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Scaling up Institutional Investment in Climate Solutions

By Aled Jones
Deputy Director, University of Cambridge Programme for Sustainability Leadership & Facilitator, HRH Prince of Wales’s P8 Group

As part of the global response to climate change, a large increase in private sector investments into climate solutions (energy infrastructure, transportation, energy efficiency and carbon sinks such as forests) is required. Institutional investors are financial organizations that control the scale of finance necessary to transition the global economy. Moreover, they are the organizations which are most likely to have the long-term investment horizons needed in these investments.

However, to stimulate their engagement, the expected returns on climate solutions investments need to be commensurate with the perceived levels of risk and need to be competitive with ‘business-as-usual’ investments. Therefore, policy has a critical role to play in helping manage these risks, whether through international, regional or domestic legislation to create markets for climate solutions, or through risk sharing with Public Finance Mechanisms.

It is clear that there are many risks associated with investments into climate solutions. These risks will impact the return that institutions demand of their investment portfolios. Managing these risks to bring the actual returns into line with expected returns (or at the very least so that the returns become competitive with business-as-usual returns) is critical to get institutions to shift the allocation of their portfolios much more towards climate-related investments.

The chief market risks related to climate change from an institutional point of view are outlined in the following table.

Major Market Risks

 Market risk


Carbon Cost 
  • Incorporating the pricing of carbon into the economic cycle will impact operating expenses, the operating lifetime of existing facilities etc., which will in turn feed through to market valuations.
Substitution Risk 
  • Risks may include: investing in early stage low carbon processes which are exposed to rapid technological change; investing in new or existing high carbon businesses; changes to purchasing patterns and consumer rejection of less efficient (and less ‘green’) products and services.
  • Location of operating assets and access to cover will increasingly become an issue as insurers re-evaluate their risk; appetite and desire to provide cover; increasing premiums and/or withdrawal of insurance cover.
  • Markets, such as fossil fuel energy markets, are likely to become more volatile and unpredictable.
  • Clean-energy markets may be less volatile, but there is much uncertainty related to carbon markets etc.
Scale of Investment 
  • Minimum investment scale required by large institutional investors
Technology risk  
  • Some technologies emerging quickly but unproven at scale.
  • Lack of general experience in emerging markets. 
  • Difficult to be highly knowledgeable in dynamically emerging markets.
Currency risk
  • Exchange rate fluctuations make returns volatile.
  • Potential to undermine profitability of investments.
Deal flow problems 
  • Insufficient number of commercially attractive, easily executable deals.
Evaluating multiple, overlapping risks
  • With limited time and numerous alternatives, the private sector finds it difficult to fully evaluate risks of low carbon investments.

For more details see United Nations Environment Programme (UNEP) and Partners, October 2009, Catalysing low-carbon growth in developing economies, Public Finance Mechanisms to scale up private sector investment in climate solutions;; RAILPEN Investments, HSBC & Linklaters, November 2009, Climate Change Investment Risk Audit, An Asset Owner’s Toolkit; Lloyd’s, 2009, Climate Change and Security: Risks and Opportunities for Business, Authored by Dyer, G. for Lloyd’s and the International Institute for Strategic Studies.

For large institutional investors, investments into climate solutions will usually take two forms: equity and debt. Equity can be provided directly into projects or via funds – this type of equity is usually called ‘Alternatives’ within pension funds. Debt is usually provided through financial instruments such as bonds. Both of these types of investment opportunities will be needed to achieve the scale required, and different projects will require differing levels of debt and equity as they develop.

Institutional investors have recently increased their investments into these types of investment (bond and alternatives) recently. As an indication of sub-sector institutional investor trends, UK Pension Funds have a reduced asset allocation in Equities1(75.2% in 1999 down to 49.8% in 2008) and increased asset allocation in Bonds (16.7% in 1999 up to 34.7% in 2008) and Alternatives (0.7% in 1999 up to 7.5% in 2008) (Investment Management Association, July 2009, Asset Management in the UK 2008, The IMA’s Seventh Annual Survey, London, UK).

“Green” bonds, set up in a similar way to standard government backed bonds, are a simple way for institutional investors to engage in this space. Pension funds already have large exposures to long-term bonds and are used to purchasing this type of financial instrument.

Alternative equity structures can take a number of different forms and no one solution is better than another. Institutional investors are all set up with different decision-making processes and different asset allocations, so offering a variety of equity investment solutions will be important. It is also true that having a variety of equity investment solutions will allow different types of projects to be funded, as some will fit better into different fund structures.

However, with all types of equity investments, similar risk management issues need to be taken into account to ensure the right sort of risk/return ratio. Public Finance Mechanisms (PFMs) should be used to increase returns and/or reduce risk and complement, not substitute for private investment.  PFMs need to be directed at funds and large-scale projects to encourage institutional investors. Initiatives to promote this include2:
  • Make country risk guarantees more explicit to institutional investors;
  • Offer low carbon policy risk cover;
  • Establish currency funds offering foreign exchange hedging products;
  • Create low carbon project development companies;
  • Public sector takes ‘first loss’ equity position in funds; and
  • Private sector institutions could access support to encourage the establishment of large-scale infrastructure, real estate, private equity or energy efficiency funds in climate change mitigation and adaptation.

However, returns will only be achieved on climate solution investments with the right set of domestic policies in place to create a market for the investments, and this should not be underestimated when setting up global or regional funds or equity projects. The engagement of domestic governments is a vital component.

Leading groups are being established in various institutional investment sub-sectors to advance thinking on climate change and on the positive actions industry can take to position themselves ahead of the curve in creating sustainable jobs and cleaner economies. 

Engagement between the public and private sectors on sustainability and financial performance in relation to climate change is being led globally by groups such as the HRH Prince of Wales’s P8 Group, the United Nations Environment Programme Finance Initiative (UNEP FI), the Institutional Investors Group on Climate Change (IIGCC), the Investor Network on Climate Risk (INCR), and the Investor Group on Climate Change (IGCC).

The importance of clear policy direction cannot be overstated. Through the networks outlined above, investors are engaged in serious dialogue with policymakers to ensure that the implementation of mitigation and adaptation policies will harness the power of  private sector capital. 

1 This type of equity refers to investments in public companies.
2 For more details see UNEP FI, October 2009, The materiality of climate change, How finance copes with the ticking clock.