16 May 2017

Renewable power plants, smart energy grids and low-carbon transport – the world’s cities require significant investment in green infrastructure to combat climate change.

Some USD90 trillion is needed in new green infrastructure over the next 15 years, according to the New Climate Economy, with the annual level of spending needing to double to USD6 trillion from about USD3 trillion today in order to keep on track with a two degrees scenario.

Governments, banks and multilateral organisations such as the World Bank already lend to green infrastructure projects. The funding needs are so great, however, that there is a significant and persistent shortfall.

Policymakers have long hoped that institutional investors could help fill the gap. Investment funds, insurance companies, sovereign wealth funds and pension funds manage about USD100 trillion of assets globally and are already active buyers of government and corporate bonds.

In many places financial rules do not provide the right incentives to encourage investment in green infrastructure

On paper, green infrastructure looks like it has the potential to be a good match for pension funds and sovereign wealth funds in particular. These investors often look for long-term investments with a degree of protection against inflation: the revenues generated by infrastructure projects (income from selling green electricity, for example) tend to rise with inflation. And investment is secured against a real, physical asset.

So far, however, take-up of green infrastructure has been low. Among large pension funds, just one per cent of their portfolio was allocated to direct equity investment in infrastructure, according to a 2015 survey by the Organisation for Economic Cooperation and Development (OECD). Of that one per cent investment, a tiny proportion was considered green.

There are a range of reasons for this. In many places financial rules do not provide the right incentives to encourage investment in green infrastructure. Investors like predictability – but few countries have a reliable national plan for big projects, explaining what will be built where, and when. And complex projects often have many idiosyncratic features, making it hard to evaluate the potential risks and rewards.

Governments, as well as development banks and national investment funds which have a mandate to promote sustainable development, recognise these barriers and are already taking steps to encourage institutional investment in green infrastructure. Some make direct investments. By taking a “cornerstone stake” at an early stage, they aim to give a project enough momentum to make it viable for private investors to join in. Others offer various forms of credit enhancement, including loan guarantees and partial credit guarantees, helping private investors manage risk.

These steps are helpful and welcome, but it is clear that much more could be done. The Institute for International Finance and the OECD are among the organisations that have proposed solutions, and we think many of the steps they suggest could make a real difference:

  • Governments can help inspire investor confidence by setting out and sticking to a clear, credible pipeline for major infrastructure projects
  • Regulators need to work together to create a more consistent, more supportive regulatory environment – ensuring that rules do not automatically characterise green infrastructure investment as high-risk, and develop a clear framework for private-public partnerships
  • Development banks and governments should continue to refine and improve the types of guarantee and seed funding that they offer
  • Public bodies should aim to agree an internationally standardised set of guarantees and a clear framework for investment so that private investors are better able to analyse and understand the potential risks and rewards of different projects

We know that institutional investors are keen to play their part in the fight against climate change. Two-thirds want to put more capital into low-carbon and green investments, according to a 2016 HSBC survey . Creating a framework that supports and enables them to do so is vital to achieve the low-carbon future we all want to see.