Written evidence submitted by Consumer
Focus
EXECUTIVE SUMMARY
- A Green Investment Bank (GIB) should be used
to address the market failures in domestic energy efficiency.
There are three important market failures:
- Firstly, a low cost financing mechanism is needed
to develop immature industries like solid wall insulation. Because
of their high cost and long payback period homeowners will be
deterred from taking action.
- Secondly, some measures need geographic co-ordination
to achieve economies of scale. These include district heating
and some community climate change adaptations. (This will need
Defra to develop an appropriate regulatory framework).
- Lastly, the GIB might play an important role
in providing working capital to smaller and not-for-profit Green
Deal providers.
- Access to low cost finance and grants
is needed in addition to legislation allowing the Green Deal repayment
to remain attached to the house's energy bill.
- GIB needs to provide services in addition to
those supplied by the existing marketplace.
- GIB could explore the possibility of raising
capital funds from retail savers through green ISAs and public
sector pension funds.
INTRODUCTION
1. Consumer Focus is the statutory organisation
campaigning for a fair deal for consumers in England, Wales, Scotland,
and, for postal services, Northern Ireland. We are the voice of
the consumer and work to secure a fair deal on their behalf.
2. This submission covers those activities of
the Green Investment Bank (GIB) which might improve households'
and communities' access to funds to adapt to or mitigate climate
change gas emissions and any role households might play in providing
capital to the bank. We have drawn on examples from other countries,
especially Germany's KfW which might provide a useful template
for the activities of the GIB. Consumer Focus has no views on
the GIB's lending to business.
MARKET BARRIERS
- 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. There are numerous market failures that inhibit
homeowners or tenants from undertaking energy efficiency improvement
to their homes even if it appears they have a financial interest
in doing so. Reviews by the previous Government have highlighted
some of the supply side weaknesses (eg Commission on Environmental
Markets and Economic Performance (November 2007[15]))
such as the lack of capacity in suppliers and in the local Government.
There are also demand side weaknesses (see studies undertaken
for the Energy Efficiency Innovation Review, 2005; Oxera's paper
has a good overview of consumer barriers[16])
such as unfamiliarity with technologies, hassle costs, landlord-tenant
issues and poor access to capital.
4. There are three specific market failures that
the green investment bank could and should address.
5. Infant industry and the lack of supplier
competition: some of the technologies are likely to become
cheaper as the market matures. In time the production process
will be improved providing economies of scale and also there will
also be more competition amongst suppliers. This is especially
true of the retrofit solid wall insulation industry and some parts
of the renewable heat industry. In 2008 roughly 13,000 homes were
retro-fitted with solid wall insulation[17]
from a stock of around six million homes with solid walls. This
sector has a huge potential to save energy. The average installed
cost was £12,600 for individual homes. At present energy
prices the payback is 20 years or more, which would deter many
homeowners. We have also heard anecdotal stories that installers
charge high mark-ups because of transaction costs, associated
with the newness of the technology, and little local competition.
The commercial viability of renewable heat and solid wall insulation
is highly sensitive to interest rates. Low cost finance from an
investment bank tasked with growing a low carbon economy could
overcome "first mover" (both consumers and suppliers)
disadvantages and bring down costs and allow these technologies
to mature and become financeable from conventional sources.
6. Co-ordination: Communal mitigation
technologies like electric vehicle recharging points or district
heating networks have difficulty in accessing finance. Their projected
revenues are low in the early years and only build up as customer
numbers grow. Interest-during-construction and interest-during-market
penetration becomes a significant proportion of the total costs.
In both cases low interest finance greatly improves the viability
of the infrastructure, by providing working capital / bridging
finance while the revenue streams develop. Such investments could
be refinanced commercially when the customer numbers have grown.
The European Bank for Reconstruction and Development (EBRD) and
the European Investment Bank (EIB) have both financed such communal
low carbon assets.
7. Climate change adaptation measures like retrofitting
sustainable drainage systems (SUDS) to hard surfaces and green
spaces when they are renewed, offer a cost-effective opportunity
to reduce expenditures to manage flood risk in areas prone to
surface water flooding. At present it is a little unclear how
the savings from those liable for mitigating and compensating
for these costs: water companies, local government, homeowners
and home and contents insurers will be routed back to the SUDS
project sponsor. Work needs to be undertaken by Defra in establishing
the appropriate regulatory framework.
8. Working capital to improve hard-to-treat
buildings: energy efficiency projects in older buildings
will have a positive but unspectacular internal rate of return
(eg 4-8%). These might include improvements to the heating system,
draught proofing, underfloor and ceiling insulation, but will
judged as quite risky. (The Government is considering introducing
support through the Energy Company Obligation for solid-wall-insulation.)
Venture capital will not be interested in financing such schemes
because of the low rates of return. Other classes of investors
(eg pension funds) might judge these returns as adequate but not
be prepared to accept the project risk while the work is being
undertaken. The GIB might play an important role in providing
the working capital to Green Deal providers especially those
in the voluntary sector that could undertake low cost energy
efficiency work in their communities but cannot access working
capital. Once the work is complete the risk profile will change
(reduced dramatically) and could be refinanced through other funding
sources (like pension funds). The EBRD has routed its investment
through local retail banks which then lend to households and small
businesses. This might be alternate model rather than lending
to Green Deal providers directly. Such "credit lines"
to retail banks have been developed in Serbia, Bosnia and Herzegovina,
FYR Macedonia, and Montenegro[18].
Loans to households have typically been for €1500.
OBJECTIVES
- 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;
9. Government already has numerous policies to
incentivise or regulate particular "green" outcomes.
These include banded Renewable Obligation, landfill taxes, Feed-in-tariff,
possible renewable heat incentive, possible future floor prices
for EU-ETS and carbon reduction commitment. Project sponsors will
already take these incentives into account when devising a project
for investment. We don't see any virtue in providing further guidance
to the GIB aside from a general requirement to promote investment
in communities and business to achieve low-carbon and environmental
objectives. The objectives might refer to the particular market
failures which deter investment. Our view on this is given above.
10. We believe the Green Investment Bank should
be free to decide which projects it chooses to invest in: including
projects on domestic energy efficiency. So far little detail has
been given on the type of projects it will fund. The press notice
accompanying the Deputy Prime Minister's speech in August on low
carbon business support said: "The Government also plans
to create a Green Investment Bank to deliver financial interventions
to deal with market failures specific to green investment, stimulating
growth while supporting environmental objectives." Meanwhile,
the Government's Green Deal will provide a mechanism for financing
the energy efficiency retrofitting of homes at commercial interest
rates. Legislation will allow the Green Deal repayment to
remain attached to the house's energy bill. We believe this is
a useful innovation but insufficient to increase the uptake of
energy efficiency of hard to treat homes. Access to low cost
finance and grants is needed too. We see no reason why households
should be excluded from accessing GIB finance. Investments that
help homes decarbonise will make the UK less dependent on imported
sources of energy and will employ local people. Economically this
is equivalent to growth in our exports.
INVESTMENT PRIORITIES
- 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
11. We agree with the need to foster areas where
the UK has technology strengths or which are likely to be internationally
important. We believe the avoidance of using imported energy
provides equivalent benefits and should be given equal priority.
12. If Government wishes to provide additional
support we would like to see investment in technologies that help
communities mitigate and adapt to climate change and which address
other environmental problems: eg sustainable drainage, community
energy, provision of working capital to SMEs working in green
investment, and the early stage retrofit of hard to treat homes.
13. The GIB should also have mind to providing
additionality to what the market is already prepared to lend to.
It might have an eye to develop technologies and projects that
venture capitalists will neglect i.e. those with low rate of return
even when mature, but which have a large carbon saving potential.
SOURCES OF
FINANCE
- the funding and governance structures required
to create an effective and accountable body, including the role
of "green bonds".
14. We are aware of the idea of the green bond
but are uncertain how these would operate in practice. Most public
sector investment banks like EBRD, EIB and KfW issue conventional
bonds at costs of finance based on their creditworthiness. These
have to varying degrees the backing of national or local Governments,
or capital injections. As a result they can lend relatively cheaply.
If Government allowed the GIB to issue bonds either directly or
through the Debt Management Office it could access capital based
on the UK's credit worthiness - around 4% presently (rate based
on a long-dated bond).
15. Households can provide a useful source of
capital for the GIB. Many households are interested in ethical
saving; they have short term saving needs (like savings accounts)
and long term saving needs (like pensions). Commercial banks are
presently offering poor savings rates, and the rates of return
from pension plans have also been disappointing of late. Attracting
capital from households offers an attractive possibility and they
might be a cheaper source of finance than the money markets, especially
if given tax advantages.
16. Cash ISAs are a tax sheltered form of saving
popular with households - savers currently have £158 billion
invested in cash ISAs with the leading high street banks. The
average interest rate being paid on cash ISAs is presently only
0.4%. Over the past ten years ISAs have paid +/-0.5% above LIBOR[19]
which has tended to be close to the base rate. This suggests if
the GIB were able to issue a tax-exempt savings vehicle it might
be attractive option for retail savers as well as being a cheap
source of finance for the GIB.
17. We note that the National Savings & Investment
(NS&I) used to offer an index linked savings certificate (RPI
plus 1% today worth 5.7%) for a fixed three or five year term.
Because the interest was free of income tax, this was worth considerably
more to the higher rate tax-payer. This was withdrawn without
notice in July 2010 because of the crowding out effect this put
on inferior savings products offered by commercial banks. This
was a very popular savings product and attracted £5.4 billion
of savings in the last three months of its existence (a 69% increase
on year on year). This suggests that NS&I might be an attractive
way of accessing retail savers.
18. Public sector pension funds are another mechanism
for directing long-term community capital into the GIB. Toronto
City public sector employee pension fund has a majority stake
in the city's innovative district cooling system Enwave investing
approximately C$250 million in the facility[20].
The appeal of this mechanism is that it avoids some of the transaction
costs and fees of accessing the conventional money markets.
19. Companies are starting to be affected by
climate change through impacts on their assets, costs and revenues.
Specific risks companies face from climate change have been classified
into five broad categories
- regulatory risk;
- physical risk;
- litigation risk;
- competitiveness risk; and
- reputational risk.
Our review of the impact of climate changes on choices
made by today's consumers[21]
found that their long-term investments are likely not to be managed
with climate risks in mind, even amongst ethical pension funds.
"Green" investments must adapt to as well as mitigate
climate change risks.
15 October 2010
15 http://bit.ly/9v2Zdm Back
16
http://bit.ly/bNHS87 Back
17
EST and Energy Efficiency Partnership for Homes (May 2009) Solid
Wall Insulation Supply Chain Review Back
18
http://bit.ly/bBSKUF Back
19
Consumer Focus (April 2010) "Cash ISA Super-complaint".
Back
20
Vaze P, Tindale S and Meyer P (forthcoming 2011) Repowering
Communities Earthscan. Back
21
http://bit.ly/aSOaYZ Back
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