Green Investment Bank

Written evidence submitted by the Green Alliance (GIB 39)


· 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 £4-6bn 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 £450bn of capital investment will be needed in UK energy supply, infrastructure and energy efficiency between 2010 and 2025. [1]

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 £50-80bn of investment between 2010 and 2025. They also estimated that pension and insurance funds might also contribute £25-40bn in that period. This still leaves a gap of £330-360bn.

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 £4bn-6bn.

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 £4bn-£6bn 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 £750m 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 £1-2bn. 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 £40bn.

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

[1] Capitalising the Green Investment Bank: Key issues and next steps , Ernst & Young, October 2010.