Work in Progress: Financing Climate Adaptation by Cities

February 19, 2018 | Climate Adaptation, Finance, Innovation Network for Communities, Urban Operating System
by Pete Plastrik

The Innovation Network for Communities (INC) and Meister Consultants Group (MCG), in partnership with Ramboll, are undertaking a research project to identify opportunities to accelerate development of the financial resources cities need to support extensive urban climate adaptation. We define this as the capacity to repurpose, leverage and obtain public and private funds to invest in infrastructure development and other adaptation actions.” This project seeks to develop insights about what it will practically take for cities to develop this capacity, including:

• New tools for measuring vulnerability to climate impacts and assessing the cost-benefit calculations on new investments.
• New competencies needed to identify, design, engineer, build, finance and maintain complex resilience projects.
• New sources of financing for a combination of public and private resilience investments.
• Strategies for maintaining the viability of insurance and other tools for hedging climate risk in urban markets.

The report will develop specific recommendations for cities and investors in the field of urban climate adaptation that address three core questions:

1. Accelerating Innovation. Are there specific adaptation finance innovations under development that warrant acceleration, and what forms of collaboration (between cities and financial institutions or between different financial sectors) might support this acceleration?
2. Filling gaps. Are there gaps in current urban climate financing efforts that warrant more attention, and how might they be explored?
3. Building capacities. What capacities – technical expertise and institutional arrangements – will cities and financial sectors need to develop or enhance for large-scale, sustained climate adaptation finance?

Strategic Assumptions

The development of recommendations for urban climate adaptation finance is guided by the following assumptions about the state of the current market.

• Accelerating change. Over the next several decades, the effects of climate change in urban areas (sea level rise; extreme storms and precipitation; extreme heat) will continue to accelerate and intensify regardless of action taken on emissions reductions.
• Many different needs. To adapt to these impacts, the public and private sectors will need to make new investments in resilience strategies. These strategies fall into three different categories:
  • Reducing physical exposure to damage
  • Reducing social vulnerability to climate impacts
  • Hedging against future risks
• A new cost of doing business. Overall, the expenses involved in these investments will increase the cost of doing business in urban markets. However, investments in prevention will be typically far cheaper than investments in recovery. (FEMA estimates that the cost-benefit ratio of prevention vs. recovery is in the range of 6:1.)
• Significant scale. The scale of investment required will be quite large, often in the billions or tens of billions of dollars in larger cities. In most cities there is precedent for making infrastructure investments of this scale for other purposes.
• Some old, some new. In many cases, there are existing financing mechanisms that can be used to raise and manage capital for resilience investments. Some resilience measures can be integrated into existing infrastructure capital budgets without requiring separate, new resilience projects, (although most measures are likely to cause an incremental increase in capital costs). In other cases, cities will need to create new sources of capital and new ways of managing the investment of that capital.
• Private markets are starting to wake up to climate risk. In the last several years, it appears that private financial markets are beginning to internalize climate risk management into their calculations. The recommendations of the Task Force on Climate-Related Financial Disclosure (TCFD) is an example of this, as is the declaration by Moody’s that they intend to take climate preparedness into account when they issue municipal bond ratings. But the implications of these developments for cities are still unclear.
• It takes a system. The need is not just for new sources of financing. Cities need to develop integrated systems that support climate adaptation investments. These systems will require:
  • New data and analytics (impact forecasting, risk assessments, performance measures).
  • Tools for cost-benefit analysis.
  • Standards for resilient infrastructure investment.
  • New planning processes to define risks and plan investments.
  • New governance structures and institutional relationships to support collaboration across sectors.

• Many challenges to overcome. There are a number of challenges that will need to be figured out in the process of building a well-functioning “system” for urban climate adaptation finance. Some examples include:
  • Inaccurate risk pricing. Many existing market mechanisms (insurance, property valuation, bond ratings, etc.) have not yet figured out how to internalize future climate risks into their calculations.
  • Difficult to quantify. There are no standardized methodologies for developing accurate cost benefit analyses, and the uncertainty of future risks makes the development of these methods complicated.
  • Difficult to monetize. Even though investments in prevention may be repaid by multiple orders of magnitude in future risk reduction, it is difficult to monetize this value in a way that it can be used to finance the prevention investments.
  • Difficult to divide. There is not yet agreement on how the costs and benefits of resilience investments should be shared between the parties making those investments and the parties most likely to benefit from them.
  • Legal limits. Even when cities are willing to tax themselves to make new resilience investments, some have legal limits on their ability to borrow that constrain them from acting.
  • Problems of scale. In many cases, the investments required span more than one municipal jurisdiction, but there is no established institution with the mission and authority to manage such regional investments.

• Timing matters. It is important for cities to “get ahead of” the adaptation investment challenge so that they avoid the “viscous cycle”. Depending on the timing of the risk, a failure to act can lead to reductions in property values, which leads to reductions in revenue, which further reduces the ability to invest. Once the “viscous” cycle starts, it is very hard to reverse.