The Fight for Climate Capital
The Just Finance Guidebook is a critical tool for policymakers and private sector executives seeking to understand the broad spectrum of issues around climate finance facing both LICs and MICs. The Guidebook is the result of months of intense collaboration among an extraordinary group of stakeholders. What follows is my attempt to lay out a series of best practice priorities for developing economy ministers that reinforce many of the themes and content contained within the Guidebook. This document reflects a personal perspective, based on a career of providing development finance advice to sovereigns.
Financial sovereign leadership is fundamentally about winning the competitive fight to attract, maximize and deploy scarce capital efficiently to the economy. For climate finance in the developing world, this intensely competitive dynamic of capturing and maintaining sustained investment is enormously complex, fraught with sometimes seemingly insurmountable challenges, particularly given the current torrential macroeconomic wind and plethora of externalities blowing against climate ambitions. Yet the fight must be fought. Ultimately, over time, like it or not, climate investment capital will flow faster across borders to the most ambitious, to those decision makers that develop a climate finance pathway with vision and clarity and then relentlessly execute against it. The contrary is true as well. In the course of implementing their Net Zero commitments, the potential for financial institutions and markets to “strand” sovereigns is high. So, if you are a senior government official with responsibilities in the areas of climate finance, what might your best practices be? What priority action steps improve your chances to fund both mitigation and adaptation policy objectives in a way that creates jobs, and increases the likelihood that you win the race to attract capital? What follows are eight best practices which should be considered:
1. Intensely Engage the Private Sector in the Development and Implementation of Your Nationally DeterminedContributions (NDC).
While the world is currently in crisis across many fronts, from food and energy to war and inflation, there is a long-term green investment paradigm shift happening below that crisis that will alter the flows of investment capital over time, as radically as did the industrial and digital revolutions. These green flows are up for grabs. In that context, as a sovereign, you should seek private sector input and support for your NDC and use it as a barometer to stress test viability and drive multi-party alignment toward its goals. NDCs are generally uneven around the world, without a guiding standard for best practice, making them often difficult to compare and qualitatively disparate. Many reflect tremendous integrated strategic planning, with cross-functional expert input and technical work that creates a strong backbone for the resulting sovereign commitments. Other NDCs are unfortunately pieces of siloed work that fall far short of any theoretical best practice. There must be a higher standard for best practice of NDCs, aided by the technical resources of international financial institutions. Remember, the NDC and the Long-Term Strategies (LTS) will ultimately have great influence over much of a sovereign’s future economic, social, financial, and political future. NDCs will lay the informational framework for how Net Zero- committed overseas private sector institutions will direct and deploy climate capital, away from you or toward you.
A glaring yet all too common flaw in the NDC development process is the degree to which sovereign decision-makers commit to a climate transition process and policy actions with little to no consultation or buy-in from the private sector. The potential of the private sector – including both local and global companies, and global and local financial service providers – to provide value to your NDC creation process, to help operationalize your NDC and to provide the backbone of the execution process is tremendous. The private sector can provide feedback on energy transition plans, mitigation and adaptation strategies, and assessments of their own contributing ambition. Most constructive and Net Zero- committed global corporations, banks, insurance companies and institutional investors are formulating detailed operating plans against their own goals and commitments. Many are preparing for significant disclosures and for markets to demand performance against their disclosed commitments, and they will invest accordingly, away from you or toward you. Private sector task forces should be set up to constructively engage sovereigns on the next phase of their NDC development and implementation. The aggregate plans of the largest private sector players in and of themselves will form a significant part of your country’s ability to deliver against your pledges.
As a Minister, imagine conceptually that in terms of FDI, the top 10-20 foreign direct investors in your country determine the bulk of the glide slope for the next decade of your climate commitments, and may largely determine the degree to which your country is able to achieve its Paris ambition. If those companies are not only consulted but embraced in the process of defining commitments, the credibility of NDCs will be markedly enhanced. For example, the global so-called “hard to abate” sector leaders in the world are developing sectoral pathways and developing massive technology capital investment plans. Of course, many of them are large investors and operators across the developing world and will allocate capital as they transition. If a fast-moving consumer goods company, as another example, is planning to invest in a facility where it knows it will have to roll up its product-level carbon footprint and disclose its Scope 3 emissions, it will most certainly compare the transition plans of the competing host country sovereigns before deciding where to invest. These multinational corporations’ investment strategies can make or break your ability to achieve your ambition. Iterative and intense dialogue is required to ensure that the investment planning process of multinational corporations is aligned in a way that benefits your country. That will require your intense engagement so that capital flows move toward you, not away from you.
2. Develop an Overarching Green Vision and a Sustainable Theme
A country can have a climate plan without a vision. However, a plan that is a demonstration of a focused vision can be extremely powerful; the secret sauce to attracting investment is a cohesive theme – a green vision around which projects are bundled and an attractive investment environment is created.
If you dissect the most important sustained and scaled investment programs in the world, they have extraordinary similarities. Be it banking hubs, technology centers of excellence, or trade and investment zones, if successful, they will have provided an enabling investment environment with a targeted geographical location, solid infrastructure, and a predictable legal, regulatory and tax framework. They will include partnerships with universities to ensure research, human talent and academia are deployed against established priorities. They will create an entrepreneurial environment that produces innovation and rapid capital formation. Those countries will have high standards of transparency and rule of law. In those successful thematic ecosystems, governments will have generally provided the initial roadmap, with a vision to catalyze the policies and planning, which will include directing funding and in-kind contributions, like real estate and investment incentives.
One ingredient in a compelling and enabling environment for investment is often underestimated and that is the power of an investment theme. If developing countries attempt to boil the ocean, with a shotgun approach of storytelling and initiatives around a myriad of sectors and projects that don’t hold together, they rarely succeed. On the other hand, countries with more focused visions around a theme clearly understood and articulated often succeed; from the Panama Canal to Silicon Valley, a clustered or thematic hub approach is a powerful driver. It also allows specific investor targeting rather than multi-investor group meetings. The thematic investment approach isn’t just true in logistics or technology, it is and will hold equally true along the sustainable investment journey. The theme can center around green hydrogen or green fertilizer, ag-tech accelerators built around a scaled agriculture initiative, or carbon credit market-making infrastructure built on the back of a planned coal early retirement plan. They can be nature-based themes that save oceans or forests. Themes can center around offshore wind farms or advanced storage research and development linked to local sustainable rare mineral extraction projects. The point is that the adaptation and mitigation themes are there for the taking and will provide an organizational discipline around which you attract sustainable and climate investments. The more advanced the country, the more themes can be handled simultaneously.
Egypt’s NWFE investment paradigm is a fantastic example of this thematic approach. It bundles energy, food, and water into an understandable construct, into a package of projects that tell an ambitious and cohesive story and provide a discipline around country priorities. It allows the grant and development finance community to align around a set of projects within the overarching vision, and then backs components of the package. It allows the private sector to assess individual projects within the context of a cohesive plan with synergies and a sense of momentum. This is a model approach that can be adapted broadly to a multiplicity of NDCs and even country Voluntary National Reviews (VNRs). The nexus between energy, water and food is also a paradigm that can be used beyond Egypt, as the three pillars are inextricably linked and the interplay between them mutually reinforcing.
Climate finance is often defined by the glass half-empty challenge of transition away from generations of fossil fuel-driven industrialization, and its resulting costs and breakage. Yet, those countries that organize themselves early to compete for what is likely to be the single largest investment paradigm shift of our time will come out net winners. The green investment boom will be driven through to emerging market countries that set themselves up as climate-friendly hosts to the Scope 3 conscious investors, and that are already reconstructing investment plans around rolling up their global carbon footprint and reporting it to Net Zero- committed investors. The dislocation and reallocation of economic investment will be as transformational as the industrial revolution, and the benefits of localizing scaled green technology investments will be tremendous.
3. Prioritize Project Development
The NDC is a climate strategy and the pathway to NDC implementation is through projects. The winners of the fight for green capital will be the sovereigns that prioritize new project creation and development, by conducting full feasibility analysis for each prioritized project. The priority should be to aggressively organize the government to develop NDC-meaningful projects, and then fund feasibility studies through grants, and target multilateral technical assistance to take projects to the stage where they can be financially assessed. This stage is often underappreciated, but it can’t be skipped. You can’t jump from “project concept” to structuring financing alternatives and catalytic funding strategies without a feasibility analysis; it is all too common for senior government officials to show bankers short concept papers for projects and ask to provide feedback on bankability. Project finance bankers, for example, looking to assess project viability and structure will expect a “data room” of plans, which would include the feasibility study and the operating financial model against which funding scenarios can be contemplated.
One of the greatest roadblocks or gaps in development finance is the shortfall in the development community’s resources allocated to accelerate project design and development. The scramble to design projects and the shortfall in capability is very similar to what has happened in the infrastructure space; the lack of global resources dedicated to project development in infrastructure has been a challenge for decades, resulting in years of frustration around the “lack” of bankable deals. The same is true now in the climate finance space. Whether developmental institutions pool resources and collaborate within a new structure, or they all dramatically increase their teams in this space separately is a choice to be made. However, regardless of where these resources sit, a global dramatic step up in specialized resources and funding for feasibility analysis and technical advice is required. Your country must call for and fight for these resources.
Several countries have commissioned consulting studies ahead of energy transition project design. These studies create an operational detailed multiyear energy plan around which projects can be constructed. With concrete and detailed project plans that fit into both the operational energy transition plan and the sustainability vision, it will be relatively easy to assess the viability of the NDC’s commitments, and to benchmark implementation progress. Keep in mind that NDC financing plans simply can’t be created without projects. The corresponding ability to attract official sector catalyzing capital and the soft circling of potential private sector funding associated with a country’s NDC will increasingly relate not just to the greenness of individual projects, but to the pathway ambition of the entire country.
4. Focus Relentlessly on Your Enabling Environment
As is the case in Egypt, and in many of the Just Energy Transition Partnerships (JETP), investors expect a local ‘enabling environment’ that is conducive to investment. This typically includes regulatory, tax, economic, political, and social requirements. It also must address the issues specific to the energy sector and its own enabling environment; this could include Power Purchase Agreements, regulatory requirements and stability, subsidy and tariff modification, disclosure requirements, grid investment requirements, and offtake agreements, etc.
As the JETP process is rolled out by the G7 and negotiations proceed with JETP-committed countries, several things are clear. One is that if this process works, whereby a country agrees to increased climate ambition in return for a specific developed country official sector support package around which private sector monies can be mobilized, then it can be replicated more broadly. The process at this point lacks a consistent framework where ambition is essentially priced transparently, but it is the right starting point. The JETP approach could eventually include more of the highest-emitting countries in the world and contribute greatly to accelerated deployment not only of the original $100 billion and beyond from developed countries, but also provide a framework for private sector engagement. The JETP process also forces a discussion of a true viable energy strategy that is unique to each country; it does not mandate a “jump to green” but a negotiated transition pathway that considers individual country needs and dynamics. Very importantly is that the JETP process encourages a difficult but necessary dialogue over the enabling framework of each country. GFANZ has begun to provide detailed feedback of what is required for the private sector to be crowded into the climate plans of countries in scale.
Where developing economies are often facing heavy debt burdens and funding constraints, it is inconceivable to develop an NDC that relies heavily on projects funded largely by the sovereign. Banks and financial institutions fund the real economy by funding private sector entities backing projects with sponsors capable of executing projects. In many cases therefore, the enabling environment is the skin in the game, and the sponsors, domestic or international, provide the funding, off-balance sheet or on balance sheet.
5. Seek Official Money to Maximize Mobilized Capital
As Chapter 4 makes clear, blended finance is hard. In addition, not all development capital is created equal. While all developmental tools ultimately can lower the cost of funding, they do so in ways that vary greatly in terms of efficiency. It is often easier for developing countries, particularly LICs, to take concessional loans and grants on a stand-alone basis rather than structure bespoke transactions that mobilize the private sector. That said, if a project has financial viability, in the age of scarce capital resources, blending is essential.
Imagine you are given a choice. On the one hand you can take a $1 grant, with no obligation to pay it back, but the likelihood that you may need that $1 dollar again and again every year. On the other hand, you can use that $1 as a risk buffer to mobilize flows of 5 to 8 times that much, creating an ongoing economic concern. Yes, you may even pay that $1 back so it can be recycled. The choice should be simple. Unfortunately, the capacity to structure transactions within the Official Development Assistance (ODA) community is still limited and there is no mandate from OECD sovereigns to significantly increase blending within the overall pool of grant money. We simply must change this dynamic.
On top of this, most MDBs are both mandated to and managed to lend, representing a clear bias toward concessional and senior lending. Funding models where only the private sector pain point is surgically dealt with in the capital structure by the MDBs and the rest is crowded in by the private sector would mobilize significantly more for your country. However, the current guidance given to the MDBs by their shareholders prevents them from taking the kind and size of risk that would give the developing world several times the capital of what they see now.
The recent G20 report on Multilateral Development Bank’s Capital Adequacy Frameworks has created considerable controversy and debate within developmental circles. It was long overdue. We now have a discussion in the public domain of what has been known and relatively ignored for years: development banks need to take more risk. The MDB risk construct backed into largely by a rating agency risk paradigm that targets a AAA risk rating has meant that many MDBs manage risk so conservatively, that it is often impossible for them to play a catalytic role that would maximize mobilized climate or sustainable capital. While GFANZ institutions are committed to operationalize their Net Zero commitments, those institutions are generally constrained by fiduciary and regulatory guidelines such that they ultimately take very little non-investment grade risk. Those that take non-investment grade emerging market’s risk are at, or near, their risk capacity, and the churn rate or redeployment of their non-investment grade exposure from brown to green is markedly insufficient to meet the developing world climate needs.
It is extraordinarily frustrating, if not maddening, for many LIC and MIC countries to hear, despite the trillions of Net Zero- committed monies from the financial community, that those funds have limitations on them that prevent them from meeting the extraordinary funding needs of the non-investment grade developing world. Changing the regulatory and prudential frameworks of financial institutions that were put in place after the financial crisis precisely to prevent them from taking weak credit risk is as unlikely as it is unwise. Nor is it the right thing for pension funds to tell their pensioners that they are ignoring their fiduciary responsibilities and investing in “B” country risk. Yet the world needs to solve this problem. We need to structure developing country climate projects such that the risk is mitigated enough to boost them up into the sweet spot of the bulk of the green capital appetite – investment grade. This is why we need blended finance structures that include capital layers that absorb risk and that provide a “junior” buffer. This won’t happen if MDBs are given more capital with the same risk model; that will result in more of the same.
Imagine that MDB success were truly measured not by deployed capital, but by mobilized capital, such that instead of taking predominantly senior risk, like that of a global commercial bank, MDBs truly took components of risk surgically targeted to maximize the amount of capital mobilized by the private sector. In that case, the pockets of tremendous risk innovation we have seen within the MDBs would be the norm, not the exception. I often say, we need one hundred MIGAs. This is because so many climate projects need sovereign non-honoring, political risk insurance or breach of contract protection. These so called “risk wraps” must be part of your tool kit.
Fundamentally, unless the shareholders of the MDBs mandate significant adjustments to the overarching risk capital construct, the resources that the MDBs have to unlock scaled private sector capital will remain limited. As G7 and G20 leaders are now more than aware of these issues, there is hope for change…maybe even around the corner.
In the meantime, financing of the likes explained in this Guidebook will be skewed toward the most proactive, the most creative and the most ambitious countries; if you want to win the fight for green capital you must put concrete projects into the MDB queue and fight for them.
6. Climate Finance SWAT Teams
Mark Twain said that history doesn’t repeat itself, but it does rhyme. In this case climate finance rhymes with infrastructure finance. Green finance is and will be fundamentally done on a project finance basis. The infrastructure funding challenges of construction risk, currency risk, long tenure, political and regulatory risk, off-taker risk, etc are by and large similar within the climate finance space. This means that the decade-old challenges of global developing world infrastructure and the need to utilize a variety of risk-mitigating tools to address those challenges all echo in the climate finance world. One helpful solution is for you to repurpose your infrastructure teams into a team of climate financiers. If you don’t have those resources, outsource components of it to local infrastructure investment banks or infrastructure boutiques. This can be extremely helpful in structuring climate deals toward bankability.
How much of the overall funding requirements for mitigation and adaptation initiatives within the NDC will be required from the government budget, how much and what type of official support is required, and how much official support is needed to mobilize from the private sector, are questions that can only be answered at the project level. Your government, as a best practice, should create a central team that can support these projects. A climate finance “SWAT” team would help centralize the best practices around the interaction with external financing agencies and entities, including Export Credit Agencies, local, regional, and global development banks, philanthropies, NGOs and Climate Funds. Don’t underestimate the power of Export Credit Agency know-how on the team, as many ECAs have insurance, low-cost funding and even comprehensive coverage capabilities.
Such a SWAT team could be housed in the Ministry of Finance, in the office of the Presidency, in your Sovereign Wealth Fund if you have one, or like in the case of Egypt, in a Ministry for International Cooperation.
7. Target International Sponsors
There is no question that the fiscal limitations and debt dynamics of the developing world limit the debt capacity and cost of climate finance projects done on the balance sheet of the government. The solution during this period therefore is to look for international sponsors, companies that have the ability to invest equity and operate projects. You need sponsors that will invest in the energy transition, mitigation and adaptation space. From renewable and green hydrogen projects to desalinization and large agroindustry projects, such as drip irrigation systems, there are large global sponsors that will show up to a competitive project if the enabling environment is acceptable and the process is well run. The more thematic the better.
Corporate investors can be given the responsibility to bring financing, and to work with ECAs, MDBs and other capital providers to manage their funding costs and risk. They can pool equity and debt with increasingly committed sovereign wealth funds. In addition to the enabling environment, part of the solution here is the vision. That has to be married with the incentives, or in-kind contributions that a government can make to incentivize bidders. The important point here is that while the sponsor may create an off-balance sheet vehicle, or invest on their balance sheet, such an approach avoids further fiscal and debt strains on the government. PPP initiatives and government agencies focused on this area are essential for this process to succeed.
8. Outcome Bundling
Climate capital of all kinds is now prepared to pay for outcomes. In fact, this may be one of the most important global trends in the move to fund Paris alignment. Investors aren’t just interested in knowing that their money is used purposefully against a sustainability objective. They want to achieve targeted outcomes. Outcomes can be greater ambition in an NDC for carbon pathways and emission reduction, or commitments around any one or multiple SDG targets, from more rhinos to more forests. Building on the concept established in ENEL’s first Sustainability- Linked Bond, whereby the funding is linked to a specific commitment (as opposed to a specific use of proceeds), now more than ever a variety of financing instruments and sources of capital can be bundled around a KPI that is measurable, verifiable and within the reasonable control of a government to deliver.
Bundling involves first finding an “outcome payor”, essentially an NGO or philanthropic organization that is willing to grant and/or lend concessionally against a chosen outcome; this anchors a funding structure that may include additional guarantees, loans or a bond that mobilizes more around the KPI. If you, as a sovereign, seek to achieve a sustainability or climate outcome and you are prepared to commit to it in return for funding that achieves a significant cost advantage over your market funding rate, then outcome bundling may make sense for you.
Of course, the bundling can include structures such as official debt exchanges for sustainable investment (debt for sustainability swaps) where part of the structure includes a sovereign that exchanges debt in exchange for the KPI or outcome. As was the case in Belize, such a structure can also include a debt buyback feature that takes advantage of the efficiently- priced capital to reduce deeply discounted market debt. In the future, these structures will create and imbed carbon credits that improve the viability of the transaction.
The type of entities that have a role to play in outcome bundling have grown significantly in recent years; they include NGOs and philanthropic funds, creditor sovereigns, UN agencies, climate funds and infrastructure funds, as well as national, regional, and multilateral development banks. In addition to ODA grant funds, there are philanthropic institutions and NGOs that are prepared to take a higher risk slice of the capital structure around which more loan and bond capital can be bundled. Organizing significant bundled funds around specific climate and sustainability objectives (linkages or outcomes) will require more standardization of governance and KPIs so as to decrease the time spent structuring and increase size and replicability of the transactions.
The current macro environment makes climate ambition and financing in the developing world extraordinarily challenging. Nonetheless, we can’t lower our guard or our ambition. The developed world will simply have to create constructs that radically improve the pace and scale for capital to flow into the developing world. Given the myriad of energy security issues which must simultaneously be considered, many countries will take two brown steps backward before they can take three green leaps forward.
There are core practices that if followed will make the difference between promise and peril. The peril of inaction may come sooner than many think, as regulatory, citizen or market action may come in waves, as so-called “tipping points” where brown activity is castigated not gradually but on a sudden basis.
The promise of a disciplined implementation of the above steps not only avoids the potential perils of climate change inaction, but will allow you to seize the significant benefits of green investment capital. This capital has many benefits that will inevitably flow to countries with ambition and a committed green pathway. And if you have ambition and follow the above steps, never stop fighting for your share of the green capital.
Jay Collins is Vice Chairman of Banking, Capital Markets and Advisory at Citi. The views presented here are his own.