Written evidence submitted by the Sustainable
Development Commission
INTRODUCTION
1. The Sustainable
Development Commission is the Government's independent adviser
on sustainable development, reporting to the Prime Minister, the
First Ministers of Scotland and Wales and the First Minister and
Deputy First Minister of Northern Ireland. Through advocacy, advice
and appraisal, we help put sustainable development at the heart
of Government policy.
2. The Commission,
as well as publishing several reports on the technical and economic
issues around energy technologies has also examined the scale
and speed of the low-carbon investment required in the UK
(see http://www.sd-commission.org.uk/publications/downloads/SND_booklet_w.pdf).
The Commission also put forward proposals for a Green Investment
Bank in the 2009 "Breakthroughs" Report (see http://www.sd-commission.org.uk/pages/breakthroughs.html)
and examined what role a Green Investment Bank could play in effecting
a step-change in neighbourhood energy efficiency and renewable
investment and wider community retrofit programmes
(see http://www.sd-commission.org.uk/publications/downloads/SDC_TFiL_report_w.pdf)
The significance of any barriers or "market
failures" requiring the establishment of a Green Investment
Bank, and any risks of not getting this done quickly
3. We identify five barriers to low-carbon investment
that requires the establishment of a Green Investment Bank: the
scale of investment required to stay within the UK's carbon budgets
and meet international agreed targets; the speed with which investments
must be made for the same aim; the inability of the market to
respond to the uncertainty (as distinct from probabilistic risk)
of climate change; the need for aggregation of smaller projects
to attract investment; and current institutional structures that
are not designed for a low-carbon future.
4. Assessments of the scale of investment required
to meet target reductions in carbon emissions vary but all of
them represent an immense challenge. Economist Dieter Helm and
others[65]
provide an "extremely conservative"
estimate of £264 billion for the required UK low carbon energy
infrastructure spend by 2020. Ernst and Young's assessment that
£450 billion in low carbon investment is required until 2025
includes £225 billion in energy "supply side" investment
and £225 billion in energy efficiency "demand side"
investment.[66]
5. These figures are made more difficult both
by current lending conditions, as the economy emerges from the
financial crisis, and the inability of traditional sources of
capital (utility companies, project finance and infrastructure
funds) to provide a small percentage of the total required. Ernst
and Young's analysis identifies an investment gap of between £370
and £400 billion between now and 2025. A Green Investment
Bank could be structured to appeal to the widest and deepest sources
of capital such as the managed funds market in the UK (which is
worth £3.4 trillion) by raising bonds in the capital markets
and co-investing in low carbon assets with the private sector
on behalf of the UK. A fund structure, for example, does not offer
this opportunity to achieve the appropriate scale.
6. The speed at which investment needs to occur
is both crucial and daunting. Globally, low carbon industries
would have to grow immediately at 24% a year, which is near the
upper limit of what can be feasibily achieved given constraints
in resources, labour, skills, capital and equipment.[67]
Although challenging, the transition is achievable, and experience
in other countries have shown that industry can rapidly scale
up if the appropriate policy and finance is in place, leading
to widespread job and wealth creation. Incremental improvements
under current government policies and structures will not be sufficient
to deliver such accelerated growth and the Government cannot rely
on price signals alone. We share the concern of the Committee
on Climate Change that the impact of the recession on carbon emissions
may lead to a temporary slowing down of the low-carbon investment
that is required now in order to meet what will be far more challenging
carbon budgets beyond 2020.
7. Uncertainty, as opposed to probabilistic risk,
and the potential for significant, irreversible and non-linear
impacts that characterises climate change cannot be addressed
in existing risk assessment and cost benefit analysis. The Green
Investment Bank can begin to move investment decisions toward
addressing these threats by developing a number of risk-sharing
and other financial products. In the absence of an institution
such as the GIB, the UK low carbon sector will not be able to
access institutional capital on the speed or scale required.
8. Aggregation is
also a barrier. Energy Efficiency "upgrade" investments
in millions of UK buildings amounting to more than £100 billion[68]
in the residential sector alone require a very high degree of
coordination between individuals, private companies and public
policy. The challenges of aggregation, distribution and payback
of funds as well as deal execution and transaction cost management
are surmountable, but it is difficult to see how the current institutional
framework and capital markets can deliver. There are numerous
SME energy projects, both commercial and community based, which
have been consented but cannot move forward due to lack of credit
finance. Small projects have struggled to get engagement from
the banks, let alone raise necessary finance. Each project may
be relatively modest in output, but with a far higher number of
potential developers and project sites, the aggregate results
can plug a vital gap in our energy supplies - at a far quicker
pace - than the larger, slower projects favoured by utility developers.
9. Current institutional structures also form
a barrier that the Green Investment Bank can help overcome. Public
sector finance is shrinking and private sector finance continues
to de-risk. The relationship between the two needs to be renegotiated.
This means that the Government must, in addition to strong climate
change policies, use limited public funds effectively and mobilise
private sector capital flows at scale to ensure value for money.
Policies directed at easing the cost of capital will significantly
lessen the overall cost of the transition to society. A Green
Investment Bank has the ability not only to engage with managed
fund finance but also build a new relationship with private sector
finance more broadly. A conventional fund model would not be able
to do this.
The objectives and roles the Green Investment
Bank should assume, the areas it should operate (and not operate)
in, and how its lending and investment decisions should balance
green benefits against financial risks
10. The GIB must be designed to provide the greatest
financial leverage and maximise the macro economic benefits to
the UK, the Bank should not be designed in isolation but in the
context of a range of policies aimed at removing barriers to a
low-carbon, resource efficient economy. Within this framework
we identify the following key roles for the GIB:
Helping to structure, in partnership with the private
sector, the financing of major projects to deliver the energy,
transport and other infrastructure investment necessary to achieve
a sustainable low-carbon transition;
Providing some initial capital or guarantees, as
part of multi-bank project financing for major renewable energy,
if it is clear that the private capital markets are unwilling
to take on the whole risk;
Helping Deliver the Green Deal by providing low cost
capital to minimise the costs to consumers as this remains a significant
barrier to its potential uptake;
Working in partnership to bundle small projects to
a scale that attracts wider investment interest;
Raising capital from government and investors;
Working closely with both Government policy makers
and the investment community to come up with innovative ways to
finance the major investment in energy efficiency, renewables,
grid improvements and public transport links that will be required
to deliver the Low Carbon Transition;
Providing loans, equity or venture capital to companies
seeking to bring a proven and demonstrated low carbon technology,
project or service to full commercialisation; and
Act as a central point of technical expertise and
advice to central and local Government on low carbon finance.
It should act in an advisory capacity to Government to ensure
new policy frameworks being developed are "bankable"
and should also have the ability to provide specialist assistance
and advice to the private sector on developing first of a kind
products to grow new low carbon markets.
The Green Investment Bank's investment priorities,
and whether and how the bank should support and foster areas where
the UK has emerging green technology strengths
11. As a priority it must unlock investment in
energy efficiency and renewable energy infrastructure - both large
scale projects but also smaller scale and community led schemes.
12. If developed effectively, a GIB could also
provide a supportive framework for many of the mechanisms for
ensuring low-carbon investment at a local level. For example,
with the Pay As You Save (PAYS) concept, the idea is that the
cash from PAYS flows to the intermediary funding vehicle which
then issues bonds (to institutions and other purchasers) or borrows
(from a bank). There would be potential for a GIB to loan money
to the intermediary funding vehicle in the early stage of the
project, which the vehicle would subsequently re-finance in the
capital markets. Some of the investment could be longer-term and
be retained by the GIB. The GIB could also play a role in setting
up and managing the intermediary vehicle. Given the amount of
time required to establish a GIB, the European Investment Bank
(EIB) could provide immediate support in these roles. Joint European
Support for Sustainable Investment in City Areas (JESSICA ) could
also be utilised differently by funding pilots. Based on PAYS,
it could sell these cash flows to an intermediary funding vehicle
or GIB, which would then refinance in the capital markets.
13. In turn, the GIB could be useful in disbursing
Green Bonds that can unlock the long-term "patient capital"
required by pension funds for investment in low carbon projects
with a high upfront cost, but a long and steady payback period.
These would be conventional bonds (to attract a wide range of
interest), but with funds ring-fenced to deliver sustainable outcomes.
Climate Change Capital and E3G recommend that a GIB would be the
most effective way to disburse funds from these in a direct, controlled
way.[69]
14. Neighbourhood partnerships could also seek
development debt from a GIB, who would bundle the mature revenue
producing assets and sell these to institutional investors, recycling
the proceeds into new developments and providing a return to communities.
The funding and governance structures required
to create an effective and accountable body, including the role
of "green bonds"
15. UK institutional investors, such as pension
funds and life insurance companies, hold assets worth over £2
trillion. The low carbon energy transition will only be achieved
if some of this large pool of capital is used to support it. To
achieve this the Bank must be given the powers to issue a range
of Green Bonds. Such products should be designed to meet institutional
investors' needs, including their fiduciary duty to achieve the
best possible risk adjusted returns for their clients and beneficiaries.
16. Ring-fencing the proceeds from long-term,
asset-backed bonds that are issued at sufficient scale will not
only attract a range of significant investors but also provide
significant flows of capital for low-carbon investment.
18 October 2010
65 Dieter Helm, James Wardlaw and Ben Caldecott (2009)
Delivering a 21st Century Infrastructure for Britain (Policy
Exchange). Back
66
Capitalising the Green Investment Bank (Ernest and Young) (2010). Back
67
Climate Risk (October 2009) Climate Solutions II: Low carbon
re-industrialisation. Back
68 SDC
(2009) A sustainable new deal. http://www.sd-commission.org.uk/publications/downloads/SND_booklet_w.pdf Back
69
Climate Change Capital and E3G (as before), 2009. Back
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