What Is the Green Swap?

Henry Lee: My name is Henry Lee and I direct the Belfer Center's Environment and Natural Resource Program. And I would like to welcome you to this morning's webinar on climate finance. We plan to use this opportunity to roll out a new idea to make capital for clean energy plants and emerging economies more affordable and more available. We have named this idea the Green Swap. Before turning to our principal speakers to explain how this idea would work, let me set the context for you. Over the last decade, developing countries have invested heavily in clean energy, and these investments are starting to make a big difference. That is the good news. However, over the same period, emerging economies have continued to invest heavily into fossil fuels, and specifically electricity generation using coal. Specifically, emerging economies have invested in 540 gigawatts of new fossil fuel - net fossil fuel generating capacity. More than 50% of their new capacity.

These investments are not done because emerging economies are unaware of the looming threat of climate change, but because the cost of capital in these countries is often double that available in developed countries. The reason for this high cost of capital is simple. Large, capital-intensive investments in emerging economies are subject to much greater financial risks. We are talking about sovereign risks, construction risks, currency risks, and demand risks. Hence, these countries have a huge incentive to direct their limited investment dollars towards the cheapest options, which often are fossil-fueled electricity generating plants, often coal. If this trend continues, the world will not be able to meet the climate goals set forth in the Paris Accords, as countries will continue to invest in new fossil-fueled facilities, since they will be the least-cost option to meet their pressing energy needs.

Today, we will lay out a path that could be a major step towards improving the financing of clean energy plants in emerging economies. Let me introduce our two speakers. Professor Akash Deep is a senior lecturer in public policy at the Kennedy School of Government and faculty Chair of Harvard's Infrastructure and Market Economies Executive Training Program. He is an expert on infrastructure finance, derivative markets and capital market reform, and has worked as a consultant for the United Nations, the World Bank, and the International Center for Settlement of Investment Disputes.

Wasim Tahir is a research fellow at Harvard Center for International Development and a fellow at the Belfer Center for Science and International Affairs. Before coming to Harvard, he worked for British International Development, the UK's International Finance Institution. He has previously worked at the Boston Consulting Group and Credit Suisse. After the speakers have spoken, we have set aside time for questions and answers, and we ask that you write the questions using the Q&A button, which is at the bottom of your screen. Let me now turn the program over to Professor Deep.

Akash Deep: Thank you, Henry, and greetings, everybody. Thank you for joining us for this webinar. And I will take you through the main proposal that we have for the Green Swap. But just to set the context about what my colleague Henry Lee talked about, the challenge of decarbonization in emerging markets and developing economies is that they are - in spite of the increases in green investment, those investments are well short of what is needed even to meet the announced pledges scenario, and far from what is needed for reaching the net-zero goals. And the basis of this research is actually two observations that were already referred to, and that are described in more detail in the paper. One, that emerging markets and developing economies, except China, are going to grow much faster than the advanced economies, and at the same time, their carbon dioxide emissions, their greenhouse gas emissions, are going to be much more significant than that of advanced economies.

And this is one of the features of this problem, and infrastructure is a very good example of the connection between climate impact and development impact. You see, 92% of the sustainable development goals are linked to infrastructure, but infrastructure, even two broad areas, power generation and transport, are responsible for about half the projected emissions over the next 25 years or so. And therefore, what you are seeing here is the per capita growth and the connection of that with carbon dioxide emissions. And that is quite different for EMDEs (emerging markets and developing economies) compared to advanced economies. And that coupled with the high cost of capital that was already also referred to in the introduction is the challenge of mobilizing financing. What you see here are the cost of capital for a typical solar PV project at utility scale and the significantly higher costs in a sampling of large emerging markets.

This problem of high capital cost is even more significant in the case of renewable energy projects because of their very large upfront cost compared to fossil fuels. And that's why we believe that it's the challenge of high cost of capital - the challenge of financing renewable energy projects coupled with the fast growth of emerging economies - is the problem that we need to deal with if we want to tackle the decarbonization issue.

And so, our research is based upon the idea of disentangling climate and development finance. Let me take a couple of minutes to explain to you the rationale on which this is based. Development and climate have quite different characteristics when it comes to fast-growing economies and emerging markets and developing economies. Think about the benefits from a development perspective of, let's say, an infrastructure project. Think about power generation, for example. The benefits of infrastructure, the development benefits, are much more localized. They benefit the region, the country in the form of economic growth, in the form of improving living standards, productivity, poverty alleviation and so on. The climate benefits of infrastructure, if it were green, are more in the nature of global public goods. They are in the form of avoided greenhouse gas emissions. That's the largest heading under which the climate benefits come, and there might be other kinds of benefits, but by and large those benefits are global as opposed to development benefits being much more local.

If you think about the cost, the goal of development is to be able to achieve those benefits at the lowest cost possible. Oftentimes, this is a brown investment and the choice of the lowest cost is in part to be able to stretch the development dollars the farthest. It's also because of the high cost of capital that we just talked about. Climate-friendly solutions tend to have higher incremental cost. And here we are talking, let's say in the case of power, not just the cost of power production, but the cost of bringing green power all the way to the users and those costs can be higher than the lowest-cost option or the fossil-fuel-based option. And finally, if you think about the risks, the risks of development are related to the politics of the country or the region that we are talking about, the regulatory infrastructure, the economic volatility and so on. Whereas the risks of climate are much more related to global carbon markets, towards climate agreements, technology and so on.

And so, it is the identification of this distinction between development impact and climate impact that leads us to believe that if these are different, so must the financing. Development finance comes from development investors, local investors, where the benefits are. Climate finance should come from global investors, because those benefits are globally distributed. Furthermore, development benefits are coming from local investors where the cost of capital is high. If we are looking at benefits that are spread around the globe, we should finance those benefits or reap those benefits using the lowest cost of capital that we can find across the globe. And that's why we believe that development finance should be disentangled from climate finance if we are going to be able to mobilize more global capital for investment in green projects, in infrastructure, in emerging markets and developing economies.

So, that's the rationale for this. I think it's relatively intuitive. We have this work laid out in more detail in an accompanying paper to this research project that will be available in a few weeks. And that's where we lay out this - the theoretical background for this. But I want to move directly into talking about the Green Swap, which is the instrument that utilizes this idea to be able to mobilize financing for green infrastructure. I will do this using a very simple example. In this example, it's a two-period example. In the first period, you make an investment, incur a certain cost, and in the following period, you get the benefits.

And there are two options to achieve the same development benefit. The first is a brown project, let's say a fossil fuel project we will refer to as brown, and the other is a more climate-friendly option. We will call that project green. The benefits from both projects is $500 - let's say $500 million. The cost of the brown infrastructure project is $400 million, whereby its rate of return is 25%. We are assuming that the cost of capital in this example is 20% in the local economy, and therefore this brown project is viable from a development perspective, from a financial perspective.

If instead the project chosen was the green project, which would provide the same benefits, it would however cost more for $50M. The rate of return would be 11% in this case, which is lower than the cost of capital in the local economy and therefore this project would not be viable. Now, we could go ahead and articulate explicitly the benefits of the green project. Let us suppose that the green project generates benefits in the form of avoided emissions that the Brown project would create, and let's say we value them at $55 million. So, now the total benefits of the green project are not just the development benefits of $500M, but also the climate benefit that is valued at $55 million.

With the cost of $450M, now the rate of return on this project would rise to 23%, because now we have additional benefits from this project. But notice that this project is still suboptimal to the purely brown project. And going for that option would still use up development dollars for a benefit that does not only accrue to the local economy. Those benefits are spread across the world. And this is the dilemma of trying to finance the green project in the developing economy. And what has been done in practice is therefore a number of attempts to try to nudge or force the developing economy into investing in the green project by, for example, lowering the cost of capital or de-risking projects, providing some kinds of subsidies or even just refusing to finance the brown project and forcing the choice of the green project.

What we recommend in our solution is actually to disentangle the climate impact from the development impact. What you now see for is a green project. In the left column are the development benefits that you have seen already, and the cost, the minimum cost for achieving those development benefits, which was $400M. In the right column, you see the incremental climate benefits that come from avoided emissions and the incremental cost. The rate of return on this project on the climate benefits and costs is 10%, but that is viable from the perspective of the global investor, because they face a lower cost of capital. In our example we have assumed that cost of capital to be 5%. It's important to keep in mind that the reason a lower cost of capital is available to the global investor is because they are not taking on the risks of development in this green project.

Here's another schematic that shows how the green infrastructure project is financed. Again, the total investment that is required is $450M. $400M of this comes from the local development investor, $50M comes from the global investor, which is equal to the incremental investment to green projects. And the benefit flows, $500M, all of the development benefits go to the development investor and the abatement benefits go to the global investor. And therefore the project that is being generated, that is being put together, is the green project. That's the set of cash flows, but let me show you the same example from a slightly different perspective and also address the question of, why do we call this the Green Swap? What is it about here that involves a swap?

Let's go back with the same set of numbers. And we start out with a standalone brown project. If the local investor invested in this project, they would invest $400M and get benefits of $500M, as we have already seen. But let's make a small change. Suppose the brown project were not a real project but a hypothetical one, but it would still determine the flow of costs and benefits from the local investor, right? And these flows would be to the global investor. At the same time the global investor would invest in the green equivalent infrastructure project. Recall that the cost of that green project would be $450M and the total benefits of that green project would be the development and the climate benefits of $555M.

If we put together the hypothetical brown-project-based flows and the flows to the green project, this is what it looks like. And now if we net out the cash flows, the global investor is investing $450M into the project but receiving $400M from the brown investor, so their net investment in the project is $50M. The global investor is receiving a benefit of $555M, but it is transmitting back $500M of those benefits related to development to the local investor, so the net benefit to them is $55M. These crimson arrows represent the Green Swap. Notice what the Green Swap is. It is the delta between the brown project and the green project. And the net result is that, as we have seen before, the green project is financed both by the local investor and the global investor and they both share the benefits in exactly the same way that we saw in the schematic earlier.

Now, it's important to highlight that even - that a few features about the brown project are incremental. First, it is not going to be built. The only project that is being built here is the green project, but the brown project serves some very important purposes. First, it is the benchmark for the costs and the benefits that are related to development. And those costs and the resultant benefits belong to the local investor. The brown project, the hypothetical brown project, needs to be viable for this whole thing to work. We don't want the green development projects that are not viable from a development perspective. Second, the brown project is what establishes the additionality of the investment of the global investor. If we are going to take those climate benefits, which are measured at $55M here, those benefits have to be additional and only then will they qualify for many of the kinds of investments that should be considered green. And therefore we need that brown hypothetical project as the benchmark to establish the additionality of the green project.

This is an important distinction between what we are proposing and what has been proposed by other research and practice. The benchmark, the viability benchmark of the green project, has been measured from a financial perspective, purely based upon the cost of capital. We believe that it's important that the viability of the green project should be measured from the development optimal benchmark. And from there the green project should think about the increment, and that's where the Green Swap is useful. We can implement this Green Swap in a variety of different ways. In the way that we have talked about before, or we can think about this as the local investor making the green investment, receiving an upfront contribution from the global investor in the amount of $50M, and then sharing the benefits. So, there are various different kinds of contractual arrangements that can allow this to happen.

I'm going to take you to one more perspective on this Green Swap, and this will be based upon a financing perspective. So, what we have here is basically a financing picture based on risk and return. On the horizontal axis is risk, and it shows that a green project has higher risk measured by a financial metric called beta compared to the brown project. On the vertical axis is a cost of capital, and what this shows is that the red line shows the cost of capital in emerging markets and developing economies. The blue line shows the cost of capital in global markets and the difference between these two is a representation of the higher cost of capital. In this picture we have kept it at 9.4%, which is the average cost of capital difference between projects in Africa versus the rest of the world. Of course, finally, as risk goes up, the cost of financing goes up as well.

So, for a project to be viable, it is important that its return be higher than the cost of capital. For a project to be financially viable, it should provide a higher rate of return, and we will see that higher rate of return on the vertical axis as well. Let's look at a very simple example. This is a calibrated example which is in our accompanying paper. We have here a green project in an emerging market and its rate of return is 16.6%. This project is not viable because its cost of capital would be higher than what the project provides. It lies below the red line. And therefore, what we propose is disentangling this project into its brown component, which now has lower risk and a higher rate of return, and its green component, which has a higher risk and a lower rate of return. Of course, that green component would not be financeable in local capital markets, but it is viable in global capital markets.

And so, this is the idea behind the Green Swap that we decompose the cost and benefits. In other words, the return from a green infrastructure project into its two components, brown and green, and finance them in two different capital markets. Recognizing that the riskiness of these two pieces is going to be different as well. But also noting that the development-related risks are still borne by the development investor and that's why the greening component of this is financed or can be financed at a lower cost of capital.

Finally, what I've shown you is examples. Let me show you one example of how this could be implemented using a real project. We will look at a geothermal renewable energy project in Indonesia that was put together about a decade ago. There were two options for this project. A brown, coal-based plant and a green component, a geothermal plant. The cost of the coal-based plant was lower at $523 million. These are present value numbers. The cost of the geothermal plant, on the other hand, was significantly higher at $658 million. At the same time, however, the brown project, the coal-based project, generated externalities, both global and local ones. The global externality was primarily in the form of greenhouse gas emissions. And these were valued at about $150 million, just the global externality.

And so the question was, how do we get Indonesia to choose the geothermal plant in spite of the fact that it was more expensive? And the solution was basically providing a set of revenue and financing subsidies. So, starting out, what you see in this chart is that the geothermal plant had negative net present value of $263 million, but together with some reduced cost of capital, a higher tariff, notice both of these costs are borne by the Indonesians, as well as loans from the World Bank through the Clean Technology Fund as well as IBRD loan made what was a financially non-viable project into a financially viable project.

We would using the Green Swap approach this differently. Let's go back and take a look at the numbers. The coal-based plant costs $523M and the incremental cost of the geothermal plant is $135M. So, what we would do is the local development investor would pay the amount that is the cost of the brown project in exchange for the development benefits. We have taken a conservative measure of the development benefits at $528M based upon the tariff. The benefits are probably much bigger than that. The incremental amount of $135M comes from the global investor. I've simplified things just in terms of present values here, in exchange for the abatement benefits that were valued at $150M. Now, these abatement benefits and the value of $150M comes from a carbon price of $20. This is viable at a slightly lower carbon price of $19 as well. And if the carbon price is higher, then of course the benefits will be much larger.

And so what we would do with the Green Swap here is that the incremental cost of the geothermal plant and the resultant global externality benefits in the form of avoided greenhouse gas emissions would be financed by the global investor. And from Indonesia's perspective, the costs ... The same benefits would be realized at the cost of a coal-based plant, but that coal-based plant would never get built. It would only be the geothermal plant. So, that's where I will stop explaining the Green Swap idea and I will pass it over to Wasim Tahir, who will talk about some of the additional implications of this idea of disentangling climate and development finance.

Wasim Tahir: Thank you, Akash, and hi everyone. And to maximize time for Q&A, I'll try to keep this brief. But if you look at global climate finance flows into EMDEs, the vast majority of this comes from international public sources. And of that the largest portion is from what you would call, what is called overseas development assistance, right? So the overseas development assistance budgets of Western countries. Now, this ODA-based funding, this climate finance, is primarily being channeled through the existing development finance architecture that's represented by multilateral development banks and by bilateral DFIs like the one I used to work for, British International Investment. Now, from a donor government perspective that's great, let's try and kill the development bird and the climate bird with birds with one stone. But from my experience, and there's increasing research on this now, climate mandates and development mandates aren't fully congruent.

And a great example of this is that vast majority of climate finance demands are from middle-income countries where we're going to see huge population growth. That's where the energy demand is going to come from and that's where the decarbonization efforts need to be, whereas the demand for development finance is really largely with low-income countries. And so, really how does the Green Swap help with that? Well, what we're trying to say is that this is a financing instrument or a framework that allows us to disentangle the development component and the climate component of a infrastructure project. And by doing that, what we can do is hopefully minimize the development financing we need drawn from these other budgets and how that is from just the development component of an infrastructure project and the climate component, that we want financed by private investors, from global private investors.

So, the whole hope with this framework, the structure, the kind of underlying principle of disentangling climate and development benefits is that we can reduce the amount of development finance needed and increase the amount of global private capital flowing into emerging markets. And I think the other final point to mention, and I'll hand it back to Akash for closing, is zooming out even further. We think researching this intersection of climate and development finance is very important. And this three levels you can look at disentangling the two or disaggregating the two. And what we've talked about today is looking at it at a transaction level. We can also go one level higher and say, "Look, how are the DFIs and MDBs doing at handling their dual climate and development mandates? And is there anywhere we can separate those two to make them both more effective?"

And then at the top level, it's around aggregate financing flows. We see that climate development financing flows are currently really muddled and there's a question around is climate finance flow as it is today really additional to the existing flows that we were having? And so that itself needs a bit of research. But look, I'll pause there, I'll hand it back to Akash for closing remarks and then we'll move into Q&A.

Deep: Great, thank you, Wasim. Just one final word to say about the broader framework. As Wasim said, we believe that in addition to applying the disentangling idea to the Green Swap for mobilizing finance, there are these additional implications which can inform decision-making at development finance institutions in the ways of deciding about the trade-off between development and climate, and how to fund both of these efforts. It can also be used to think about both how should we use the limited resources that we have, particularly the ones that we generate through global mechanisms like the $100 billion fund that we have had and which is now going to be a $300 billion fund. How to use those purely for green for climate-related purposes. In our example it is the incremental part of financing, which is the climate-related benefit. And we believe that this funding should be used for that purpose rather than the entire development piece, that will just leverage those limited climate resources to the maximum possible extent.

And it will also in the broadest sense help think about how to size our needs for climate finance. Right now, as Wasim said, those two needs, the development needs and the climate needs are commingled together and as a result they appear larger, but they include the development needs as well. And so trying to separate those out will give us a much better sense of how to size these needs moving forward. I'll stop there and let's move to question and answer sessions. Please type your questions using the Q&A button, and we will take as many questions as we can. Back to you, Wasim.

Tahir: Right. Look, we've got quite a few questions in the queue here, so let's see how many we get through. But to start with, Akash, we have a question here saying or asking, "How do you value the additional climate benefits and how do you get the private sector and banks to agree to that?"

Deep: Right, that's an important question. And the two features that we need to put in place in implementing the Green Swap are one, contractually separating the two impacts, the development impact and the climate impact, which means benefits, costs and risks. And then being able to value those climate benefits. I mentioned the separation first, because the value of those climate benefits will very much be a function of how we bring about that separation. And what we will need is markets or mechanisms that will value those benefits. Now, that valuation is at a much more advanced stage in compliance markets, it is at a more preliminary stage in voluntary carbon markets. It might be valued using other mechanisms such as Article 6 credits, and that market will need to be developed, it is also much more fragmented at this point in time.

But that is the manner in which it will need to be valued if we are looking to draw private financing to these investments. If on the other hand we are looking to draw financing from countries or from public sources, that valuation is somewhat easier to do than if we were to draw private financing. And that is one important prerequisite for mobilizing any kind of private financing for climate infrastructure or green infrastructure.

Tahir: Akash, another couple of questions which from our perspective are related. How do you accurately identify theoretical brown investment? And related to that, what is the role that MDBs might play in the orchestration of the Green Swap? And the question continues both from the sovereign and non-sovereign side.

Deep: Right. Yes, and the two are indeed related. So, identifying that brown project clearly is critical to this whole exercise and the definition of the Green Swap, right? And this is where creating a credible contractual benchmark is important, and that's where we believe is the role for MDBs. Just think for a moment about the examples that I showed you about Indonesia. If today Indonesia were to generate the next megawatt of power, there is an 80% chance that it would come from a fossil fuel based resource. That is the portfolio of energy investments that is planned for an Indonesia or many other emerging market economies. And again, it is because of the high cost of capital, the urgent need for more power, and the high cost of renewable energy investments. The realistic benchmark is that there's an 80% likelihood that this will be fossil fuel based power, and that is something that the development institutions such as MDBs know very well.

And that is where the role of the MDBs comes in, establishing the credibility of that benchmark and the financial structure, the benefits, the costs, the risks of that benchmark have to be contractually defined so that the green project can utilize that as to define the increment that the green investor would provide. Again, both in terms of the climate benefits, the climate costs, as well as the risks that are embedded in that project.

Tahir: Great, thank you very much, Akash. Another question here is, "Any comments on the differences in financing solar versus nuclear?" And to make it a bit more broader, what is the applicability of the Green Swap across types of renewables, and whether it's applicable more broader than that?

Deep: So, we believe that the applicability of the green swap idea is the more straightforward for those green options where the brown option can be defined more clearly. So, if counterfactual, we would get the power from fossil fuel based project as opposed to a nuclear project, then it is as applicable for nuclear projects or as a renewable if it is generating the climate benefits that are important here. There can be other areas in which it is harder to specify that counterfactual. Let's move away for a moment from power generation to transport, for example. The counterfactual for green transport is a little bit harder. It might include both switching fuels to more greener fuels, but it might also result in model shifts. Or it might come from avoided demand. And in those situations when defining the counterfactual is more complicated, using the Green Swap becomes more challenging.

Or think about, and even yet another problem, adaptation. Disentangling development in climate impact is going to be harder for adaptation. We are not saying that the Green Swap can be applied to every last dollar of climate financing that needs to be mobilized, but we believe that for a large part of the climate financing mobilization problem, particularly as it relates to infrastructure and a power generation in particular, the Green Swap is going to be a powerful mechanism to mobilize that finance.

Tahir: This is possibly one for you, Henry, and this is within the backdrop of what's happening in U.S. politics, but we have a question here asking, "How would you apply this approach in the U.S. given the shift to fossil-based investment under the new administration?"

Lee: Well, to be perfectly honest, whether the present administration would embrace this, I have some skepticism. But the reality is that we're trying to come up with an option that for the long haul and we'll address this on a global basis. So, where our audience is as much the EU, the World Bank, the Asian Development Bank, than it is the Trump administration. But it's the concept, and is the concept going to be viable? Akash has done a very good job of pointing out some of the remaining challenges that we are going to be working on in the next year, particularly how to develop a value for our carbon emission reductions that is going to be commercially viable. Right now the voluntary market is extremely small. And there are a number of other things that we can look at, but there's no magic bullet to this.

I think that if the United States pulls back on all foreign aid, as it did in a memo earlier this week, this might be a little bit more difficult, because that basically infers that we're not going to be pouring money into the multilateral banks or other similar institutions. But it doesn't detract from a concept that we have outlined here this morning.

Tahir: And we have a couple of related questions. What types of investors would you target for the climate component? What is that investor base? Where are they located? Yeah, so that's a question to you, Akash, do you have a view?

Deep: Sure. And as I said, that market needs to be developed in a way that brings in more investors. What we have seen based on the few examples of these investments outside of compliance markets is demand from corporate investors, for their own, Microsoft for example, has been a significant investor in some of these kinds of projects. We also expect there to be investment from portfolio investors. And that we believe is a market that would grow in the future, but it does require a series of, shall we say, policy measures or regulatory measures to be able to provide value to private investors through these investments. And so, we believe that there is policy work that needs to be done. We believe that some of that policy work has been slowed down in part because of the challenge of establishing the integrity of carbon markets. And that's where we think the role of regulatory measures, MDBs, to be able to create that integrity is going to be important.

Once we have some kind of a viable credible source that is vouching for the credibility of these we believe that that market will be much bigger. But let's look at the broader picture here. We believe that from the abatement benefits that green infrastructure will provide, we believe that those investments are desirable from a global perspective, from a worldwide perspective to be able to meet the goals that we want to achieve in terms of reduced emissions. If that is indeed the policy position that we have collectively in the world, that means that there is a consensus overall that the value from those green investments is significant. The idea, the goal behind creating carbon markets is to be able to articulate those benefits and to transmit them to a set of investors with sufficient volume and credibility so that they would be willing to make the investments that are required.

Let me also, Wasim, if I may, address two issues that I just read here in the comments and it's important to clarify. There's a question that says, "So, are you saying that MDB should continue to invest in brown projects?" And not at all. Again, the brown project is a benchmark. It will not get invested in. The only project that will happen is the green project. The brown project is the benchmark that will be used to decide how much is of this green project's costs are going to be borne by the local investor and the balance will be borne by the development investor. By the same token, it will decide how much of the risks of the project are going to be borne by the local investor. So, there's another question about the assumption of the lower cost of capital at which the incremental green finance will come in.

And the reason we believe that that can happen is because the contractual structure will keep all of the development-related risks, the political risks, the regulatory risks, the tariff risks, the economic risks, they are all linked to development and they will stay with the development investor. That's why the position of the swap perspective is useful, because the global investor owns the green project, but it owes the brown project. And when you net out those two positions, the risks of development goes squarely back onto the development investor. Only the incremental risks that arise from the greening of the brown infrastructure project stay with the global investor.

Tahir: Thank you, Akash. And related to that we have another question, which is something we get from time to time when we present this work. And from Justine who says that, "Climate change is the defining human development issue of our time. Climate is and has always been an integral part of development. Is it reasonable to decouple the two?" 

If I can quickly give my spin on this, which is that the project that gets created is still going to tackle both, right, climate and development, it's going to climate benefits and development benefits. But what we're trying to do is provide a framework for systematically disaggregating and quantifying the two. Climate benefit and the development benefit.

And by doing that, what you can do is you can allocate and optimize financing flows against those benefits. And if you optimize financing flows, then by default you then optimize the cost of capital and the hope is you optimize the cost of capital to an extent that it brings the overall weighted average cost of capital down to a point where it's viable. So, that's my elevator pitch for the Green Swap. And I don't know if you want to add to that, Akash?

Deep: No, that's absolutely right, Wasim. And I think the question is right that these, climate is one of the defining issues of our time, but at the same time we have to keep in mind is that development is ... There are a very large number of countries that are developing very fast. And if we expect that for the adverse climate impact that that development might create we should slow down that development or stymie that development in some manner that is not the right solution. And indeed, that has been a bone of contention between advanced economies and developing economies about where are the emissions coming from and who has, let's say, generated more emissions in a bid to grow faster. And now that it is the turn of developing economies, they have decided that they want to grow fast. And some of them have said, "We will think about climate a little bit later." And that's why various countries have set their net-zero goals not at 2050, but let's say 2060 or even 2070.

And we believe that instead of looking at this as backwards as saying whose emissions caused the problem, we should look forward, and looking forward is the logical way to look at this. Because the benefits of green infrastructure in emerging economies has benefits across the world. But just putting a climate, let's say filter on development is not the way to go. It is sort of co-financed, rather than a conditionality that is put on development. And that co-financing then tells us how we should share that responsibility. To us in this project the obvious way to do that is in proportion of how the benefits of that green choice will be shared across local and global investors. And that's the reason why putting those together, it's not about separating the two, it's about separating the impact to be able to source the financing, which will then come together to finance the green infrastructure and make it more viable. Indeed, I can even say, make it more fair for emerging markets to make green investment choices rather than brown investment choices.

Tahir: Henry, one for you on the carbon markets. Is there some applicability here to combine this with the EU's efforts such as on the CBAM? And also is there a way to use Article six credits as well and link that to the Green Swap?

Lee: Well, as you know, the European trading regime does not allow for credits, carbon credits to be used to meet the requirements of the trading regime if that credit was developed in an emerging market outside of Europe. And there were reasons, because there was grave doubts on the credibility of the carbon reductions made in a lot of those markets. We believe that if you cannot reduce the incentive to go with the brown plants in those markets over the next 10 years, and Akash is right, in the long term they intend to go green, but they're saying, "We can't go green right now because we have all of these issues of poverty and development that we must address. And if the cheapest option to address it is a coal plant, they'll go with a coal plant. And we're trying to provide an alternative to that." I think that same argument if presented to the European Union would at least hopefully stimulate a second look at this restriction. Because that is going to be a major barrier.

Now, the other argument is working the other way with CBAM. That CBAM is going to, you have a situation in which Japan, for example, steel company cannot reduce. It's very expensive for them to reduce their carbon. So they go and invest in a carbon reduction project in Indonesia, they then go back to Europe and say, "We want to count the Indonesia project as meeting the CBAM requirement." It's highly doubtful that Europe is going to let that happen in the present regime, in the present mentality, simply because the whole idea here of CBAM is to protect European steel companies and European heavy manufacturing. And if you're in a situation in which you're allowing in Japan to not have to pay the full price of the reduction while the German steel company has to, that's going to be hard political sell in the present European regime. So, I am not fully persuaded that CBAM is going to stimulate a lot of carbon credit, a larger carbon credit market. I think there's still a lot of challenges ahead if we're going to realize that.

Tahir: Right. Great, thank you, Henry. I think there's a question, we've covered the applicability around this in terms of sub-sector, renewables, adaptation. There's a question around whether this is applicable in middle-income countries only, low-income countries as well, in countries would only somewhat develop some market system in place. Did you have a view on that, Akash, as to what type of country this would be applicable to?

Deep: Yeah, my sense is that, let's think about where the problem is the most significant. I showed a graph earlier about fast growth, economic growth per capita, remember that picture on the horizontal axis, and carbon dioxide emissions per capita on the vertical axis. And it is those countries that are growing the fastest, and they tend to be middle-income countries. So, I would say that those are the countries that are probably the most obvious candidates for doing this. I'm just looking for chart that I showed you. This is the chart that was there. And if you look at this chart, you will notice that look at the countries which are on the upper right side. I mean, India is for example, very good candidate other Asia Pacific, that's where the Indonesias, the Vietnams are in there, Eastern Europe, et cetera. I mean, those are the big countries where this is.

The countries in which growth is not that rapid is not good news from an economic perspective, but it will not result in the emissions, high rate of emissions either. I would also say that in part based upon some of the questions earlier, it is correct to say that there is some carbon market infrastructure that is required to be able to mobilize this financing. And at this point much of that, those mechanisms are much more based upon individual countries, we don't have an integrated global market. So, the policy effort, if it is going to be put into creating those kinds of carbon markets within individual countries, they will fetch much greater impact in an Indonesia and India or Brazil or Vietnam than in many other countries, simply because the size of the problem is much more significant. That's the reason why I believe that it's these fast-growing middle-income countries, which are probably the most obvious, the lowest-hanging fruit in this effort.

Tahir: All right, look, thank you, Akash. We've got two minutes to go, so I think it's time, we should probably bring this to a close. And I appreciate we have a lot of questions still outstanding. We do have a publication on the Green Swap. Akash, do you want to show the link to that?

Deep: Sure.

Tahir: Yeah, look, here's the paper, we've published it. Please take note of the website link. There's a QR code there as well to scan it, and there's a lot more information contained within that document. And you can also find our contact details available through Google search if you want to reach out to us about this topic. Akash, Henry, any closing remarks?

Lee: Yeah, I just would like to thank all of you for joining us this morning, and I would also like to thank Liz Hanlon who did all of the work to put this together, and we are very, very grateful. If you have questions or you want more information on this, please look at the paper, The Green Swap, and get in touch with us. We've given you Akash's and Wasim's email address. We are going to continue work on this, particularly trying to deal with the challenges of developing a stronger carbon emission reduction market. And so this is only the first step in a larger climate finance effort here at the Kennedy School and the Belfer Center. So I'd like to thank you all, and you have a good day.

Deep: Thank you everybody.