Toward net zero: harnessing catalytic capital

February 2024  |  FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

February 2024 Issue

The transition to net zero – that is, the aim to achieve net-zero emissions by 2050 – is one of the greatest challenges facing mankind. It is a task requiring the allocation of capital to the highest impact solutions to transition global economies toward a cleaner, more sustainable and more inclusive future.

Moreover, the capital required is considerable. According to McKinsey & Company, capital spending on physical assets for energy and land-use systems in the net-zero transition would amount to about $275 trillion, or $9.2 trillion per year on average, an annual increase of as much as $3.5 trillion from today.

In comparative terms, notes McKinsey, $3.5 trillion is approximately equivalent to half of global corporate profits, one-quarter of total tax revenue and 7 percent of household spending. An additional $1 trillion of today’s annual spend would, moreover, need to be reallocated from high-emissions to low-emissions assets.

“The transition to net zero, as well as to a regenerative economy, requires a significant increase in blended finance mechanisms,” contends Dr Steve Fawkes, managing partner at the EP Group. “Many of these investments, whether they be economically viable in their own right or not, require development capital, and markets find this hard to provide.”

“However, development capital – that is, the capital needed to develop bankable projects – whether they be in energy efficiency, community energy systems or in biodiversity, is highly risky,” he continues. “It is this area that needs blended finance, a mixture of public and private finance, with public finance being used to de-risk the development investment as far as possible.”

Catalytic capital

In its 2023 ‘Bridging divides: Catalytic capital for a global just transition’ report, the Impact Investing Institute highlights catalytic capital as an effective means of securing more private capital to support fair and inclusive decarbonisation pathways in emerging markets and developing economies.

Catalytic capital, as defined by the Catalytic Capital Consortium, a joint initiative of the MacArthur Foundation, Rockefeller Foundation and Omidyar Network, is debt, equity, guarantees and other investments that accept disproportionate risk or concessionary returns relative to a conventional investment in order to generate positive impact or enable third-party investment that otherwise would not be possible.

Moreover, catalytic capital delivers impact and unlocks conventional investment in several ways, including: (i) helping to prove new and innovative products and business models; (ii) demonstrating the financial viability of high-need geographies and populations; (iii) establishing a track record for new and diverse managers; and (iv) growing small-scale efforts, so they can attract conventional investment.

“Catalytic capital plays a critical role in delivering a global just transition,” says David Krivanek, a senior programme manager at the Impact Investing Institute. “It is usually more patient, flexible and risk tolerant than private capital, which generally seeks market-rate returns, and can therefore be deployed in a manner that absorbs risks. Catalytic capital providers can support the development and scaling-up of innovative financial instruments and financing vehicles that have a clear, just transition ambition and can mobilise private capital at scale.”

That said, the use of catalytic capital is not without concerns. “A key drawback of catalytic capital is that it is scarce and should be deployed carefully,” explains Mr Krivanek. “Deployers of catalytic capital, such as development finance institutions (DFIs), multilateral development banks (MDBs) and philanthropies, might also have competing priorities and internal constraints that can prevent deployment toward private finance mobilisation.”

Another concern is that catalytic capital may only be seen as helpful to private capital to get projects funded that otherwise would not be funded. “Therefore, the providers of catalytic capital need to take a leadership role in defining projects and bringing together all the key stakeholders as well as private capital,” adds Dr Fawkes.

A sustainable and inclusive future

Despite the aforementioned issues, catalytic capital is growing in prominence as an effective tool for unlocking the resources needed to drive a fair and inclusive transition to net zero. Its deployment is critical if the transition is to be impact-focused, and centred on building a more equitable and sustainable future.

“We have seen the importance of catalytic capital toward a global transition over the last few years, and we expect it to continue as some of the harder questions of the transition come to the fore,” says Mr Krivanek. “Among these are the social consequences and opportunities for the workforce, suppliers, consumers and local communities, which are increasingly being recognised by policymakers as well as greater numbers of investors and deployers of catalytic capital.”

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Fraser Tennant