Dis­rupt­ing mul­ti­lat­eral cli­mate fi­nance


Are­cent re­port by the United Na­tions In­ter­gov­ern­men­tal Panel on Cli­mate Change warns that to avoid the direst con­se­quences of global warm­ing, so­ci­eties must make so­cial and eco­nomic changes on a scale with “no doc­u­mented his­toric prece­dent.”

As we have noted pre­vi­ously, only in­sti­tu­tional in­vestors – like pen­sion funds, sov­er­eign wealth funds and in­sur­ance com­pa­nies – hold enough fi­nan­cial fire­power to ad­dress cli­mate change.

How­ever, to min­i­mize risk, in­sti­tu­tional in­vestors gen­er­ally pre­fer to al­lo­cate their cap­i­tal to op­er­a­tional in­fra­struc­ture that is al­ready gen­er­at­ing stable rev­enue, rather than to new projects. For the same rea­son, their in­vest­ments are fo­cused in ad­vanced economies, which in re­cent decades have re­ceived more than 70 per­cent of pri­vate­sec­tor in­vest­ment in in­fra­struc­ture.

Cli­mate change re­quires in­sti­tu­tional in­vestors to move be­yond these bound­aries. But they need help to mit­i­gate the as­so­ci­ated risks, which is why we be­lieve the world needs a new global cli­mate fi­nance fa­cil­ity, ex­clu­sively tar­geted at mo­bi­liz­ing in­sti­tu­tional in­vestor cap­i­tal, and de­signed to ad­dress the short­com­ings of cur­rent mul­ti­lat­eral ini­tia­tives.

Aside from sev­eral promis­ing en­ter­prises, gov­ern­ments and mul­ti­lat­eral fi­nance in­sti­tu­tions are strug­gling to mo­bi­lize pri­vate cap­i­tal at a scale rel­e­vant to cli­mate change.

Cru­cially, in­sti­tu­tional in­vestors have been largely ab­sent from such ini­tia­tives, for sev­eral rea­sons.

First, MFIs and in­sti­tu­tional in­vestors have dif­fer­ent pri­or­i­ties. The ac­tiv­i­ties of MFIs are based on mem­ber coun­tries’ pol­icy goals and client coun­tries’ needs, and do not al­ways re­flect in­vestor de­mand.

By con­trast, in­sti­tu­tional in­vestors, as com­mer­cial ac­tors be­holden to pen­sion­ers and other stake­hold­ers, will not in­vest in projects deemed too risky or un­likely to yield ad­e­quate fi­nan­cial re­turns.

To at­tract their in­ter­est, MFIs’ terms must be com­pet­i­tive with those of­fered by the pri­vate as­set-man­age­ment com­pa­nies used by in­sti­tu­tional in­vestors. More­over, many in­sti­tu­tional in­vestors are un­fa­mil­iar with in­fra­struc­ture in­vest­ment in gen­eral, let alone in emerg­ing mar­kets. Con­se­quently, MFIs must also build ca­pac­ity to ad­dress these in­vestors’ con­cerns about en­gag­ing in un­fa­mil­iar sec­tors and re­gions.

Sec­ond, there is a dis­con­nect be­tween pro­mot­ing pri­vate in­vest­ment in low­in­come and frag­ile coun­tries, and mo­bi­liz­ing pri­vate cap­i­tal for cli­mate ac­tion in mid­dle-in­come coun­tries, where car­bon emis­sions are far higher. Whereas green in­vest­ments in the first group of coun­tries may ap­peal mainly to a small set of spe­cial­ized pri­vate in­vestors and “im­pact in­vestors,” larger sums of pri­vate cap­i­tal, in­clud­ing from in­sti­tu­tional in­vestors, could be mo­bi­lized in the sec­ond group.

At the mo­ment, how­ever, MFIs’ poli­cies do not dis­tin­guish suf­fi­ciently be­tween these two con­texts, which re­quire en­tirely dif­fer­ent strate­gies, re­sources, and in­sti­tu­tional struc­tures.

Third, MFIs need to raise their pres­ence on in­sti­tu­tional in­vestors’ col­lab­o­ra­tive plat­forms, take on more risk, strengthen part­ner­ships with lo­cal strate­gic in­vest­ment funds, and ad­just their gover­nance struc­tures to con­form with the cor­po­rate gover­nance prin­ci­ples to which pri­vate in­vestors are ac­cus­tomed. Ac­cord­ing to a re­cent G-20 re­port, MFIs should also strengthen their ca­pac­ity to mo­bi­lize eq­uity in­vest­ment.

Fi­nally, with few ex­cep­tions, ex­ist­ing mul­ti­lat­eral ini­tia­tives – such as the Green Cli­mate Fund and the Clean Tech­nol­ogy Fund – mo­bi­lize pri­vate cap­i­tal at the project level, rather than at the port­fo­lio level.

But, be­cause most in­sti­tu­tional in­vestors man­age large amounts of cap­i­tal with small in­vest­ment teams, they typ­i­cally do not have the ca­pac­ity to in­vest di­rectly in in­di­vid­ual projects; they need a ve­hi­cle or fund to chan­nel their in­vest­ments.

In light of these chal­lenges, in­vestor con­trol is the key to mo­bi­liz­ing pri­vate cap­i­tal for green in­fra­struc­ture. Pri­vate in­vestors are ex­tremely hes­i­tant to re­lin­quish con­trol to pub­lic en­ti­ties, ow­ing to fears that pub­lic bod­ies can be swayed by po­lit­i­cal in­flu­ence and may not in­vest on com­mer­cial terms. To as­suage these con­cerns, MFIs must em­pha­size the in­de­pen­dence of the in­vest­ment al­lo­ca­tion process.

One in­ter­est­ing model is In­dia’s Na­tional In­vest­ment and In­fra­struc­ture Fund, a $6 bil­lion gov­ern­ment-spon­sored in­vest­ment fund that’s been highly suc­cess­ful at mo­bi­liz­ing in­sti­tu­tional in­vestors’ cap­i­tal.

The In­dian gov­ern­ment holds a fixed 49 per­cent mi­nor­ity share in the NIIF it­self, and in the com­pany that man­ages it, with pri­vate and in­sti­tu­tional in­vestors con­trol­ling the ma­jor­ity stake. The NIIF op­er­ates like a stan­dard com­mer­cial in­vest­ment fund, and the gov­ern­ment has only two rep­re­sen­ta­tives on the six-mem­ber board.

The fund’s in­vest­ment com­mit­tee, which makes all in­vest­ment de­ci­sions, is made up en­tirely of in­vest­ment pro­fes­sion­als, who (like the NIIF’s staff) are re­cruited mainly from the pri­vate sec­tor. These curbs on pub­lic-sec­tor con­trol are de­signed to free the NIIF from pos­si­ble po­lit­i­cal in­flu­ence, thereby re­as­sur­ing in­vestors that the fund op­er­ates on fully com­mer­cial terms within its pol­icy-de­fined man­date.

Ac­cord­ing to a re­cent paper by re­searchers at Stan­ford Univer­sity and Maas­tricht Univer­sity, to mo­bi­lize in­sti­tu­tional in­vestor cap­i­tal for fi­nanc­ing the fight against cli­mate change, MFIs must start func­tion­ing in a sim­i­lar way. But large in­sti­tu­tions change slowly, and the ur­gency of cli­mate ac­tion re­quires dis­rup­tive changes, rather than in­cre­men­tal re­forms. That is why a new GCFF, tar­geted at mo­bi­liz­ing cap­i­tal from in­sti­tu­tional in­vestors and mod­eled on the NIIF struc­ture, may be an im­por­tant part of the an­swer.

To be sure, while MFIs would be mi­nor­ity in­vestors in the pro­posed GCFF, they would still play a key role in help­ing pri­vate in­vestors as­sess risks in new con­texts.

MFIs would also need to share these risks and sup­ply tech­ni­cal sup­port based on their ex­per­tise across a broad range of sec­tors and re­gions. Crit­i­cally, to re­as­sure MFIs that their AAA credit rat­ing and pre­ferred-cred­i­tor sta­tus would not be threat­ened, the GCFF’s bud­get would need to be “ring-fenced” from other fi­nanc­ing ini­tia­tives. But these chal­lenges can be man­aged.

In gen­eral, MFIs in­habit a dif­fer­ent world from the in­sti­tu­tional in­vestors whose cap­i­tal they seek to mo­bi­lize. To at­tract enough pri­vate cap­i­tal to ad­vance cli­mate-change so­lu­tions, MFIs must start to treat large in­sti­tu­tional in­vestors as their part­ners and clients. A new GCFF, with the right re­sources and high-level sup­port, would help drive the re­quired change.

MFIs in gen­eral in­habit a dif­fer­ent world from the in­sti­tu­tional in­vestors

Havard Halland is a vis­it­ing scholar at the Stan­ford Global Projects Cen­ter at Stan­ford Univer­sity.

Justin Yifu Lin, for­mer chief econ­o­mist of the World Bank, is dean of the In­sti­tute of New Struc­tural Eco­nomics and the In­sti­tute of South-South Co­op­er­a­tion and De­vel­op­ment, and honorary dean of the Na­tional School of De­vel­op­ment at Pek­ing Univer­sity. THE DAILY STAR pub­lishes this com­men­tary in col­lab­o­ra­tion with Project Syn­di­cate © (www.project-syn­di­cate.org).

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