging than mapping costs for tangible fixes like roads (infrastructure). And a lack of unified global methodology for this adds to the difficulty
Solutions to tackle the challenges
To bridge the identified finance gaps for L&D, overcome the highlighted challenges, and operationalise the fund, innovative finance mechanisms are a way forward. These include:
1)Fiscal instruments such as carbon pricing, financial transactions tax, fossil fuel extraction levy, global wealth tax, international aviation levies and shipping levies,
2) Debt-related instruments such as catastrophe bonds,
3) Direct resource allocation instruments like special drawing rights, and
4) Insurance instruments like subsidised insurance.
- Fossil fuel extraction levies, air passenger levies, financial transaction tax within the national borders of high-income/ developed countries contribute to the pool of FRLD in the short run. In the long-run, national carbon price mechanism and fossil fuel subsidies could be other forms of additional revenue for L&D. A use case of such mechanism is Chile’s proposal on air passenger levy. This is modelled on its domestic version raising US $100+ million yearly since 2012 for climate adaptation. Revenues supported vulnerability assessments in vulnerable regions, demonstrating feasibility for L&D pooling
- Catastrophe bonds are high-return debt instruments with triggering mechanism with partial or complete loss of principal if a catastrophic event unfolds, allowing investors to aim at enhancing climate resilience, disaster preparedness, and recovery efforts in affected regions. American Family Mutual Insurance (AFMI) issued a US $100 million, 3-year bond through SPV Mariah Re Ltd., covering severe thunderstorms/tornadoes with an industry loss trigger of US $825 million. Investors got 6.25% coupons post 2011 tornado outbreaks, principal paid out to AFMI for claims, aiding recovery. This illustrates cat bonds’ role in scaling L&D finance, with market growth to US $40 billion+ outstanding by 2025
- Insurance mechanisms such as parametric insurance or subsidised insurance provide financial protection against climate-related risks, enabling timely recovery and reconstruction efforts. For instance, R4 rural insurance initiative initiative in Ethiopia, Senegal, Malawi and Zambia protected 40,000 smallholder farmers in drought-prone regions. It linked farmers, local relief society, insurers, rural banks, universities and donors to US $2.2 million, with US $370,000 worth premiums and US $450,000 as payouts
In conclusion, these innovative finance mechanisms provide actionable solutions to operationalise the FRLD, bridging massive funding gaps while overcoming attribution, eligibility, and valuation challenges for LDCs, SIDS and EMDEs. Scaling proven pilots will deliver transforming global solidarity into tangible resilience beyond adaptation limits.
Bibliography:
Fund for responding to Loss and Damage | UNFCCC
https://ourworldindata.org/grapher/damage-costs-from-natural-disasters
Adaptation Gap Report 2024 | UNEP – UN Environment Programme
https://www.who.int/news-room/fact-sheets/detail/climate-change-and-health
https://www.orfonline.org/research/the-loss-and-damage-fund-questions-concerns-and-suggestions
https://reliefweb.int/report/world/loss-and-damage-fund-two-big-challenges
Implementing innovative finance instruments for loss and damage | SEI
https://perspectives.cc/wp-content/uploads/2023/10/L_D_Instruments_Final.pdf
https://www.chicagofed.org/publications/chicago-fed-letter/2018/405