How to design smart green incentive schemes

The role of smart incentive schemes in “greening” the financial

sector and the role of the public sector and development Banks.

KfW Financial Sector Development Symposium: Greening the Financial Sector From Demonstration to Scale in Green Finance

30th and 31st January, 2014

Berlin, Germany

Amal-Lee Amin

E3G – Third Generation Environmentalism

Focus of this session

• Public sector role in providing green financial incentives

• Role of DFIs in providing green finance support through various instruments and assistance: technical assistance, guarantees, longer tenors or subsidized interest rates

• Consider how these instruments are being deployed to overcome barriers and risks to green investments and draw on case examples to identify what makes these smart?

• Unique role of DFIs in design of smart green incentives – consider need for stepping up engagement for green transformation

2

These barriers and risks create a considerable challenge for governments that are pursuing green growth-related objectives. Public interventions can help to encourage green investments, usually by:

These risks are exacerbated for green technologies.

Challenges for Green Finance

E3G 3

R

I

S

K

R

E

T

U

R

N

GAP

Technology risks

Policy and regulatory risks

Market risks Capacity constraints

Scale of Investment Barrier

Reducing level of risk

Increasing return on

investment

Public sector de-risking instruments

E3G 4

Many public sector instruments are available - appropriate instrument will depend on the type of risk preventing private sector investment

Intrinsic relationship between successful use of financial de-risking instruments with the broader policy and regulatory framework

Policy de-risking instruments

1

Financial de-risking instruments

2

E3G 5

National governments have active programmes of public climate finance to support, underpin and develop

investment grade projects that mobilise private capital

Early and on-going managed dialogue with institutional investors and local and

international private sector

Clear, long term and coherent policy and regulatory framework

Price signals in the market including subsidies and carbon

price supporting the deployment of low carbon alternatives

Underpinning economic drivers realigned to support sustainable growth

Invested grade policy: The utopia

Targeted concessionality

Transparency and

predictability

Defining smart green finance incentive schemes

E3G 6

Integration with policy

Additionality

Effective Stakeholders Engagement

E3G 7

Conceptualising Transformational Change

•Leverage •Market Creation

•Synergies •Polices & Institutions

•Risk Sharing •Public Private Partnerships

Investment and Projects

Ambition/ Scale

Scope

Learning & Replication

Transformation

Transformation has multiple levels, reflecting the complexity of driving

towards a low carbon, climate resilient development pathway.

At the top level, transformation requires:

• Having sufficient ambition/scale to avoid lock-in; •Scope to drive sectoral change rather than bolting on ‘climate proofing’ to existing development models; and •Learning and replication to avoid reinventing the wheel.

Targeted concessionality

Transparency and

predictability

Defining smart green finance incentive schemes for transformational change

E3G 8

Integration with policy

Additionality

Effective Stakeholders Engagement

Prototyping innovative public-private risk-sharing instruments across a range of country, sector and technology contexts

Accelerating learning and capturing lessons

Ensuring limited expertise and

financial resources are

pooled to maximise synergies

The role of the development finance institutions

E3G 9

• Promoting market development and provide a bridge between policy and finance.

• Understanding unique risks and barriers faced in the local environment

• Ability to aggregate large number of small-scale transactions

National development banks

• Influencing support for established technologies and strong regulatory frameworks.

• Role of honest broker in dialogue between governments and private sector investors.

• Leverage effect.

• Ability to access and channel international concessional green finance

• Conferring preferential access to foreign exchange.

• Providing TA or other capacity building.

Bilateral and Multilateral development banks

Green financial instruments

Concessional Loans

10

E3G

Ad

va

nta

ge

s

• Can leverage significant investment.

• Uses local expertise and allows capacity building.

• Can be integrated with other development focused investments. C

ha

lle

ng

es

• Requires a long-term coherent policy and regulatory framework underpinned by legislation.

• Determining the right level of concessionality to avoid undesired market distortions and maximize leverage could be complex .

• M&E challenges to improved transparency and execution of programs to evidence that concessional finance is crowding in new players.

Direct use of concessional loan to mobilize private sector: IDB provided a concessional loan for the project developers of Eurus, a 250 MW wind farm in Oaxaca, Mexico.

Estimated IDB Co-financing: US$50 million Total Cost of Eurus - Historic : US$525 million

Case Example : The CTF Investment Programme for RE in Mexico

Green financial instruments

Green lines of credit to commercial banks

E3G 11

Ad

va

nta

ge

s • Builds local capacity and mobilizes local capital

into new markets.

• Draws in local expertise for development of a robust pipeline of projects.

• Can allow blending with other (more expensive) funds to provide well-structured, reasonably-priced loans.

• Marketing efforts of involved commercial banks can help to increase awareness and reach a larger number of customers.

Ch

all

en

ge

s

• Lack of transparency: M&E challenges to provide evidence that concessional finance is crowding in new players.

• Leverage potential is relatively low.

• Usually requires technical assistance

• Concerns over market distortion effects if used in well functioning commercial financial sectors.

Case Example : Turkey Private Sector Renewable Energy and Energy Efficiency Project.

This programme provides promotional loans to the housing and the SME Sector distributed to intermediary investing banks via a branch network of German commercial banks. To ensure that the commercial bank passes on the low interest rate to the investor, the KfW establish and publish a maximum interest rate, including the commercial bank’s margin that can be applied. As of August 2012 the project financed 969 megawatts (MW) of RE and EE investments.

Tackling the transparence challenge: KfW financial incentives for household EE in Germany

Green financial instruments

Grants for technical assistance

E3G 12

Ad

va

nta

ge

s

• Supports institutional strengthening.

• Local capacity building and increase of awareness.

• Allows the combination of local knowledge and international expertise.

• Can help to establish an enabling environment to attract private sector investment.

Ch

all

en

ge

s

• Government leadership and extensive inter-agency collaboration within the government is critical for the success of this type of initiative.

• High transaction costs can reduce use of this instrument (time/ resource intensive).

• Risk of lack of customized approach and flexibility to country specific characteristics/needs.

• Risk of lack of continuity.

Case Example : China’s Green Credit Policy

Lead by the Ministry of Environmental Protection with technical support from the IFC on: policy advice,

capacity building, and development of technical resources and tool for financial institutions.

Extensive inter-agency collaboration Provides strong regulatory signal to the market Driving financial sector investments switch and increase of awareness.

Between 2008-2009 Green Credit loans represented a 9% of the total bank lending in China.

Green financial instruments

Grants for investment

E3G 13

Ad

va

nta

ge

s

• Flexible and relatively simple to use.

• Useful in countries such as LDCs where financial markets are often underdeveloped.

• High level of transparency.

• Builds local capacity.

• Increases awareness. Ch

all

en

ge

s

• Low leverage effect.

• Can have a distortionary impact if not designed carefully, particularly in well-developed financial markets.

• Risk of lack of continuity.

• Might need to be coupled with technical assistance.

Case Example : IDCOL for micro-finance institutions

In 2002, the Government of Bangladesh launched a market-based off-grid electrification programme and with Infrastructure Development Company Limited (IDCOL) as the implementing agency with a wide network of the participating organizations which covers the entire country. By December 2011, 1.25 million SHS have been installed (65 MW) and SHS costs in Bangladesh are now among the lowest in the world (US$8–9/Wp); In addition, 70,000 new job are associated to the project and local supply chain/technical skills have been development.

Green financial instruments

Guarantees

E3G 14

Ad

va

nta

ge

s • Potentially high leverage effect.

• Can help to build diversified and risk-mitigated portfolios of loans by financial intermediaries.

• Allow for easier access to private sources of finance by loans tailored to specific market needs. C

ha

lle

ng

es

• M&R procedures can be onerous and insurance products can have restrictive legal clauses.

• Overreliance on this type of subsidy could undermine the sustainability of the investments after the completion of the program making an exit plan critical.

• May be challenging to structure in the absence of extensive data on market conditions and credit profiles.

Case Example : The Utility-based Energy Efficiency Finance (CHUEE) Program in China

In CHUEE a loan loss reserve fund (LLRF) set up by IFC and GEF is used to share the financial risks Chinese commercial banks face by guaranteeing loans they make to energy management companies who finance upgrades for their customers. Leverage effect: estimated leverage of US$1.18 billion, with emission savings of 2.3mtCO2/year

Government policies and market opportunities were identified as top two drivers for banks to engage in energy efficiency lending

Targeted concessionality

Transparency and

predictability

Lessons for design of smart incentives to share risks between public and private sectors

E3G 15

Integration with policy

Additionality

Effective Stakeholders Engagement

Prototyping innovative public-private risk-sharing instruments

Accelerate learning and capturing lesson

Maximise synergies

Early and extensive

Appropriate mix of policy, regulatory and financing incentives

Carefully tailored and with a programmatic approach

With a clear exit strategy and M&E

processes

Appropriated identification of market

gaps and mix of instruments

Development finance institutions as key partners on green finance

Critical friend

Serving wider societal needs

Confidence building

• Governments need help with policy and regulatory design

• Strengthened institutional arrangements fit for purpose

• DFIs role in risk-sharing to develop green markets faster: Addressing technology risk Addressing policy risk Addressing strategic risk Market enabling activities

• Build on co-investment role and innovate with new products such as green equity co-investment and policy risk insurance

• Riskier and often smaller projects – EE and RE can provide higher value investments

Expanding global green finance markets

• Collaborate to create agreed criteria for best practice and a coherent monitoring and evaluation framework

• Honest broker role in securitisation to foster a liquid market for green assets?

• Direct co-investment with institutional investors?

E3G 16

Concluding remarks

17

• Evidence of progress by DFIs in catalyzing green finance and markets.

• BUT differing approaches in design and evaluation of green finance schemes – means fragmentation of international support to developing countries.

Increases burdens on limited developing country institutional capacity. Inefficient use of public resources. Reduces transparency and predictability for investors.

• Undermines potential for strong national and global green investment frameworks and

markets. • Potential for convergence towards an International Green Finance Protocol?

Criteria and norms on design of smart green finance schemes. Incentivising green financial innovation – allocate small proportion of portfolio for high risk investments with high transformative potential. Coherent monitoring and evaluation framework.

E3G

Detailed materials of E3G finance work can be found at www.e3g.org

I can be contacted at Amal-Lee.Amin@e3g.org

18 E3G