8 steps to bring investors into the $1trn per annum needed to prevent dangerous climate change

The CO2 emissions horse is about to bolt and we have yet to significantly deploy solutions that will enable us to stop it.
 We know the investment required: the International Energy Agency (IEA) estimates that $1 trillion of investment in energy, transport and building sectors are required each year above business as usual. And according to the UN Environment Programme, if the sustainable management of natural resources such as forests, fisheries, agriculture and water is included, an average additional annual investment of $1.3 trillion is required out to 2050. But public sector balance sheets are, to say the least, constrained. So the bulk of the money is going to have to come from the private sector; in particular from the $75 trillion of assets under management by institutional investors. This is possible. Investments in climate resilient infrastructure from renewable power to energy efficiency projects typically involve high capital expenditure that creates secure and predictable long-term assets; very close to what pension funds and insurance investors are looking for. Investment in these assets have focused on equity; but bonds are a great funding instrument for such high cap-ex, long-life projects. Climate Bonds – asset-backed or ring-fenced bonds issued to raise finance for climate change solutions – have been developed as one means of tapping that market.
But funds are still not flowing. So how do we get some action? Here are 8 steps:1. To create deal flow, think big.
Investors say there are simply not enough big deals. Bond markets want deal flow lumps of half to one billion dollars and investors will only buy if there’s going to be liquidity as a result of large volume issuance. The bigger the opportunities the more investors will be interested. In equities this is beginning to change with landmark deals such as PensionDanmark’s recent acquisition of a huge offshore wind farm from Dong energy. Bond opportunities remain scarce. One challenge is that both the renewable energy and energy efficiency markets are smaller in deal size than traditional energy sectors. Bond investors need scale, so smaller projects need to be aggregated into larger offerings. Banks providing project finance are recapitalizing and will do so increasingly under Basel III regulations. That means they are curtailing their smaller business and project lending. Other players, like utilities and governments, are similarly financially constrained. If banks and utilities are to be major players in growing the climate economy, they need to become project developers and financiers, dealing with the upfront risks of setting up new energy infrastructure. Then they should be flipping what will be low-risk assets and loan portfolios to institutional investors using equity and asset-backed security offerings, and aggregating smaller offerings to do so as well. Governments may

have to kick start this process. In the US, Connecticut and Pennsylvania are setting up warehouses to buy up and securitise energy efficiency loans. The UK Government is working with financiers to set up a “Green Deal Warehouse”. These aggregation facilities need to be big, and we need them everywhere. The same applies to wind farms. But post-crash, the securitisation market is on life-support and appetite for exposure to renewable energy assets is low. Apart from government getting the new regulatory environment right, we’re going to have to take investors on a journey of understanding. The Climate Bonds Initiative has developed a mechanism for issuing “asset-linked” corporate climate bonds. These are fully backed by corporate treasuries but report on the performance of the underlying asset as part of the package. Institutional investors have expressed strong interest. In December last year, five of the world’s largest insurers called for more aggregation and standardisation of products such as climate bonds. The corporate climate bond market could be developed with partial treasury guarantees to ensure that investment grade ratings are maintained, until investor and market maturity allow the development of a fully asset-backed market.
2. Engineer investment grade offerings.
When institutional investors say “big deals” they mean low-risk big deals. For better or worse, the yield curve in the bond market is not going to change: the demand is for investment grade, although BBB, A and AA will do just fine. As most people in the renewable energy field appreciate, ratings agencies persist in over-estimating policy and resource risk for renewables while under-estimating the carbon penalty risk for coal and oil companies. Until there is a longer track record for at-scale renewable investmentsto counter perceptions of “novelty”, major deals are likely to depend on various kinds of public sector support, from power purchase agreements (such as feed-in tariffs) and tax-breaks (common in the US), to low-cost loans to show how its done (as KfW Bank is providing for offshore wind farms in Germany) and regulatory support (in some markets just removing subsidies for fossil fuel energy is all that’s needed). What’s needed is a grand pact between governments and institutional investors: government engineers a stream of large scale investment opportunities and does everything it can do make sure they are investment grade; in return institutional investors turn on the taps.
3. Be clever about public sector risk-sharing.
Public support doesn’t always have to be fiscal. There are many options: from guarantees to ‘knocking heads together’ to regulatory measures, all of which can encourage institutional investors.
Insurance products could include:

• First loss and selective loan guarantees.
• Policy risk insurance
• Currency risk insurance

But regulatory support can also work. For example, the UK’s Green Deal collects energy efficiency loan repayments through the utility bill and ties those loans to the house not the inhabitants. The legislation effectively de-risks investments by ensuring that default rates will be minimal (everyone pays their power bills). On the back of that loan portfolios can be built and securitised. In Germany the covered bond (Pfandbrief) market is worth nearly a trillion dollars. By extending that legislation to cover renewable energy assets Germany can
hugely expand institutional investor access and participation in the renewables market and lower borrowing costs. In Japan the government is legislating to give preferential treatment to renewable energy bonds over other unsecured debt. This tactic has worked for the Japanese nuclear utilities; it can work for renewables.
4. Build green enabling institutions.
We know that the solutions have to involve new forms of private/ public risk sharing. We also know that the “understanding” gulf between treasuries and investors is huge. Rapid change requires special purpose teams and institutions operating at the border between investors and government and tasked with finding quick ways to achieve change. Green investment units and banks are needed where state banks are not strong. Where they exist they need to be greened. The European Investment Bank, for example, is the world’s largest clean energy lender, but they have a dark side that uses cheap public money to build new coal-fired power stations. It’s policy lunacy because it means the EU’s bank is undercutting EU emissions reduction targets (let alone the world’s). They should be switching that dark side money to the light side and then leveraging it, for example by offering guarantees for qualifying climate bonds. Same thing applies to all the development banks (ask the EBRD about their coal lending!)
5. Give tax incentives for climate bonds.
This is not rocket science; it’s been used for many years to support the oil and gas industry in the US! A little treasury loss can be a big boost to investment.
The Climate Bonds Standards and Certification Scheme (see point 7) is designed exactly to support this.
6. Build an economic recovery narrative.
The money is there, much of it parked in cash, sitting out the crash.
Shifting the economy by building productive investments is a recipe for a long-term economic stimulus plan. A green growth narrative does that, while addressing the single most substantial threat of our era. As we address climate change we will need to revamp our economies across every sector.7. Use Climate Bond Standards as a screening and preferencing tool.
In order for the market to grow and for liquidity to develop investors need tools to help them monitor and verify the climate effectiveness of their investments. Other advantages of the Climate Bond Standards are:

• Governments need to be able to signal encouragement for and track private capital financial flows in investment-poor areas of the economy.
• Institutional Investors, particularly public sector funds that dominate the rankings of largest funds in the world, need to be able to assure the public that institutional capital is being invested in their interest.
• The public needs to know that a vehicle for catalysing large-scale financial flows for future environmental stability is available and that the financial sector is supporting this future.

A large and liquid climate bond market will stimulate innovation from banks, issuers and policy makers alike and will make an important contribution to bridging the finance gap that currently exists.
8. Make it easy for politicians.
This is where real work is needed. Investors are aware of the risk of climate change – organisations representing $20 trillion have been calling for change for years – without huge success. That’s because too many politicians are focused on the short-term, caught in the headlights of the fossil fuel lobby (just go to Washington DC and feel the number of coal and oil lobbyists around). If concerned bond investors and business issuers are to get the policies needed to address climate change, they have to be better at packaging politically sellable solutions. That means working on and supporting industrial and investment plans that can address the challenge, showing how multiple sectors of the economy can be engaged, developing marketing campaigns to get those plans adopted and helping politicians to successfully sell those plans to voters.
It’s time to match the fossil fuel lobby!