19 November 2015

Putting the market to work on climate change

By Shaun Kingsbury

In under a month negotiators from more than 190 nations will gather at the UN Conference on Climate Change in Paris seeking to agree a new and ambitious global deal.

We’ve been marched up this hill before. Swap Paris for Kyoto, Bali, Copenhagen, Cancun or Durban and it’s a familiar story. Some of these gatherings have delivered important progress, others depressingly little, but none have delivered the necessary transformation. These gatherings are generally viewed with a sense of resigned weariness.

So what makes Paris different?

One reason: for the first time ever the outcome of a conference on climate change is likely to be a defining event for global financial markets.

This claim is underpinned by one achievement from Paris that has already been secured: 156 countries have agreed and submitted a voluntary plan setting out their path to a low-carbon future. For the first time we now have a firm connection between the intent to act on climate change and plans for how we will do so. Not a vague global plan, but bottom-up, country-by-country, designed by nations for themselves. It’s a triumph of pragmatism and it provides a basis to build momentum.

Below this gear-change in global policy and national commitments we also have a powerful combination of factors coming together which will deliver real change, quickly. The renewable technologies which underpin green infrastructure projects are increasing in efficiency and falling in cost (and are often viable without Government subsidy). Simultaneously, financial markets are realising the opportunities of a new investment class and gaining a better understanding of the risks associated with fossil fuels.

The frustrating thing about a tipping point is that you are never quite sure when it’s happening – but there are plenty of signs that one is underway.

Across the world, renewables already account for more investment in electricity generation capacity than fossil fuels and China has taken a leading role, growing their investment in renewables by a third in 2014 to $90bn. Globally, renewables investment has more than doubled from £84bn in 2006 to £188bn in 2014. Closer to home the UK renewables industry recently set a new record by producing 25% of the UK’s electricity for a whole quarter.

This increase in investment is being matched by more efficient technology and falling costs. Solar PV panels are today 15% cheaper than they were just a year ago and offshore wind 14% cheaper. In energy efficiency, LED lighting is now six times more efficient than incandescent bulbs and is 75% cheaper than in 2010. Many renewable energy technologies now compete with fossil fuels on price, and that’s before you even begin to consider fossil fuels’ un-priced costs and subsidies.

Alongside this we have the quiet progress which is likely to prove the most effective of all – a reduction in carbon intensity through improving energy efficiency. Globally, carbon intensity reduced by 2.7% in 2014, while in developed economies electricity consumption per unit of GDP is being driven down by a combination of greater energy efficiency, renewable energy investment and a shift to less carbon-intensive activities.

At the point where we are reaching a global network of action plans we have a series of low-carbon technologies up to the challenge. The stage is set.

The challenge is now this: how do we finance the $90 trillion of investment in the infrastructure we need to see over the next 15 years? And how do we ensure it is low-carbon? It’s a challenge that has drawn the focus of the UK Prime Minister, Chancellor and the Governor of the Bank of England over the past few months.

The PM has often spoken about the need to get the “market to work on climate change”. This must be the right answer. Paris shows that all nations know they cannot afford to delay action. The reality is governments cannot afford to finance all the action they need. The market may not be perfect but it has shown, time and again, that it is the most effective route to positive transformational change – in economic and social terms – way beyond the capability of any Government. It now needs to do so again.

The UK Government will, no doubt, make climate finance the centrepiece of their approach to Paris. They would be right to do so: it is both the most powerful policy response and an outstanding economic opportunity for the UK, the global headquarters for climate finance.

The Chancellor in his conference speech was more specific and spoke about the link between infrastructure and productivity and the need to find new ways to fund British regional infrastructure. He placed a specific focus on pension funds to play an increased role, set out a plan to create half a dozen British Wealth Funds and tasked Lord Adonis to lead an invigorated   National Infrastructure Commission.

Meanwhile, Mark Carney, the Governor of the Bank of England, went further in a landmark speech to insurers by highlighting the transition risks faced by large investors as the world shifts emphasis from high-carbon investments to low-carbon. These risks are now being seriously discussed in the boardrooms of investors and utilities across the world.

He also identified the opportunity: “Financing the decarbonisation of our economy is a major opportunity for insurers as long-term investors. It implies a sweeping reallocation of resources and a technological revolution, with investment in long-term infrastructure assets at roughly quadruple the present rate. For this to happen, ‘green’ finance cannot conceivably remain a niche investment over the medium term.”

This challenge was neatly summed up by the Environment Agency pension fund recently. They have committed to cut their investments in coal by 90% and oil and gas by 50% with a commitment to invest almost £450m in low-carbon and energy-efficient stocks and assets. Their Chief Investment Officer said about their £450m investment target: “This goal will be the most difficult to achieve — much more difficult than reducing our coal, oil and gas exposure.”

So we cannot simply expect “the market” to get to work on its own. It needs investible opportunities and experts ready and willing to build products to suit investor needs.

Pension funds and life assurance funds are a vital piece of the jigsaw. They are an ideal combination of capital seeking long-dated, predictable returns with infrastructure projects offering exactly that. And yet the connection remains weak. While these investors want more infrastructure assets, and are increasing their target allocations to 5% of their portfolio, they typically only have around 3% today – mainly in roads and airports. Canadian, US and Australian pension funds have led the way, often topping infrastructure league tables, well ahead of British investors.

It should be no surprise that investment in infrastructure is lower than we would like. Listed equity and debt have been the focus of institutional investors for decades. While some parts of the rapidly growing infrastructure market are well understood and well served, the area of low-carbon investment is not. There remains a market failure: knowledge and experience. This, of course, is entirely typical in a new, fast-growing market trading on what are, to many investors, new technologies. It remains a highly-niche field with investors tending to bring a narrow focus on specific technologies or financing solutions.

There are very few investors working across the field of green infrastructure with the flexibility to structure a financial package to meet the needs of a project developer. This is where the UK Green Investment Bank comes in.

GIB, set up and financed by the UK Government, was created to be a new centre of expertise in this nascent market. While our ability to directly provide the finance necessary to get projects into construction has been vital in delivering over £10bn of UK green infrastructure, our longer-term value goes beyond that. We act as a catalyst on three fronts. First, by creating financial products that encourage new investors to take a first step into the green infrastructure market. Second, by creating a demonstration effect that green investment is a profitable business, encouraging other investors to build their own direct investment capability. In achieving this we will push the frontier of the market deeper into the UK green infrastructure sector. And third, by using our expertise and experience to help forge new conventions and greater standardisation in the assessment and reporting of green impact.

It’s already happening.

We played a leading role in the listing of the first listed renewable energy yield co. This new asset class has raised £2.4bn in Europe and $8.3bn in the US. We have also raised the UK’s largest renewable investment fund providing pension funds, insurance firms and sovereign wealth funds with an opportunity to access the predictable yields they need. Through GIB we now have pensioners and life insurance policy holders in the UK and Sweden investing in UK offshore wind farms.

The logic behind these two financial innovations is simple: understand what investors want, structure your investment opportunity accordingly and let the market do the rest.

We are also now a profitable business. We have proven our business model to a degree that private investors are interested in financing our growth. The UK Government has responded to this by indicating a plan to sell a majority of its shares in our business, moving us from 100% publicly owned to majority privately owned. This will give us the capital we need to grow our business both in scale and also by widening the range of green infrastructure we can finance. It will also provide the ultimate demonstration of the commercial opportunity in financing the transition to low-carbon infrastructure.

The UK Green Investment Bank is one demonstration of the future that Cameron, Osborne and Carney have been pointing to. We are one of the market experts needed to bridge the gap between the investible green infrastructure projects the world wants and the deep pools of institutional capital that we need to finance it. This is the market getting to work on climate change.

Current expectations are that, at best, Paris will make some progress but fall short of the commitment required to limit an increase in global temperatures to less than 2c. The hope is that in building demonstrable momentum, and capitalising on technological developments, we can harness the transformative potential of the market to deliver solutions that carry us beyond what gets agreed between Governments next month.

Shaun Kingsbury, Chief Executive of the UK Green Investment Bank