Instrument Overview

These funds allow cities to establish dedicated funds to finance climate-related projects, often leveraging private sector investment. These funds can support climate projects in multiple ways, such as grants, loans, equities or guarantees. Some of these funds are revolving, meaning that they are repayable over an agreed period and can, if the city wishes, be reinvested in other climate change-related projects in the future, maximizing the value of the fund. The funds can also be divided into sub-types such as mezzanine loans or city funds acting as a guarantor or underwriter to a project [1].

Why it matters for cities

• Establishing a dedicated fund sends a clear signal to citizens, businesses and investors regarding the city’s ongoing commitment to support projects that reduce emissions and increase resilience. This can increase investor certainty as well as encourage businesses and other project proponents to identify new low carbon or climate resilient projects [2].
• Climate funds can help de-risk finance from more conventional sources. By acting as a guarantor or an underwriter, climate funds can entice more private sector actors or other commercial lenders to invest in the cities’ projects [2].
• City funds can address areas that commercial banks cannot, as the risk–return profile is too low or not commercially attractive [2].
• Where cities invest in their own projects, they have a stake in these projects and this can have positive impacts on overall project management and operational efficiency [2].

Key features

The design and operation of these funds vary by city, but some common themes include a degree of independence from political decision-makers in making investment decisions, speciality finance projects and terms, and investment decision criteria linked to a city’s broader environmental, social or economic policy objectives [2].

How It Works

A city climate fund uses different financial tools to support projects, programmes and schemes with environmental benefits and – in most cases – social and economic benefits. Sometimes also referred to as “green banks” or “revolving loan funds”, they vary in terms of the types of projects supported, their funding approach, and their investment objectives. Most commonly, these funds support energy efficiency and renewable energy projects. Some also support waste, low-emission vehicles and other projects that meet the city’s environmental or social policy objectives. While closely linked to the city’s mission, many city climate funds are independent and self-sustaining legal entity, operating at the intersection of city councils, financial organisations, the property industry, and in some cases that of social enterprises and civil society [3].

A city climate fund can be structured in different ways, depending on the needs of the city and the local conditions. The strategy employed to leverage finance for low carbon projects depends on a variety of factors such as mayoral powers, regulatory and legislative context, type and scale of infrastructure project, and the risk/reward profile of stakeholders [3].

Benefits & Challenges for Cities [2]

Benefits

• Significant GHG emissions reductions and improved air quality;
• Improved public-private sector collaboration;
• Additional private sector financing due to cities’ involvement in low carbon projects that may otherwise be perceived as risky investments;
• Ideally Returns on Investment, which can be reinvested in similar activities;
• Enhanced local project management and technical expertise;
• Increased employment opportunities; and
• Large scale market change, with some initiatives and programmes being taken up at regional and national levels and delivering even more positive impacts. 

Challenges

• City climate funds generally require cross-department collaboration and can be administratively difficult to establish. 
• A city will need to find the initial capital to create the fund, with some cities using national or international transfers or the sale of property within the city to capitalise the fund. This initial capital is often used to leverage private funds to increase the pool of funding available for projects. 
• Depending on the structure and operation of the fund, the operating costs can be high, particularly where professional fund managers are contracted. 
• Transaction costs can be high and constitute barriers to smaller projects. To address this, some cities operate a separate programme outside of the fund to support smaller projects. 
• Funds often offer only near market rates in order to stay competitive. The margin (ideally a small margin) may not be sufficient to compensate for the level of project risk and/or the costs of operating the fund. To address this, some funds attract projects through offering more flexible finance terms or other incentives, with less emphasis on offering the cheapest financing available in the market. 
• A fund is only as good as the projects it invests in. Some cities operate project preparation programmes to support the development of projects that can be funnelled through to their city climate fund. Some funds will also work closely with project proponents to improve the viability of their project. 
• Lending partners or other capital providers might expect to get involved in fund management.

Use Cases

Leuven Climate City Fund

As part of the city’s climate action plan, the Leuven Climate City Fund which aims to finance a portfolio of climate projects for district heating, clean mobility, and more, by combining projects with strong financial returns with projects that mainly deliver social and climate benefits. To make this work, the fund must address four key questions:

• Which breakthrough projects have a business case with an attractive financial return or predictable cash flow?
• Which breakthrough projects are indispensable from the point of view of social return and how do you determine that?
• How do you combine them in a fund that links financial and social returns and ensures that investments always happen in the whole?
• Who then wants to invest in it and how do you make sure the necessary resources find their way to the fund?

Business case analyses show that while some climate projects, particularly within the energy sector, align well within traditional financial models, this is less so for other cases, such as mobility projects. However, a socially just climate transition requires financing that goes beyond narrow financial returns. The Leuven Climate City Fund is therefore essential to ensure that all breakthrough projects can be realized, delivering both financial sustainability and strong social impact.

When to Use It

City climate funds need to be established at appropriate scale, particularly in the current climate of low interest rates. The right scale will depend on the fund’s unique mandate and the level of operational budgets they require. Though these funds can be costly to operate, the operational budgets are a relatively fixed cost (with the exception of marketing and communications budgets). As the capital scale increases but the fixed overhead remains the same, the fund’s profitability should improve [2].

References

[1] https://citiesclimatefinance.org/financial-instruments/instruments/city_climate_funds

[2] iGNW4ywKRix6hPj9BvUQSnhbNncrmy982Ki4hGpV.pdf

[3] C40 Cities Finance Facility | C40 Cities Good Practice Guide - City Climate Funds

[4] https://www.climateaction.org/images/uploads/documents/new_perspectives_lr.pdf

[5] https://en.leuven2030.be/doorbraakproject/a-transition-fund-for-leuven

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