Gaia platform aims to fill the climate finance gap

Banks and financial institutions looking to make climate-linked investments in developing countries may be wary of the potential risks attached to some of the poorest jurisdictions around the world.

Looking to bridge the climate finance gap between the global north and the global south, a group of institutions that include Japanese bank MUFG, Canadian financial solutions firm FinDev and a consortium of UN partners have launched Gaia, a $1.5bn platform designed to bring in climate-linked investments to support developing countries.

The new platform, which takes its name from the ancient Greek word for Earth, is a blended finance tool designed to provide long-term investments for climate mitigation and adaptation, targeting some of the most vulnerable countries in the world.

Expected to launch in the second quarter of 2024, Gaia will direct 70% of its portfolio investments to loans for climate adaptation projects, with a further 25% specifically directed to the world’s least developed countries (LDCs).

The platform aims to help institutions overcome some of the barriers that might hinder transactions from private institutions to climate-related projects. The model uses a mixture of commercial and concessional capital sources, creating a structure that can be replicated in other segments of the market.

Mitigating investment risks

While climate change is a worldwide phenomenon, it does not affect every country in the same way. LDCs and nations with low per capita income are more likely to feel the worst effects of rising temperatures, which can have repercussions that stretch across the social, economic and political spheres.

At the same time, investments in LDCs are seen as riskier than other types of transactions. A report by the Swedish Ministry of Foreign Affairs says that the business environment of LDCs can compromise the investor’s ability to manage commercial risks with the same level of efficiency as in developed countries. This, in return, requires more financial support for investors.

Christopher Marks, head of portfolio solutions, innovative finance and growth markets for Europe, the Middle East and Africa at MUFG, says that LDCs have had difficulty attracting mainstream private investors because of a lack of familiarity with their operating environments, and because these environments carry real and perceived risks that might be difficult for firms to incorporate at this stage. In that environment, creating an “appropriate balance of risk and reward” for investors is a core challenge for platforms like Gaia, he says.

“The capital structure of our platform has a robust layer of first loss equity provided by our public partners, which is the essential purpose of blending concessional public capital in climate and Sustainable Development Goals funds — notably, the platform includes a significant equity commitment of $150m from the UN Green Climate Fund as well as an equity investment from FinDev Canada. Senior lenders can also benefit from arranged commercial insurance cover to provide an extra layer of protection,” says Mr Marks.

Through these layers of equity protection and commercial insurance around its portfolio, the Gaia platform is able to transform individual country risks that may be rated as B or BB — which denote an elevated chance of default of a nation’s credit obligations — and transform that into a solid BBB.

Paulo Martelli, vice-president and chief investment officer at FinDev Canada, says that what sets Gaia apart from similar platforms is a capital structure that aims to go beyond the “conventional risk-return appetite” of investors. “That’s why we don’t describe Gaia as just a fund, but a tool that helps different entities come together and partner up with other entities to help fund climate mitigation projects,” he says.

Mr Martelli adds that Gaia has been designed with several other facilities that will help it address some of the main risk concerns for its clients. “In terms of foreign exchange risks, we have set up a fund that will help mitigate some of the outstanding costs and expenses for investors, while we have also established a specific committee to deal with environmental, social and governance-related issues,” he says.

The Gaia platform creates a structure that enables investors who would not ordinarily invest in developing markets to enter new jurisdictions. “What makes Gaia so special is that it is a source of finance that wouldn’t ordinarily be available. Through the structure of this platform, we have figured out how to bring it to the table,” Mr Martelli adds.

Climate mitigation investments

Annual climate finance flows have been on a growing trend over the years, reaching $653bn on average in 2020. Although public and private climate finance has almost doubled since 2011, according to a report from the Climate Policy Initiative, to reach climate objectives set out by the Paris Agreement, climate investments will have to increase at least sevenfold by the end of this decade.

The UN says that foreign direct investments saw a 77% uptick worldwide in 2021, but only 19% went to LDCs.

Climate adaptation and mitigation projects in LDCs are long-term initiatives that often do not have profit turnover as quickly as other sustainability-linked projects. “Adaptation projects are not limited to something as simple as building a seawall or restoring mangrove forests — they are much more complex than that,” says Mr Martelli.

“They include projects dealing with wastewater, electricity grid resilience, soil rehabilitation, food storage, upgrading existing infrastructures to make them stronger against the elements, and the list goes on,” he explains.

Taking all of this into account, investors need to be aware of the fact that they are setting themselves up for a long game where short-term results are not always guaranteed. Mr Martelli says that, regarding the full disbursement of capital by Gaia, investors should expect a ramp-up period of around seven years. Although he believes that growing interest in the platform and adaptation projects will potentially help reduce the ramp-up period.

Nevertheless, Mr Marks believes that while sustainability-linked financing in major markets could provide similar returns in the current rate environment, investors should not base their business decisions solely on profitability. “It may be easier to invest in a wind project in Mexico or a solar field in a country like Chile with a very strong investment grade — but there has to be, at the level of the investor, a basic sensibility of wanting to follow the direction of the climate debate,” he says.

The world will unarguably be a more complicated place 10 years from now, he adds, and big institutions will have to learn how to make more of these climate adaptation and mitigation investments over time.

“These projects are important, and the argument that I make to some of our senior investors is that these are, in fact, small investments to make today — whether $50m, $100m or more — which is nothing compared to the amount of forward-looking sector knowledge that you’re going to get in addition to returns,” says Mr Marks.