Unlocking climate finance for railways

Climate finance instruments could go a long way in overcoming this financial hurdle. But while there is a plethora of climate finance instruments available, most railways have yet to tap into these resources effectively.

In a recent World Bank report, we discussed various avenues through which railways can potentially access climate finance, drawing on the experience of several developing countries. Here are some of our key findings.

There are several climate finance instruments that could benefit railways

• Green Bonds & Loans: Green bonds and loans are commercial bonds/loans that finance green investments and are labelled accordingly. Several Governments, railways, and public-private partnership (PPP) projects have successfully utilized green bonds to finance rail investments supporting GHG reductions. These climate finance instruments are accessible to creditworthy railways and bankable railway projects. They can complement financing from other sources, including conventional bonds, public sector funding, and development finance.

• Sustainability-Linked Financing Instruments: Sustainability-linked finance can be any financial products in which issuers pledge to achieve specific sustainability objectives. Once the issuer receives the financing, the interest rate will be adjusted if the issuer’s is unable to meet the sustainability performance targets that have been agreed upon. The use of these instruments has seen significant growth in recent years. These instruments can be accessed by governments, railways, PPP projects, and other rail-related companies (e.g., manufacturing companies), to secure financing based on sustainability performance.

• Carbon Markets: Carbon finance markets enable the trading of carbon credits, which represent reductions and/or removals of greenhouse gas emissions. Since railways typically allow for significant GHG savings, they could potentially sell carbon credits on these markets to unlock additional financing. To make this possible, however, the regulations and standards governing carbon markets need to be adaptedto include railways.

• Climate Funds and Results-based Finance: Several multilateral climate funds have been established to promote investment in climate change mitigation and adaptation measures, while results-based climate finance is money paid for achieving agreed-upon climate objectives such as GHG savings. Although currently somewhat underutilized, both mechanisms have already demonstrated success in financing railway projects, particularly in the urban sector. In the future, these instruments could complement other financing options, or enhance certain opportunities, e.g., by incentivizing the adaptation of electrified rolling stock or providing risk guarantees for commercial financing.

What are the main challenges and what needs to be done?

To fully unlock the potential of climate finance, it's essential to address several key challenges, which can be categorized into four main areas:

• Creditworthiness: High levels of creditworthiness are required for borrowers to access any form of financing from commercial markets, including most climate finance instruments. This can be a challenge for many railway companies, as funding is often inadequate, or not provided in a structured and predictable way. Efforts to improve creditworthiness, particularly for state-owned enterprises (SOEs) and public entities, are essential for overcoming this challenge.

Development institutions like the World Bank could help railways achieve creditworthiness, for instance by offering technical support on their sector reforms. The provision of various types of guarantees could also help de-risk climate financing for rail projects and establish a favorable track record with investors for future financing.

• Familiarity: Fragmentation among climate-specific financing sources and a general lack of familiarity with the rail sector pose challenges. By bridging the information gap between railways and climate financiers, development institutions can help railways structure their projects to tap into climate finance and support them in advocating for their projects to climate financiers. This could include bundling projects to meet GHG savings requirements and explaining to investors how supporting railways helps reduce the footprint of hard-to-abate sectors like transport.

• GHG savings: Railway investments are capital-intensive and their abatement costs tend to be high, due to projects typically requiring high up-front investment with development and climate benefits accruing over a long project life. In comparison to other sectors, the GHG savings per invested dollar from rail projects are generally moderate, especially in developing countries who’s overall GHG emissions from transport are small. This can be an issue for certain climate finance instruments, which may prioritize short-term cost efficiency in their project selection criteria. Prioritizing projects with higher GHG savings and aggregating activities could address this challenge.

• Standards: Different climate finance instruments use different standards for verifying that the investment is indeed climate-friendly, that GHG-savings are achieved, or that the agreed KPIs are met. This complexity can seriously impact railways’ ability to access climate financing. Development institutions could contribute to the development of harmonized monitoring, reporting and verification standards (MRV) for railway investments, enhancing their eligibility for results-based climate finance instruments such as carbon markets.

Unlocking climate finance for railways requires a concerted effort to address challenges and capitalize on opportunities.  As a first step, the World Bank is already supporting governments and railways in bolstering their creditworthiness. Concurrently, collaborative efforts with other organizations and financial institutions are needed to bridge the familiarity and knowledge gap between financial investors and the railway sector. Looking ahead, the World Bank and other development institutions could play a pivotal role in facilitating the creation of blended financing plans for railways. Such blended finance, which incorporates various sources including the public sector and development finance, will be instrumental in harnessing the full potential of railways… and, ultimately, moving the future of transport in a more sustainable direction.

Figure 1: Solutions for Scaling Up Climate Finance for Railways