Climate Finance: Engaging the Private Sector

7/31/2019 Climate Finance: Engaging the Private Sector

1/32

C m e F ce:Engaging thE PrivatE SECtora baCkground PaPEr For Mobilizing CliMatE FinanCE,a rEPort PrEParEd at thE rEquESt oF g20 FinanCE MiniStErS

t s p pe w s p ep e y Shilpa Patel , he ,

C m e C e S e y Me cs, i e

F ce C p (iFC). i s se y c

w p s p e y e E pe b

rec s c de e pme (Ebrd)

Mck sey & C mp y. a m e s

c mme s p e y ibrd, iEg, oECd, Eib

a db e s ee c e . t e s

p s exp esse e e ecess y e ec

e ews e p e s

e mem e c es.


2/32

t e C e s

C ntext ................................................................................................................................... 1

Structure f paper ................................................................................................................ 2

Secti n 1. Current Investment in Climate-related Activities ............................................ 2

Secti n 2. A Typ l gy f Private Sect r Investment ......................................................... 4

Secti n 3. A Private Sect r View f Risk and Barriers t Investment .............................. 6

Secti n 4. P licy and Financial Supp rt Required t Catalyze the Private Sect r ........ 10

a. P cy s pp .......................................................................................................... 10

b. S ces F ce.................................................................................................... 11

C. C cess F ce................................................................................................ 16

Secti n 5. Investment Required f r a 2C Pathway .......................................................... 21

ANNEX: Interesting Initiatives ........................................................................................... 25

Bibli graphy ................................................................................................ inside back cover

B xes

b x 1: C cess de tec c ass s ce E e new M e s............. 17

b x 2: C cess de C y e e W P we M e Mex c.............. 17

b x 3: g ee/r s S e P c s P m e de e pme o jec es........ 18

b x 4: tec c ass s ce i e y E e y E fc e cy opp y................... 19

Figures

F e 1: W w e w-c es me 2010 (uSd pe m)....... 3

F e 2: M pp s ces f c s es w-c ec ye e pme .................................................................................................. 4

F e 3: t ee m c e es e s es me s w-c sec s.................................................................................... 8

F e 4: d mes c e e e s ess e s w-ces me ..................................................................................................... 9

F e 5: Mdb es me e e e s m , 2010....................... 14

F e 6: le e e c s iFCs c m e- e e p .................................. 15

F e 7: le e e c s Ebrds c m e- e e p .............................. 15

F e 8: i es me ee s 2C p w y (uSd , e e

es me )................................................................................................... 21F e 9: S y e M a eme C s C e.................................................. 22

F e 10: app p e mec sms e y c y............................................. 23

F e 11: app p e mec sms e y sec ................................................ 23

Tables

t e 1: r s s F ce y P e Sec i es s de e p C es.................. 7

t e 2: b e s Se ec e C m e Sec s de e p C es.................. 10


3/32

C m e F ce:Engaging thE PrivatE SECtor, novEMbEr 2011

C exThe Secretary-Generals High-level Advisory Group onClimate Change Financing (AGF) was set up with a cleartask: to identi y how to mobilize the USD100 billion

per year by 2020 that was promised or climate changein Copenhagen in December 2009. The ensuing reportconcluded that it was challenging but easible to meet thisgoal, and identi ed the private sector as being critical to thee ort. A unctioning carbon market, with carbon prices inthe range o USD20-25 per ton, as well as judicious use o public unds, could generate around USD100-200 billiono gross private capital fows or mitigationor net fowso between USD10-20 billion.1

With respect to the private sector, the report analyzed thebarriers to private investment in mitigation and adaptation,discussed the options or deploying public sectorinterventions to overcome these barriers, and attemptedto estimate the potential scale o international privateinvestment. Key ndings are that the potential or privateinvestment is substantial, but that to unlock these fows, a range o existing country and project speci c barriers willneed to be overcome. This in turn will require appropriatedomestic and international public interventions. Domesticpublic policies and programs, international publictechnical assistance and nancial instruments, and carbonmarkets all represent the tools or levers that can be used toovercome market ailures. The report suggested that thelarge potential or private investment to achieve climate-

related objectives justi es using a substantial share o thepublic nding available to stimulate this investment.

1 The AGF report introduces the concept o net bene ts o gross private fowscalculated as the reduction in returnthat a private investor is prepared to accept or the risk-mitigation or revenue enhancement provided by public

unds. This portion represents a net gain to the recipientcountry.

The report concluded that International privateinvestment fows are essential or the transition to a low-carbon, climate-resilient uture. These investments can be

stimulated through the targeted application o concessionaland non-concessional public nancing. Care ul and wiseuse o public unds in combination with private unds cangenerate truly trans ormational investments. Further work is recommended on nding the most e ective use o grant

unding or climate actions.2

The present paper attempts to build on the analysiscontained in the AGF report to explore in greater detailissues related to private nancing o low-carbon investment.Obtaining consistent data across the wide range o privateinvestment fows directed to climate is a di cult task,since there is no systematic global data capture mechanismcovering such fows. Climate nancing is not disaggregated

rom other private investment fows, and the coverageprovided by specialized market analysts and industry groupsis patchy. However, there is one class o market player thatis active in supporting climate-related private investmentin developing countries: multilateral development banks(MDBs) that operate in the private sector. These banks dotrack the nancing they provide, and have experience indeploying several o the instruments that the AGF reportre ers to (technical assistance, concessional and non-concessional public nance). They represent, there ore,a reliable and ready source o in ormation that can be

analyzed to shed greater light on questions surrounding private sector climate nance.

2 Advisory Group on Climate Change Financing (AGF).(2010). Report o the Secretary-Generals High-level Advisory Group on Climate Change Financing , November 2010.United Nations. para 28, p 10.


4/32

2 Climate Finance: Engaging the Private Sector

S c e p peThis paper is ocused on climate-related investmentin developing countries. It provides the reader withan overview o climate-related activities, clari es theterminology and discusses the sources o nance andpublic support.

1. Section 1 gives an overview o current investment inclimate-related activities.

2. Section 2 de nes a typology o private sectorinvestment according to stage o technology development and type o project/investment.

3. Section 3 outlines the risks aced by a private investorin emerging markets, how these risks are typically mitigated, and discusses how barriers to low carboninvestment can exacerbate these risks.

4. Section 4 discusses the di erent types o supportrelevant or the private sector and, building onthe experience o the EBRD and IFC, the leverageassociated with the di erent project types andsupport sources. Case studies o innovative use o concessional nance are also provided.

5. Section 5, using the two main available sources o in ormation, assesses the level o investment that willbe required or a 2C pathway and concludes with a description o the support mechanisms that will beneeded to mobilize private fows.

6. An annex provides a list o interesting initiatives

being implemented by other intergovernmentalorganizations and agencies that also speak toimproving private sector engagement in the climateinvestment space.

SECTIoN 1. C e i es me C m e- e eac es

It is surprisingly di cult to obtain consistent andcomparable data on climate-related investment, since theentities that report such data use di erent de nitions o climate nance and report on di erent aspects o it. There isno standard de nition o climate nance that is universally used. While there is one statistical system in place thattracks international public climate nance in the ormo ODA,3 it largely covers only bilateral donors. No suchdata or statistical system exists to de ne and track privateclimate nance. Most data sources that track investmentdo so or renewable energy and energy e ciency; someinclude low-carbon transport. Furthermore, investments

are not tracked consistently and separately or public and

3 The so-called Rio Markers are policy markers that areused to monitor climate change speci c aid. See OECDDevelopment Assistance CommitteeCreditor Reporting Service (DAC-CRS).

private sectors or or emerging or developed markets. Inaddition, private climate nance data, limited as it is, tendsto be commercial and available only upon subscription.4

From estimates by PEW and HSBC, shown in thechart below (see Figure 1),5 it appears that in 2010, overUSD200 billion were invested in low-carbon investmentin developing countriesabout 40% o total investment.China alone accounted or two-thirds o the totalinvestment going into developing countries, with Brazil,India, Mexico and Turkey accounting together or close toone- th.

4 See also Buchner, Barbara, Jessica Brown and Jan Cor ee-Morlot. (2011). Monitoring and Tracking Long-term Finance to Support Climate Action.May 2011. OECD/IEA Project

or the Climate Change Expert Group on the UNFCCC.5 The estimates were derived using data rom PEW (2010).

Whos winning the clean energy race? G-20 Investment Powering Forward.Pew Charitable Trust and Robins, Nick et al. (2010). Sizing the climate economy . September 2010.HSBC Global Research.


5/32

Climate Finance: Engaging the Private Sector 3

Renewable energy accounted or over 40% o totalinvestment globally (both developed and developing), within renewables, wind alone accounted or 46% o investment with solar coming in second with 34%.Energy e ciency (EE) and low carbon transport consisto transport e ciency (approximately 40%), building e ciency (around 30%), industrial e ciency (around20%) and energy storage and smart grids (around 10%).The private sectors share in these fows is not known withany certainty. One estimate indicates that private climate

nance provided between USD60-160 billion over 2008-2010; the broad range o estimates is symptomatic o thelow quality o data.6 Recent UNCTAD estimates suggest

6 Stadelmann, Martin, Paula Castro, Axel Michaelowa. (2011). Mobilising Private Finance or Low-Carbon Development .September 2011. Climate Strategies.

that FDI fowing rom developed to developing countriesin this area amounted to about USD37 billion in 2008.7 Renewable energy accounted or hal o the new electriccapacity added globally in 2010, with investment indeveloping countries surpassing that in developedcountries.8 However, as described in the section below,private sector climate-related investment encompasses a broader range o activities than those covered by these data sources, and so the estimates are likely to be understated.

7 UNCTAD (2010). World Investment Report: Investing inLow Carbon Economy 2010.

8 REN21 (2011). Renewables 2011 Global Status report Paris:REN 21 Secretariat.

Figure 1: W w e w-c es me 2010 (uSd pe m)

By region/country By sector

Total

R&D

Subtotal

Developedcountries

Total developingcountries

Other developingcountries

Turkey

Mexico

India

Brazil

China

Total

EE & lowcarbon

transport

Efficiency &low carbon

tech/services

Biofuels

Otherrenewables

Solar

Wind

10

6

3

28

81 119 200

54 80 13540 69

127 187 314

208 307 515

35

243 307 550

19

80

28

20

6

109

119 187 307

214 336 550

Low carbon energy EE & carbon transport 1

Developing countries 2

Developed countries 2

1 EE and low carbon transport allocated proportionally (Total EE & low carbon transport in 2010: USD180 billion)2 Pro-rated split between developing and developed countriesSOURCE: PEW, HSBC, team analysis


6/32


SECTIoN 2. a typ y P e Sec i es mePrivate sector climate-related activities encompass a widevariety o sectors and project types; most (i not all) areconcentrated on mitigation. The diagram below showsthe stages o low-carbon development and deployment, as well as the fnancing sources typically associated with them(Figure 2). Research will typically be unded by government,even i undertaken by the private sector. Technology development is generally fnanced by early-stage venturecapital and private equity frms interested in making technology bets and prepared to take a port olio approachto risk. Once there is proo o concept, manu acturing andcommercial deployment o the technology can be fnancedby public equity markets; o ten, established players will

acquire new technology through acquisitions. In addition,debt and project fnance come into play in scale-up andcommercial roll-out o the interventions.

Most deployment o low-carbon technology in developing countries will take place at the later stages o this continuum.Di erent nancing sources come into play at the di erentstages. For the types o investment typically encounteredin developing countries, nancing comes rom equity,both private and through public markets, and throughdebt. Most MDB nancing has been or projects at the

manu acturing scale up and asset nance (project nance)level. Sources o nance or low-carbon investment indeveloping countries are discussed in Section 4. Althoughcarbon markets have provided resources to low-carbonprojects via the Clean Development Mechanism, overallfows have been small relative to investment needs.9

Within these development stages, the types o low-carbonprojects typically encountered in developing countries aredescribed below.

re ew e E e yRenewable energy (RE) capacity investments use a

range o technologies, each representing very di erentcharacteristics. Such projects can be both grid-tied ando -grid. Traditionally, renewables consisted o biomass,used or heating and cooking, and hydroelectricity. New renewables include wind, solar, geothermal, small hydro,modern biomass and bio uels. Together, renewablescomprised one-quarter o global power capacity rom allsources and delivered 18% o global electricity supply in2009.10 Availability o limited recourse project debt is key to acilitate the growth o independent power producersdue to the capital intensity o the sector.

9 Carbon nance is the subject o another background paperand is not discussed here.

10 REN21 2011.

Figure 2: M pp s ces f c s es w-c ec y e e pme

Process Funding

Government

TECHNOLOGYRESEARCH

TECHNOLOGYDEVELOPMENT

MANUFACTURINGSCALE-UP

ROLL OUT(ASSET FINANCE)

Venture Capital

Private Equity

Public Equity Markets

Mergers and Acquisitions

Credit (Debt) Markets

Carbon Finance

SOURCE: Bloomberg New Energy Finance


7/32


Renewable energy technologies are at di ering stageso cost-competitiveness with conventional ossil- uelbased energy, with some technologies at or close to grid-parity. Not surprisingly, private investment fows to thosecountries where a suitable policy regime is in placemorethan 100 countries have enacted some type o policy target with respect to renewables, including renewable port oliostandards requiring the provision o a certain share o electricity rom renewable sources, and pre erential priceand tari support. Developing countries account or morethan hal o global renewable power capacity, and makeup more than hal o countries with policy targets orrenewable energy promotion policies.11

E e y E fc e cyEnergy e ciency (EE) represents a signi cant emissions-reduction opportunity and also encompasses a wide array o sectors. Energy e ciency improvements can take placeon both the demand and the supply side, and commonly represent the least-cost option or reeing up generationcapacity. Improvements in generation, transmission anddistribution (here called Power Energy E ciency or PEE)result in more e cient supply o energy. On the demandside, improvements in energy use in buildings, appliancestandards, lighting, industry, transport can all contribute

signi cant reductions in overall energy use.

PEE projects will generally take place in the power utility through balance sheet nancing and the issue o corporatedebt. Industrial Energy E ciency (IEE) lends itsel toboth this type o direct nancing and indirect nancing through nancial intermediaries, e.g., leasing companies.Since many IEE projects are small in size, MDBstypically nance them via a nancial intermediary (FI)in the country concerned. This intermediary could be a local bank or private equity und, or an Energy ServiceCompany (ESCO).12

rE EE s pp y c sIncreases in Renewable Energy and Energy E ciency investment will require a corresponding increase in themanu acturing o components that eed in to the RE andEE supply chains. Examples o such components include

11 REN21 2011.12 An ESCO is a business that develops, installs and arranges

nancing or energy e ciency projects or a third party,typically sharing in the cost savings with the recipientthrough contractual arrangements.

wind turbines, or solar photovoltaic devices such as solarcells and modules, and building insulation materials.

W s e M emeThe collection, transport, processing, recycling and disposalo wasteboth liquid and solido er energy generationand EE opportunities. Activities typically encounteredinclude land- ll gas capture or waste-to-energy projects.Livestock projects with manure management or emissionsmitigating eatures could also o er private sectorinvestment potential.

a c e F es yTo date, private sector interventions in carbon-sequestering agriculture and land use activities, as well as orestry, havebeen limited seen rom the MDB nancing perspective.However, these could well represent signi cant privatesector investment potential going orward.

C e ecCleantech is a cross-sectoral investment theme. For thepurposes o this paper, cleantech investing re ers to ventureand growth capital stage investments in companies whoseproducts and services support signi cant natural resource

e ciency and/or pollution abatement (including, butnot limited to, GHG emissions abatement). The rangeo sectors cleantech covers is broad; however, EE andRE sectors dominate investment volumes. In sustainableenergy, sub-sectors include: new renewable energy technologies or business models (particularly solar);industrial and end-user energy e ciency; advanced energy storage; and bio uels. Other cleantech sectors include: ITapplications or process monitoring and control to supportresource e ciency ( or example, smart irrigation and smartcold chain management); more e cient water use, waste water treatment, or desalination technologies; sustainableagriculture ( or example, sustainable pest control, saline ordrought resistant seeds); clean transport; green buildings;bio-chemicals; recycling. Limited clean technology development takes place in developing countries: three-quarters o the over USD8 billion venture capital nancing in 2010 among G-20 countries took place in the UnitedStates, with China in a distant third place at aroundUSD300 million.13

13 PEW 2010.


8/32


a pThe private sector will not be immune to climate risk and impact, and will have a role to play in adaptationinvestments. An activity could be considered an adaptationinvestment i it reduces the risk, exposure or sensitivity o human or natural systems to climate change; increasesclimate resiliency; builds problem solving capacity todevelop responses to climate change or addresses impactsexclusively linked to climate variability and change. Inpractice, it is very di cult to disaggregate that portiono an investment that is linked to adaptation and that which is sound development. Building climate resiliency into project design, particularly or long-lived assets;incorporating climate models into hydrological surveys

or dam construction; taking climate considerations intoaccount when designing and building new in rastructure incoastal areasthese are all examples o sound developmentin the ace o a changing climate. Given the relatively limited experience to date in private sector adaptationinvestment, it has not been possible to develop a typology

o private sector adaptation investment, much less draw any lessons on nancing structures or leverage. TheOECD DAC database indicates that multilateral support

or climate change adaptation amounted to USD12.2million on average over 2008-09; it is not known how much, i anything, was directed to the private sector. Data on bilateral support or climate change adaptation willbe available at the end o 2011.14 UNEP estimates thatbilateral support to adaptation amounted to close to USD4billion in 2009 rom our institutions alone.15 However, as

with other published in ormation on climate nance, thereare a number o de nitional caveats, and the portion o the fows directed to the private sector remains unknown.

Clearly, this is an area where urther work is needed.

14 OECD-DAC (2011). Tracking aid in support o climate change mitigation and adaptation in developing countries .September 2011. www.oecd.org/dac/stats/rioconventions

15 UNEP (2010). Bilateral Finance Institutions and Climate Change A Mapping o 2009 Climate Financial Flows toDeveloping Countries . UNEP 2010.

SECTIoN 3. a P e Sec v ew r s b e s i es mePrivate rms make investment decisions based on theprojects commercial viability. Prospective investments arethus expected to cover the ull costs o the project, including the cost o capital, and achieve a return commensurate withthe risks associated with a particular project. This principledrives private investment across economies, rich and poor.

r s s F ce y e P e Sec e

MTable 1 below provides a typology o risks likely to be acedby a private sector investor in any investment in emerging markets. It does not purport to be exhaustive; neither is itmeant to imply that all projects ace all these risks in allemerging markets. It is provided as an illustration o therisks that an investor will consider in a typical nancialassessment o an investment proposition.

At the project level, the key risk will be the overallnancial viability o the projectcost structure, markets,

availability o inputs and certainty o revenues, to namea ew de ning actors. Technology risk would includerisks associated with high rst-mover costs and unprovencommercial application o a new technology. A numbero country risk actors will come into play, including regulatory issues related to pricing, protection o property

rights, tax and subsidy regimes and contract en orcement. A oreign investor will want access to oreign exchange andthe ability to hedge exchange risk. Other sovereign risksrelate to nationalization, overall economic and politicalstability o the country in which the investment takesplace, and the ability to repatriate pro ts. Financing risk concerns the availability o nancing at a ordable cost andrequired tenors.


9/32


The private investor will invest in those activities and inthose countries where the risks identi ed above can bemitigated. The bulk o climate-related investment currently takes place with existing mitigation instruments or therisks identi ed above. Project risk is assessed throughthe investors due diligence process, and addressed in theproject structuring. A strong contractual agreement witha creditworthy party may mitigate the projects o takerisk; insurance products may provide com ort on businessinterruption; oreign exchange risk may be hedged wheresuch instruments are available. Political risk insurance cancover certain sovereign risks. Sometimes governments will

provide explicit undertakings, such as a eed-in tari andincentive tax regimes. MDBs are able to structure nancing packages that provide long tenors with de acto politicalrisk cover; they can also provide partial risk guarantees toprovide com ort to investors on government per ormance.

However, and particularly in the area o low carboninvestment, there exist certain barriers to investment, asdiscussed below, such that some o these commonly-usedmitigants may simply not be available, or would renderthe economics o the project unattractive. Low-carbontechnology o ten aces an incremental cost disadvantage,

or example. Increasing low-carbon investment will requirethat these barriers be addressed so as to bring perceived orreal project risk down to levels that can be mitigated by the market. However, there may still remain some risks or which public nance will be needed in order to catalyzeprivate capital fows in order to accelerate deployment o

low carbon technology. The key to achieving the maximumleverage o private investment per public dollar will beto mitigate such perceived or real risks using existing instruments and structures to the ullest extent possible,and using public unds as critical last resort support.

Table 1: r s s F ce y P e Sec i es s de e p C esriSkS invEStor nEEdS EXiSting inStruMEntS

P r o J E C t r i S k Costs capex & opex

Revenue volatility Resource risks Technology risk (higher i limitedper ormance track record or limitedmarket penetration)

Risk assessmentReturns commensurate with risk

Due diligence, easibility studiesCommercial insuranceCreditworthy o -take agreementsTurnkey construction contracts

C o u n t r Y r i S k

Regulatory risk Pricing policy market distortions

Weak IPR Tax and subsidy regimesContract en orcement

Foreign exchangeConvertibility Exchange rate stability

Sovereign risk Nationalization and appropriationEconomic and political situation o country

Policy certainty, clarity, longevity IPR protectionRule o law Repatriation o capitalMacroeconomic stability Political stability Political risk cover

Partial risk guarantees covering publicper ormanceHedge, swap marketsECAsMIGA MDBs

F i n a n C i n g

r i S k

Debt availability Adequate debt tenorsReasonable debt terms (limitedrecourse/collateral/leverage ratios)Equity availability

Access to nancing on terms thatprovide or adequate returns tosponsor equity

MDBsNDBsBilateral development banksIFIsCapital markets


10/32


b e s i es meBarriers to low-carbon investment may be nancial,structural or technical, as outlined in the chart below (Figure 3). Financial barriers will discourage local businesses,project developers, vendors, technology providers romo ering low carbon solutions to the market, and hamperinstitutional and market nancing mechanisms enabling such businesses to grow. Policy and structural barriers a ectthe viability and economic attractiveness o low carbonoptions, and policy and regulatory measures are essential

or pricing the carbon externality. Finally, neither policy nor nancing will achieve much i there are technology and technical capacity barriers that impede technologicaland business model innovation.

Addressing these barriers will require di erent domesticand international levers, as summarized in Figure 4. Firstand oremost is the right policy environment, conducive toprivate sector investment more generally, and to climate-related activity in particular. Fossil uel subsidies, stillprevalent in many countries, deteriorate the economics o low-carbon projects. Government intervention is requiredto create a level playing eld between energy sources:removing ossil uel subsidies16 and pricing the carbonexternality adequately will alleviate pricing distortionsthat currently work against RE and EE. Other policy andregulatory barriers or incentivesappliance standards, EEpoliciesneed similarly to be brought into coherence

to incentivize low-carbon growth. The chart below provides some examples o the sorts o policies requiredto encourage low-carbon investment. International nance

16 For a uller discussion, please see the ollowing paperprepared or the G20IEA, OECD, OPEC, World Bank:The Scope o Fossil-Fuel Subsidies in 2009 and a Roadmap or Phasing out Fossil-Fuel Subsidies , 2010.

Financial

Structural

Technical/Capability

Revenues(where unsubsidized)

Higher capital intensity

O&M costs

Risk

Network effects

Fragmentation andtransactional costs

Agency problems

Status quo bias

Immaturity

Awareness and education

Inability to price risk

Technical solution

Many fossil fuels still subsidized ($300 bn globally)and carbon externality not yet consistently priced

Many low carbon technologies face large overall capital needsand higher financing cost than high carbon alternatives

For some low carbon technologies O&M cost is high (e.g., offshore wind)

but typically lower than for low carbon alternatives

Many technologies rely on networks to happen (e.g., solar and windrequire flexible and sufficient grid capacity)

Many low carbon investments are small scale which makes them difficultto deliver and typically leads to higher transaction costs

In energy efficiency, the person paying for the investment is often not the onereaping the benefits

Markets are only evolvingcapacity needs to be built across the value chainincluding in the financial community

Lack of awareness of opportunity and understanding of the technicalsolutions available as well as their financial benefits

Inability to price risk due to limited historic data Cross-industry linkages make risk assessment more challenging

Products are inferior or perceived to be inferior on some usage dimensions(e.g., the case for energy efficient light bulbs)

Like with most changes, there is a bias in society for the status quo

Higher technology and financing risksLower market risk exposure

Barrier Description

Figure 3: t ee m c e es e s es me s w-c sec s


11/32


Figure 4: d mes c e e e s ess e s w-c es me

Financial

Structural

Technical/Capability

Price carbon externality Carbon pricing

Phase out of fossil fuel subsidiesSupport low carbon measures through effectivedomestic mechanisms (e.g., feed in tariffs)Reduce risk profile of low carbon investments(consistent and predictable regulation, guarantees,concessional capital)

Improve economics of investments through: Income support like feed-in tariffs Reduction of financing costs (e.g., concessional loans) Reduction of risk (e.g., guarantees)Share information on project risk /help to increasetransparency to reduce perceived risk Reduce political risk through co-investment

Use standards to overcome structural barriers, e.g., Vehicle efficiency standards

Building standardsDirect government support (including government

capacity development) to build related industriesCreate supportive environment (e.g., city planning;planning regulation)

Channel funds through local banks to build lending capabilitiesSupport governments to design and implementeffective regulation

Fund demonstration projects to build credibility /awarenessRun awareness /education campaignsEstablish independent technical expertise centersSupport R&DEncourage sharing of industry /risk data

Help to fund investments with demonstration effect /transformative effect

Role of international financeDomestic policy measures

can support these policies, but cannot substitute or themin any sustainable, e ective manner.

More speci cally Table 2 juxtaposes some o the key barriersand solutions identi ed above with the project typology developed earlier. What is common across all project typesis the lack o incentive or low-carbon investment createdby energy pricing distortions. Markets are still immaturein many o these technologies in developing countries, andmeasures to develop markets more generally, including awareness raising and building capacity to understandtechnical solutions, will be required to oster low-carbon

investment. This capacity building extends across the valuechain, including the nancial sector. There is value in

demonstration projects to build awareness and credibility.Risk reduction measures may also be needed to improverisk-return pro les and incentivize private investment.

Section 4 below describes in greater detail the policy andnancial support required to address these barriers and

risks, and provides some examples rom MDB experienceon the success ul deployment o technical solutions using concessional nancing and technical assistance.


12/32


SECTIoN 4. P cy F c S pp re e C y e e P e SecThis section is sub-divided into three parts. Part A describesthe main instruments o policy support that are needed

or low-carbon investment. Part B goes into the sources o nance typically available to nance low carbon activities,

including nancing o private sector investment by MDBs.Part C describes the instruments o concessional nancethat have been used to date and provides some interesting case studies o innovative nancing rom the experience o

EBRD and IFC, the two MDBs with the largest privatesector nancing experience.

a. PoliCY SuPPortPrivate frms make investment decisions based on theprojects commercial viability. Prospective investments arethus expected to cover the ull costs o the project, including the cost o capital, and achieve a return commensurate withthe risks associated with a particular project. This principlecan o ten lead to under-investment in activities promising

strong environmental and social benefts but lacking inrequired and reliable returns. In the climate space, the key externality is carbon emissions, the cost o which is not yetintegrated into decision making in any meaning ul way inmost parts o the world. Recognizing this, policymakers havelong experimented with alternative strategies to induce thedesired investment. In some economies, investments o thiskind are undertaken by the public sector, with risks and costs

borne entirely by taxpayers. Governments, seeking greaterimpact rom their limited resources, are now increasingly looking to approaches that leverage the capabilities, resources,innovation and e fciencies o the private sector.

Policy support is necessary to catalyze private investmentin low carbon technologies. Public support typically takesthe orm o regulation or policy that creates an incentiveto move a market in a desired direction. This can beprovided via a regulatory ramework or policy prescription

which applies market-wide and is not directed to any one

Table 2: b e s Se ec e C m e Sec s de e p C esProJECt tYPE kEY barriErS hoW to addrESS

rEnEWablEEnErgY

Fossil uel subsidiesLarge up- ront capital costSome technology risk Network e ects

Price externality Feed-in tari sPredictable regulationRisk reduction measuresNetwork upgradesDevelop project risk data

induStrialEnErgYEFFiCiEnCY

Energy pricing distortionsLack o standardsLack o ESCOs / in-house technical expertiseTransaction costsInability to price risk

Develop and en orce standardsLocal banking capacity Risk reduction measuresDemonstration projectsDevelop industry/risk data

buildingEnErgYEFFiCiEnCY

In addition to the barriers or industrial energy e ciency:

Agency problems

In addition to the measures or industrial energy e ciency:Reduce builder-user in ormation asymmetry by establishing building codes and per ormance standards

SuPPlY ChainSFor rE and EE

Dependent on downstream market Develop downstream markets or EE and RE

ClEantECh Weak local venture capital or private equity marketsMost technology innovation originating romdeveloped countries

Support local R&DSupportive tech trans er regimeSupport local venture capital / private equity unds


13/32


project or technology solution in particular. EE standards,or example, would apply market-wide, with any cost o

compliance being internalized by the project and passed onto the client. The client in this case could be the consumer, who may pay a higher price or the good in question, or thegovernment itsel , which subsidizes the program. Feed-intari s and/or RE port olio standards are another example o public support, with the cost o compliance generally being absorbed by the public sector. Depending on the nature o the subsidy and its delivery mechanism, the fnancing plan

or the private sector investment would be completed onprevailing market terms by all parties involved, or through a blended package o commercial and concessional fnancing.

It is important to make a distinction between policy rameworks that make a technology or a solution economically

viable and rameworks that enable commercialization andscale up by addressing the business environment, fnancing barriers, transaction costs and risk perceptions. Both arenecessary to encourage low carbon investment.

imp e C mpe e ess v y l w C tec es

Investment-friendly policies. Investment- riendly policies are critical to sustained private sector nancing

fows to developing countries. International money orspeci c climate-related nancing cannot replace ine ectiveor counterproductive policy. This point cannot be stressedenough. Investment- riendly policies speci cally gearedto climate include RE port olio standards, eed-in tari s(discussed below), EE standards and appliance standards.These would be in addition to policies that aim to increasethe overall ease o doing business.

Feed-in tariffs. A eed-in tari is a policy mechanismdesigned to accelerate investment in RE. It consists o revenuesupport through a long-term purchasing agreement at somepre-determined rate, typically based on the cost o generationo the RE technology. The rate is usually set to provideenough o an incentive to the RE producer, and typically incorporates some ratchet-down mechanism to incorporatetechnological changes and cost reductions over time.

Energy pricing policies. Many developing countriessubsidize ossil uels or energy produced rom ossil uels.Such subsidies work against greater adoption o RE orEE. Energy subsidies are discussed elsewhere and will notbe addressed here, except to underline their key role inincentivizing low-carbon investment.

Carbon offset markets. Carbon markets can provide a signi cant revenue source that can help improve the returns

rom private sector projects in climate-related areas, and inmature nancial markets, nancing can, in principle, beraised against uture carbon revenues. However, this paperdoes not discuss carbon nance given that it is treated ingreat detail in another background paper.

Once there is a case or competitiveness o a technology orlow carbon option, there is a need or nancing to enablecommercialization and scale up.

b. SourCES oF FinanCE As illustrated in Figure 2, di erent sources o fnance willcome into play at the di erent stages o investment activity.These sources range rom outright government support(mostly or R&D activity) through venture capital anddebt and equity markets. This section also discusses MDBexperience in fnancing low-carbon investment and the roleo concessional fnance in catalyzing low-carbon investment.

P e S ces F ce A wide range o private sources can be tapped or the

nancing o private investment,17 as long as risk-returnexpectations are met. These include the private companiesthemselves, local, regional and global commercial banks,non-bank nancial institutions, leasing companies, privateequity investors and institutional investors.

Financing schemes can take on a wide range o orms andcomplexity. In its simplest orm, a private sector projectcould be nanced on the companys balance sheet whichitsel will consist o shareholders equity and short- andlong-term debt. Additional equity nance may be providedby private equity unds, or raised through capital marketsthrough share issues. Debt can be raised through borrowing

rom a bank, or through capital markets via the issuance

o bonds or other commercial paper. Financing planso ten increase in complexity with an increase in projectcomplexity, and a variety o nancial instruments may be utilized to complete a nancing plan in a large project

nance structure. For example, contractual arrangementsembodying eed-in tari s or other price support, such astake-or-pay provisions, can serve as collateral or otherwiseprovide com ort to lenders.

17 The paper re ers to long-term nancing needs; generally,the local banking sector is able to meet rms short-term

nancing needs.


14/32


Private fnance may be domestic or international. Somecountries have mature capital markets, while others may not be able to provide private equity or long tenor debtor even take the non-recourse project fnancing structuresupon which much privately fnanced in rastructure depends.In mature markets, international agencies can ocus onaddressing risk perception to catalyze private fnancing, while nascent markets may require a strengthening o thelocal fnancial sector and capacity building in order to do so.

g ee b sGreen bonds are themed bonds ocusing on low carboninvestments. The market or climate bonds is a nascentone, and there are very ew examples o green or climatethemed bonds being used to raise nancing by privatesponsors or low-carbon energy projects. However, MDBshave success ully raised nancing rom pension unds andinstitutional investors through such instruments. Whilethere are di erences in the design o these instrumentsbetween the di erent MDBs, in general proceeds o thegreen bond issue are ring- enced and applied to climate-related activities according to pre-de ned eligibility criteria.The IBRD and IFC have both issued green bonds, as havethe other MDBs, allowing them to reach new investorsand to provide traditional investors with a new asset class

o ten the rst taste that these investors have had o climate-related investment. The Climate Bonds Initiative o ers themost comprehensive listingalbeit not exhaustiveandprovides in ormation on 28 issues, o which more than hal are by MDBs or government entities. Nine issues are or wind or other renewables, and at least two o these havean explicit guarantee by a governmental agency. Total

nancing raised is in excess o USD12 billiono whicharound USD3.8 billion were raised by MDBs or projectsin developing countries. However, all the MDB greenbonds have been against the overall credit standing o theissuing institution (as opposed to the underlying project

credit). Furthermore, the nancing raised by green bondsoverall is a drop in the bucket when compared to the sizeo the global bond marketUSD95 trillion outstanding in 2010, including over USD6 trillion issued in 2010.18

18 See http://climatebonds.net/ The Climate Bonds Initiativeis a global civil society network and is a joint project o theNetwork or Sustainable Financial Markets and the CarbonDisclosure Project.

P c S ces S ppGovernments can support climate-related investmentby the private sector through a variety o mechanisms.Quanti ying the nancial value o such support is not,however, straight orward, since much o the support isimplicit and embodied in policies and conducive enabling environments. The cost o the policy is sometimes passedon to the consumer directly, or provided through budgetary support. Furthermore, public support can be domestic,provided through the host countrys budget, or it can beinternational, provided through public unds by donorgovernments as part o their o cial aid programs. Finally,the Global Environment Facility (GEF) and the ClimateInvestment Funds (CIF) are examples o mutlilateralpublic sources o concessional nance or climate-relatedinvestment in developing countries.

Export credit agency guarantees. ECAs provide unds(direct loans) or guarantees to acilitate exports. ECAs canremove the risk and uncertainty o payments to exportersby shi ting it to themselves in return or a premium. They can also underwrite the commercial and political riskso investments in overseas markets. In recent years, themajority o medium and long term o cial export creditfows that go rom OECD governments to developing

countries have supported GHG emitting sectors: transport(37%) and industry (26%), ollowed by energy projects(11%), o which about 1% is estimated to go to renewableenergy and energy e ciency in the power sector.19 Specialliberalized rules governing the provision o ECA support orrenewable energy and water projects were agreed by severalOECD countries, who are also engaged in negotiations to

urther strengthen the ability o export credit arrangementsto support action against climate change.20

b e S ppOECD-DAC estimates that USD9.4 billion were

provided in 2008-09 in the orm o bilateral o cialdevelopment assistance (ODA) or climate change relatedactivities, primarily mitigation.21 Indeed, climate changemitigation-related aid represented 7.4% o DAC memberstotal bilateral ODA, with the largest donors being Japanand Germany. These gures include contributions tospeci c climate unds, such as the Climate Investment

19 Buchner, Brown and Cor ee-Morlot 2011.20 OECD (2010) Arrangement on o fcially supported export

credits . January 2010. OECD.21 OECD-DAC 2011.


15/32


Funds. In addition, countries provide support through themultilateral system; in the same period, such assistanceamounted to USD429 million and was channeled throughthe Montreal Protocol, the Global Environment Facility and IDA. However, the portion o fows directed to theprivate sector is unknown; ODA generally fows to thepublic sector in recipient countries.

Another assessment o bilateral nance committed todeveloping countries is provided by UNEP,22 which coversdata rom our bilateral institutionsthe Agence Franaisede Dveloppment (AFD), Japans JICA, Germanys K W and the European Investment Bank (EIB23). According

to this report, these our institutions provided a total o close to USD13 billion towards mitigation and adaptationclimate nance to developing countries in 2009, with thelargest share coming rom JICA (USD6.4 billion). As canbe seen, even these two sources o dataOECD-DAC andUNEPraise questions o comparability and are di cultto reconcile by the lay reader. Collection and reporting o data are plagued by the amiliar-sounding litany o problems: a lack o universally accepted de nition o whatcounts as mitigation and adaptation nance; di erences inaccounting periods (not all institutions report data on anannual basis); and patchy or non-existent in ormation onfows to (and rom) the private sector.

Some interesting initiatives speci cally targeted to theprivate sector by bilateral assistance, working in partnership with MDBs, are presented in the Annex to this paper.

de e pme b sMultilateral development banks (MDBs) and their nationalcounterparts (NDBs) are an important source o fnance orclimate-related investment in developing countries. MDBsare able to provide tenors that are compatible with the needso climate-related investment, particularly RE. Annualinvestment by MDBs in mitigation activities in developing countries amounted to around USD19 billion in 2010, insupport o projects worth around USD60 billion (see Figure5).24 It is estimated that at least 25% o MDB fnancing

22 UNEP 2010.23 The European Investment Bank is more typically classi ed

as a multilateral development bank, which is also theclassi cation used in this report.

24 Assuming an average leverage o 3 times, and based onestimates o total climate-related investment in developing countries gathered rom various published sources and teamanalysis.

was or private sector projects. Since MDBs tend to play a catalytic role in the provision o fnance, they can mobilizemultiples o their own fnancing rom other sources.

Data gathered by Bloomberg New Energy Finance (BNEF)indicate that national development banks accounted orUSD5.8 billion in clean energy nancing in 2010.25 BNEFde nes clean energy as renewable energy, which does notcover energy e ciency, large hydro, or nance to supply chain projects like component manu acture. Wind andbioenergy were the biggest recipient sectors. NDBs coveredinclude Brazils BNDES, K W, AFD, China DevelopmentBank, the Indian Renewable Energy Development Agency

(IREDA) and the Overseas Private Investment Corp(OPIC) o the USA. Most NDBs are ocused on thecountry or region in which they are based. K Ws ocus,

or example, is described as being largely European. Theshare o the private sector in the reported NDB nancing is not available, but some NDBs have an explicit mandateo working with the private sector. OPIC has the speci cmandate o working with the US private sector to supportUS investment in emerging markets.26 BNDES client baseconsists primarily o private companies and entrepreneurs.27 However, assembling a true picture o nancial fows romthese institutions to private climate related activity remainsdi cult. IREDA is said to source more than hal its unds

rom other development banks,28 so the data presentedabove may include some double-counting. More work is needed to assemble a true picture o climate-relatedinvestment fows attributable to NDBs.

MDBs o ten play an honest broker role between hostgovernments and the private sector, providing com ortto both sides and enabling investment that might nototherwise have taken place. They can also pass on the de

acto immunities such as pre erential access to oreignexchange a orded to them by the host country to otherlenders within a syndicated transaction. Neither EBRD

nor IFC is able to provide concessional nancing or itsown account, but both have garnered signi cant experiencein channeling concessional nancing to climate-relatedprojects, since they serve as implementing agencies o the

25 Bloomberg New Energy Finance (2011).Clean Energy Research Note, The past, and uture, o development bank fnance to clean energy projects . April 2011. Bloomberg New Energy Finance.

26 http://www.opic.gov 27 http://www.bndes.gov.br28 BNEF 2011.


16/32


GEF and, more recently, access the Clean Technology Fund(CTF) to create blended nancing packages in supporto low-carbon investment in developing countries. Bothinstitutions also manage technical assistance or advisory programs in support o climate-related investment. Theseactivities are described in greater detail in Part C below.

Leveraging public resources with private unds A key element o MDB nance is leveragede ned asthe amount o private nancing that can be mobilized perdollar o public or quasi-public support.29

As mentioned earlier, there are very ew sources o reliableand consistent data on leverage in private sector climate

nance. MDBs active in private sector lending are onesuch source, with multi-year data sets on low-carbonenergy and climate-related nance. CTF is another source,

29 De nitions o leverage vary, making comparisons tricky.Leverage gures reported in Figure 5 mostly re er to privatecapital mobilizedwhich in the case o concessionalIDA-type loans may be small, even i the overall leverage orconcessional nance may be quite large.

although its recent establishment means that it may notyet have a very large number o private sector transactions

rom which to draw conclusions.

Both EBRD and IFC have a long history o private sectorinvestment, and data on climate-related investment istracked by both institutions. Figure 6 and Figure 7 show the average leverage actors derived rom IFCs and EBRDsclimate-related port olio, broken down by type o project.The data analyzed cover 353 projects or EBRD and 225projects or IFC over the period 2006-2010. EBRDsSustainable Energy Investment (SEI) model involves thesystematic provision o TA, provided on a grant basis and

unded by donors. IFCs Cleaner Production program alsoinvolves the provision o TA, but in the time period analyzed,it was limited to port olio clients or small incrementalinvestment volumes. Leverage ratios or activities thatbenefted rom some orm o concessional fnance are alsopresented. While both institutions have had access to GEFfnancing, IFC appears to have made greater use o it, buteven so, GEF unding has been used in only eight projectsin the time rame reviewed. Given the relatively recent

Figure 5: Mdb es me e e e s m , 2010

Financial flows Leverage ratio of private capital 4

Developedcountries FSF3

TOTAL

EuropeanInvestment Bank

AfricanDevelopment Fund

IFC

The World Bank

ADB

European Bank

IDB 3.6

3.3 1

2.7

3.9

1.3

2.7 2

19.2

~12

1.6 1

Annual Investments in mitigation activitiesUSD billions Leverage ratio Sample instrument

I n c r

e a s i n

gl y

c on

c e s s i on

al

IFC and commercialMDB lending

Highly concessionalIDA-type loans

3x6x

1x1.5x

Note: exchange rates used: 1=$1.501 For EBRD and IFC private sector lending main activity; for other MDBs share of total financing to private sector (separate window)2 Additional USD12.5 billion in climate change mitigation investments in the EU3 Part of funds through MDBs4 Leveraged capital can include additional public funds (e.g., local development banks), however except for large renewables very small share5 Financial data for 2010 only if without remarkSOURCE: GEF, MDB reports, WRI


17/32


Figure 6: le e e c s iFCs c m e- e e p

Leverage factor by technology, 20062010 average

Concessional financing

Reason for magnitude of factor

Climate relatedcomponents

Power sector EE

Industrial EE

Renewables-Hydro

Renewables-Other 4

7

4

2 6.8

9 2.0

12

8

SOURCE: IFC

Lack of familiarity, high internal transaction costs andmarket perceptions for new technologies reduce leverage

Likely that national development banks play large role

Lack of familiarity, high internal transaction costs andmarket perceptions for new technologies reduce leverage

Mostly established technologies with high capital intensity

Similar to general manufacturing projectsCompanies often with long-term supply contracts thatreduce percieved risk

141

2

3

1

3

4

5

73

46 20

15 112

38 6

28 14

USD millions Donorfunds

IFCtotal

Projecttotal

Project leverageIFC/Donor Project/IFC

Renewables 19.6 33.9 230.0

Industrial EE 96.7 862.9 1,720.4

Definition of leverage: project value divided by IFC lending (concessional + non-concessional) for climate related projects, weighted by project size.

Average IFC invest per project, in USD millions

Number of projects 20062010

Figure 7: le e e c s Ebrds c m e- e e p

1 Total SEI volume/grant volume2 Total project volume/EBRD volumeSOURCE: EBRD

Two biomass CHP plants & implementationof EE in adjacent pellet production plants

Enable Renewables lending through directlending facility

EE in a sugar production plant

Refinery EE

N.a.

Lighting replacement in a furniture factory

Public transport modernization

Heating and hot water EE

Gov. Program to fuel industrial andresidential EE

Enable commercial banks to lend to EE andsmall-scale RE

1

3

4

Project descriptionProject volume , in USD millionsGrant SEI EBRD Project

Project leverageGrant 1 Project 2

Renewables

Other

Municipal EE

Buildings

(Commercial)

Clean energyproduction(Power EE)

Industrial EE

20.1 51.6 51.6 64.5 969 1.3

8.5 75.0 75.0 150.0 9 2.0

0.6 26.6 54.3 57.9 44 1.1

0.1 102.0 225.6 721.5 1,028 3.2

0.1 64.2 64.2 406.5 524 6.3


18/32


advent o CTF fnancing, it is air to assume that the vastmajority o the projects undertaken did not beneft romany special concessional fnancing regime.

Leverage actors di er by sector. It is not surprising thatthey tend to be higher or established technologies andmore capital intensive projects, and lower or neweractivities where in ormational barriers and other marketperceptions may deter other nanciers rom participating in the nancing plan. For IFC, the leverage ratio or new renewables (other than large hydro) and or IEE tendsto hover around 4, which not coincidentally approachesIFCs overall nancing ratio o 25% or most real sectorprojects. Relatively high leverage actors are achieved inPEEessentially because these projects are very capital-intensive and large in size. They are also undertaken withestablished players and present relatively ew technologicalsurprises, and are thus able to attract other sources o

nance. In some countries, notably Brazil, NDBs play a very important nancing role in such projects. This is alsotrue or large scale hydroelectric projects. IEE, on the otherhand, tends to achieve relatively low leverage ratiosanaverage o 4 based on a sample o over 100 projects. Thisaverage gure masks important di erences, however: when IEE is undertaken through nancial intermediaries,leverage is considerably lower than this average, whereas

when IEE in undertaken directly with a client, leverageis higher. In the case o IEE via nancial intermediaries,MDB nancing is provided as a credit line to the localbank, which onlends the proceeds with a very smalladditional contribution rom own unds.

Component manu acture is in essence no di erentrom any general manu acturing project, and in many

cases, the company is likely to have a long-term supply contract or other o take agreement or the components itmanu acturesproviding com ort to lenders and reducing the perceived risk o the project.

IFC and EBRD calculate leverage ratios in di erent ways,although they report on their total climate nancing onsimilar and comparable terms. IFC calculates leverage asthe total value o the climate-related portion o a projectdivided by IFCs pro-rata share o the nancing planattributable to that portion. EBRD calculates leverage asthe total value o the project (including the non climate-related portion) divided by the value o the SEI nancing.

The leverage associated with EBRDs leverage actors alsoshows some variability.

But regardless o the di erences in calculationmethodologies between IFC and EBRD, what emerges

rom the above analysis is that MDBs lending to theprivate sector can mobilize signi cant nancing romother sources; that such multiples are higher or the moreestablished technologies and in areas where regulatory

rameworks are well-de ned; and that judicious use o TA can unlock signi cant investment opportunity in EE, where market awareness may be low.

C. ConCESSional FinanCEThere are typically three main rationales or providing concessional nance to private sector climate investments:(i) market ailures, which undermine economic e ciency;(ii) equity or distributional goals, such as promoting a ordable access to basic services to under-served people;and (iii) market development or policy goals, such aspromoting investment in innovative sectors.

The main market ailure relevant to private investmentis the existence o public goods or positive externalities,such that the social returns rom an investment exceedthe private returns expected to be captured by the investor.The market ailure could be a result o asymmetrical orimper ect in ormation. These conditions can result inunder-investment. The most important market ailure inmost o the world today is the lack o carbon pricing. Theprovision o some orm o subsidy or other orm o specialsupport can help to address this gap and even narrow the gap or uture investments through the learning thatemerges rom demonstration projects.

Beyond questions o market ailure, most societies embracevarious equity or distributional goals, such as enhancing the a ordability o basic services like clean drinking water and education to under-served groups. Targeting,incentive, and nancial sustainability issues are usually major considerations in the design o relevant strategies.

Output-based aid is one o several approaches or deploying subsidies to meet equity or distribution goals.

Governments may also choose to subsidize certain activitieson account o policy imperatives and to incentivize marketdevelopment. Pre erential tari s or renewable energy, ortax incentives or certain types o investment, are exampleso such support.

An increasingly critical role is or concessional nance toabsorb the gap in risk-return expectations o the market(private sector). This concessionality is typically provided


19/32


by the concessional nance taking a small, but moreadverse risk-return position in the nancing o a programor a project than the private sector, enabling the project tomove orward. Such structures hold the promise to unlock large private fows to low carbon investment in developing countries or relatively small amounts o public unds.

i s me s C cess F ceThe support con erred through concessional fnancing can bestructured through di erences in rate, tenor, security or rank,or a combination o these levers, as required by the projectand client to proceed with the project. These levers mostcommonly apply to debt products, but are also present in

guarantees/risk sharing products inso ar as those guaranteesreceive sub-market ees or the risk they cover and are o tende acto in a subordinated (rank) position as partial frst loss.

Debt productsConcessional debt products can be tailored to address thehigh cost o early market entrants, and are typically provided

to address issues o liquidity, tenor and cost o unds.Concessionality can be linked to the achievement o thedesired results through interest rate reductions, longer tenors,or with di erent rank and security packages (see Box 1).

Subordinated debt / Mezzanine fnancingSubordinated or mezzanine debt nancing with a lowerrepayment priority than senior loansmay be necessary to address a combination o risk and cost barriers in thesame transaction. This product can be use ul to strengthena projects equity pro le and to encourage additionalcommercial lenders to provide senior debt nancing. IFCused concessional subordinated debt to support one o the

rst wind projects in Mexico (see Box 2).

B x 1: C cess de tec cass s ce E e new M e s

TURSEFF, the Turkish Sustainable Energy FinanceFacility, provides a combination o commercial-priced

nance with concessional co- nance and substantialTA support to commercial banks in Turkey oron-lending to EE and small-scale RE. The acility will eventually cover ve local private banks, andis expected to lead to a total o 160 projects, withabatement o 232,000 t CO2/ year. The TURSEFFloan package consists o EBRD loans, complementedby concessional nancing and TA grant rom the CTF,in addition to TA rom the EU to support projectimplementation. The aim o the use o concessionalco- nance and grant in this case is to provide anincentive to private sector banks to enter a new market.By reducing the costs o the loans or the banks, theEBRD covers their expenditure in establishing thisnew line o business. The use o TA urther de-risksthe market entry, by ensuring that demand or thebanks loan products is stimulated through projectpreparation by technical specialists and more generalmarketing. TURSEFF is an element in the CTFCountry Investment Plans strategy or banking sectortrans ormation, which is jointly implemented by theIBRD, IFC, and the EBRD.

B x 2: C cess de C y e e WP we M e Mex c

In 2010, IFC used concessional fnancing rom theClean Technology Fund (CTF) to support one o thefrst private sector wind arms under the sel supply

ramework in Mexico. In addition to high costs (early market entrants were required to pay or the constructiono new transmission lines they would not use and which would beneft uture entrants), the sponsor experiencedearly-market-entrant challenges including an evolving regulatory regime and lack o a sector track record.IFC used a concessional debt product to rebalance theprojects risk-reward profle and demonstrate to otherinvestors that such projects could take on more debtthan current lenders are willing to take. By providing the project with a subordinated loan with concessionalpricing and an amortization schedule that includeda de erral mechanism, IFC/CTF was able to (a) helpcreate a fnancing package that covered approximately 18% o the additional costs the sponsor aced as anearly market entrant, (b) promote the creation o a track record which would reduce the perceived risk

or uture investors, and (c) encourage the continueddevelopment o wind projects. This project has already helped demonstrate the viability o wind developmentin Mexico. While the frst CTF transaction to benegotiated was unable to attract commercial banks,the second CTF transaction attracted two commercialbanks in the fnancing plan. There are now a number o large wind developers moving into this space withoutthe need or CTF support.


20/32


Guarantee / Risk-sharing products

When the perceived risks o investing in an activity promising strong environmental or social bene ts are themain barrier to investment, concessional unds can be used

in a subordinated position or structured products suchas partial credit guarantees, risk sharing acilities (RSFs),structured debt unds and securitizations. Client nancialinstitutions pay a below-market ee to receive the bene t o the guarantee coverage provided by the risk sharing acility on a port olio o assets. The coverage is typically providedto enable the client nancial institution to enter into new sectors promising strong social bene ts, but where theperceived risk is high, making market based pricing or the

rst loss tranche prohibitively expensive (see Box 3).

Equity/Quasi-equity products While subordinated debt has some o the risk pro le o

equity, it is primarily a structure that mitigates risk orsenior lenders; higher risk-taking equity, on the other handcan encourage developers to accept risks they otherwise would not by sharing in the equity risk. Equity may beneeded to support projects that have viable businessplans but where sponsors either do not have the nancial wherewithal to implement the project alone, cannotpersuade institutional investors to participate due to theoverlayering o sector speci c and developing country risk, or because project sponsors are unwilling or unableto shoulder the ull risks associated with entering a new and unproven market. The risk pro le o some early stage,highly innovative companies (e.g., cleantech companies)makes the use o even concessional debt inappropriate dueto the uncertainty o the size and timing o cash fows.

Technical assistanceIn some cases, the instrument required may be technicalassistance or project preparation support rather than orin addition to outright nance. Technical assistance andother advisory services may be required to help build theright enabling environment, to promote market awarenessamong consumers, or to build capacity o local personnelto devise, manage and monitor climate-related policy

rameworks. Advisory services o ten play a key role indisseminating the experience o the early movers thatbene tted rom concessional nance to other potentialmarket entrantsensuring an e ective demonstratione ect. At the project level, technical assistance may be a very e ective use o donor resources to create awareness o EE investment opportunities whose main barriers lie withsponsors lack o awareness, experience, or relevant skillsets (see Box 4).

B x 3: g ee/r s S e P c s P m ede e pme o jec es

The China Utility-Based Energy E ciency FinanceProgram (CHUEE), initiated in 2006, supportsmarketing, development and equipment nancing services to energy users in the commercial, industrial,institutional and multi- amily residential sectorsto implement energy e ciency projects in China.Under CHUEEs risk sharing program, IFC shares a certain percentage o the credit risk in port olios o loans originated and unded by the partner banks orenergy e ciency (EE) related projects. By sharing therisk in the EE loan port olio, IFC provides com ortto and reduces the risks taken by the partner banks.The rst loss portion o IFC and the banks exposuresis protected by Global Environment Facility (GEF)

unding. GEFs concessionally priced rst lossprotection makes the overall risk sharing programattractive or the partner FIs to enter the EE lending market with IFC. In addition, GEF also providedTA or capacity building in local banks. CHUEE isexpected to have signi cant developmental impact inpromoting energy e ciency, reducing pollution andgreenhouse gas emissions in China. This project waspart o an evaluation undertaken by the World BanksIndependent Evaluation Group in 2010 and one o thekey ndings was the importance to orient the programssubsidy element to the areas o market ailure. ThreeCHUEE programs have now been approved, each one with a lower amount o rst loss being covered. As o December 2010, the rst 142 sub-projects under theCHUEE programs were nanced by USD573 million

o IFC loans, backed by risk sharing acilities. Thetotal value o the investments so nanced is estimatedat USD1.18 billion, with emissions savings o 2.3 mt CO 2/ year. However, the banks have expanded their

nancing activities well beyond these amountswiththe total value o nancing estimated at USD1.7billion or 200 projects. While it is di cult to attributecausality to any one actor, the act remains that theseresults were achieved on the back o around USD26million o concessional nancing.


21/32


B x 4: tec c ass s ce i e y E e y E fc e cyopp y

Since 2008, EBRD has provided three loans with climatemitigation elements (a ourth one is to be signed thisyear) to Astarta, a sugar production company in theUkraine, helping to signi cantly improve the energy e ciency o the company. The transactions succeeded incombining investment in equipment, training, and carbon

nance, and thereby broke new ground in Ukraine. Therepeat transactions show the power o energy audits inuncovering savings potential. All the loans are given atmarket-equivalent interest rates, with no subsidy element.

Climate nance was market-based, through carbonmarket transactions. The only use o donor unding was in the provision o energy audits. This amounted toUSD150,000 in totaland resulted in loan nancing o USD54.3 million, including USD26.6 million o EEmeasures identi ed through energy audits commissionedby the Bank. The energy savings resulting rom theupgrade and modernization o equipment and heat supply systems brought the energy intensity o Astartas businessconsiderably closer to EU standards. Part o the 60,000 tCO 2 savings realized by the investment were purchased by participants o the EBRD/EIB Multilateral Carbon Credit

Fund. In order to increase the management capabilitiesin relation to EE, a grant unded Energy ManagementTraining was carried out or 20 Astarta engineers andspecialists in 2008. This will reduce reliance on externally

unded consultants in the uture, and ensure that Astarta will continue to pursue EE opportunities within itsbusiness. Grant support or the implementation o Energy E ciency Management Systems through the EBRDsShareholder Special Fund was also provided.

EBRDs Sustainable Energy Initiative (SEI) was launchedin 2006 and provides a unique combination o RE and EEinvestment nance, carbon nance and donor unds orTA ( easibility studies and energy audits), and investmentgrants (to address speci c market barriers). The trans ero skills to the local market is one o the long-lasting bene ts o this program, as nancial institutions andthe engineering community in the host country become

amiliar with international best practice. To date, 369projects have been nanced in 29 countries, with SEIinvestment o EUR6.6 billion in support o total projectvalue o EUR35 billion, and expected reductions o 39.6 mt CO 2/year.

Leverage in the context o concessionality

A review by the Independent Evaluation Group(IEG) o the World Bank Groups carbon nanceand climate change activities30 discusses exampleso leverage or low-carbon energy. According tothe IEG, leverage is the product o : (a) thechange in project resources mobilized by the instrumentconcerned and (b) the additional returns (including global bene ts) to the mobilized unds, relative totheir use in the absence o the instrument. Theconcept o net fows, evoked in the AGF report,also refects a similar, though complementary sentiment. The AGF de ne gross fows as the

total amount o private nance made available,and net fows as the value o the lower return thatinvestors are prepared to accept on account o any risk-mitigation that they receive through publicor quasi-public support (concessional nance, orexample, or MDB loans). Both IEG and the AGFrecognize that not all instruments that crowd inprivate capital (such as carbon o sets) do so in a

way that reduces expected required return.

IEG urther points out that a central problemor low-carbon energy investments is the needor relatively large amounts o up- ront capital,

together with the need or investors to be con dentin long-term promises to buy power or repay loans.IEGs ndingthat the ability o the World Bank and IFC to make long-tenor loans is an importantsource o leverage, though the leverage ratio isrelatively lowis equally applicable to all MDBs.

A teen year loan makes it much more easibleto meet debt service coverage requirements thana typical ve year commercial loan. Moreover, thedemonstration e ect can be trans ormative i localbanks were initially excessively risk-averse. IEG/CC2 also concludes that demonstration projectscan resolve uncertainty about technical and

nancial easibility. By doing so, they can increaseinvestors willingness to invest in an entire class o projects, rather than just a single venture.

30 IEG (2010). Climate Change and the World Bank Group, Phase II. The Challenge o Low CarbonGrowth. 2010. World Bank, IEG/CC2. Also, dra tnote on Lessons rom evaluation or the design o the Green Climate Fund . 2011. World Bank/IEG


22/32


Under the CTF and other concessional nance managedby IFC, the principle o minimum concessionality isemployed, refecting the idea that the subsidy included inconcessional nancing should be no greater than necessary to induce the intended investment. This approach seeksto accelerate trans ormation o nascent markets, andreduces the potential or market distortions. It alsoseeks to maximize the leverage o the resources availableto und subsidies. Determining the minimum level o support requires an evaluation o the individual marketand the barriers inhibiting investment. This can be a complex process to operationalize when trying to catalyzeunderdeveloped or absent markets, where there are no

obvious price signals. In some cases, it may be easibleto use competitive bidding to elicit market in ormation,such as when rival rms are invited to bid or projects onthe basis o the least subsidy required. Where competitivebidding is not easible, commercial negotiations willbe required, in ormed by relevant market benchmarks.

Where markets are in their in ancy, fexibility and coursecorrection should be designed into the approach toavoid market distortions and over-subsidizing, but alsoto respond to signals and move the market to achieve

the objective o the concessionality. To support e ectivemarket trans ormation, the level o subsidy providedto successive investments in the same market is usually reduced progressively to acilitate transition to nancing on ull commercial terms.

Similarly, EBRD has de ned a set o principles to ensureappropriate use o subsidies and avoid distortionary impacts, particularly relevant in the area o concessionally priced debt instruments which could have secondary impacts on nancial markets.

The subsidies embedded in concessional nance might takeone or a combination o several orms: the pricing o debtinstruments; the sub-market return expectations o equity investments; or the concessional terms o guarantees/risk sharing products. The approach ollowed to date hasbeen to tailor the most appropriate way o structuring thesubsidy to the particular barriers inhibiting the investment.

TA, although usually provided on a grant basis, is notgenerally seen as a subsidy to the provision o commercial

nance.


23/32


SECTIoN 5. i es me re e 2C P w yIn order to gauge investment needs or a 2C pathway, twosources o data were analyzed and compared. The rst is

rom McKinsey & Companys Climate Desk or the 2016-2025 time rame.31 The second is rom the World Energy Outlook.32 Figure 8 shows the projections by region andby sector. Given the various actors and uncertaintiesinherent is such orecasts, it is reassuring to nd thatboth sources come to a similar conclusion in overallmagnitudes o nancing required, albeit with di erentsectoral breakdowns. The data include both public andprivate sector investment. At the present time a breakdownbetween the two is not available.

McKinseys estimates are based on the assumption thatemissions need to be reduced by 14 Gt in 2020 relative tobaseline emissions o 58 Gt, which in turn is estimated to berequired in order to limit global temperature rise to 2C. A 450 ppm pathway with overshoot, with a 50% probability o limiting temperature rise, is used. The abatement mix prioritizes the di erent abatement measures according to

31 McKinsey Abatement Cost Curve 2.1.32 International Energy Agency (2010)World Energy Outlook .

2010. Paris: OECD/IEA.

their cost e ectiveness, which may not be borne out inreality. WEOs orecast is also based on their 450 ppmscenario, and is provided as total investment needs overthe 2010-2035 period, with annual investment needsderived by dividing by the number o years. AlthoughMcKinseys orecasts are available or 5-year periods, orcomparability with WEO, the relevant orecasts or thesame time rame were aggregated and similarly divided by the number o years to arrive at an average gure. This isa grossly simpli ying assumption; a more likely scenario

would incorporate investment ramp-up.

Regardless o the actual numbers, it is clear that investment

needs or mitigation are signi cant compared to currentinvestment fows. What will it take to mobilize privatesector nancing around these needs? Figure 9 attempts tomap out the nancial instruments and support mechanismsthat will be needed or di erent project types, juxtaposedon a stylized version o the amiliar McKinsey abatementcurve, and based on MDB private sector lending experience

Figure 8: i es me ee s 2C p w y (uSd , e e es me )

By region/country By sector

1 Russia, South Africa and the countries of the Middle East2 Annual average investment based on 2016-2025 total investment3 Annual average investment based on 2010-2035 total investment; for international transport only bunker fuelsSOURCE: World Bank analysis based on McKinsey Climate Desk, WEO IEA

McKinseyClimate

Desk 2

WEO globalenergy

outlook 3

OECD+

Other majorcountries 1

Other countries

Internationaltransport

100% = 698 720

McKinseyClimate

Desk 1

WEO globalenergy

outlook 2

Transport

Buildings

Power

Industry

BiofuelsOther

100% = 698 720

169

204

156

123

1729

290

225

97

80

280

317

248

121

13

320

232

125

44


24/32


to date. This chart reiterates the underlying message o thispaper: that mobilizing private investment in low-carbonactivities will need a combination o conducive policiesand tailored instruments to mitigate perceived risk.

One size will not t all, and the solutions will di errom country to country. Figure 10 examines some o

the instruments that could be used to promote privateinvestment, and maps their relevance based on overallmarket development. Market development embodiesmany thingsease o doing business, rule o law, capitalmarket development, vibrancy o the private sector. 33 Relatively sophisticated instruments such as eed-intari s presuppose a conducive regulatory ramework andreasonably well-developed capital markets. Instrumentslike rst-loss cover are less likely to be needed whenmarkets are well-developed and in ormation and otherbarriers to investment are low. In contrast, or guarantees

33 World Bank Group Doing Business 2011: Making a Di erence or Entrepreneurs 2011 discusses some o these

actors and provides a ranking o countries based on theoverall ease o doing business.

to work e ectively, a well- unctioning domestic nancialsector is needed. Developing countries with a high degreeo market development will be able to attract many sourceso nance, with limited MDB support needed; similarly,concessional nance may be less needed in markets wheremarket mechanisms are able to mitigate risk. Nonetheless,as discussed in Section 4, low carbon investment may stillpresent risk-return gaps which will need some degree o MDB and concessional nance support.

The appropriate mechanism will also vary by sector. Figure11 attempts to tie the various analyses together based on theMDB experience described above to provide an indicationo the state o play today and to suggest a road map o thesources o unding and types o support mechanisms that

will be needed to incentivize private sector investment by major project type. What will need to be explored, or eachcountry and market, is whether these sources o unding and support are available, and i not, what needs to bedone to unlock them.

Low carbon investment pre-requisites

SOURCE: Adapted from Pathways to a Low-Carbon Economy, Version 2 of the Global Greenhouse Gas Abatement Cost Curve, McKinsey & Company, 2009

Effective carbon pricing Carbon creditsTargeted systems for agricultureand deforestation linked tonational development agendasRisk mitigation (e.g., guarantees,subordinated debt, mezzanine,equity, concessional loans)Feed-in tariffsTA & capacity building

Renewable Energy(e.g., small hydropower,

wind, biomass, solar) Mechanisms to drive selectedkey technologies down thelearning curveResearch and developmentRisk mitigation (e.g., cost buy down, patient capital)CAPEX subsidiesFeed-in tariffs

CommerciallyUnproven Technologies

(e.g., carbon capture & storage,wave power, 2nd generation biofuels)

Regulation (e.g., technicalstandards for buildings,transportation)

Access to finance(e.g., credit lines)Risk mitigation(e.g., guarantees)TA & capacity building Carbon credits

Conducive policy environment (e.g., remove energy pricing distortions, price carbon externality, consistent and predictable regulation,overall ease of doing business)Clean technology (upstream): R&D, technology transfer, venture capital/private equity Supply chain (e.g., access to finance for component manufacture)

Awareness raising (e.g., education campaigns demonstration projects)

Energy Efficiency(e.g., lighting, HVAC, insulation,

industry, transportation)

A b a

t e m e n

t c o s t

GtCO e/yr

Financial instruments and support mechanisms to facilitate energy sector investmentsFigure 9: S y e M a eme C s C e


25/32


Figure 11: app p e mec sms e y sec

S urces f funding Financial supp rt mechanism other

BalanceSheet Banks

Financialinvestors

Capitalmarkets1 MDBs

Feed-intari s

Guarantees/frst-loss

Concessionalfnancing

Carboncredits/tax

Technicalassistance

Renewables [ ] Industrial energye fciency [ ] ? [ ] [ ] [ ] Building energye fciency (municipal,commercial, residential)

[ ] ? [ ] [ ]

Component manu actureRE and EE chain [ ] [

Climate Finance: Engaging the Private Sector

Documents

Transcript of Climate Finance: Engaging the Private Sector