Leverage in IFC’s Climate-Related Investments (2005-2013) SUMMARY Development banks – whether global, regional perceived. The public sector has a large role to or national, or multilateral, bilateral, or play in creating an appropriate enabling domestic – can play an important role in environment conducive to investment in financing climate-related investment and in general, and low-carbon activities in particular.2 leveraging significant resources from the private sector to do so. This report presents an This paper demonstrates that significant analysis of the International Finance private finance can be mobilized for climate- Corporation’s (IFC) climate finance experience related investment. It attempts to glean lessons over a nine-year period from July 2004 to June from IFC’s extensive experience in financing 2013, and provides insights on trends in the such investment; these insights could inform nature of the activities that have been the deliberations currently taking place in the financed, as well as the leverage and design of international climate finance mobilization achieved. mechanisms. Why this paper? Climate change is now Starting from a relatively modest level in 2005, acknowledged to be one of the greatest when IFC began tracking its climate-related challenges facing our planet. The recent World activities (21 projects amounting to IFC Bank publication, Turn Down the Heat: Why a investment of $211.7 million, or 4% of IFC’s 4° C Warmer World Must be Avoided, own account commitments), IFC’s activities describes well the perils that face our planet if have grown in volume as well as in the breadth we continue on our current emissions of sectors involved, to reach 14% of total own trajectories.1 Climate change could erode or account3 commitments in 2013. This review reverse the gains that the world has made in encompasses 562 investments undertaken economic development. Action to move growth over the 2005-20134 period in a variety of trajectories to lower-carbon pathways is sectors, using the full panoply of IFC financial urgently needed, and massive investment in structures and instruments. mitigation and adaptation will be required. It is also widely acknowledged that this investment The analysis points to a number of interesting will need to come predominantly from the observations and insights: private sector. However, the private sector is reluctant to invest where the returns are not 2 commensurate with risks, be they real or See IFC (2011). Climate Finance: Engaging the Private Sector available at www.ifc.org/Report- ClimateFinance 3 Investments that are carried on IFC’s balance sheet; does not include monies mobilized through third parties. 1 See wrld.bg/mBkXD 4 IFC’s fiscal year runs from July 1 to June 30. LEVERAGE IN IFC’S CLIMATE-RELATED INVESTMENTS 1 There is great potential in leveraging associated with multiple lenders and complex private sector climate-related investment project finance structures. through multilateral development banks (MDBs). As IFC’s experience shows, one Lower leverage activities may still fulfill dollar of IFC climate-related investment brings important market development roles. In in close to 3 additional dollars from other some cases, leverage appears to be low investors on average; and that one dollar of because of the conventions underlying project IFC investment has itself been leveraged on accounting for that type of activity (as in FI the strength of IFC’s shareholder capital. All activity, for example). In other cases, the MDBs follow a similar funding model, and underlying technology may be less well would likely have similar leveraging potential. understood by the market, and a critical mass of activity may not yet have been attained for Average leverage ratios, while useful, mask market demonstration purposes, leading to significant variations across project types. limited co-financing interest on the part of other A nuanced picture of leveraging potential investors. IFC can play an important role in emerges when the underlying activities are financing such activities, so as to bring them broken down into “like” categories. Even within up the curve and create greater market a relatively homogeneous category, such as awareness and acceptance. renewable power generation, there are variations depending on technology and Climate-related investment follows market characteristics. The private sector does underlying market trends. The growth in not behave in a homogeneous fashion. IFC’s climate-related business, particularly for renewable energy (RE), reflects underlying A simple leverage ratio calculation does not market trends in the RE business, which has always tell the full story. Because of the way seen significant growth in many of IFC’s IFC accounts for investments, the leverage markets. IFC has been ready and able to that will actually be achieved on the ground is support such growth, but the supply of capital, not always captured. This is particularly the while undoubtedly critical, is not necessarily case for indirect investments, as through the defining element in the growth of such financial intermediaries (FIs). Direct investment activity. financing better captures the actual investment that takes place. Neither case captures the Climate-related investment needs a broader multiplier effects of investment on conducive underlying investment income and economic development. environment. Most of the activities that IFC has undertaken to date have not involved Greater leverage is achieved with well- explicit subsidies. This means that their established technologies. Where creditworthiness derives from the prevailing technologies are well established and business environment, policy and regulatory understood by the market, it is easier to attract regimes in the countries involved. In the other financiers to participate in the investment absence of such conditions, such investments plan. Where there are technical issues will simply not take place – or will require associated with a technology, as in solar additional risk mitigation measures. thermal electric technology (concentrated solar power – CSP), or where the activities financed Active “selling” of climate-related activities have not yet entered the mainstream, as in can help. In some cases, climate-related some types of energy efficiency (EE), leverage opportunities may not be immediately obvious ratios are lower. to a client. This is particularly the case in some EE improvements. In such cases, the Leverage ratios are often higher for larger difference between their adoption or not is the projects. Big, capital-intensive projects tend to advice and technical expertise that can be attract more financiers, as individual lenders brought to bear in a given project. IFC’s in- run up against exposure limits. Large projects house technical experts (engineers and can also absorb the higher transaction costs environmental specialists) are key to such LEVERAGE IN IFC’S CLIMATE-RELATED INVESTMENTS 2 active client engagement, particularly in the Advisory services and capacity building are context of IFC’s Performance Standards5 essential components of some activities. which requires clients to consider resource This paper has not examined Advisory efficiency possibilities. Services (AS) and the role that it has played in supporting IFC’s climate-related activities. The Climate finance is often a portion of the brief description of AS programs provided overall financing. In many cases, the climate- shows that some technical assistance and related portion could be tangential to the main capacity building activities are essential investment being pursued, yet there may well building blocks for certain types of climate- be opportunities to reduce the project’s related investment. emissions footprint through captive renewable energy (RE) or EE measures. Such Leverage is an important “bang for buck” components may be a small part of the project measure, but not the only one. Leverage overall, but they should not be discounted for shows how much money was mobilized on the their impact or demonstration value. Here back of a public dollar, but it does not capture again, active client engagement by IFC’s the impact of that money in terms of GHG technical staff is key. reductions, or employment creation, or any number of other co-benefits on health and local Blended finance can nudge investment into pollution or other objectives that a country may promising, but as yet commercially wish to pursue. These should be areas for unproven areas. Often, being a first-mover further work for IFC and others. entails risks that make it difficult for a client to complete a financing plan on acceptable terms. The perceived risk may be too high even for a This paper is a part of a series of development finance institution like IFC. A publications underpinning a report to the small amount of concessional finance used to address such risks can act as a catalyst and G20 Development Working Group on mobilize the necessary financing. “Mobilizing Public and Private Funds for What gets measured gets managed. It is Inclusive Green Growth Investment in only when IFC made a public commitment to Developing Countries.” grow its RE and EE activities6 that a tracking system was put in place; it is only when such investments began to be tracked and targets The full version of this paper and the set that staff realized that there were several climate-related opportunities in the business aforementioned report are available online that could, with a little extra effort, be at www.ifc.org/climatebusiness. materialized. IFC’s commitment to grow its climate-related business has given a boost to such endeavors. 5 www.ifc.org/performancestandards 6 In Bonn in 2005. LEVERAGE IN IFC’S CLIMATE-RELATED INVESTMENTS 3 Contact Information: Climate Business Department International Finance Corporation 2121 Pennsylvania Avenue NW Washington, DC 20433 Authors: Shilpa Patel and Rusmir Musić www.ifc.org/climatebusiness Twitter: @IFCClimate November 2013