Public financial instruments are designed to reduce real or perceived risk and/or to increase returns on investment. UNDP (2013) and Micale et al. (2013) identify two main categories of de-risking instruments:
Another key barrier for green finance is the general lack of affordable long-term capital and so the inability for investors to refinance green assets. Without efforts to address this, the ability for delivering scaled up green investments over time will be reduced.
Financial de-risking instruments can help shift the risk-reward profile of green projects. Four basic types of financial instruments can be used by the public sector to mobilize green private sector investment, notably grants and other subsidies such as tax relief, concessional loans, guarantees, and equity investments. Tables 2 summarizes the four main instruments, considers the key advantages and disadvantages (GCF, 2013), and examples from the case studies examined here. Of the seven case studies, only the South African Green Fund used guarantee or insurance mechanisms and only Morocco employed equity investment as one of the financial instruments for green growth.
These instruments may be used at different points in an investment program cycle to target different investors. In general, higher shares of public finance and subsidy in the form of grants or tax incentives are needed when the market for green projects is very new or under-developed. The use of non-reimbursable grants for technical assistance (TA) and other advisory services may be particularly important in assisting countries with the development of policy and regulatory frameworks and institutional strengthening, and other market enabling activities. Tax incentives and relief may be attractive to governments since while grants require outlay of the public budget, tax incentives impact revenues.
Governments and development financial institutions can also support the market for green finance by mitigating risk through concessional loans. For example, green credit lines may be offered to financial institutions to help recipient banks develop their portfolio of green investments and mitigate credit risk, in turn promoting the financing of private green investments, or by providing concessional loans directly to investors. Governments can also support debt finance indirectly through policies that enable financing arrangements through third parties (such as on-bill finance) and introducing guarantees and risk-sharing facilities (Blyth and Savage, 2011; Hilke and Ryan, 2012). Rapidly developing countries may have less capital available to finance green infrastructure, leading to high costs of debt finance. CPI proposes two solutions for financing renewable energy in the developing world: First, index renewable energy tariffs to foreign currency so that currency hedging costs are eliminated; second, improve the cost-effectiveness of domestic renewable energy support programs by providing lower-cost debt through debt concession programs before implementing other support programs (Nelson and Shrimali, 2014).
Guarantees may also be used to cover both policy and financial risks associated with green investment. Policy risk insurance (PRI), which is now emerging as a new green finance product, can be provided by institutions such as the Multilateral Investment Guarantee Agency (MIGA) and the Overseas Private Investment Corporation (OPIC) and can indirectly address policy risk under their expropriation coverage but is limited. Partial Risk guarantees provide risk mitigation for specific government obligations, and can provide investor certainty against the impacts of specific retroactive regulation changes (Micale et al., 2013). First loss guarantees protect investors against a pre-defined amount of financial losses, thus enhancing credit-worthiness and improving the financial profile of the investment (Herve-Mignucci et al., 2013). Multi-lateral and national development banks have increasing experience of these instruments.