House of Commons - The Green Investment Bank - Environmental Audit Committee

The Green Investment Bank - Environmental Audit Committee Contents

2 A Green Investment 'Bank', not a 'fund'

18. There has been much debate about whether the Green Investment Bank will be a 'bank' or a 'fund', including it seems within the Government (paragraphs 37-39). Investment 'banks' raise their own finance from capital markets and create financial products for investors. They use this finance to lend money, or to invest in companies or financial products, in order to make a financial return.[25] A 'fund' would have finite resources, which would be disbursed as grants, loans or investments aimed at specific purposes.

The advantages of a 'bank'

19. The overwhelming majority of our witnesses supported the Green Investment Bank being a 'bank', able to raise its own finance, and not just another 'fund' to disburse government funding. They identified a range of benefits, as follows.

A BANK IS ABLE TO RAISE ITS OWN FINANCE

20. The Spending Review 2010 announced that the Government will capitalise the Green Investment Bank in 2013-14 with £1 billion, together with proceeds from the sale of government assets.[26] The Economic Secretary to the Treasury was unable to explain to our satisfaction the basis for the £1 billion figure. She told us that it would be "unwise" to provide any details of the assets to be sold or when proceeds would be available.[27] Giving details could prejudice the Government's commercial position during the sales.[28]

21. Ernst and Young estimated that over the current Spending Review period (until 2014-15) the Green Investment Bank would require capitalisation of £4-6 billion in order to tackle the investment barriers in offshore wind, carbon capture and storage and associated infrastructure, and large-scale roll-out of micro-generation and energy efficiency[29] Green Alliance believed that £1 billion plus further unspecified amounts in a fund, without the ability to raise its own funds, would not solve the green infrastructure funding problem.[30] The Aldersgate Group, similarly, believed that £1 billion alone, without being topped up from any additional proceeds, would be unlikely to lever in finance at ratios achieved by other development banks, such as KfW (the German state-owned development bank) and the European Investment Bank.[31]

22. Capitalising the Green Investment Bank with £1 billion, plus unknown and unspecified proceeds from the future sale of government assets, will only be enough to start to lever in the scale of private sector finance required if it is able to operate as a 'bank'. The Government must keep the level of capitalisation under review, and be ready to increase it as soon as the fiscal position allows.

A BANK IS ABLE TO RAISE FINANCE QUICKLY

23. Gordon Edge from RenewableUK told us that a Green Investment Bank would be needed to help deliver the investment in green infrastructure at the pace required:

[...] if we had all the time in the world, we could probably do that investment, find vehicles for the investment and the institutional investors to come into the market. They'd get used to the risks; they'd work it out; they'd find the right structures. But we don't have the time. It is because we need to be building this stuff at the pace, certainly according to the timeframes of the institutional investors, of a sprint that we need that aid, that buying down of the risk through a governmental or quasi-governmental institution.[32]

A BANK WILL BRING IN EXPERTISE

24. Green Alliance considered that the barriers for financing green infrastructure were different from those that existed five years ago. A Green Investment Bank would help to bring finance expertise into government so that new barriers could be anticipated and tackled.[33] Sir Rob Margetts from the Energy Technologies Institute noted that a well-run bank, rather than a government fund, would bring in professional skills from the private sector to help make judgments about projects.[34]

A BANK WOULD SIGNIFY INDEPENDENCE AND PERMANENCE

25. The transition to a low carbon economy is a multi-decade project that requires a long term redirection of private capital. If the market is to develop confidence in the longevity of Green Investment Bank investments, then isolating the Bank from day-to-day political interference would be essential. This is particularly important for attracting the capital in pension and insurance funds which seek investments over a longer term.[35] A Treasury-controlled fund, with finite resources allocated only for the four years of a Spending Review period will not have the permanence to satisfy investors that it will be a lasting and safe place for their money. Investors will work on the assumption that any money allocated by a Government could be taken away again in the next Spending Review.[36]

26. Independence from Government will remove any suspicion investors have that the Green Investment Bank is, as one witnesses called it, the "plaything of politicians"[37] European investment banks have a clear governance structure that separates government from those banks,[38] an issue we discussed on our visit to KfW in Germany (Annex A).

A BANK CAN OFFER A WIDER RANGE OF INTERVENTIONS

27. Ingrid Holmes from E3G supported the case for a Green Investment Bank that could provide a range of tools to back policy, and remove risks for investors. She pointed out that the Bank will need to be able to do things a fund would not, such as making equity and debt investments, providing technical assistance and packaging loans and selling these as bonds to investors.[39]

A BANK WOULD BE ABLE TO FILL THE GAP IN THE MARKET FOR GOVERNMENT-BACKED BONDS

28. The most important advantage of a 'bank', however, would be its ability to issue 'green bonds' to attract significant sums from the private sector. Green Alliance argued that:

The Bank needs the powers to issue Green Bonds [to] give the institutional investors a vehicle by which to invest in the low carbon economy. At the moment, it's very easy for pension funds to invest in the high carbon economy [...] It's very hard for those large pools of capital to access the low carbon market at the moment.[40]

29. David Paterson from the National Association of Pension Funds told us that there is an undersupply of long-dated, index-linked securities (for example bonds) that pension funds can hold to maturity. Providing a strong government guarantee, or government backing, for these securities would make such investments more attractive to investors. There is a gap at that end of the market.[41] For example, green bonds issued by the World Bank, the European Investment Bank and other institutions have been bought up by the New York State and European pension funds.[42]

30. The Green Investment Bank needs to be a bank, able to raise its own finance, fill a gap in the market for government-backed bonds, bring in banking expertise, be permanent and independent from government, and have the flexibility to offer a range of interventions.

Raising private finance—Green Bonds

31. A bond—effectively an IOU—is a formal contract to repay borrowed money, with interest, at fixed intervals until it reaches maturity. Bonds are bought and traded mostly by central banks, pension funds, insurance companies and banks. A 'green bond' is a bond whose proceeds are ring-fenced for green projects.[43] The Green Investment Bank Commission suggested that well-structured green bonds would be a key way of accessing the £1.5 trillion of assets managed by UK pension funds.[44] (The Green Investment Bank could also raise finance through other types of financial product, Green ISAs for example, which we discuss more fully in Part 3.) As the Green Investment Bank Commission explained:

Pension funds and life insurance companies have long-term investment horizons with liabilities averaging 20 years or more. Their investing is naturally driven into equities and long-term bonds, which fits well with climate-related projects [...] The lack of supply of high-quality sterling bonds is driving such funds to invest in non sterling assets [...] [This] suggests the existence of substantial potential demand for bonds issued by the Green Investment Bank—up to £10 billion per annum on some estimates.[45]

32. The BT Pension Scheme, the largest corporate pension fund in the UK, emphasised to us the importance of designing green bonds to meet the needs of pension funds. Pension funds have a fiduciary duty to invest in the most commercially competitive bonds after considering price, credit risk and liquidity.[46] Our evidence suggested a number of practical considerations that a Green Investment Bank should consider in developing successful bonds that appeal to pension funds:

The need to start early to kick-start the market and get investment flowing.[47] Pension funds approach new investment areas cautiously, so work needs to start immediately if the capital is to be available in the timeframe required.[48]
The need for a commitment from the Bank or Government to the long term issuance of bonds—to create an ongoing supply and liquidity, enabling the bonds to be traded.[49]
'Green' branding alone will not attract institutional investors. Green bonds should essentially resemble any other bond in the market so that big investors readily understand them.[50]
Pension funds and other institutional investors will require a good reason to shift from the types of investment they are already comfortable with such as gilts, private equity, venture capital and real estate.[51] They may need to be more financially attractive to offset any preconceptions of higher political or technological risk, or greater due diligence requirements arising from their unfamiliarity.[52]
Bonds must be long-dated to match investors' preferences.[53] Many of the Green Investment Bank's investments will take several years to produce a cash flow, and in the interim there may be a need for the Bank to cover the cost of servicing the bond.[54]
A guarantee or explicit Government backing behind the Bank's bonds may be desirable, because the Bank initially will not have a track record in raising bonds or have a credit rating.[55]

33. The last point—Government backing—is perhaps key. KfW, the state owned German development bank, has a government guarantee for its bonds. This underpins its 'AAA' credit rating, enabling it to raise finance from issuing bonds in the German and international capital markets (€75 billion in 2009).[56] The Government could provide a similar guarantee to investors that some or all of their green bonds or other investments in the Green Investment Bank would be protected. Such a guarantee would be particularly important early on, as the Green Investment Bank gets going and starts offering green bonds. Ingrid Holmes from E3G told us:

[...] a bank issuing bonds without any track record and without any rating will struggle to get people interested unless you have a Government guarantee in the first instance.[57]

34. A degree of Government guarantee would increase the Bank's credit rating and thereby lower the Bank's financing costs as investors would require a lower return commensurate with that lower investment risk. Without a government guarantee, it is unclear how the Green Investment Bank would achieve a sufficiently high credit rating.[58] There may be scope, however, for fine-tuning the depth of the guarantee, to take account of the prospective public/private classification of the Bank (Part 6) as well as to reflect a range of views on investors' risk appetite. There were different views on what kind of risk and return institutional investors would look for from green bonds. We were told that while some investors would seek 'AAA'-rated bonds, others may want a lower rating, perhaps 'A', to allow a higher return from them.[59]

35. We expect the Government to allow the Green Investment Bank, as a bank, to issue bonds to institutional investors to raise much of its finance. It is clear that they will need to be backed by a government guarantee, calibrated to make them still attractive while paying out low rates of interest, and also minimising the potential government liability (and the consequences for the fiscal deficit). The Green Investment Bank could be assisted by the Treasury's Debt Management Office, who could share their experience in packaging government bond ('gilt') issues to maximise the sums raised.

36. We recognise that setting up the Green Investment Bank as a bank, able to raise its own finance, is not a straightforward matter. How the Bank is likely to be classified in the National Accounts will impact on the Government's management of its fiscal objectives and will therefore be a key consideration. If the Bank is classified as within the public sector, then its borrowing will also be included; if it is classified as being in the private sector, then its borrowing will not. The Office for National Statistics (ONS) decides the treatment in the National Accounts, and the amount of government control over the Bank will be a key issue when the ONS makes its decision. This is discussed in more detail in Part 6.

37. Throughout the course of our inquiry there have been persistent reports of disagreement within government about whether the Bank will be able to raise money from the finance markets, due to such classification issues.[60] Bob Wigley put it thus:

[...] what's happening is an intelligent debate and analysis between a group of people who, as far as I can see, are all committed to creating a substantive Green Investment Bank that has a real impact over time but, on the other hand, safeguarding the savings to the public sector borrowing requirement, public sector net debt, and reduction of the deficit that has just been hard fought for through the Comprehensive Spending Review.[61]

38. When we questioned the Business Secretary on the debate as to whether the Green Investment Bank should be a 'bank' rather than a 'fund', he responded:

I want to make it clear that we see this as being more than a fund; that is a slightly false dichotomy, I think, between a fund and a bank. What we want to do is to deliver a range of financial products into the market and reinvest the proceeds [...] We certainly envisage it being a lot more than a fund. Certainly the analysis that has been done so far suggests that there is certainly a scope for—and a need for—borrowing over and above any injection from the Government in our additional allocation and in asset sales. Banks perform a variety of functions: they lend, they borrow, and this institution would do the same and it would certainly merit the label of a Green Investment Bank.[62]

The Economic Secretary to the Treasury told us that there was no difference of opinion between the Treasury and BIS about whether the Green Investment Bank should be a bank or a fund.[63] But the Business Secretary indicated that the need to take account of the fiscal position could entail a sliding scale of private funding as the position improved:

There is an immediate net debt objective that the Government has, a key fiscal target, together with deficit reduction, for 2014-2015, and we have to operate within that. We don't know what the fiscal position will be subsequently. I think we probably both assume it will be a lot better than it is now, and this will give a great deal more scope for institutions of this kind. We think of this in a long-term sense. It will have to start on a modest scale, partly because it has to establish its track record and its credibility, partly because it is operating within borrowing constraints. But over the long term it could well develop into a very substantial institution.[64]

39. It is clear to us from our many witnesses that the extent to which the Green Investment Bank is a 'bank' or a 'fund' is a key consideration as to whether the significant investment needed for the UK to meet its emission reduction and renewable energy targets will be raised. We welcome the Business Secretary's ambition for the Green Investment Bank to be "a lot more than a fund", being able to lend and borrow. We recommend that Ministers deliver swiftly, and in full, on this ambition.

25 Q 34 [Mr Hewett] Back

26 HM Treasury, Spending Review 2010, Cm 7942, October 2010, paragraphs 1.41 & 1.42. Back

27 Qq 228-230 Back

28 HC Deb, 28 February 2011, col 295W. Back

29 Ernst and Young, Capitalising the Green Investment Bank: Key issues and next steps, October 2010, p iii. Back

30 Qq 6, 13 Back

31 Qq 13, 34 Back

32 Q 28 Back

33 Q 26 Back

34 Q 45 Back

35 Ev 127 Back

36 Q 34 [Mr Hewett, Green Alliance] Back