New sources of capital and new instruments are required to power the green transition
Green Transition is a reality: it is here and now.
The recent spate of high-impact climate-related disasters across the world (floods, wildfires, heatwaves, etc.) have underscored the magnitude of challenges facing humanity cutting across country borders. This has prompted societies and leaders across the world into thinking and action. The concerns and choices of various countries will find a formal forum at the COP26 later this year. Developed countries have, in an act of significant foresight at Cancun, Mexico in 2009, promised a USD 100 billion of climate finance to the developing world.
The other reason is more prosaic: across a range of technologies, it is now becoming more economically viable to be green. Renewable power, even without carbon taxes on fossil fuels, are becoming cheaper; electric vehicles, with battery prices falling, are reaching or breaching the total cost of ownership for the final consumer compared to the internal combustion engine (ICE) vehicles. Ideas and technologies in other fields are also at promising stages of development and customer acceptance: from plant-based meats to battery walls. These ideas need nurturing.
Even with the political environment and economic trajectory being on the right side of green, the transition itself will not be easy, quick, or painless. Many non-green assets have long economic lives (think coal power plants), have many jobs associated with them (think the entire service value chain of ICE vehicles), and skilling into new technologies will require societal and personal investments. This means that transition to the new green world will require significant handholding by policymakers to make this a “just transition”.
There is an important role to be played by governments in setting their national climate policies, creating internal markets (or taxes) for carbon, and reach global agreements on carbon tariffs.
Money, money, money
Large capital flow is required in all the three dimensions above: (a) between developed and developing countries, (b) to technologies which can hold promise for a greener future, and (c) to societies and citizens who may not be able to easily adapt to the transitions.
Transition capital instruments need to: (a) pool capital from those who owe the world a climate debt, (b) transfer it transparently to countries and societies that need capital support in deploying new technologies or in making a just transition, (c) take risk on emerging technologies – some of which may not succeed, and (d) be patient for a longer period as transitions play themselves out.
The climate challenge is a humanitarian one and hence solutions need to come from various institutions and not just the governments of individual countries. Philanthropies, multi-lateral development agencies, large pools of common capital (like the Green Climate Fund), all need to play their roles in nurturing the transition and amplifying the changes.
Sources of capital
- Global capital: Green Climate Fund, established post Cancun to pool together a significant portion of the annual USD 100 bn commitment, has pooled in only USD 10 billion of capital over the last decade. With many of the rules of operation of the fund now in place, it is time to reinvigorate global contributions. Large multilateral pools of capital can help share best practices of adaptation and mitigation transitions within societies. This capital can play a catalytic role by broad basing their focus beyond only financial returns.
- Bilateral (or small group) commitments: Like trade agreements between two (or a small group of) countries, commitments on specific initiatives that countries agree upon can be made. They can focus on technology transfer between countries or specific assistance in developing skills at a local level (for say afforestation, carbon capture, etc.), or joint contribution to funds that invest in mutually relevant technologies.
- Multilateral development institutions: Global development financial institutions can play the role of both technical assistance and deployment of long-term, patient capital. They can operate with a two check-book philosophy: one looking at commercial returns and other, social impact.
- Private capital: Private equity and venture capital funds taking a bet on new technologies and deploying them for consumer adoption already exist. Philanthropic capital with longer horizon and possibly, lower return thresholds can add to the available capital. Many firms with a non-green background are now committing to net-zero targets: cash flows from their fossil fuel businesses are now being channelized into green ones.
Instruments for sharing risks and returns
- First-loss capital: Funds willing to take first loss can crowd-in significant amount of other risk-taking capital. A pool of funds in which say 10% of the capital is designated as “first loss” means that remaining 90% of fund contributors can be offered a better risk-return trade-off. Alternatively, payout to such capital takes place only when impact outcomes are met.
- Guarantees: This is a force-multiplier instrument. Unlike first-loss capital which requires actual deployment of funds, guarantees are a way to backstop such payouts, as and when the need arises. If run by credible counterparties like the multilateral development institutions, this can reduce the need to deploying upfront capital. As and when guarantees are needed to absorb any losses from the investment, such guarantees can be honored.
- Forever funds: One aspect which constrains investing today is the finite time period (ranging from 7-15 years) for private or government funds. Eventually funds and their returns must be returned to contributors. Funds which commit to reinvest all (or most of) the proceeds back in furthering green transition can offer a much longer time duration for projects to mature. Specific interventions may vary over the life of the funds – however, that they do not need to be returned can allow such funds to take a longer view of the transition process.
The intermeshing of sources of capital and specific instruments can create a wide range of tools for financing the transition. Institutions that create propriety in reporting to avoid green washing need to develop alongside these new financial instruments. This will power the green transition to be a green revolution!
The author is with National Investment and Infrastructure Fund (NIIF). Views are personal.