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
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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
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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
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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
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Financial de-risking instruments
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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
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Integration with policy
Additionality
Effective Stakeholders Engagement
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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
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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
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• 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
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• Can leverage significant investment.
• Uses local expertise and allows capacity building.
• Can be integrated with other development focused investments. C
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• 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
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Ad
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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.
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• 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
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• 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.
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• 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
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• 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
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• 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
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Ad
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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
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• 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
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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?
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Concluding remarks
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• 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.
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Detailed materials of E3G finance work can be found at www.e3g.org
I can be contacted at [email protected]
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