Written evidence submitted by Kirsty Hamilton
RE FINANCE PROJECT
SUBMISSION ON A GREEN INVESTMENT BANK
SUMMARY
Background on the RE Finance Project: relevance of
its work for the Inquiry.
The importance and relevance of:
Objectives and role: a GIB should solve actual problems
in the marketplace that private financiers cannot overcome at
present. General phrases like "low carbon", or "green"
infrastructure will need defined, and understood with precision;
The centrality of understanding the interaction between
energy policy developments and the GIB, and how government clarifies
its expectations over what each "piece" is expected
to deliver in terms of investor behaviour, any GIB entity may
be less effective if considered in isolation from tackling overall
sources of risk in projects;
Timing and timeline: this is a critical factor and
needs fully understood in the context of a realistic timeframe
for the establishment of a GIB; and also when its resources would
need to be deployed. This is key for any role linked to Round
3 offshore wind, should that become a focus of the GIB;
Building confidence and momentum: an announcement
of any GIB and the timeline until its establishment must not undermine
existing investment momentum;
RE infrastructure and specific areas of activity
("products"): two areas in particular have come up as
those that could assist round 3 offshore wind;
Brief comment on simplicity: governance and structure.
1. Background
1.1 By way of background, I am an Associate Fellow
at Chatham House, and have 20 years background in the UNFCCC climate
process, as well as climate and energy policy across that period
(many years outside the UK). I have been running the Renewable
Energy Finance Project for the last five years at Chatham House,
working with leading, mainstream renewable energy (RE) financiers
on policy conditions for investment.
1.2 The resolution of this work has been at the
level of actual policy debates that affect investment decisions:
the first finance roundtable on the UK was in 2005, during the
first review of the Renewables Obligation (RO), by way of example.
1.3 Financiers have primarily been those that
have led investment in the RE market (UK, EU) from project or
structured finance within banking, and specialised private equity.
Synthesised, this work led to a view on the importance and characteristics
of "investment grade" policy.[77]
1.4 Financial crisis and the Green Investment
Bank: following the financial crisis, the significantly changed
investment conditions were explored in some detail, to contribute
to accurate, early input to policymakers (Q1 2009) focusing on
the role of government in the context of financial conditions
(rather than simply resolving policy-related factors).
1.5 During Q4 2009 and Q1 2010 more detailed
work was done looking ahead to 2020, examining investment issues
in the context of the UK's 2020 commitments under the EU Renewable
Energy Directive. The Green Investment Bank (GIB) was discussed
in that context, ie understanding the underlying issues/problems
that exist (a range of views) and therefore what pieces need to
be or can be put in place by government, including public finance
tools (the summary of these discussions is appended to this submission).
Towards the end of this period, February/March, the Wigley Commission
got underway, and financiers were brought into the debate in a
slightly more structured way, including those that had been also
providing views in this area, eg through the Energy, Environment
and Technology Board of the British Venture Capital Association
(BVCA).
1.6 The purpose of this submission is to pass
on to the Committee two relevant outputs of this work, reflecting
the perspectives of financiers involved in RE transactions:
"Starting point on the 'Green Investment Bank'
discussion, Working Summary, March 2010.
"Offshore Wind: RO/FIT Finance Survey, October
2010, this reflects the view on capital requirements/constraints
for the offshore wind sector, as well as a question on the GIB.
It also reflects the importance of the policy debate in investment
decisions.
It may be useful to state that both of these outputs
have been re-circulated to financiers and therefore can be seen
as an accurate, indicative range of views from a cross section
of financial institutions.
The Committee is interested in receiving written
evidence that looks at:
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;
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;
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; and
the funding and governance structures required to
create an effective and accountable body, including the role of
"green bonds".
2. Objectives and roles of a GIB
2.1 The focus of any GIB or public finance intervention
should be based on identifying first and tackling actual financing
problems in the marketplace; specifically those that are currently
an obstacle for private finance, and linked to delivering public
policy goals. The UK's obligations under the EU Renewable Energy
Directive is a case in point and the focus of this submission
and the two supporting documents is on the RE sector, with particular
attention to the offshore wind.
2.2 This means that the scope of the GIB must
be clearly defined in order to analyse the above accurately. Terms
like "green investment" or "low carbon infrastructure"
could include very different infrastructure or technology areas
(including within power generation, or within the various renewable
energy sub-sectors) that face different market barriers, and have
different financing characteristics and needs, and therefore implications
for capitalisation of the entity. Offshore wind has specific issues
relating to a range of risks particularly construction and technology
risk at present, and return expectations, that would not be the
same in other RE sectors, or indeed for energy efficiency.
2.3 Questions that may arise linked to objectives
include: is it to ensure that a tranche of specific infrastructure
projects get through to construction (e.g. to secure public policy
obligations/goals); or is it to facilitate any projects that come
forward from the private sector, if so will this be capped. Both
of these have implications for capitalisation. The recent announcement
in Germany that public finance institution KfW will provide Euro
five billion in credit for the first 10 offshore wind projects[78]
is very simple, clearly focused and aimed at targeting a specific
financing challenge.
2.4 The development of a GIB must have an explicit
intention to retain and build on current momentum in the existing
RE market. This means as much clarity as possible for private
financiers, early on, as to the functions and role of any entity
and the timetable of its rollout. This must including government
announcements: to avoid what was described one financier as "tragedy
by announcement" (in relation to another set of public finance
interventions following the financial crisis in the US) where
investment delays occur as further detail and operation is awaited.
"Crowding out" of private financial institutions is
a key issue, even if unintended. One might imagine being in a
financial institution negotiating an RE deal when a GIB is announced
and being asked to explain, eg to a credit committee, what impact
this new institution may have on the specific investment, existing
investments, or in terms of the investment environment going forward.
2.5 Finally, there are several "moving pieces"
in the policy debate intended to influence investment: not only
the GIB, but also Electricity Market Reform, and the question
of a shift from the Renewables Obligation (RO) to a feed-in tariff
(FIT) for offshore wind. It will be very important to clarify
what each of these tools is expected to deliver in terms of influencing
financing decisions, to ensure more detailed input from the finance
sector.
2.6 In both work on the Green Investment Bank
and the survey on finance views of the RO-FIT issue (October 2010)
financiers reinforce the importance and priority of tackling policy-related
risks directly through policy improvements (eg OFTO, planning)
given that this is the simplest solution to reducing many of the
risks impacting investment, which are policy-related. Indeed in
the RO-FIT survey, a GIB, while potentially useful, was described
as a "second order" issue, compared to tackling the
policy framework by some.
3. Timing and timeline: significance of any
barriers or "market failures" requiring the establishment
of a GIB; any risks of not getting this done quickly
3.1 Critical timing issues for capital deployment
in order to deliver public policy goals need to be identified
in detail. This would also have relevance if a "staged"
approach was intended in terms of the capitalisation of the entity.
3.2 The survey of financiers on RO-FIT for offshore
wind indicates very clearly that capital requirements (and therefore
constraint) will be most acute in the next two to five years,
linked to financing Round 3. The GIB as an intervention would
therefore have to be established, complete a detailed analysis
of the market in which it will operate, and be operational within
a timeframe mapped against this period.
3.3 There are mixed views on the nature of any
shortfall, with views ranging from the fact that project finance
can indeed supply UK offshore wind capital requirements, to various
well publicised estimates of very large capital requirements (often
for overall energy infrastructure) and therefore a substantial
shortfall compared to today's investment volumes. The large overall
figures need broken down into specific sectors, with detailed
"reverse engineering" to understand both the policy
and financing pieces that need to be in place, in what timeframe,
to secure investment.
3.4 For offshore wind supply chain issues, port
infrastructure, planning related factors and critically offshore
grid-related matters are consistently raised as key areas for
offshore wind. Any shift in support mechanism would also impact
investment decisions; reinforcing the fact these elements need
understood as a package.
FROM THE
OFFSHORE WIND:
RO/FIT FINANCE SURVEY,
QUESTION ON
THE GIB
Key issues for GIB
Objective: the basic issue of what the institution
will do remains the up front question from financiers; there is
a sense that the institutional should be run by commercially experienced
staff, with direct RE financing experience.
Need for focus: limited capital should be used very
carefully, eg "on a few strategic sectors" rather than
spreading limited money too thinly. There is general support for
a focus on the offshore wind sector and means to pull in larger
sources of capital.
Avoid competing with private finance ie crowding
out. Unsurprisingly this is a central issue ("only where
there is no financing availability, and only once this has been
proved….otherwise it will be a disincentive"). The unintended
consequence of the EIB intermediated loan framework is highlighted
in this regard (the three banks channeling the EIB monies are
able to offer preferable rates).
Adequate capitalisation: "Key is credible level
of capitalisation if we are talking guarantees provided by GIB.
Otherwise those guarantees have no real value. Distribution of
loans originated by banks a more realistic option for GIB if thinly-capitalised,
as acting as a conduit wouldn't require GIB to have substantive
capital."
4. Green Investment Bank's investment priorities
4.1 Two particular areas have been raised by
financiers in relation to offshore wind that may benefit from
public intervention: mitigating risk linked to the construction
period and the technology; and secondly providing a distribution
channel to reduce the amount of debt held on banks' books for
the long-term. The latter would free up that capital for further
investment, as well as potentially provide a conduit for larger
pools of institutional capital to enter the market. In addition
there is a view that equity co-investment is required if it is
assumed the utilities will play a dominant role in delivering
Round 3 offshore wind investment.
4.2 These areas, or others, need properly assessed
by financiers that are practitioners in the sector, bearing in
mind the need for clarity over the objective and to avoid unintended
consequences. Both the GIB Working Summary, and the RO/FIT survey
provide additional detail.
4.3 This debate is occurring as a key Round 2
offshore wind transaction is under negotiation in the latter part
of 2010. This is regarded in the market as a "benchmark deal"
given its size, the quality of the sponsors and the fact it introduces
construction risk and will therefore test the appetite of both
debt and equity providers. This will provide some important lessons
for the construction period, and the role of any GIB entity. In
the RO-FIT survey where this issue was raised there was a clear
view that the government will be able to learn from this in relation
to Round 3.
5. Funding and governance structures
5.1 In the context of how ambitious this entity
may be, or its future evolution, it might be useful to think about
simplicity and confidence building. In other words establishing
something that is relatively straightforward, facilitates projects
getting to completion that otherwise would not, is linked to the
achievement of clearly outlined public policy goals where this
may require a public finance intervention, and the inclusion of
a specified review period (and clearly defined review scope).
5.2 Lessons. There is now experience with both
PFI and Infrastructure-UK in the UK, as well as private financiers
working with EIB, and deals that involve EU export credit agencies
or other national public finance institutions. Some financiers
highlight the importance of capturing lessons from both the public
and private experience of these entities, in relation to both
structure, governance and operation. This may be drawn out through
submissions to this Inquiry, but is outside the scope of this
submission.
18 October 2010
77 "Unlocking Finance For Clean Energy: the Need
for 'Investment Grade' Policy", Chatham House Programme Paper,
December 2009; in addition a very short guide to the basics of
private finance of renewable energy was produced, published with
Bloomberg New Energy Finance and UNEP. Both of these are available
from:
http://www.chathamhouse.org.uk/research/eedp/current_projects/renewable_energy_finance_policy/ Back
78
Euro 5 billion credit programme "Offshore Wind Power",
www.bmu.de, 28 September 2010. This states that this facility
is "To allow investors to gain the necessary experience for
the competent management of the technical risks of offshore technology,
support must be granted for the speedy construction of the first
ten offshore wind farms. To this end the Kreditanstalt für
Wiederaufbau (KfW) will launch a special programme "Offshore
Wind Power" with a total credit volume of five billion euros.
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