The largest Green Climate Fund-backed facility to be operated by a purely private sector player was announced just before the Marrakech COP. The Universal Green Energy Access Program (UGEAP) led by Deutsche Asset Management (Deutsche AM) may not enjoy the snappiest of acronyms, but it does signal an important development in the way forward for partnerships between the private sector and the kind of public finance represented by the GCF.
We wanted to ask the UGEAP’s lead originator, Andrew Pidden, London-based Head of Sustainable Investments at Deutsche AM, not just about the programme but about some of the lessons for others seeking to put together these public / private innovations.
“Paris coming into force so quickly has also really been a signal to the mainstream markets that we have crossed some kind of line”
Deutsche Bank was the first – and is still one of only four – purely commercial banks to become Accredited Entities* of the GCF (the others are Credit Agricole, HSBC and Xac Bank in Mongolia). And the 30-strong team Andrew Pidden leads, spread across Frankfurt, London, New York, Luxembourg and Hong Kong, is itself an interesting bellwether for the times. It has been pulled together over a three-year period, and consolidates a number of prior teams and initiatives which had been sponsored across the Bank.
Pidden says that, as a single portal now within the Bank for sustainability-based products, the team has the full backing of senior management, and that investors are keen to see green and climate-related products emerge. He believes that teams like his are using core skills to move investment goals on from purely ESG* standards. “While ESG screening will hopefully ensure you aren’t doing any harm, we believe that investors now want to go beyond this, so all our investment products are based around outcomes, with positive and identifiable social or environmental effects.
“I think,” he says, “that Paris coming into force so quickly has also really been a signal to the mainstream markets that we have crossed some kind of line. So our major investment clients realise that this is now a vital element of portfolios for the future.” But that said, he also points out that a great deal of education will still need to be done to get people comfortable with the markets for these investments.
“That’s why the structure of the facility is important, because it gives people access to an investment which carries a yield – presently hard to come by – but at the same time by having a junior layer* underneath the senior layer where mainstream investors will be coming in, we have taken out a good piece of the risk. That will allow investors to see how these markets and investees work, and in time give them confidence to take more risk themselves.”
Leverage and Reinvestment the Key
Pidden also notes that the benefits of the UGEAP structure was also “something of a revelation” for the GCF, whose Board is mainly comprised of non-financial experts, though it does have private sector advisers and a private sector secretariat. The revelation here was the extent to which leverage* can be created by public finance seeding or underwriting private finance. Pidden notes that while the ‘raw’ leverage in the fund is some 3x (approximately $80 million with a possible increase to $120 million of a $500 million fund), the fact that funds will be reinvested several times over during the 15-year life of the programme means that “in the end, something like $3 billion will have been channelled through it, creating massively more leverage than the base figure”.
Giving more detail on the structure of the fund, Pidden said that the GCF would be providing the bulk of the junior layer (some 80%), with the balance mainly coming from a foundation, whose investment would be partially guaranteed by a developed nation aid agency. Deutsche itself would be investing in both the junior and senior layer, to the regulated maximum of a 3% stake. Neither the GCF nor the Deutsche participations would be covered by the guarantee.
The UGEAP programme will lend money in two main ways. Firstly, to local banks for on-lending to companies involved in off-grid and mini-grid energy generation and distribution, and second by participating in syndicated loans directly to borrowers. The latter is likely to be the route through which the fund mainly targets getting industry to switch out of carbon-intensive processes and generation. Loan sizes to intermediaries are likely to average around $25 million, and to direct corporate borrowers $2-15 million. UGEAP will not invest in other funds.
Pidden says that Deutsche’s long experience with running previous funds for or with development finance institutions provides it with confidence in dealing with both kinds of lending. Due diligence* on the final borrowers will, he says, obviously be more intense for direct deals, but the team will perform appropriate due diligence on the intended end users of loans to banks. He says that he is also confident that the absorptive capacity is there to take the levels of investment the fund will offer, but does note that there are issues with the present size of many companies in the space and that consolidation will undoubtedly occur.
We asked about the foreign exchange aspect of the loans, which will be made and repayable in US dollars. Pidden noted that he didn’t see this as an issue for banks, given that they tend to have two-way trading flows which enable them to effectively self hedge.
Three Investment Targets
The three categories of final investment the fund will target are: off-grid energy generation and use (for example domestic solar), mini-grid generation and distribution (for example village level schemes) and industrial and household electricity use, where the focus will be on replacing high-carbon processes and supply sources such as diesel generators with low-carbon alternatives. Pidden notes that the technology risks associated with these investments are being rapidly reduced. “Costs of systems are falling constantly while expertise in ‘build operate transfer’ turnkey project management or energy supply/service company (ESCO) models are well advanced in the developed world and ready to be rolled out into markets like sub-Saharan Africa.
The initial target countries for the programme are Benin and Nigeria in West Africa and Kenya, Rwanda, Tanzania, Uganda, Zambia and Namibia in Eastern and Southern Africa.
The approval of its anchor investment by the GCF is just the starting point for the final development phase of the fund, which, as a regulated entity in Luxembourg, will need to go through the approval process there. The Deutsche team is looking to Q3 2017 to start formal marketing, though there will have been a good deal of pre-marketing ahead of the final prospectus being issued. A first close at around $100 million is expected by the end of 2017, with a further two closes over the succeeding two years leading to a final fund size of around $500 million. Pidden is still debating whether to get the fund rated*. This would increase the number of institutional investors that could take up the opportunity (with many being limited to rated/investment grade issuance).
“There is real goodwill at the GCF to get things done”
Turning to lessons he and his team have learned during the process of structuring the fund with the GCF, Pidden says that there were many of the to-be-expected initial frustrations of two rather different worlds coming together. The mainly government-oriented Board of the GCF was, for example, unfamiliar with the language and constraints of a private sector financial institution, and vice versa for the Bank team in terms of political pressures. Though the GCF is, Pidden says, “clearly balancing a lot of different needs and demands, nevertheless there is real goodwill there to get things done. The Private Sector Secretariat and Advisers to the Board really went out of their way to push things through.” The main stumbling blocks, he says, arose from “lack of awareness of the disciplines we work with as a commercial bank. For example, if a proposal gets delayed, there is a significant cost for an asset manager, both in terms of team time and the opportunity cost of not being able to work on other things.”
To spread learning from the process and about the way the private sector works, Pidden is hoping to run workshops for GCF staff on the needs of the private sector for successful funding approvals, and for the private finance sector on how to interact with the GCF to promote growth for both sides. That will be an awareness-raising effort only matched by the patient investor education effort he and his team will need to put in during the coming year before the first close of his pioneering fund.