By Aled Jones
Deputy Director, University of Cambridge
Programme for Sustainability Leadership & Facilitator, HRH Prince of Wales’s P8
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
- 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.
- 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
- 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
- Some technologies emerging quickly but unproven at scale.
- Lack of general experience in emerging markets.
- Difficult to be highly knowledgeable in dynamically emerging markets.
- 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
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
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
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.