Breaking Barriers: Financing the Low-Carbon Transition

Tackling climate change and building a global green economy is the opportunity of our time. The economic case for climate action is strong— investments in clean, resilient infrastructure contribute to the development priorities needed to achieve the United Nations Sustainable Development Goals (SDGs) by 2030 and the 2015 Paris Agreement. Finance flows for such projects should therefore be massive, but this is not yet the case. While project bankability and access to finance are major barriers to scaling-up project implementation, one question remains: What can be done to break these barriers?

Sustainable infrastructure investment: A cornerstone for the SDGs

Keeping pace with population growth, migration and urbanization trends demands an increase in infrastructure development especially in emerging economies and developing countries. Energy, water supply, sanitation and waste management, mobility services and communications systems are critical to ensuring effective economic and social development. According to the OECD, more than 80% of the SDGs rely on infrastructure development. Successfully reaching the SDGs will require unprecedented investment across multiple sectors and given the long-term nature of infrastructure, the type we implement today will lock-in economic and climate benefits – or costs – for the decades to come. If we are to mitigate climate risks, improve living standards and deliver long-term sustainable growth, infrastructure projects need to be low-emission, energy-efficient and climate-resilient.

In the face of rapid urban expansion, the demand for such sustainable infrastructure projects is particularly high at the city, state and regional levels. Projects designed and implemented to serve the needs of these expanding populations, typically of mid-size or between $5-50 million in construction costs, offer the greatest potential. When appropriately prepared, projects that deliver both energy and public services can have significant impacts on local populations by reducing greenhouse gas emissions and air pollution, creating employment opportunities and improving overall health.

For John Tidmarsh, Chief Investment Officer at R20 Regions of Climate Action, a non-profit environmental organization, mid-size projects offer an unprecedented opportunity to maximize development impact while meeting the financial objectives of investors. “Mid-size, subnational and sustainable infrastructure can make a highly attractive investment proposition. They represent a potentially huge investment market in terms of number and of aggregate capital required for implementation. If such projects are designed to integrate the needs of a broad range of stakeholders, not only will social, economic and environmental impacts be achieved and scaled-up, but consequently, investment risks can be significantly reduced.”

Why investor interest isn’t enough

There is growing interest amongst investors in what is a potentially huge investment market. Recent estimates suggest that between $90-100 trillion worth of investments are needed over the next 15 years to fully implement the SDGs. Of the investment needed, 60-70% will be required by emerging countries with the lion’s share required for transport (43%) and energy (34%).

Given the need, market size, and growing appetite amongst private investors, why are not more projects taking off? Some lay the blame at the door of policy-makers, others at that of investors and the private sector. However, the truth lies somewhere in-between. For R20, the problem of project bankability and access to appropriate finance are amongst the major barriers to scaling-up project implementation.

While project bankability can mean different things to people, it most often refers to the financial returns, factors of design, equipment used, availability of contracts and local capacities. However, the wider aspects of bankability that are associated with the social and environmental impacts of a project—the context in which it is developed, its compatibility with plans and policies and the vested interests of key stakeholders— is less often considered. To address these issues of “bankability” projects need to be designed and developed taking these factors into account, and all stakeholders must be coordinated to represent the community, public and private sectors, as well as investor interests.

For R20, the problem of project bankability and access to appropriate finance are amongst the major barriers to scaling-up project implementation.

As R20’s Executive Director, Dr. Christophe Nuttall, explains, “One of the major bankability issues today comes from the limited degree of collaboration, understanding and interconnection between policy-makers, clean technology providers and public-private investors. These key stakeholders tend to work in silos and, almost invariably, do not understand each other’s interests nor how their decisions can negatively impact each other and thus the bankability of projects.” Addressing this requires mobilization of and better collaboration between a broad range of stakeholders that are involved the length of the project development and financing value-chain. Bringing together expertise, resources and knowledge, coordinating efforts of the most important stakeholders, and building the capacity, understanding and trust that is necessary to deliver and replicate shared objectives is key to fostering project implementation.

This problem of bankability is also at the root of the second problem facing the scaling implementation of projects: access to finance. Because the project development value chain is not widely understood by those influencing project identification and development, projects do not meet the needs of investors. The earlier stage a project is at, the harder its “access to finance”.

Access to finance is often understood as a question of matching demand with supply, or projects with investors. The reality is far more complex. Generally, it is assumed that matching projects with investors regardless of the stage of maturity is sufficient to result in implementation. What is too often ignored is that projects have financing needs that are different depending on the stage of their development and that each stage has associated with it a different level of risk—or in the view of the investor—expected financial returns. For a project to have a chance at accessing finance, it must meet an investor interested in taking on the “risk-return” profile that is specific to the project’s maturity and provide the investor with the information necessary to assess this profile.

But the challenge of accessing finance goes beyond matching the right opportunity with the capital that has an appetite for it. This matching must be available to finance each stage of project development and implementation, and must be coordinated to assure that projects successfully reach maturity in a timely manner, each successive financing stage following on from the other. This coordination is key to scaling-up the ready supply of projects that meet the needs of different sorts of capital, and thus to the scaling in deployment of the capital necessary to reach the SDGs and climate objectives.

So how do we go about this coordination? Both the challenge and the solution lie in creating innovative approaches and financing tools that allow different types of donors and investors to work together in a coordinated manner that industrializes and scales-up the matching process. In this way, the unique characteristics of each capital type can be leveraged towards the shared objective of scaling-up private investment to meet the SDG targets and climate action impacts. This coordinated approach is increasingly referred to as “blended finance.”

The World Bank, World Economic Forum, UN and many philanthropic foundations and private sector companies all agree that “blended finance”, such as the use of development capital from public or philanthropic sources to spur private sector investment, that could be the game-changer in delivering on the SDGs. By de-risking infrastructure investments and allowing the private sector to participate, blended finance can help capture over $1 trillion in additional annual investment potential. Blended finance can play a major role in addressing the “access to finance” barrier, especially when it is deployed by funding vehicles that finance project identification, development and implementation and meet the expectations of public and private investors.

Climate funds for sub-nationals: Enormous potential to deliver on the SDGs.

A number of factors are required to deliver bankable projects to investors to accelerate the clean and climate-resilient infrastructure needed for achieving the SDGs: (1) involve sub-national governance from the start, as well as other local stakeholders, in full alignment with national plans and policies; (2) fast-track the development of projects the length of the project development and financing value-chain; and (3) “blend” donor, public and private capital.

If we are to mitigate climate risks, improve living standards and deliver long-term sustainable growth, infrastructure projects need to be low-emission, energy-efficient and climate-resilient.

R20 is applying these principles to set-up an integrated value chain approach. The “value chain” helps connect the dots between multiple stakeholders in policy, technology and finance sectors, providing a workable framework to identify, support development and secure the financing of high-impact, low-carbon and climate-resilient infrastructure. Among the key elements, the value chain deploys thematic, donor-funded, Pre-Investment Facilities and dedicated Sub-national Climate Funds (SnCFs).

Created in partnership with leading engineering firms, Pre-Investment Facilities finance and provide the expertise for the technical, legal and economic feasibility studies, as well as the social and environmental impact assessments required by investors. In so doing, they provide the necessary technical assistance to convert potential projects into bankable investment opportunities. Sub-national Climate Funds are created in partnership with leading impact fund managers to finance the selected projects coming from the value chain. The first of such funds is the Sub-national Climate Fund for Africa (SnCF-Africa).

SnCF-Africa is a fund structured to invest in a portfolio of projects that will provide clean energy, waste valorization and energy efficient municipal lighting services to cities and regions in 15 African countries. It “blends finance” from philanthropists, foundations, governments, development finance institutions and private investors and targets projects conceived and developed at the sub-national level, of between $5-50 million in capital expenditures. Considered too small for institutional investors or too large for sub-nationals and NGOs to finance, projects of this size are currently least-served by existing funding and investment-for-development vehicles.

The fund expects to invest in 30 projects and mobilize additional climate finance in the form of co-investment in projects. In so doing, the fund should significantly contribute to the SDGs by reducing 2 million tons of CO2 per year (SDG13), creating up to 28,000 temporary and induced jobs (SDG8), and bringing better services (SDG7 & 11) to more than 17 million people. To back-up the environmental, social and economic claims for each project, R20 is working to make SnCF Africa the first fund to be fully certified by Gold Standard for the Global Goals, a next generation standard designed to accelerate progress toward the Paris Climate Agreement and the SDGs.