by, Helga Birgden, Global Chair, Sustainable Investment, Mercer, Kate Brett, Global Intellectual Capital Leader – Sustainable Investment, Mercer, Jonathan Cross, Sustainable Investment Consultant, Mercer
We believe mobilizing capital to support the low-carbon transition in Africa can be key to achieving global climate goals. At the same time, climate investing across the continent can present investment opportunities.
Key takeaways
Institutional investor capital is expected to play a significant role in financing the transition in Africa and beyond.
Climate-related investment frameworks implemented by institutional investors should incorporate a broad definition of transition. Carbon reduction needs to be considered alongside the following: required investments in economies that have yet to see their emissions peak; the role of nature; adaptation to the physical impacts of climate change; adoption of circular economy approaches; and support for principles of equality for sustainable development.
Mobilization of private capital at the scale required to support the African transition requires investors to advocate for the transition; set credible commitments that build demand signals; align policies with these commitments that acknowledge the importance of local context; encourage collaboration across the financial ecosystem; promote de-risking of investments; and report progress.
This article explores the need for, and proposes the key characteristics of, a transition finance and investment framework that a broad range of institutional investors may use to invest with confidence across asset classes, strategies and sectors to support the low-carbon transition in Africa. It summarizes:
The role private capital can play in supporting the low-carbon transition in Africa, including what transition means in the African context;
An assessment of the current landscape of initiatives and frameworks that investors can draw upon to guide their approach to transition finance, including in emerging and frontier markets; and
The key characteristics of an overarching finance and transition framework that investors can use to allocate strategically to the African transition.
This article draws upon findings from an upcoming report, a contribution to the Green Investment Principles’ Africa Chapter, which takes a deep dive into this topic. Informed by survey results and discussions with investors and key stakeholders, the forthcoming report discusses the key risks and opportunities faced by investors, the landscape of investments solutions and specific actions that investors can take to turn the proposed framework into action.
The Role Private Capital can Play in Supporting the Low-carbon Transition in Africa
We have identified a growing number of global investors that have committed to align their portfolios with net zero outcomes, are actively seeking investment opportunities in emerging markets (EMs), including Africa, and which provide a compatible risk-adjusted return alongside support for the regional transition. Despite the established need for private capital, many investors are yet to be convinced by the current range and depth of EM transition investment opportunities.
Across the many countries that make up the African continent, and the Global South more broadly, investing for transition supports critical economic and social development, from the delivery of renewable energy sources and improvements in energy efficiency, to the enhancement of economic infrastructure and resilience to the effects of global warming. Shifting just 3.7 percent of the $100 trillion of global assets under management by institutional investors each year could enable achievement of the Sustainable Development Goalsi.
There are untapped investment opportunities. By way of illustration, the annual sustainable financing gap is equivalent to 7% of Africa’s gross domestic product (GDP) and 34% of its investments in 2021. This annual gap equals less than 0.2% of the global and 10.5% of the African-held stock of financial assetsii COP 27 and 28 are rightly focused on this opportunity to finance sustainable development and, specifically, the role of private capital.
According to Climate Policy Initiative research (2021), about 55% of the transition financing required to meet globally agreed targets for 2050 will need to come from the private sector − equivalent to an almost six-fold increase from current levels.
Furthermore, there is chronic underinvestment in risk reduction and preparedness. Private investment in climate adaptation, supporting adjustment to actual and expected physical climate change effects, continues to lag far behind current levels of investment in climate mitigation strategies or projects. Efforts to channel alternative sources of funds have been limited, as adaptation has not yet become a widespread investment proposition for private investors.
We explore advancing the transition through an assessment of current investment/financial/transition frameworks, culminating in the development of an investor-specific framework that can be applied to financing the transition in Africa. Any transition framework designed to support investors to allocate capital strategically to the low-carbon transition in Africa needs to consider the heterogeneity of Africa’s 54 nations. It must also encompass nations’ specific development needs and transition end-states, whilst allowing consistency in investment decision-making when selecting and retaining investments. Example projects in this paper highlight the unique economic and political contexts of African markets.
Investor net zero frameworks can play a key role in mobilizing capital flows, but currently they focus heavily on ongoing decarbonization, which may not be compatible with Africa and other emerging markets where emissions are yet to peak. For sustainable development to succeed in Africa, climate finance needs to account for a “fair share carbon budget,” recognizing differences between the Global North and Global South. Inequality is structural: 52% of carbon emissions were produced by 10% of the world’s richest population over the last 25 years, while over 50% of the world’s poorest produced an estimated 7%iii .
Definition of Transition in the Context of Africa
Mercer’s view is that there is a need for a broader definition of transition within such frameworks − expanding from investment approaches that target carbon reduction alone, to address economies that have yet to see their emissions peak, nature loss, physical risks and adaptation, engage in a circular economy and support principles of equality for sustainable development.
Encompassing the above interrelated issues requires investors to recalibrate what investment risk management and return maximization means today for investment in Africa and beyond.
With the focus on Africa through COP27 and COP 28, the case for investing in climate transition and adaptation, with a particular focus on areas such as renewable energy technologies, including solar, onshore wind, small hydro, biomass and landfill gas, to meet sustainable development aims and contribute to economic prosperity is cleariv. Mirroring the proposal to broaden the definition of transition, investment will also be needed to support a wide array of sectors as they transition to be compatible with a low-carbon and sustainable economy.
Asset owners seeking to manage risk and build resilient portfolios recognize the need for closing the funding gap between Global North and South to achieve global financial stability. In response, we are seeing investments emerging that address transition through nature-positive investing, physical risks and adaptation, circular economy and fair share considerations. Further investors are understanding the social impacts of investing and the need to support a Fair or Just Transitionv.
Fair Transition considerations include recognizing that transition financing will need to be aligned to sustainable development goals and will differ in focus depending on the current level of development. In some countries, such as South Africa, transition financing will need to be focused on transitioning away from fossil fuels, with fair transition centering on re-skilling for communities that were dependent on coal-related jobs, for example. For other lower-income countries, the Fair Transition Approach offers an opportunity to build sustainable energy systems, connect communities to the grid for the first time and bypass the traditional fossil fuel-based energy models.
We believe there is a need for transition-investor frameworks to accelerate, streamline and scale up investment opportunities in the support of a sustainable transition. Such frameworks can support investor-capital allocation. We also see that a broader definition of transition − reflected in taxonomies, disclosures and target-setting − will help investors better navigate a complex risk landscape whilst providing opportunities for investment for sustainable growth. Such an approach requires reassessment of what investment risk management and return maximization means in the context of investing for transition, both across the African continent and beyond.
Perceptions of Risk and Opportunity in Allocations in Africa
While the climate investment case for Africa is strong, there are barriers, perceived and real, that often hamper private sector capital allocation: political instability, conflict and corruption, unpredictable impacts of climate change, aging infrastructure and technology, inconsistent policy and regulation and economic volatility are at the forefront of concernsvi. Country risk can be assessed in terms of transparency, harm and adverse impacts − irreparable or systemic − and can be red flags to potential capital allocators.
However, when research is undertaken to unpack the case for investing in particular African economies − in sustainable infrastructure, for example − studies show that while major risks exist, there is little systematic evidence available to suggest that there is significant difference between the actual default rates of projects in Africa and other regions of the worldvii. We see opportunity for a new framework to support a more fundamental reassessment of risk perception across African markets.
While investors try to navigate barriers to investing in Africa, a range of financing mechanisms are now at play to support finance flows into projects on the continent. The African Development Bank Group has developed finance programs to encourage private-sector participation in climate action and green growth in Africaviii. Such programs encourage investors to “learn by doing,” often using a public/private funding mix to de-risk investments and support investor allocation.
Such project finance leverages the technical expertise and grants of Development Finance Institutions (DFIs), enabling deals through capital guarantees, risk-sharing mechanisms and targeted measures like currency hedgingix.
In some cases, sovereign risk is offset by government support, as recently seen in Egypt’s Benban Solar Project and Kenya’s Thika Power Project. Other initiatives carrying a partial risk/credit guarantee include Kenya’s Lake Turkana Wind Power Project, Senegal’s Taïba Ndiaye Wind Farm, Ethiopia’s Tulu Moye Geothermal Power Station and Djibouti’s Ghoubet Wind Power Station. Other mechanisms can include first-loss provisions, mezzanine finance, contingent loans, viability-gap funding and demand aggregation. Projects in Guinea Bissau (Saltinho hydro), São Tomé and Príncipe (mini-hydro) and Togo (mini-grid) were financed using these approachesx.
The South African Renewable Energy Independent Power Producer Procurement Program (REIPPPP) also known as REI4P, has been successful in rapidly increasing the supply of renewable energy, while lowering its costsxi. Such programs carry the potential for replication in other African countries. Further, such programs and projects build the financial ecosystem, where “refinancing gains” once projects are “live” are viewed as having lower credit risk than during development and construction. This can attract lower-cost long-term debt from institutional investors, which can replace commercial bank debt.
With abundant solar, wind, hydro, biomass, and geothermal resources, as well as ocean renewable energy, still largely untapped, the energy transition is a growth sector that will help to meet domestic and potentially global energy demand. Other developments on renewable energy in, for example, the Democratic Republic of Congo, Ethiopia, Malawi, Nigeria, South Africa, Sierra Leone, and Uganda are in focus, supported by initiatives formed during COP 26xii. Kenya is one of the top global producers of geothermal energy, and Morocco boasts the world’s largest concentrated solar power plant. Next year, Egypt is set to build a wind farm that could generate enough electricity to meet domestic needs and export to Europe and Saudi Arabia.xiii
The support for Circular Economy initiatives to reduce waste, shifting away from an extraction or “take, make, waste” economy, is gaining momentum through programs such as the European Union-funded SWITCH Africa Green initiative and SwitchMed projects, which have benefitted more than 3,000 micro, small and medium Enterprises (MSMEs) and eight sub-Saharan African countries in agriculture, integrated waste management, manufacturing and tourism.
Overall, we observe an evolving matrix of sustainable investment approaches. However, such funding remains somewhat siloed, rather than providing a holistic view of investing and the interplay between the net zero transition, accounting for nature loss, physical risks and adaptation, engaging in a circular economy and supporting principles of equality for sustainable development.
Unrealized potential: Natural capital investment in Africa
Having seen a decline in their Biodiversity Intactness Index (BII) score over many years, African economies are disproportionately exposed to nature loss which is accelerating across the continent, exceeding the global averagexiv. At the same time Africa is home to 65% of the world’s arable landxv, and 20% of the global tropical rainforest area. African economies also offer natural-capital opportunities, if well regulated. Increasingly African policymakers and regulators are considering how to better manage natural capital to attract finance to African countries as a part of their response to climate challenges through voluntary mechanisms such as climate finance governance and reporting against the Task Force on Climate-related Financial Disclosure framework (TCFD) and Taskforce on Nature-related Financial Disclosure (TNFD) frameworks.
An assessment of the current landscape of initiatives and frameworks for ‘transition’
Why are Frameworks Helpful? Investment frameworks serve as roadmaps for investors and help them navigate the complex world of finance whilst aligning with their financial objectives, impact objectives and risk tolerance. In the context of supporting the African transition, they serve to:
Support consistent decision-making (strategic and tactical). Frameworks provide a structured approach for evaluating investment opportunities. This is likely to include a definition of the types of investment that contribute positively to the African transition alongside the steps that can be taken to assess the potential risks and returns of various options.
Enable goal alignment. Frameworks help align investments with specific financial goals, an investor's fiduciary duty and any impact objectives.
Establish and evolve risk management. Frameworks help investors identify and mitigate risks associated with different transition investments, including through the use of risk assessment tools and techniques.
Manage asset allocation. Frameworks assist investors in how to allocate funds strategically across various asset classes and return drivers, taking into account diversification, risk tolerance and time horizon.
Monitor performance. Frameworks provide guidelines for tracking and evaluating the performance of investments over time, from both a financial and non-financial perspective. This allows investors to make any necessary adjustments to portfolios over time.
What Transition Frameworks Currently Exist? The growing number of transition frameworks available to investors can vary in approach − some focus on regions, others on sectors and range from principle-based guidance to more detailed recommendations. For example, in October 2022, the G20’s Sustainable Finance Working Group (SFWG) published a set of specific principles on the transition finance framework around five interrelated pillars:
Identification of transitional activities and investments
Reporting of information on transition activities and investments
Transition-related finance instruments
Designing policy measures
Assessing and mitigating negative social and economic impacts
The Net Zero Asset Owner Alliance, formed in September 2019, has catalyzed asset owners’ interest in supporting the goal of net zero greenhouse gas emissions by 2050 or sooner. This initiative combined with other financial sector alliances − such as the Net Zero Asset Managers’ Initiative and the Net Zero Insurance Alliance − have the potential to encourage financial institutions to accelerate financial flows in line with global climate objectives. The emergence of regional initiatives, such as the Glasgow Financial Alliance for Net Zero (GFANZ) Africa Network, is testament to the pressing need to develop climate finance at scale across the African continent. This Network works closely with African banks, asset owners and managers, policymakers, regulators and multilateral development banks, to catalyze financial flows for climate investment in Africa.
G20 Sustainable Finance Report
Emerging Markets Just Transition Initiative
AIGCC*/IGCC** Mobilizing Climate Investment in Emerging Markets
World Economic Forum Financing the Transition
World Economic Forum Mobilizing Investment for Clean Energy in Emerging Markets
Sustainable Markets Initiative Asset Manager and Asset Owner Task Force
Green Investment Principles
British International Institute: Transition Finance for Africa
Net Zero Asset Owner Alliance Target Setting Protocol
Institutional Investors Group on Climate Change Net Zero Investment Framework
*Asia Investor Group on Climate Change ** Investor Group on Climate Change The initiatives and frameworks listed above − just a handful of those in existence − are a mix of high-level principles and more detailed guidance/recommendations for different end users. Broadly speaking, ‘Net-Zero investor frameworks’ support investors to align their portfolios with a net zero outcome, considering the levers available to them to manage the impacts of climate-related risk upon their portfolio and the impact of their portfolios upon the climate. “Transition finance frameworks” are not expressly investor-specific, but provide relevant insights, including on the role of taxonomies in classifying activities that support a transition, and the role of blended finance in creating bankable opportunities (i.e., projects where the risk/return profile meets investors' criteria and financing can be secured).
The table below sets out the purpose of these different frameworks, their focus areas and relative strengths. There are frameworks that sit at the centre of the Venn diagram, that bridge areas of Net-Zero investment frameworks and transition finance frameworks, as well as focusing on emerging (and frontier) markets. These reflect the growing awareness across international investors that the transition to a low-carbon global economy requires all regions to transition successfully, alongside the recognition that real-world impact can be achieved through investment in emerging and frontier markets.
The Emerging Markets Just Transition and AIGCC/IGCC Mobilising Climate Investment in Emerging Markets initiatives address the need to consider Just Transition outcomes as part of investment in climate solutions. They recognize the importance of fair and equitable distribution of the potential benefits of the green economic transition, as investment in companies or activities drive substantial reductions in, or removals of, greenhouse gases. The table below is not an exhaustive list, but shows just some of the programs currently in progress.
Why be Guided by Finance and Transition Frameworks?
Drawing on the strengths of and lessons gleaned from the range of frameworks developed over time, Mercer view the following elements as supportive of increased capital allocation into the African transition:
Market participants advocating for transition in Africa (alongside other emerging markets and developing economies). Investor advocacy should focus on the importance of these regions in delivering the global transition to a low-carbon economy, the current financing gap and the role that private capital can play in delivering tangible economic, social and environmental impacts alongside financial returns.
Investor commitments through establishing credible Net-Zero/transition finance frameworks to build demand signals for investable projects and innovation. Importantly, investor-specific frameworks should be flexible to local context, recognizing a “fair share” of the available global carbon budget and the associated trajectory for emissions reductions. Example commitments could include a target allocation to climate solutions, with specific allocations to different regions, including Africa.
Alignment of policies and approaches with these commitments, using frameworks to categorize assets that fulfil the objective (e.g. taxonomies) as well as incorporating awareness of sectoral and regional differences.
Collaboration of multiple stakeholders (e.g. development banks, climate finance sector and local private sector) to build local knowledge and work to establish an enabling regulatory/investment environment, supporting overall accessibility. Current collaborative initiatives, such as the G20 Sustainable Finance Working Group Private Sector Roundtables, GIP’s Africa Chapter need to be built upon and scaled to crowd in private sector funds at the level required.
De-risking of investments (e.g. blended finance, guarantees and long-term FX hedging) to support the flow of capital, supporting overall affordability.
Reporting by asset owners against target allocations to climate solutions in Africa and emerging markets.
At COP 28, we look forward to joining discussion and supporting advances in the development of an investor-specific transition framework for Africa, bringing together stakeholders from across the global investment management and asset-owner arena to deliver this critical lever in order to increase capital flows in Africa, and to ultimately support global climate goals.
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Reference
ii https://www.oecd-ilibrary.org/sites/3269532b-en/index.html?itemId=/content/publication/3269532b-en
iii Can investors save the planet? 2023, accessed at:https://academic.oup.com/cmlj/article/18/2/172/7050972?login=false
iv Africa’s green business opportunities are abundant, UNEP study shows (August 2023)
vi United Nations Environment Programme (2023), pp. 256–59. Africa Environment Outlook
for Business: https://doi.org/10.59117/20.500.11822/43127 s
vii Infrastructure and financing in sub-Saharan Africa – Opportunities and impacts for institutional investors Mercer, Mida Advisors, Standard Bank (Sept 2021), page 8
ix International Energy Agency Financing Clean Energy in Africa, p. 78.
x Op cit, p. 79.
xi Op cit, p. 37. For further detail, also see Upington Solar Project.
xiv https://fsdafrica.org/wp-content/uploads/2023/07/Nature-Regulatory-Agenda-Final-Single-Page4692.pdf
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