Christopher Kaminker of the OECD has identified barriers to institutional investors filling the financing gap in sustainable energy investing, outlining recommendations to policy makers on how these barriers can be mitigated.
Mapping Channels to Mobilise Institutional Investment in Sustainable Energy, Christopher Kaminker
Over the next 20 years, the capital expenditure needed – in energy supply and efficiency – in order to get emissions consistent with limiting global temperatures to 2oC over preindustrial levels will top US$53 trillion, which cannot be reached without the capital controlled by institutional investors. Yet in 2013, large pension funds allocated just 1% of their assets to direct investment in infrastructure projects of any type, and only 3% of that infrastructure investment was in sustainable energy infrastructure.
Capital is available to be deployed for sustainable energy projects, but there is a dearth of bankable projects. In order to significantly boost the flow of capital to sustainable energy projects by institutional investors, governments need to consider policy interventions to make more projects viable for institutional investment.
Kaminker analysed 47 examples of investment by large pension funds in sustainable energy projects totaling in excess of US$8 billion, along with 20 examples of investment in companies engaged exclusively in sustainable energy activities.
He established a classification framework and set of investment pathways to illustrate how to classify a particular investment, to identify where investment is or is not flowing, and highlight how governments can support new investment channels.
The result is a review of the investment channels (instruments and funds) that can be used and the policy interventions that can enable these investments, either through mitigating risks (eg. guarantees or public stakes) or lowering transaction costs (eg. securitisation).
For instance, project bonds often can’t attain the investment grade rating required by institutional investors due to a lack of performance history, but policy makers can use public funds to improve their creditworthiness as is done with the EU project bond initiative. They could revise covered bond legislation to open up the market to sustainable energy, or pool smaller projects to create securities of an investable scale. Listed equity funds that pool projects, known as YieldCos, are a rising trend among institutional investors, raising approximately US$4.5 billion in the US and UK in 2014.
Risks and recommendations
Emerging markets will particularly benefit from sustainable energy investment, but bring specific and additional risks: foreign exchange risk, lack of a proven track record from the asset developer, liquidity risk affecting the ability to exit an investment and a lack of credit-worthiness of many state-owned power utilities as offtakers of the energy produced.
These are in addition to the broader set of risks, for which the author makes the following set of recommendations to policy makers:
- Improve the legal and investment regime underpinning sustainable energy infrastructure investments, strengthen competition policy and create a level playing field between independent and stateowned power producers.
- Institute a green investment policy framework to avoid sudden or retroactive policy changes. Address unintended consequences of other policies or regulation.
- Address market failures: improve electricity market design; put an explicit price on carbon; phase out fossil fuel subsidies.
- Establish a national infrastructure strategy and road map and create a credible sustainable energy pipeline.
- Develop liquid markets for sustainable energy infrastructure financing instruments and funds (eg. green bonds and YieldCos).
- Mitigate investor risks to attract private investment (e.g. credit enhancements and revenue guarantees).
- Reduce the transaction costs associated with sustainable energy investment and foster collaboration amongst institutional investors and financial institutions.
- Promote market transparency and standardisation.
- Consider establishing a specialpurpose green investment bank.
RI Quarterly vol. 9: Investing in a low-carbon world
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How policy makers can make sustainable energy projects bankable