Green Investment Bank

Written evidence submitted by The Carlyle Group (GIB 25)

The Carlyle Group is pleased to submit this brief paper in response to the Environmental Audit Committee’s call for evidence.

Summary

· The Carlyle Group agrees that a Green Investment Bank (GIB) needs to be established. The scale of the investment in new technologies, new infrastructure assets and supply chains required to meet the UK’s legally binding climate change and renewable energy targets is enormous.

· There are, however, a number of market failures and investment barriers in financing low carbon infrastructure and unless they are addressed, the UK’s emissions targets will not be achieved. A massive injection of private sector investment is a prerequisite for the UK meeting its legal obligations.

· The government should move to establish the GIB without delay, in order to provide investors in low carbon technologies with the clarity and certainty about the policy environment that they need. There is a risk that continued delay and uncertainty will deter investment.

· The GIB should be self-funding, giving priority to the longest-life projects with the largest carbon savings and the highest speed to market.

· The GIB should be established by an Act of Parliament, with ministers setting the overall priorities of the bank and a board of directors setting strategy and investment decisions. The GIB should contain a bank that is regulated by the Financial Services Authority and complies with relevant FSA/Bank of England requirements; and

· The GIB would need to raise three forms of funding to ensure that it is able to sustain its operations: government funding for disbursement of grants (i.e. existing quangos and funds); financing for ongoing activities and "commercial" investment; and initial Bank capitalisation and funding.

1. About The Carlyle Group

1.1. The Carlyle Group is one of the world’s largest private equity firms. It has $81.1 billion under management and current investments in more than 200 companies.

1.2. Carlyle was established in Europe in 1997 and today manages €14 billion in dedicated European funds.

1.3. Carlyle portfolio companies have 360,000 employees globally, including over 46,000 across Europe.

1.4. In the UK companies in which we have invested include household names like Britax. Other firms include companies such as Ensus (a bio-refinery in Teeside), Mill Digital Media (post-production and video distribution services for television) and Talaris (a global provider of cash handling technology solutions).

1.5. The Carlyle Group has become one of the world’s most successful private equity firms through its consistent application of:

- a conservative investment approach in industries we know;

- investing for the medium and long term;

- employing the best business management talent in the world to support our portfolio companies; and

- aligning our interests with our investors by investing our own money alongside theirs;

1.6. The breadth and depth of our portfolio means Carlyle has valuable insights into the elements that are important for business growth.

1.7. Our international reach also means we have wide-ranging experience of the support and assistance provided to business by governments, and the factors that make a country an attractive place to invest.

2. 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.

2.1. The Climate Change Act 2008 sets a legally binding target to reduce the UK’s greenhouse gas emissions by 80 per cent (off a 1990 baseline) by the year 2050. The carbon budgets established under the Act set, in effect, an interim target for 2020 to reduce emissions by 34 per cent. The UK’s targets for using renewable energy are no less ambitious. Under the EU Renewable Energy Directive, this country is committed to sourcing 15 per cent of all energy from renewable sources by the year 2020. This compares with a figure of 3 per cent in 2009.

2.2. The scale of the investment in new technologies, new infrastructure assets and supply chains required to meet the UK’s climate change and renewable energy targets is enormous. Estimates of the investment needed between now and 2020 range from £200 billion (as suggested by Ofgem) to £550 billion (Dieter Helm, for Policy Exchange). Given the state of the public finances, funding the transition to a low carbon economy vastly exceeds the capability of the public sector. As a result, a massive injection of private sector investment is a prerequisite for the UK meeting its legal obligations.

2.3. There are, however, a number of market failures and investment barriers in financing low carbon infrastructure and unless they are addressed, the UK’s emissions targets will not be achieved. The Green Investment Bank Commission has concluded that the pools of capital available from long-term debt and equity finance are neither large nor long enough. Further, with uncertain energy demand, higher borrowing costs and the need to protect their credit ratings, utilities do not have the balance sheet capacity to fund these investments.

2.4. Markets for low carbon technologies are reliant on various forms of government intervention to drive returns. Where political and regulatory certainty is essential, there has been a history of policy changes.

2.5. Entrepreneurs pursuing the new technologies face a number of challenges: technology risks; difficulties in attracting capital from equity investors because of uncertainties surrounding the policy framework, including the timetable, role and structure of the Green Investment Bank.

2.6. Institutional investors (who could provide a significant proportion of the funds needed) will need to earn adequate risk-adjusted returns from large numbers of small, low carbon investments. The appropriate market structures will need to be in place in order to access this capital.

2.7. The Carlyle Group agrees that a Green Investment Bank needs to be established without delay. The GIB could play a central role in the provision of finance and in mitigating and better managing risk – both political risk and in balancing the risks and rewards in the financing of new technologies and funding public infrastructure.

2.8. The concept of a Green Investment Bank has secured unusually widespread support, including from the three main political parties in their general election manifestos, the Aldersgate Group, a broad-based business and environmental coalition and financing sources, such as The Carlyle Group. Creating such an institution would provide a clear signal that the political will exists to build a low-carbon economy.

3. 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.

3.1. The Carlyle Group endorses the recommendation of the Green Investment Bank Commission that a GIB should be established "to support the delivery of the UK’s emission reduction targets as set by the Climate Change Act 2008" and that "the support should be based on a public-private investment model and address specific market failures and investment barriers in a way that will achieve emission reductions at least cost to taxpayers and energy consumers."

3.2. The GIB should have the following major roles:

(a) identifying and addressing market failures limiting private investment in carbon reduction activities: increasing the availability of capital; providing risk mitigation mechanisms for the private sector; and developing standardised financial products / instruments for investment in projects where a specific market failure or funding gaps persists;

(b) providing coherence to public efforts to support innovation in relation to climate change by rationalising existing Government-established bodies and funds; and

(c) advising on financing issues in central and local government policy making.

3.3. Strict principles would be needed at an operational level to ensure the GIB does not crowd out the private sector. The private sector should lead and execute deals wherever activity is viable; in such cases, the GIB would co-invest in opportunities provided by the private sector. The GIB should operate only where its actions achieve a result that would not otherwise have been possible and then in partnership with the private sector wherever possible.

3.4. The Green Investment Bank should aim for commercial rates of return on its banking operations. The GIB should be self-funding, giving priority to the longest-life projects with the largest carbon savings and the highest speed to market. For early stage projects unable to secure private funding, the GIB should run separate funding operations, potentially on non-commercial terms. There is also a need to consolidate and simplify existing sources of government funding for low-carbon projects.

4. 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.

4.1. The Carlyle Group submits that in its initial phase, the Green Investment Bank should focus on supporting the areas where the maximum impact on emissions and the fastest speed to implementation can be achieved. For example, the scale up of investment in proven energy efficiency projects that can lower the overall development need of renewable energy sources; investment in enabling technology, such as smart grids, that reduce the cost for other low carbon investments; and support of both proven and high impact third-round offshore wind, should all be priorities.

4.2. The types of product that the GIB could develop include the following:

· early stage grants for pre-commercial propositions – aggregating the grant payments that are currently made to a range of quangos for low carbon innovation, to achieve greater private sector leverage and higher rates of deployment;

· equity co-investment – most likely, in situations where the availability of private capital is limited;

· mezzanine funding – for proven technologies that can secure workable levels of project finance debt but not at gearing levels sufficient to provide equity investors with the necessary rate of return;

· offering to buy completed renewables assets;

· purchase and securitisation of project finance loans – until an improvement in bank balance sheets can provide the capital needed for green infrastructure like offshore wind;

· insurance products – for example extreme events insurance and contingent loan facilities;

· long-term carbon price underwriting – given that the EU ETS has limited price visibility beyond 2014 and the EUA price may give insufficient incentives for investments in long-term clean energy assets.

4.3 The GIB should be prepared to underwrite the decisions of investors when they are based on an assumption that particular policies will remain in place. In other words, investors should be compensated in the event that there is a change of policy later on.

5. The funding and governance structures required to create an effective and accountable body, including the role of ‘green bonds’.

5.1. One of the principal challenges in establishing the Green Investment Bank will be to ensure that a body with the power to invest public money and borrow with government guarantee is accountable to parliament and reflects the overall policy priorities of the government, whilst ensuring that the GIB enjoys sufficient operational independence from ministers to be credible with the markets. There is an inherent tension between the position in the public sector and its need to be operated on a commercial basis.

5.2. The Carlyle Group submits that both objectives can be achieved by:

· establishing the Green Investment Bank by an Act of Parliament;

· charging ministers with setting the overall priorities of the bank and with appointing the non-executive chairman and directors;

· ensuring that the bank is not accountable to ministers for individual investment and lending decisions;

· having a board of directors to set strategy and approve investment decisions, who would be drawn primarily from the public sector;

· having a management team with relevant commercial experience;

· ensuring that the Green Investment Bank contains a bank that is regulated by the Financial Services Authority and complies with relevant FSA/Bank of England requirements; and

· providing for the non executive chairman to appear before relevant parliamentary select committees on at least an annual basis.

5.3. The Carlyle Group sees green bonds as being essential for funding the Green Investment Bank (where they are issued by the bank), and for the lowering the cost of debt for projects. The UK bond market, including pension funds and insurance companies, valued at around £1.2trillion, is an essential source of investment for low carbon energy projects. However, at the moment, most of this capital flows to high rather than low carbon projects.

5.4. Green bonds could address current market capacity constraints [see above], enable targeted public co-investment to address confidence gaps and unlock opportunities for new public-private investment.

5.5. In order to persuade pension funds and insurance to shift from gilts, private equity, venture capital or real estate, to the low-carbon energy sector, green bonds should broadly reflect the existing bond offerings, carrying similar characteristics − including level of return. Green bonds would also need to be Government-guaranteed and backed by visible, stable and transparent revenue streams to pay coupons.

18 October 2010