How to mo­bi­lize pri­vate cap­i­tal for cli­mate ac­tion

Mul­ti­lat­eral fi­nance in­sti­tu­tions have com­mit­ted to mo­bi­liz­ing cap­i­tal from pri­vate in­vestors, largely through so-called blended fi­nance, in or­der to fund cli­mate ac­tion and achieve the Sus­tain­able De­vel­op­ment Goals. To suc­ceed, these in­sti­tu­tions may nee

Financial Nigeria Magazine - - Contents - By Hå­vard Hal­land, Justin Yifu Lin

The con­clu­sion of the United Na­tions In­ter­gov­ern­men­tal Panel on Cli­mate Change’s most re­cent re­port is stark: cli­mate ac­tion is far more ur­gent than pre­vi­ously be­lieved, and it must in­clude a wide range of ini­tia­tives, from im­proved reg­u­la­tion to con­tin­ued tech­no­log­i­cal in­no­va­tion. But with­out mas­sive amounts of long-term “pa­tient” cap­i­tal – which only in­sti­tu­tional in­vestors can muster – it will be im­pos­si­ble to trans­form en­ergy sys­tems fast enough to mit­i­gate the risk of eco­log­i­cal, eco­nomic, and so­cial dis­as­ter.

Tech­ni­cally, in­sti­tu­tional in­vestors – such as pen­sion funds, sov­er­eign wealth funds, and in­sur­ance com­pa­nies – hold suf­fi­cient fi­nan­cial fire­power to ad­dress cli­mate change, and some are seek­ing to align their port­fo­lios with the UN Sus­tain­able De­vel­op­ment Goals (SDGs). In OECD coun­tries alone, in­sti­tu­tional in­vestors con­trol an es­ti­mated $92 tril­lion in as­sets. An­nual of­fi­cial de­vel­op­ment as­sis­tance by mul­ti­lat­eral fi­nance in­sti­tu­tions (MFIs) and gov­ern­ments amounts to just 0.16% of that – about $145 bil­lion.

But, as com­mer­cial ac­tors, in­sti­tu­tional in­vestors’ pri­mary ob­jec­tive is to max­i­mize fi­nan­cial re­turns. Even as some purge their port­fo­lios of car­bon-in­ten­sive com­pa­nies, they gen­er­ally con­sider in­vest­ing in new clean-en­ergy in­fra­struc­ture projects to be too risky, par­tic­u­larly in emerg­ing mar­kets.

To fi­nance the SDGs, in­clud­ing cleanen­ergy in­fra­struc­ture, MFIs have

com­mit­ted to mo­bi­liz­ing cap­i­tal from pri­vate in­vestors. This mo­bi­liza­tion takes place largely through so-called blended fi­nance, whereby MFIs and other pub­lic fi­nance in­sti­tu­tions use their own cap­i­tal to crowd in pri­vate fi­nanc­ing. But in­sti­tu­tional in­vestors have been largely ab­sent from mul­ti­lat­eral blended-fi­nance ini­tia­tives, which have, in turn, failed to achieve a scale rel­e­vant to cli­mate change.

So what will it take to mo­bi­lize the needed cap­i­tal from in­sti­tu­tional in­vestors? A re­cent pa­per by re­searchers at Stan­ford and Maas­tricht uni­ver­si­ties sug­gests fo­cus­ing on three re­cent de­vel­op­ments in the global fi­nan­cial sec­tor.

First, a grow­ing num­ber of in­sti­tu­tional in­vestors are re­duc­ing their de­pen­dence on fi­nan­cial in­ter­me­di­aries. In­sti­tu­tional in­vestors have tra­di­tion­ally out­sourced their in­vest­ments to in­vest­ment man­age­ment firms, whose per­for­mance is gen­er­ally as­sessed on a quar­terly ba­sis. Yet the in­vest­ment hori­zon for in­fra­struc­ture, in­clud­ing clean-en­ergy in­fra­struc­ture, is of­ten more than 20 years.

From the per­spec­tive of blended fi­nance, tra­di­tional fi­nan­cial in­ter­me­di­aries, with their short-term bi­ases, con­sti­tute a bot­tle­neck be­tween in­sti­tu­tional in­vestors and MFIs. The elim­i­na­tion of such in­ter­me­di­aries could thus pro­vide new op­por­tu­ni­ties for di­rect co­op­er­a­tion be­tween in­sti­tu­tional in­vestors and MFIs, as it en­ables the for­mer to fo­cus more on in­vest­ment in long-term as­sets.

Sec­ond, many in­sti­tu­tional in­vestors are es­tab­lish­ing col­lab­o­ra­tive plat­forms to en­able cost-shar­ing on deal sourc­ing, due dili­gence, and other stages of the in­vest­ment process. Each of these plat­forms rep­re­sents a very large amount of long-term cap­i­tal. But, with few ex­cep­tions, they do not in­clude MFIs.

Third, there are new types of lo­cal strategic in­vestors that can be highly ef­fec­tive at mo­bi­liz­ing pri­vate cap­i­tal, in­clud­ing from in­sti­tu­tional back­ers. Over the last decade, at least 20 coun­tries have es­tab­lished state-spon­sored strategic in­vest­ment funds to co-in­vest in in­fra­struc­ture projects with pri­vate-sec­tor part­ners. Other coun­tries have es­tab­lished green banks, whose do­mes­tic fo­cus re­flects the fact that 90% of pri­vate cli­mate-fi­nance in­vest­ments are made within the cap­i­tal’s coun­try of ori­gin.

The strategic in­vest­ment funds that have suc­cess­fully mo­bi­lized pri­vate cap­i­tal are struc­tured much like pri­vate in­vest­ment or­ga­ni­za­tions. They em­pha­size the in­de­pen­dence and in­tegrity of the in­vest­ment de­ci­sion-mak­ing process; and their boards and board com­mit­tees have a high share of in­de­pen­dent direc­tors se­lected for their fi­nan­cial and busi­ness ex­per­tise. Some funds, such as In­dia’s Na­tional In­vest­ment and In­fra­struc­ture Fund, are owned mainly by pri­vate and in­sti­tu­tional in­vestors, with the gov­ern­ment in a mi­nor­ity po­si­tion.

Man­aged by fi­nance pro­fes­sion­als re­cruited from the pri­vate sec­tor, these strategic funds in­vest pri­mar­ily in eq­uity, and take an ac­tive role in struc­tur­ing and ar­rang­ing new deals. Be­cause they are linked to lo­cal gov­ern­ment and busi­ness net­works, they are in a strong po­si­tion to mit­i­gate lo­cal risk.

MFIs, by con­trast, tend to em­pha­size coun­try rep­re­sen­ta­tion on their boards, leav­ing these boards with less fi­nan­cial­sec­tor ex­per­tise in the rel­e­vant sec­tors. At the man­age­ment and staff level, the pri­vate-sec­tor branches of MFIs fre­quently have ex­per­tise in a wide range of ar­eas. De­spite this, MFI boards – un­like their pri­vate coun­ter­parts – gen­er­ally do not es­tab­lish a broad in­vest­ment pol­icy or del­e­gate de­ci­sions on in­di­vid­ual in­fra­struc­ture projects to an in­de­pen­dent in­vest­ment com­mit­tee; in­stead, they them­selves make the de­ci­sions on cap­i­tal al­lo­ca­tion.

Given MFIs’ bu­reau­cratic struc­tures and fre­quently cum­ber­some pro­ce­dures, in­sti­tu­tional in­vestors tend to be scep­ti­cal about them. In­sti­tu­tional in­vestors of­ten con­sider the projects MFIs pitch to be too small, too risky, or not prof­itable enough, and they worry that, if some­thing goes wrong, MFIs’ bu­reau­cra­cies will not per­mit them to ad­dress it swiftly.

Whereas MFIs have ex­panded their of­fers of risk mit­i­ga­tion for in­vestors, they over­whelm­ingly re­main providers of debt. Cru­cially, they in­vest very lit­tle in in­fra­struc­ture eq­uity. This is a sig­nif­i­cant dis­tinc­tion, be­cause whereas eq­uity in­vestors fre­quently take an ac­tive role in struc­tur­ing and ar­rang­ing new in­fra­struc­ture projects, providers of debt and risk mit­i­ga­tion gen­er­ally en­gage once a project is fully doc­u­mented and con­firmed as “bank­able.”

To achieve their goal of mo­bi­liz­ing pri­vate-sec­tor cap­i­tal, MFIs need to en­gage on in­sti­tu­tional in­vestors’ col­lab­o­ra­tive plat­forms, and ad­dress these in­vestors’ con­cerns. This means help­ing them to as­sess and mit­i­gate risk in new re­gions and sec­tors where green in­fra­struc­ture is needed, if ap­pro­pri­ate in co­op­er­a­tion with lo­cal strategic in­vest­ment funds and green banks.

By de­vel­op­ing the ca­pac­ity to as­sess and bear risk on com­mer­cial terms, tra­di­tion­ally risk-averse MFIs could en­gage more pro­duc­tively with in­sti­tu­tional in­vestors. And by build­ing up the ca­pac­ity to un­der­take eq­uity in­vest­ment in cleanen­ergy in­fra­struc­ture, MFIs could in­crease their ca­pac­ity to en­gage with in­sti­tu­tional in­vestors at rel­e­vant stages of the in­fra­struc­ture-in­vest­ment cy­cle.

Sim­ply put, in or­der to mo­bi­lize in­sti­tu­tional cap­i­tal ef­fec­tively, MFIs will need to start func­tion­ing more like pri­vate in­vest­ment or­ga­ni­za­tions, even as they ful­fill a pol­icy-de­fined man­date. This is a tall or­der; the OECD has sug­gested that ef­fi­cient pri­vate cap­i­tal mo­bi­liza­tion may re­quire a cul­ture change within MFIs. But, if we are to curb cli­mate change and achieve the SDGs, it could be the only way for MFIs to mo­bi­lize in­sti­tu­tional in­vestor cap­i­tal at any rel­e­vant scale.

Hå­vard Hal­land is a vis­it­ing scholar at the Stan­ford Global Projects Cen­ter (GPC) at Stan­ford Univer­sity.

Justin Yifu Lin, for­mer Chief Econ­o­mist of the World Bank, is Dean of the In­sti­tute for New Struc­tural Eco­nomics and the In­sti­tute of SouthSouth Co­op­er­a­tion and De­vel­op­ment, and Hon­orary Dean at the Na­tional School of De­vel­op­ment, Pek­ing Univer­sity. His re­cent books in­clude Go­ing Be­yond Aid: De­vel­op­ment Co­op­er­a­tion for Struc­tural Trans­for­ma­tion and Beat­ing the Odds: Jump­start­ing De­vel­op­ing Coun­tries. Copy­right: Project Syn­di­cate

Given MFIs’ bu­reau­cratic struc­tures and fre­quently cum­ber­some pro­ce­dures, in­sti­tu­tional in­vestors tend to be scep­ti­cal about them.

World Bank head­quar­ters, Wash­ing­ton DC

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