The stock of cumulative investment in clean energy looks set to increase annually by at least US$300bn to US$350bn over the next decade. But it will have to increase by much more if we are to meet the commitments implied in the Paris Agreement on Climate Change. This means that global debt capital markets must be accessed. Ben Caldecott explains why.
The global investment-grade bond market is worth around US$33tn. As of 31 December 2017, this includes all bonds with a minimum credit rating of BBB-, except mortgage-backed securities (MBS) – as tracked by the Citigroup’s World Broad Investment-Grade Bond Index Excluding MBS (Non-MBS WorldBIG).
Access to bond investors is essential as the balance sheets of many traditional project sponsors – such as power utilities – are increasingly constrained. And, under the Basel 3 regulations, banks cannot afford to provide loans with tenors that match the lifetime of projects.
Despite the size of cumulative investment so far, and their importance, the market for clean energy infrastructure bonds and asset-backed securities (ABSs) has not yet taken off. There are several reasons why.
First, it is not easy for markets to price climate change and transition risks. There is work on this by, among others, the European Central Bank (ECB).
Second, there is a chicken-and-egg problem. Historical data on the performance of clean energy assets – especially data on default rates and loss given default – is lacking. This makes it hard to generate demand for issuance and that perpetuates a lack of data.
Third, policy frameworks are fragmented. There is a preference for having pooled assets operate under similar or identical policy regimes. However, policy frameworks for clean energy differ within and across countries. Common standards and guidelines would make it easier to securitise green assets and to increase overall financing scale.
Fourth, the role of securitisation in the global financial crisis has tamped enthusiasm for ABSs. Perhaps more importantly, the quantitative easing that followed the crisis has made it more attractive for power utilities to re-finance assets – very cheaply – by issuing corporate bonds, rather than green bonds.
However, the ECB announced its corporate sector purchase programme (CSPP) in 2016 as part of quantative easing. After that, the proportion of green bonds outstanding in the industrial sector grew from under 4% in March 2016 to over 9% at the end of September 2018. The ECB argues that the CSPP helped reduce the yields of green bonds making it cheaper to issue them.
There are three significant prizes for policymakers associated with the smooth and efficient re-financing of operational clean energy projects:
- lower financing costs
- making capital available at scale
- freeing up bank balance sheets for the construction and development phase of clean energy projects to ensure there is a robust pipeline.
Policymakers can help kick-start this in the first instance by purchasing subordinated tranches – ie, first-loss tranches – in green securitisations. This would provide comfort to investors in senior tranches and could be done via a national infrastructure bank, or a multilateral development bank.
The main benefit of this approach is increased market familiarity with the underlying cash flow profiles of such projects – and technology. Once that expertise is in place, there is a strong institutional – and individual – incentive to re-use it.
Dr Ben Caldecott is founding Director of the Oxford Sustainable Finance Programme at the University of Oxford and Co-Chair of the Global Research Alliance for Sustainable Finance and Investment.