By Peter Dunscombe
Chairman of the Institutional Investors Group on Climate Change (IIGCC)

The climate is changing and the investments needed for mitigation and adapation are huge. Private sector capital will be critical to meeting this challenge, with estimates suggesting that around 85% of the total investment must come from private sources, including institutional investors such as pension funds and sovereign wealth funds. 50-60% of these investments must be made in emerging economies. Many private investors are already acting to address climate risks and opportunities. They integrate climate issues into their investment practices, address climate strategies in dialogues with companies and they consider investment opportunities in energy efficiency and renewable energy. However, no matter how committed investors may seem, private sector investment will not reach the scale required to address climate change effectively unless governments provide clear and ambitious policy signals. The single most significant driver of private sector investment in climate change solutions is strong, stable, transparent and credible policy.

Pension funds are bound by fiduciary duty to provide the best possible risk adjusted returns across their portfolios. It falls within this responsibility to take stock of the risks and opportunities associated with climate change and to adapt investment strategies and practices accordingly. Investors will only allocate capital to climate change investment on the scale required if policy provides clear, credible and sustained incentives. For pension funds to allocate a greater proportion of their investments to climate solutions, these investments must provide similar risk adjusted returns to other types of investments, and climate policy is critical to this.

Institutional investors urge greater dialogue between policymakers and the finance sector

This is why the Institutional Investors Group on Climate Change (IIGCC) and similar investor groups around the world called on policymakers in the run-up to COP15 to agree a strong and binding global agreement which would set the framework for strong action on climate change at national and regional levels. A basic lesson to be learned from past experience in renewable energy in countries such as Denmark, Spain and Germany is that almost without exception private sector investment in climate solutions has only been attracted by consistent and sustained policies.

As outlined in the 2010 Investor Statement on Catalysing Investment in a Low-Carbon Economy, investors are looking for policies that put an effective price on carbon and accelerate the development of carbon markets and energy and transportation policies that support the deployment of energy efficiency, renewable energy, green buildings, clean vehicles and fuels and low-carbon transportation infrastructure.

The importance of credible regulatory frameworks and low-carbon domestic policies for attracting private sector investment in size applies to both developed and developing countries.  In some emerging economies, investors may face additional risks, for example more limited transparency, third party dependency, transaction costs and higher financial as well as political uncertainties and risks. This means that private sector investment in climate solutions in these countries will only be accelerated if risk levels are brought down through a combination of capacity and policy development and the formation of financing models to attract private capital.

Leveraging private finance by altering the risk reward balance

Lessons from other regions and other major development efforts, e.g. the Marshall Plan, the preparation for EU accession and sub-national infrastructure development programmes, suggest that the risks associated with investments in climate solutions in developing countries can be brought down substantially by a combination of policy and capacity building measures, and by developing coherent national or regional strategies which place each project in the context of a development plan.

Public sector finance mechanisms should be designed with a view to leveraging private finance and assisting private investments by altering the risk reward balance. This could be achieved through strong and credible national policies involving private-public partnerships as well as through the provision of public finance mechanisms. The latter should be based as far as possible on existing mechanisms such as MIGA/ECA export credit guarantees or lending arrangements by development banks, and any potential distortion of traditional market structures should be curtailed.

Investors are calling for a focused dialogue on the nature and the design of such measures between multilateral development banks (MDBs), bilateral finance institutions and private investors such as pension funds. It is important to adopt a flexible approach that recognizes that countries are at different levels of development; an approach that can be adapted to very different political and financial contexts and to the requirements of different kinds of investors.

In addition, these measures must be adaptable, as domestic policy frameworks are strengthened and carbon markets develop. The deal flow for low carbon projects in developing countries will be improved with the implementation of strong and credible national policies, and public financing mechanisms should be designed bearing in mind that the need for them will diminish over time.

If policies are right, money is available

A key priority for the recently established high-level Advisory Group on Climate Change Financing should be to consider how some of the funds pledged under the Copenhagen Accord could be used to leverage private sector investment in developing countries. Investors are willing to contribute to this discussion, and hope to have greater clarity on the scope of the funds agreed in Copenhagen, as current uncertainties are hampering investment decision-making. There is a risk that the notion that “something new“ is on its way may stall markets and/or drive them unintentionally in a specific direction.

The Advisory Group may want to consider how some of the $30bn fast start money could be used to produce a series of “early wins”. Such an approach would assist relevant international financial institutions and private investors in forming alliances focusing on concrete projects. An aim should be to develop more generally applicable financing models and to provide examples of concrete risk mitigation measures in order to leverage private sector money to be invested in this field.

These experiences can then be adapted to other projects in different countries. In addition, the fast start fund as well as the Copenhagen Green Climate Fund should support countries in developing their capacity, policies and strategies, which in turn would support well-coordinated and well-designed flows of bankable projects that attract private sector investment.

Therefore it is critical that the Advisory Group establishes a dialogue with the financial community on how to accelerate private sector investment in developing countries. If policies are right, money is available – even in the short term.