Innovative Financial Instruments and Their Potential to Finance Climate Change Adaptation in Developing Countries

The report analyzes why private finance for climate adaptation in developing countries remains low, citing lack of clear revenue streams and high transaction costs for small-scale projects. It evaluates established and emerging financial instruments—such as blended finance, guarantees, and payment for ecosystem services—and argues that the most effective path forward is not the creation of new instruments, but the innovative combination and application of existing ones to match specific project needs.

• Private sector investment in climate adaptation is significantly lower than public investment, accounting for only 2.3% of finance flowing to adaptation projects in 2019/2020.
• Adaptation projects are often less attractive to private investors than mitigation projects because they frequently lack clear revenue-generating opportunities and are typically smaller in financial scale, leading to higher relative transaction costs.
• Analysis of Green Climate Fund (GCF) data as of January 2023 shows that private sector financiers favor larger projects; the average size of adaptation projects with private financing was over 3.5 times larger than the average size of all adaptation projects.
• Blended finance, which combines public catalytic capital with private investment, remains the primary means for private sector support in adaptation, though there is a need to move beyond grants and concessional loans toward credit de-risking tools like guarantees and liquidity facilities.
• Packaging adaptation projects with revenue-generating activities (e.g., combining seawalls with toll roads) or creating aggregated portfolios can make them more attractive to private investors who require a return on investment.
• Certain financial instruments, such as stormwater markets and tax increment financing (TIF), are used in developed countries but are currently infeasible in many developing countries due to a lack of institutional capacity for taxation and monitoring.
• Payment for Ecosystem Services (PES) can effectively channel funding to adaptation, as demonstrated by Peru's Quiroz-Chira Water Fund, but success depends on strong institutional trust and early participant buy-in.
• The report concludes that the greatest potential to increase private sector financing lies not in developing new instruments, but in innovating how existing instruments are combined and matched to specific projects.
• Grant and concessional public finance remains the only suitable option for adaptation interventions in the most poor and fragile regions where projects cannot provide an adequate return on investment.

APA

Gouett, M., Murphy, D., & Parry, J.-E. (2023). Innovative Financial Instruments and Their Potential to Finance Climate Change Adaptation in Developing Countries. International Institute for Sustainable Development. https://www.iisd.org/system/files/2023-06/financial-instruments-climate-change-adaptation.pdf

Chicago

Gouett, Matt, Deborah Murphy, and Jo-Ellen Parry. Innovative Financial Instruments and Their Potential to Finance Climate Change Adaptation in Developing Countries. International Institute for Sustainable Development, 2023. https://www.iisd.org/system/files/2023-06/financial-instruments-climate-change-adaptation.pdf.

Wikipedia

{{cite report |last1=Gouett |first1=Matt |last2=Murphy |first2=Deborah |last3=Parry |first3=Jo-Ellen |title=Innovative Financial Instruments and Their Potential to Finance Climate Change Adaptation in Developing Countries |publisher=International Institute for Sustainable Development |date=May 2023 |url=https://www.iisd.org/system/files/2023-06/financial-instruments-climate-change-adaptation.pdf |access-date=23 October 2026 |via=Climate Insights Directory}}

BibTeX

@techreport{gouett2023innovative, author = {Gouett, Matt and Murphy, Deborah and Parry, Jo-Ellen}, title = {{Innovative Financial Instruments and Their Potential to Finance Climate Change Adaptation in Developing Countries}}, institution = {International Institute for Sustainable Development}, year = {2023}, month = may, url = {https://www.iisd.org/system/files/2023-06/financial-instruments-climate-change-adaptation.pdf}, urldate = {2026-10-23}, note = {Indexed by Climate Insights Directory} }