Green Investment Bank

Written evidence submitted by World Development Movement (GIB 31)

The World Development Movement (WDM) campaigns to tackle the root causes of poverty. With our partners around the world, we win positive change for the world’s poorest people. We believe that charity is not enough. We lobby governments and companies to change policies that keep people poor. WDM is a democratic membership organisation of 15,000 individuals and 60 local volunteer groups, with offices in London and Edinburgh.

Summary of key points in response:

— The financial crisis cost the UK £129 billion in annual GDP and increased the structural deficit by £93 billon .

— The UK can’t afford another meltdown, yet short term, high risk, carbon intensive investments are still business as usual for the banks.

— The coalition government has an opportunity to redefine the role of banks in society, rather than allow the sector to return to the short-termist approach which con tributed to the financial crisis – and a Green Investment Bank (GIB) should form a key part of this.

— If adequately resourced and managed, the new GIB can provide a number of crucial functions to kick-start low-carbon growth, including enabling risk-sharing, providing a benchmark standard for green investments, supporting research and development, attracting global expertise, leveraging additional capital and offering a focal point for UK government policy coherency on green financing.

— The bailed-out banks should be brought within the policy framework of the GIB. The largest public recapitalisation of a UK bank occurred at the Royal Bank of Scotland, with the UK government currently having an 83% stake in the bank. With the government shareholding in RBS, there is an opportunity to use this bank to set an example to its peers. In order to protect its shareholding and demonstrate its commitment to a low carbon future, the new Government should utilise RBS as a way of delivering the GIB.

— The GIB needs to drive the development of zero-carbon energy in order for the UK to achieve its goal of cutting greenhouse gas emissions by 80% by 2050. The GIB should support innovators and small businesses that are developing the low carbon and energy efficient technologies of the future.

— GIB must have clear accountability and strong active management to deliver the investment required, and a single government department should have responsibility for its success.

— The GIB will need to apply a longer investment horizon than the short-termism that drives much of the behaviour within the City and be in a position to provide enough certainty for investors and share enough risk to leverage funding from the private sector.

— The GIB has an opportunity to use the credit rating of the government to securitize debt and guarantee loans, without increasing the national debt.

— The establishment of a GIB provides significant opportunities to develop a market framework that could help the financial sector play a more active role the urgently needed transition to a low carbon economy and, in so doing, rediscover a socially useful purpose.

— By creating a GIB with sufficient scale and momen tum, the UK will benefit from improved energy security, stabilised energy costs, the creation of green jobs, greater efficiency and improved international competitiveness.

Answers to questions outlined by the Environmental Audit Committee:

1. Barriers or market failures requiring the establishment of a GIB; and risks of not getting this done quickly

There has been exten sive analysis of the causes of the financial crisis, with a complex range of factors cited including US sub-prime mortgages, regulatory failure, excessive consumer debt levels, short-term funding markets, and international trade imbalances. There has also been a major spotlight on the banking sec tor after what were thought to be "invincible" banks failed.

The financial crisis cost the UK £129 billion in annual GDP and increased the structural deficit by £93 billon (see appendix for details of calculations) . The initial budget cuts announced by the coali tion government demonstrate the pain this is causing to public services. The UK can’t afford another meltdown, yet short term, high risk, carbon intensive investments are still business as usual for the banks. Allowing this to continue presents an unacceptable financial and environmental risk, for example banks such as RBS continue to finance companies opening up new sources of fossil fuels, despite the warnings of the Stern Review on the economics of climate change and the predictions of the IPCC about the impacts of further rises in global average temperatures.

The cost of the financial crisis to the UK

There are three main ways in which the financial crisis has impacted the UK economy:
- the cost of bailing out insolvent UK banks;
- the loss of productive capacity in the UK economy arising from the economic crisis;
- the impact on the public finances through lower productivity capacity leading to lower tax receipts and higher public expenditure.

Unless the financial sector changes the way it does business, the UK risks being exposed to further meltdowns in the future, with a weakened economy even less able to deal with the subsequent stress.

The problems at Northern Rock, Bear Sterns, Lehman Brothers, RBS and HBOS indicate the need for a change from the focus on profit at the expense of vulnerable customers and small businesses. At present there is a risk that the big investment banks are just returning to business as usual, i.e. short-termism.

The largest public recapitalisation of a UK bank occurred at the Royal Bank of Scotland, with the UK government currently having an 83% stake in the bank. With the government shareholding in RBS, there is an opportunity to use this bank to set an example to its peers. The £45 billion RBS shareholding sits with UKFI. [1] At the time of investment it was indicated that UKFI would seek to divest from the banks at an appropriate time in the future. The new government may be taking a more long-term view however, which Vince Cable MP, expressed just prior to the May 2010 election that: "These banks should remain effectively under public control for something in the order of a decade." [2]

This approach provides the new government with the opportunity to direct RBS as a force for good, rather than use the excuse of potential divestment to avoid responsibility as the previous government did.

The Office for Budget Responsibility has recalculated the deficit for 2010-11 at £114 billion. [3] The government spent a total of £117 billion recapitalising the banks. [4] With the coalition government under severe pressure to reduce the deficit and cut expenditure, it is even more imperative that they demonstrate some value from this investment.

If the regulatory framework is not set up to deliver more responsible financial products, then the GIB will not flourish, which will send the wrong signal to other banks. Those banks, such as RBS, which the government has an interest in need to be aligned with a low carbon banking agenda, otherwise taxpayers’ interest in them will be at risk. If the government is serious about meeting its greenhouse gas targets then it needs to entrain financial institutions to deliver the required infrastructure.

The new government is promoting mutuals, setting lending targets for banks, and establishing a committee to review separating the retail and investment banking divisions of large banks.vii This agenda, combined with the establishment of a GIB, provides significant opportunities to develop a market framework that could help the financial sector play a far more active role in supporting viable entities to contribute to a low carbon economy, and in so doing, rediscover a socially useful purpose.

2. Objectives and roles the GIB should assume; areas it should and should not operate in; how its lending and investment decisions should balance green benefits against financial risks. The GIB’s investment priorities; whether and how the bank should support and foster areas where the UK has emerging green technology strengths

The Stern Review on the Economics of Climate Change in 2006 for HM Treasury outlined the case for early action on climate change: [5] Stern observed that; "climate change is a result of the greatest market failure that the world has seen." [6] The financial crisis also serves as a warning that relying on unfettered markets to solve climate change is a very high risk strategy, and the framework established by governments needs to significantly improve.

History shows us that without a clear mandate to initiate a transition to a low carbon economy, financial institutions have limited interest or incentive to address this issue.

The longest standing example of this is perhaps the UK Export Credit Guarantee Department (ECGD), which for years has chosen to interpret its mandate to merely respond to the demands of existing fossil-fuel based energy companies, rather than drive development of a new clean-tech UK industrial base. [7] The coalition government has accepted the need to change this situation which could complement the work of a GIB by supporting exports of UK-based renewables manufacturers.

It is estimated that at least £200 billion needs to be invested in UK energy infrastructure over the next 10-15 years. The proposed GIB must be clearly aimed at financing renewables and energy efficiency, in order to deliver the rapid emissions cuts the UK has committed to. If adequately resourced and managed, the new GIB can provide a number of crucial functions to kick-start low-carbon growth. These include enabling risk-sharing, providing a benchmark standard for green investments, supporting research and development, attracting global expertise, leveraging additional capital and offering a focal point for UK government policy coherency on green financing.

The "green" standards need to be at the core of all investments promoted by the GIB. This should be defined so that it drives investment to the leading edge of low carbon energy. The GIB needs to ensure it is only financing projects or technologies that will reduce the carbon intensity of energy production. The GIB needs to be driving the development of zero-carbon energy in order for the UK to achieve its goal of cutting greenhouse gas emissions by 80% by 2050.

A significant level of investment in research and development and new infrastructure is needed in order to advance the renewable industry even further and make it the global norm, rather than a novelty. Whatever the industry, it has always been necessary to invest in development to deliver fundamental change. The limited sums invested by the oil majors in renewables compared to the amounts ploughed back into deepwater technology (e.g. Gulf of Mexico), and unconventional oil exploitation (e.g. Canadian tar sands) have restricted the growth of renewables. The negative externalities of this focus for local communities and the global environment are now clear for all to see. The GIB needs to support innovators and small businesses that are developing the energy technologies of the future.

The GIB will need renewables expertise, in order to understand the markets it is trying to promote, and how to overcome the barriers currently faced by the sector. Other regulatory environments have historically been more favourable than the UK, although following the offshore wind regime developments, the UK became joint 6th most attractive regulatory climate for renewable according to Ernst & Young’s analysis in February 2010. [8]

3. Funding and governance structures required to create an effective and accountable body, including the role of green bonds.

We believe it will be important for the GIB to have clear accountability and strong active management to deliver the investment required. It would therefore be preferable for a single government department to have responsibility for the success of the GIB, and to report against both investment targets and carbon emissions reductions and renewable targets. These climate change related targets should also be a major part of any incentive package for those employed by, contracted to or partnering with the GIB.

The GIB will need to apply a longer investment horizon than the short-termism that drives much of the behaviour within the City. There are already approaches emerging which exemplify this.

Venture capitalists typically own companies for at least five years, giving them a strong interest in the viability of a company over several years. It is also vital for them to demonstrate a healthy future for their companies in order to realise an exit strategy. For example Vantage Venture Capital focuses on groups of clean-tech companies that complement each other. [9] It has holdings in electric vehicle manufacturers, battery manufacturers, infrastructure providers and zero carbon power generators that together form a value chain for the roll-out of electric cars.

In a departure from its fossil fuel activities, the World Bank has issued a series of green bonds (totalling $1.5 billion), in partnership with commercial banks such as SEB (Sweden) and Daiwa Securities (Japan), which have attracted investment from a range of US and Scandinavian Pension Funds. [10] All projects meet low carbon criteria developed by the World Bank and consist of a range of climate change mitigation and adaptation activities from around the world.

The Labour government’s proposal was that half of the initial £2 billion in equity is to be provided by the sale of state assets, such as the channel tunnel rail link, with the other half coming from the private sector. There are a range of other revenue streams which could be earmarked to provide ready capital for lending. These include:

→ The Committee on Climate Change has indicated that it expects revenues from the auctioning of EU Emissions Trading Scheme permits to raise £40 billion by 2020, (estimate only). The government’s platform for banking reform also indicates new a banking levy and social responsibility levy for the sector which could be used to ensure a ready flow of capital into the GIB.

→ The UK government has averaged £9 billion per annum in oil and gas revenues over the last 5 years [11] (Norway used its petroleum revenues to establish an investment fund in 1990 which now stands at US$ 838 billion). [12] The government could also learn from its Scandinavian counterparts and establish a sovereign fund that seeks to finance a sustainable future for the country, rather than continuing the policy of exploiting finite resources such as coal and oil, with no investment plan for a viable low carbon economy beyond this.

→ The GIB could also go to the markets to raise capital, using mechanisms such as green bonds or venture capital funds. This would be a way of bringing in private capital to augment the funds provided by the government purse.

The GIB should not be reliant on a significant state funding stream, especially in the context of the huge budget deficit facing the UK. However it must be accepted that some investment is needed in order to deliver the green growth that is needed to drive the UK out of recession. It is more important however that the GIB is in a position to provide enough certainty for investors and shares enough risk to leverage funding from the private sector.

The different funding needs of initially capital-intensive renewable projects which have low operating costs need to be met by the products offered by a GIB. Risks faced by the renewable sector need to be addressed so that it is more attractive to investors. For example, guarantees covering regulatory risk or insurance for offshore wind construction risk could remove current barriers for investors. The bank will therefore need to be managed by people with expertise in these target sectors, as well as in finance.

International experience of raising finance and structuring deals will be required to get UK projects moving. The GIB could provide a range of different types of financial services to the green sector over time. These could include:

→ Risk guarantees and insurance pools

→ Securitization funds

→ Bond issuance

→ Venture capital

→ Research loans

It is also interesting to note that the new government is keen to promote green retail products such as green Individual Savings Accounts (ISAs), which will provide greater tax benefits. These retail products will also need a green economy to invest in, which links to the role of the GIB. There is also scope for working with institutional investors, including the government pension funds, and fund managers, who apply responsible investment criteria to produce a range of investment products.

If the GIB is set up with an initial £2 billion in equity it is clear it will need to leverage private capital many times that amount each year in order to deliver the clean energy infrastructure required by the UK. Since the credit crunch, the primary challenge to the banking sector has been to start lending again, in order to facilitate the flow of capital. The GIB has an opportunity to use the credit rating of the government to securitize debt and guarantee loans. Critically, these forms of support will not increase the national debt, as the GIB would not be providing the actual finance. The GIB can also play a crucial brokering role between the renewable energy industry and private financial institutions, to help overcome any existing barriers to finance. As well as working with private finance, the GIB will also be expected to identify international sources of funding, from the European Union for example.

The GIB needs to part of an overall policy framework of tax incentives, market mechanisms and regulations which drive green investment. The UK has been hedging its bets for too long, not providing certainty over the direction our energy future should take. This has resulted in a perpetuation of the status quo – a dependence on fossil fuels. A GIB will only be successful is there are no more mixed messages, and a clear path is agreed, with all government departments and interests aligned.

The Royal Bank of Scotland is ideally placed to deliver GIB’s required functions, with its existing experience in financing renewables. In particular, RBS has been active in the offshore wind sector, which Infrastructure UK indicates as a likely first priority for finance. The government must establish a policy framework to support the objectives of the GIB, and then ensure that RBS is aligned to this strategy to ensure it make s the most of investment opportunities in the green energy sector. In order to protect its shareholding and demonstrate its commitment to a low carbon future, the new Government should therefore utilise RBS as a way of delivering the GIB.

The benefits of financial sector reform to the UK

An effective GIB at the heart of a more sustainable financial system should bring the following benefits:

Improving energy security, by easing initial costs of paying for the new infrastructure to deliver long-term energy security for the UK, so it can become an energy exporter.

Stabilising energy costs, by ensuring the scaling up of renewables and so reducing the financial costs of the energy supplied in the long term.

Creating green jobs, by delivering growth in the low carbon economy. The environmental goods and services sector is predicted to create around 50,000 jobs per year, if the GIB delivers the necessary growth.

Supporting international competitiveness by increasing the UK’s market share in environmental industries.

Increasing government efficiency by providing a focus for its green finance interests which are currently dispersed and lacking overall coherence.

This submission is based on the report ‘A Bank for the future; maximising public investment in a low carbon economy’, June 2010. It was commissioned by the World Development Movement and Platform, and written by James Leaton.

Appendix

The Treasury’s total net cash outlay for purchases of shares in banks and lending to the banking sector, including Northern Rock, amounted to around £117 billion by 2010. The Treasury’s additional potential exposure to banking losses (through insurance of bank assets and Bank of England lending) totals over £1 trillion. The Treasury estimated in April 2009 that there may be a one-off loss to the taxpayer of between £20 and £50 billion.

The March 2010 Budget assumed that by 2015, the reduction in output was 6.5% of GDP.

The June 2010 Pre-Budget forecast from the Office of Budget Responsibility produced revised estimates which suggest a greater reduction in output – 8.75%. This means that, on the most recent government estimates, the financial crisis permanently reduced UK output by almost 9 percent per year. The latest ONS projections suggest that in the current tax year, GDP will be valued at £1.476 trillion. 8.75% percent of this figure equals around £129 billion in lost GDP.

In the 2007-08 tax year HM Treasury calculated the structural deficit to be 2.5% of GDP. The recent forecasts from the OBR estimate that the structural deficit increased to 8.8% of GDP in the year 2009-10. [13] The correct measure of the effect that the financial crisis has had on the structural deficit can be arrived at by subtracting the 2007-08 deficit (pre-crisis) from the 2009-10 deficit (post-crisis). This gives a figure of (8.8 – 2.5) = 6.3 percent of GDP. This suggests that the financial crisis had an overall impact on the public finances equal to around £93 billion.

The estimates presented here, although substantial, should be viewed very much as lower bounds on the cost of carrying on with ‘business as usual’. It has become clear that complex risk transfer products only provide short-term profits for the few, at huge cost to the overall economy. Similarly the externalities of fossil fuels, in terms of both local pollution and global climate change, bring negative consequences for our societies which are not acceptable.

Endnotes