Tag Archives: institutional investors

Greening institutional investment in India

March 20, 2018 | and

 

India’s energy demand is increasing, and, to achieve its clean energy target of 175 GW by 2022, finance will be crucial.

One promising opportunity lies with foreign and domestic institutional investors who have $70 trillion and $564 billion assets under management, respectively. These investors are bound by their fiduciary duties meant to maximize financial returns to their beneficiaries, without taking excessive risks, while also meeting their liabilities over the long-run. Renewable energy, though a relatively new technology, is well matched to these needs as it offers high returns as well as meets environmental, social and governance (ESG) considerations in their investment strategies.

However, how can India unlock this opportunity to create a clean energy future?

A recent study by Climate Policy Initiative attempts to answer this question by developing a business case for institutional investors to invest in the Indian renewable energy sector, identifying key barriers to investment, and proposing potential pathways forward.

The changing economics of energy in India
According to the report, the renewable sector is becoming increasingly attractive compared with other energy investment opportunities in India. For instance, the solar tariff has actually become 23% cheaper than coal plants, and coal plants exhibit greater risk in cash flows (i.e. 40%) as compared to wind (i.e., 20%) and solar (i.e.,10%).

In the medium term, these changing economics mean that the existing power portfolio of investors, who are mostly exposed to fossil based investments instead of renewable investments, would underperform due to declining demand for fossil based power. Consequently, it is in the interest of institutional investors to gradually rebalance their portfolio in favour of climate friendly investments, in India and elsewhere.

Is India an attractive renewable energy market for institutional investment?
The study builds a case that India as a market is strong and economically attractive for foreign institutional investors compared to other similar markets across the world.

First, it benefits from strong renewable policy commitments as well as a large market size — ~480 GW expected capacity addition over 2016-40 — that is third only to China and the United States. Second, India is ranked 2nd in Ernst & Young’s renewable energy country attractiveness index, based on five pillars including macroeconomic environment, policy enablement, supply–demand dynamics, project delivery, and technology potential. Third, renewable energy in India provides a financially attractive investment, as measured via excess returns,  the difference between the expected return on capital invested and the weighted average cost of capital. India offers higher excess returns of 3.5% compared with other large markets, such as the US (2.4%) and China (1%). While some markets provide higher excess returns than India—for example, Mexico, Canada, and Chile – these are much smaller markets.

So what’s next?
Institutional investors with long-term investment horizons are mostly seeking yield generating investments in low risk and long duration assets, i.e., traits that align well with the current investment profile of renewable energy; this has changed from small size and high risk-high return investments to large size and medium risk-moderate return investments. Although the expected return from renewable energy projects have come down from 20% to 15% over time, this still matches institutional investors’ overall India market portfolio return requirements.

Renewable energy sector stages with risk-return mapping

However, our study finds there are still some barriers to unlocking this apparent match – including, sector specific risks like off-taker risk and limited listed and highly graded investment opportunities, along with currency risk.

The good news is that with appropriate regulatory and policy changes, the sector can provide a high match with institutional investors’ investment objectives.

For example, the central and state agencies could address the off-take risk through a transparent and credible payment security mechanism. Regulators could consider developing incentives to encourage banks and Non-Banking Financial Companies (NBFCs) to securitize their renewable energy loan portfolios, freeing up capital for more renewable energy projects. And investors themselves can consider developing risk management frameworks to assess and manage climate risk, identifying and investing in forward looking investment opportunities, renewable energy being one, to mitigate climate risk in their portfolio.

These steps, and the others we outline in the study, are a win win for all – for India, it’s a way to get much needed capital in a much needed area. For investors, their long-term portfolios depend on it.

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Three ways to attract domestic institutional investment for renewable energy projects in India

September 10, 2015 |

 

Institutional Investment

In order to achieve India’s renewable energy targets of 175 GW of solar and wind power by 2022, approximately USD 100 billion of investment in renewable energy infrastructure will be required, including USD 70 billion of debt.

While these ambitious renewable energy targets are important and admirable, financing them is going to be no easy task. Renewable energy in India has traditionally relied on domestic commercial banks for financing; however, this bank financing has become constrained by several limitations. Many banks are nearing their exposure limits to the power sector, and existing regulations do not distinguish between lending to fossil fuel-based power and renewable energy. In addition, the typical tenor of bank loans is around ten years, whereas most renewable energy projects require longer-term financing that matches the project life cycle of 20 to 25 years. Finally, bank debt at 12-13% interest rate is also costly; and together these inferior terms of debt – the high cost, short tenor, and variable interest rates – make renewable energy in India approximately 30% more expensive than in the US or the EU.

Achieving India’s renewable energy targets is going to require mobilizing a lot more debt at more attractive terms, from alternative sources.

One promising solution is domestic institutional investors, such as insurance companies and pension funds, who are ideally positioned to both increase availability of debt and provide debt at more attractive terms to renewable energy projects. Compared to commercial banks, institutional investors not only invest over longer terms, but also accept lower returns in exchange for lower risks, thus providing a better match with the risk-return profiles of renewable energy projects.

Preliminary analysis by CPI, performed earlier this year, shows that these institutional investors are likely to invest approximately USD 400 billion from 2014 to 2019. Based on their traditional share of 3.75% of their investments going to the power sector, if this share could be diverted to renewable energy, that would provide USD 15 billion of debt financing – a significant amount of the debt required to meet the targets.

So, what’s the catch? First, given high risks during construction, institutional investors, who prefer low risk, are unlikely to invest in renewable projects before they start operation. Second, even for operational projects, institutional investors require a domestic debt rating of AA or higher, which most renewable energy projects do not have.

The first issue is manageable – domestic banks can continue to fund projects under construction, and institutional investors can help refinance operational projects. This would free up bank debt to be used for new projects.

As to the second issue – enabling institutional investment will require financial instruments that can raise the credit rating of renewable energy projects. There are two promising instruments that may be able to do this: infrastructure debt funds by non-banking financing companies (IDF-NBFCs) and renewable energy project bonds with partial credit guarantees (PCGs).

IDF-NBFCs are pooled investment vehicles designed to facilitate investment across infrastructure sectors, including renewable energy. PCGs are a form of credit enhancement where the borrower’s debt obligations are guaranteed by a guarantor with a strong credit rating.

Both of these instruments can reduce risks to meet institutional investors’ minimum requirement of an AA rating. Compared to commercial loans, they have the potential to provide provide more attractive terms of debt by lowering the cost of debt by up to three percentage points, and increasing the tenor by up to five years.

However, both instruments face structural and regulatory issues which have impeded their use as investment vehicles. We identified three of the key issues that, if addressed with the right policy changes, could enable institutional investment in renewable energy.

First, for both instruments, the domestic debt market does not differentiate between construction and refinanced loans, making it hard for banks to release debt for refinancing. This can be addressed by encouraging public banking institutions to provide loans during the construction state of renewable energy projects, in order to catalyze the construction debt market.

Second, IDF-NBFCs require a three-way agreement between the project developer, the project authority (usually state-owned power distribution companies called DISCOMs), and the IDF-NBFC. However, in India, the poor financial health of DISCOMs presents a risk. The government can mitigate this risk by creating a model agreement for IDF-NBFCs which includes government guarantees for off-taker risk and robust termination provisions.

Third, for renewable energy bonds with PCGs, existing regulations limit institutional investors to investing in only up to 10% of the bond offering. This would require more than ten institutional investors per bond offering, which is difficult given associated transaction costs and the small number of institutional investors in India. Relaxing this regulation so that investors could subscribe to 25-33% of the bond offering would help address this barrier, making it possible to raise the required debt from only three to four institutional investors.

By taking these three steps, the government of India may be able to make significant progress towards financing India’s renewable energy targets, by harnessing the potential of institutional investment into renewable energy.

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3 Reasons for Measured Optimism about Climate Finance

December 4, 2014 |

 

A version of this blog first appeared on Responding to Climate Change: http://www.rtcc.org/2014/11/21/three-reasons-to-be-optimistic-about-climate-finance-flows/

This year’s UN climate talks opened in Lima earlier this week and for those who hope the world can avoid dangerous climate change, some major recent announcements have given cause to celebrate. Last month, the world’s two largest emitters – the U.S. and China – reached a deal to tackle emissions. Then, the U.S., Japanese, and UK governments joined others by pledging billions to the Green Climate Fund to help developing nations deal with climate change. These political announcements are clearly timed to inject momentum into the negotiations taking place in Lima. But key questions remain unanswered: What do these financial pledges mean in terms of existing investment in a low-carbon economy future? How should money be spent? And are we on the right track?

At Climate Policy Initiative, our analysis of global climate finance flows helps to identify who is investing in climate action on the ground, how, and whether investments are keeping up what is needed to transform the global economy. We have just released the latest edition of our Global Landscape of Climate Finance report. It shows global climate finance has fallen for the second year running and we are falling further behind the level of investment needed to keep global temperature rise below two degree Celsius – but reveals some positive news as well.

Firstly, that nations around the world are investing in a low-carbon future in line with national interests. Last year, climate finance investments were split almost equally between developed and developing countries, with USD 164 billion and USD 165 billion respectively. With almost three-quarters of total investments being made in their country of origin, the majority of climate finance investments are motivated by self-interest—either for governments or businesses. Motivations include increasing economic productivity and profit, meeting growing energy demand, improving energy security, reducing health costs associated with pollution, and managing climate risk including investment risks.

Secondly, that getting domestic policy settings right offers the best opportunity to unlock new investment. When policy certainty and public resources balance risks and rewards effectively, private money follows. In 2013, private investments made up 58% of global climate finance with the vast majority (90%) of these being made at home where the risk to reward ratio is perceived relatively favorably. Addressing the needs of domestic investors offers the greatest potential to unlock investment at the necessary scale. This is not to say that international and domestic public policies, support and finance don’t have complementary roles to play. It is significant, for instance, that almost all of the developed to developing country finance we capture in our inventory of climate finance flows came from public actors. But ultimately, it is getting domestic policy frameworks right, with international support where appropriate, that will drive most of the necessary investment from domestic and international sources.

Thirdly, that despite a fall in overall investment, money is going further than ever. While investment fell for the second year running, this is largely because of decreased private investment resulting from falling costs of solar PV and other renewable energy technologies. In some cases, deployment of these technologies is staying steady or even growing, even though finance is shrinking. In 2013, investment in solar fell by 14% but deployment increased by 30%. Technological innovation is reducing costs and because of this renewable energy investments in some markets are cheaper than the fossil fuel alternatives, particularly in Latin America. Achieving more output for less input is one of the basic foundations of economic growth, so this is great news. From solar PV, to energy efficiency and agricultural productivity, growing numbers of low-carbon investments are competing with or cheaper than their high-carbon counterparts. This despite a highly uneven playing field in which global subsidies to fossil fuels continue to dwarf support for renewables and where carbon prices do not reflect the true costs of emitting CO2.

So what do our findings mean for the recent China/U.S. deal and Green Climate Fund pledges? Increasing political pressure on other countries to keep pace in terms of their domestic action and international commitments is an encouraging sign as the deadline nears for finalizing a new global climate agreement in Paris just one year from now. Reaching a global accord offers the best prospect for tackling climate change. But we must recognize that international agreements are themselves, guided by collective national interests. There is clear recognition that international public resources should complement and supplement national resources where these are insufficient. But if we are to bridge the investment gap they should also be focused on finding ways to lower costs, boost returns and reduce risks for private actors. Public finance alone will not be enough to meet the climate finance challenge.

Many private investors are ready to act. In September, over 300 institutional investors from around the world representing over $24 trillion in assets called on government leaders to phase out fossil fuel subsidies and implement the kind of carbon pricing policies that will enable them to redirect trillions to investments compatible with fighting climate change. Businesses and citizens are investing, and technological innovation means more and more investments are making economic and environmental sense. Accompanying innovation with policy, appropriately targeted finance and new business models can build the momentum and economies of scale to make the low-carbon transition achievable. The low-carbon transition isn’t just a way of reducing climate risk, it also represents a huge investment opportunity.

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Why policy matters for institutional investment in renewable energy

May 23, 2013 |

 

Institutional investors steward a large fraction of our society’s wealth. In OECD countries, pension funds, insurance companies, endowments, foundations, and sovereign wealth funds collectively manage over $45 trillion in assets ($71 trillion if you add in other investment managers and pension assets outside of pension funds). Needless to say, the financial security of these institutions is a matter of significant public importance.

Many of these institutions have investments in carbon-intensive assets – such as coal, oil, and gas extraction companies – which could have less value in a climate constrained world. Recently, policymakers, the public, and beneficiaries of these institutions have begun to call on institutions to divest from fossil fuels to reduce their exposure to this potential risk.

Another option may be to increase investment in low-carbon assets like renewable energy. To date, however, not much research has addressed the policy constraints on increasing institutional investment in low-carbon assets.

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Expanding green finance: What’s already working and what’s next?

December 5, 2012 |

 

Despite reaching $364 billion in 2010/2011, global investment to combat climate change still falls far short of the level required to stabilize global temperature rise to 2°C. According to the IEA, we need to reach $1 trillion each year of incremental investment in energy supply and demand technologies, and more will be needed to achieve climate resilient development globally.

Policymakers and others will need to scale up what’s working, and explore new approaches to pool more capital from the private sector. However, investors’ real and perceived risks are increasing as a result of stalled international negotiations and national policy frameworks reforms.

On the 20th and the 21st September, Climate Policy Initiative hosted the Second Meeting of the San Giorgio Group (SGG) on the island of San Giorgio Maggiore in Venice to discuss what’s already working in green finance, what’s not working, and to identify new options to bridge the gap between supply of climate investment and the demand for mitigation and adaptation finance. Here is a summary of some of the highlights.

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