Best Practice Report

Index

Mobilizing investment / Public financial instruments for risk mitigation and increasing return on investment

5. Public financial instruments for risk mitigation and increasing return on investment

Green projects often appear to present higher risks to investors due to the higher capital costs often associated with green, and perhaps unproven and unfamiliar technologies, the financing risks from immature financial markets and institutions, the perceived risk associated with finance in a particular country and sector, and policy risks. These latter risks are not specific to green growth investments but where they apply they add to the already higher risk profile of green projects. The impact of these will vary depending on sector and country context. The real or perceived risks associated with green projects may lead to their rejection by private investors. Providing access to capital through public direct investment will not fix this problem on its own; targeted financial instruments are required to restructure risks in order to attract private capital. The key question to be addressed here is what features characterize good practice in the use of public finance instruments for sharing risks and mobilization of private sector finance?

Lessons learned on financial instruments to de-risk and increase return on investment of green projects are:

  • Public finance instruments and support remain essential to raising finance for green investment through their role in mitigating risk and increasing the return on green investment for the private investors.
  • Different financial instruments play a role at different stages of the market development for green growth. Higher shares of public finance are needed initially, which drop as the private financial sector takes over.
  • The range of financial instruments currently being used for green growth is relatively limited, with most experience in the use of grants and concessional loans demonstrated. Moving towards scale of investment is likely to require a wider range of instruments tailored for use in differing country and sector contexts.
  • Publicly-financed preferential rate loans can cut financing costs significantly for investors but may not be sufficient to encourage financial institutions to actively seek customers for green loans if there is still sufficient risk perceived on the capital.
  • Risk guarantees or even credit lines from public budgets may be needed initially to mitigate the perception of risk associated with green projects in order to encourage financial institutions to offer concessional loans to investors in green projects.
  • Transparency of green finance can be improved through project monitoring and reporting requirements and when independent financing vehicles with a greater level of transparency are used. The absence of detailed information on the terms of finance provided is often related to commercial confidentiality, which makes it very difficult to assess whether or how green finance is being used most effectively.
  • Exit strategies for public finance of green growth remain relatively underdeveloped in the case studies examined. It is important that governments try to devise financing plans that transition to a green economy financed by the private sector.