Three challenges to scaling up international climate finance
Morgan Hervé-Mignucci, March 2012
Last month, the CPI climate finance team, led by Dr. Barbara Buchner, held outreach events with some of the key actors in climate finance. From these discussions, I identified three major challenges to increasing the amount of funding for low-emissions, climate-resilient projects. Needless to say, the CPI climate finance team intends to focus on these areas over the course of this year.
Unlocking long term investors’ money
The recent CPI report on the Landscape of Climate Finance estimates global climate funding at around USD 97 billion and identifies four major sources of climate finance: public money (official aid and policy money), private finance (i.e. project developer money), carbon offset markets, and global capital markets (institutional investors, high-net worth individuals, and lending institutions).
Out of all the existing major sources of finance, institutional investor finance might have the most transformative effect. CPI analysis highlights the fact that the amount of private finance is almost three times greater than public finance. Therefore, diverting more institutional money towards new mitigation and adaptation uses becomes critical. The financial institutions that participated in our outreach events indicated that such investors have the appetite to invest but that a lack of dedicated instruments and vehicles has prevented significant investment.
Participants also named risk aversion and aversion to change as major barriers to investment. Existing businesses are slow to accept new models and instruments. Using simple and known structures can alleviate their concerns, as can new information on the effectiveness of finance (USD per ton of GHG avoided) – that is, knowing how to use money most effectively can help unlock additional funding.
Getting the policies right to attract capital
Policies can curb GHG emissions, but getting the policies right is not a straightforward matter.
Recent CPI analysis [link] highlighted the fact that policies incentivizing the deployment of renewables in the US and Europe have also had significant impacts on project financing costs. Policies that affect costs and revenues, however, are just part of the picture. Getting the tariff right is another part, since the signals that policymakers implicitly send to investors matter too. Investors’ confusion in the wake of the 2010 Spanish solar tariff cuts is one illustration of this. The credibility of climate policies has become a prime concern.
Another area of ongoing concern for institutional investors and lenders is the impact of financial regulations (Basel III and Solvency II) on their ability to get involved in climate projects. Likewise, on the public side, what we’re witnessing these days is a shift from policies that solely target emissions reductions to policies that have co-benefits (green jobs and green growth) as major objectives.
The alignment of public and private interests therefore becomes crucial to ensure the sustainability of policy support. This need is particularly acute in developing countries.
Making sources of finance “comfortable” with adequate financing structures and instruments
Making sources of finance “comfortable” means providing them with investment alternatives that are (1) at least as profitable on a risk-adjusted basis as BAU investments, (2) simple to understand and invest in (cheap and short due diligence), and (3) able to address investor-specific requirements (matching liabilities profile or diversification). In this respect, not everything can be addressed with public finance. This is where financing structures, private arrangements, and financial engineering are needed to complement public finance.
Out of the events’ discussions, two (complementary) ways forward emerged. One approach is to rely on straightforward, “plain vanilla” structures that are familiar to investors. In this vein, I believe that structures involving debt or public money leverage will continue to play a critical role. Given what is required to make sources of capital comfortable with the risks of projects, it also seems clear to me that arrangements such as PPP (public-private partnership) and climate funds that tap both private and public money are part of the solution (the UK DFID suggested “accelerating the takeoff by putting taxpayers money”). Still, the challenge with this first approach is that generic structures do not expressly target investor requirements.
The second way forward involves resorting to more complex structures with asset-backed securities, derivatives, or guarantees. It is critical to isolate financial investors from the risks they are likely to bear (early technology, price, and policy risks) by reallocating these risks to the most able parties. Citigroup’s proposal of a “green” monoline insurance for clean energy projects (“a global OPIC”) is a step in the right direction. The challenges with this second approach, however, are, first, to put the public and investors at ease about using structures associated with the recent financial and economic crisis and, second, to deal with the additional work involved in creating a pocket of money to look after .
In 2012, CPI will be exploring case studies that should shed light on some of these issues; we’ll share our findings over the next months.
 These events took place in New York City, Washington, DC, and London with the support of the World Bank Group and Citigroup.