Hello philanthropy! Let’s make a deal
Hello philanthropy! Let’s make a deal
We all know by now that we are warming the planet at an alarming rate due to our runaway greenhouse gas emissions, and that we’re going to have to decarbonize very rapidly and arrive at net-zero emissions by mid-century in order to have a fighting chance to keep global temperature rise to below 1.5C.
We also know that this is achievable, but it will take strong and unwavering policy action from governments, greater international cooperation, effort from all of us—and money. A lot of money: McKinsey estimates that more than $9 trillion per year on average will need to be spent between now and 2050 on physical assets for energy and land use systems. Not all of this is “new” spending, but even so, we will need to invest $3.5 trillion per year more than we currently do while reorienting some of our current spending away from carbon-intensive activity.
And just as we will all need to work together to decarbonize, we will need to bring all sources of capital to bear to pay for all this.
The bulk of the investment will have to come from the private sector. Companies will need to invest to concretize their net-zero commitments. They will need to raise debt and equity from capital markets, so financial institutions will play a critical role. In addition to setting the right policies, the public sector will need to invest, either directly in state-owned assets, or indirectly, through (fiscal) support for private investment. Multilateral institutions—development banks as well as climate finance facilities like the Green Climate Fund—will need to step up and help countries make some of these investments. And developed nations will need to make good on their commitments to financially help developing countries achieve climate goals.
In addition to these usual suspects, another player needs to step up its contribution to the cause: philanthropy. A survey of foundations suggests that they provide $150 billion per year in philanthropic grants across a range of sectors and countries. This may be small in light of needs, but it is of the same order of magnitude as annual foreign aid (or overseas development assistance), and if used judiciously, these funds could help mobilize several multiples in investment flows.
“Blended” finance is a term that is much used these days. Essentially, it means using catalytic capital from public or private sources to crowd in private sector investment. Below are some examples of blended structures from my recent work. There are many more. They have been shown to work and they need to be scaled up.
Energy efficiency is a necessary component of our decarbonized future. But energy efficiency investments remain notoriously difficult to finance, despite having very attractive payback periods and internal rates of return. These projects tend to be disparate and small in size, which greatly increases transaction costs. Banks in many countries tend to collateralize their lending; energy efficiency improvements do not lend themselves to being easily collateralized. Loan officers may not be comfortable assessing the credit risk of such projects, while businesses may not easily find the expertise needed for energy audits and other preparatory work. Technical assistance can help build capacity, both in identifying and in evaluating energy efficiency measures, and donor (or philanthropic) funding can help finance it.
Such capacity constraints exist in different climate arenas. Investors lament the dearth of a bankable pipeline of climate-friendly projects, and developers face high upfront development costs that are not easily financed. Dedicated technical assistance and project preparation facilities can play a critical role in creating these bankable projects.
Concessional support—through multilateral, bilateral or mission investment channels—can play an important catalytic role in investment. These sources are prepared to accept lower returns, or take greater risk, than the market. The beauty of such support is that it can be tailored to the specific needs of the initiative, and can be structured in a way that crowds in private investment. One project might need a tranche of lower interest or longer tenor debt; another may need quasi-equity or mezzanine finance. Blended with more traditional sources of finance such as private equity or bank loans, concessional support can help create a capital structure to meet the different needs of the different investors. Such support is not available from commercial sources and could be the critical lynchpin in the deal.
Investors are reluctant to invest where the risks may not be well understood, or where perceptions of risk may be very high. Guarantee structures can help in risk mitigation—and climate finance or philanthropy can help, either by providing the guarantee, or covering first loss. Portfolio guarantees can increase the lending capacity of banks; credit enhancement can facilitate the raising of debt in capital markets: a stronger balance sheet, backed up by government commitments if needed, can provide the comfort necessary for investors to invest.
Where does philanthropy fit into all this? Philanthropic capital is employed across the entire returns spectrum, from grants to concessional investments to market rate investments. This means that there are multiple points of entry in terms of the support that philanthropy can bring to an endeavor. Grant funding can help with project preparation and technical assistance. Mission investment can provide concessional debt and equity, as well as guarantees or credit enhancement. And, as philanthropic foundations (and others) increasingly align their endowment investment with their values, there will be potentially large demand for climate-related assets – and an opportunity for financial institutions to get creative and provide the investment instruments that can attract such funding.
Global capital markets saw over $40 trillion in new issuance in fixed income securities and equities in 2020. Let’s channel some of this to investment in our long-term prosperity – let’s make a deal!
This post was originally published on the World Bank Group’s blog here.