3. Pathways and levers to scale-up institutional investment in green infrastructure
The previous chapter 2 shows the relevance of unlisted funds and direct investments for asset owners and the importance of the securitised instruments YieldCos, infrastructure REITs and INVITs for asset managers to shift and scale up institutional investment in infrastructure. Based on that mapping of current holdings, this chapter develops a framework to identify levers and policy priorities to shift and accelerate institutional investment in green infrastructure. Important levers exist for both investors and policymakers. Interventions to scale up investment through unlisted funds and direct investment should aim to target investment-decision making by asset owners. Interventions to scale-up investment through securitised instruments should aim to target investment-decision making by asset managers. Policymakers can employ a set of measures to accelerate institutional investment in green infrastructure. These include establishing an enabling policy environment, clarifying fiduciary duty, supporting institutional innovation, to active de-risking and public-private initiatives, and facilitating securitisation of infrastructure assets.
In the context of shifting and accelerating institutional investment in infrastructure assets that are aligned with global climate and development objectives, the empirical mapping provides three key takeaways:
1. The lion’s share of current investment holdings is held through unlisted funds, direct project-level equity/debt and securitised vehicles;
2. Asset owners demonstrate a preference towards illiquid infrastructure instruments;
3. Asset managers exhibit a preference towards liquid infrastructure instruments.
Using these findings as a point of departure, this chapter shifts to the perspective of policy-makers to provide guidance on how to mobilise larger amounts of institutional capital towards green assets. It begins with a brief discussion of the barriers to institutional investment in green infrastructure as identified in existing literature. The chapter then goes on to form an analytical framework, building on relevant barriers and empirical evidence from chapter 2. The framework identifies levers and policy priorities to upscale investment in green infrastructure. This is followed by a consideration of the role of policy-making in upscaling institutional investment in green infrastructure.
A rich body of literature points to a variety of factors that impede institutional investment (OECD, 2015[1]; Kaminker et al., 2013[2]; Nelson and Pierpont, 2013[3]; Kaminker, Stewart and Upton, 2012[4]; Blended Finance Taskforce, 2018[5]). From currency and transfer risks to political risk, an investor will face different permutations of challenges depending on the jurisdiction of investment. Regulations in an investor’s home jurisdiction, for instance quantitative limits on cross border holdings, may further compound the challenge. Figure 3.1 presents a composite (although not comprehensive) view of the barriers to institutional investment. Notably, many barriers in Figure 3.1 have an effect on price incentives, such as a lack of or low carbon prices. While barriers are not the focus of this report, certain barriers are discussed where relevant in this chapter. Figure 3.1’s sources give an overview over all barriers mentioned as well.
Source: Authors based on (OECD, 2015[1]; Ang, Röttgers and Burli, 2017[6]; OECD, 2017[7]; OECD, 2018[8]; G20/OECD, 2013[9])
The 3 key takeaways (from the empirical mapping) cited at the beginning of this chapter highlight a relationship between asset owners/asset managers and the instruments they prefer to use for green infrastructure investment. The majority of green infrastructure investment by asset owners is held through unlisted funds and in project-level equity/debt. The main means for scaling up green infrastructure investment by asset owners is to influence their investment decision-making by encouraging investment in the channels for which they have most appetite and room to expand investment: unlisted funds and direct investment. This relationship is the primary conduit (see Figure 3.2.) for scaling up investment in these channels. At the same time, asset managers can be encouraged to expand investment in these channels, despite their main focus on liquidity. Asset managers’ investment decision-making with respect to unlisted funds and direct investment is a secondary conduit for scaling up investment in these channels (see Figure 3.2). Similarly, to upscale investment through securitised structures, policy and other interventions should target investment activities by asset managers (primary conduit). The distinctions in Figure 3.2 provide the basis of the analytical framework for this chapter, as they help identify potential pathways to scale investment. They are simplified, drawn for ease of analysis, and are not intended to be interpreted beyond the context of this report. Though other instruments and mechanisms exist, the focus of this chapter is levers and policy action to increase green infrastructure deployment by scaling investments through unlisted funds, direct investment and securitised structures (most relevant in this chapter: YieldCos, infrastructure REITs and INVITs).
Note: This figure has been developed for the sole purpose to facilitate analysis and should not be interpreted beyond the context of this report. The analysis presented below focuses on primary influence only.
Source: Authors
Based on Figure 3.2, Figure 3.3 proposes a framework to pinpoint levers for policy-makers and investors, as well as related pathways from policy action to investments.1 For the three instruments unlisted funds, direct equity/debt and securitised vehicles, the framework below presents a deconstructed view of the elements of the investment process mapped in Chapter 2. The framework highlights key elements at each step of the investment process and connects them with relevant policy areas and actors (not limited to asset owners and asset managers). In particular, the framework is intended to focus attention on key action areas to accelerate the flow of institutional capital towards green infrastructure assets. Figure 3.3 should be read as a description of the ecosystem of institutional investment in green infrastructure and not as a flow chart with sequential actions or relationships. The framework aims to demonstrate how the various components of the investment ecosystem relate to, interact with and influence each other.
Note: Asset Owners may invest in units of securitised vehicles and passive funds directly. The framework above has been simplified to aid analysis.
Source: Authors
The framework in Figure 3.3 highlights three pathways to scale green infrastructure investments which are interlinked and can be combined: Green project pipelines, Mandates, and Securitised products.
Green pipelines: Policymakers create an environment that enables origination of investment-grade (“bankable”) green projects and allows development of a project pipeline. This ensures deal flow for asset owners (looking to invest directly in projects) and private infrastructure funds.
The levers related to green pipelines are:
Infrastructure planning and development policies;
Enabling investor partnerships.
Mandates: Policymakers clarify fiduciary duty in relation to green investments. This would allow and encourage asset owners to issue greener mandates to asset managers.
The lever for this pathway is
Financial regulation and investment policies (in particular clarifying fiduciary duty)
Securitised products: Policymakers allow securitised products like INVITs and YieldCos.2 Project sponsors and short-term financiers off-load operating projects through securitisation, allowing early-stage investors to reinvest in new projects. Units of securitised vehicles may be privately placed3 with institutional investors or publicly offered. Public offering of units (at stock exchanges), allows participation by a wider set of investors beyond asset managers, e.g. retail investors and defined contribution pension plans. Bringing in these two groups of investors more systematically could enlarge the pool of capital available for infrastructure development. In addition to providing a demand side push by investing on behalf of their clients, asset managers may include units of securitised infrastructure vehicles in passive funds and index products to increase sustainable finance offerings.
The levers associated with securitised products are:
Demand and innovation – Enabling frameworks for securitisation;
Demand and innovation – Institutional investors as ‘recyclers of capital’; and
Demand and innovation – Leveraging the trend towards passive investment.
The following sections discuss in greater detail how these two pathways and related levers can scale-up investments, including the cross-cutting issue of public policies and direct public action. These sections focus on applications within relevant classes of investment instruments.
Green pipelines: Infrastructure planning and infrastructure development policies
Policy action is central to planning and developing infrastructure projects. This planning and coordination activity, incentivised and carried out by public agencies and ministries, provides information, orientation and a long-term investment view for investors. (OECD, 2018[8]) provides a detailed analysis of six factors to establish and strengthen green project pipelines: leadership; transparency; eligibility criteria; project support; prioritisation; and dynamic adaptability (see Table 3.1). Bespoke de-risking by public financial institutions and institutional innovation (e.g. Green Investment Banks (OECD, 2016[10]; OECD, 2018[8])) can be jointly viewed as the seventh factor to establish a pipeline of investment-grade assets and attract institutional capital towards critical infrastructure projects.
Asset owners and direct investment
Through direct equity and debt positions, pension funds, insurance companies and sovereign wealth funds (SWFs) hold an aggregated USD 62 billion in green infrastructure. The decision to invest directly at the project-level is a function of a variety of factors that are individual to an investor, for instance, risk-return objectives, skill and internal capacity. Regardless, from a systemic standpoint the unavailability of sufficient investment grade projects is a cross-cutting limitation. This limitation affects all types of existing and potential investors looking for projects or products where projects are bundled. As has been noted in the literature, it is the absence of enough investment-grade projects with attractive risk-adjusted returns, and not a lack of capital, that is a major impediment to green infrastructure investment (for an overview see OECD (2018[8])).
Infrastructure assets are operationally intensive and require methods of analysis distinct from traditional assets such as bonds and corporate stocks. For instance, fair values are appraised rather than observed. Infrastructure assets also often need specialist knowledge of local conditions for their effective management. Investing in illiquid infrastructure can therefore warrant developing specific skills and capacity, including in some cases establishing local presence, both by asset owners (in case of internal investment management) and asset managers. The costs of capacity and skill development are difficult to justify for a one-off opportunity. A pipeline of investment-grade projects and a government’s clear commitment to environmental policy goals signal continued green investment opportunities. More importantly, they attract multiple interested investors, indicate exit possibilities and facilitate an active market for infrastructure assets.
Asset owners and unlisted funds
Like for direct investments by asset owners, a large limitation to infrastructure investing (green and otherwise) through unlisted funds, is insufficient deal flow (pipeline of investment-grade projects). The amount of committed, but unallocated capital in unlisted infrastructure funds (dry powder) grew at a rate of 15.5%4 year-on-year from 2015 to 2019. At the end of Q2 2020, the committed, but unallocated capital equalled 38%5 of total capital raised. For infrastructure funds, this is synonymous with a lack of investment-grade projects which would otherwise be an investment opportunity. Low returns on traditional assets like bonds or corporate stocks, persistently low interest rates and increased capital raising for new funds have led to high valuations for unlisted infrastructure (UBS, 2019[11]).
In-depth interviews for this report confirm that heightened competition for attractive risk-adjusted returns has made it increasingly difficult to access green infrastructure assets, as more investors look to accommodate infrastructure within their portfolios. Viewed through a demand-supply lens, having limited supply of investment-grade projects contributes to high valuations and depresses overall returns-this discourages investment.
From a policy standpoint a pipeline of investment-grade projects can ease some of these effects and spur investment. There is a rising interest in infrastructure investment. Despite the economic headwinds from COVID-19, infrastructure fundraising overall continues to be on a steady trajectory, though the picture may be more nuanced for subsets of specialised funds. Q1 2020 recorded the third highest amount of quarterly capital raised (albeit with notable regional differences) (Prequin, 2020[12]). An enabling policy environment facilitating a robust pipeline of green assets in each country seeking investment, coupled with the increasing focus by asset owners on green investments, could be a powerful combination to capitalise this momentum and accelerate green infrastructure investment. However, the challenge of strengthening enabling environments and establishing an investment-grade policy framework in each country where investment is needed is far from being met.6
Green pipelines: Enabling investor partnerships
Policy-makers in infrastructure-related agencies and public financial institutions can play a key role in accelerating investment by actively promoting and partaking in investor partnerships. Aside from co-investing, policy-makers could take on other enabling roles. For instance, they can create strategic investment funds (SIFs) and collaborate closely with the financial sector to address specific barriers to investing.
Asset owners, direct investment and unlisted funds
Asset owners with their long investment horizons are in a unique position to foster new and emerging sectors, such as off-shore wind. Partnerships between asset owners, in particular pension funds and life insurance companies, are proving to be an effective way to share risks, lower cost of capital, develop specialised capabilities and unlock long-term patient capital (Bachher, Jagdeep Singh, Adam Dixon, 2016[13]).
The example of the Danish wind industry is instructive for risk-sharing through partnerships, in the case of on-shore and also recently off-shore. Collaboration between Danish pension funds, supported by incentives from the government, was instrumental in developing collective know-how, expertise and mainstreaming the sector. A notable example is the 2011 deal for the 400 MW Anholt offshore wind farm, in which PensionDanmark and PKA together acquired 50% at EUR 900 million (Clean Energy Pipeline, 2014[14]). The Pension Infrastructure Platform in the United Kingdom is another example of the efficacy of partnerships in steering capital towards critical infrastructure aligned with environmental goals. Other initiatives focused on accelerating institutional investment in green infrastructure may encourage other types of partnerships and other means of up-scaling institutional investment.7
Investor partnerships can be instrumental in achieving scale, lowering transaction costs and fostering new sectors. Partnerships between governments and investors could accelerate origination of investment-grade projects and in turn, private investment. An emerging example of this approach is the concept of partnerships between general insurers, governments and life insurers. Broadly speaking, private infrastructure is typically insured by general insurers who, owing to their short-term liabilities, do not invest in infrastructure assets. Investments in infrastructure are largely provided by life insurance companies. While general insurers underwrite private infrastructure, public infrastructure assets are largely uninsured (they are self-insured by the government). This elevates the risk profile of public assets. In-depth interviews with experts point to ongoing efforts to establish partnerships between the insurance and public sectors to allow the two to work together across the entire lifecycle of projects. Working closely with governments, general insurers can develop bespoke products to underwrite public assets thereby lowering perceived risks for these assets and attracting investment from life insurance companies and other investors.
Mandates: Greening mandates
One key policy angle for greening infrastructure investments by institutional investors is to encourage greener mandates provided by asset owners, or a greener choice of investment consultants used by asset owners (as discussed below). While policy-makers do not have a direct influence on mandates, a clarification of fiduciary duty in relation to green infrastructure can encourage investment. The role of regulators and other policy-makers here would be to provide clarification on the relationship between fiduciary duty, duty of care and consideration of climate-related and other environment-related risks (UNEP FI, PRI, 2019[15]; Climate-Related Market Risk Subcommittee, 2020[16]). In-depth stakeholder interviews carried out for this report confirm this view. Adjustments or clarifications regarding fiduciary duty would create space for willing investors to make green infrastructure investments -- investors who otherwise may be reticent due to the risk of a breach in fiduciary duty.
Asset owners and unlisted funds
Asset owners and asset managers share a principal-agent relationship. Asset owners acting as limited partners play a critical role in the strategic asset allocation decisions of unlisted funds through the mandates they issue (PRI, 2018[17]). Asset owners have a determining influence on the priorities of asset managers and the overall industry. This is evidenced by the recent proliferation of sustainable investment funds—in 2019, 360 new sustainable investment funds were launched in Europe alone (Morningstar, 2020[18]). In addition, 250 European funds were repurposed from traditional to sustainable (Morningstar, 2020[18]).
Asset owners have a powerful tool in their mandates to support green infrastructure investment. According to 85 % of the respondents to a recent survey of hedge fund managers, demand from institutional investors is the foremost driver of ESG and therefore also green infrastructure investing (KPMG, AIMA, 2020[19]). At the same time, investment data tracked for this report shows consistently higher capital allocations by unlisted funds to non-green assets. Given that unlisted infrastructure funds invest in line with the mandate from limited partners (i.e. asset owners or asset managers investing in the funds), this points to the need for greening mandates. Interviews conducted for this report support this view.
A critical juncture to integrate climate and development objectives in investment decisions is the selection of asset managers and investment consultants. An increasing number of asset owners retain consultants for a range of functions from portfolio construction to asset manager selection. The growing role of investment consultants in capital allocation makes them important actors to accelerate green infrastructure investments. Despite rising recognition of the materiality of environmental and other non-financial risks to investments, there appears to be a continued disconnect with the services asset owners demand of their consultants and managers (PRI, 2017[20]).
Securitised products: Demand and innovation – Enabling frameworks for securitisation
Creating an enabling regulatory framework for securitised products targeted at green infrastructure would aid deal flow and help capitalise the rising interest in infrastructure in favour of green asset. Though the role of policymakers in structuring securitised vehicles is limited, regulations permitting securitised products and active de-risking (as in the case of UK Greencoat YieldCo) can encourage mainstreaming. The recent adoption of INVITs in India are a prime example of the efficacy of securitised products in monetising assets and freeing capital for new asset creation.
Asset managers and securitised structures: Extending the investor base to DC plans and retail investors
Apart from asset owners, asset managers also invest on behalf of a variety of other investors with a preference for liquidity, low risk, e.g. retail investors and individual savers who are members of defined contribution schemes. Globally there is an increasing shift from defined benefit (DB) to defined contribution (DC) pension schemes (Broadbent and Palumbo, 2006[21]). By the end of June 2019, total assets in DC plans in the United States alone amounted to USD 8.2 trillion (28% of all pension assets in the United States) (NAPA, 2019[22]). Defined contribution8 plans represent a vast pool of long-term patient capital. However, as investment decisions are taken by the intended beneficiary9 instead of a trustee, possible sizes of investment are much smaller. Unlike DB plans, DC plans do not allow for allocating large sums of capital -- from hundreds or thousands of investors -- to a single investment.
Securitised vehicles like YieldCos, REITs and INVITs offer a possible channel to scale-up infrastructure investment through defined contribution plans. As per the empirical mapping presented in chapter 2, asset managers currently hold USD 128.6 billion of renewables through YieldCos – over 70% of their total investment in green infrastructure. The available investment data does not shed light on the share of YieldCo investments on behalf of DC assets. However, the investment characteristics of YieldCos align well with retirement-focused long-term investing. In addition, YieldCos, REITs and INVITs provide liquid access to physical assets with regular distributions and opportunities for capital appreciation. This liquidity is necessary, as DC beneficiaries can alter their allocations periodically. Further, securitised structures offer exposure to operationally intensive assets without the need for any specialised skill, monitoring and oversight by the unit-holders. Securitised vehicles can offer a good fit to DC beneficiaries, thereby expanding the set of investors that can invest in infrastructure.
Traditional assets have posted declining returns since the aftermath of the 2008 global financial crisis. The COVID-19 pandemic is expected to compound this trend, highlighting the need for including alternatives with higher returns in long-term portfolios. Current market conditions provide fertile ground for the uptake of financially viable distribution-based vehicles10, especially given their low correlation to traditional assets. (Wilshire Funds Management, 2016[23]) provide empirical evidence that inclusion of REITs and other high-yielding assets in DC plans can increase returns without elevating total risk. To support green infrastructure investment, policymakers could evaluate allowing inclusion of liquid alternatives in DC plan offerings. Asset managers could welcome the opportunity to provide innovative and green investment options.
Securitised products: Demand and innovation – Institutional investors as ‘recyclers of capital’
The case for securitised vehicles is also linked to the role of institutional investors as ‘recyclers of capital’. With their long investment horizons, institutional investors are well suited to free scarce construction stage risky capital for new investments. Project sponsors and other short-term investors can monetise operating assets by offloading them to the balance sheets of institutional investors. Mainstreaming YieldCos, INVITs and similar structures as instruments for this offloading process can be a helpful tool for bundling, scaling up and selling infrastructure investment. As highlighted in Figure 3.3, financial regulation including on securitised products is a key lever to shift and scale-up capital flows towards critical green infrastructure.
It is important to recall, however, that the financial viability and attractiveness of securitised structures are, at their core, a function of the soundness of the underlying assets. Steady supply of quality projects is critical to scaling-up securitised vehicles. In this respect, investment and infrastructure planning as well as infrastructure development policies are essential levers to shift and scale-up capital flows towards critical green infrastructure. They make a steady supply of projects much more feasible.
Securitised products: Demand and innovation – Leveraging the trend towards passive investment
There is a changing paradigm within the asset management industry, from active to passive strategies (Bloomberg, 2019[24]). Securitised vehicles with green infrastructure projects as the underlying assets can both leverage and contribute to this trend. Including more YieldCos, and other distribution-based vehicles like INVITs, in infrastructure indices and passive infrastructure ETFs can provide the means for a strong demand side push from asset managers. Inclusion of such vehicles would facilitate mainstreaming. Additionally, the availability of such liquid vehicles holding green infrastructure assets can aid creation of more passive ESG/sustainable investment products, possibly bringing in additional investors.
A corollary to the rising focus on infrastructure and green investments is increasing attention to the definition of ‘green’. The present landscape of sustainable finance definitions and standards is a diverse one marked by the coexistence of a variety of standards, definitions and guidelines both from the public and private sector (Martini and Youngman, 2020[25]).
More precise and consistent definitions of which investments are “green” could facilitate investment by giving confidence and assurance to investors, and avoid market fragmentation. Additional benefits could include easier tracking of green infrastructure investment to measure them or tailor policy actions to these investments. The current debate around the increased certainty on the environmental sustainability of different types of investments and economic activities makes clear that a common understanding of what is green infrastructure is key (Martini and Youngman, 2020[25]). Policy makers may have an interest in coordinating on issues around taxonomies and definitions, and could apply multiple tools, ranging from binding taxonomy to voluntary guidelines. A common understanding, developed in collaboration with industry stakeholders, would facilitate more straightforward communication and decision-making regarding investments and accelerating investment flows.
Further regulatory measures to increase transparency regarding “non-green” investments could highlight risks related to investments in fossil fuel-based or environmentally detrimental investments. Regulatory measures increasing transparency of these risks for investors could include the implementation of recommendations of the Task-Force on Climate-Related Financial Disclosures (Task Force on Climate-related Financial Disclosure, 2017[26]), ESG-related regulation, a brown taxonomy (see also Martini and Youngman (2020[25])) or forward-looking climate scenario analysis.
Direct action by public financial institutions is already used effectively to mobilise private and commercial capital towards policy objectives. Tapping into the full potential of this ability is more important in times of budgetary and fiscal constraints. In addition to financial regulation and investment and infrastructure development policies, the public sector can unlock private investment through financial and institutional innovation.
A range of tools and techniques are available to governments and other public actors to mitigate project-level risks (see box 3.2). From anchor investments and grants to blending and guarantees, public actors can use a suite of instruments to credit enhance projects and attract institutional investors (Röttgers, Tandon and Kaminker, 2018[27]). The choice of de-risking instruments is broadly guided by the extent of liability assumed by public funds. From first loss tranches over loans and guarantees to grants, the risk assumption by public funds can span a broad spectrum. Shrinking fiscal space and debt ceilings in many countries have however, reduced the latitude of public interventions (Wai, Cheng and Pitterle, 2018[28]; Roy, Heuty and Letouzé, 2007[29]; International Monetary Fund, 2018[30]). Governments can be reluctant to provide guarantees for infrastructure projects or may not be able to provide the concessional capital or other public support needed to promote nascent sectors. In this environment, it is critical for public funds to be used in a manner that: maximises the amount of private money leveraged; effectively demonstrates the attractiveness and feasibility of investments; and builds self-sustaining markets poised to expand significantly after de-risking and other supporting measures are phased out.
Institutional innovation provides one more avenue. Institutional innovation can include setting-up a (public) green investment bank (GIB), a green window in an existing DFI, or a strategic investment fund (SIF). GIBs are specialised entities with a targeted and dynamic mandate (OECD, 2017[31]). This allows them to design and deploy a variety of interventions to respond to evolving market needs. While the mandate of GIBs can vary depending on the country context, it is the flexibility and latitude for innovation that makes them agile and effective in fostering new sectors and leveraging private investment (OECD, 2016[32]) (see box 3.1). An alternative to establishing a GIB is creating a ‘green window’ within an existing development finance institution, for instance as seen in India (Ministry of New and Renewable Energy, Government of India, 2019[33]). Through this approach, the existing sectoral, operational and institutional expertise of DFIs is leveraged to deploy bespoke green interventions in priority sectors.
Another approach is establishing SIFs. A SIF is a fund created to invest alongside private investors in priority sectors. Modelled along the lines of private equity funds, SIFs operate to mobilise private capital towards policy objectives while maintaining a commercial focus (Halland et al., 2016[34]). In many countries SIFs (e.g. Ireland Strategic Investment Fund) actively originate deals and focus on greenfield infrastructure. By carefully considering the purpose and mandate of an SIF, policymakers can effectively crowd-in private money (OECD, 2020[35]), lower investment risk and eventually cost of capital.
In addition to governments, multilateral financial institutions play an important role in mitigating risks and catalysing investment (Röttgers, Tandon and Kaminker, 2018[27]). MDBs may develop initiatives and facilities by themselves or jointly with the private sector- a relatively new approach. Public-private initiatives, such as those developed in the CPI Global Innovation Lab11 or the World Bank Group’s Scaling Solar programme12 are examples of this, as is the recently launched “FAST-Infra” (Finance to Accelerate the Sustainable Transition – Infrastructure) initiative13.
Accelerating green infrastructure investment requires interventions on both the supply and the demand side. While much attention is paid to the need of improving supply of assets (creating pipelines of investment-grade projects), demand side interventions must evolve in tandem to foster an infrastructure investment ecosystem that efficiently allocates capital at the pace and scale needed. The central idea here is matching the right kind of investor with the appropriate project risk.
Every stage of a project’s lifecycle carries different types of risks. For instance, during the construction stage a project has an elevated risk profile that is unsuitable for institutional and retail investors. Short-term financiers like project developers and banks have a higher risk tolerance (i.e. are willing to take on higher levels of risk in exchange for higher returns) and are much better placed to fund construction. However, once a project is operational, its risk profile becomes more acceptable to long-term investors like pension funds and insurance companies. At that stage, the project can be re-financed by these investors, freeing up scarce project development finance for other projects. Secondary markets play a key role to activate this concept of ‘recycling capital’. As discussed below, a well-functioning secondary market for infrastructure is pivotal to offload operational assets to long-term investors and recycle capital. Efficient secondary markets could optimise risk pricing and reduce the overall cost of capital for infrastructure projects.
The public sector has a role to play in developing secondary markets for sustainable infrastructure. Australia’s Clean Energy Finance Corporation (CEFC) and New York State’s Green Bank provide two such examples.
Creating Secondary Markets for Sustainable Infrastructure in Australia – The Role of CEFC
In 2018, the National Australia Bank (NAB) bundled eight loans it had extended to seven renewable energy projects, into a portfolio worth AUD 200 million. The bank packaged 75% of the portfolio into a close-ended investment vehicle that issued project bonds to private investors, including institutional investors. CEFC made an AUD 90 million cornerstone investment in the offering to catalyse institutional investors. Insurance Australia Group, the largest insurance company in Australia, invested AUD 50 million alongside CEFC. In a first for Australia, the NAB low-carbon shared portfolio provided institutional investors an opportunity to get exposure to clean energy infrastructure without investing in single projects directly. The loan repayments provided by underlying projects are passed-through to institutional investors and other bondholders. NAB retained 25% of the portfolio on its own balance sheet and absorbed the management costs. The transaction allowed NAB to free-up capital to finance new projects by shifting assets to investors with commensurate risk appetite.
Creating Secondary Markets for Sustainable Infrastructure in US – The Role of NY Green Bank
Launched in 2014, the NY Green Bank has a specialised mandate to leverage private capital and expand clean energy markets. To that end, the NY Green Bank provides long-term refinancing to clean energy projects with merchant risk to facilitate their acquisition. The NY Green Bank targets operational projects that do not benefit from long-term offtake agreements and are exposed to market risk. More specifically, NY Green Bank refinances projects along with commercial banks in order to demonstrate the viability of long-term refinancing of clean energy projects with merchant risk. Through its interventions, the NY Green Bank aims to (i) improve liquidity in the secondary market; and (ii) spur large-scale deployment of renewables by signalling to project developers and financiers that there is enough capital available for new projects to be refinanced and/or acquired.
Source: https://www.cefc.com.au/case-studies/nab-low-carbon-shared-portfolio-opens-up-investment-opportunities/ ; https://www.iag.com.au/sites/default/files/Documents/Climate%20action/IAG_Climate_Action_Plan_October_2018_1.pdf;
https://www.climatebonds.net/files/files/2018-06%20AU%20NAB%20Trust%20Services%20Limited.pdf;
https://news.nab.com.au/more-investment-in-renewable-energy-projects/;https://greenbank.ny.gov/Investments/Portfolio; https://greenbanknetwork.org/ny-green-bank/
Based on empirical insights from Chapter 2, this chapter proposes three independent but interlinked pathways for scaling up institutional investment in green infrastructure, in addition to overall climate policy and climate investment incentives: Green pipelines, Mandates and Securitised products.
The Green pipelines pathway aims to address the limitation of sufficient investment grade projects. Without a robust pipeline of available infrastructure projects, costs of capacity and skill development are difficult to justify based on one-off investments. Aside from certainty on overall climate policies such as carbon pricing, higher certainty of follow-on projects would allow investors to take calculated risks on investments in these factors. Additionally, a robust pipeline of investment grade projects could help address currently high valuations of projects and therefore allow higher returns, making infrastructure attractive over other investments. It would also allow partnerships of investors to form, which can be effective ways to share risks or otherwise share costs of infrastructure development.
The role of policymakers in building robust pipelines is to provide or support leadership, transparency, eligibility criteria, project support, prioritisation, and dynamic adaptability. Providing risk-mitigation could be particularly useful interventions by public investors. Depending on the state of PFIs in a given jurisdiction, this may require institutional innovation, e.g. adjusting mandates of public financial institutions or forming a new institution like a green investment bank.
The Mandates pathway also aims at leveraging the role of asset owners as principals in their relationship with asset managers and investment consultants. Asset owners’ mandates form the basis for capital allocation decisions of asset managers and investment consultants. Critical to integrating climate and development objectives in investment decisions is the selection of asset managers and investment consultants. Clarification on the relationship between fiduciary duty, duty of care and consideration of climate-related risks could help greening mandates if permissible from a regulatory point of view.
The Securitised products pathway aims at tapping investors with a preference for liquid investment products. Aside from general preferences that asset managers show for liquid investments, securitisation could in particular capitalise on trends towards defined contribution pension plans and passive investment. Securitisation would allow not only to finance infrastructure through liquid products, but also facilitate adjusting to the small scale necessary for these types of investments, in particular to the scale of DC pension plans. YieldCos, and other distribution-based vehicles like infrastructure REITs and INVITs, could be useful instruments in this regard.
To avoid market fragmentation, for securitised products and otherwise, more precise and consistent definitions of which investments are “green” could facilitate investment by giving confidence and assurance to investors. A common understanding, developed in collaboration with industry stakeholders, enables straightforward communication and decision-making regarding investments, accelerating investment flows. The EU Sustainable Finance Taxonomy is the latest example of a policy with this aim.
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Notes
← 1. Analysis in this report should not be misconstrued as investment advice.
← 2. Unless stated otherwise, the term YieldCo in this report refers generally to the legal structure that enables securitising illiquid physical assets, and not to any particular vehicle or strategy in existence in the market either presently or at any time in the past.
← 3. A private placement is a direct sale of securities to an investor, as opposed to a sale at public markets.
← 4. Across all infrastructure strategies, i.e. core (very low risk portfolio), core plus (low to moderate risk), value-add (moderate to high risk), and opportunistic (very high risk); authors’ calculations based on Preqin (2020).
← 5. Authors’ calculations based on Preqin (2020).
← 6. OECD publications on policy frameworks to enable investment includes but is not limited to OECD (2015[39]), Ang, Röttgers and Burli (2017[6]), OECD (2018[8]), OECD (2016[10]). Initiatives aimed at addressing the challenge include the Climate Investment Platform (https://www.climateinvestmentplatform.com/).
← 7. Examples of such initiatives include Blended Finance Taskforce, Climate Investment Platform, Closing the Investment Gap, and FAST-Infra (formerly VERT-Infra; see also below).
← 8. Excluding collective defined contribution plans
← 9. Investment decisions are delegated to a trustee in the case of collective defined contribution plans.
← 10. Distribution-based vehicles generally distribute most or all of the operational cash-flow to shareholders.
← 11. https://www.climatefinancelab.org/about/how-it-works/
← 12. https://www.scalingsolar.org/news/
← 13. https://www.weforum.org/agenda/2020/09/how-to-drive-investment-into-sustainable-infrastructure/
