Development finance needs to be better aligned with climate change objectives, and many experts see net zero portfolio targets as a powerful way to achieve this. This paper explores the operational implications of net zero portfolio targets for development finance institutions (DFIs). We set out an agenda to move development finance towards net zero goals in a way that acknowledges development concerns. These include (1) setting context-specific emissions pathways with granular bottom-up data and emphasising climate-development win-wins; (2) dealing with inertia and lumpiness in the portfolio through ‘when’ flexibility (multiyear carbon budgets) and ‘where’ flexibility (sharing of carbon space); (3) encouraging transition projects through future-emissions accounting and transition credits; (4) managing climate-development and other trade-offs with an internal carbon price and ESG standards; and (5) accounting for emissions after project-end with monitoring and legal provisions.
- Development finance institutions (DFIs), defined here as bilateral development institutions and multilateral development banks, play an essential role in advancing an equitable transition to net zero carbon emissions in developing countries. DFIs are under international pressure to up their climate game.
- DFIs are still grappling with the question of how to operationalise net zero and combine it with their poverty alleviation mandates. However, the direction of travel is clear. DFIs must move from input targets (e.g. climate finance objectives) and process adjustments (e.g. internal carbon prices, net zero investment principles) to outcome targets (i.e. portfolio emissions that are on a pathway to net zero).
- We argue that well-devised net zero portfolio targets can reflect the specific country and sector contexts in which a DFI operates. They can accommodate the fact that DFI portfolios turn over slowly and may contain lumpy investments. They can retain incentives to invest in high-carbon projects with a view to cleaning them up. They can incentivise climate-development win-wins, and they can prevent premature exits from high-carbon projects.
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