Reducing the risk of investing
Public action and support can attract private investment by improving the risk-reward calculus
Private investment in green technologies faces a number of risks:
- Political risks include changes in government that affect the legal system, and the risk of civil unrest in certain countries.
- Macroeconomic risks include fluctuations in economic conditions and commodity prices, interest and exchange rates.
- Policy risks entail regulatory changes, such as those to feed-in tariffs or fossil-fuel subsidies that can alter a project’s economic viability.
- Technology and operational related risks are those intrinsically related to the technology in question. These range from performance-related risks, where revenues might be lower than expected, to risks resulting from the lack of or unreliable supporting infrastructure, such as electrical and water-grid networks.
- Capacity risks refer particularly to development assistance and aid, where institutions and governments are unable to ensure funding is disbursed to projects and utilized.
Mobilizing private finance at scale requires that the risks of green investments be reduced to about the same levels as those faced by alternative, conventional investments (for example, in generating fossil fuel-based energy or environmentally sub-optimal infrastructure). As shown by the case studies in Appendix 2, development finance institutions, multilateral development banks, and domestic governments have successfully leveraged significant private investment through targeted support.
Table 3: A taxonomy of public instruments and mechanisms to create attractive green-growth investment conditions
Source: Adapted from World Resources Institute, 2012
Insurance and guarantees
De-risking green investments to levels that are palatable to investors can be partially achieved by smoothing the investment landscape using guarantees and innovative insurance products. Political-risk guarantees are particularly useful in developing and emerging markets. The World Bank Group’s Multilateral Insurance Guarantee Agency (MIGA) is one example of a political-risk insurance guarantee provider, having provided more than US$ 24 billion in insurance coverage since 1988. Between 2005 and 2011, however, MIGA provided fewer than 10 guarantees for projects in ‘green’ sectors;64 and MIGA guarantees are not available for smaller and medium-sized investments.
Policy-related risks can be mitigated through regulatory risk insurance or guarantees. The US Overseas Private Investment Corporation (OPIC), for example, provides investors with financing, guarantees, political-risk insurance and support for private equity investment funds to help mobilize private capital. OPIC also offers regulatory risk coverage specific to renewable energy projects. The aim of this type of insurance/guarantee is to reduce the risk inherent in investing in non-conventional technologies, in non-conventional regions, and to create a level playing field for alternative investment choices.65 Examples of risks covered could include material changes to feed-in tariffs, or revoking licences and permits necessary to operate a project. To scale up insurance solutions for green investment, it will be necessary to align interests, most likely with a public-private partnership between the insurance industry and various governments and regulators.
Loan guarantees and partial risk/credit guarantees are commonly provided by development finance institutions and have also proven useful in ‘on-lending’ arrangements where governments underwrite loans provided through intermediaries, such as commercial banks or state utility companies. In cases of default, the government agency or development finance institution can absorb some or all of the risk. This is particularly beneficial for new markets where private lenders are not initially comfortable or familiar with the technology in question.
Tunisia’s Prosol Programme (see Appendix 2) is an example of debt default risk being removed from suppliers of solar water heaters. Commercial banks provided loans to customers through accredited suppliers, which were repaid through customers’ electricity bills. Customers’ services were withheld when they did not pay. The state utility acted as debt collector, enforcer and loan guarantor, shifting the credit risks from lenders to borrowers. This has improved awareness and expertise of commercial banks for renewable energy lending.
Work completed by the Green Growth Action Alliance highlights the potential role of partial credit guarantees in India to mobilize finance at scale, while in Kenya, the Alliance and the UNEP Finance Initiative are looking to design a Takeout Finance Facility to address the perceived asset-liability mismatch that has been identified as a bottleneck for private finance for renewable energy lending; local lenders often seem unable to lend beyond seven years while project developers seek 15-year loans.
There is significant potential for public sector and public financial institutions to provide more guarantees for higher-risk investments but guarantees alone cannot improve the commercial viability of all investment types. A combination of de-risking instruments is needed to bring investment risk down to acceptable levels.
Interest rate and currency facilities
Where project developers need protection against macroeconomic risk and/or political volatility (for example, in emerging markets) interest rate and currency derivatives and facilities can reduce perceived risk. These are typically cross-border loans provided in the local currency that can protect the borrower from volatile fluctuations in the exchange rate, thereby avoiding repayments in foreign currency, and liquidity facilities, such as lines of credit that can inject short-term cash flow into projects, allowing the borrower to manage exchange-rate fluctuations. Fees are usually required for interest rate and currency facilities, which reduce the overall economic viability of the investment. As a result, this mechanism is not often used in green investing. Government and financial institutions need to cooperate to provide these facilities at a lower rate or with no charge to encourage private-sector investment in countries where green growth is critically required but volatility in the local currency is high.
The private-sector facility of the United Nations Framework Convention on Climate Change (UNFCCC) Green Climate Fund (GCF), formally established as part of the Cancun Agreements in 2010, is one contender for providing interest rate facilities and guarantees to increase the capacity of banks and encourage increased lending for green projects. The GCF’s mandate is to help developing nations limit or reduce their greenhouse gas emissions and adapt to the impacts of climate change. Its main role is to channel new, additional public financial resources from developed nations to affect private and public finance for mitigation and adaptation in developing countries. The private-sector facility of the Fund enables it to directly and indirectly finance private-sector mitigation and adaptation activities at international levels. The mandate is broad and could include a range of de-risking instruments to bridge the green technology cost gap, instruments such as subordinated debt (described below), risk guarantees and even equity66 among others.
Development financial institutions (DFIs) play an important role in underwriting loans and offering liquidity facilities at concessional rates to reduce macroeconomic risk. The Japan Bank for International Cooperation (JBIC) provides loan guarantees for the co-financed portion of green projects. In 2010 and 2011, JBIC’s Green Initiative provided an estimated US$ 300 million in loan guarantees to local development banks for four renewable energy projects in Asia and South America.67 Development banks are typically more familiar with political risk and macroeconomic conditions in developing countries and as such are well-placed to increase access to underwriting facilities to scale up private-sector investment in these regions.68