The transition to sustainable and low-carbon urban systems requires significant financial investments and poses various challenges for municipalities. Document Joint Research Centre (JRC) "Financial instruments for mitigation actions, adaptation and energy poverty” serves as a key guide for local governments, helping them identify financial barriers and opportunities in implementing Sustainable Energy and Climate Plans (SECAPs).

The role of local governments and their challenges

Local governments are at the heart of transforming financial planning into effective climate action. They are responsible for identifying funding sources, developing partnerships and effectively allocating resources to maximise climate and social benefits. Despite their strategic position, local governments face significant challenges, such as: limited budgets, insufficient administrative capacity and technical and regulatory barriersMore than 85% of local governments report insufficient financial resources to implement climate change adaptation measures. In addition, smaller municipalities often lack the human resources and skills to prepare applications for EU funds or other financial instruments.

Financial instruments for climate action

The document classifies financial instruments into three main categories: traditional, innovative and alternative, based on funding sources, contract types and level of innovation.

1. Traditional tools

Traditional tools such as grants and soft loans, are reliable and well-established solutions.

• Grants are crucial for covering initial investment costs, especially in projects requiring significant upfront investment, such as energy efficiency retrofits, renewable energy installations and infrastructure improvements. An example is the SEAI fund in Ireland, which provides financial support for improving the energy efficiency of homes.
• Soft loans They offer below-market interest rates and extended repayment periods. They are essential to bridge the financing gap in the early stages of energy efficiency initiatives. An example is the Smart Cities programme by Belfius in Belgium, which supports sustainable urban transformation projects at low interest rates thanks to guarantees from the European Investment Bank (EIB).

2. Innovative tools

Innovative models are designed to address financial challenges in a more flexible and modern way, often using private capital.

• Public-private partnerships (PPP) They allow for the sharing of financial risks and technical expertise. They are particularly effective in leveraging private capital for public benefit, as seen in the wind energy projects in Copenhagen.
• Green bonds are debt instruments issued to finance environmental and climate projects. Municipalities use them to attract private investors, such as the city of Gothenburg in Sweden to finance sustainable transport systems.
• Energy Service Companies (ESCOs) a Energy Performance Contracts (EPC) they allow the implementation of energy efficiency improvements without initial costs for the municipality, with investment costs being covered by the energy savings achieved.
• Carbon pricing, including carbon taxes and emissions trading systems (ETS), create financial incentives to reduce emissions. New York City, for example, has implemented a system where buildings exceeding emission limits pay a fine, effectively acting as a local carbon tax.
• Insurance mechanisms, such as parametric insurance, are innovative tools to strengthen climate change adaptation. They provide rapid payouts based on pre-agreed climate indicators such as rainfall intensity, which is critical for urban areas prone to flooding, such as Paris.

3. Alternative tools

Alternative models encourage direct community participation.

• Crowdfunding and energy cooperatives empower citizens to invest directly in local renewable energy projects. An example is the Bettervest platform in Germany, which supports energy efficiency projects through community investment. The Melpignano cooperative in Italy involves citizens in the creation and management of photovoltaic systems.

Addressing financial obstacles

To overcome shortcomings in administrative capacity and limited knowledge about funding options, they offer points of single contact (OSS) effective solution. These centers provide centralized access to technical assistance, information on funding opportunities and simplified project implementation processes. For the successful achievement of SECAP objectives, it is essential combination of traditional and complementary instruments, capacity building and strengthening of governance at multiple levelsThis allows cities to diversify their funding sources, attract private capital and reduce perceived risks, making climate projects more attractive to investors. Spring

Glossary of key terms

• Adaptation: Measures aimed at increasing resilience to the impacts of climate change, such as extreme weather events, rising sea levels and changing precipitation patterns.
• Bankable project: A well-documented and economically viable initiative that is attractive to investors because it offers sufficiently clear and certain returns and risks.
• White certificates: A market mechanism that certifies verified energy savings that can be traded between obligated entities to meet energy efficiency targets.
• Blended finance: Strategic use of public or philanthropic funds to mobilize private sector investment in sustainable development projects, reducing risks or increasing returns for private investors.
• Blue bonds: A specialized subcategory of green bonds, designed to finance projects that protect and restore aquatic and marine ecosystems and promote sustainable management of water resources.
• Capacity building: The process of improving the ability of local governments, personnel and institutions to effectively manage and implement projects, including obtaining and using funds.
• Climate resilience bonds: A subset of climate bonds specifically designed to finance projects that improve resilience to climate risks, such as flood mitigation measures or drought-resistant infrastructure.
• Climate bonds: Financial instruments issued to finance climate-related projects, the primary objective of which is to mobilise private capital for initiatives that reduce greenhouse gas emissions and accelerate the transition to a low-carbon economy.
• Carbon pricing: A market mechanism aimed at assigning a monetary value to greenhouse gas emissions, thereby internalising the environmental cost of carbon-intensive activities. Includes emissions trading schemes and carbon taxes.
• Carbon finance: Generating financial value from verified reductions in greenhouse gas emissions, typically through the issuance and sale of carbon credits in regulated or voluntary carbon markets.
• Covenant of Mayors for Climate and Energy (CoM): An ambitious initiative for local climate and energy action.
• Crowdfunding: A funding mechanism that mobilizes small contributions from a large group of people, typically through online platforms, to support projects.
• Debt financing: Obtaining funds through loans, with terms of repayment of principal and interest.
• Energy poverty: Lack of access to affordable, reliable and sustainable energy, including the inability to invest in energy efficiency or renewable solutions and difficulties in paying energy bills.
• Energy cooperatives: Community organizations that pool funds to finance renewable energy and energy efficiency projects, strengthening community ownership and involvement.
• Energy performance contracting (EPC): A contractual agreement between a beneficiary and an ESCO that implements energy efficiency improvements and receives payment based on the energy savings achieved.
• Energy-efficient mortgages (EEM): A mortgage loan that takes into account the energy efficiency of the home, which can mean better loan terms.
• Energy services companies (ESCOs): Companies that finance and implement energy efficiency projects, with their revenues dependent on the energy savings achieved.
• Emissions trading system (ETS): A “cap-and-trade” system that sets an overall maximum limit on permitted greenhouse gas emissions and allocates or auctions emission permits.
• Equity financing: Raising funds by issuing shares or equity interests in a project, allowing investors to become partners who share both risks and returns.
• Eurostat: The Statistical Office of the European Union, which provides statistical data to support EU policies.
• Financing: Investments with an expected return, often focused on economically viable projects, such as loans or bonds.
• Forfeiting (Buying of receivables): A form of transfer of future receivables from one party (e.g. an ESCO) to another (e.g. a financial institution) for a discounted lump sum payment.
• Funds (Funding/Grants): Typically non-repayable funds provided by governments or non-governmental organizations, aimed at public benefits without a requirement for financial returns.
• Green bonds: Bond instruments issued specifically to finance environmental and climate projects that allow local governments to attract private investors.
• Green loans: An innovative financial instrument that supports sustainable environmental projects, often with preferential terms such as reduced or zero interest rates.
• Green criteria: Specific environmental indicators and standards integrated into project frameworks, especially in PPPs, to ensure compliance with climate objectives.
• Green certificates: A mechanism to support the production of energy from renewable sources, where producers receive certificates for each MWh of electricity produced from renewable sources.
• Hybrid contracts: They combine elements of both bond and equity financing, such as mezzanine financing.
• Energy Improvement Mortgage (EIM): A loan that finances energy improvements to an existing home under a mortgage using monthly energy savings.
• Insurance mechanisms: Financial instruments that mitigate financial risks associated with climate disasters, for example through parametric insurance or catastrophe bonds.
• Model "intracting" (Internal contracting): The Public Internal Performance Commitments (PICO) model, where a department within the public administration acts as an ESCO, organising, financing and implementing energy efficiency improvements using its own funds.
• Joint Research Centre (JRC): The Joint Research Centre, a scientific and knowledge service of the European Commission, provides scientific support for EU policy-making.
• Land value capture (LVC): A financial approach that allows municipalities to generate revenue from increases in land values due to public investments or regulatory changes.
• Leasing: A way of acquiring the right to use property (instead of ownership) that helps overcome the barrier of initial costs.
• Mini-bonds: Small debt instruments issued by unlisted companies, SMEs or municipalities to raise capital, typically with a limited nominal value and shorter maturity.
• Mitigation: Measures aimed at reducing greenhouse gas (GHG) emissions, such as investments in renewable energy and energy efficiency.
• Multilateral development banks (MDBs): Institutions such as the European Investment Bank (EIB) or the World Bank, which provide grants, concessional loans and technical assistance to support urban adaptation strategies.
• Non-repayable contracts: A category including grants and subsidies, where funding is provided without expectation of repayment.
• On-bill financing: A mechanism where energy suppliers integrate loan repayments for energy efficiency investments directly into customers' energy bills.
• One-Stop Shops (OSSs): Centralized service centers that simplify access to finance and technical support for energy-poor households and other entities.
• Parametric insurance: It provides predefined payouts when specific climate indicators (such as precipitation intensity or wind speed) exceed agreed thresholds.
• "Pay-for-performance" (P4P) models: Financing mechanisms where payments are directly tied to achieving specific and measurable results, such as energy savings or emission reductions.
• Payments for ecosystem services (PES): Voluntary mechanisms for financing environmental protection through agreements between beneficiaries and providers of environmental services.
• Pooled procurement: Bringing together public or private entities to collectively purchase energy-efficient products or services, thereby reducing costs through economies of scale.
• Project financing: Long-term financing based on the project's projected cash flows rather than the project sponsors' balance sheets.
• Public-private partnerships (PPPs): Cooperation between public institutions and private sector entities to mobilize resources and expertise for projects.
• Revolving funds: Financial mechanisms aimed at ensuring sustainable financing of a series of investment projects by reinvesting project payments into new initiatives.
• Risk-sharing tools and guarantees: Mechanisms such as partial risk guarantees, which provide external partners as collateral for part of the project debt, thus improving access to finance.
• Sustainable Energy and Climate Action Plans (SECAPs): Local territorial plans that define the climate and energy actions to be taken.
• Social bonds: Financial instruments specifically designed to raise funds for projects that address important social problems and generate measurable social outcomes.
• Soft loans: Financial instruments that offer below-market interest rates and extended maturity periods, often accompanied by guarantees to mitigate the risk of default.
• Special purpose vehicle (SPV): A company or other legal entity established to fulfill some narrowly defined or temporary purpose that facilitates off-balance sheet financing of projects.
• Sustainability bonds: Hybrid financial instruments combining the features of both green and social bonds, the proceeds of which are allocated to both green and social projects.
• Tax incentives: Fiscal measures, such as tax exemptions or rebates, designed to encourage investment in specific sectors or technologies.
• Tax increment financing (TIF): A public financing method that uses future tax revenues from a specific area to fund infrastructure.
• Traditional bonds: Debt securities issued by governments or corporations to raise capital, where the borrower pays interest and/or repays principal to the lender.
• Vendor financing: Financing offered by suppliers for the purchase of goods or services that helps the manufacturer sell its product by facilitating financing of the purchase by customers.
• Voluntary actions: Actions that provide strong support for climate change adaptation projects encourage community engagement and increase the availability of resources during the implementation phase.