FINANCING ASIA’S CLIMATE COMMITMENTS – CENTRAL ROLE FOR A GREEN INVESTMENT BANK?

02/12/2017

Over the past two decades, Asia has been the fastest developing region in the world.  Many countries have achieved spectacular economic growth, which has delivered prosperity to many and led to significant industrial upgrades and rapid urbanisation.

Asia’s Infrastructure Challenge
Alexandra Tracy

However, 1.6 billion people are still living in poverty, with 800 million lacking access to electricity.  The region faces a significant challenge to close infrastructure gaps and build cities that offer an acceptable quality of life.  Moreover, as home to over half of the world’s people, but much less than half of its natural resources, sustainable economic prosperity in Asia depends on being able to transition to cleaner and more efficient modes of development.

And this requires cash.  The United Nations predicts that investment of some US$2.5 trillion a year until 2030 is needed for sustainable development in Asia: to upgrade basic services and infrastructure and to protect the environment, enhance energy efficiency and respond to climate change.

Transformation of NDCs into Robust Investment Pipelines

Increasing the volume of climate-smart development has become more than a distant aspiration for emerging markets in Asia.  Under the 2015 Paris Agreement on climate change, countries have each put forward Nationally Determined Commitments (NDCs) through which they have pledged to reduce carbon emissions by developing low carbon energy and greener infrastructure.  With that agreement now in force, and 59 Asian governments having submitted a mitigation target, the policy focus is shifting to how each country’s NDCs can be turned into clear investment pipelines. The Climate Finance Accelerator is an excellent example of this process beginning.

This process should create substantial markets for low carbon technologies and generate huge opportunities for businesses in the region.  McKinsey Global Institute estimates that by 2030, more than 550 million people will move to cities in Asia, where they will generate more than 85% of GDP.  Opportunities for urban housing, infrastructure and mobility systems could reach US$1.5 trillion, with investment in affordable housing alone reaching US$505 billion.  Electric vehicles are projected to reach 35% of overall car sales in Asia by 2040.

Also by 2030, transitioning to sustainable energy and materials systems could generate new business worth US$1.9 trillion in the region, according to the Business and Sustainable Development Commission.  At the same time, adoption of sustainable business models in agriculture and food production, distribution and retailing could produce opportunities worth US$1 trillion.

Mobilising the Private Sector

Government reserves are far outweighed by private funds, much of which are managed in the global capital markets.  But very little of this private capital is currently allocated to low carbon sectors in emerging markets.  Achieving NDCs across Asia – many of which are conditional on supply of international financing – and unleashing their enormous potential for clean growth, will require that ambitious new solutions are implemented to motivate private sector actors.

The People’s Bank of China, for example, forecasts that China needs to spend over US$1 trillion annually for the next five years to meet its environmental targets – but the government has the capacity to finance only 15%, while the rest must be met by private sources.

Much of the funding for NDCs will likely come from the traditional development banks, many of which committed to scale up climate finance at the time of the Paris Agreement.  For South East Asia, for example, the Asian Development Bank has committed to double its contribution to US$6 billion by 2020.

But capital needs of such magnitude call for larger scale solutions that will encompass bold intervention to establish targeted public and private cooperation and channel global investment flows to projects of all sizes that meet local needs.

Carbon Markets to Provide Policy Direction

Experimentation with carbon trading has been gathering momentum in Asia, as governments seek to implement market-based policy instruments that provide emitters with market incentives to reduce emissions at the same time as providing a signalling device to guide decision making on future consumption.

A lot of attention is currently focused on China’s efforts to move beyond its pilot markets and go national

Of the eighteen emissions trading systems in force globally, twelve are operating in Asia.  Moreover, 26 countries across the region have expressed their interest in their NDCs to engage in the use of market-based approaches to enhance the cost-effectiveness of their mitigation efforts.  Many are also exploring the possibility of enhancing regional or bilateral cooperation to link emissions trading systems, increase prices or improve measurement, reporting and verification systems.

Already, a Japan-led cooperative approach is in place which is intended to facilitate subsidised implementation of low carbon technologies into host countries to generate credits that contribute to achieving Japan’s emissions reduction target.  Eleven countries in Asia are participating in this Joint Crediting Mechanism together with the Japanese government.

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At a national level, a great deal of attention is currently focused on China’s efforts to move beyond its pilot markets and launch a nationwide emissions trading scheme by the end of this year.  Building on lessons learned through the eight regional markets, the national scheme will cover 40-50% of its total greenhouse gas emissions and more than 8,000 companies.  If successfully implemented, this will create the world’s largest carbon market.

And earlier this year, the Singapore government announced the introduction in 2019 of the first national carbon pricing scheme in South East Asia, calling it “the most economically efficient and fair way” to reduce greenhouse gas emissions.  The country, which is the world’s 26th largest carbon emitter per capita despite its small land area, aims to cut emissions intensity by 36% below 2005 levels by 2030.  It has also pledged to stabilise peak emissions by 2030.

Green Investment Bank to Catalyse Investment on the Ground

Regulations, especially those which are properly market-based, will play an important role in influencing corporate behaviour in Asian countries.  But to achieve real “transformational” change in society, regulation needs to be accompanied by reasonable incentives for industry and by creative mechanisms that will increase funding flows into clean infrastructure and new business models.

One such financing mechanism would be a Green Investment Bank focused on Asian emerging markets, which could play an essential catalytic role in attracting private capital to the region.

A Green Investment Bank is a new kind of government financial institution set up specifically to channel private finance into low carbon infrastructure and climate-friendly construction.

It uses public funding to provide financing tools and market support that enable private sector financing for green projects on acceptable terms.  Rather than subsidising green infrastructure, Green Investment Banks structure projects on a commercial basis and seek to create liquid markets that can stand on their own.

Development banks do already provide technical assistance and blended finance tools in emerging markets, but their mandate is far broader and they do not place so much emphasis on private sector involvement.  While some of them are becoming increasingly active in climate finance, a Green Investment Bank with a single mission of crowding in private investment for clean infrastructure is able to build specialised expertise and rapidly establish commercial pipelines in its target markets.

Green Investment Banks may directly finance low carbon projects, or provide capital to other financial entities which then deploy it in projects.  They offer a range of financial mechanisms to reduce the risk of green investments for private investors, such as co-investing, insurance, loan loss guarantees and provision of subordinated debt or equity funding.

Whatever the mechanism employed, the most important outcome is that the existing Green Investment Banks (there are thirteen operating around the world) have demonstrated the capacity to encourage private investment – and thereby, low carbon development – that would not have occurred without their involvement.

For example, the United Kingdom Green Investment Bank created the world’s first offshore wind fund to catalyse investment in what was at the time an underfunded technology.  That fund is now Europe’s largest dedicated renewable energy fund with over £1 billion under management and investors including sovereign wealth, insurance and pension funds.  Many of those institutions had never previously invested in wind power.

Green Investment Banks can also help to fund smaller clean energy initiatives at a local level.  Australia’s Clean Energy Finance Corporation (CEFC), for instance, is providing finance to help the city of Melbourne undertake an AUS$30 million programme of clean energy initiatives to help it reduce its energy use and reach a goal of zero net emissions by 2020.  CEFC’s involvement is enabling multiple city councils in Australia to develop similar programmes using renewable energy, energy efficiency and low emissions technology, with support from private investors.

In addition to providing capital and risk mitigation tools which directly attract private investors into the transactions it sponsors, a Green Investment Bank is intended to serve as a centre of expertise that helps to educate local banks and investors about the opportunities in low carbon sectors.  An important part of its mission is to enable companies and financial institutions to increase their competencies and develop low carbon business pipelines that are commercially sustainable – so that over time government involvement can be reduced.

The expansion of the corporate green bond market may have been a valuable signalling mechanism, but many parts of Asia need more customised financial tools that directly address their particular funding barriers.

Clear Focus on Asian Emerging Markets

Drawing on the successful interventions in these other markets, there is enormous potential for an Asia based Green Investment Bank.  Scaling up investment in these markets requires tailored risk mitigation, project pipeline development and focused technical assistance.  The Green Investment Bank would aim to fill the specific gaps along the project origination, execution and finance spectrum which particularly impede investment in Asian emerging markets.  It would play a critical role in making the local financial sector comfortable with green investments, as well as in linking local markets with international capital providers looking to make such investments.

And a Green Investment Bank can use its credit enhancement capabilities to offer innovative financing structures that go beyond the solutions being offered by most commercial and development financial institutions today.  The expansion of the corporate green bond market may have been a valuable signalling mechanism, but many parts of Asia need more customised financial tools that directly address their particular funding barriers.

Many countries are looking to implement small and geographically dispersed projects, such as off-grid power or residential energy efficiency programmes.  These kinds of investments typically struggle to raise financing because, by their nature, the projects are relatively low cost and may differ in terms of credit, technology and location.  The high transaction costs and time required to analyse the projects often deters investors and lenders.

A Green Investment Bank in Asia could play a role in aggregating these smaller projects into a single entity.  By vetting the projects to diversify risk and achieve scale, it would create a vehicle that is more likely to be attractive to private funders.  The bundled assets can then be refinanced by sale to commercial banks or investors or through securitisation in the capital markets.  By increasing the ability of these projects to access finance, the Green Investment Bank would not only lower their cost of capital, but also increase the liquidity of project developers, allowing them to put capital back into building new projects.

Leveraging the Strengths of Asia’s Infrastructure Capital

The logical home of Asia’s Green Investment Bank would be Hong Kong, which has for many years been the regional leader in structuring private capital flows into Asian infrastructure.  Home to Asia’s most sophisticated capital markets, Hong Kong has both the skills and the financial resources required to create a robust financial institution which can execute on a clear mandate to maximise private investment in low carbon development in the region.

The logical home of Asia’s Green Investment Bank would be Hong Kong

Crucially, it is Hong Kong’s capacity to deploy public funding to catalyse private investment that would transform its Green Investment Bank from another “talking shop” into a powerful economic tool.  The government’s substantial financial resources, as well as its favourable credit rating, would underpin the bank’s viability and its capacity to provide comfort to investors on the transactions it will undertake.

Moreover, Hong Kong’s longstanding reputation as a well-governed financial centre, strengthened by confidence in its transparency, compliance and the rule of law, puts it well ahead of other markets which might seek to host a similar institution.  It is essential that the Green Investment Bank demonstrates operational independence and it must be clear to the markets that there would be no government interference in its investment decision-making.  (Any perception that a Green Investment Bank is supporting pet projects, rather than focusing on market needs, would make it impossible to attract long-term private capital).

Establishment of a Green Investment Bank in the city would demonstrate that Hong Kong intends to take the lead on rolling out green finance in the region and that it is ready to use its capacity to attract international capital at scale in order to fund low carbon growth.

A comprehensive policy move of this nature is absolutely necessary to achieving financing for the Asia’s NDCs and accelerating progress towards a greener growth trajectory for the region.

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