Green Investment Bank Summit II
Monday 13th June 2011
To view the video highlights of this event, click here.
Elizabeth Rigby, Chief Political Correspondent at the FT welcomed attendees and thanked the event sponsors, Linklaters and Bank of America Merrill Lynch.
Lord Green, Minister of State for BIS, opened the discussion, describing the GIB as “an essential component of the low carbon landscape that will play an important role in overcoming market failure.”
He emphasised the challenges that the transition to low carbon will pose for the UK economy, such as the major investments required, when technology is still developing and the costs are spread over a long timeframe. Although the GIB will be essential to smooth this path, it must work in tandem with other mechanisms, such as electricity market reform, a carbon floor price, the Green Deal and a major waste policy review.
The Government’s published plans for the GIB include a capital commitment of £3bn, which “considering all the circumstances, is pretty good”, and when the fiscal situation permits it will be able to leverage that capital, which will mean “de-risking the project from the point of view of other investors, whether they are domestic ones or indeed inward.” At all stages of its development, Lord Green insisted that the GIB should be run to be profitable, although “it should have a double bottom line, ie it should make money but should also be contributing measurably to the greening of the economy.”
The greatest issue to be overcome is “the risk profile, the uncertainty about returns”, which highlights the fundamental point, that the committed capital, “even at the very generous £3bn, it is in itself a small number compared to the total investment needed.” It will therefore be essential that the GIB’s own balance sheet is “used it in a way that attracts money that otherwise will not come in, because it doesn’t like the risk profile.”
Key areas for development, Lord Green advised, would include renewable energy which could become a world-leading competence of benefit to the UK domestically and in export performance. “We have to address Britain’s ability to pay its way in the world.” Investment in infrastructure will also drive the UK towards a low carbon path and be in the interests of the British economy. The GIB’s role in the Green Deal remains an open question, because “at the risk of stating the absolute obvious, the more it does of one thing, the less it will be able to do of other things and we will have to set some priorities.” Moreover, Lord Green cautioned against the assumption that the GIB should be involved in all green projects, when many could access traditional forms of capital. A better area of focus will be how to aggregate smaller projects “into something that could potentially access the capital markets on a more wholesale basis.” This would help span the so-called “valley of death” for small projects, when funding cannot be sourced to take new technologies through the development stage and to market.
Given that the GIB will not be able to provide all the investment needed, it could fulfil another role by becoming a centre of expertise “that will be of benefit, not only to the government as it thinks about its policy going forward, not only to the operators and investors, but also to the capital markets. And if we get all of this right, we have done the British economy a favour.”
Lord Green defended the “long-standing tradition in HM Treasury which I happen to believe is exactly the right way of doing it, not to pretend that things are off the balance sheet when they are really on the balance sheet.” This drew criticism from some other speakers, but Lord Green maintained that whether other European countries operate differently is moot, because “that is the way we think things should be done and I’m afraid you’ll have to take that as a fixed point in public finance management in this country.”
Xavier Rolet, CEO of the London Stock Exchange insisted that the central focus for the GIB must be to fund innovation.
Usually innovation is funded through debt, but Mr Rolet suggested “that we should start thinking of ways to issue debt specific ventures to finance the GIB initiatives.” Equity is the asset class best suited to financing risk (ie financing innovation), but “this is an asset class that has been very badly treated in the last 30 years by financial regulation, fiscal policies and a general state of neglect.” Equity will not be able to cover large investments involving a large degree of risk, which means that financing innovation is still largely reliant upon bank finance, and bank debt. “We need an asset class that is suited to the inordinate level of risk that investors need to bear when they finance innovation”.
Recently the London Stock Exchange launched a FTSE environment opportunities index and funds are now starting to launch alongside the green investment goals. Mr Rolet suggested this proved “there are things we can do as a financial participant that can help attract attention and direct capital to these particular sectors”, but “if we don’t get the right financing structure to finance what is at the core – the need to finance innovation – we will struggle.”
Risk remains the issue because, contrary to popular opinion, “we are not looking for capital: capital is quite plentiful.” Mr Rolet estimated that “there is about €1.5trn of cash sitting on the balance sheets of corporate Europe (including the UK); it’s yielding peanuts.” One possible method to tap into this would be for the GIB to play an advisory role to large companies that have capital to invest. They would be incentivised – possibly on a pan-European basis – to invest in developing innovation and risk would be reduced by using the GIB’s expertise. “That is a way of using capital that we believe the GIB would be perfected suited to.”
In terms of big debt projects such as infrastructure, these require tens and sometimes hundreds of billions in funding, which the London Stock Exchange believes could be financed through revenue bonds. “Here debt techniques are highly suitable, where you have an underlying revenue stream / generation and the revenue streams are quite well known.” Infrastructure upgrade projects could be, “not perhaps the most productive use of capital”, but a constructive use because they would have “very significant impacts in terms of greening our economy.”
Mr Rolet emphasised his belief in the importance of the GIB being operated for profit. “That’s not to diminish the good that will be done, but a corner stone should be that it is operated with a strict ‘for profit’ criteria”, because by allowing the GIB to become a battleground for community interest, social interest and political interest, you start to create risk.
Giles Hutson, Head of Debt Capital Markets at Bank of America Merrill Lynch wholeheartedly endorsed the creation of the GIB, which “fills a gap in the capital markets.”
The UK capital structure is built around the amount of money available from the pension fund and insurance industry that is applicable to projects once a reasonable degree of risk has been mitigated, and that mitigation can come from the equity markets or the GIB. The fact that the GIB can do that, “I think is a great place to start.”
The next question is over prioritisation, ie the use of the GIB’s core capital for direct investment versus leverage. “Is £3bn pounds enough?” If so, will the bank be able to leverage that into a larger amount of money by retaining core capital in the same way that a bank or a government-related entity does?
The subsequent question is the cost of finance, which we can think of in terms of an arm’s length entity: “there is a reasonable correlation between how long your arm is and the cost of that finance, so if you have a very long arm and you are very far away from government, the cost of finance will go up.” Similarly if you are more closely correlated to central government, the cost of finance will be lower.
This institution has the possibility of filling the gaps which exist in the capital markets. Meeting the carbon reduction targets, “which is what this is all about”, must be on a portfolio basis: “we can’t bet the house on any particular entity.” The GIB will also have to work by association, because it will not have the capability to look at all the different areas of expertise that were discussed at this event.
Bruce White, Head of Global Project Finance at Linklaters, noted that borrowing constraints will require Government to leverage from capital markets and using third party debt, because “the banks cannot finance it all themselves, so there is only one realistic answer – the capital markets.”
In the Government’s proposals for the GIB, Mr White commented that one of the most interesting sections was on the products. One is designed to “put in a mezzanine tranche or an extra layer of risk capital so that you increase the likelihood of the senior debt being repaid and increasing the credit rating, thereby attracting investors.” The proposals suggest a structure whereby project finance banks might finance during construction, which the capital markets are not comfortable with. The debt might be taken out after three-to-five years, thereby meeting the banks’ requirements for reducing the tenor of their debt and transferring the asset into the capital markets. There is an underwriting commitment for the re-financing. “Both of these initiatives are directly targeted at the capital markets and that is the natural home for long term debt.”
Mr White commended the Government’s drive to harness the appetite of investors, although recognised that this will be challenging, “because structuring, implementing and documenting it is not easy. But I genuinely believe that can be done and once done we’ll set a template for a market, thereby re-invigorating the capital markets in the UK for this type of asset.”
John Jenkins, President & CEO of GE Capital UK suggested that a key role for the GIB will be creating predictability, with a long-term view of new technology enabling investment.
He noted that it will be interesting to see how the GIB enables industrial investors to fill some of the void in investing in new technologies. As Mr Rolet suggested, a core part of this will be mitigating risk in a way “that make us feel comfortable in investing in the right technology and not betting on Betamax when everyone knows it’s going to be VHS.”
The GIB will also need to consider small to medium enterprises (SMEs), because although large-scale infrastructure is important, businesses also need to be supported in producing the basic components of technology, commercialising and distributing it. This may be building refit, micro-generation through solar panels, landfill sites and turbines. The smaller projects must also be commercialised.
In terms of new technology, “there is a lot of fairly well-developed technology that now needs some adoption help.” This feeds into the Green Deal and points about predictability. “As a small example, micro-generation of solar panels on roofs is working because there is a clear, predictable, feed-in-tarifdf.” Predictability is vital and can be provided by the Government in the a form of insurance or a grant. Mr Jenkins emphasised, “creating that predictability allows people like me to invest much more readily because the business itself can see how it’s going to pay for it.” The GIB’s more important role will be in enabling investment, rather than investing itself.
Peter Young, Chairman of the Aldersgate Group believed that with publication of the GIB proposals, “the Government has probably done as much as we can reasonably expect it to have done.”
Mr Young welcomed the Bank’s mandate, which aims to accelerate investment in the UK’s transition to a green economy, and “the design document that has come out is extremely good, but there are places where the wheels could come off the rails.” For example the mandate is broadly stated, but “cannot just mean debt: it must mean bonds, it must mean equity, it must mean insurance-type solutions and we must see all of these developed to reach the aim.”
The commitment to legislation is positive, but “we must be aware that the GIB also has its competitors in the European Investment Bank, among others. We need to make sure that we don’t hamper it any more than they do,” particularly in regards to “putting it on the public balance sheet. This doesn’t seem to be a difficultly that our continental cousins have,” and Mr Young questioned why the UK Treasury insists that the GIB should sit on the public balance sheet.
The GIB’s day-to-day operational independence and the opportunity for the GIB to determine its own borrowing mechanism are positive, along with the commitment to make investments from April 2012. Nonetheless, Mr Young emphasised the urgency of putting the GIB team together at sufficient pace to ensure timely delivery of its services, and also development of “its role in aggregating up some smaller scale investments.”
SMEs are vital hubs of innovation and “one of the key things that the GIB has to do early in its life is to make that bridge between the need for capital, much of which cannot get its head around the detailed, complex areas of technology, and the green investment opportunities, which often lie in relatively small firms which have too high risk ratings for standard investors.” Mr Young argued, “we know, if we look at the family of opportunities, that we will have winning technologies and winning solutions that the UK will gain greatly by bringing to market early. The GIB will have to play a role to bring these along.”
Finally Mr Young suggested that one of the biggest risks for all green projects is policy uncertainty. The GIB could mitigate this by improving the quality of advice going back to government on how its decisions and future actions will impact the investment community. “If it does that well, it will de-risk the whole investment community and the UK position.”
Mr Young concluded, that “what I’d like to see most of all is the GIB really demonstrating how good the UK can be, rebuilding global confidence in our banking and investment capabilities. It will enable us to take our place on a global market that we wouldn’t otherwise be able to do.”
This event was supported by Linklaters and Bank of America Merrill Lynch.