INVEST4CLIMATE KNOWLEDGE SERIES ENABLING INSTITUTIONAL INVESTMENT IN CLIMATE SMART INFRASTRUCTURE TABLE OF CONTENTS © 2020 International Bank for Reconstruction and Development Some rights reserved This work is a publication of the World Bank. While believed reliable, the World Bank does not guarantee the accuracy, reliability or completeness of the content included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. © Kokouu/Getty Images Acknowledgements..................................................................................................................................2 Abbreviations............................................................................................................................................2 01 | Executive Summary ......................................................................................................... 4 02 | Key Concepts.................................................................................................................. 12 Objective ......................................................................................................................................... 12 Climate-Smart Infrastructure......................................................................................................... 12 Institutional Investors..................................................................................................................... 14 Refinance and Securitization......................................................................................................... 14 Report Focus and Alignment with the Paris Agreement.............................................................. 15 03 | Challenges and Opportunities to Close the Climate Investment Gap.................................20 The Climate Investment Gap.......................................................................................................... 21 Climate Investment Savings..........................................................................................................22 The Role of Governments and DFIs................................................................................................24 Climate-Smart Infrastructure and Institutional Investors ..........................................................26 Infrastructure Finance Options...................................................................................................... 27 Green Bonds and Green Securitization...........................................................................................30 Case Study 1: Clifford Capital CLO Infrastructure Take-Out Facility (Bayfront n.d.a.)................33 Attracting Institutional Investment..............................................................................................36 04 | Barriers to Institutional Investment in Climate-Smart Infrastructure ..............................38 Traditional Investment Barriers ..................................................................................................... 41 Case Study 2: Colombia’s Fourth Generation (4G) Roads Concession Program......................... 44 Case Study 3: Refinancing with Green Bonds: North American Development Bank (NADB 2018)........................................................................47 Case Study 4: Take-Out Financing Using AIF - Indian Renewable Energy Development Agency (Singh et al 2019)...............................................................................................................52 Case Study 5: Using Innovative Financial Tools to Refinance on Better Terms—kWh Analytics.........................................................................................................56 Case Study 6: Green Bonds Programme - Kenya (GBP Kenya n.d.a.)...........................................58 Climate Investment Barriers ..........................................................................................................59 Case Study 7: Green Asset-Backed Securities — FlexiGroup (NAB 2016).....................................63 Case Study 8: The Environment Positive Innovations for Cities Investment Planning Tool (EPIC).........................................................................................69 05 | Conclusion ..................................................................................................................... 72 References...............................................................................................................................................76 Appendix 1: Invest4Climate ...................................................................................................................82 Appendix 2: Types and Availability of Financing...................................................................................83 Appendix 3: Financial Regulations for Institutional Investors ............................................................85 Appendix 4: Definition for Private Sector Mobilization and Private Sector Catalyzation.................. 86 Acknowledgements This report was prepared under the auspices of IFC; Lori Kerr, Senior Infrastructure Specialist the Invest4Climate platform co-launched by the Global Infrastructure Facility and Lauren Carter, World Bank Group and United Nations Development Engagement Advisor, Invest4Climate UNDP. The Programme (UNDP). It is a collaborative effort authors would like to thank the following peer with the World Bank, the International Finance reviewers for their invaluable comments and Corporation, and the Global Infrastructure Facility. feedback: Stephane Hallegatte, Lead Economist Michael Grimm, Senior Financial Specialist, World Climate Change Group, World Bank; Satheesh Bank and Sandrine Boukerche, Climate Change Kumar Sundararajan, Senior Infrastructure Finance Specialist, Invest4Climate World Bank, led the Specialist IPG, World Bank; and Catiana Garcia- conceptualization and write-up of the report, Kilroy, Lead Financial Sector Specialist, FCI, World with contributions from Invest4Climate team Bank. The report was edited and designed by members Don Purka, Principal Investment Officer Phoenix Design. Abbreviations AIF Alternative Investment Fund LCOE Levelized Cost of Energy CFF Climate Finance Facility MDB Multilateral Development Bank CFLI Climate Finance Leadership Initiative MIGA Multilateral Investment Guarantee Agency CLO Collateralized Loan Obligation NADB North American Development Bank CSP Concentrated Solar Power OECD Organization for Economic Cooperation and Development DFI Development Finance Institution SDG Sustainable Development Goal IPCC Intergovernmental Panel on Climate Change UNDP United Nations Development Programme IREDA Indian Renewable Energy Development Agency Note: All dollar ($) amounts are U.S. dollars unless otherwise indicated. IFI International Financial Institution 2 © Nikada/Getty Images SUMMARY EXECUTIVE 01 01 | Executive Summary The world is not on track to address climate in their entirety in a single report; as such, the change. As countries move toward developing report highlights many key concepts and provides stimulus packages to stem the economic impact additional resources for further review. of COVID-19, it will be vitally important to build the foundation for a more resilient, sustainable and Decarbonization of the global economy is prosperous future (Stephen Hammer, Stéphane key to achieving the goal of limiting global Hallegatte & Ferzina Banaji 2020). The challenge warming (World Bank 2015b) and leads to a net of the low carbon transition starts with tackling benefit to society exceeding $26 trillion (GCEC the chronic lack of financing and the need to find 2018). Decarbonization requires the reversal new sources or leverage existing ones, especially of deforestation, the adoption of sustainable in emerging markets and developing countries. agricultural practices and the elimination of fossil This will involve spending public budgets better fuels from the world’s electricity generation, and smarter, making international public climate industrial and transportation systems (World Bank finance more transformative1 and leveraging the 2019c). Shifting energy infrastructure away from private sector (World Bank 2019d; World Bank Group fossil fuels and toward climate-smart solutions 2020; IFC 2016). While infrastructure investment can go a long way to solving the problem, as the gap estimates are complex to measure and vary burning of fossil fuels for energy is responsible for 73 depending on the scenario and assumptions used, percent of anthropogenic greenhouse gas emissions the need for significant investment in climate- (ClimateWatch n.d.a.). Decarbonization of energy smart infrastructure and the existence of a climate also will lead to significant energy efficiency gains, investment gap is clear, ranging from 2 to 8 percent reduced total energy requirements, reduced total of GDP annually by 2030 (World Bank 2019d). To close infrastructure investment requirements, increased the financing gap, private capital is necessary in all employment, lower total energy expenditures, and scenarios (World Bank 2015b). lower social and climate costs (IMF 2019; GCEC 2018; Jacobson et al. 2019; GSPP 2020). While the focus The objective of this report is to explore of this report is on mitigation investments, climate innovative financing approaches and case adaptation and resilience investments are also briefly studies for enabling institutional investment discussed as an important area for further in-depth in “climate-smart” infrastructure projects in research. Regardless, increased levels of climate- emerging markets that can help close the climate smart infrastructure investment are needed to reap investment gap. The successful implementation these rewards and close the climate investment gap of such approaches requires addressing policy, (World Bank 2019d). regulatory, and other barriers and could coincide with work that is already ongoing. This report is Climate finance is at record levels, but still short of intended not only for audiences at DFIs already what is needed. From $1.6 trillion to $3.8 trillion of familiar with infrastructure investment in annual investment is needed between 2016 and 2050 emerging markets, but also as a resource for those for supply-side energy system investments to keep institutional investors who are interested in, but global warming to less than 1.5°C (IPCC 2018). The less familiar with, investing in emerging market level of investment required to address the climate infrastructure. The interactions and frameworks crisis outstrips public budgets and the capacity of involved are complex and cannot be discussed DFIs to address. OECD pension funds alone hold more 1 The Transformational Climate Finance report (World Bank Group. 2020) identifies eight sets of levers to make international public climate finance more transformative: project-based investments; financial sector reform; fiscal policy; sectoral policies; trade policy; innovation and technology transfer; carbon markets; and climate intelligence. 4 Enabling institutional investment in climate-smart infrastructure than $27.6 trillion in assets under management but are often constrained in the types of investments they can make (OECD 2019). OECD institutional investors more broadly hold more than $100 trillion in assets under management (World Bank 2015), more than enough to close the gap. Recent years have seen a rapid increase in institutional investment in infrastructure and a growing concern with responsible investing, but © Philou1000/Getty Images institutional investors can face significant barriers to infrastructure investment, particularly in emerging markets. Governance structures are critical to enabling the necessary levels of infrastructure investment and are determined by governments (OECD 2017b). DFIs also have a critical role to play in providing technical assistance to help governments create bankable transaction structures and participating in blended finance structures to enable institutional investment. models of debt. Models to recycle equity, such as YieldCos and Clean Energy Investment Trusts are also Deploying institutional capital in climate-smart mentioned, and resources are provided for further infrastructure requires addressing the dearth reference. Refinance and securitization models also of bankable projects and not only leveraging enable DFIs and commercial banks, which are critical traditional approaches to infrastructure finance, at the project level to ensure bankability, to recycle but also enabling further use of green bonds and capital so they can lend to new projects at the levels securitization. The bond markets could provide an needed. Assuming the policy and regulatory barriers additional $1-$1.5 trillion annually in private sector that limit project pipelines are addressed, lenders are capital for climate-smart infrastructure through increasingly likely to face capital constraints. Basel III wider use of securitization (White & Case 2018). implementation may also limit the ability of lenders The refinancing of debt and the securitization of to offer the long-term loans that are critical to debt and equity in infrastructure projects creates infrastructure investment.3 As work to address policy opportunities for institutional investors to invest in and regulatory barriers to infrastructure investment climate-smart infrastructure even if they may not in emerging markets proceeds, designing the be able to invest directly in greenfield2 projects due enabling environment to facilitate later securitization to regulatory barriers, minimum diversification and will enable future capital recycling and institutional credit rating investment restrictions, a preference for investment. As the use of green bonds and securities brownfield projects, or a lack of budget or capacity to expands, methods to prevent greenwashing and understand each underlying asset and market. The ensure funds are directed toward climate-smart focus of this report is on refinance and securitization infrastructure also grow in importance. 2 The term “greenfield” refers to projects that are newly constructed as opposed to “brownfield” projects which are already in operation. 3 Basel III is a 2009 international regulatory accord that introduced a set of reforms designed to mitigate risk within the international banking sector, by requiring banks to maintain proper leverage ratios and keep certain levels of reserve capital on hand. See: https:// www.investopedia.com/articles/economics/10/understanding-basel-3-regulations.asp 5 Chapter 1 | Executive Summary The first chapter of the report introduces key investment as demonstrated by case study 2 concepts related to the need for increased levels – Colombia’s Fourth Generation (4G) Roads of climate-smart investment and the potential of Concession Programme. refinance and securitization as a tool to facilitate further institutional investor involvement. The second 3. Green bond issuance and refinancing approaches chapter discusses the challenges and opportunities to provide local financing and address currency to close the climate investment gap, highlights the exchange rate and inflation risk as demonstrated different roles of government, DFIs, and institutional by case study 3 - Refinancing with Green Bonds: investors, and the opportunity to use green bonds North American Development Bank (NADB). and green securitization and other methods to attract institutional capital. The third chapter reviews and 4. Concessional capital and alternative provides a framework to examine the interconnected investment funds to address financing layers of investment barriers specific to institutional barriers such as limited local financial market investment in climate-smart infrastructure. capacity as presented in case study 4 - Take- Considering these barriers together allows investors Out Financing Using AIF - Indian Renewable and other stakeholders to better understand the Energy Development Agency. complex web of challenges to expanding investment in climate projects and identify opportunities to 5. Innovative solar revenue puts or insurance and address each barrier. credit enhancement approaches to address commercial barriers as shown in case study Eight innovative case studies and topic boxes 5- Innovative Financial Tools to Refinance on are interspersed throughout the report to give Better Terms—kWh Analytics. examples of ways these barriers can be addressed and the financial structures that can be used to 6. The creation of a domestic green bond market attract institutional investment to help achieve to address transaction costs, green technology, the goals of the Paris Climate Agreement. In many financing, and credit risk barriers to help of the case studies, there is an intermediary that finance environmentally friendly development absorbs higher risks; identification and structuring of including Kenya’s first bond issuance to such an intermediary, with a strong balance sheet, is support affordable and environmentally critical to implementing many innovative financing friendly student housing as shown in case solutions. The case studies are outlined in table 1 and study 6 – Green Bond Programme Kenya. feature the following approaches: 7. Green asset backed securities to bundle 1. Widescale green securitization approaches projects and help reduce transaction and due through bankable governance frameworks diligence costs for smaller project and achieve and policies, standardization of terms for the a transaction size attractive to institutional underlying projects, and innovative platforms investors as presented in case study 7 – such as shown by case study 1 - Clifford Capital FlexiGroup. CLO Infrastructure Take-Out Facility. 8. Software tools for planning long term, 2. Technical assistance and public-private complex and multisector investment partnership concession programs to address considerations in cities that enable the use long-term planning, policy and regulatory, of the best technologies and approaches for and project pipeline barriers to enable both decarbonization, such as the EPIC software domestic and international institutional tool in case study 8. 6 Enabling institutional investment in climate-smart infrastructure © Rodrigo Kugnharski/Unsplash 7 Chapter 1 | Executive Summary Table 1 Summary of Case Studies # Case Study Structure Barriers Implementer Project Size Addressed Location (USD million) 1 Clifford Collateralized Policy and regulatory, Bayfront 16 Countries $458,00 Capital CLO loan obligation financing, transaction Infrastructure Capital Infrastructure issaunce and due diligence Take-Out Facility costs 2 Colombia's Fourth Technical Project pipeline, World Bank Group Colombia $14.800,00 Generation (4G) assistance and long-term planning, Roads Concession public-private policy and regulatory, Programme partnership financing, cost concession structure program 3 Refinancing with Green bond Macroeconomic, North American Mexico $126,40 Green Bonds: issuance and Financing, transaction Development Bank North American refinance and due diligence (NADB) Development costs Bank (NADB 2018) 4 Take-Out Alternative Financing, policy and Indian Renewable India $300,00 Financing Using investment funds, regulatory, transaction Energy Development AIF - Indian green Masala and due diligence Agency (IREDA) Renewable bond issuance costs Energy Development Agency (Singh et al 2019) 8 Enabling institutional investment in climate-smart infrastructure Table 1 Summary of Case Studies # Case Study Structure Barriers Implementer Project Size Addressed Location (USD million) 5 Using Innovative Solar revenue puts Commercial, financing, Invenergy LLC, kWh USA N/A Financial Tools green technology Analytics (196MW) to Refinance on Better Terms— kWh Analytics 6 Green Bond Domestic green Financing, green Acorn Holdings Kenya $42,50 Programme bond issuance technology, (issuer) Guarantco, Kenya transaction and due Kenya Banker’s diligence costs, credit Association, Climate risk Bonds Initiative, Nairobi Securities Exchange, FMO, and Financial Sector Deepening Africa 7 Green Asset- Green asset Transaction and FlexiGroup, National Australia $203,70 Backed Securities backed security due diligence costs, Australian Bank — FlexiGroup financing, green technology 8 Environment Planning software Long-term planning International Finance Cities (global) N/A Positive tool Corporation (IFC) Innovations for Cities (EPIC) Investment Planning Tool 9 Chapter 1 | Executive Summary The private sector has an important and increasing There is significantly more to be done in role to play in climate-smart infrastructure. achieving low carbon resilient development Addressing barriers, both traditional and specific pathways to help achieve national climate to green technologies, can help enable institutional ambitions under the Paris Agreement. There is investment. Domestic and international institutional no single solution to overcoming the complex, investors both face barriers; some obstacles multifaceted barriers associated with financing are regulatory while others are those typically climate change projects particularly given the need encountered in infrastructure investment such as a for large, complex, investments and the rapidly limited pipeline of bankable projects, concerns over changing pace of green technologies. Turning the macroeconomic environment such as foreign the climate crisis into an opportunity for green exchange risks, concerns over country risk and local growth requires international collaboration among policy support, access to appropriate financing, governments, DFIs, and private-sector entities. and commercial and credit barriers. Climate-smart Governments that prioritize climate-smart infrastructure projects can also face additional infrastructure and create enabling environments barriers such as the need for business models that to facilitate the rapid deployment of innovative enable stakeholders to benefit from the lower life green technologies and financing models stand to cycle costs associated with green technologies, reap significant benefits (OECD 2017). The scale structures that enable bundling of smaller projects and complexity of bridging the climate investment to achieve cost reductions and the scale needed to gap also requires participation, capability, and attract institutional investment, access to support capacity in local markets from both governments (from governments, DFIs, and the private sector) to and the private sector. This report outlines several help increase the diffusion of new technologies, and approaches and instruments that can all contribute clear policy signals from governments to address to increasing critical climate investment and long-term planning barriers. The report presents upholding our global commitment to keep global several approaches and tools that can help address warming to less than 1.5°C. barriers to institutional investment; however, these tools are not prescriptive and must be tailored to each situation. 10 © Grandriver/Getty Images CONCEPTS KEY 02 02 | Key Concepts Objective locked in at current emission levels (i.e. resilience and adaptation) but also to reduce existing, or prevent The Invest4Climate platform, a World Bank further, greenhouse gas emissions and resulting Group–United Nations Development Programme climate change from happening to the extent (UNDP) partnership, was designed to mobilize4, possible (i.e. mitigation). “Principles for climate-smart coordinate, and deliver the financing needed to infrastructure include: close the climate financing gap and help countries transition to a low carbon resilient future that 1. Applying rigorous science supports jobs and growth. For more information, see appendix 1 and https://www.worldbank.org/ 2. Prioritizing equitable outcomes invest4climate. The Invest4Climate Knowledge Series provides targeted reports on expanding 3. Spending limited resources wisely private investment in climate action through financial innovation and collaborative partnerships. 4. Planning proactively, holistically, and The objective of this report is to explore innovative transparently (UCS 2017).” financing instruments and approaches for enabling institutional investment in “climate-smart” Examples of climate-smart infrastructure projects infrastructure projects in emerging markets. This globally range from large solar, wind, geothermal report reviews the existing literature, provides an and hydroelectric generation projects such as the $3 overview of key concepts related to climate-smart billion Noor-Ouarzazate concentrated solar power infrastructure, highlights key barriers in scaling-up (CSP) complex in Morroco, which received funding private investment in climate-smart infrastructure, from the African Development Bank, Climate and showcases innovative refinancing, Investment Funds, the World Bank, and European securitization, and other financial instruments financing institutions, to low-carbon transportation that can be used to de-risk projects, recycle lender such as light rail and electric vehicle charging capital, and create opportunities for institutional networks, water and waste management, and energy investors to support low carbon resilient, climate- efficiency, among others. This report is targeted at smart infrastructure projects. climate-smart infrastructure projects specifically. However, quotes from the literature review refer variously to sustainable, green, clean, and climate- Climate-Smart Infrastructure smart projects with some overlap in meanings. Where needed, the original language in the quotes While definitions of climate-smart infrastructure has been retained as the findings apply similarly to may vary, this report defines climate-smart climate-smart projects. infrastructure as infrastructure that is resilient and can withstand damage caused by extreme weather, Figure 1 shows that total global climate finance flows extreme temperatures, and climate change and are generally trending upward. However, while climate that reduces greenhouse gas emissions (e.g., carbon finance has reached record levels, action still falls dioxide, methane, black carbon, nitrous oxide) far short of what is needed under a 1.5˚C scenario. to the maximum extent possible.5 Climate-smart Estimates of the investment required to achieve the infrastructure is not only built to withstand the low-carbon transition for supply-side energy systems future effects of climate change that are already alone range from $1.6 trillion to $3.8 trillion annually 4 See annex 4 for definition on private sector mobilization as per MDB harmonized definition. 5 See https://www.ucsusa.org/sites/default/files/attach/gw-smart-infrastructure-pricncipals.pdf 12 Enabling institutional investment in climate-smart infrastructure between 2016 and 2050 (IPCC 2018), while the Global Figure 1 Total global climate finance flows, 2013-2018 Commission on Adaptation (GCA 2019) estimates adaptation costs of $180 billion annually from 2020 to 2030 (CPI 2019). Estimates of the amounts needed vary according to the scenarios used. Ensuring that infrastructure investment is truly climate-smart is critical to achieving the goals of the Paris Agreement. A variety of sustainability-related principles and standards governing infrastructure project development were implemented over the last decade along with certification schemes for green bonds and carbon credits. However, certification standards targeting infrastructure projects Source: Climate Policy Initiative 2019, “Global landscapes of Climate Finance”. specifically have only just begun to be piloted. The IFC Performance Standards (IFC n.d.a.) offer a set of guiding principles for sustainable project development with such certification schemes, cash is fungible, and form the basis of the Equator Principles (Equator and the issuance of green bonds and other green Principles n.d.a), which govern member bank advisory securities may free up capital which is then invested and lending practices related to project finance in fossil fuel infrastructure. Certification standards transactions. The Climate Bonds Initiative offers could be strengthened to address the potential certification of green bonds (CBI n.d.a.), and a variety for greenwashing by requiring issuers of green of independent assessments and indices that rely on securities to agree not to further invest in fossil fuel the Green Bond Principles (ICMA 2020) as a basis are infrastructure, particularly greenfield projects, beyond available for green bond issuances both internationally what is needed to safely decommission facilities or and nationally (BIS 2017). Carbon credit verification directly reduce their emissions. is available under schemes such as the “Clean Development Mechanism (CDM) or the Gold Standard” Much of the infrastructure investment needed (Gold Standard n.d.a.).6 However, certification specific under a 1.5˚C scenario is needed in the emerging to infrastructure projects was not available until just markets, creating a significant opportunity for recently. The Global Infrastructure Basel Foundation is private sector investors. The IFC identified nearly now working on the first pilots for certification under $23 trillion of climate investment opportunities in the SuRe Standard7 (SuRe n.d.a), which is specifically six sectors and three regions by 2030 stemming focused on certifying infrastructure projects that are from the Paris Agreement (IFC 2016). However, sustainable and resilient. even with certification schemes becoming available to help assure institutional investors that a given It is important that entities issuing green bonds or infrastructure project is developed sustainably, other green securities adhere to certification schemes regulatory frameworks and other barriers often such as those above to avoid the potential for funds make it challenging for institutional investors to to be misused or to enable “greenwashing.” Even invest in emerging markets. 6 See: https://www.climatebonds.net/certification/approved-verifiers 7 The SuRe Standard integrates 14 themes and 61 criteria across environmental, social, and governance to ensure infrastructure projects with SuRe certification are developed meet these sustainability and resilience criteria. As such, the standard can be applied to many climate-smart infrastructure projects. 13 Chapter 2 | Key Concepts 2019 INFRASTRUCTURE FUNDRAISING & DEALS UPDATE DOWNLOAD DATA PACK 2019 Infrastructure Institutional Investors $98 billion raised globally in unlisted infrastructure funds in 2019 (Preqin 2020). This included The private sector is an important source of investments into two funds targeting $20 billion financing for climate-smart infrastructure, and each, Brookfield Infrastructure Fund IV and Global Fundraising & Deals levels of investment are increasing. “Private climate Infrastructure Partners IV. In addition to investing in finance reached a record high of $330 billion in 2017, unlisted infrastructure funds, several of the largest representing an increase of $99 billion from 2016, or pension funds and sovereign wealth funds with the 43% year-on-year growth (CPI 2019).” This includes capacity to do so have created teams that specialize Update institutional investors, who have long been hailed in investing directly in infrastructure and renewable as a potential source of capital to support climate- energy projects. However, many pension funds smart infrastructure investment. Institutional and other institutional investors lack the capacity investors consist of sovereign wealth funds, pension to support dedicated teams that understand the funds, insurance companies, investment advisors, complexities of directly investing in infrastructure endowments, and mutual funds, as well as banks, projects in each potential market. credit unions, hedge funds, REITs, and other types of financial firms and asset managers. This report The report aims to review the literature on focuses largely on pension funds and sovereign institutional investors and climate investments, wealth funds given their significant capital base and highlight barriers that make it difficult for long-term investment needs, which matches well institutional investors to support climate-smart 2019 a banner waswith year infrastructure for infrastructure: as an asset class (OECD 2013). total fundraising infrastructure hit an in emerging markets, andall-time showcase high and innovative financing approaches that can help to record-sized funds As shown closed in Figure 2, institutional investors are address barriers to investment. Securitization and increasingly investing in infrastructure, with refinance are two approaches being used to create opportunities for institutional investors to support Fig. 1: Global Unlisted Infrastructure Fig. 2: Unlisted Infrastructure Funds in Market climate-smart infrastructure investments. Fundraising, Figure 2000 2 Global unlisted - 2019 fundraising, 2000-2019 infrastructure 2011 - 2020 140 120 300 Refinance and Securitization Aggregate Capital Raised ($bn) 253 120 100 250 Refinancing and securitization can create 208 No. of Funds Closed 100 2 80 opportunities 200 not only for lenders to free 190 up capital 184 193 173 80 155 162 so that they can finance additional 149 148 greenfield 60 135 150 but projects, also to create ways for institutional 128 125 60 investors who may lack the capacity or ability to 117 91 93 83 92 98 40 invest100 directly in projects that support climate-smart 40 infrastructure. Refinancing and securitization of green 20 assets50can be accomplished through the issuance 20 of green bonds for the purpose of refinancing or 0 0 through0 the issuance of green asset-backed securities Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 (CBI 2018). New financial products can help further 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 unlock value when used to refinance climate-smart Year of Final Close infrastructure (kWh Analytics 2019). Green bonds No. of Funds Raising No. of Funds Closed Aggregate Capital Raised ($bn) generally are issued to provide capital for future green Aggregate Capital Targeted ($bn) projects or for the purpose of refinancing existing Source: Preqin. Pro Preqin Source: 2020. projects. Green asset-backed securities are generally Source: Preqin 14 Fig. 3: Global Infrastructure Deals, 2009 - 2019 Fig. 4: Global Unlisted Infrastructure Dry Powder, 2000 - 2019 Enabling institutional investment in climate-smart infrastructure issued to free up capital from existing projects and to create opportunities for institutional investors to support climate-smart projects. “A green CLO market has large growth potential… [and the S&P] hypothetical green CLO analysis showed that green loans may have different fundamental characteristics to corporate loans such as lower asset yields, higher credit quality, and higher recovery rates © JaCZhou/Getty Images (S&P 2018).” Reasons for the low issuance of green CLOs to date include the limited number of green loans outstanding, challenges for green bonds or loans issued in emerging markets to receive ratings above the sovereign, and the short history of the green finance market compared to corporate loans (S&P 2018). Despite the challenges facing green asset-backed securities “providing the banking sector with recyclable and experienced experts. The approaches presented liquidity will become increasingly important as demand also hinge upon host governments erecting sound for sustainable investments accelerates (White & Case project governance structures. These solutions can be 2018).” Additionally, “by aggregating the funding into a used to help provide the capital needed to limit the common structure, securitisations enable institutional increase in global average temperatures to less than investors to finance small scale assets and small- and 1.5°C above pre-industrial levels in accordance with medium-size businesses (CBI 2018).” the goals of the Paris Agreement. Securitization, refinance, and the other approaches highlighted in this report are being used to address Report Focus and Alignment with barriers to investment, attract institutional investor the Paris Agreement capital, and free up lender and developer capital so it can be reinvested in new projects to accelerate the This report is written in the context of the Paris shift toward decarbonization. DFIs have a critical Agreement,8 which commits parties to pursuing role to play in enabling broader use of refinance efforts to limit the increase in global average and securitization, not only by providing technical temperatures to less than 1.5°C above pre-industrial assistance to ensure the underlying assets are levels. The Intergovernmental Panel on Climate bankable and can later be securitized, but also in Change (IPCC) Special Report, Global Warming providing concessional finance, blended finance, and of 1.5°C, indicates that “global warming is likely political risk insurance or partial credit guarantees to to reach 1.5°C between 2030 and 2052. . . [In] address risks other stakeholders cannot. Although pathways with no or limited overshoot of 1.5°C, global this report contains solutions that can be replicated, net anthropogenic CO2 [carbon dioxide] emissions these solutions are not prescriptive but are intended decline by about 45 percent from 2010 levels by 2030, to demonstrate what is possible. Most solutions reaching net zero around 2050 (IPCC 2018).” The IPCC would need to be tailored to local legal, regulatory, Special Report was issued before the release of a and market conditions with the help of qualified study by researchers at 10 universities and the U.S. 8 See http://unfccc.int/files/essential_background/convention/application/pdf/english_paris_agreement.pdf 15 Chapter 2 | Key Concepts Observed Changes and their Causes Topic 1 Figure 3 Greenhouse gas emissions by economic sectors 2010, both drivers Unfortunately, outpaced policies, emissiongovernance regulations, reductions from improvement Greenhouse gas emissions by economic sectors in energy intensity structures, integrated gross domestic of resource product (GDP) (Figure 1.8) plans, and Electricity markets often fail to capture the full Increased use of coal relative to other energy cost of sources has reversed and heat production Energy 25% 1.4% carbon the emissions trend long-standing and thein full value gradual of sustainable (i.e., reducing the decarbonization approaches carbon andof intensity technologies energy) of thelike renewable world’s energy, energy supply. {WGIII SPM.3 AFOLU 24% clean transportation, and vertical TS.2.2, 1.3, 5.3, 7.2, 7.3, 14.3} farming. The social Industry costs of greenhouse gas emissions are not being Buildings 6.4% 11% fully accounted for as “only 20 percent of global GHG emissions 1.3 are covered Attribution of a carbon price and less byclimate Transport than 5 percent of those changes and impactsare currently priced at levels Transport Total: 49 Gt CO2-eq 0.3% consistent with reaching the temperature goals of 14% (2010) the Paris Agreement (World Bank 2019).” Renewable Industry The energy can provide a for evidence human reliable power influence supply even on the climate 21% Buildings system for large countries like thesince has grown AR4. U.S. (RMI Human 2018). influence has Clean 12% been detected transportation in warming solutions can meet of the atmosphere and the transportation Other ocean, needs, the global water in changes ininfrastructure and climate-smart more cycle, in reduc- energy 9.6% AFOLU tions broadly can in snow essential provide and ice, services, and in global mean all at low life sea level 0.87% cost and cyclerise; and with savings significant likely it is extremely toto society. have been the domi- Direct GHG emissions Indirect CO2 emissions Attracting of theinvestment institutional nant cause observed to climate-since the mid- warming smart infrastructure 20th century. In is therefore critical in recent decades, achieving changes in climate Source: IPCC. 2014. have of the goals the Paris caused Agreement impacts and the on natural focus and of human systems Figure 1.7 | Total anthropogenic greenhouse gas (GHG) emissions (gigatonne of CO2- this report. on all continents and across the oceans. Impacts are equivalent per year, GtCO2-eq/yr) from economic sectors in 2010. The circle shows the shares of direct GHG emissions (in % of total anthropogenic GHG emissions) from five due to observed climate change, irrespective of its economic sectors in National 2010. The pull-out and Oceanic shows how shares of Administration Atmospheric indirect CO2 emissions The first section cause, of this indicating report the details the sensitivity of natural and human that found (in % of total anthropogenic GHG methane emissions)emissions have from electricity and been heat production are challenges and opportunities systems to changing climate. society faces in attributed to sectors of final energy use. underestimated by ‘Other energy’ to 25 percent refers 40to all GHG(Hmiel emission percent seeking to close the climate investment gap sources in the energy sector et al 2020).as defined in WGIIIgives This finding Annexhumanity II, other than electricity and a shorter related to infrastructure. The second section heat production {WGIII Annex II.9.1}. The emission data on agriculture, forestry and timeline and requires further emissions reductions focuses on the barriers institutional investors other land use (AFOLU) includes land-based CO2 emissions from forest fires, peat fires than those indicated The causes of observed changes in the climate system, as well as in an and peat decay that approximate to net CO2 influxthe IPCC from Special Report. the sub-sectors of forestry and face in relation to infrastructure investment in other land use (FOLU) as described in Chapter 11 of the WGIII report. Emissions are natural emergingor human marketssystem impacted generally by climate, are established follow and climate-smart Figure 3 shows converted into CO2-equivalents the based on sourceGlobal 100-year of the emissions Warming causing Potential (GWP100), ing a consistentspecifically. infrastructure CaseDetection set of methods. studies andaddresses topic the question o taken from the IPCC Second Assessment Report (SAR). Sector the global temperature increase. Greenhouse gas definitions are provided whether boxes areclimate or a natural interspersed or human throughout system the reportaffected by climate ha {WGIII Figure in WGIII Annex II.9.emissions SPM.2} can be attributed to electricity and heat actually changed in to give examples of statistical a ways these sense, while barriers canattribution be evaluates th production (25 percent); agriculture, forestry, and land relative and tools of contributions addressed multiple that can be causal used factors to an observed change to attract use (“AFOLU”) (24 percent); industry (21 percent); institutional investment to help achieve the goals transport (14 percent); other energy (10 percent); of the Paris Agreement. Given that 73 percent of and buildings (6 percent) (IPCC 2014). The IPCC, the the problem is related to the use of fossil fuels for U.S. Environmental Protection Agency (EPA 2019), energy, many of the case studies focus on large- Decomposition of the change in total global CO2 emissions from fossil fuel combustion by decade and the World Resources Institute agree that the scale energy. However, the tools and opportunities 12 al CO2 emissions by decade (GtCO2/yr) source of most of these emissions from all sectors presented can often be adapted to other types of 10 other Carbon than of intensity agriculture energy is the burning of fossil fuels for Population climate-smart infrastructure projects. Additionally, energy. Energy While intensity spread across of GDP several economic sectors, Total change many of the technology solutions available to help 8 seventy-three GDP per capita percent of human-caused greenhouse keep global warming below 1.5°C can also provide gas emissions is the result of burning fossil fuels for climate benefits across multiple sectors as shown 6 6.8 energy (ClimateWatch n.d.a.). in box 1 below. 4 16 4.0 2 2.9 2.5 0 Enabling institutional investment in climate-smart infrastructure Box 1 Vertical farming © AzmanL/Getty Images Vertical farming uses hydroponics, aquaponics, and aeroponics to raise crops in vertically stacked layers housed in climate and environmentally controlled buildings that protect against weather and pests. Vertical farming offers not only significantly greater crop yields of 10 times or more per hectare, but also the potential to reduce water usage by up to 95 percent. Vertical farming can also be done organically, without the use of pesticides and chemical fertilizers. The global vertical farming market, which includes the United States, Canada, Germany, the United Kingdom, Japan, India, China, South Korea, South Africa, Brazil, Mexico, Argentina, Netherlands, and Belgium, is estimated to have reached between $2.23 billion and $3.16 billion in 2018 and is projected to reach $12.77 billion to $22.07 billion by 2026. Recent investments in vertical farming companies include $90 million in Bowery Farming by GV (formerly Google Ventures), with the funds coming from investors such as Singapore’s Temasek; $200 million invested in Plenty by SoftBank Vision Fund, and $55 million being invested by AeroFarms in its 138,000 square foot Cane Creek Industrial Park building. AeroFarms also recently received an investment from the Abu Dhabi Investment Office, under the $272 million AgTech Incentive Programme, to build the world’s largest indoor R&D vertical farm. 17 Chapter 2 | Key Concepts Box 1 Vertical farming (continued) Transport Because vertical farming facilities are enclosed, they are resilient from a climate perspective and can be built in any environment to raise any crop. These enclosed structures allow vertical farms to be located near customers and can therefore reduce the need for shipping, which also reduces the associated emissions. For example, agriculture is estimated to account for as much as 31 percent of all freight in the United States (USDA n.d.a). Agriculture, Forestry, and Land Use Vertical farms can produce food year-round rather than just seasonally, and they require significantly less land to provide the same crop yield. As a result, they can free land for potential use in renewable power generation, buildings, or reforestation and afforestation. Humanity is responsible for removing an estimated 2.6 trillion trees, or 46 percent of the pre-industrial total (Crowther et al. 2015), with most of this previously forested land being cleared for agricultural purposes. Vertical farming has the potential to help reverse the trend in deforestation if adopted on a wider scale and combined with reforestation and afforestation programs. Energy Vertical farming has the potential to reduce fossil fuel energy use in both the long-distance transport that is required for agriculture and in the running of farming equipment usually needed to grow crops. As the use of both long-distance transport and farming equipment declines, the emissions from the fossil fuels used to provide energy to both also declines. However, vertical farming energy needs are still significant, as vertical farms need constant lighting, with electricity representing one of vertical farming’s greatest costs. Enabling vertical farms to source renewable electricity at utility-scale prices would not only help reduce costs for vertical farms, but also help reduce the overall greenhouse gas emissions associated with energy use for agriculture. 18 © Mlenny/Getty Images 03 CHALLENGES AND OPPORTUNITIES TO CLOSE THE CLIMATE INVESTMENT GAP 03 | Challenges and Opportunities to Close the Climate Investment Gap The current scope and scale of Multiple estimates exist of the gap between global climate finance are grossly current levels of investment and what is needed to keep global warming below 1.5°C with estimates insufficient to limit the worst varying according to the underlying assumptions effects of climate change – there of the technologies and approaches used to achieve this goal. What is clear throughout is is a need for a tectonic shift that investment needs to shift rapidly away from beyond ‘climate finance as usual’ fossil fuels toward climate-smart alternatives, toward truly transformative and that this reallocation toward climate-smart infrastructure will lead to significant long-term policies and investments. The savings and benefits for society (IMF 2019; GCEC IPCC (2018) warns that a breach 2018; Jacobson et al. 2019). of the 1.5 °C threshold in global It is also clear that the investment required warming between 2030 and 2052 outweighs the existing sources of public finance will result in irreversible damage from government and domestic, bilateral, and multilateral DFIs (CPI 2019). Institutional investors to the environment and welfare have a critical role to play in bridging the climate losses. Keeping warming below investment gap, as they hold enough capital to this level necessitates rapid, large- meet the remaining investment requirement and are increasingly viewing infrastructure as a way to scale emissions reductions, and diversify their investment portfolios while achieving a corresponding transition away their long-term investment objectives. Unlocking institutional investor capital will require not only from high-carbon production and increasing the investible climate-smart project consumption, across all sectors. pipeline but also the use of approaches that will While there is no single estimate enable a broader range of institutional investors to participate in the low-carbon transition. of the investment required to meet these goals, indicative, This section quantifies the climate investment gap regional, and sectoral estimates and the benefits in closing it, covers the roles of governments and development finance institutions show that the gap between in developing climate-smart infrastructure existing investment and what projects, discusses the potential for institutional investors to help close the climate investment is needed represents an order gap, gives a brief introduction to traditional of magnitude. This means that infrastructure finance options, delves into the use incremental increases in climate of green bonds and green asset-backed securities to finance climate-smart infrastructure projects, finance flows will not deliver on and concludes with the need to address barriers these objectives. in order to attract institutional investment to climate-smart infrastructure. Climate Policy Initiative. “Global Landscape of Climate Finance 2019.” 20 Enabling institutional investment in climate-smart infrastructure The Climate Investment Gap The third investment gap is the climate investment gap, which represents the investment needed to The ability to reach the Paris Climate Agreement keep global warming to less than 1.5°C degrees. goals depends on bridging the climate investment Between $1.6 trillion and $3.8 trillion of investment in gap by reallocating large capital flows toward low-carbon solutions will be needed annually to keep climate-smart infrastructure and away from fossil warming to less than 1.5°C (IPCC 2018). However, as fuel investments to help shift to a green, just, low- with the sustainable development investment gap, carbon global economy. some of this investment can come from re-allocating investment away from conventional infrastructure Society faces three distinct investment gaps toward climate-smart infrastructure. Applying the related to infrastructure. The first gap is a general high-end investment requirement to keep warming infrastructure investment gap between current to less than 1.5°C of $3.8 trillion leads to a climate investment trends (i.e., “business-as-usual”), investment gap of $.6 trillion annually compared estimated at $3.1 trillion annually on average over to business-as-usual, or $0.1 trillion compared to the period 2016 to 2040, and the investment needed the infrastructure investment gap. The $0.6 trillion to provide developed country-level infrastructure climate investment gap is therefore approximately globally, estimated at $3.7 trillion annually over the in-line with the $0.7 trillion sustainable development same period. This results in a general infrastructure investment gap, and the $0.6 trillion general investment gap of $0.6 trillion on average annually infrastructure investment gap. without consideration for concerns over climate change or sustainable development goals (Global Other scenarios can achieve similar outcomes for Infrastructure Outlook 2019).9 much less. The report Beyond the Gap: How Countries Can Afford the Infrastructure They Need while The second gap is the gap between business-as- Protecting the Planet for example shifts the analysis usual investment and the investment needed to of investment needs away from a simple focus on achieve the sustainable development goals (SDGs), spending more and toward a focus on spending which can be viewed as a sustainable development better on the right objectives, using relevant metrics. investment gap. Achieving the sustainable Exploring thousands of scenarios, this report finds development goals is estimated to require that funding needs depend on the service goals and investment of $3.9 trillion on average annually from policy choices of low- and middle-income countries 2016 to 2040. Much of the total spending required and could range anywhere from 2 percent to 8 percent to meet the sustainable development goals can of GDP per year by 2030 (World Bank 2019d). The come by shifting spending away from conventional actual amount depends on the quality and quantity infrastructure toward sustainable infrastructure. of services targeted, the timing of investments, This results in a sustainable development investment construction costs, and complementary policies. gap of $0.7 trillion annually (Global Infrastructure Finally, infrastructure maintenance is also key to Outlook 2019) compared to business-as-usual, generating substantial savings by reducing the total or $0.1 trillion compared to the infrastructure life cycle cost of transport and water and sanitation investment gap.10 infrastructure by more than 50 percent. Improving the efficiency of infrastructure spending, including better 9 The general infrastructure investment gap is calculated on an annual average basis as follows: $79 trillion divided 24 years (i.e. 2016- 2040) = $3.3 trillion annually; $94 trillion divided 24 years (i.e. 2016-2040) = $3.9 trillion annually; Investment Gap = 3.9-3.3 =$ 0.6 trillion annually. 10 The sustainable infrastructure investment gap is calculated on an annual average basis as follows: $97 trillion divided 24 years (i.e. 2016-2040) = $4.0 trillion annually; Investment Gap = 4.0-3.3 = $0.8 trillion annually. 21 Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap maintenance, could significantly help to reduce the infrastructure and how such investment will result investment gap estimates (World Bank 2019d). in substantial savings that more than offset the investment needed to close the climate investment Two scenarios that demonstrate how infrastructure gap. It then discusses the importance of the overall costs can be reduced while still meeting the goals enabling environment and innovative financial of the Paris Agreement have also been provided structuring models to facilitate leveraging the large under other recent studies (IRENA 2019; Jacobson balance sheets of institutional investors. et al. 2019). The first is an energy system in which electricity meets 50 percent of end use energy, up from 20 percent currently, and is supplied by Climate Investment Savings 86 percent renewable energy (IRENA 2019). This would result in a payoff of between $3 to $7 for Aligning investment with climate goals “could every dollar spent on the transition (IRENA 2019). deliver economic benefits of US$26 trillion to 2030 - The other scenario assumes the electrification of and this is a conservative estimate (GCEC 2018).” end-use energy across all sectors for 143 countries, representing 99.7 percent of man-made fossil fuel Figure 4 shows the various benefits associated emissions, with electricity provided entirely by with transitioning to a low-carbon economy. The renewable energy (Jacobson et al 2019). This scenario $26 trillion in climate investment savings is a net reduces end-use energy by 57.1 percent, reduces economic gain that more than offsets the cost. annual energy costs from $17.7 trillion to $6.8 trillion, Aligning investment with climate goals would also and reduces social costs by 91 percent compared to avoid over 700,000 premature deaths, raise $2.8 business-as-usual. The scenario also results in a net trillion in revenues and fossil fuel savings annually, gain of 28.6 million jobs across the 143 countries increase female employment and global gross studied. This scenario can be accomplished by domestic product, and generate 65 million low- an 80 percent transition to renewable energy by carbon jobs by 2030 (GCEC 2018). 2030 and 100 percent by 2050 for generation and using technologies such as electric vehicles rather Pursuing electrification of energy across all sectors than internal combustion engines or molten oxide and full decarbonization leads to even greater electrolysis rather than traditional steelmaking benefits, estimated at a 57.1 percent reduction processes to electrify all sectors. This also results in in energy needs, a 61 percent reduction in energy improved energy efficiency and the elimination of costs, a 91 percent reduction in social costs, and a the need to extract and transport fossil fuels and the 28.6 million net gain in jobs compared to business- associated infrastructure costs. as-usual (Jacobson et al. 2019). This reduces energy costs from $17.7 trillion per year to $6.8 trillion per Regardless of which estimate is used, it is clear year, resulting in an annual savings of $10.9 trillion that there is a large and urgent financing gap to per year, higher global gross domestic product, and achieve a low carbon global transition in line with a payback period of less than seven years on energy the Paris Agreement goals, and this will require a cost savings alone (Jacobson et al. 2019). Regardless number of solutions and approaches to shift the of which climate investment gap estimate is used, global economy toward a climate-smart energy the benefits of decarbonization far outweigh the transition. Furthermore, the savings associated costs. The overall cost is also likely to continue to with climate-smart infrastructure are even higher decline because of green technology price trends, when factors beyond up-front investment are but each year of delay results in greater damage considered. The next section discusses the economic and lost savings and increases the investment that benefits of channeling funds toward climate-smart will need to be made up for in subsequent years. 22 For this Report, the potential benefits of scaling-up the widescale use of appropriate carbon prices and some of the exciting proof-points of successes were phasing-out fossil fuel subsidies, seizing energy and assessed through an economic model (see Box 4).70 Such industrial energy and resource efficiency gains, halting modelling exercises have many limitations, and their deforestationEnabling and restoring investment institutional in climate-smart degraded lands, infrastructure accelerating results need to be interpreted with care. This is because the penetration of electric vehicles, and integrating traditional economic models do not adequately capture intermittent renewables into the power system—was the risks of climate change, which can have wide variations found to deliver significant benefits. Transitioning to in scale and nature with drastic potential impacts, this low-carbon, sustainable growth path could deliver for instance, the submergence of coastal megacities, a direct economic gain of US$26 trillion through to desertification, migration, or conflict. On the damage 2030 compared to business-as-usual, according to side, marginal The annual change costs to applied social ofgrowth models delay also misses far outweigh analysis for this undercharging for Report. Taking ambitious general consumption taxes (7climate action the scale the and nature costs of risks; on(IMF of investment the policy side, marginal 2019; GCEC 2018; could also percent) andgenerate for supplyover costs65 (7million percent)new (IMFlow-carbon 2019).” models can misset Jacobson the 2019). of disruptive change to a new benefits al. jobslargest The in 2030, equivalent subsidies in 2015to were today’s entire in China workforces ($1.4 sustainable growth path, the dynamic public economics of of the UK trillion), the and Egypt United combined, States as well ($649 billion), as avoid Russia over ($551 The systemic benefit change and associated gains from with decarbonization innovation. billion), 700,000 the European Union premature deaths ($289 frombillion), and India air pollution compared becomes more apparent once fossil fuel subsidies ($209 billion). Increasing attention with business-as-usual (see Figure is being paid toreform 2). Subsidy this, Given are it is likely quantified. the economic, that fuel Fossil subsidies were employment, estimated reforming fossil fuel subsidies for a cleaner, fairer and carbon pricing alone could generate an estimated to have been $5.2 trillion (6.5 percent of GDP) would and health benefits of the low-carbon transition in future (World Bank n.d.a.). US$2.8 trillion in government revenues per year in be even alonethan greater 2017 (IMF the models 2019). can capture, “By component, while the underpricing 2030—equivalent to the total GDP of India today— costs of forcontinuing down is local air pollution a business-as-usual still the largest source pathway (48 Putting policies in place to eliminate fossil fuel much needed funds that can be used to invest in public instead would percent inbe even 2015), more while stark. that for 71 Even global with these warming is subsidies and redirect resources from fossil fuels priorities. While all economic modelling exercises have caveats in mind, similar a global to earlier climate estimates (24action scenario percent), followed by toward climate-smart, sustainable growth is also limitations, these results echo and reinforce recent prepared for this broader Report using environmental costs of E3ME the model road fuels (15 percent), starting to provide the signaling and incentives needed analyses by leading economic institutions, such as the that combines a range of opportunities including OECD.72 Figure 2 Figure 4 The Global Benefits of a Decisive Shift to a Low-carbon Economy when Compared with Business-as-usual The Global Benefits of a Decisive Shift to a Low-carbon Economy when Compared with Business-as-usual. Avoid over Raise 700,000 US$2.8 trillion premature deaths in carbon price revenues and fossil from air pollution fuel subsidy savings to reinvest in public priorities US$26 TRILLION BENEFITS UP Increase TO 2030 Higher female employment global GDP growth and labour participation Generate over 65 million additional low-carbon jobs Source: The results cited for the US$26 trillion in direct economic benefits are cumulative for the 2018–2030 period, whereas Source: the other GCEC 2018. data points reported are for the year 2030. Source: Garrido, L., et al., 2018.73 23 22 UNLOCKING THE INCLUSIVE GROWTH STORY OF THE 21ST CENTURY Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap to help recalibrate institutional investor portfolios investments, will be extraordinarily consequential in and accelerate financial flows into climate-smart ensuring that they can rebuild stronger and better infrastructure and projects. The number of companies and avoid locking in compounding vulnerabilities, participating in networks such as the Institutional environmental issues, high-carbon trajectories and Investors Group on Climate Change, RE100, and the stranded assets for decades to come.12 “Governments Net-Zero Asset Owner Alliance is growing rapidly have a once-in-a-lifetime opportunity to reboot their and leading to pressure for companies to adopt such economies and bring a wave of new employment practices as climate-related financial disclosures and opportunities while accelerating a shift to a more divestment from fossil fuel assets. resilient, low carbon, energy future (IEA 2020).” The governance structure and overall enabling The Role of Governments and DFIs 11 environment is essential to effectively implementing infrastructure projects and attracting Governments and DFIs have a key role, but the institutional investment, and the government private sector is also critical in bridging the climate is responsible for creating the governing public- investment gap. private partnership framework. “Successful governance of infrastructure depends on a coherent The investment needed to strategically plan for strategic planning process, an open and transparent and build new climate-smart infrastructure and to prioritization mechanism and decision processes based retrofit or replace old infrastructure is greater than on affordability and cost efficiency, a clear regulatory public budgets and commitments under existing and institutional framework, robust co-ordination nationally determined contributions (United Nations across levels of governments and evaluation 2020). While the cost of failing to bridge the climate mechanisms that monitor performance throughout investment gap will fall disproportionately on the life cycle of the asset (OECD 2017b).” emerging economies and the most vulnerable (IPCC 2018), the recent fires in Australia, California, Siberia, Studies such as the “Decarbonizing Development: Brazil and Canada demonstrate that no country will Three Steps to a Zero-Carbon Future” 2015 report; be spared the adverse effects of the climate crisis. the “Getting Infrastructure Right” 2017 report; the “Lifelines for Better Development” 2019 report; the As governments move toward developing stimulus “Climate Change and Governance: Opportunities packages to stem the economic impact of COVID-19, And Responsibilities” note 2019; the “Sustainability it will be vitally important to build the foundation for Checklist for Assessing Economic Recovery a more resilient, sustainable and prosperous future Interventions” 2020 proposal; and the “Sustainable (Stephen Hammer, Stéphane Hallegatte and Ferzina Recovery: World Energy Outlook Special” Report 2020 Banaji 2020). The choices that governments make offer useful frameworks and exhaustive lists relating to restart their economic engines, including the to the role of government in promoting low carbon long-term social, economic, and environmental co- resilient and competitive development pathways and benefits they seek to achieve through their stimulus enabling environments for private sector investment. 11 “National and international development finance institutions (DFIs) are specialized development banks or subsidiaries set up to support private sector development in developing countries. They are usually majority-owned by national governments and source their capital from national or international development funds or benefit from government guarantees. This ensures their creditworthiness, which enables them to raise large amounts of money on international capital markets and provide financing on very competitive terms:” https://www.oecd.org/development/development-finance-institutions-private-sector-development.htm 12 For further information on the types of criteria and factors for assessing such interventions, please see the “Proposed Sustainability Checklist for Assessing Economic Recovery Interventions.” April 2020. World Bank: http://pubdocs.worldbank.org/ en/223671586803837686/Sustainability-Checklist-for-Assessing-Economic-Recovery-Investments-April-2020.pdf 24 Enabling institutional investment in climate-smart infrastructure These include supportive institutional and legal 8. Generate, analyze and disclose useful frameworks (such as supportive regulation for data to increase transparency and ensure financing options), the provision of needed climate and accountability. disaster risk information (such as hazard maps), public sector core functions (such as land-use planning, 9. Integrate mechanisms to evaluate the medium-term investment planning), concessional performance of assets throughout their life cycle. financing terms and structures, and first mover or risk absorption functions. The OECD Framework for the 10. Review existing infrastructure resilience in the Governance of Infrastructure, for example, identifies face of evolving natural and man-made risks ten areas and principal policy objectives relating to the and develop guidelines to future proof new role of governments in planning and implementing infrastructures (OECD 2017b).’ infrastructure investment: Furthermore, governments must address a 1. “Establish a national long-term strategic vision number of global governance challenges that that addresses infrastructure service needs. climate change presents including the tragedy of the commons, differential impacts, extended 2. Manage the integrity and corruption threats time frames, uncertainty, unclear accountability at all stages of the process, from project and perceived tradeoffs (World Bank 2019c). For conception to delivery. instance, addressing climate change requires long-term planning and looking well beyond 3. Establish clear criteria to guide the choice of the typical planning horizon and electoral cycle. delivery mode (PPP vs direct public provision, etc.). “Such an extended timeframe poses a problem of credible commitment. It is uncertain that future 4. Ensure good regulatory design and governments will continue today’s policies no maintain a predictable regulatory framework matter how enlightened they may be” (World Bank for investment. 2019c). Countries are putting in place long-term plans through Nationally Determined Contributions 5. Integrate a consultation process early (NDCs), 2030 climate action plans, or 2050 vision enough so that decisions benefit from real plans. But these face the risk of being changed stakeholder engagement. according to political cycles or short-term public sentiment. Long-term visibility and reliability of 6. Coordinate infrastructure policy across levels policies and private sector signaling matters for of government in such a way that investment private investment, particularly in large, long- decisions by central and subnational term investments such as infrastructure. Enacting governments are coherent. long-term, climate-related plans into legislation, such as through a “framework climate legislation,” 7. Guard affordability and value for money by is enabling some countries to strengthen the using and applying cost-benefit and other credibility of emissions reduction targets and methods rigorously and consistently. address the “credible commitment” problem.13 13 Framework climate legislation is an overarching, supra-sectoral instrument that lays down general principles and obligations for climate change policymaking and implementation. Framework climate laws often have the explicit aim of reducing greenhouse gas emissions and building resilience to climate change by establishing national long-term mitigation and adaptation objectives. Framework climate laws usually establish the institutions and processes needed to meet these objectives, with more specific policy measures defined through subsequent regulation (including sector-specific laws). 25 Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap Multilateral development banks (MDBs) and DFIs constrained in the types of investments they can also have critical roles to play in creating enabling make (OECD 2019). OECD institutional investors more environments and mobilizing finance for climate- broadly, including sovereign wealth funds, pension smart infrastructure in emerging markets (Wharton funds, insurance companies, investment advisors, 2018). MDBs have decades of experience operating endowments, and mutual funds, as well as banks, in the countries they serve and underwriting credit unions, hedge funds, REITs, and other types infrastructure projects. The ability of DFIs to deploy of financial firms and asset managers, hold more concessionary capital, provide technical assistance, than $100 trillion in assets under management and assume risks in ways the private sector cannot, (World Bank 2015). As such, institutional investors coupled with their local knowledge and arrangements alone have more than sufficient capital to fund with the governments they serve, is important the entire investment needed to keep increases in in creating enabling environments and ensuring global temperatures to less than 1.5°C assuming project structures are designed such that established barriers to investment, including limited investment financial institutions are willing to lend to a country’s opportunities, can be removed and successful models projects at a reasonable interest rate (i.e., the to enable investment replicated. The amount of project is “bankable”). The ability of DFIs to support investment needed to close the climate investment projects hinges on the governance structure and gap is also falling as green technology prices decline enabling environment in the country as “no amount not only for renewable energy and energy storage of blended finance will compensate for a poor enabling (BNEF 2019), and clean transportation (EESI 2018), environment and a structurally weak economy” but also for new technologies and practices in (Blended Finance Task Force 2018). The climate industrial processes (e.g., molten oxide electrolysis investment gap is far beyond the capacity of DFIs in steel manufacturing (Boston Metal 2019), food alone to solve and will require that the private sector production, vertical farming (USDA 2018), agriculture, reallocate investment. plant-based protein (Maixner 2019), circular waste management, green buildings (Billimoria et al 2019), and climate-smart urban planning. Climate-Smart Infrastructure and Institutional Investors In addition, many pension funds are facing a shortfall (Vanham 2017) as they struggle to find investment Institutional investors have the capital to bridge opportunities that can provide sufficient returns the climate-investment gap but struggle to find to meet future obligations. Despite the benefits ways to invest in climate-smart infrastructure, of investing in climate-smart infrastructure and particularly in emerging markets. availability of capital, institutional investors face significant barriers in deploying their capital to Institutional investors, particularly pension funds, support climate-smart infrastructure. This situation have large pools of capital, a long-term investment is unfortunate given that properly structured climate- horizon, and a need to generate returns sufficient smart infrastructure projects, such as wind and solar to meet future obligations. This makes institutional projects, not only provide attractive returns but investors a good match for infrastructure projects, also have a low operating risk profile that could fit given unlisted infrastructure’s low volatility, within an acceptable range of credit risks for many predictable cashflows, and opportunities for institutional investors. diversification (OECD 2013). Climate-smart investments also provide attractive OECD pension funds alone hold more than $27.6 returns ranging historically from 3 percent to trillion in assets under management but are often 6 percent for green bonds, 5 percent to 20 percent 26 Enabling institutional investment in climate-smart infrastructure for “green” public equities, 6 percent to 10 percent Institutional investors, including some of the larger for renewable project debt, and 12 percent to pension funds, are investing directly in asset- 18 percent for renewable project equity (WEF financed infrastructure projects in more established 2016). For infrastructure more broadly “70% of markets in addition to purchasing green bonds. institutional investors report historical performance However, infrastructure projects in emerging markets on their overall asset allocation to infrastructure often face challenges in attracting institutional (both funds and direct equity investment) between investment as governance structures are often not 12% and 17%. In developing countries, the evidence bankable (World Bank 2017). Asset finance, including is less comprehensive. However, returns appear on project finance, creates assets that can be securitized average to be 200-600 basis points above those to create investment opportunities for institutional in developed markets, albeit with higher variation investors. However, securitization requires that a in outcomes (Blended Finance Task Force 2018).” credit rating agency issue a rating, which can often be These returns are above the returns that pension challenging due to the bespoke nature of emerging funds are likely to receive otherwise (WEF 2017) market infrastructure transactions. Structural and provide an opportunity not only to bridge challenges and market barriers also need to be the climate investment gap, but also to shore up resolved to create a successful securitization program pension fund shortfalls. (White & Case 2018). As such, most capital for infrastructure projects Infrastructure Finance Options still comes from non-private sector participation (non-PSP) approaches, or asset finance, including As national budgets and public sector loans project finance. Figure 5 summarizes the traditional from DFIs are insufficient to meet the climate financing options for infrastructure at a high level, investment gap on their own, public-private including direct government funding. partnerships are increasingly being used to good result and can create assets which are attractive to In traditional models of public finance, the Private sector participation in public sector financing institutional An introduction investors. government provides the resources directly to Figure 5 Financing Options Figure 1. Financing options Traditional (non-PSP) government project exchequer financing Project financing Corporate financing Finance Government Government Government Shareholders Govt. funding Govt. funding Eq Corporate Loan Shareholders ui ty Project Project Finance Project Funding bt Finance De Construction Operation Construction Operation Construction Operation Source: Deloitte 2018. In general, however, infrastructure finance is long term 27 and is secured to the asset cash flows rather than extended security. Figure 2 below sets out the types Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap construct and operate the project. In corporate The private sector is playing an increasingly finance transactions, the company that is developing important role in meeting infrastructure needs the project uses its own balance sheet to raise and achieving SDGs (Deloitte 2018), particularly in financing for the project, typically giving lenders financing renewable energy projects. Public-private security over the project assets and recourse to the partnerships and project finance have emerged as an company. In public-private partnerships, commonly effective way to attract private sector investment referred to as PPPs or P3s, project finance is often to infrastructure projects with good results, with used. The key elements of project finance are: the number of public-private partnerships and infrastructure projects completed on a project finance – The creation of a special purpose vehicle basis growing rapidly (OECD 2014; UN Environment (SPV) or “project company” with no previous 2019). The benefits of public-private partnerships business or record whose sole purpose is to are also becoming apparent, with the UK finding carry out the project. a 70 percent reduction in project budget overruns and a 65 percent reduction in schedule overruns for – The use of contracts to govern construction, projects using public-private partnerships (McKinsey operation, and the revenue stream. 2017). From 2010 to 2019, asset finance, including project finance, accounted for $2.1 trillion of the – Limited or no recourse to the sponsors of total $2.8 trillion invested in renewable energy the project. (UN Environment 2019). In 2018, of $236 billion in projects financed on an asset finance basis, – The project remaining off-balance-sheet for $144 billion were financed using on-balance-sheet the sponsors and for the host government transactions from developers and utilities, with $90 (World Bank n.d.a.b). billion financed using a non-recourse project finance basis (UN Environment 2019). Leveraging private sector investment, innovation, and knowledge will be critical to delivering climate-smart infrastructure and services to reduce carbon emissions by 45 percent compared to 2010 levels as needed to limit global warming to 1.5°C (IPCC 2018) and to avoiding locking in inefficient, costly, high-carbon infrastructure for decades to come (IADB 2016). Figure 6 summarizes the various types of capital available, for both the construction and operational periods of a typical PPP project, and the associated risk and cost for each type of capital. Using power projects as an example, the terms of debt available prior to construction tend to © Guvendemir/Getty Images be very conservative, with a high debt-service coverage ratio, shorter tenors in the case of on- balance-sheet transactions, higher interest rates, and / or lower levels of leverage achievable. The conservative terms of construction loans are due to the uncertainty over whether all parties will 28 term institutional investment in climate-smart infrastructure In general, however, infrastructure finance is long Enabling and is secured to the asset cash flows rather than extended security. Figure 2 below sets out the types of finance available at different periods of the project, depending on the level of risk being assumed. Figure 6 Types of financing over construction and operation periods Figure 2. Types of financing over construction and operation periods Risk /Cost Low High Construction Senior debt Mezzanine/Subordinated debt Equity period Project bonds Mezzanine/Subordinated debt Sponsor equity Private equity Construction Vendor financing Operation Senior debt Mezzanine/Subordinated debt Equity period Project bonds Equity Pension/Institutional lenders/Insurance Sponsor equity Source: Deloitte 2018. 26 meet their obligations; sponsors will contribute project developers to raise debt may be accentuated their equity in a timely manner; the engineering, as Basel III capital requirements continue to be procurement, and construction contractor will achieve implemented, with full implementation expected by milestones on target; and the project will be fully January of 2022 (FSB n.d.a.). constructed, satisfy testing requirements, and be completed on schedule. There is also uncertainty Figure 7 details the types of financing available about whether the loans can be refinanced, and at various project sizes with the largest projects whether operational cash flows will be sufficient to involving the private sector in emerging markets repay debt as scheduled. Operational risks include often being financed through blended finance the intermittency of renewable resources, whether involving DFIs and a syndicate of commercial banks. the offtaker will honor its payment obligations as scheduled, and whether the facility will be operated Appendix 2 provides a more detailed overview and maintained properly. courtesy of Deloitte for each type of capital and their associated characteristics (Deloitte Once the project is operational, construction risks 2018). Both project finance and on-balance disappear, and the operational risks can be assessed sheet transactions create opportunities to issue given a stable initial operating period. Refinancing green bonds or securitize existing assets. Even at that point offers an opportunity not only to governments, such as Hong Kong, which issued enhance the economics of the project by having more a $1 billion green bond in 2019, are also able favorable debt terms and resulting returns, but also to finance some projects through green bond to pool assets or create securities that will enable a proceeds. In all cases, the issuance of green bonds broader range of institutional investors to support and other green securities creates opportunities these projects. This is critical as the challenge for for institutional investors. 29 Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap Figure 7 Debt Financing Options for Private Enterprises According to Type and Size PROJECT SIZE $1,000 $10,000 $50,000 $100,000 $1 mil $10 mil $10 mil >$10 mil Private Small and Micro, small and Larger corporations medium-sized Infrastructure Enterprise medium-sized enterprises & small & multinational projects (demand) enterprises (SME)s corporations corporations Financial Commercial Institutional Microfinance Commercial Institutions institutions banks banks and capital investors and (supply) markets capital markets Micro-loan Financial Corporate loan Instruments Corporate bond Project Finance, PPP Insurance Development finance (MDBs, DFIs, IFIs) Source: Table adapted from UNEP 2016 report “Demystifying Adaptation Finance for Private Sector”. Green Bonds and Green Securitization as “institutional investors generally have a preference for brownfield-type (e.g. operational) investments, Green bond issuances create opportunities for which they see as less risky and more aligned with a institutional investors to support climate-smart long investment horizon (OECD 2013).” infrastructure, and models of refinancing and securitization using green bonds and green asset- Green securitizations can offer advantages compared backed securities have the potential to attract to green bonds issued in support of new projects, capital in the amounts necessary to bridge the including an established payment track record, climate investment gap. limited to no construction risk, and an operating performance history. Despite potential advantages Green securitization takes existing financial assets in the securitization of existing green assets, green and pools them into a marketable security. These securitization still represents a small portion of both securities are referred to as asset-backed securities, the overall green bond market and the overall CLO collateralized loan obligations (CLO), collateralized market. “Global green bond and green loan issuance debt obligations, and receivables or “distributed reached an adjusted USD257.7bn in 2019, marking a energy asset receivables” such as those issued by new global record. The total is up by 51% on the final BBOXX for off-grid assets in Africa in 2016 (PV 2016). 2018 figure of USD170.6bn. Of the total, USD10bn (4%) Securitization creates assets which can be attractive are green loans” (CBI 2019). In comparison, only $32.4 30 Enabling institutional investment in climate-smart infrastructure billion of green asset-backed securities were issued made under the CLO 2.0 and CLO 3.0 frameworks in 2019 (CBI 2019), whereas the global CLO market (Milbank 2014) to reduce the risk associated with reached approximately $850 billion (BOE 2019). CLOs, and the fundamental differences between mortgage-backed securities and infrastructure-asset- Unlocking the funding needed to bridge the climate backed securities. investment gap and meet the 1.5°C Paris Agreement goal will require all stakeholders to increase climate- Project finance loans are significantly different smart investment significantly, well beyond what from mortgages as an asset class and “assets like bank and DFI balance sheets can support. As [sustainable infrastructure projects] provide the long- such, funding mechanisms that enable financial term income preferred by many institutional investors institutions to recycle capital to continue offering and CLOs can provide institutional investors access to loans will be required to prevent banks, and the these assets while improving the risk-adjusted returns overall climate movement, from being constrained with an optimum liability structure which works by rapidly running into lending limits once pipeline through economic cycles (White & Case 2018).” Project barriers are resolved. finance loans, including infrastructure, demonstrate not only investment-grade levels of default but also “The bond market could provide USD 1-1.5 trillion exceptionally high levels of recovery in an event of annually in additional private capital for sustainable default, which would justify an investment grade projects… however, some structural challenges and rating on a project basis in many cases. Project finance market barriers will need to be removed and policies loans exhibit a 5.6 percent 10-year cumulative default and incentives put in place to ensure adequate returns rate with an average recovery rate of 77.5, and more for investors (White & Case 2018).” While green bond than 58 percent of transactions resulted in 100 issuances are growing rapidly, the overall size of the percent recovery (Moody’s Investors Service 2019). This market still falls short of what is possible and what compares with cumulative default rates of 5.1 percent is needed. In 2019, $257.5 billion in green bonds were for Baa3-rated corporate bonds and 9.9 percent for issued, up from $171.1 billion in 2018 (CBI 2019) and Ba1-rated bonds. Project finance transactions also green asset-backed securities accounted for only “trend closer to default rates for single-A corporates by $32.4 billion of the total despite most utility-scale year seven (Moody’s Investors Service 2019).” Ten-year renewable projects being asset-financed (including default rates were 7.8 percent in emerging markets project finance). and 8.6 percent in developing markets, higher than the 5.4 percent default rate in OECD countries but still The slow pace of securitization is likely attributable well below the 9.9 percent default rate for Ba1-rated to several factors. In addition to structural challenges corporates. The global default rate was 5.2 percent and market barriers, asset-backed securities more for public-private partnership projects and 5.8 percent broadly fell out of favor after the global financial for infrastructure projects (Moody’s Investors Service crisis of 2008 as models failed to account properly 2018), demonstrating that, for infrastructure project for the possibility of a broader market decline in real finance (including climate-smart infrastructure), estate and underestimated the correlation between risk perceptions diverge from risks observed in the the underlying mortgages in the event of a financial bank market. crisis (FRB 2013, CRS 2010). Given the resulting rise in defaults and the decline in market value of asset- In addition, infrastructure projects are “relatively backed securities experienced during the financial uncorrelated with other asset classes (JPM 2017),” crisis, some market participants remain hesitant this is particularly true in emerging markets where about asset-backed securities. This is despite infrastructure projects are typically governed by revisions to the rules governing CLOs, which were a concession or other agreement that provides 31 Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap for reliable cash flows over the life of the project. investment gap. This model allows commercial banks Individual projects are also typically not correlated and DFIs to continue to underwrite infrastructure with each other. Adverse events affecting a wind farm loans to ensure that the underlying project structures in Kazakhstan will have no effect on a solar farm in mitigate and allocate risks appropriately. Institutional Panama or an electric rail project in Manila. These loans investors may not be able to invest directly at are less vulnerable to the same risks that caused the a project level, but most can easily purchase mortgage asset-backed security markets to fail during investment-grade rated or publicly listed securities. the financial crisis. As such, securitization of climate- smart infrastructure loans can create investment The use of CLOs for infrastructure is not a new grade–rated securities with reasonable returns that concept, but it offers a model that can leverage offer exceptionally high levels of diversification the capabilities of existing market participants and can justify the rating at a fundamental level. and an established product to enable increased Aggregating loans and notes into a common institutional investor participation in the amounts structure and securitizing the assets can also enable needed to close the climate investment gap, even in institutional investors to finance small-scale assets emerging markets. Notably, despite 36 percent of and small- and medium-size businesses (CBI 2018). the underlying loans in the case study being made Case study 1 demonstrates a securitization model that to infrastructure projects in emerging markets, the has been successful in replenishing more than $458 securities were still able to achieve ratings as high million in bank capital and is being expanded based on as Aaa due to the payment track record and credit this success. Using such models globally can unlock support of the underlying assets, diversification institutional investment opportunities of the size across assets and geographies, and the credit needed to address the climate crisis. support of a highly rated entity for the issuance. At the time of issuance, 27 percent of the loan portfolio Case study 1, although not limited to renewable was also still under construction but was supported energy or climate-smart investments, presents an by sponsor completion guarantees and sovereign approach whereby lenders can free up capital to guarantees. Over 30 percent of the portfolio also continue making new loans and enable a broader set had credit enhancement from multilateral financial of institutional investors to support climate-smart institutions or export credit agencies. The main investments. Many institutional investors may be barriers to rolling out the model presented in case unable to invest in climate-smart infrastructure study 1 are the limited pipeline of bankable, climate- without structures like this due to barriers that can smart projects, structural bottlenecks that may prevent them from investing directly at a project prevent the underlying loans from being securitized, level. Some of these barriers are regulatory, and and the willingness of lenders to “give up” loans to relate to investment policies that require minimum climate-smart infrastructure projects before they levels of diversification or prevent investment in have encountered capital constraints. Otherwise, the assets below a certain credit rating, a lack of budget model can be replicated or expanded globally using or capacity to understand each and every market in the architecture that is already in place: DFIs to help which a project may be located, and unfamiliarity structure bankable projects; DFIs and commercial with investing in emerging market infrastructure. banks to lend to them; intermediaries to securitize, Barriers and examples of other possible ways to underwrite, rate, and issue the CLOs; and institutional address them are discussed in the third section of investors to continue investing in CLOs as they already the report, “Barriers to Institutional Investment in are. In emerging markets, DFIs are also well-positioned Climate-smart Infrastructure.” DFIs, institutional to take a first loss-tranche in a CLO structure, as investors, and other capital sources each have a Clifford Capital does in case study 1, to enhance the unique and critical role to play in bridging the climate credit rating and marketability of the issuance. 32 Enabling institutional investment in climate-smart infrastructure Case Study 1: Clifford Capital CLO Infrastructure Take-Out Facility (Bayfront n.d.a.) On July 31, 2018, Bayfront Infrastructure Capital Pte. Structure Collateralized loan obligation Ltd. (a special-purpose vehicle that Clifford Capital issuance established for the purposes of the transaction) issued notes for a $458 million take-out facility, the Size $458 million first-ever securitization of infrastructure and project finance loans originating in the Asia-Pacific region. Figure 8 provides a visual representation of the transaction structure. Region Singapore (issuance), 16 countries or country (underlying) The issuance pooled 37 infrastructure asset and project finance loans from across the Asia-Pacific region and the Middle East; emerging market loans Barriers Policy and Regulatory, Financing, accounted for approximately 36 percent of the total. addressed Transaction and Due Diligence Costs Project countries for the underlying assets include the following: Australia (20.6 percent); Indonesia Figure 8 Bayfront Infrastructure Transaction Structure Source: Bayfront n.d.a. 33 Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap (14.4); Vietnam (14.4); Oman (10.3); Mongolia to prevent moral hazard. The subordinated tranche is (8.2); Papua New Guinea (6.2) Jordan (4.1), Kuwait structured to take first loss on defaults and ensures (4.1), Singapore (4.1), India (3.1), Saudi Arabia (3.1), that Clifford Capital would be among the first to Malaysia (3.1), Bangladesh (2.1); and China (2.1). absorb any losses. The subordinated tranche also Sectors include the following: Conventional Power results in credit enhancement of the other tranches, & Water (32.7); Integrated LNG (20.8); Renewable increasing their respective ratings. At issuance, all Power (12.9); Metals and Mining (11.9); Transportation tranches were oversubscribed, and Moody’s Investors Infrastructure (7.9); Energy Shipping (5.9); Other Oil Service recently upgraded the ratings of the B notes and Gas (5.0); and Gas Infrastructure (3.0). to Aa2 and the C notes to Baa2. Figure 9 shows the amounts and ratings of the four classes of notes. The underlying loans came from the DBS Bank, HSBC, Mitsubishi UFJ Financial Group, Standard Chartered, The issuance received investments predominantly from Clifford Capital, and Sumitomo Mitsui Banking the following sources: insurance companies, pension Corporation outstanding loan portfolios. Notes funds, and endowments (39 percent); bank treasuries were issued in four classes (A, B, C, Sub), with credit (33 percent); asset managers (21 percent); and private ratings ranging from Aaa to Baa3 sold to institutional banks (7 percent). Among investors, 65 percent were investors, with Clifford Capital retaining subordinated from the Asia-Pacific region, with 23 percent from notes representing 10 percent of the total issuance Europe, and 12 percent from the Middle East. Figure 9 Bayfront Infrastructure Capital four note classes The Class A Notes, Class B Notes and Class C Notes are rated by Moody’s and listed on the Singapore Exchange. The Subordinated Notes are solely held by Clifford Capital as Sponsor and Manager of the transaction. Class Amount Amount Issue Spread3 Legal Issued Outstanding2 Ratings Maturity (US$ million) (US$ million) (Moody’s) Date A 320.6 247.3 Aaa (sf) 145 bps 11-Jan-2038 B 72.6 72.6 Aa3 (sf)4 195 bps 11-Jan-2038 C 19.0 19.0 Baa3 (sf)4 315 bps 11-Jan-2038 Subordinated1 45.8 45.8 Not rated N.A. 11-Jan-2038 1 Retained and not offered. 2 As of 13 January 2020. 3 Spread is applied over 6 months LIBOR. 4 Ratings for Class B and Class C Notes were upgraded by Moody’s to Aa2 (sf) and Baa2 (sf) respectively on 21 August 2019. 34 Enabling institutional investment in climate-smart infrastructure © Suriyapong Thongsawang/Getty Images The Asian Infrastructure Investment Bank (AIIB) and additional capital annually (White & Case 2018) Clifford Capital recently announced the establishment in support of climate-smart infrastructure. This of Bayfront Infrastructure Management Pte. Ltd. compares to $1.6 trillion to $3.8 trillion of annual (BIM) to help close the infrastructure financing gap investment needed for supply-side energy system in the Asia-Pacific region. The BIM platform will investments to keep global warming to less than acquire project and infrastructure loans from financial 1.5°C (IPCC 2018). A similar approach can be found institutions with the goal of selling securitized notes in the Renewable Energy Platform for Institutional to institutional investors through the public markets. Investors (REPIN) proposed by the European Investment Bank (CFL n.d.a). Securitization platforms like Bayfront Infrastructure Capital and BIM will be fundamental in enabling institutional investors to benefit from the expertise of experienced institutions in the project finance AIIB’s investment in BIM is closely space while supporting climate-smart investments aligned with our objectives of and enabling lenders to recycle capital to continue supporting new projects. The approach can be developing Asian infrastructure replicated with loans to climate-smart projects as an asset class and supporting globally; this would not only free up capital for private capital mobilization. lenders so they could support additional greenfield (i.e. new) projects, but it would also create a Through robust environmental, pipeline of green collateralized loan obligations social and governance criteria, the platform provides institutional and brownfield (i.e. established) projects in which institutional investors could invest. investors with a unique The issuance included project finance loans to opportunity to support sustainable renewable energy projects demonstrating that securitization models like this case study hold infrastructure projects in Asia. the potential to recycle lender capital and create AIIB Vice President and opportunities for institutional investors to invest Chief Investment Officer D.J. Pandian in renewable energy projects in emerging markets. Models like this can unlock $1 to 1.5 trillion in 35 Chapter 3 | Challenges and Opportunities to Close the Climate Investment Gap Attracting Institutional Investment – An investment-grade equivalent credit rating for any securities involved (with the sovereign Addressing barriers specific to institutional credit rating often constraining project-level investors to unlock additional pools of capital risk assessments). to close the climate investment gap is of critical importance to ensuring a transition to a low- – Sufficient transaction size to attract carbon, climate-resilient economy. institutional interest. Although significant attention has been paid – Appropriate risk management of price risks, in recent years to finding ways to attract foreign exchange risks, and operating risks institutional capital to infrastructure finance, these efforts have not reached the level of success – Overall sound host country macroeconomic needed because of the challenges they present and policy situation. such as restrictions on institutional investor asset allocation, the limited risk appetite required, and However, “even within developed economies where limitations on exposure to emerging markets. returns have generally been strong, private investors “Infrastructure accounts for less than 1% of pension still perceive infrastructure as a hard asset class. It is fund assets, a number which needs to increase illiquid. Regulatory frameworks limit the potential for to about 3-4% by 2030 to deliver on the SDGs institutional investors to play. The business models (Blended Finance Task Force 2018).” often involve substantial counterpart risk. FX hedges are expensive and typically only available over a To attract local and international institutional relatively short time-frame. Infrastructure remains investors to infrastructure projects in developing a sector which is prone to corruption. Institutional countries, the following conditions are fundamental: weaknesses and missing markets act as barriers to matching large-scale capital with sustainable – Sound project structures (including a fair risk investment opportunities. And international private allocation and appropriate levels of government capital will only participate at scale if complemented support in the concession agreement). by sizeable amounts of domestic private capital. All this compounds to limit capital flows, especially cross- – Sound operating and financial performance border into emerging markets. But these risks are often in the case of brownfield projects (including as much perceived risks, as they are real (Blended payment track record from the off-taker, Finance Task Force 2018).” The next section provides a as applicable). detailed discussion of barriers to enabling institutional investment in climate-smart infrastructure. 36 © Nirian/Getty Images 04 BARRIERS TO INSTITUTIONAL INVESTMENT IN CLIMATE-SMART INFRASTRUCTURE 04 | Barriers to Institutional Investment in Climate-Smart Infrastructure Delivery on the SDGs and the fixed income investments such as investment-grade objectives of the Paris Agreement liquid bonds, listed equities, and listed funds). This emphasis on liquid marketable securities has left will require scaled-up flows of pension funds and other investors heavily exposed public and private investment to market fluctuations, as the market effect of the novel coronavirus pandemic has demonstrated. in infrastructure that is socially, Domestic and international institutional investors economically and environmentally each also face barriers unique to their own sustainable. To reach these goals, situations. Global institutional investors prefer large well-structured projects whereas domestic there is a broad consensus in the institutional investors may be able to support international financial community smaller well-structured projects in sectors of less that the main barrier to increased interest to global institutional investors. Domestic institutional investors may also be able to accept investment is not a lack of available a domestic investment grade rating depending finance, but rather a lack of well- on the regulatory environment whereas global institutional investors will seek ratings from prepared and investment-ready international ratings agencies. Medium-sized bankable projects – i.e., whether international institutional investors may also a project is attractive enough for take comfort from the participation of a domestic institutional investor group to bolster due diligence investors to decide to invest. This and show local support. Domestic and international is evident in developing countries, institutional investors both have critical roles to play in meeting the goals of the Paris Agreement. where there is often limited capital available for project preparation, Domestic institutional investors often lack but also in developed economies – access to international partners and have limited experience with climate-smart infrastructure. Local in the G20, only half the countries financial markets are also constrained in their publish infrastructure pipelines. ability to provide local currency financing at the levels needed to support large-scale infrastructure The Global Commission on the Economy and Climate. investment, and local bond markets are often “Finding the Pipeline: Project Preparation for Sustainable Infrastructure.” undeveloped. Domestic institutional investors seeking to invest in projects with an international component would also face currency exposure should they be required to invest using foreign Institutional investors face significant barriers in currencies. However, participation by domestic deploying their capital to support climate-smart institutional investors is often helpful in attracting infrastructure. Institutional investor-specific international capital. barriers necessitate not only good underlying project design, but also investment opportunities “Failure by domestic investors to allocate enough and securities that meet their requirements and capital to sustainable infrastructure assets in their are of sufficient size to be of interest. For example, own country sends a strong signal to international pension funds are restricted in the level of credit risk investors – that even the locals think that the they can tolerate and diversification they need (e.g., returns are not high enough to justify the risks. As 38 Enabling institutional investment in climate-smart infrastructure a result, finding ways to crowd in domestic private credit rating (by Moody’s, Fitch, or Standard and capital into infrastructure deals is particularly Poor’s) exceeding BBB to A depending on the type significant; it is central to inspiring confidence in of investment. International institutional investors the international markets – no foreign institutional also often lack the capacity to navigate the investor will be comfortable taking risks that the complexities of domestic regulatory environments local pension funds or insurers won’t take (Blended and to assess the risks associated with each Finance Task Force 2018).” project. As such, they depend heavily upon the structuring capabilities of MDBs, the expertise “Furthermore, the willingness and ability of of specialist infrastructure asset managers, and the host country and its population (pensions, the ratings of the international ratings agencies. entrepreneurs, SWFs, development banks, etc.) Currency controls and political risks such as to invest alongside international investors on pari expropriation are also of concern to international passu or junior terms can also demonstrate local investors, and political risk insurance from entities will and execution capacity, as well as local and such as MIGA will often be required to provide non-local financial alignment (CFLI 2020a).” While the comfort needed to attract international the lack of domestic institutional investment can institutional investment. hinder international institutional investment, work is being done to facilitate domestic investment. “A low carbon transition requires increased long- term finance flows to developing countries and a “The WBG Finance Competitiveness & Innovation bigger share allocated to low-carbon investments group is working on amendments to local (World Bank 2015b).” This necessitates addressing regulations that would allow domestic institutional the obstacles to attracting investment to both investors to invest in infrastructure in numerous increase the financing available for infrastructure markets. It is often overlooked that many developing to “grow the pie,” and increasing the portion countries have high savings rates relative to flowing to low-carbon investments to “green the developed countries. These domestic resources can pie” (World Bank 2015b). Many countries still lack be used to finance infrastructure, thereby avoiding the public funds and local capital markets that can hard currency debt (which can prove crippling for facilitate infrastructure investment at the levels projects and countries to pay back if their home needed, particularly for long-term investments. currencies devalue). A focus on local markets also As such, addressing barriers that affect the helps “crowd in” local financial institutions and ability of all infrastructure projects to leverage investors thereby developing experience and skills existing sources of finance, and facilitating the which can be used for future projects. This provides use of financing models such as those presented benefits in the long run by reducing reliance on in the case studies to attract new sources of international banks and development agencies capital, can help grow the pie. Additionally, it is (Blended Finance Task Force 2018). “ important to address the barriers to investment in low-carbon technologies, which can range International institutional investors may have from differences in upfront and life cycle costs to limited experience investing directly in climate- different risk perceptions compared to conventional smart projects in developing economies and technologies. Therefore, enabling financing models are often constrained in terms of the types that allow climate-smart infrastructure projects of investments they can make and minimum to be financed on a long-term basis can facilitate investment criteria. For example, many pension countries in being able to take advantage of the funds are restricted to investing in listed and liquid opportunities being created by new technologies to securities and funds or bonds with an external further green the pie. 39 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure This section provides a framework for the barriers that most directly impact the ability understanding the main barriers to expanding of institutional investors to support climate-smart institutional investment in climate-smart infrastructure in developing countries. Additional infrastructure projects and discusses the importance barriers including market imperfections and of the governance framework in creating an enabling behavioral-related barriers such as the lack of a environment that can attract private sector capital. It carbon price in many markets, and other impacts builds on a literature review of existing publications from perceived risks, can also play an important role and initiatives to expand private sector investment. as discussed in more detail in other reports such as To better understand the challenges of investing in Decarbonizing Development: Three Steps to a Zero- climate-smart infrastructure in emerging markets, Carbon Future (World Bank 2015b). this report identified two categories of barriers that must be overcome to enable investment at the scale Case studies are interspersed throughout to provide needed to address climate change. examples that have been successful in addressing specific barriers. It is important to note that the The first category of barriers focuses on traditional solutions presented are not prescriptive but are risks and obstacles that affect both climate-smart provided to give examples of the ways that risks and conventional infrastructure projects, while and barriers have been addressed successfully. the second focuses on barriers specific to climate- Given the bespoke nature of many infrastructure smart infrastructure more broadly. Considering projects in emerging markets, solutions often these barriers together allows investors and other need to be tailored to the circumstances of the stakeholders to better understand how these host government. Figure 10 provides a visual barriers interact with one another and to develop representation of how the cumulative effect potential solutions to address specific challenges. of these barriers can make it challenging for It should be noted that this list of barriers is not the private sector to invest in climate-smart intended to be exhaustive but rather is focused on infrastructure projects in emerging markets. Figure 10 Private Sector Investment Barriers Long-Term Planning Monetizing Resilience Climate These barriers are more Investment Green Technology specific to investment in Barriers climate projects Transaction & Due Diligence Costs Cost Structure Credit Risk Commercial These barriers compromise Financing basic project finance Traditional Investment Policy and Regulatory investment risks regardless Barriers of sector. Within these basic Country Risk risks, climate projects can present unique challenges Macroeconomic Project Pipeline 40 Enabling institutional investment in climate-smart infrastructure Traditional Investment Barriers The lack of a bankable pipeline of projects is perhaps the most significant barrier to private investment in This section reviews traditional barriers to private climate-smart infrastructure in emerging markets. investment and how these barriers manifest in To attract private sector capital, projects require a climate-smart infrastructure projects, summarized sufficient quality and size and should offer a fair in figure 11. There is an additional focus on how risk allocation among the host government, the these barriers may be exacerbated in climate-smart buyer or off-taker, and private investors. Figure 12 infrastructure as a result of the additional complexity shows the rising amount of unallocated funds held of climate projects and intricacies of the climate by asset managers that have yet to find suitable finance architecture. Each barrier impacts the various infrastructure projects in which to invest, with such stakeholders, including the government authority “dry powder” exceeding $200 billion at the end of and private investors. 2019 (Preqin 2020). The amount of unallocated funds is a direct result of the “lack of a significant pipeline Project Pipeline Barriers of well-prepared and well-structured infrastructure projects in emerging markets (World Bank 2017).” – Limited national government and local developer capacity to create well-structured The lack of bankable projects is often attributed to and bankable projects limited local government and developer capacity for designing and structuring transactions that are – Limited early-stage project preparation attractive to private sector investors, with the lack of support capacity resulting in weak project-related contractual – Government identification and prioritization frameworks (GCEC 2016). of projects can be inconsistent To help address the critical need for project preparation support and pipeline size, the Global Infrastructure Facility was established in 2014 as “Public and private investors broadly see that lack a G20 initiative14 to support governments at the major of investment-ready, ‘bankable’ projects as a Long-Term national and subnational level—including cities—and Planning constraint to greater investment in low-carbon and multilateral development banks with funding and Monetizing Resilience Climate climate resilient infrastructure” (GCEC 2016). These hands-on technical expertise barriers to design are andmore structure Investment Green Technology specific to investment in Barriers climate projects Transaction & Due Diligence Costs Figure 11 Traditional Investment Barriers Cost Structure Credit Risk Commercial These barriers compromise Financing basic project finance Traditional Investment Policy and Regulatory investment risks regardless Barriers of sector. Within these basic Country Risk risks, climate projects can present unique challenges Macroeconomic Project Pipeline 14 G20 is an international forum for governments and central bank governors of 19 countries and the European Union. 41 bn) 0 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure No. of Funds Raising n) Aggregate Capital Targeted ($bn) Pro Source: Preqin Pro Fig. 4: Figure Global Unlisted 12 Unallocated Infrastructure investment Dry “dry powder” for unlisted Initiatives to offer replicable frameworks such as Powder, 2000 - 2019 infrastructure Open Source Solar,16 a joint effort of International Renewable Energy Agency and the Terrawatt 250 Initiative, and the International Finance Corporation’s Scaling Solar17 program can also facilitate and streamline development of bankable projects. It is Aggregate Deal Value ($bn) 200 important to note that experienced subject matter Dry Powder ($bn) experts must adapt these programs to local market 150 conditions, and the programs cannot be used off-the- shelf in all situations. These programs are also solar- specific, and a transition to a low-carbon economy 100 will require support for all renewable electricity types, energy storage, transportation, water and waste management, and other types of climate-smart 50 infrastructure and technologies. 0 Box 2 highlights the new Climate Investment Platform, which is being designed help address the Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 project pipeline barrier by assisting governments with support to design bankable project Pro Source: Source: Preqin Pro Preqin. 2020. frameworks, providing a marketplace to match projects with investors, and making financial de- risking support available. Preqin Ltd. © investment infrastructure www.preqin.com opportunities that are Case study 2 demonstrates an approach that has attractive to private capital.15 It was designed to proven effective at addressing project pipeline address pipeline size through standardization, barriers by engaging in long-term planning and aggregation, and concerted private sector removing policy barriers to enable commitments engagement to generate interest in projects. totaling over $14 billion in Colombia’s roads from both domestic and international institutional Even before selecting specific projects, investors can investors (World Bank n.d.a.d.). Long-term planning struggle to identify climate-smart infrastructure barriers and regulatory barriers are discussed in projects in developing countries that align their return their relevant sections below. Approaches like expectations with their expectations about the effect the one used in case study 2 can be adapted that the project will have. SDG Impact, a flagship to facilitate investment in climate-smart UNDP program, has developed bottom-up investor infrastructure to help accelerate decarbonization. maps for a series of priority countries that potential Implementing models that improve the efficiency investors can use to screen investment opportunities of spending through improved procurement and according to sector, subregion, return expectation, competition for public works can help increase investment size, and sectors (including climate, energy infrastructure construction without the need to access, sustainable infrastructure, and agriculture). change public budgets. 15 See https://www.globalinfrafacility.org/sites/gif/files/GIFBrochure.pdf 16 See https://opensolarcontracts.org/ 17 See https://www.scalingsolar.org/ 42 Enabling institutional investment in climate-smart infrastructure Box 2 Spotlight: Climate Investment Platform Track 1 Track 2 Targets Policies & — OBJECTIVE Regulations Helping countries to — OBJECTIVE raise and specify their Providing support for well- energy targets in NDCs. designed and implemented national clean energy policies and regulations to scale-up private investment. Track 4 Track 3 Market Place De-Risking — OBJECTIVE — OBJECTIVE To declutter access to Facilitating access to climate investment through project preparation facilitated deal-making, funding and de-risking syndication, and matching of instruments to ensure projects and funding. bankability. Source: https://www.climateinvestmentplatform.com/ Launched at the U.N. Secretary General’s Climate Summit in late 2019, the Climate Investment Platform is an inclusive global partnership led by International Renewable Energy Agency, the United Nations Development Programme (UNDP), Sustainable Energy for All, and the Green Climate Fund. The first phase is focused on the transition to renewable energy, with subsequent service lines dedicated to climate adaptation, sustainable land use, cities, and infrastructure being introduced in 2020. The platform consists of four tracks: supporting governments in specifying ambitious energy targets and increasing their nationally determined contributions; establishing well-designed, well-implemented, well- enforced renewable energy policies and regulations; reducing the financial risk of energy projects; and providing a marketplace where renewable energy investors and project sponsors can connect. A crucial component of the platform is the Track 2 policy risk reduction work, which UNDP is leading. This track will offer various services to assist countries with renewable energy policies and regulations, including facilitating and match-making between countries and partners involved in Track 2; providing direct technical assistance to governments on drafting, implementing, and enforcing well-designed policies; promoting transparent communications and data on domestic renewable energy policies and investment risks, including diagnostics and targeting information gaps; and facilitating knowledge and sharing of the latest international good practices and innovations in policy design. This track will involve close work with the Center for Policy De-risking, a new initiative to provide developing countries with rapidly deployable, hands-on, in-country technical support in policy design and implementation. 43 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Case Study 2: Colombia’s Fourth Generation (4G) Roads Concession Program © Arturo Rosenow/Getty Images Colombia’s Fourth Generation Roads Concession Structure Technical assistance and public Program (4G) was developed to address the need for private partnership program improved road infrastructure, which was hampering Colombia’s further growth and competitiveness. The Size $14.8 billion World Bank Group provided advisory and financing support to identify improvements in the local regulatory and institutional frameworks to enable Region Colombia both domestic and institutional investors to support or country building critical roadways. IFC provided transaction Barriers Project Pipeline, Long-term Planning, advice in the award of 32 road projects totaling $14.8 addressed Policy and Regulatory, Financing billion. As part of the program, IFC also invested $50 million in a domestic infrastructure debt fund 44 Enabling institutional investment in climate-smart infrastructure and $70 million in Financiera de Desarrollo Nacional and regulatory, financing, and long-term planning (FDN), Colombia’s national infrastructure bank. MIGA barriers to institutional investment in climate-smart provided a loan guarantee for FDN. infrastructure. The case study also demonstrates the importance of participation by domestic institutional The program was developed using World Bank investors and ways to attract international Group’s MFD approach and included assistance institutional investment. in developing an enabling environment through revisions to the regulatory and institutional framework, expanding the pre-existing PPP program, Macroeconomic Barriers capacity building for local officials and investors, and direct investment in FDN. The enabling environment – Foreign exchange risk was improved through the passage of a new PPP – Interest rate risk umbrella framework, with further reforms suggested in 2014, along with the establishment of a new – Inflation transportation concessions body called the “Agencia Nacional de Infraestructura,” and the co-investment by IFC and FDN in the Colombia Infrastructure Collective Debt Vehicle, which facilitates institutional “Strong institutions with a track record of good investment in infrastructure. The work also created governance and the commitment and capacity a standardized project bond and guarantee structure to provide stable macroeconomic management and associated regulations and pricing benchmarks. is a major factor for investors as are sound The PPP program was improved through the advice of macroeconomic policies to drive broad-based the IFC, which helped the government to standardize growth, provide investors with broad assurance of transaction documents, streamline processes, reduce the financial sustainability of their investments transaction costs, and increase efficiency. IFC also (CFLI 2020).” supervised transaction advisors in the first three 4G projects that were tendered. The investment by For foreign investors, currency volatility is one IFC in FDN was accompanied by $78 million from of the most pervasive challenges to investing in Inter-American Development Bank and $50 million developing countries over the long term. Foreign from the Corporación Andina de Fomento (CAF), investors typically denominate their balance sheets which was also an anchor investor alongside IFC in a in hard currencies, such as dollars, yen, euros, or local infrastructure fund which mobilized domestic pounds. Investments in local currencies, especially institutional investors for one of the projects. for long-term infrastructure projects, can create an asset-liability mismatch and can expose investors to The initial results of the 4G program were promising significant foreign exchange risk (Blended Finance with nine projects representing $4.6 billion reaching Task Force 2018; CFLI 2020). Denominating projects financial close by the end of 2017. However the in hard currencies can be better for foreign investors program was temporarily paused due to delays and but can expose the local offtaker to more foreign other challenges. It was restarted in early 2019 with exchange risk unless proper government support is the 176-km Autopista del Mar 1 project reaching contained in the concession agreement. financial close, new disbursements occurring, and several of the previously awarded concessions Some solutions to currency risks include hedging nearing completion during 2019. This case study instruments and local currency financing to the provides a valuable template and lessons learned private sector. For example, Guarantco and the that can be adapted to address project pipeline, policy Currency Exchange Fund offer investors and 45 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure investors in the project (CFLI 2020), the tariff can also include inflation indexation for the cost components vulnerable to inflation. Two networks have formed to share best practices and experiences on macroeconomic, fiscal, and public finance management policies for low- carbon, climate-resilient growth. The Network of Central Banks and Supervisors for Greening the Financial System, launched in 2017, is a group of central banks and supervisors willing to share best © Arturo Rosenow/Getty Images practices and contribute to the development of environmental and climate risk management in the financial sector and to mobilize mainstream finance to support a transition to a sustainable economy. Similarly, the Coalition of Finance Ministers for Climate Action, which the World Bank and the International Monitory Fund co- convened in 2018, recognized the unique role of finance ministers in addressing climate challenges and developed the Helsinki Principles and the governments opportunities to hedge their currency Santiago Action Plan (World Bank 2019; Coalition exposure. The Currency Exchange Fund pools of Finance Ministers for Climate Action 2019). The foreign exchange risk into a global fund with a coalition brings together 50 finance ministries and first-loss tranche that allows foreign lenders to institutional partners, including UNDP, OECD, the provide local currency loans, and Guarantco offers United Nations Framework Convention for Climate local currency guarantees. To mitigate the risk of Change Secretariat, UNEP Finance Initiative, the currency fluctuations and asset–liability mismatch, European Commission, the Nationally Determined international financial institutions, such as the Contributions Partnership, and the Network for International Finance Corporation, can provide local Greening the Financial System. currency financing to the private sector, including loans, swaps, guarantees, and risk-sharing facilities,18 Currency barriers can also be addressed through although these solutions are not sufficient to address green bond issuance. Case study 3 is a novel the need, and more sustainable solutions will come approach whereby a green bond was issued from more developed local capital markets and an in Europe to institutional investors and then expansion of local currency financing through local swapped using derivatives to both refinance and international commercial banks (IISD 2015). brownfield projects and issue new loans to In traditional project finance transactions with greenfield renewable energy projects in Mexico. international developers and sponsors, currency This approach addressed interest rate and foreign and inflation risk can also be captured in the project currency concerns and created an opportunity for structure. The tariff can be paid and indexed in a institutional investors to support climate-smart hard currency or the currency of the private sector infrastructure in the process. 18 The International Finance Corporation has provided more than $13 billion in local currency financing (see https://www.ifc.org/wps/ wcm/connect/corp_ext_content/ifc_external_corporate_site/Solutions/Products+and+Services/Treasury-Client-Solutions). 46 Enabling institutional investment in climate-smart infrastructure Case Study 3: Refinancing with Green Bonds: North American Development Bank (NADB 2018) © Franck Reporter/Getty Images North American Development Bank (NADB) is a 25- Structure Green bond issuance and refinance year old development finance institution capitalized by the governments of the United States and Mexico that supports infrastructure projects that preserve, Size $126.4 million (bond issuance), protect, or enhance the environment along the U.S.- $53.06 million (refinance) Mexican border. NADB leveraged its strong ratings of AA/F1+ from Fitch Ratings and AA1/PRIME-1 Region United States (issuer), Mexico from Moody’s Investors Service to issue its first or country (recipient), Switzerland (country green bond in 2018, which was issued in accordance of issue) with NADB’s Green Bond Framework (NADB n.d.a.), and adheres to the International Capital Market Barriers Macroeconomic, Financing, Association green bond principles (ICMA 2020). The addressed Transaction and Due Diligence Costs purpose of the green bond issuance was to finance and refinance eligible projects. 47 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure The green bond was issued for $126.4 million in Sonora, Mexico; the 250-MW El Mezquite wind equivalent under management by Credit Suisse with project in Nuevo Leon, Mexico; and the 5-MW SEPV a coupon rate of 0.3000 percent and a maturity in project in California. Combined, these projects are July 2026 in the Swiss franc market, with a value expected to produce 2,613 GWh of electricity annually, of 125 million Swiss Francs. The proceeds were equivalent to 348,410 households, and they are converted to U.S. dollars through a cross-currency expected to avoid 1,137,781 metric tons of carbon swap, resulting in a rate equivalent to a three-month dioxide equivalent emissions annually. London Inter-Bank Offered Rate plus 42.20 basis points. The proceeds are being used to support six This green bond issuance enabled international renewable energy projects with a cumulative installed institutional investors to support the refinancing and capacity of 1,118 MW generating an estimated at financing of renewable energy projects in a middle- 3,312 GWh in renewable energy annually. This is income country, and it provides a model for a bond equivalent to the amount of electricity that 438,000 issuance in a foreign currency with proceeds ultimately households use annually. These projects are expected used to support climate-smart investments locally. to help avoid more than 1.45 million metric tons of Such models can be used to overcome financing greenhouse gas emissions, the equivalent of taking barriers to enable institutional investment in climate- 309,440 cars off the road annually. smart infrastructure in countries lacking a local green bond market. The projects also benefited from the involvement of a development finance institution The issuance of our first Green whose expertise in financing projects such as these ensured that the projects were properly structured and Bond in 2018 represents a logical were aligned with the host government’s renewable step in our evolution and our desire energy policies. to be at the forefront of innovation. NADB Acting Managing Director Calixto Mateos-Hanel Country Risk Barriers – Currency convertibility, transferability Of the green bond proceeds, $53.06 million was used to refinance NADB’s loan to the 199.5-MW EDP – Breach of contract Renewables North America Wind farm in Coahuila, – Expropriation Mexico, which was initially financed with an $89.8 – War, terrorism, civil disturbance million loan from NADB and began operations in September 2017. The Mexican mining company Industrias Peñoles, S.A.B. de C.V. purchases power from the project under a long-term power purchase agreement. The project generates approximately 699 “Policy risks, such as expropriation, sovereign GWh per year, equivalent to the energy that 89,791 breach of contract, or lack of availability of hard households use per year, avoiding 337,680 metric currency, are crucially important considerations for tons of carbon dioxide equivalent annually. investors (CFLI 2020).” The remaining $73.36 million was used to finance Although some country risks, such as currency five projects: the 317.5-MW Puerto Libertad project convertibility, transferability, breach of contract, and in Sonora, Mexico; the 148-MW Santa Maria project expropriation, are clearly within the control of the host in Chihuahua, Mexico; the 125-MW Orejana project government, others, such as embargos, war, terrorism, 48 Enabling institutional investment in climate-smart infrastructure and civil disturbance, may be outside a government’s in a climate infrastructure deal can have powerful co- control. Country risks can be addressed by including benefits (Blended Finance Task Force 2018). appropriate provisions in the project agreements and further mitigated using political risk insurance or Policy and Regulatory Barriers partial risk guarantees if structured properly. – Restrictions related to international financial Foreign currency convertibility risks can be addressed regulations (e.g., capital requirements, by having the tariff paid in a major currency or treatment of guarantees) including appropriate indexation and timing – Change in law provisions and ensuring that proper transferability provisions are included in the concession or – Policy inconsistency implementation agreement and can be covered – Lack of strong, efficient, impartial domestic by political risk insurance. “The degree to which a dispute resolution system country can peg its currency to a hard currency, or denominate project revenues in a hard currency is thus an important consideration (CFLI 2020).” Similarly, provisions governing events such as “Low-carbon projects are particularly vulnerable expropriation, war, terrorism, and civil disturbance to policy risk, such as the ability to predict and rely can be captured in the project agreements, on stable tariffs, due to declining input costs and a including the concession agreement. With such reliance on government subsidies (CFLI 2020).” a framework in place, political risk insurance from an organization such as the Multilateral Long-term investment in infrastructure, climate- Investment Guarantee Agency (MIGA) or the U.S. smart or otherwise, requires a strong enabling International Development Finance Corporation; a environment to ensure sufficient capital flows, partial risk guarantee from an organization such including a strong rule of law with clear rights and as the Japan Bank for International Cooperation, obligations of private investors and an efficient, the African Development Bank, the International transparent, impartial dispute resolution system. Bank for Reconstruction and Development, or the Without an appropriate policy and regulatory International Development Agency; or a partial environment, many developing countries will struggle credit guarantee from the Asian Development Bank to encourage private investment. DFIs and both can be used to mitigate country risk. domestic and international institutional investors can also face regulatory hurdles that can create barriers Some of these macroeconomic or country risks can to investment in clean infrastructure. also be partially mitigated by involving domestic institutional investors, who have more than $5 trillion With an annual climate investment gap of $2 trillion in assets under management (Blended Finance Task to $3 trillion, mostly in the developing world (Blended Force 2018). These local investors have a stronger Finance Task Force 2018), governments will need understanding of domestic markets than outside to develop appropriate enabling environments and investors, so they may be more comfortable with strategically use limited public funding to attract country-specific and political risks. Local investors private capital to meet their climate ambitions. also avoid concerns over currency risk and are often “With insufficient public finance comes the need for not bound by the same investment restrictions that government to set market conditions for attracting international institutional investors face (see appendix capital through effective regulation, budgeting, budget 3). Bringing local and international investors together and investment forecasting, and project development 49 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure and management. This can strongly influence the Although guarantees are effective at de-risking investment environment for public infrastructure and infrastructure investment, the regulatory improve project bankability GCEC 2018b.” constraints of using guarantees can make it difficult for originating banks to sell their At the investor level, institutional investors both exposures to a given asset, and the subsequent domestic and international can face regulatory illiquidity can reduce the attractiveness of restrictions on the types of investments they can guarantees to risk managers and regulators make. “Local pension funds are often restricted by law (Blended Finance Task Force 2018). Conversely, from investing in infrastructure. Policy-makers play public sector organizations have disincentives an important role here: for example, the Colombian to use guarantees because OECD pledges are government recently implemented regulatory changes counted based on money spent rather than money to allow pension funds to invest in infrastructure-debt leveraged. Given the power of guarantees to unlock funds, meaning they could invest in the country’s and increase private capital for climate-aligned Fourth Generation ‘4G’ roads project, giving confidence development, demand is increasing for MDBs and to international investors. The Peruvian infrastructure institutional investors to reassess the regulatory bonds market has also seen strong success partly treatment of infrastructure investment (G20 Group because local pension funds were allowed to invest 2018); but until these changes are in place, existing in infrastructure bonds in 2001 (Blended Finance regulations remain a barrier to institutional Task Force 2018).” Some investors may also be investment. Nevertheless, the G20 Eminent subject to financial regulations that prohibit or Persons Group (G20 Group 2018) and other think restrict them from investing in developing countries tanks and industry associations are increasingly or in infrastructure more broadly (Blended Finance encouraged that the capital requirements for Taskforce n.d.a). Appendix 3 provides a summary institutional and MDB investment in infrastructure of many of the regulations affecting institutional can be reassessed. investors in the US, UK, and Europe. Financing Barriers At the project level, regulations and policies also have significant impact, and adverse changes in governing – Underdeveloped capital markets laws can lead to losses. To address weaknesses in – Limited access to affordable and local law, the parties can agree to have a more widely concessional capital, especially in local used legal system (often the U.K. system) govern currency the project agreements. Similarly, if local dispute resolution mechanisms are lacking, the parties can – Limited risk capital, first-loss financing, agree to international arbitration by a recognized or junior tranche equity that can unlock arbitration center. Provisions governing change commercial financing in emerging markets in law and dispute resolution can then be covered – Lack of standardized term sheets through political risk insurance or guarantees, enabling institutional investment. Change in law can be addressed through provisions the project agreements, specifically to ensure that the project SPV is compensated through a revised tariff as the “The challenge of limited local commercial banking result of any adverse change in the law and that such experience and capabilities, such as the lack of adjustment is also captured in the concession or long-term, fixed-rate, non-recourse debt and implementation agreement so that it can be covered limited liquidity in local debt and equity markets, by political risk insurance or a guarantee. can be a hindrance for investors (CFLI 2020).” 50 Enabling institutional investment in climate-smart infrastructure There is often a mismatch between local currency To address the shortage of local currency deposits and the need for long-term financing for loans available for climate-smart projects, the infrastructure projects. This inherent mismatch Development Bank of South Africa launched between assets and liabilities can make it difficult the Climate Finance Facility (CFF) in February for local banks to provide long-term loans. Projects 2019. The CFF is the first green bank model in an also take time to construct and cannot service emerging market with support from the Green loans until after the commercial operation date. Climate Fund and Convergence Blended Finance. This concern over the timing of when a project The CFF offers two main credit enhancements in will start repaying investors can make it difficult the form of concessional finance to attract private for local banks to lend to greenfield projects. investments and address market gaps: long-term The limited access to affordable, long-tenor subordinated debt and tenor extension of up to loans in local currency, can force developers to 15 years because the CFF does not face the same seek out loans denominated in dollars or other regulatory constraints as local lenders. The CFF hard currency, which can expose the project works with domestic commercial banks to blend to significant foreign exchange volatility and public and private capital at the project level and undermine profitability. Private developers also invests in local currency (South African rand), with face challenges in funding climate projects. In the goal of leveraging an overall portfolio ratio of 1:5 many developing countries, proven, commercially (Convergence n.d.a.). By working through local banks viable climate-smart technologies (e.g., off-grid to offer credit enhancements, CFF fills a necessary power, solar mini-grids, distributed urban solar financing gap while increasing the capacity of local farms, energy- and water-efficiency technologies) financial institutions to finance climate projects. are unfamiliar to domestic investors and commercial banks (Convergence 2019). Project size and deal flow pose additional challenges for climate-smart infrastructure projects in Investors have the ability to access development developing countries and “offer less opportunity for finance from a variety of sources, including private financial institutions to reach economies of scale in sector arms of MDBs, such as the International their financing activities (CFLI 2020).” A green bond Finance Corporation, and climate funds, such market would be possible; however, aggregation and as the $10.3 billion Green Climate Fund, $8.4 securitization are limited by market size and the lack billion Climate Investment Funds, and $21 billion of a standardized approach. “Regional integration Global Environment Facility. But these funds are may address this challenge, but creates new credit, inadequate to meet demand, and the process to structuring, and legal complexity (CFLI 2020).” access this funding can be lengthy and complex As such, standardization of project agreements (Blended Finance Task Force 2018). Of the 88 can increase the attractiveness of these smaller entities accredited to access capital from the Green investments and facilitate aggregation in addition to Climate Fund, only 16 (18 percent) are from the reducing transaction and due diligence costs. private sector, and only six of these have signed the necessary legal agreements with the Green Properly structured infrastructure investments, Climate Fund to begin funding projects (GCF n.d.a.). particularly those aligned with the SDGs, can be The private sector received 25 percent of the an attractive asset class in which institutional investments from Climate Investment Funds, and investors can diversify. Case study 4 presents a approximately one-third of co-finance is coming model of the use of alternative investment funds from the private sector (CIF n.d.a.), which shows to refinance debt in the Indian market to create how difficult it can be for private investors to access opportunities for institutional investors to support concessional capital. infrastructure assets. 51 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Case Study 4: Take-Out Financing Using Alternative Investment Funds (AIFs) - Indian Renewable Energy Development Agency (Singh et al 2019) © Bremec R./Getty Images Rules governing Alternative Investment Funds (AIFs) Structure Alternative investment funds, green in India were proposed in 2011 and finalized in 2012. Masala bond issuance AIFs are private investment vehicles that pool funds to be invested under a predefined investment policy and Size $300 million (London Stock are equivalent to alternative investment funds in the Exchange Group 2017) United States and AIFs in the European Union. This example presents opportunities that could be replicated Region India (fund domicile), UK (Masala in other markets to support climate-smart investments. or country bond issuance) Figure 13 shows how an AIF would operate. Barriers Financing, Policy and Regulatory, The Indian Renewable Energy Development Agency addressed Transaction and Due Diligence Costs (IREDA) is a government of India enterprise under the administrative control of the Ministry of New and 52 Enabling institutional investment in climate-smart infrastructure Figure 13 How an alternative investment fund would operate Source: Singh et al 2019. Renewable Energy that was established as a public to capital markets: securitizing diversified loan limited government company and a nonbank financial portfolios; using the proceeds of capital market institution in 1987 for the purpose of promoting new issuances to retire existing debt rather than renewable sources of energy. In collaboration with refinancing the loans directly; increasing investor the Climate Policy Initiative, IREDA has advanced protection in the event of default; developing the concept of using AIFs in India to expand capital risk-transfer mechanisms such as credit default market access to renewable energy in the medium swaps to make investments more attractive; and term while the country addresses other structural using AFIs to bridge the $315 billion need for debt challenges. IREDA issued the first-ever green Masala finance for renewable energy projects by 2030, bond on the London Stock Exchange International assuming the 70/30 debt versus equity split typical Securities Market (London Stock Exchange Group in India (Singh et al. 2019). An AIF issuance can 2017). The Climate Bond Initiative certified the issue benefit from the ability of entities like IREDA to (CBI 2020a). The $300 million bond had a 7.125 offer a partial credit guarantee, improving the risk percent coupon and a 5-year maturity. Proceeds from profile of the issue; act as an aggregator to bundle the bond issuance were earmarked to finance wind multiple project loans into securities; and crowd in and solar projects across India totaling 831 MW. Prior long-term institutional investors by acting as an to this issuance, IREDA had raised capital through anchor investor. Masala bonds issued in the domestic market. IREDA offers its own credit enhancement product IREDA is working with the Climate Policy Initiative in the form of a partial credit guarantee (IISD 2018), to advocate for several ways to shift project debt which is offered to developers of wind and solar 53 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure projects in India when issuing green bonds. IREDA Commercial Barriers can offer an unconditional partial credit guarantee on up to 25 percent of the bond issuance, not to exceed – Demand for infrastructure services and 20 percent of total project costs. Tools such as these competitive environment can enhance the credit rating of bond issuances, – Local developer and contractor capabilities, increasing their credit rating and marketability. particularly in construction and operation – Resource risks There is an indisputable shift in – Market size limitations on project or investment momentum in green and sustainable financing across the world and “Smaller markets do not necessarily present London Stock Exchange Group greater risk, but generally offer less opportunity for is proud to be spearheading the financial institutions to reach economies of scale in their financing activities” (CFLI 2020). growing global green and sustainable financing movement, developing Commercial risks are inherent to the project or the innovative products and services in market in which it operates. Commercial risks can consist of commercial viability and revenue risk, partnership with our customers. construction risk, operating risk, resource or other supply risk, and natural force majeure risk. All these LSE Group CEO Xavier Rolet risks affect the ability to structure the project so that it provides a reasonable economic return to investors in any market and can be more pronounced An example of an AIF in India selling debentures in emerging and developing countries. to institutional investors to refinance climate- smart loans was the issuance of $35 million in Commercial viability and revenue risk, using power nonconvertible debentures to institutional investors projects as an example, is often addressed through to refinance loans to two solar projects recently contractual structures, such as power purchase acquired by the Infrastructure Development agreements, which ensure that new generation Finance Company (Susmit 2017). The Infrastructure capacity is fully used and that the power produced Development Finance Company was created in is purchased. The challenge in achieving a bankable 1997 to support development of infrastructure state is to ensure not only a fair risk allocation, but projects throughout India (IDFC 2020). The also that creditworthy entities support payment debentures were sold to institutional investors obligations, which often requires government through India Infrastructure Fund II, an AIF owned guarantees and political risk insurance. For projects by Infrastructure Development Finance Company exposed to demand and price risk, such as power Alternative Ltd., a subsidiary of Infrastructure projects selling into a wholesale market without a Development Finance Company. power purchase agreement, this risk can be mitigated using tools such as contracts for difference,19 although these are unavailable in many markets. 19 Contracts for difference, used in some countries with wholesale markets, are contracts between a low-carbon electricity provider and a government or other entity that guarantees the generator a price for electricity over the life of the contract regardless of market price fluctuations. For more detailed information, see https://www.emrsettlement.co.uk/about-emr/contracts-for-difference/ 54 Enabling institutional investment in climate-smart infrastructure Construction risk hinges on availability of experienced local developers and contractors to build a project to specifications and meet “conditions precedent” for commercial operation. Locating such parties can be challenging in developing markets. This risk is typically mitigated by ensuring that the engineering, procurement, and construction contractor is an experienced entity with the financial capacity to meet any potential financial obligations under the © Augustine Fernandes/Getty Images engineering, procurement, and construction contract. Such payment obligations consist of items such as liquidated damages, should the project not be completed on time or to specification, and warranty payments for a period after completion. Similarly, the project must be maintained and operated to ensure that it performs according to expectations and maintains any warranty coverage. This operational risk can be addressed in an operations and maintenance agreement with a reputable operator of similar projects. sources of energy such as solar or onshore wind. Similar products could be developed for other types Natural force majeure risk is the risk of a prolonged of infrastructure as well, for example, ridership disruption to operations or destruction of the facility insurance for light rail. due to a natural occurrence outside the control of the project sponsors, such as fire, storm, earthquake, Finally, the commercial viability of the project is flood, or other natural disaster. Although this risk contingent upon the type of infrastructure being is typically addressed through insurance, it is also used. This risk is substantially mitigated in the case of important that the effect of any force majeure event conventional power projects by take-or-pay provisions be captured properly in the contractual framework in the power purchase agreement, although renewable of the project to relieve parties of their obligations energy projects are often granted only priority grid should such an event occur. access. With the greater reliability associated with hybrid projects involving one or more generation Input supply or feedstock risks are risks such as types combined with some form of energy storage, resource risks for wind and solar projects. These including take-or-pay provisions in the power purchase risks can be addressed using conservative estimates agreement would help level the playing field and of resource performance (e.g., using an exceedance further decrease the cost of electricity for renewable probability of P90, which means that the resource energy projects. For other types of infrastructure, such is expected to outperform the estimate 90% of the as rail or water, this risk can be somewhat mitigated time), a make-up well drilling program in the case using market studies and including availability-type of a geothermal project, or financial derivatives payments in the project agreements. or insurance. As will be seen in case study 4, new insurance products can provide lenders and investors Case study 5 presents a new type of insurance with greater comfort regarding the cash flow of product being used to mitigate several of these a project, even one that relies on intermittent commercial risks. 55 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Case Study 5: Using Innovative Financial Tools to Refinance on Better Terms— kWh Analytics was the first Contract for Difference (CFD) to benefit Structure Refinance using a “solar revenue put” from kWh Analytics’ solar revenue put. Figure 14 gives an overview of the solar revenue put structure.20 Size 23 MW & 173 MW Invenergy is a Chicago-based developer, owner, and operator of more than 146 power facilities, including wind, solar, gas, and energy storage totaling more Region United States than 22,600 MW across the Americas, Europe, and or country Asia. Invenergy’s award-winning (Invenergy 2020) Grand Ridge project includes a 210-MW wind farm; a Barriers Commercial, Financing, and Green 20-MW (23 MW direct current) solar farm; and three addressed Technology energy storage units of 31.5 MW, 3 MW, and 1.5 MW. Hybrid configurations such as this enable more reliable energy output than wind or solar alone, making them attractive to grid operators. The Grand Ridge Invenergy LLC recently used an innovative “solar project is one of the largest hybrid renewable projects revenue put” insurance policy provided by a wholly operational globally and is in La Salle County, Illinois. owned subsidiary of kWh Analytics, with the insurance kWh Analytics also recently structured another solar policy underwritten by insurer Swiss Re Corporate revenue put for the refinancing of the 173 MW direct Solutions, to refinance loans from Mitsubishi UFJ current Cal Flats solar project in Monterey California. Financial Group for its Grand Ridge Solar project. This The solar revenue put is an insurance product and credit enhancement that guarantees up to 95 percent of a solar project’s P50 exceedance probability. Figure 14 Solar Revenue Put Structure Figure 14: Solar Revenue Put Structure Although the specific terms of this refinancing have not been publicly disclosed, projects are typically financed on a P75 or P90 basis with a debt service Sponsor Equity Debt Bank coverage ratio of 1.3x or higher. Using a solar revenue Solar Project put enables financing with a target debt service (asset owner) (debt provider) Fee for risk coverage ratio of 1.1x to 1.15x. Although this is unlikely protection to substantially affect loan pricing, the put enables the project to support as much as 10 percent higher Insurance claim will Insurance debt levels and can potentially enhance returns for cover difference in revenue in event of Provider equity sponsors. generation shortfall Although products such as the solar revenue put, Source: Adapted from Bloomberg 2018 and kWh Analytics n.d. Note: Gray lines represent Solar Put coverage. Source: Adapted from Bloomberg NEF 2018 and kWh Analytics n.d. or the wind proxy revenue swap that insurer Allianz Note: Gray lines represent Solar Revenue Put coverage offers (Allianz 2016), are unavailable in many 20 A contract for differences (CFD) is an arrangement made in financial derivatives trading where the differences in the settlement between the open and closing trade prices are cash-settled. See: https://www.investopedia.com/terms/c/contractfordifferences.asp 56 Enabling institutional investment in climate-smart infrastructure developing markets, these products offer greater agreement is relied on to ensure that qualified, certainty regarding product cash flows and therefore experienced parties will be responsible for operating improve the credit profile of the project. the asset. The off-take and concession agreements govern the cash flow of the project, so the credit of the other counterparties, particularly the offtaker, Investors have long sought becomes a critical risk in assessing the bankability of assurance that solar power plants the project and likelihood of repayment. will perform as promised. With Structuring a bankable project often requires kWh Analytics and Swiss Re now that counterparties have support in the form of a protecting their investments, guarantee or letter of credit from an investment- grade-rated entity, and that a creditworthy entity stakeholders are better able to can be substituted if a counterparty’s rating is or invest the hundreds of billions becomes short of what is required. This assumption is reflected in the Standard & Poor’s Counterparty of dollars that the solar industry Risk Framework and Methodology (S&P 2014), which requires in the coming years. assumes that a counterparty can be replaced when it falls below the acceptable rating. Lenders also require kWh Analytics CEO Richard Matsui step-in rights in the project documents so that they can take over the project to replace the operator in an event of default. Such provisions become even more Credit Risks important in the context of securitization, under which investors in a security are typically further – Creditworthiness of emerging markets and removed from the operation of the project. developing countries – Counterparty risk and creditworthiness of Even with credit enhancements and other tools such offtaker as guarantees and political risk insurance, credit rating agencies will rarely pierce the sovereign ceiling for a bond. Exceptions happen in cases such as the recent debt financing of the Elazig Hospital in Turkey, which Whether the counterparty is a government, utility, benefited from political risk insurance from MIGA state-owned enterprise, or private project developer, combined with an 89 million euro interim liquidity project participants must have sufficient balance facility from the European Bank for Reconstruction sheets, track records, and management and and Development, allowing Moody’s to assign the operations systems to meet bankability requirements project bond a Baa2 rating, two notches above or be otherwise supported by credit-worthy entities. Turkey’s sovereign rating (EBRD 2016). Ninety-three percent of low- and middle-income countries are In on-balance-sheet asset finance and typical project below investment grade or are unrated (GCEC 2018b) finance structures, cash flows associated with the which is a significant barrier for private investors who asset are critical for loan repayment, so the credit risk are restricted to investment-grade assets. assessment extends beyond the borrowing entity. In project finance particularly, a new special-purpose Case study 6 presents an approach that enabled vehicle without a track record will be responsible green bonds to be issued to finance affordable and for owning and operating the assets of the project. environmentally friendly housing for college students Therefore, the operations and maintenance in Kenya with higher a credit rating than the sovereign. 57 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Case Study 6: Green Bonds Programme - Kenya (GBP Kenya n.d.a.) © Carl Fourie/Getty Images Kenya’s first green bond issuance closed in October Structure Technical assistance and green bond 2019 and was subsequently listed on the Nairobi issuance Securities Exchange as the first environmentally friendly fixed income security in the exchange’s Size $42.5 million 65-year history (Reuters 2020b). The issuance was Climate Bonds Certified and rated B1 by Moody’s, one notch higher than Kenya’s B2 sovereign rating Region Kenya (CBI 2019b). The issue was supported by Guarantco, or country structured by Stanbic Kenya, and verified by DNVGL. The issue enabled both domestic and international institutional investors to support issuer Acorn Barriers Financing, Green Technology, Holdings development of environmentally friendly, addressed Transaction and Due Diligence Costs, Credit Risk affordable housing for 5,000 university students in Nairobi (CGTN Africa 2019). 58 Enabling institutional investment in climate-smart infrastructure The bond was the first to be issued under the Green Climate Investment Barriers Bonds Programme – Kenya, which was brought together by the Kenya Banker’s Association, Climate This section highlights barriers specific to climate- Bonds Initiative, Nairobi Securities Exchange, FMO, smart infrastructure projects and how they interact and Financial Sector Deepening Africa. IFC and with other barriers, summarized in figure 15. The the WWF – Kenya provided technical assistance section also highlights ways these barriers may be and the program itself is endorsed by the National misperceived and can be mitigated. Treasury, Central Bank of Kenya, and Capital Markets Authority. The program was designed not only to Cost Structure (Upfront Costs vs. Life cycle Costs) support Kenya’s first green bond issuance, but also Climate mitigation projects, including renewable to support the development of a domestic green energy and electric transport projects, may bond market. The program had seven work streams require higher upfront capital expenditures than and outputs: researching green bond potential conventional approaches but often exhibit lower in Kenya; engaging with local and international operating and life cycle costs. This dichotomy investors to develop a pipeline of green investments; between upfront costs and life cycle costs can make leveraging leading banks and corporates to support it challenging for investors (government and private) demonstration issuances; promoting use of green to justify higher upfront capital costs despite that Islamic finance; creating Kenya-based verifiers; such investment often results in the ability to creation of a cooperative fixed income facility to lower the overall cost of services provided to end enable smaller entities to access the capital markets; customers, unless financing is available to enable and replicating the Kenya experience across the East investors to benefit from a life cycle cost approach. Africa Community. A similar approach was taken by Nedbank, which launched South Africa’s first For example, the life cycle cost for power projects is Renewable Energy Bond on April 30, 2019 on the represented by the levelized cost of energy (LCOE), Johannesburg Stock Exchange (SFI 2019). Models which equates to the electricity tariff under a such as these can help attract domestic institutional power purchase agreement. Capital costs for solar capital as well as capital from international photovoltaic ($900 to $1,100 per kW) and onshore institutional investors interested in supporting wind ($1,100 to $1,500) are comparable with gas climate-smart infrastructure in a specific country. peaker ($700 to $950) and gas combined cycle ($700 For those investors seeking exposure to greenfield to $1,300) but significantly lower than coal ($3,000 projects and geographic diversification, and who are to $6,250) as of 2019 (Lazard 2019). However, as willing to accept exposure to a single-developer and shown in figure 16 below, given the lack of a fuel cost, technology, bonds such as Scatec Solar’s (Scatec and low operation and maintenance costs for solar 2017) are also an option. and wind, the LCOE for solar and onshore wind is generally below even gas combined cycle. This makes Figure 15 Climate Investment Barriers Long-Term Planning Monetizing Resilience Climate These barriers are more Investment Green Technology specific to investment in Barriers climate projects Transaction & Due Diligence Costs Cost Structure Credit Risk Commercial 59 These barriers compromise Financing basic project finance Traditional Investment Policy and Regulatory investment risks regardless Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure renewable energy from solar and wind the cheapest by 13 per cent or more and result in substantial form of electricity generation on a LCOE basis in many operating cost savings, leading to significant life markets (Lazard 2019; BNEF 2019). The cost to both cycle cost savings for green buildings (RMI 2018b). construct and operate new-build wind and solar is Similarly, electric buses, particularly when powered expected to fall below the operating costs, let alone by renewable energy grids, demonstrate significantly capital costs, of conventional generation some time lower life cycle costs than traditional diesel buses. over the next decade (BNEF 2019). This is already the Upfront costs for electric transit buses are $200,000 case in the United States, where “local wind and solar higher than for conventional buses, but lifetime could replace approximately 74% of the U.S. coal fleet fuel and maintenance savings are approximately at an immediate savings to customers (EI 2019).” $400,000, resulting in a net savings of approximately $200,000 if not financed (USPIRG 2018). Box 3 below When fossil fuel subsidies are added back to the provides a real-world example where electric buses levelized cost of energy from these generation sources, reduced the cost per kilometer to 70 Chilean pesos the cost savings associated with renewable energy from 300 pesos per kilometer for traditional buses become even more pronounced. For example, adding (Enel X n.d.a). back the $2 trillion of 2017 post-tax coal subsidies (IMF 2019) to the levelized cost of energy would result in a The ability for governments and investors to take levelized cost of energy of $266 per MWh to $352 per advantage of these lower life cycle costs in renewable MWh for coal, versus $28 per MWh to $54 per MWh energy hinges on the availability of financing, which for wind and $32 per MWh to $44 per MWh for solar. is itself contingent upon bankable project governance frameworks (CFLI 2020). Box 3 illustrates the use of Constructing new buildings to be all-electric and innovative financing models being used to enable a exclude gas infrastructure can reduce capital costs transition to clean transportation. Figure 16:Levelized Figure 16:Levelized Cost Cost of Energy of Electricity for Energy forGeneration Electricity Generation Types Types Source: Source: Lazard. 2019. “Levelized FigureLazard. Cost 16 2019. of Levelized“Levelized Energy and Cost Cost offor Levelized of Energy Energy Cost 2019.”Cost and Levelized of Storage Electricity Generation of Storage 2019.” https://www.lazard.com/perspective/lcoe2019 https://www.lazard.com/perspective/lcoe2019 Types Source: Lazard 2019. Note: Unsubsidized Note: Unsubsidized Analysis. Analysis. Selected renewable Selected energy renewable generation energy generation technologies Note: Unsubsidized are cost Analysis. technologies competitive Selected cost competitive are conventional renewablewith energy generation with technologies conventional are cost competitive generation generation technologies technologies under certain under certain circumstances circumstances with conventional generation technologies under certain circumstances 60 10 10 Enabling institutional investment in climate-smart infrastructure Transaction and Due Diligence Costs One solution to financing smaller climate projects is “Transaction costs are already higher for infrastructure bundling them together in a blended finance vehicle than many other asset classes and are then magnified to “increase transaction size, improve liquidity by the real and perceived challenges of new green of long-term assets, diversify risks, enhance the technology, the small scale of some projects, and underlying creditworthiness of the assets and create the complexity of cities’ project development and separate tranches of capital that appeal to different financing systems. Inefficient processes and delays, types of institutional investors (Blended Finance high due-diligence costs for investors, and the high cost Task Force 2018).” In addition to bundling projects, of capital also drive up transaction costs. Since many standardizing successful models once they have transaction costs are fixed, this is especially challenging been proven would help channel critical funding to for small projects (CCFLA 2015).” climate projects in the $1 million to $5 million range Box 3 Innovative Financing for Clean Transportation © Getty Images More cities are testing electric bus (e-bus) technology to address urban air pollution while providing flexibility and lower cost than building light rail or metro systems. Globally, sales of e-buses increased 80- fold between 2011 and 2017 (WRI 2019). E-Buses in Chile In the past few years, Santiago, Chile, has procured an impressive 400 e-buses and now has the largest city fleet outside of China. The program was piloted in 2016 when Enel made Chile’s first electric bus available to the Santiago city government. By the end of 2018, the program had expanded to 100 electric buses under a public-private partnership, with Enel X purchasing the buses from Chinese manufacturer BYD and the local bus company MetBus operating them. The buses have zero emissions and “also provide a cheaper option in terms of operating costs, which are up to 70 percent lower than diesel-powered units. The new electric buses cost 70 Chilean pesos per kilometer traveled, while traditional buses run at around 300 pesos per kilometer.” By the end of 2019, the number of electric buses had risen to 386 (Enel X n.d.a). 61 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Box 3 Innovative Financing for Clean Transportation (continued) Enel X provided a turn-key solution for Chile under the program, handling engineering and construction of the project and the associated charging infrastructure and provisioning of the power required to charge the buses. Enel X also constructed Chile’s first three electric bus terminals and implemented a real-time charging solution that enables the buses to maximize power from the grid and fully recharge in five hours to enable high up-time and low operating costs. Proterra E-Buses Proterra, a U.S.-based zero-emissions bus company, piloted an innovative financing model to address the problem of enabling investors to take advantage of lower life cycle costs. Proterra sells battery-powered electric buses to cities for the cost of a diesel bus and leases them the battery for 12 years through a performance-based contract that includes a battery warranty. This allows cities to buy zero-emissions buses using the same financing model that they are accustomed to while removing the perceived technology risk of electric batteries. The Proterra model addresses the financing barriers of electric bus adoption, but some countries are limited in their procurement of these buses because national regulations require that buses be manufactured locally. There is substantial opportunity for private companies to offer similar financing models in developing countries that have the capacity to produce zero-emissions buses locally or are not limited to buying locally manufactured buses. that often struggle to access capital, although as the United States or Europe, and large pension blended finance transactions are often bespoke to funds with the ability to allocate significant resources meet the specific needs of different investors and to each market. Replicating successful models of based on country and sector context; this can make securitization and comingled funds can help bridge them difficult to replicate and expand. the infrastructure investment gap and the funding gap for pension funds. This is also why financing models that pool and diversify risk - such as green bonds, asset- Case study 7, although it occurred in an OECD country, backed securities such as outlined in case study is an example of an approach that can be replicated 1, yieldcos, or clean energy investment trusts (CPI in other markets to crowd in finance by pooling green 2017), and alternative investment funds backed assets to reach an issue size that would be of interest by infrastructure assets - can be particularly to domestic and international institutional investors. attractive. There is a growing trend of pension Securitization has been attempted in developing funds investing in infrastructure through comingled country bond markets; however, many project bond funds, such as Brookfield Renewable Energy’s issues are not large enough to attract international recent $20 billion close of its global infrastructure interest. Standardization and aggregation of a fund Brookfield Infrastructure Fund IV, and through number of these issues across borders would not direct investment in project finance transactions. only increase diversification and reduce the foreign Direct investment requires significant manpower exchange risk of the portfolio, but also help the and knowledge of the local energy markets, which issue reach a transaction size that would be more is why it is often limited to developed markets such appealing to institutional investors. 62 Enabling institutional investment in climate-smart infrastructure Case Study 7: Green Asset-Backed Securities — FlexiGroup (NAB 2016) © Apichon Tee/Getty Images FlexiGroup’s 2016 issuance of green asset-backed Structure Green Asset-Backed Securities securities is the first green securitization that the Climate Bonds Initiative certified (CBI 2020b) and was Australia’s first green asset-backed issuance. Size $39 million (2016), $38 million (2017), FlexiGroup is a provider of finance products and $61.7 million (2018), $65 million (2019) payment solutions that operates in Australia, New Zealand, and Ireland and has been listed on the Australian stock exchange since 2006. The class A2-G Region Australia green notes obtained a rating of AAA from Fitch or country Ratings and Aaa from Moody’s. Figure 17 shows the structure of the issuance. Barriers Transaction and Due Diligence addressed Costs, Financing, Green Technology The initial bond was part of a larger AUD260 million issuance, with National Australia Bank acting as 63 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Figure 17 FlexiGroup ABS Structure Source: CBI 2020b. sole arranger and joint lead manager. The trust is The success of this program resulted in subsequent backed by AUD256.2 million in consumer receivables issuances for each of the following three years, with originated by Certegy Ezi-Pay Pty Ltd., a wholly owned the AUD90 million issuance in March 2019 being subsidiary of FlexiGroup that finances consumer the largest yet and the first to simultaneously back receivables; 33.5 percent of the initial issuance was energy storage assets. This enabled institutional backed by residential solar photovoltaic receivables, investors, such as Australia’s Clean Energy Finance resulting in the AUD50 million ($39 million) class A2-G Corporation, to help support investment in rooftop certified green bonds, with these proceeds earmarked solar photovoltaic systems and small-scale energy to refinance existing solar photovoltaic systems. storage. Asset-backed securities like these are appropriate for bundling smaller receivables together The class A2-G bonds were priced five basis points for residential renewable energy projects to attract lower than the non-green notes in the same institutional investors interested in a specific market. issuance. The bonds have a coupon of one-month Receivables across geographies can also be bundled bank bill swap rates plus 150 basis points, with a legal into larger securitizations, offering a model to allow maturity of five years, but were expected to be repaid developers of smaller-scale projects to recycle capital within one and a half years of the issue date because by attracting international institutional investment in of the amortization profile of the underlying assets. countries lacking an established green bond market. 64 Enabling institutional investment in climate-smart infrastructure However, successful securitization would likely implied by low-emission pathways to 2050 demand require availability of reliable customer payment more rapid resource reallocation and faster technology data and the participation of a strong financial diffusion” (OECD 2017), necessitating an embrace intermediary or DFI. of new clean technologies. Governments that work together to enact policies to encourage private sector investment and to encourage the transition to a low- We believe the financial sector carbon economy can reap significant benefits (OECD has an important role to play in 2017). Blended finance can also be utilized to help de-risk and more rapidly diffuse new technologies supporting the transition to a low- (OECD 2017). Private equity funds (GCEC 2018b) and carbon economy, and the exciting accelerators can also work with newly created DFI venture funds to further increase the rate of adoption opportunities this provides, not and deployment of new low-carbon technologies. only for NAB, but for customers such as FlexiGroup. “We are on the cusp of a new economic era: One that is driven by the interaction between rapid technological Steve Lambert NAB Executive General Manager, change, sustainable infrastructure investment and Capital Financing increased resource productivity… many technologies that can accelerate the energy transition over the coming decades are already known, proven, and starting to be deployed at scale (GCEC 2018).” Rapidly declining costs Green Technology Barriers and technological advances are causing sustainable “Managing perceptions of risks is also vital for investments to become increasingly attractive, with ensuring bankability. Even as new technologies and many renewable energy technologies now costing business models become better established, risk less than traditional fossil fuel-based technologies perception may be higher for renewable energy and (GCEC 2018). New economic models that can capture energy efficiency investments as investors tend to the benefits of transformative technological advances view these as less familiar or more exposed to risks of are needed, as are well-capitalized public-private policy changes compared to fossil fuel technologies partnerships that can pilot and scale the deployment of or centralized utility models (GCEC 2016).” new climate-smart technologies (GCEC 2018). Despite the promise of new low-carbon technologies, “Yet supportive policies and market incentives to climate-smart infrastructure projects can face further [sustainable technologies] are lagging, and barriers due institutional inertia and lack of financiers in local capital markets are reticent to invest familiarity among lenders (GCEC 2018b) and due to limited experience (GCEC 2018).” Bankability institutional investors (OECD 2013), and uncertainty decisions can be impacted by a lack of capacity within caused by the rapid pace of technological change financial institutions, which can fail to engage because (Deloitte 2018). This inertia is partially due to of unfamiliarity with the technology, business model, misperceptions of the relative riskiness of new or geography and risk-averse credit committees sustainable technologies versus conventional fossil (GCEC 2016). Institutional investors can also be fuel technologies, which face an increasing risk of hesitant to invest in climate-smart infrastructure becoming stranded assets going forward (OECD due to uncertainty around energy and environmental 2017, IADB 2016). Regardless of the dislocation regulations and policies, and challenges for rating between risk perceptions and reality, “the swift agencies to give investment grade ratings to new infrastructural, technological and industrial shifts technology related projects (OECD 2013). 65 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure “Technological breakthroughs are changing the very smart infrastructure, ensure the availability of nature of infrastructure investing as well as the speed bankable infrastructure project structures and power and efficiency of the investments (Deloitte 2018).” purchase agreements for local offtakers, and tie This is causing new complexity as technologies can NDCs to credible and effective domestic policies that rapidly become obsolete (Deloitte 2018). “Lenders have the flexibility to adjust to new technologies worry that if any technology used in the project (OECD 2017). “Climate change mitigation action performs badly that will hamper operations, the requires flexibility: old technologies and infrastructure project will lose revenue, and the sponsor won’t be need to be replaced by new ones. New OECD research… able to repay its debts. This is one of the main reasons shows that governments need to provide a flexible why financiers and sponsors seek tried and tested regulatory environment – which does not restrict firm technologies that are not likely to become obsolete creation, market entry or competition – to encourage during the life of the project (Deloitte 2018).” The private investment and innovation and thus make concerns described by Deloitte apply precisely to the most out of the low-carbon transition… Reforms fossil fuel-based technologies, which are quickly to reduce the costs of structural change and boost becoming obsolete or more expensive than the latest technology diffusion would therefore be particularly clean technologies, leading to stranded asset risk relevant (OECD 2017).” Policies can be enacted that (IADB 2016; Financial Times 2020), which makes stimulate economic growth, support investment fossil fuels a better target for such risk aversion. in low-emission infrastructure, and stimulate Fossil fuels also face risks of long-term unavailability, diffusion of new low-carbon technologies to ensure such as the 2018 gas explosion in British Colombia a cost-effective low-carbon transition (OECD 2017). that forced an outage of a baseload gas-fired Policies to support the low-carbon transition can plant (The Columbian 2018), gas explosions such be disruptive, but the disruption can be offset by as those in Texas (Daily News 2020), and gas leaks spreading the benefits of growth widely through such as experienced in California (Alter 2015). Over policies that improve access to new economic the last 20 years the United States experienced opportunities and provide an adequate social safety 5,741 significant or serious incidents, resulting net to workers (OECD 2017). Governments working in 282 fatalities and $9.5 billion in costs from together and taking advantage of new technology fossil fuel pipeline incidents alone (USDOT 2020). trends early stand to reap even greater benefits Fossil fuel plants also face regularly scheduled through economies of scale in climate solutions, maintenance requirements that can take entire hastened declines in technology costs, faster facilities off-line for weeks or months at a time, penetration of new low-carbon technologies, and necessitating significantly underused peaker plant other “first-mover” advantages (OECD 2017). New backup or energy imports to make up the gap in solar panel designs and materials can achiever lower fossil fuel generation. Clean technologies do not face cost and efficiencies up to 47.1% versus 8-12% in the these issues. 1970s (NREL n.d.a.). New wind turbines can reach capacity factors of 60% (NREL n.d.a.b), particularly Policy support is needed at a government level to in offshore wind, higher than typical fossil fuel based strengthen cooperation on technology development, capacity factors (USDOE 2015). New energy storage to promote deployment of the best technologies and technologies promise longer life and lower life cycle business models available today, and to promote costs (Reuters 2020). The faster these technologies investment and deployment of next-generation can be deployed in commercial projects the greater technologies (GCEC 2018). To drive investment and the benefits to governments (OECD 2017). remove bottlenecks in clean technology finance, governments need to enhance public-private Private sector and DFI initiatives can also help cooperation, improve business models for climate- accelerate the adoption of new technologies. 66 Enabling institutional investment in climate-smart infrastructure “Innovative blended finance instruments, of monetizing socioeconomic benefits; the often structures, and pooled funds therefore offer a large and diverse stakeholder groups, including way for investors to participate in clean energy vulnerable populations without the ability to pay for investment opportunities in countries with riskier benefits from the interventions; and uncertainties policy environments, often encapsulated by a lower related to climate effects and timing of benefits credit rating, and/or technologies and business that depend on when an extreme climate event models without an established track record (Blended might occur. Finance Task Force 2018).” Private equity (PE) firms and infrastructure funds have an estimated To help monetize investment, governments, cities, US$2.7 trillion in assets under management, and the private sector need approaches to properly with many PE first targeting returns between 15 price risk and incorporate costs of externalities percent and 25 percent, and “strategies such as into economic analysis and financial planning. taking technology risk (innovative deployment of Nevertheless, although insurance and catastrophic emerging technologies) do offer one area where these risk transfer markets offer proxy markets to price return expectations may be met (GCEC 2018b).” risk, this is complex, because there is no single SWFs can also co-invest with local PE companies metric, such as a price on carbon for climate and technology companies to address capacity mitigation, that applies to all sectors and countries. constraints (GCEC 2018b). DFIs can also play a role Many climate risks are local, and risks and prices will at the early stage of technology development as differ according to location (GCA 2019). Much more demonstrated by the United Nations Children’s international collaboration is needed to produce Fund (UNICEF n.d.a.) and the Asian Development global data on hazards and exposures, calculations of Bank (ADB 2020), which both recently announced probabilities, and knowledge of local conditions and the creation of new venture funds to support impact vulnerabilities and to create new risk management technology startups in line with the SDGs. products and pool risk across countries. In addition, establishing clear climate goals, including at the city Monetizing Resilience Barriers level, is particularly important for many essential Adaptation and resilience projects are often adaptation projects that may not be bankable in focused on reducing losses from event-driven or the traditional sense but could attract investment if acute effects (e.g. severe weather events) and long- prioritized (CCFLA 2015). term or chronic changes (e.g. drought) associated with climate change rather than generating The private sector has a critical role to play in revenue. One of the barriers to greater private reducing, preparing for, and recovering from shocks sector participation is the challenge of monetizing and disasters; and with changing risk perceptions, benefits and identifying clear revenue streams that is increasingly investing in resilience through would allow investors to recover their full costs innovative financing approaches and business over the lifetime of an asset. Large infrastructure models that blend finance and share risk and adaptation projects can incur high upfront costs value (GCA 2019). To help coordinate efforts across and may not prove their value for decades, such as the private sector, the World Economic Forum, infrastructure built to withstand 50- or 100-year Willis Towers Watson, the Global Commission on flood events (CCFLA 2015). These projects can also Adaptation, the government of the United Kingdom, involve the complex challenge of quantifying the and the Government of Jamaica are developing the value of natural infrastructure such as coral reefs Coalition for Climate Investment, a private sector– and mangroves to mitigate the effects of climate- led coalition with assets of $5 trillion that brings related natural disasters for a combination of together companies all along the infrastructure reasons (WBG 2019b), such as the inherent difficulty investment value chain (IIGCC 2019). 67 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure Long-Term Planning Barriers long-term investment and planning within the Climate-smart investments and planning need context of uncertainty constitute a new field to account for the effect of long-term climate and include robust decision making, decision trends and build in flexibility to harness new trees, and adaptive pathways. This new field clean technology innovations and promote cross- also considers methodologies that favor robust sectoral, systems-based approaches. Current solutions that perform well across a wide range procurement processes often contain inefficiencies of futures, preferences, and worldviews, although that prevent the rapid expansion needed to achieve it may not be optimal in any particular one. the goals of the Paris Agreement and fail to take However, the complexity and lack of such robust, a long-term planning perspective. Countries need long-term methodologies and policies present a to develop robust least-cost long-term planning, barrier to private sector signaling and investment which often requires analysis beyond the capacity (WBG 2019b). and resources available locally. For example, feed-in tariffs typically result in a higher cost of electricity There are a number of initiatives focusing on than can be achieved through a competitive tender long-term planning at the global, national, and (IRENA 2015). The literature review also indicates municipal level that need to be well coordinated, that combining multiple distributed generation interlinked, and reinforcing at all levels, including facilities, co-locating solar and wind where the 2050 Pathways Platform,21 which supports possible, and using offshore wind where available countries seeking to develop long-term net-zero- is the lowest-cost, fastest way for countries to GHG emissions and climate-resilient sustainable- decarbonize electricity generation and maintain development pathways; Vision 2050 of the World reliability (Brown et al 2018; RMI 2018; Jacobson et Business Council for Sustainable Development, al. 2019; NREL 2012). This pathway is followed by which convenes 200 forward-thinking global many of the 27 countries that generate more than companies; and the C40 Climate Action Planning 80 percent of their electricity from renewable Program, which supports almost 100 cities in energy (World Bank n.d.a.c), yet few procurement planning for net neutrality pathways by 2050. For processes or integrated resource plans enable instance, Costa Rica launched its decarbonization this approach. As countries such as Uruguay have plan in February 2020 that covers 10 sectors demonstrated, effective procurement requires a and policy packages up to 2050.22 The long-term long-term commitment to decarbonization and planning process helped set sectoral milestones regulations and rules that enable it (IEEFA 2018). for 2030 as well as a list of priority actions and investments (e.g., in electric transit) and is helping The effect of climate change on the spatial address some of the barriers identified. distribution and intensity of natural hazards also makes planning challenging and all assessments Case study 8 features a software tool developed by uncertain. For instance, climate change models the WBG that helps cities improve their long-term show a wide range of possible futures for global strategies for climate investments, policies, and sea level rise and change in timing and intensity planning opportunities. It provides powerful, data- of climate patterns. The effects of technology driven scenario planning that helps city officials make shifts, as mentioned above, also need to be decisions about the future of their energy, transport, considered. Methodologies and approaches to and waste systems. 21 See https://www.2050pathways.org/resources/ 22 https://www.2050pathways.org/costa-rica-launches-decarbonisation-plan/ 68 Enabling institutional investment in climate-smart infrastructure Case Study 8: The Environment Positive Innovations for Cities Investment Planning Tool (EPIC) The IFC is piloting a new software called the Structure Planning software Environment Positive Innovations for Cities (EPIC) to help cities prioritize and transition to a low-carbon and resource efficient urban growth pathway.23 The Size Not applicable on-line software is an early-stage pre-feasibility climate investment tool that helps cities identify and evaluate green investments, policies, and planning opportunities. Region Global or country EPIC starts with a baseline-case, projected business- as-usual scenario to 2030. Users can quickly see the Barriers Long-Term Planning effect of different measures on the city’s business- addressed as-usual performance into the future, including on future energy consumption, water requirements, 23 Please note the EPIC tool has been built on and evolved from a previous version developed by the World Bank in collaboration with C40, Bloomberg Philanthropies, and the Global Covenant of Mayors, known as CURB (Climate Action for Urban Sustainability) and applies the same GHG methodologies and approaches. See https://www.worldbank.org/en/topic/urbandevelopment/brief/the-curb- tool-climate-action-for-urban-sustainability 69 Chapter 4 | Barriers to Institutional Investment in Climate-Smart Infrastructure © Piksel/Getty Images waste production, private vehicle travel, carbon In Ho Chi Minh City, Vietnam, EPIC helped identify emissions, and air quality. It then aggregates essential policy and planning actions needed to emissions, showing the baseline case and the target ensure the efficacy of public transport investments. trajectory with the savings from selected measures. In Ahmedabad, India, EPIC was used to assess EPIC will be used to identify a list of low-carbon actions in the city’s “carbon neutrality vision” investments and track the effect of investments presenting a climate investment opportunity of based on costs, payback, GHG emissions, and $1.8 billion. IFC is in the process of investing in feasibility, leading to a pipeline for climate financing Ahmedabad Municipal Corporation.24 (e.g., green bonds, green loans). 24 See https://www.proptiger.com/guide/post/ahmedabad-municipal-corporation-to-raise-through-dollar-bonds 70 © Hraun/Getty Images CONCLUSION 05 05 | Conclusion Investment in climate-smart infrastructure will for climate-smart infrastructure through the need to be accelerated rapidly to achieve the 1.5°C increasing use of securitization, enabling lenders target under the Paris Agreement. Much of the to recycle capital to support additional projects. infrastructure investment required under a 1.5˚C Wide scale securitization can be facilitated through scenario is needed in the emerging markets, creating bankable governance frameworks and policies, investment opportunities that could exceed $23 standardization of terms for the underlying trillion by 2030 for institutional investors should projects, and innovative platforms such as shown barriers to investment be addressed. Decarbonization by Bayfront Infrastructure Capital in case study requires the reversal of deforestation, the adoption 1. The report identifies several case studies that of sustainable agricultural practices, and the create opportunities for further research and pilot elimination of fossil fuels from the world’s electricity programs in emerging markets such as India. generation, industry, and transport. The burning of fossil fuels for energy is responsible for 73 percent Governments wishing to benefit from both economic of all anthropogenic carbon emissions; as such, growth and climate-smart infrastructure need to investments in climate-smart infrastructure to help enact supportive policies and effective governance decarbonize the energy system can go a long way structures to support the achievement of their NDCs toward meeting the goals of the Paris Agreement. and long-term climate objectives. Enacting long term Robust certification standards can help prevent climate planning into law can provide the signaling instances of greenwashing and ensure infrastructure and incentives needed to attract institutional investment is truly climate-smart and aligned with investment and address the “credible commitment” a low-carbon pathway. All stakeholders have critical challenge. DFIs play a critical role in providing roles to play in bridging the climate investment gap technical assistance to support governments and accelerating the energy transition. Doing so will in developing bankable project structures and result in an estimated $28 trillion or more in net participating in blended finance transactions to help benefits to society. de-risk climate-smart infrastructure projects in the markets they serve. The identification of a strong Through the literature review, barriers analyses intermediary is critical to the structuring of many and case studies, the report identifies promising innovative financing solutions. DFIs are well-placed to opportunities and models for institutional play such an intermediary role. Institutional investors investors to support climate-smart infrastructure have more than sufficient resources to bridge the in emerging markets. Should barriers be addressed, climate investment gap and can use investments in and project pipelines reach the levels required to climate-smart infrastructure to help bridge pension achieve the Paris Agreement targets, it is likely shortfalls and achieve return targets. New models that lenders, including commercial banks, DFIs and for infrastructure finance, such as green bonds, green other financial intermediaries, will run into capital securitization, and the use of new financing tools can constraints. Institutional investors, despite having help create opportunities for institutional investors capital sufficient to address the problem and a to support the transition. Domestic and international need to generate returns, also face barriers to institutional investors both have critical roles to supporting climate-smart infrastructure. Refinance play in meeting the goals of the Paris Agreement. and securitization can help recycle capital at Participation by domestic institutional investors financial institutions and create opportunities for is central to inspiring confidence in attracting institutional investors to invest in climate-smart international capital to emerging markets. infrastructure and bridge the climate investment gap. The bond markets could provide $1 trillion Investment in climate-smart infrastructure can to $1.5 trillion annually in additional funding be accelerated by addressing traditional barriers 72 Enabling institutional investment in climate-smart infrastructure © Orbon Alija/Getty Images 73 Chapter 5 | Conclusion inherent in infrastructure projects generally study 4. Commercial barriers are traditionally consisting of pipeline, macroeconomic, country risk, addressed contractually using long-term concession policy and regulatory, financing, commercial, and agreements and conservative lending criteria; credit barriers. Most significantly, governments need however, new financial instruments, such as to work actively to create a governance structure contracts for difference and “solar revenue puts” as and enabling environment that would address the shown in case study 5, are also offering new ways to pipeline shortage of bankable projects by engaging address commercial barriers. Credit risks are typically with DFIs and the private sector on initiatives like covered through meticulous credit analysis, credit the Climate Investment Platform presented in box ratings, and through the support or substitution 2. Additionally, governments must tackle project of credit-worthy counterparties. However, the pipeline, long-term planning, and regulatory and development of a local green bond market can policy barriers by enacting a robust public-private enable developers, even of smaller projects, to raise partnership program to mobilize both domestic capital from institutional investors and issue green and international institutional investment as bonds above the sovereign rating as demonstrated demonstrated by Columbia and the World Bank in case study 6, Green Bond Programme - Kenya. Group in case study 2. Macroeconomic barriers, such as currency exchange rate fluctuations and Addressing investment barriers specific to climate- inflation, can be addressed through government smart infrastructure, such as the cost structure, policy, appropriate provisions in the project transaction and due diligence costs, green agreements, and use of derivatives markets and technology barriers, challenges with quantifying the offerings from entities like Guarantco and The benefits of adaptation and resilience investments, Currency Exchange Fund. When possible, green and long-term planning barriers, can also help bonds can also be issued internationally to provide accelerate the transition. The cost structure of local financing both for greenfield projects and climate-smart projects may create barriers due to refinance, as demonstrated by NADB in case study higher up-front costs despite lower life cycle costs 3. Country risk can be addressed through the project and significant lifetime savings; the availability of governance framework and the use of political risk long-term financing and innovative approaches, insurance or partial risk guarantees from entities such lease financing as offered by Proterra, and like MIGA and the Japan Bank for International bulk procurement and public-private partnerships, Cooperation, and the greater involvement of local as offered by Enel X in box 3, can enable a life cycle stakeholders. Policy and regulatory barriers, such cost view and the development of climate-smart as concerns over changes in law, can be partially infrastructure. Transaction and due diligence costs addressed through project structures and the use for project finance transactions often preclude of guarantees. However, institutional investors smaller projects from utilizing this approach. can face additional regulatory barriers that limit However, bundling assets into vehicles such as clean infrastructure investment and cannot be addressed energy investment trusts, alternative investment through project governance. Regulations governing vehicles, and asset-backed securities - such those the accounting for guarantees can also provide issued by FlexiGroup and NAB in case study 7 - disincentives for their use. Financing barriers, can help defray transaction and due diligence such as limited local financial market capacity, costs and achieve a transaction size attractive to can only partially be addressed through access institutional investors. Green technology barriers to DFI concessional capital, structures like the can be addressed through government policy, Development Bank of South Africa’s Climate blended finance approaches, and new capital being Finance Facility, securitization, and the use of made available at DFI venture funds, such as those alternative investment funds as presented in case offered by UNICEF and ADB. Innovative approaches 74 Enabling institutional investment in climate-smart infrastructure to help quantify and monetize the benefits of international investors with the requisite capacity climate resilience and adaptation investments are can invest directly. Increasing the project pipeline also being pursued. As presented in case study through the use of such approaches for the energy 8 and case study 2, long-term planning barriers sector and the implementation of Basel III may lead also require governments to implement policies to an increase in the number of lenders facing capital that enable the use of the best technologies and constraints. Refinance and securitization approaches approaches for decarbonization, and tools such as such as the one used in Case Study 1: Clifford Capital the EPIC software being piloted by the World Bank CLO Infrastructure Take-Out Facility will become Group can assist with long-term planning. increasingly important to help recycle lender capital to reinvest in climate-smart projects in emerging Innovative financing approaches, such as those markets. These innovative approaches also create outlined in this report, are being developed and opportunities for institutional investors that may not deployed to address barriers to climate-smart be able to invest directly at a project level or in other infrastructure investment; but significantly more types of green assets to support decarbonization work remains to be done to support governments indirectly. Strong certification standards can help in achieving low-carbon, resilient development prevent greenwashing when using these approaches. pathways. There is no single solution to overcoming Further work is also needed to facilitate investment the complex, multifaceted barriers that institutional in adaptation and resilience projects. In all cases, investors face in financing climate-smart governments, DFIs, and institutional investors infrastructure. 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Invest4Climate aims to mobilize, coordinate, and deliver finance to close the climate financing gap and help countries transition to a resilient low-carbon future that supports jobs and growth. Invest4Climate acts as a convener, facilitator and knowledge provider to leverage finance and facilitate scaled-up approaches to tackle climate’s biggest challenges Convener Deal Knowledge Facilitator Provider – Mobilizing existing – Convening potential – Bringing respective UN – Driving knowledge teams and relationships providers of finance at & WBG experience in sharing and capacity in developing countries senior decision-making pipeline identification building on climate – Drawing on WBG unique level around common – Assisting potential action and finance suite of financial tools, challenges and specific climate focused – Piloting and resources and knowhow climate mitigation and transactions to prepare demonstrating viable resilience investment for and come to market deals, standardization – Incorporating blended opportunities for finance and new models for finance and maximizing finance for development – Convening – Facilitating the de-risking and scaling approaches governments, financial identification and climate investment institutions, investors, allocation of risks to – Amplifying success philanthropists, and providers of finance that stories at global scale to multilateral banks to can best manage them. influence the regulatory support policy reform and policy environments – Leveraging investment and crowd in private and de-risking investment instruments though targeted policy and regulatory support; technical assistance and advocacy; financial engineering (loans, grants, guarantees, policy lending, results based finance 82 Enabling institutional investment in climate-smart infrastructure Appendix 2: Types and Availability of Financing Characteristics of various types of financing The table below sets out the characteristics of the various types of financing available Type of Available Short term Cost Sectors Complexity Geography Potential finance to vs. long scale $M term Municipal bonds Government Medium to Low- Transport, Low Used globally, but 200–billions long term medium schools, airports mainly in the US and seaports Dim sum/ Panda Corporate/ Long term Low- Corporate Medium China 200–billions bonds government medium finance Qualified public Government Long term Low- Public Medium US 200–billions infrastructure focused medium Infrastructure bonds Industrial Corporate/ Medium to Low- Airports/ High US 100-500 revenue bond government long term medium sewage facilities TIFIA loans Government Medium to Low All Low US long term infrastructure Tax increment Corporate Medium term Low- Construction Medium US financing medium Debt Institutional Mainly Medium to Medium All sectors – Medium Mainly developed 50-1,000 investors (incl. corporate long term (High in depending on countries such pension funds) focused, case of experience as Canada, the although equity) may only Netherlands, UK, now entering finance post- and US project construction market phase Senior debt – Corporate/ Short to Low- All sectors Low Used globally, 50-2,000 bank funding project long term medium although not all finance banks/countries provide long-term debt products Project bonds Project Long term Low- All sectors Low Globally used 200-2,000 focused medium Sukuk bonds Project Medium to Low- Renewables Low Islamic-based 50-1,000 focused long term medium social countries (e.g., development Middle East, Southeast Asia) Export credit Corporate/ Medium to High Corporate Medium Globally used 20-500 (ECA) government long term finance/projects 83 Appendix Type of Available Short term Cost Sectors Complexity Geography Potential finance to vs. long scale $M term Green bonds Corporate/ Long term Medium- Utilities/sewage Medium Globally used 100-2,000 project high facilities/ renewables Social impact Corporate/ Long term Low- Social High Globally used 0-100 bonds project medium development Hybrid Financing Products International Project/ Long term Low- Social High Emerging/ 20-500 nongovernmental corporate/ medium development Underdeveloped organizations government countries – capital being provided by developed countries (e.g., EU/ EIB, World Bank, USAID) Multilateral Project/ Short to Low- All sectors Medium Developing 50-1,000 financing corporate/ long term medium countries government Mezzanine/ Corporate/ Short to Medium All sectors Medium Globally used 20-500 subordinated project long term debt Vendor finance Project/ Short/ Low- Energy/ Medium Globally used 0-200 corporate Medium term medium technology Alternative Project/ Short/ Medium- All sectors High Developed markets 25-500 lenders corporate Medium term high Equity Contractors Project Medium to High All sectors Low All countries 5–10% (e.g., long term of equity construction firms and operators) Infrastructure Project Medium to High All sectors Medium Developing 50–1,000 funds Project long term countries Sovereign Project Medium to High All sectors Medium All countries 100–1,000 wealth funds long term Crowdfunding Corporate Long term High Social High Mainly North focused development, America and technological Europe infrastructure Source: Deloitte 2018. 84 Enabling institutional investment in climate-smart infrastructure Appendix 3: Financial Regulations for Institutional Investors Financial Regulations and Their Effect on Institutional Investor Segments in the United States, European Union, and United Kingdom Deposit and reporting req. Asset/wealth managers Insurance companies Compensation limits Private equity limits Brokerage fee limits Legislative Region Central clearing Leverage limits Pension funds Private equity Collateral req. Liquidity req. Trading tax Banks Dodd-Frank Wall Street Reform US and Consumer Protection Act 619 (12 U.S.C. 1851) of the US Dodd-Frank Act (Volcker Rule) Foreign Account Tax US Compliance Act Third Basel Accord / Capital All Requirements Directive Undertakings for the Collective Investment of Transferable EU Securities V Alternative Investment Fund EU Managers Directive Solvency II Directive EU Markets in Financial EU Instruments Directive II European Market Infrastructure EU Regulation European Commission’s EU Liikanen proposals Financial Transaction Tax EU Packaged Retail Investment EU Products International Financial EU/ Reporting Standards US Retail Distribution Review UK Source: Better Finance, Better World 2018 Report. 85 Appendix Appendix 4: Definition for Private Sector Mobilization and Private Sector Catalyzation Private Sector Mobilization: The MDB harmonized definitions for mobilized private sector capital are detailed in the Joint MDB reporting on private investment mobilization: methodology reference guide 2017. The current methods for the estimation of investments mobilized from the private sector are limited to flows within the project boundary – direct and indirect financing at investment commitment as per the table below. Table MDB harmonized definition of private co-financing and mobilization Private Co-financing/ Mobilzation Private Direct Mobilization The investment made by a private entity, which is defined – Convening potential providers of finance at senior as a legal entity that is decision-making level around common challenges and – Carrying out or established for business purposes and specific climate mitigation and resilience investment opportunities – Financially and managerially autonomous from national or local government. – Convening governments, financial institutions, investors, philanthropists, and multilateral banks to Some public entities that are organized with financial and support policy reform and crowd in private investment managerial autonomy are counted as private entities. Other examples include registered commercial banks, insurance companies, sovereign wealth funds, and other institutional Private Direct Mobilization investors investing primarily on a commercial basis. Financing from private entities provided in connection with a specific activity for which an MDB is providing financing, where no MDB is playing an active or direct role that leads to the commitment of the private entity’s finance. PIM includes sponsor financing, if the sponsor qualifies as a private entity. Private Direct Mobilization + Private Indirect Mobilization = Private Co-Financing/Mobilization Source: MDB Task Force 2019 Private Sector Catalyzation: Currently there is no common MDB definition or methodology for estimating investment flows catalyzed beyond the project boundary. The 2017 Report on Mobilization of Private Finance by Multilateral Development Banks and Development Finance Institutions presented a diverse set of case studies of MDB activities with individual proposals to calculate catalyzed finance. Given the wide range of estimations, tools, and approaches used, MDBs have not yet agreed on a harmonized methodology for tracking catalyzed private finance (MDB Task Force 2019). 86