Rachel Kyte, IFC: P8, Who cares wins and green investing in developing countries

IFC leads call for investor action to spur on Copenhagen agreement this year.

When it hosts next month’s, low-key Washington meeting of the Prince Charles led P8 pensions powerhouse for sustainable investment (Link to RI story) the International Finance Corporation (IFC), the private sector financing arm for developing countries of the World Bank Group, aims to start putting into action some of the significant research it has done in the last five years to galvanise institutional investors around the issues of climate change and investment in poor countries. The evolution could be seen as the ‘action’ stage in the IFC’s involvement in the Who Cares Wins project, a joint research effort between investors, the Global Compact, IFC and the Swiss government, which unveiled its final report last month at the World Economic Forum in Davos. The project, which led to the creation of successful offshoots including the Enhanced Analytics Initiative (EAI), made ten final recommendations to support its goal of achieving better integration of environmental, social and governance issues into investment (see downloads). They included the embedding of ESG (environment, social and governance) criteria into pension fund mandates as well as greater lobbying for ESG inclusion into ratings agency methodologies.The IFC operates as an individual entity with its own board, investment portfolio and strategy. Importantly, it raises its own capital in the markets and works on a purely commercial basis with in-house treasury operations, equity investments, loan books, asset management programmes and advisory services. In short, it speaks the financial language of institutional investors, enabling it to bring market experience to move the P8 initiative forward. Rachel Kyte, vice president advisory services at the IFC, said its interest in mobilising institutional capital came about both because it raises money for its own development bond issuances, but also through its interest in how to take what she calls “capital that cares” into emerging markets and find it the right kinds of investment opportunities: “Historically, within the responsible investment movement there was just a tiny percentage of investment that was going into emerging markets. We were very interested to see whether responsible/caring capital owners would and could put more assets to work in emerging markets where many good growth companies are starved of development capital and where the investment could do much more in terms of development than investing in

domestic markets. We wanted to fill the gap of deep, long-term strategic investment into developing countries.” Kyte says part of the investigation of Who Cares Wins was to test the premise that extra financial issues were an important element of understanding investment risk and return. This aimed to compliment existing work on the impact of both regarding good corporate governance, increasing environmental standards and emerging work on social issues such as human capital and labour standards. “The questions we were asking were things like: are these notions only applicable in OECD markets? Do they stand up? If so, could they work for emerging markets? What we found, however, in emerging markets was that for companies to be good on ESG issues involves a cost in terms of increased operational input and certification over a certain time. As a result, there is no meaningful return for investors during that period.” The findings prompted the organisation to look at whether there was any way it could start to build a market ‘signal’ itself, acting as Kyte puts it, like “synapses” – the chemical pathways that enable the human nervous system to function. “At the time there was no analysis of ESG in emerging markets and as a result asset owners weren’t taking an interest. One question we asked was that given that many institutions were starting to introduce sustainability mandates, or had a legal onus to do so, how were they ensuring that the underlying assets globally conformed to those sustainability criteria? Another was whether the IFC could act as proxy or a reassurance that a decent degree of performance could be achieved in emerging markets while running money in line with thoseprinciples. One part of the answer is that the IFC does the underlying due diligence on all the investments we make in developing countries, our investments are public and investors are free to use that information. It’s a kind of seal of approval. Who Cares Was a conversation about how to mainstream that work and we’ve reached a conclusion on that for time being and it led very much to the work we’ve done on climate change and now to the P8 discussions.”

“It’s a question of finding the right kinds of investment vehicles to develop.”

Kyte says next month’s Washington meeting feeds into the kinds of solutions that could underpin this year’s Copenhagen summit to find a successor to the Kyoto Protocol. “One of the big issues about Copenhagen is financing. The question in the international community is who is going to pay for a new green deal? With the traditional transfer of technology from developed to developing countries, one doesn’t close to the kind of real finance needed. Therefore, most of the money will come from the private sector. Who is missing in the Copenhagen negotiations? Well, it’s the financial sector writ large: the banking, insurance and institutional investor community. One of the things we’ve been looking at in the IFC is how do you find ways of bringing private sector money into the equation? What kinds of projects and processes are necessary? We know there is capital looking to invest in emerging markets for diversification reasons, so it’s a question of finding the

right kinds of investment vehicles to develop.” She says there are two subsequent problems: one is that developing appropriate vehicles such as infrastructure or large off-grid renewables projects takes a long time, due to government processes and tenders, etc. The second, she says is a cascade of political, currency and project investor risks associated with emerging markets investment. Consequently, the IFC’s proximity to emerging markets and the development of local projects and understanding of risk was deemed to be the ideal platform for institutional investors to develop their own related capacities via the P8 next month. Kyte explains how this might work: “The Danish government, ahead of Copenhagen, has become very interested in looking at strategically pushing initiatives that may be able to leverage significant amounts of private finance. It’s an essential element ahead of the political deal to be struck. At the moment, it’s difficult for political leaders in developing countries to say what this so-called climate change driven development is going to look like when maybe 80% of the population has no access to electricity or clean water and yet they’re being told to grow in a less carbon intensive way. That’s one of the big conundrums in the Copenhagen negotiations. If you can’t visualise what the development looks like then it’s very difficult to negotiate towards that end-point. We need to be able to show to a sceptical developing world that in fact money will flow. We have institutional investors that want to commit long-term capital to this area because of its steady return prospects. We’re interested in instruments, whether they are funds or funding facilities that can combine with the IFC’s ability to source projects, know the investment landscape and risks in developing countries and bring projects to the table where the P8 could be associated. I don’t have any strong views about exactly how the mechanism would work.For example, though we’ve had a lot of experience in debt structuring for projects where the different risk appetites of investors can be accommodated. That might mean that the IFC or another donor organisations takes the first loss position, the mezzanine could be taken up by IFC and the senior debt be taken by banks or institutional investors. We’ve used this for energy efficiency financing in Eastern Europe and school and health financing in Africa.” Kyte says the kind of win-win project they might invest in would be the creation of a business for a bank of targeting energy efficiency where it could work with loan money to utilities and customers to help them become more efficient: “This works because you are developing a finance business, helping companies become more sufficient and helping people to pay less for heating. In the least developed countries, another initiative is to enable people to be connected to low-pollution electricity. We’ve got projects where we have performance-based grants and aid as a way to provide targeted subsidies to power distributors based on the number of people that are connected to the grid. These kinds of projects are low-hanging fruit, which can be cost-negative over time but often don’t get done.” Kyte says it’s about helping governments in developing countries do the easy stuff first, about finding ways to show what does and what doesn’t work. But, she notes, these projects need to be mapped up quickly if important steps are to be made to fight climate change: “We know that investors are increasingly concerned about water and energy issues. There is also a growing belief that access to resources is the long-term financial challenge and a huge opportunity for global economic stimulus. Rather than base economic policy on encouraging consumer spending, wouldn’t it be better to create real things for the billions of people at the bottom of the pyramid and help them earn their way out of poverty.”