Unlocking climate capital for emerging markets and developing economies: An adaptive regulatory and policy reform agenda

This discussion paper by Luiz Awazu Pereira da Silva, published by the Centre for Economic Transition Expertise (CETEX) at the London School of Economics, examines how regulatory, policy and institutional reforms can unlock climate finance for emerging markets and developing economies.

The transition to net zero cannot be won without a massive redirection of global capital towards emerging markets and developing economies (EMDEs), encompassing both mitigation and adaptation finance. These countries face annual external financing needs in the order of US$1.3 trillion by 2035, yet international flows remain a fraction of that. This discussion paper sets out a comprehensive, sequenced and politically ambitious agenda of regulatory, policy and institutional reforms to help close that gap. The author outlines a set of reforms to overcome the impediments limiting the flow of climate finance into developing countries.

Key messages

• There is no silver bullet – only a coherent package of reforms, spanning prudential, market-based, technological and concessional measures, can shift risk perceptions and reduce the high cost of capital in EMDEs.
  
• Prudential regulation must evolve to reflect climate risk more explicitly while preserving the integrity of Basel III.
  
• Mobilisation of institutional investors is key for scaling up financing. The centre of gravity for scale sits with non-bank institutional capital such as sovereign wealth funds, pension funds and insurers. Prudential reforms can unlock bank balance sheets and improve warehousing and aggregation into vehicles that institutional investors will buy.
  
• Credit rating methodologies must stop amplifying EMDE risk premiums and begin recognising multilateral development bank guarantees, risk-sharing mechanisms and climate resilience measures.
  
• Reform of credit rating agencies’ role and methodologies is needed to reduce the procyclicality of their ratings and address structural biases against EMDE investment in the net-zero transition, including through the use of new technologies such as artificial intelligence and machine learning.
  
• Foreign exchange risk solutions, including callable capital-backed facilities and structured hedging platforms, are indispensable to attract long-tenor investment.
  
• Carbon market infrastructure and robust taxonomies can unlock new flows and help ensure integrity in climate finance.
  
• New financial technologies – including tokenisation, central bank digital currency platforms and smart contracts – can reduce transaction costs, enhance transparency and crowd in private capital.
  
• Green bond markets require scaled credit enhancement from multilateral and national development banks to deliver investment-grade paper at scale.
  
• Global climate funds and solidarity levies must provide predictable concessional anchors, channelling international taxation proceeds into stable revenues for de-risking, adaptation and just transition finance.
  
• Coalitions of the willing and variable-geometry approaches will be essential to advance reforms even in the absence of universal consensus.
  
• Sequenced implementation – starting with reforms feasible under existing mandates while preparing more ambitious changes – can help build credibility and momentum.