Event Summary: Green Investment Bank Summit

Ethical Markets Green Prosperity, SRI/ESG News

Event Summary: Green Investment Bank Summit
Tuesday 9th November 2010

Joan Walley opened the meeting, declaring that she believed, “like most people here, a Green Investment Bank (GIB) is urgently needed.”

Martin Donnelly, Permanent Secretary for the Department of Business, Innovation and Skills, described the Green Investment Bank (GIB) as “one of a number of critical policy initiatives in place to encourage the necessary level of investment in green infrastructure.”

This investment is substantial, as the National Infrastructure Plan recently highlighted when it reported that the UK economic infrastructure will need £200bn over the next five years, and investment in the energy sector will almost double over the same period.

The scope and structure of the GIB will be evaluated by three key tests: effectiveness, affordability and transparency. It is part of a portfolio of policies which includes reform of the                   electricity market, changes to the climate change levy, introduction of a renewable heat incentive, the review of waste policy, reviews of Ofgem and Ofwat and the introduction of the new Green Deal. The Permanent Secretary noted, “There will, sometimes, still be a need for government to make direct financial interventions in order to meet the high ambitions for green infrastructure and this is the role of the GIB”. It will have a mandate to tackle risk inherent in financing green infrastructure that the market currently cannot adequately accommodate. For example, in offshore wind the construction risk can be a prohibitive issue for investors, and government is looking at types of de-risking products for construction and operating phases, to help the private sector introduce cheaper forms of low risk capital.

“Any financial product will have to be designed and tested in detail and will be subject to those key tests of effectiveness, affordability and transparency”. Once established the GIB is likely to seek to make interventions across a number of sectors. Whilst reducing risk in order to mobilise additional capital in the market, the institution will also seek to make a return on investment and to reinvest the proceeds into further green infrastructure financing.

Credibility with financial markets will be key, that is why the GIB will be run on an independent and commercial basis employing appropriate private sector skills and expertise, and be free from political interference in its day-to-day operations. Initial funding has been announced by the government in the form of £1bn of departmental funding and there will be “significant proceeds from the sale of government owned assets to capitalise the institution.” The departmental funding can be expected for 2013-2014 “but the proceeds of asset sales, whilst contingent on successfully concluding those sales, could well be realised earlier allowing the institution to make investments more quickly.” The government is committed to establishing the governance arrangements and the design of the business and operating model of this new institution by the end of May 2011, ready for launch by the end of December 2011. “It is possible that the GIB could be in a position to make its first investments within 6-12 months of the next announcement in the spring”, although this will be subject to legal and regulatory compliance, which could take longer to be approved.

Abyd Karmali, Managing Director, Global Head of Carbon Markets at Bank of America Merrill Lynch agreed with the Permanent Secretary “that the GIB is an institution that is very much needed.”
Bank of America Merrill Lynch supports the creation of the GIB, because “we need to rapidly shift finance from investing in high carbon assets to low carbon assets”. The carbon markets have developed significantly, “but provide an insufficient signal and run the risk of delivering high carbon intensive asset lock-in.” Fundamentally, “the system is blocked: private capital is paralysed. The markets don’t know                   when or how much to invest in the low carbon space, which is why we’re seeing the increasing realisation that there is a need for a publicly funded institution”.

Mr Karmali advocated particular focus on four areas in the coming months. Regarding sources of capital, “We believe that green bonds are one high potential source of capital for the GIB”. The World Bank has sold roughly $1.5bn of green bonds in the past couple of years, showing that “clearly the appetite is there among investors.” A second source is EU allowances as by 2013-2020 there will be 100% auctioning of allowances in the power sector and a much higher percentage in other covered sectors. Mr Karmali estimated that this has the potential “to deliver up to £4bn per year, some of which presumably could be allocated to the GIB.”

A second area for focus is which risks the GIB should address, since it would not, nor should it, derisk all clean investment opportunities. One that merits attention is “the aggregation challenge for small scale investments”, for example in energy efficiency. Some European countries have mistakenly chosen “to retroactively tinker with their renewable energy promotion schemes”, but having mechanisms in place through the GIB would provide long-term policy certainty.

The third area is to consider which sectors of the economy should be targeted and Mr Karmali advocated offshore wind, energy efficiency and network infrastructure. “There are of course others but those would be three of my favourites.”

Fourthly the GIB’s menu of financial products need careful consideration. These will naturally “depend on the sectors and the risks that the bank chooses to address.” Mr Karmali advocated lowering the cost of capital for subordinated debt as a high priority, “because in terms of the absolute scale of financing delivered, that is the one that’s going to have most impact.”

Jon Kimber, Managing Director of British Gas New Energy argued that support from the GIB “could create jobs and bring forward investment in the two key areas of energy efficiency and wind power.”
British Gas welcomes the Green Deal and “we believe whole-heartedly that removing the upfront cost of energy efficiency will encourage more households to take action.” Mr Kimber cited the British Gas “Rent a Roof” scheme, which offers customers PV installations at no upfront cost; “we rent the roof from them, they benefit from the energy that’s produced and we take the feed-in tariff.” Thus far, British Gas has had 11,000 applications for the service, “and that’s without actually marketing it.”

British Gas has committed £30m to “go early” on the Green Deal: “to trial it, learn from it and generate experiences.” The experiences have highlighted that “energy supplies cannot take the full weight of this market and the Green Deal will bring a new asset class.” “The key to financing this new asset class is to unlock the capital markets, securitising the Green Deal repayments as green deal bonds and it’s here where the GIB can take a leading role.”

Alongside energy efficiency, the GIB should invest in wind, “providing pre-construction equity.” By “plugging the equity gap” the GIB can provide greater confidence in the policy regime and renewables obligation, thereby encouraging more investors. “By speeding up offshore wind development, the GIB can help strengthen this growing industry and the jobs and economic growth it creates.”

James Wardlaw, Managing Director, Investment Banking Division at Goldman Sachs “took a lot of heart from the Permanent Secretary’s comments about the desire to accelerate the milestones in the development of the GIB.”
Mr Wardlaw emphasised that “many of us in the private sector would take the view that speed is of the essence; we just need to get on with this.” He warned that the GIB might not be perfectly formed from the outset, but it will evolve. “I’m very keen that one of the principal roles of the GIB should be to facilitate the recycling of capital into renewable technologies and projects of this nature.”

Institutional investors are coming under pressure from government to finance all sorts of things, when their appetite is really for mature assets that are producing a cash-on-cash yield. “They are not the natural financiers of new infrastructure projects of any kind,” but arguably the banks are. “I see a role for the GIB in taking on the aggregation challenge and trying to free up the bank balance sheets and accelerate the progression of the mature assets that they have on their books into the capital markets, so the banks can then invest in new projects.”

It is worth considering how success should be measured for the GIB. Mr Wardlaw drew on the example of the early ‘80s, when “the success in terms of regeneration was measured in the gearing effect of £1 of public money; how much could it attract in terms of pounds of private money.” The Docklands Development Corporation achieved a 10:1 gearing and “that, to my mind, is exactly how we should be thinking about the GIB.”

Nick Robins, Head of Climate Change Centre at HSBC suggested that “one of the realities of the low carbon economy, is that it is a more capital intensive economy,” estimating that global capital investments will rise from an estimated US$460bn today, to US$1.5 trillion in 2020.
Clearly, countries that cut the costs and reduce the risks of capital will have a head start, “not just in meeting environmental objectives but in terms of competitive positioning.” Mr Robins identified several elements which would mobilise the capital: market reform, carbon pricing, secure incentives, strategic R&D, planning, infrastructure and so on, “but it’s very rare to see countries that have made a success of low carbon growth, that have done it without innovative public financing.” Germany, “with many decades head start”, has the KfW which provided €20bn of investment in the energy and climate sector last year – 30% up on 2008.

“In terms of the particulars of the UK, the watchwords are scale, leverage and speed.” Like others, Mr Robins was encouraged by the sense of pace that the Permanent Secretary described and he emphasised the importance of maintaining momentum.

One of the aims of the GIB is to facilitate the entrance of new types of investments into green infrastructure. “I think there is now considerable latent demand for green bonds. We have a                   total fixed income issuance of about US$ 2.3 trillion globally, and we have a stock in the UK of institutional investments of about £2 trillion.” The bank could play an aggregator role in creating that market, allowing the issuance to be sufficiently large to provide the liquidity. Another important aspect will be how to reduce the risk of those bonds, particularly in new areas.

Finally Mr Robins suggested that there is a role for the GIB to help develop market place standards for green bonds. If international institutional investors are to buy them, the bonds will need environmental integrity. Mr Robins emphasised that this is a growing area and “the GIB can help make London the centre of the new green bond market.”

Peter Young, Chairman of the Aldersgate Group welcomed the Permanent Secretary’s description of the possible speed with which the GIB could be set up.
The urgency is a significant point. Designing the operating model is challenging and “the expertise is going to have to come from across the financial community to get that right.” The goal must be to get the GIB operating during 2011 with the                   requisite expertise on board.

Equally, “on the capitalisation level, bringing the timing forward is absolutely essential. The particular thing here is this opportunity to advance some of the receipts from capital sales and maybe get those up and running before the end of next year. I think that is plausible but it’s going to be challenging. It would be good to see implementation in the market because the private sector is desperate to join in, but cannot do so until these commitments are made.”

Mr Young suggested, “it’s important to recognise that this is a public sector finance initiative, and we need to have awareness of the public good.” He advised starting with the desired outcomes: “is it helping us meet our mandatory carbon targets and our renewables targets, helping create jobs here in the UK, stimulating growth and innovation, is it giving a more balanced economy with high technology manufacture, is it supporting the regions and the rural areas to even out the benefits of wealth, and ultimately is it going to help grow this Big Society concept by meeting energy needs and making sure that we share the proceeds?”

Green bonds have been central to the AG message, and Mr Young welcomed the Permanent Secretary’s comment that de-risking products to help the private sector issue them could be included as one of the options of the package. There is a lot of work to do on the details – will they be asset based and long dated, how to cover off the aggregation issue and bring in the institutional investor. Green ISAs will also be important, because “we need public participation here. It’s not so much the sums of money involved but actually making society feel part of this fantastic opportunity of the green economy.”

“Let’s make sure that the GIB is not only a success against the criteria that we’ve heard tonight, but also is a real showcase for the UK to show how we can bring together our financial expertise and deliver.”

This event was sponsored by PwC, Business in the Community, Green Monday, TransformUK, Bank of America Merrill Lynch and Centrica.?