Written evidence submitted by Green Alliance
SUMMARY
- Green Alliance believes there is a very strong
case for the creation of an independent, state backed, Green Investment
Bank with a remit to facilitate sufficient private capital investment
in infrastructure in order to deliver the legally binding carbon
reduction targets set out in the Climate Change Act 2008.
- The case has now been accepted by government
that, without some intervention by the public sector to share
more of the risks of these investments, the private capital is
simply not available at the scale required to deliver the low
carbon transition.
- The finance gap exists in many parts of the low
carbon economy, including equity and debt availability for large
infrastructure projects, lack of financial products to enable
institutional investors to get involved in energy efficiency or
smaller scale renewable, insufficient insurance to cover construction
risk in offshore wind and growth capital for low carbon manufacturers
to scale up their businesses.
- An independent Green Investment Bank, initially
capitalised with government equity, but with the powers to raise
its own finance on capital markets, through bond issuances, would
have the financial expertise, balance sheet and knowledge of the
policy process to be able to make long term investments, share
risks with the private sector and thereby attract more private
capital into the UK low carbon economy.
- The GIB should be established by an Act of Parliament,
clearly linked to the Climate Change Act. Its remit should be
clear not to compete with private investors and crowd out other
institutions, but only make investments where there is evidence
that the private sector would not otherwise do so.
- Ernst & Young have estimated that such a
bank would need to have an initial capitalisation of £4-6
billion over the period of the current Spending Review to be effective.
It would also crucially need to have the powers of other development
banks such as the EIB and KfW in Germany, to borrow and lend money
independent from government control. This power would enable a
far higher leverage of private capital over time.
- The Government has announced it will create a
Green Investment Bank, but has yet to agree what powers and freedom
it should have. If it follows through on its commitment to set
up a Green Investment Bank with the £1 billion allocated
from departmental budgets, and quantifies the amount they can
raise from asset sales, it could attract tens of billions of pounds
of private investment to modernise the UK's infrastructure. This
would be a flagship institution driving the UK on a trajectory
of green growth. If however the government puts the money in a
fund with no ability to raise money on the financial markets it
will be too small to make an impact. This would be reneging on
the prime minister's commitment to set up a bank and the coalition
agreement.
1. BARRIERS TO
PRIVATE INVESTMENT
IN LOW
CARBON INFRASTRUCTURE
1.1 It is now widely accepted that a very large
amount of money needs to be invested in low carbon infrastructure
in order to deliver the targets in the Climate Change Act. The
figures vary and the definitions of each study are different at
the margins, but we are talking about several hundreds of billions
over a decade or two. Far more than has been invested in the previous
decades.
1.2 Estimates from Ofgem, the Institution of
Civil Engineers, PwC, Policy Exchange, the CBI and others have
all pointed to the large capital investment needs of the UK, a
large majority of which are needed to decarbonise the economy
and improve energy security. The most recent review of the investment
needs of the UK to deliver energy security and keep to the emissions
trajectory set out by the Committee on Climate Change is from
Ernst and Young. They estimated that £450 billion of capital
investment will be needed in UK energy supply, infrastructure
and energy efficiency between 2010 and 2025.[62]
1.3 The majority are also clear that the current
policy framework and market conditions will not deliver anywhere
near the scale and speed of investment required. The financial
risks of those investments are far too great for the private sector
to bear alone, when other less risky opportunities are out there.
Some of these risks could be reduced by changes to the planning
regime or the way grid infrastructure is delivered. But even these
changes will not remove the perception of risk making private
capital more expensive in this area. Further measures are required.
1.4 Ernst & Young estimated that, without
such interventions, traditional sources of capital, such as utility
balance sheets, project finance from the major commercial banks
and infrastructure fund, might be able to fund £50-80 billion
of investment between 2010 and 2025. They also estimated that
pension and insurance funds might also contribute £25-40
billion in that period. This still leaves a gap of £330-360
billion.
1.5 The Green Investment Bank Commission, a group
of independent financial experts, chaired by Bob Wigley, asked
by the Conservative party to look at the case for a GIB, also
argued that in current conditions only about 15% of the investment
required to deliver 2020 low carbon targets in the UK, is in place.
The vast majority of this comes from utility bond issuances, which
are very unlikely to be expanded to meet the other 85%. Indeed,
utilities themselves, such as Centrica, have stated they do not
believe their balance sheets are large enough to deliver the capital
required.
1.6 Other potential areas of capital, such as
banks, infrastructure funds and institutional investors, like
pension funds, are not investing at the pace and scale required.
There is little evidence that they will do without further ways
to reduce the risks and therefore cost of the capital.
1.7 Work of the Green Investment Bank Commission,
the Carbon Trust, PwC, E3G and others has shown a variety of areas
of the low carbon economy where a finance gap exists, including
equity and debt availability for large infrastructure projects,
lack of financial products to enable institutional investors
to get involved in energy efficiency or smaller scale renewable,
insufficient insurance to cover construction risk in offshore
wind and growth capital for low carbon manufacturers to scale
up their businesses.
1.8 Whilst each of these gaps could be addressed
by specific policy interventions, a Green Investment Bank with
a clearly defined, but broad remit, would be able to address all
of them, and anticipate future finance gaps because this is a
transition that will take decades, not just a few years.. That
is not to say that a GIB would be a silver bullet, but Green Alliance
believes it will be an essential part of any low carbon transition
package.
2. OBJECTIVES
AND ROLE
FOR THE
GIB
To fulfil the pledge in the coalition agreement,
we believe the Green investment Bank must have the following characteristics:
2.1 It must be established as a permanent, independent
financial institution, under an Act of Parliament, to maximise
private investment into the infrastructure required to deliver
the targets set out in the Climate Change Act. The low
carbon transition 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 GIB investments, then making the
bank permanent and independent of day to day political interference
is essential. This is particularly important for engaging with
the large pools of capital in pension and insurance funds.
2.2 It must be able to take decisions that
affect investments in to infrastructure provision, deployment
of low carbon technologies at scale and the improvement of the
energy efficiency of our building stock. As described above,
there are finance gaps in many parts of our low carbon economy.
Unless the GIB is given the remit to find solutions in all of
these areas, then it will not be able to structure its investments
in the most cost effective way. Investment in energy efficiency
now, for example, will reduce the capital requirements for energy
supply in later years.
2.3 It must have some initial capitalisation
from government at a scale that will allow the GIB to make a significant
impact on private investment flows into those markets. Ernst
& Young estimated that the minimum required over the period
of the Spending Review would be £4 billion-6 billion.
2.4 It must be able to issue debt and raise
money from the capital markets, whilst the government liability
is restricted to its subscribed equity shares, so keeping the
total capital raised off the public sector balance sheet.
This is the critical power that makes it a independent bank and
not a government controlled fund. It would allow for significantly
more leverage of private investment in years to come, would enable
engagement of institutional investors through green bonds, and
give the bank credibility in the City. The government has not
yet agreed to give the bank this power, and it is known that HM
Treasury is reluctant to do so. Without this power, the GIB would
simply not be able to do the job that Ministers are setting it
up to achieve.
2.5 It should also be given the ability to
create green individual savings products (eg Green ISAs) and offer
the government independent advice on policy barriers to private
low carbon investment. Issuing green savings products would
be a politically powerful way to engage citizens more directly
in the low carbon economy, beyond what they do with their own
homes and vehicles. It would also be another means of raising
capital, so building the balance sheet and enabling greater potential
for leverage. The policy advice function would be a vital way
to ensure that future regulatory changes are made with a much
better understanding of their potential impact on investors. The
lack of understanding of the investment needs within the policymaking
community has become a common criticism.
2.6 It should be clear that GIB loans or investments
must not directly compete with the private sector, but only be
made where there is evidence that private capital is not available.
One fear is that GIB capital would simply displace investments
that private banks would be making anyway, thus distorting the
banking sector and not facilitating addition investment in the
low carbon economy. Experience of the EIB, KfW and other development
banks shows this need not be the case, but it should be clear
in the Act of Parliament that such "crowding out" would
be against the bank's investment criteria.
3. INVESTMENT
PRIORITIES
3.1 Inevitably there are a whole range of potential
areas that the GIB could get involved with, and it is easy to
be drawn into discussions about the ideal structure for a GIB
to solve any given low carbon finance problem. There will be a
number of priority areas that need attention first, but it would
be a mistake to design the GIB solely around optimising those
early activities. For the job of the GIB will be a long term one.
Its structure and remit should be defined in an open way so as
to enable interventions on many fronts. That, however, does not
mean that it has to intervene on many fronts from day one of its
existence.
3.2 The Carbon Trust and others are making a
strong case that some support in terms of equity investment is
required to help address the financial challenges of deep offshore
wind projects. This has led others to argue that to address that
problem, government could just set up an equity fund, and doesn't
need a Green Investment Bank. Whilst this narrow statement may
well be true, it ignores the fact that there is plenty of evidence
of a simultaneous shortfall in debt financing for low carbon infrastructure,
with utility balance sheets unable to provide all the investment
and private sector project finance sources not able to fill the
gap.
3.3 There are a number of insurance products
that the GIB could issue to help overcome some of the construction
risk issues facing offshore wind, as well. These might include
extreme weather insurance, which the private sector is not yet
willing to provide as there is little experience of deep offshore
turbine construction.
3.4 There is also an immediate need for low cost
capital for energy efficiency investments. Modelling from E3G
suggests that the Green Deal financing is unlikely to be scaled
up into a major programme of retrofitting without some deep source
of low cost capital. This is the lesson from successful retrofitting
schemes in Germany, where the state bank, KfW provides much of
the capital at low cost, but distributed by retail banks.
3.5 We also know there is a shortfall of early
stage investment in low carbon technologies and manufacturing,
however these are higher risk investments and before getting heavily
involved in these markets, the GIB would need to develop an investment
track record. Allowing GIB to be involved in longer term, lower
risk investments such as grid and pipe network upgrades, as the
EIB does, might be another way of offsetting the higher risk VC
style investments.
3.6 These are the finance gaps that exist at
the moment. We can also be sure that new problems will arise in
the years to come, which we cannot anticipate now. Another role
of the GIB would be to adapt to the new market conditions and
provide products and solutions to them as they arise.
4. FUNDING AND
GOVERNANCE STRUCTURES
4.1 For the bank to be credible with investors,
it has to be independent from day to day control of politicians
and Whitehall officials. The investments made have to make a return,
albeit one over a longer time period than would be demanded by
a fully private bank. At the same time there will be considerable
taxpayer investment in the institution, so accountability to Ministers
and Parliament must also be in place.
4.2 The Act of Parliament should set out the
objectives and terms of reference for the bank. An independent
board and chair should be appointed. That board would then establish
its own investment committee to decide on disbursement. The accounts
of the bank should be a transparent as possible, with annual published
reports and scrutiny of the National Audit Office, Public Accounts
Committee and Environmental Audit Committee.
4.3 Representatives of the board, including its
chair, should be required to appear at a public joint session
of the PAC and EAC on an annual basis.
4.4 The GIB cannot be set up without some tax
payer funds being put up as initial capitalisation. But from the
outset the aim is to attract private sector capital as well, as
it is clear that current public sector finances cannot accommodate
the size of balance sheet that a GIB would require to carry out
the task of levering the level of private sector investment into
low carbon infrastructure that is required.
4.5 Ernst & Young have recommended that an
initial capitalisation of £4 billion-£6 billion will
be required over the period of the Spending Review to enable the
bank to function and grow its balance sheet in future years. Currently
the government have pledged £750 million from the UK departmental
expenditure limits, with an additional £250 dependent on
the Scottish Executive, to come in 2013-14. They have also said
that funds from asset sales would be also be used to capitalise
the bank but have not specified what assets, estimates of the
value or timing of such sales. If, for example, the proceeds of
HS1 rail link were used, then this could be £1-2 billion.
Proceeds of the sale of nationalised banks could be used, but
obviously the timing of this is less certain.
4.6 To enable the balance sheet of the GIB to
grow over time, giving it the opportunity to lever far more private
capital, it must be given the powers to issue bonds and raise
finance from the capital markets and institutional investors,
such as pension funds. In the current fiscal climate the inevitable
concern is over the treatment of such a bank on the public sector
balance sheet. How much liability does the tax payer need to take
on?
4.7 Some have argued that if this private sector
capital were only raised through bonds, guaranteed by the government,
then this would simply be more public sector borrowing and count
against the deficit. A non-starter in the current fiscal environment,
but could be a viable option at a different point in the economic
cycle.
4.8 The position, however, is not as simple as
that and there are many factors that influence whether how much
of the liability of the GIB would rest on the public sector balance
sheet. Diversity of capital sources helps, so if some initial
equity came from other development banks, sovereign wealth funds
with low carbon mandates, or through the ability to offer green
ISAs, then the UK liability would fall. Also if the GIB were UK-wide
with equity stakes coming from England, Scotland, Wales and Northern
Ireland, that would spread the risk.
4.9 Independence of control is also a factor
that determines the ruling by the Office for National Statistics
over whether something counts as public sector debt or not. Here
we come to the heart of the paradox in government thinking. An
off-balance sheet institution being hard to control, but and on
balance sheet one being impossible to afford. The trade-off politically,
is whether the government, and specifically the Treasury, is willing
to give away control of the capital investment it has made to
a new body established under clear statutory rules and independent
governance. If it does not, and wishes to retain control, then
there will be a clear limit on how large the balance sheet can
get. And a GIB with a small balance sheet will not be able to
make the interventions in the infrastructure market particularly
to make much difference to capital flows.
4.10 One possible solution could be the provision
of limited government protection of the equity base of the GIB.
This would enable some risk to be removed from the equation for
private investors. The first set of green bonds may need a time
limited government guarantee, but as the track record of good
investments is be established then the balance sheet could be
grown through more green bonds, probably not AAA high investment
grade, but possibly slightly lower grade which would give a higher
return.
4.11 Finally there are other routes to further
capitalisation in years to come, possibly through the allocation
of a proportion of the revenues from EU carbon permits, due to
start in 2013. The estimates revenue from these auctions is up
to £40 billion.
5. CONCLUSION
The government could go down in history in the next
few weeks and months by setting up an enduring financial institution
that started to forge a genuine partnership between public and
private sectors to deliver the low carbon transition. But the
risk of short termism, lack of political will and a determination
to control from the centre of government, could still snatch defeat
from the jaws of victory. The Green Investment Bank is a big idea
for a big problem, with a coalition of business, finance, engineers,
NGOs and academics behind it. If the idea is watered down by Whitehall,
then the small idea that is left will be inadequate for the challenge
of the low carbon transition.
25 October 2010
62 Capitalising the Green Investment Bank: Key issues
and next steps, Ernst & Young, October 2010. Back
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