Green Banks: New IRENA Reports Highlights the Role of Risk Mitigation in Climate Finance

At the historic Paris climate summit in 2015, governments raised their level of climate ambition and agreed to hold global average temperature increases to well below 2°C above pre-industrial levels and to pursue efforts to limit temperature rise to 1.5°C. To achieve this goal, immediate, deep cuts in global carbon emissions are required. Shifting to a low carbon growth pathway calls for massive investment in renewable energy and energy efficiency.  Investments in clean energy have rapidly increased in the last five years and reached a record level of $286 Billion in 2015. (UNEP, BNEF, Frankfurt-UNEP School; Global Trends in Renewable Energy Investments, 2016.) Despite the accelerated growth, the total amount invested is still insufficient to meet the world’s climate goals.

A new report by the International Renewable Energy Agency (IRENA) puts the investment need in stark terms. Closing the finance gap by 2050 requires doubling current investment in renewables to $500 billion US dollars per year up to 2020, and then increasing annual investment to $900 billion through 2030. IRENA notes that public funding alone will simply not be enough to close this investment gap, and the Paris agreements highlighted the role that non-state actors must play in the low carbon transition. Private financiers—including institutional investors, pension funds, insurance companies, endowments and sovereign wealth funds—will play an increasingly central role in scaling up renewable energy and energy efficiency investments. Mainstreaming private investment in clean energy infrastructure will be critical to achieving the world’s climate goals.

Green Banks, such as the UK Green Investment Bank featured in the new IRENA report, are well suited to help mainstream climate finance. Green Banks work hand-in-hand with the private sector to mitigate risk—both real and perceived—in clean energy projects. Using tools like credit enhancements, project aggregation and standardization, Green Banks use public dollars to “crowd in” private sector investments, by improving lending terms and increasing project bankability. Green Banks also help connect developers with low-cost capital for clean energy projects.

IRENA conducted a survey of risk mitigation tools and found that use of risk mitigants in many public finance institutions is limited—surveyed institutions on average dedicated 4% of risk mitigation funds to renewables, and several institutions had never implemented a risk mitigation tool for a clean energy project.[1] Of course, many of these institutions do most of their investment outside of the clean energy sector, but this still demonstrates a clear opportunity for growing the use of these risk mitigation tools to increase private investment in clean energy.

Green Banks and other public finance institutions play a key role in mitigating project risk and creating track records for new energy technologies. Green Banks are also an efficient use of public dollars as risk mitigants (like loan loss reserves and subordinated debt) are repaid and then “recycled” back into Green Banks to finance new rounds of projects.

The IRENA report highlights the role of risk mitigation as an important step to mainstreaming climate investment, and demonstrates the clear benefits of Green Bank and other structured financing models to help achieve the world’s climate goals. Governments and public finance institutions can also structure and design on-lending and co-lending options which improve access to finance and build local lending capacity. Green Banks are a special category of financial institutions well-positioned to catalyse the transition towards a low-carbon, climate resilient development pathway. Innovative Green Bank finance instruments address common barriers of entry into the clean energy market and help mitigate risk inherent in low-carbon, climate resilient projects.

To lower barriers to market entry and offer private investors improved access to capital, Green Bank financial products are designed to optimize the capital debt structure through mechanisms such as on-lending, loan syndication, subordinated debt, convertible grants and convertible loans. As quasi-public entities, Green Banks also offer various guarantees and risk instruments which reduce or reallocate investment risk. A suite of risk mitigation instruments offered by Green Banks are useful in addressing currency, liquidity, political, policy, regulatory, credit and technology risk.

Guarantees are the most prominent financial mitigation tools and they offer an efficient way of leveraging private sector investment using limited public capital. Guarantees also have an enormous potential to bolster private investment in clean energy. It is estimated that increased use of guarantees could result in an additional USD 100-165 billion in private sector investment in Low-carbon, climate resilient infrastructure over the next 15 years (Bielenberg et al., 2016, referenced in IEA report). The most common forms of guarantees offered by Green Banks and Development Finance Institutions include Government-backed Loan Guarantees, Partial Risk guarantees and Export credit guarantees. Structured finance mechanisms aim to scale up investment by making renewable energy investments available through mainstream investment channels. Structured finance mechanisms address barriers associated with renewable energy transactions, including high due diligence costs and the small and discrete nature of some renewable energy and energy efficiency projects.

Credit enhancements, standardised contracts, loan-loss reserves and project aggregation are just a few of the standardized finance mechanisms  Green Banks have incorporated into their deal structures to attract private sector lending.

While the scale of the climate burden calls for a raft of strategies to combat climate change, Green Investment Banks are a promising first step on the path towards a low-carbon, climate resilient trajectory.

 

[1] IRENA Survey of:  ADB, AfDB, Africa Trade Insurance Agency, Development Bank of Southern Africa, UK Export Credits Guarantee Department, Export Development Canada, EBRD, GuarantCo, International Bank for Reconstruction and Development, Islamic Corporation for the Insurance of Investments and Export Credit, IDA, IFC, Korea EximBank, MIGA, OPIC and Swiss Export Risk Insurance.

Post a comment