By: Carter Hoffman
The narrative around climate finance rarely stays consistent. As the pendulum swings one way, the existential challenges that climate change poses to humanity and our planet seem to be top of mind and present in nearly every industry conversation. A few years will pass, however, and that pendulum will swing the other way, and the urgency of the issue will be put on the back burner while the planet continues its slow simmer around us.
As the environmental conversation enters another phase of retrenchment, hidden by the seemingly more pressing issues of global trade disruption, those close to the matter are using some new terms related to climate finance: transition finance and adaptation finance.
This article will take a look at what these terms mean and why they matter for the finance industry, the planet, and humanity at large. Let’s start with transition finance.
What is transition finance?
Transition finance refers to capital that enables carbon-intensive companies, industries, or countries to transition toward net-zero emissions. Unsurprisingly, the key term there is transition. Unlike pure “green finance”, which might fund already-green projects (like wind farms or solar panels), transition finance often supports those in hard-to-abate sectors to progressively decarbonise. In other words, it’s financing targeted at activities that aren’t fully green today but can (with the right investments) transition to becoming significantly cleaner over time.
For example, this could include helping a cement manufacturer upgrade to lower-carbon processes or financing a utility company’s shift from coal to renewables. Neither of these would be considered “green” industries, but that’s the point. Traditional green finance (like green bonds and loans) covers projects already widely recognised as sustainable. Many high-emitting activities, however, currently don’t qualify for green financing. Transition finance fills this gap by channelling capital into the grey area of not green yet, but getting greener.
Achieving global climate goals will require trillions of dollars of investment to transform our energy and industrial systems. The International Energy Agency estimates that annual clean energy investment must rise to about $4.5 trillion by 2030 to keep the world on track for 1.5°C warming. Analysts from Citi, a bank, project that decarbonising just five major sectors (aviation, shipping, road freight, steel, and cement) could require up to $1.6 trillion per year in investment.
These are ambitious figures to reach and, while momentum is growing, transition finance is still very much in its infancy. Banks, investors, and bond markets are beginning to embrace the concept, and there have even been specially labelled “transition bonds” issued to fund things like refinery upgrades or cleaner shipping fuel. However, issuance of transition bonds has thus far been rather modest. After an initial burst of interest, only about $3 billion of transition bonds were issued in 2022 and 2023 combined, less than 1% of the sustainable debt market.
Because the concept is new, various organisations are working to standardise what counts as credible transition activity. Financial industry alliances and standard-setters have started to release guidelines. For instance, the Glasgow Financial Alliance for Net Zero (GFANZ) and the Climate Bonds Initiative (CBI) have proposed frameworks for transition finance, and new taxonomies (such as in Singapore and ASEAN) are defining which transitional activities are aligned with climate goals. Their hope is to provide guardrails so that transition finance doesn’t become a loophole for greenwashing. The market is rightfully wary that, without clear standards, companies or banks might label business-as-usual loans as transition finance, and therefore undermine climate goals.
To counter this, any financed transition activity should be tied to a credible strategy for the counterparty to decarbonise over time, with progress monitored and reported regularly. In practice, this means borrowers should have transition plans (e.g. committing to retire coal plants by a certain date or to ramp up low-carbon spending), and lenders may impose targets or incentives to ensure the funds genuinely help reduce emissions.
For example, a bank might extend a transition loan to an energy company to build out its renewable portfolio (even as it phases down fossil assets), or an investor might buy “transition bonds” from a shipping firm retrofitting its fleet for cleaner fuels. These investments, while not green at the start, can help emissions-heavy sectors take the steps they need to become green in the long term.
The onus will be on financiers and standard-setters to demand robust evidence so that transition finance can be a driver for decarbonisation in the real world. Their task is an important one. Without trustworthy transition financing, whole swathes of the global economy, from heavy industry to transport to agriculture, may struggle to fund their decarbonisation, putting climate goals out of reach.
What is adaptation finance?
On the other side of the climate coin is adaptation finance, which is funding to help societies adapt to the impacts of climate change that are already happening or imminent. Even if we stop all emissions tomorrow, the damage from decades of environmental abuse has already been inflicted. The evidence of this is all around us today, in the form of more extreme weather, rising sea levels, shifting agricultural zones, and other disruptions.
Adaptation finance is about protecting communities, economies, and ecosystems from these effects. The World Economic Forum formally describes it as “helping people, businesses and countries adapt to the impact of climate change… reducing the risks posed by climate change while positioning infrastructure and systems for the future”.
In practice, adaptation projects would be something like reinforcing infrastructure in flood-prone areas, developing drought-resistant crops, building sea walls and flood defences, upgrading drainage systems in cities, investing in early-warning systems for disasters, or redesigning roads and bridges to withstand more extreme conditions. Essentially, they are investments to climate-proof economies and communities.
Climate adaptation has often been described as the neglected half of climate action. For years, the focus (and funding) was skewed toward mitigation efforts like cutting emissions. While these efforts are certainly vital and will help to prevent worst-case scenarios from arising, they are by their nature forward-looking and not necessarily best suited to coping with the damage already done to our environment. (It’s similar to how quitting smoking, while helpful, won’t cure lung cancer once it has already developed).
From a humanitarian and economic standpoint, adaptation is perhaps most critical, especially for climate-vulnerable countries. Many of the countries least responsible for global emissions (e.g. least developed nations, small island states) are among those hardest hit by climate extremes, facing stronger storms, persistent droughts or floods, and long-term shifts like desertification. Without adequate adaptation finance, climate impacts could devastate their agriculture, infrastructure, and trade, trapping them in a cycle of disaster and recovery.
The sobering reality is that adaptation finance is woefully below what’s needed. Various estimates show a massive gap between current spending and required investment. The UN Environment Programme’s 2024 Adaptation Gap Report projects that developing countries alone will require $187–359 billion per year this decade in adaptation funding to meet their needs. Yet the flow of adaptation finance today is only a fraction of that. According to the Climate Policy Initiative, total global adaptation finance tracked in recent years reached an all-time high of about $63 billion per year (average 2021–2022).
In other words, current investment is less than one-third of the lower-bound estimate of needs. For developing nations specifically, the shortfall is even more acute. The OECD’s analysis of climate finance shows that while adaptation funding is growing in absolute terms, it remains a minority share. In 2022, adaptation finance was about $32 billion (three times higher than in 2016, a positive sign of growth), but still only roughly 30-40% of total climate finance, whereas mitigation accounts for about 60%. The Global Center on Adaptation and other bodies have called for at least a fourfold increase in adaptation finance flows to developing countries in the coming years to begin closing this gap.
Perhaps most striking is the imbalance between public and private finance in adaptation. Unlike mitigation projects (renewables, clean tech, etc.), which have started to attract substantial private capital, adaptation is still largely funded by governments or international public finance. IMF research from November 2024 highlights that nearly 98% of tracked adaptation finance comes from public actors, with the private sector contributing barely 2%. Climate Policy Initiative data similarly found only around $1.5 billion per year in identifiable private-sector adaptation investments in 2021/22, an almost negligible slice of the tens of billions invested.
Why is private investment so low? A number of barriers make adaptation projects less naturally “bankable” compared to, say, a solar farm that sells electricity. Often, adaptation benefits are diffuse or long-term (i.e., avoided future losses rather than immediate revenue). There may be no obvious cash flow to repay investors. For example, a seawall or a mangrove restoration project doesn’t generate a profit, even if it provides enormous societal value by preventing flooding. Lack of revenue models, difficulty in quantifying benefits, and higher perceived risk all deter private capital. There is also a knowledge gap. Many banks and investors simply aren’t familiar with adaptation opportunities in the way they are with, say, renewable energy projects.
Closing the adaptation finance gap will require creativity and concerted effort from both public and private sectors. On the public side, wealthy nations and multilateral institutions are under pressure to boost their support. (Notably, developed countries just barely met the long-promised $100 billion annual climate finance goal in 2022 – two years late – and a significant chunk of that was loans and investments targeting mitigation).
There are calls for a dedicated new global adaptation finance goal to channel more resources to resilience. At COP29 and other forums, developing countries have emphasised the need for greater grant-based funding, concessional loans, and loss and damage support for climate impacts. But public finance alone won’t suffice; hence, attention is turning to mobilising private finance for adaptation, much as it has for mitigation. This is where innovative financing models come in.
Experts suggest we need to reframe adaptation projects as investment opportunities, not just expenditures. For instance, blended finance (in this case, using public or philanthropic funds to de-risk projects and make them attractive to private investors) can be an effective approach. Debt-for-resilience swaps (also called debt-for-climate swaps, where a country’s debt can be partially forgiven by creditors in exchange for the debtor nation investing the savings in local adaptation projects) are another promising tool. Such swaps have started to be explored as a way to tackle the dual challenges of high debt burdens and underinvestment in resilience, especially for climate-vulnerable low-income countries. Similarly, insurance and catastrophe bonds can transfer climate risks and free up capital for adaptation.
Over time, as more data on the benefits of adaptation becomes available and as climate risks become more financially material, one can expect private financiers to show greater interest, especially if adaptation can be tied to revenue streams or cost savings (e.g. resilient infrastructure that secures long-term business continuity, or agribusiness investing in drought-resistant farming to protect supply chains). This means that for forward-looking investors and lenders, adaptation finance could represent a significant untapped market, and a chance to do well and do good by building resilience in a warming world.
