Best Practice Report

Index

Mobilizing investment / Effective use of public budget and frameworks / Public intermediaries and use of dedicated green funds
4.2.

Public intermediaries and use of dedicated green funds

Public finance for green growth projects may not always be managed primarily or exclusively through public budgets; governments often use intermediaries and funds for a variety of reasons. They can provide an institutional set-up to blend public and private funds from various sources and thus form a focal point for regrouping many smaller sources of funding to a single budget. Secondly, intermediaries can administer the distribution of the funds to the target group. Thirdly, separating green funds from the public budget allows the funds to be kept off the balance sheet of public expenditure. The main types of intermediaries and funding arrangements found for green growth projects are:

•  Dedicated funds;
•  Public banks and financial institutions;
•  Sovereign wealth funds; and
•  Green bonds.

Dedicated funds, such as government loan funds, and public banks may disburse funds directly to program applicants or cooperate with entities, such as local banks, that can serve as local contact points for program applicants. Combinations are also possible. For example, applicants have to first pass through a mandatory assessment procedure by a local partner before applying directly via a central application portal. Green bonds also have a role in providing a vehicle for funds to be collected and disbursed to green growth projects. They can aggregate projects and achieve sufficient scale to reach new groups of private investors (Hilke and Ryan, 2012). Bonds have been the dominant asset class favored by institutional investors in portfolio allocations of institutional investors across OECD countries. Consequently, much attention has been focused on the potential to develop the use of fixed-income vehicles to support greater institutional investor participation in green growth investments (Kaminker et al., 2013; Kaminker and Stewart, 2012).

UNDP outlines the advantages of ‘national climate funds’ in terms of:

•  Collecting and distributing funds to activities that support national priorities;
•  Facilitating the blending of public, private, multilateral and bilateral sources of funding4
•  Coordinating national climate change activities; and
•  Enabling ‘direct access’ to international climate finance (Flynn, 2011).

Green funds have become a popular institutional innovation by countries seeking to create a domestic mechanism for blending funding from different sources and for allocating and reporting it against green growth priorities. However, there are also concerns that these funds are disconnected from formal budget processes and can result in a dilution of accountability and transparency. They can also be sidelined, and may not have much influence on the direction of the main budget process (Irawan et al., 2012). Funds have often been rapidly developed in order to create a signal of commitment and in some cases to attract international climate finance. But establishing the human and institutional resource capacity to manage a fund effectively takes significant time and may not be adapted to dealing with all types of recipients, in particular smaller investors and individuals (Flynn, 2011).

Of the cases explored here South Africa’s climate change and green growth aspirations are directly supported by the Minister of Finance, who set aside R800 million (USD 80 million) within the 2011 national budget to catalyze investment in green economy initiatives via a new Green Fund (Gordhan, 2011). Following an initial tendering, additional funds have been allocated to meet the overwhelming demand for green project development.

In other cases, governments have introduced new functions within existing funds. For example, the National Forestry Financing Fund (FONAFIFO) in Costa Rica now operates a payment of renewables premiums and the Payment for Ecosystem services systems.

Another example of a more tightly focused and specific fund with financial mechanisms is the example of Morocco, whereby MASEN was established as an extra-budgetary entity through a range of domestic public finance sources, including investments from the national budget of the Government of Morocco, the national utility, and existing national investment funds (Moroccan Agency for Solar Energy, 2011).

Public banks or financial institutions are an important type of intermediary well-placed to collect and disburse public finance for green growth projects. CPI estimates that of the USD 359 of climate finance spent globally in 2013, USD 69 billion was contributed by National Development Banks (NDBs), USD 38 billion by multilateral development banks (MDBs), and USD 15 billion by bilateral finance institutions (BFIs), compared with USD 1.6 billion by climate funds and USD 12 billion by government budgets (Buchner et al., 2013). Public finance through development financial institutions (MDBs and NDBs) can have significant advantages over direct budget allocation because they can “raise funds on the capital markets, reinvest earnings, and mobilize additional funds through co-financing (either with commercial banks, financial institutions, development partners, or other international finance institutions)” (Buchner et al., 2013).

National development banks (NDBs) have an advantage over other forms of public finance as they usually have knowledge and long-standing relationships with the local private sector, which puts them in a better position to access local financial markets and understand local barriers to investment. As public institutions, NDBs are more likely to be able to take risks than the commercial financial institutions, and therefore can provide long-term financing in local currency in their local credit markets (Smallridge et al., 2013).

The German Government has harnessed the expertise of its national development bank, KfW, to support the country’s energy efficiency investment programs, drawing on its capital base through EUR 4.65 billion as equity capital and EUR 3.25 billion as subordinated loans (OECD, 2012b). With a balance sheet total of more than EUR 450 billion, KfW is one of Germany’s three largest banks (Hilke and Ryan, 2012). KfW refinances its lending business almost exclusively in the international capital markets and, since it is backed by the German Federal Republic, it can borrow at relatively low interest rates. As the bank has no branch network, funds are extended to customers by using the concept of ‘on-lending’ via commercial and savings banks.

The UK Government launched a new Green Investment Bank in November 2012, committed to delivering UK green objectives as set out within the Climate Change Act and related policy measures. In 2012/2013 a total of 25 projects were backed committing GBP 764 million which will mobilize GBP 3.2 billion when fully deployed. It is estimated that the bank so far has leveraged an additional GBP 3 of private capital for every GBP 1 invested by the Green Investment Bank (GIB, 2014).

Brazil’s national development bank, Banco Nacional de Desenvolvimento Economico e Social (BNDES), offers an energy efficiency credit line Proesco, with annual rates of 14 percent. In 2011 about R$ 30 million (USD 16.5 million) of financing was approved from the line (Bloomberg, 2012). BNDES also manages the Amazon Fund and has approved support in the amount of R$ 16.4 million for environmental sustainability in the state of Amazonas to develop a management project on indigenous land, covering approximately 50% of the indigenous territories in the state.

Multilateral development banks or MDBs and bilateral financial institutions can also play a pivotal role particularly in the poorest countries to address market barriers (high perceived risk, high transaction costs, low liquidity, etc.) and to leverage investment in green growth. They can provide seed funding and lines of credit to NDBs or governments directly for green growth investment and also other forms of support such as technical assistance when the market is less developed.

Public investment can also be deployed in green projects through sovereign wealth funds. A sovereign wealth fund (SWF) is a state-owned investment fund or entity (kept separate from the nationalbudget) that is commonly established from balance of payments surpluses, official foreign currency operations, the proceeds of privatization, governmental transfer payments, fiscal surpluses, and/or receipts resulting from resources exports (World Economic Forum and IHS Cambridge Energy Research Associates, 2012).5 The long-term investment horizon of such funds makes them potentially compatible with green investments (Mao and Schmitz, 2012). Current examples include Norway’s Government Pension Fund Global and Abu Dhabi’s Mubadala who are each invested in renewable and sustainable energy.

Green bonds are broadly defined as fixed-income securities issued by governments, multi-national banks or corporations in order to raise the necessary capital for a project which contributes to a green economy (Della Croce et al., 2011). They differ from regular bonds, mainly in that the funds raised are exclusively used for specified environmental and sustainable development purposes which means that investors that are looking for socially responsible investments (SRI) may be targeted (Hilke and Ryan, 2012). Della Croce et al. (2011) estimated that green bond issuances in 2011 had amounted to USD 15.6 billion, representing only a fraction (0.017%) of the global bond market and Deutsche Bank (2014) estimates that this is continuing to increase. In 2014, a consortium of investment banks developed the Green Bond Principles which are “voluntary process guidelines that recommend transparency and disclosure and promote integrity in the development of the Green Bond market by clarifying the approach for issuance of a Green Bond” (CERES, 2014).6 This should help scale up the market by providing consistency and transparency across green bonds.

A new EU Project Bonds pilot (part of the European Commission’s Connecting Europe Facility7 aims to stimulate investment in key strategic infrastructure sectors and to establish debt capital markets as an additional source of financing for infrastructure projects. Green infrastructure projects, packaged into bonds can therefore offer long, steady, and inflation-adjusted income streams for green investments as they mature. The Climate Bonds Standards Board of the Climate Bonds Initiative is developing standards for investments eligible to be called Climate Bonds, which is a subset of green bonds (CBI, 2014).

 

4. Public-private approaches are increasingly popular as a way of leveraging private sector funding in green growth projects. There are many advantages of this approach and these are discussed in further detail in Chapter 7: Public -private collaboration [link].

5. The definition of sovereign wealth fund exclude, among other things foreign currency reserves assets held by monetary authorities for the traditional balance of payments of monetary policy purposes, state-owned enterprises in the traditional sense, government-employee pension funds, or assets managed for the benefit of individuals’ (SWF Institute, 2014).

6. Four banks drafted the principles: Bank of America Merrill Lynch, Citi, Crédit Agricole Corporate and Investment Banking and JPMorgan Chase; while the following banks announced their support of the Principles: BNP Paribas, Daiwa, Deutsche Bank, Goldman Sachs, HSBC, Mizuho Securities, Morgan Stanley, Rabobank and SEB.

7. A new facility proposed by the Commission in the 2014–2020 Multi-financial Framework that would use both grants and financial instruments such as project bonds to accelerate infrastructure investment.