Davos speech: An 8 point plan for Mobilizing Bond Markets for the Low Carbon Transition

Posted on 26. Jan, 2012 by in blog

This was the handout to go with a talk I’ve just given in Davos (thank you to the Corporate Knights/Inflection Point Capital Management ”Global 100 Dinner” for inviting me). Let me know what you think – what sounds right, what needs more work?

The Context

We need a FAST transition; the emissions horse is about to bolt and we have yet to significantly deploy solutions that will allow us to rein it in.
The needed climate change solutions will require a lot of investment. The International Energy Agency (IEA) estimates that, worldwide, $1 trillion of investment in energy, transport and building sectors are required each year above business as usual . 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.

Public sector balance sheets are, to say the least, constrained. 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 to achieve. Investments in climate resilient infrastructure, from renewable energy to energy efficiency, 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 so far focused on equity; but bonds are a great funding instrument for such high capex, long-life projects. On top of that we are, in the light of the crash of the past few years, entering the Age of Bonds. Institutional Investors have realised that high returns in equity can be illusory and have been busily shifting across to the bond market; that market is now worth $99 trillion compared to $55 trillion for equities, the reverse of a few years ago.

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; 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 on offer — 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. Which means 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 few.

One of the big challenges is that both the renewable energy and energy efficiency markets are much more disaggregated than traditional energy sectors with many small projects. Bond investors need scale; those smaller projects need to be aggregated into larger offerings suitable for the appetite of the big investors.

Banks providing project finance are having to recapitalise, a process that is going to happen with even more vigour as new Basel III regulations come into force. That means they are curtailing their smaller business and project lending, and will squeeze even more in the future.

Other players, like utilities and governments, are similarly constrained in their financing capacity.

If banks and utilities are to be major players in growing the Climate Economy, we need them to change their focus. They need to be project developers and financiers, dealing with the upfront risks of setting up new energy infrastructure.

Once they’ve done that they should be flipping what will then be low-risk assets and loan portfolios into the calm waters of the institutional investor ocean, using equity and asset-backed security offerings, and aggregating smaller offerings to do so as well.

Governments may have to kick start this process. Connecticut and Pennsylvania, for example, are setting up warehouses to buy up energy efficiency loans and securitise them. 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 lesson applies with applies to wind farms.

But post-crash, the securitisation market is on life-support and the appetite for exposure to renewable energy assets is low. Apart from government getting the new regulatory environment right, to revive it 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 this style of debt. Five of the world’s largest insurers, for example, publicly called in December for more aggregation, and for standardisation of products as climate bonds .

The corporate climate bond market can then be developed with partial treasury guarantees, ensuring 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 would appreciate, ratings agencies persist in over-estimating policy and resource risks 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 investments to counter perceptions of “novelty”, major deals are likely to depend on various kinds of public sector support, from the nature of 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 which can encourage institutional investors.

Insurance products could include:

> First loss and selective loan guarantees. Well known tools for development banks; a lot more could be done with them in renewable energy investing and other climate change solutions.

> Policy risk insurance (e.g. building on the under-utilised Multilateral Insurance Guarantee Agency).

> Currency risk insurance (like the scheme run by the Dutch Government for development finance).

But regulatory support can also work:

> The UK’s Green Deal legislation collects energy efficiency loan repayments through the utility bill and ties those loans to the dwelling not the mobile dwellers. 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 German 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 renewable energy bonds over other unsecured debt. This tactic has worked for the Japanese nuclear utilities; it can work for renewables.

In summary, the mantra has to be leverage leverage leverage (of private finance), but can be regulatory leverage as much as financial.

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 astoundingly large. 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 already 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!)

While we’re at it, can we cut back 100% project lending by development banks in favour of leveraging private finance? The EIB for example talks a lot about leverage but doesn’t do that much; it’s still lending 100% of funds willy-nilly. Time to better stretch that public sector balance sheet.

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 for example. Just a matter of defining what your qualifying universe is and doing it.

Very 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. And that’s what it would be.

The economy needs a narrative to right itself. A green growth narrative does that, while addressing the single most substantial threat of our era.
Part of that narrative is signalling where we can expect to see the economy go. 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.

Climate Bonds offer a tool to help investors and policy-makers to rapidly scale-up finance and action for the transition to a low carbon economy.

There is growing appetite from the investment community for investment-grade bonds that are specifically targeted at financing the low-carbon economy. However, 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.

There are many benefits to Climate Bond Standards:

> Governments need to be able to signal encouragement for and track private capital financial flows in investment-poor areas of the economy.

> Institutional Investors, particular public sector funds that dominate the rankings of largest funds in the world, need to be able to signal investment areas they are interested in and 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 to ensure 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 financing 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 see the policy settings needed to address climate change, they have to get better at packaging politically sellable solutions, not just making inchoate demands like protesters in the street.

That means working on and supporting industrial and investment plans that can address the challenge; that means showing how multiple sectors of the economy can be engaged in the task; and that means developing marketing campaigns to get those plans adopted and helping politicians see how they can successfully sell those plans to voters.

It’s time to match the fossil fuel lobby.


$3bn of 20yr wind bonds / Japan preferencing RE bonds (go Tokyo!) / Dark side of heroic EIB / Special 25% off Enviro Bonds Conf 15 Feb / US PACE bonds lifeline / Hear Kiernan raging / and more

Posted on 23. Jan, 2012 by in blog

> The European Investment Bank is a hero bank – it’s 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 offering guarantees for qualifying climate bonds). See this useful overview about just how EIB lending is tying countries to carbon-dependent paths for 40 years, by CEE Bankwatch campaigner Manana Kochladze.  Read more.

> Bonds from renewable energy companies will get preferential treatment over other unsecured debt under plans being considered by the Japanese Government to foster clean energy. This tactic is already used to help utilities raise funds for energy infrastructure — such as the nuclear plants now closed after post-Fukushima reviews. Debt issuance is a critical way of raising funds for investment, so extending the legal protection to renewable energy companies will be a big step in opening up the energy system to new players. Read More 

> RWE has raised £600m in 22 year bonds to build offshore wind farms. Two weeks ago Dong Energy issued a 20 year £750m corporate bond and a €700 hybrid capital bond (hybrid capital bonds are like convertible bonds), we assume to fund their ambitious renewables development. They should consider doing an asset-linked Climate Bond!. RWE and Dong may have been inspired by renewables developer Iberdrola, who raised €600m last October. Who says bond markets are dead in the EU?

> If you’d like to come to the 2012 Environmental Bonds conference in London, 15 Feb, you can now get a 25% discount, simply because you’re a Climate Bonds friend! It’s a line-up full of Climate Bonds experts. All you have to do is Click Here.

> A Californian court ruling could revive the use of PACE bonds to finance residential energy efficiency improvements. Excellent! Read more at Environmental Finance and PACENow.

> Ideas for investing: new Science article on 14 most effective measures for reducing climate change, like encouraging a switch to cleaner diesel engines and cookstoves, building more efficient kilns and coke ovens, capturing methane at landfills and oil wells, and reducing methane emissions from rice paddies by draining them more often. They could cut emissions by half. Read More. 

> New article by Sean Kidney in Canadian Corporate Knights magazine: “There’s a train leaving the station, one with a green paint job …” Read more.

> Good story in Scotland’s Holyrood magazine. “The City could rehabilitate itself and help combat climate change by focusing on clean finance, but the market will need new instruments and new skills….” Read More.

 

> Join me for coffee with legendary Innovest founder Matthew Kiernan as he rages on “How does refusing to take into account the biggest threat the planet faces make you a prudent investor?” – London 31 Jan @ 4pm. Email for details.

 

 

 

 

 

 

 

 

The true story of US CREBs and QECBs / China ups solar target 50% / Singapore+climate+insurance

Posted on 11. Jan, 2012 by in blog

1. Did you hear that China raised its 2015 solar energy target from 10 to 15 GWp just before Christmas? They have around 3 GWp now, and they’d already raised their target to 10GWp after the Japanese nuclear disaster. In contrast, Germany has 25 GWp of installed solar. China is likely to direct banks to offer cheap finance, although there have been indications of a debt market beginning.

2. If you’re in Singapore 30/31 Jan you might be interested in the Annual Climate Change Summit for Asia’s Insurance Industry. You’d get the chance to hear our SE Asia coordinator, Louis Perroy, speak, and to meet our Indian co-chair, Sumantra Sen.

3. Where did all the CREBs and QCEBs go? Mystery solved.

The US has for a long time used tax credits to promote the development of oil and gas and other industries. With tax credits the bond issuer still pays a coupon, but their payment is subsidized, effectively lowering the rate of interest paid.

The Obama administration brought in a big program of credits for renewable energy bonds. The plan was that States, large local governments, tribal governments and public power bodies would issue bonds to finance energy efficiency or renewable energy. The US Treasury states that some $5.6bn of allocations to over 1800 applicants have been made for these tax credits. This would seem to suggest that there were $5.6bn of bonds out there, but when we went looking we found we could only find out information about a few of them.

A report late last year by the US National Association of State Energy Officials has helped explain what’s happening. It seems that only a small part of the approved tax credits have actually led to a bond being issued.

The Government allocated $2.4bn for Clean Renewable Energy Bonds (CREBs) and $3.2bn for qualified energy conservation bonds (QECBs). After some investigation, Bloomberg New Energy Finance calculates public issuance at $646m, although they believe there is also a private placement market of up to $400m. That would bring total issuance up to around $1bn. I.e. bonds have been issued for less than 20% of allocated tax credits – that’s a severely under-utilized public finance mechanism!

Renewable energy financing consultant and former Ernst & Young senior partner, Jonathan Johns, has previously written for us on the benefits of tax-exempt bonds. I asked him what was going on.

First, he said that “he’s not that disappointed”. He says that “these are nudge rather than demand pull measures and require participants to pull schemes together and go through various procedural hurdles involved.  In a way they illustrate the future challenges of the industry as it seeks new sources of capital from the bond markets.”

Jonathan says that nudge mechanisms are often undersubscribed. “It’s interesting to note that those states with a strong record in renewables, e.g. California have used very high percentages of their allocations (which are based on population) whereas some more equivocal states have not. For other states there will be a natural cap on appetite if there are state or local borrowing limits.”

“There are lessons to be learned for the US and other jurisdictions – future schemes need to be more streamlined and remove some of the barriers – and also be accompanied by focus on demand stimulation and distribution channels for the bonds themselves.”

“Tax exempt bonds are a cost effective form of support, as relief is limited to the interest on the capital and not based on the capital itself. There’s also a relatively high payback per job created, with that payback localised when there’s a strong energy efficiency component – that’s been the case in over 50% of QECBs issued.”

A relatively large number of bonds issued are for small schemes in the $1m to $5m range. In other jurisdictions this has been difficult to achieve, with bond issues confined to recycling of large scale project finance portfolios.

Johns thinks it’s important to build on the CREB/QECB story and take the bond market to its next stage of development through the Climate Bonds Initiative and other mechanisms. Positive thinking.

Webinar invite 11 Jan: “Evaluating Clean Energy Public Finance Mechanisms”, new UNEP SEF Alliance / Climate Bonds Initiative / Irbaris report

Posted on 04. Jan, 2012 by in blog

Join us for a Webinar on January 11, 2012

Space is limited. Reserve your spot now at:
https://www1.gotomeeting.com/register/825499744

The UNEP SEF Alliance will host the webinar on Thursday, January 11, 2012 at 9 am EST (New York time).

The webinar will cover the results of the recently released SEF Alliance/Climate Bonds Initiative /Irbaris report, “Evaluating Clean Energy Public Finance Mechanisms“. The report evaluates government funding of programs supporting the low-carbon, clean energy economy; it also examines the effectiveness of different types of public finance mechanisms at different stages of the clean energy continuum and how they perform in different environments.

The call will feature the report’s principal authors, Karl Mallon and Padraig Oliver of Climate Bonds Initiative and David Lyon of Irbaris, to give an overview of their findings. The report can be downloaded at http://www.unepsefalliance.org.

You can use your computer’s speakers, a USB headset, or telephone for the audio portion of the webinar. Please contact Maria@cleanegroup.org with any questions. Pre-registration is required for this free event.

Time Conversions:
9 am US (New York)
6 am US (California)
2 pm UK/Ireland
3 pm Central Europe
4 pm Eastern Europe
7.30 pm India
10 pm Singapore
1 am Australia (Sydney)

Title:   UNEP SEF Alliance Webinar: Evaluating Clean Energy Public Finance Mechanisms

Date:   Wednesday, January 11, 2012

Time:   9:00 AM – 10:00 AM EST

After registering you will receive a confirmation email containing information about joining the Webinar.

System Requirements

PC-based attendees
Required: Windows® 7, Vista, XP or 2003 Server

Macintosh®-based attendees
Required: Mac OS® X 10.5 or newer