Green Investment Bank

Written Evidence Submitted by Kirsty Hamilton (GIB 34)

Thank you very much for the opportunity to make a submission to the Environmental Audit Committee on government plans to establish a Green Investment Bank (GIB). Please find attached a short submission, as well as two supporting documents from earlier this year that cover the GIB but in the context of understanding the underlying renewable energy investment conditions in the UK:

· ‘Starting point on the ‘Green Investment Bank’ discussion, Working Summary, March 2010

· ‘Offshore Wind: RO/FIT Finance Survey, October 2010 (context is capital requirements/constraint).

Kind regards

Kirsty Hamilton

Assoc Fellow, RE Finance Project

10 St James Square

London SW1Y 4LE


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:

o 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;

o 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;

o 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;

o Building confidence and momentum: an announcement of any GIB and the timeline until its establishment must not undermine existing investment momentum;

o RE infrastructure and specific areas of activity (‘products’): two areas in particular have come up as those that could assist round 3 offshore wind;

o Brief comment on simplicity: governance and structure.

1. Background

1.1By 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 [1] .

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, i.e. 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, e.g. 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 5 billion in credit for the first 10 offshore wind projects [2] 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, e.g. 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 (e.g. 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.

2. Timing and timeline: significance of any barriers or ‘market failures’ requiring the establishment of a GIB; any risks of not getting this done quickly

2.1 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.

2.2 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 2-5 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.

2.3 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.

2.4 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, e.g. ‘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 i.e. 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."

3. Green Investment Bank’s investment priorities

3.1 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.

3.2 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.

3.3 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.

4. Funding and governance structures

4.1 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).

4.2 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


[1] ‘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:

[1] http://www.chathamhouse.org.uk/research/eedp/current_projects/renewable_energy_finance_policy/

[2] 2.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.

[2]