photo: Maryland GovPics
How sovereign and hybrid funds may help address climate change
One of the biggest bangs at the opening day of the Paris COP21 climate summit was without doubt the dual financing announcements by the Breakthrough Energy Coalition, led by Bill Gates and other high-net worth individuals, and the Mission Innovation, whose signatory governments have committed to doubling their allocations to clean-energy research. The two initiatives aim to increase financing for clean-energy innovation, from the basic research stage -funded by governments- to commercialization of promising new technologies -with venture financing provided by private investors.
In developing countries, where many households and companies have very limited access to energy, new clean-energy technologies will serve the dual purpose of expanding energy access and constraining carbon emissions. For this to happen, innovative thinking will be needed not only in the development of new technology, but also in financing the deployment of these technologies.
The two initiatives announced in Paris reflect the realization that carbon-dioxide emissions would continue to rise even if every commitment to cut carbon emissions were fulfilled. By 2035, the concentration of carbon in the atmosphere will already exceed the estimated levels required to maintain the internationally agreed 2 degrees Celsius limit. The development of new technologies will increase the options available to efficiently address climate change.
Source: Global Apollo Program to Combat Climate Change
Leveraging to bridge the technology finance gap
Mission Innovation and the Breakthrough Energy Coalition aim to address the technology finance gap. Even if these initiatives turn out to be highly successful, the challenge still remains of substantially scaling up financing for the deployment of clean-energy technologies, including in developing countries. Pooling public funding and leveraging it with private sector capital could increase the uptake of existing and new clean-energy technologies.
Indeed a new trend is emerging in the deployment of public capital: an increasing number of governments are considering the use of investment structures that combine public and private capital, mainly for the purpose of infrastructure investment and venture financing for young firms. This trend has been underpinned by shrinking government budgets since the 2008 financial crisis, a persistent infrastructure financing gap, and a realization that the active involvement of private capital is critical for the achievement of national development goals.
Climate-smart sovereign and hybrid investors
Global public funds are a convenient way to pool individual countries’ resources for the common purpose of addressing climate change. But multilateral funds’ resources are insufficient to meet countries’ needs for clean-energy investment. Could national or regional government-owned strategic investment funds, or public-private “hybrid” funds also become important actors in financing the deployment of climate-smart energy?
Public-private” hybrid” funds could be another possible investment vehicle to support or fast-track the uptake of climate-smart energy infrastructure. These funds manage pools of combined public and private capital, and may offer a variety of investor return-enhancing mechanisms, including differential timing of investment draw-downs of public and private investors, leveraging the returns of private investors with publically provided debt, capping the profit entitlement of the public investor, and partial guarantee of compensation to the private investor for loss of invested capital.
A central issue for publically owned or capitalized funds is the independence of investment decisions from political pressures. In “hybrid” funds, investment decisions are left in the hands of a private general partner, with countries participating as limited partners. The capital of strategic investment funds and sovereign wealth funds may be managed internally and/or externally, subject to governance and transparency requirements, as well as market-based checks and balances including co-investment and partnership arrangements.
A new way to address climate change
Climate change has already generated a considerable amount of financial innovation, notably emissions trading and green bonds. Following the lead from Paris, this innovation must continue. Sovereign and hybrid funds may have a significant role to play in the provision of truly patient capital for clean-energy infrastructure.
The views expressed in this article are not necessarily those of the World Bank.
The authors are grateful to Nina Vucenik and Jacob J. Kloeper-Owens for editorial assistance