Smart Climate Governance: Beyond The “Hot & Cold” Approach

Smart climate governance needs to be set in place that aligns incentives and institutions to de-risk climate finance, unlock public–private synergies, and deliver scalable solutions

The current Paris Agreement climate governance model based on nationally determined commitments (NDCs) will deliver only ~15 percent global greenhouse gas emission cuts by 2035, far short of the 45–60 percent needed for the 1.5°C target. Despite a COP29 goal of mobilising US$300 billion per year until 2035, there are several implementation challenges that a mere declaration of commitments cannot resolve. Designing smart systems to help realise such ambitions is equally important. To add to this, there are political constraints like the current US administration revoking its climate financing commitments, amounting to a loss of at least US$18 billion, roughly 6 percent of the US$300 billion target. The time is ripe to discuss how climate governance can be redesigned smartly to move beyond the “hot and cold” approach.

There are political constraints like the current US administration revoking its climate financing commitments, amounting to a loss of at least US$18 billion, roughly 6 percent of the US$300 billion target.

Why Do the UNFCCC and The Paris Agreement Frameworks Fall Short?

The fundamental issues lie in the scientific misunderstanding around decarbonisation, the lack of integrated systems thinking seen in the design of these frameworks and the assumptions that underpin them, how actors have been incentivised to prioritise decarbonisation and the uneven representation of relevant actors in the climate governance platforms.

Nationally Determined Commitments are a Structural Flaw

NDCs were introduced as a bottom-up approach—a divergence from the Kyoto Protocol’s top-down approach—in the hope that it would encourage more climate participation. It was also the only political consensus possible at the time. However, owing to their discretionary nature, binding constraints, and the inherent difficulty for sovereign states to manage global commons, the NDCs were structurally misdesigned.

NDCs do not systemically promote decarbonisation. For instance, the carbon credit system and purchase of Renewable Energy Certificates under Article 6.2 of the Paris Agreement, incentivise countries to rely on offsets, which do not lead to real carbon reductions. NDCs imply trade-offs, encouraging sector-by-sector decarbonisation rather than transforming entire energy grid systems, which would be the optimal net-zero pathway for a country. Further, NDCs with its five-year ratchet mechanism under Article 4.2 of the Paris Agreement (progressive climate commitments) focus on flow (carbon emissions) instead of stock (carbon accumulated). For example, if a country emits 10 tons of carbon (flow) but buys credits for 10 tons of “avoided deforestation”, they can claim “net zero” on paper, but in reality, the stock in the atmosphere has still increased by 10 tons. This ratchet mechanism and the leeway for offsetting (without actual carbon reduction) create a clash of the temporalities, reinforcing a five-year policy cycle and creating an illusion of progress towards net zero despite the country only meeting an accounting goal, not a climate goal.

NDCs imply trade-offs, encouraging sector-by-sector decarbonisation rather than transforming entire energy grid systems, which would be the optimal net-zero pathway for a country.

The Paris Agreement, at the time of conception, hoped that flow reductions would turn the carbon concentration curve downward. Ten years later, that hasn’t happened. COP outcomes are simply declarations and lack effective implementation systems, especially where there is no corresponding domestic legislation.

Failure to Address Buy-Side & Sell-Side Constraints Produced the Biggest Market Failure

The persistent gap in climate financing is fundamentally a market failure due to a deep structural misalignment where technically viable climate transition projects are blocked by outdated financial metrics. A primary issue on the buy-side (capital allocation) is that returns are evaluated using traditional risk-adjusted methods that exclude climate externalities and expected climate impact from the profit and loss accounts and projected cash flows. This makes decarbonisation seem financially unattractive, while the internal rate of return (IRR) for fossil fuel investments is overstated in comparison to clean energy investments. Due to this gap, private capital continues to flow towards fossil fuels, which are deemed more financially attractive. ESG disclosures alone cannot cause a substantive shift in investment behaviour; there has to be an impact on cash flows and pricing for alignment of investor incentives.

For emerging markets and developing economies (EMDEs), borrowing costs are often three to five times higher than in advanced economies, despite faster growth, manageable debt, and strong economic fundamentals.

On the sell-side (capital supply and risk pricing), this problem is compounded by biased sovereign risk assessment and debt sustainability frameworks that inflate the borrowing costs for countries in the Global South. For emerging markets and developing economies (EMDEs), borrowing costs are often three to five times higher than in advanced economies, despite faster growth, manageable debt, and strong economic fundamentals. These frameworks focus on short- to medium-term debt and liquidity indicators and treat additional borrowing, regardless of its productive use, as a fiscal risk. They fail to fully account for the long-term benefits, resilience, and revenue-generating potential of climate investments (and focus on the upfront capital required). As a result, EMDEs are penalised through unfavourable financing terms, higher discount rates, shorter maturities and refinancing risk. This makes even ‘rational’ engineering projects, like low-carbon grids, financially unattractive because they are evaluated through short-term commercial lenses rather than the long-term concessional framework required for climate infrastructure. Even Small Island Developing States (SIDS) suffer from a similar structural constraint.

To add to this, climate (and debt) governance forums are fragmented (UNFCCC, G20, MDBs, regional bodies (like ASEAN), etc.), which creates further complexity for countries to navigate finance and technical support. Global North seeking stronger NDCs instead of fixing financeability will only lead to a further rise of non-traditional financing like bilateral lending from China, different forms of SDR rechanneling, etc., given the economic and diplomatic opportunities they offer.

Climate inaction is fundamentally an implementation failure rather than an ambition failure.

Despite the risk of a mutually reinforcing lowest common denominator ambition cycle embedded in the design of NDCs, ambitions rose primarily due to rapid technological maturity (solar PV, wind, battery storage) and decarbonisation pathways becoming viable for nearly every major sector, turning clean energy into one of the cheapest and commercially attractive forms of new energy generation. Thus disproving the assumptions of perceived trade-offs, static systems and passive consumers. Consequently, natural market alignment should have occurred as these technological advancements represented “good investments”, especially in emerging markets. Yet, this has resulted in one of the biggest market failures due to market fragmentation and misaligned incentives. Climate inaction is fundamentally an implementation failure rather than an ambition failure. Countries repeatedly showcase ambition, but no credible process exists to translate that into scalable and predictable finance.

Suggestions For Climate Governance Redesign

Taking a Scientific Integrated Systems Approach:

• Replace the Centrality of NDCs: Replace the five-year NDC cycle with Long-term Low Emission Development Scenarios (LT-LEDS) under Article 4.19 in the Paris Agreement. These should be a 30–50 year investment roadmap for countries that look at economy-wide technical modelling rather than just sectoral emissions targets.
• Shift Approach from “Flow” to “Stock”: Climate governance must stop focusing solely on annual emission “flows” (which allow for offsetting) and instead focus on addressing the total atmospheric “stock” of greenhouse gases (as this is what determines temperature rise) through a structured approach in the Paris Agreement for carbon dioxide removal (CDR) mechanisms. Currently, there is no commitment placed on carbon extraction in the Paris Agreement.
• Simplify and Coordinate Governance: Reduce the extreme complexity and bureaucratic bottlenecks in current processes like the Green Climate Fund and REDD+ to ensure Least-Developed Countries (LDCs) and SIDS can actually access timely technical and financial support. There also needs to be more coordinated responses from governance forums and institutions (UNFCCC, G20, MDBs, regional bodies (like ASEAN), etc.) tackling climate and debt issues.
• Strengthen Private Sector Participation: Despite the private sector having a disproportionate climate impact—100 companies contribute over 70 percent of the global carbon emissions—and the need for private capital to support climate transition, they are represented in the climate negotiations by public-sector bureaucrats rather than their own leadership. Without formal representation, private enterprise lacks the direct incentive to engage with climate governance objectives.

Addressing the Market Failure:

• Use Public Finance to Unlock Private Finance: Employ a complementary two-pronged approach where both public and private capital work together rather than in isolation, as they mutually reinforce each other, would prove useful. Structural constraints that prevent private capital from flowing into emerging markets can be addressed by using public finance as a ‘market marker’—by expanding the fiscal space and providing long-term concessional loans to subsidise large clean energy infrastructure projects and to make them “investable” for the private sector. Further, increased use of de-risking mechanisms such as pooled guarantee funds, liquidity facilities, etc., can lower this perceived risk of EMDEs for private investors.
• Reform Debt Sustainability Frameworks and Loan Terms: Reform international debt frameworks to differentiate between “productive” borrowing (e.g., clean energy infrastructure) and “non-productive” consumption-based borrowing. MDBs must transition from short-term commercial loans to long-term concessional loans (“patience capital”) that match the lifespan of climate infrastructure and address the maturity mismatch.
• Update Global Financial Standards: While global standards like the IFRS Sustainability Disclosure Standards issued by the International Sustainability Standards Board (ISSB) mandate climate-related financial disclosures that enable investors to assess climate risk and incorporate it into risk-adjusted valuation models, these accounting standards do not require financial recognition of climate impact in its profit and loss accounts or cash flows. Future climate-related costs (asset devaluation, expected regulatory costs, etc.) must be provisioned for today as a notional expense (‘internal carbon pricing’) so they are reflected in the projected cash flows, much like depreciation accounts for future wear and tear of plant and machinery. Addressing this gap will make decarbonisation appear less punitive to the shareholders by correcting the distorted IRR for clean energy investments when compared to fossil fuel investments.

Conclusion

The sweet spot for smart climate governance lies at the intersection of designing incentives for both countries and the private sector, addressing structural constraints and de-risking pathways for countries seeking climate finance, unlocking both public and private finance (as mutually reinforcing forces), leveraging and synergising existing institutions and policy levers, and ultimately, keeping models and solutions simple yet effective and scalable.

This commentary originally appeared in Observer Research Foundation.

This analysis draws on the key insights from a discussion with climate experts – Dhruba Purkayashtha (Adviser, Observer Research Foundation, India), Lisa Sachs (Director, Columbia University’s Center on Sustainable Investment), and Olivier Colom (Former Senior Diplomatic Adviser to President Nicolas Sarkozy).