Climate Technology Program | In Brief No. 11 Monetizing Green Impact Lessons from Africa’s First Green Outcomes Fund For green Small and Growing Businesses (SGBs), access to finance is one of the key constraints in scaling innovative business models. Investors, even those with the intention and mandate to support smaller deal sizes, consider these early stage businesses to be costly and risky. In South Africa, the World Bank Group’s Climate Technology Program, together with the University of Cape Town’s Bertha Centre for Social Innovation and Entrepreneurship, GreenCape and WWF-South Africa, has designed a first-of-its-kind financial structure to address this issue. The Green Outcomes Fund incentivizes local investment in green SGBs by paying fund managers for green outcomes achieved by their investees. By monetizing impact, the GOF is able to mitigate the disproportionately high costs and risks associated with these investments, thereby developing the green finance sector. Almost two years in design, the Green Outcomes Fund is now registered as a legal entity, and should begin operations in 2018, following fundraising efforts. This In Brief dives into some of the lessons generated throughout the conceptualization and design phases. It follows up and expands on In Brief No. 8, “Can Outcome-Based Financing Catalyze Early Stage Investments in Green Small and Growing Businesses? Lessons from South Africa.” Introduction Design and Structure The Green Outcomes Fund (GOF) addresses the challenge The GOF was developed through a design thinking process of access to finance for green Small and Growing Businesses that included engagement with market players, sector experts, (SGBs) by incentivizing local South African fund managers local SGBs and fund managers. The design partners have (Recipient Funds, or RFs) to increase their green investment a large network of local impact and early-stage investors, activity by paying for outcomes such as green job creation, incubators, accelerators, and SGBs in South Africa. Engagement CO2e mitigation, and improved water and waste management. demonstrated that South African SGBs face three major It creates demand for verified, pre-agreed green outcomes constraints in starting-up and scaling-up their businesses: generated by SGBs and purchased through local fund managers, 1) access to finance, 2) capacity to manage and grow, and while simultaneously creating a common base for growing the 3) access to markets. These issues are multiplied in the green South African green impact investing market. By only paying economy, where new business models and technologies are for outcomes achieved, the GOF ensures maximum efficiency in being pioneered. To address this, the GOF has been structured to: allocating funders’ resources. • Incentivize local fund managers (Recipient Funds) to increase The GOF tests whether an outcomes-based payment model green SGB investments, by providing outcomes-based can catalyze additional local investment in green SGBs, and funding that is calibrated to cover any additional costs and ultimately further the development of a robust green impact mitigate risks of investment in green SGBs, such as business investment industry in South Africa. It represents the first development and technical assistance. blended finance model in local currency in South Africa, where public and private capital, concessionary and commercial, blend • Enable local investment funds to raise additional capital through access to de-risking instrument in local currency together to increase the uptake of social and environmental business models. By using concessionary funding to catalyze • Encourage the uptake of verifiable green metrics across the private sector finance directly, while also crowding in additional local investing industry. investment for the green economy in the long run, the GOF • Develop capacity among investors in RFs to assess green aims to achieve the most efficient use of grant funding and credentials, e.g. local pension funds. value for money to funders. • Support price discovery on delivery of green outcomes by This innovative approach catalyzes the green economy at RFs and outcomes funders. multiple levels, including: • Test and demonstrate the potential for a new blended finance model in growing private investment in impact 1. Building a pipeline of green businesses by increasing the sectors in order to scale the Green Outcomes Fund as a local demand for green businesses from local investors, and blended finance facility enabling access to capital 2. Supporting innovative finance strategies, including linking the cost of capital to social and environmental outcomes, and allowing price discovery of green outcomes 3. Unlocking private sector capital to accelerate the green market In Brief No. 11 | Page 2 GREEN OUTCOMES FUND OVERVIEW Target Fund Size ZAR 20m – ZAR 50m Domicile of Fund South Africa Inception year 2017 Target Geographies South Africa, Southern African Development Community (SADC) Investment Terms Grant capital (consisting of both returnable and non-returnable grants) Target Capital Providers/ Foundations, governments, DFIs, impact investors Investors Recipient Investment A range of local early-stage fund managers (deal sizes ranging from R80 000 to R100m+) with a Funds positive track record, a demonstrable interest in investing in green SGBs, and experience with early stage impact deals. Target Sectors Green buildings and the built environment; sustainable transport and infrastructure; green energy and energy efficiency; resource conservation and management; sustainable waste management; sustainable agriculture; food production and forestry; water management; sustainable production and consumption; and environmental sustainability. Outcome Metrics Green sector jobs created; CO2-eq sequestrated; clean energy access connections; energy generation; energy efficiency; waste to landfill avoided; avoided waste incinerated; waste recycled/reused; chemical recovery; water use reduction; wastewater treated; water productivity; wastewater recycled or reused; water sourced from an alternative resource In Brief No. 11 | Page 3 The GOF Process Key lessons from the governance design process The GOF will provide matched (returnable) grant funding • Hands-on knowledge management throughout the pilot: The Green to local fund managers in support of investments into Outcomes Fund, as the first of its kind, will offer significant lessons for green SGBs that make a demonstrable contribution future iterations, scale, and replication. In addition to the traditional to the green economy. The RFs will use their own focus on ongoing fund management, the GOF requires a strong focus investment capital to invest in green SGBs initially. Once on impact measurement, evaluation, and knowledge management. To green SGB investees start achieving the pre-agreed facilitate this, a dedicated team has been assigned to gather, analyze and green outcomes, the GOF will disburse outcomes disseminate learnings throughout and beyond the pilot. payments to the recipient funds. Outcomes will be • The importance of a dedicated fund administrator: To keep the assessed in relation to an outcomes-based contract pilot lean and ensure the best use of funder resources, the initial GOF signed between the Fund and each RF. This contract will design kept the fund administration function internal. However, with the be tailored to each fund depending on the additional intention to use lessons from the pilot to scale the GOF, an independent, costs of engaging SGBs. The GOF manager will monitor dedicated fund administrator was appointed. This ensures that a team the achievement of these results and the fulfillment of of professional, experienced fund administrators will set up the GOF in a the contracts over time. See Figure 2. robust way that can be scaled up after the pilot. Figure 2: Green Outcomes Fund Process Funder commitment Agreement on green Recipient fund Green SGBs achieve outcomes among GOF managers invest in green outcomes manager, funder and green SGBs recipient funds Funder GOF manager GOF manager Fund managers Fund managers receives disburses payments verifies outcomes report achieved monitor and measure impact report for verified outcomes reported outcomes to GOF outcomes achieved every 6 manager by green SGBs months Recipient fund managers Green SGBs achieve invest in green SGBs green outcomes In Brief No. 11 | Page 4 • The value of a mission-driven, neutral market player • Timely demonstration of impact driving design: The GOF was designed with a market- building and ecosystem objective. This was achieved, and • Alignment with international best practices (IRIS standards) could be clearly articulated, thanks to a consortium of neutral The full list of metrics is outlined in Table 1. market players with these specific mandates leading the design and co-ordination. The project lead, the Bertha Centre’s 2.1 Key lessons from the metrics design process Innovative Finance Initiative, is built around the need to develop an impact-focused social investment market in Sub- • Clearly defined and communicated metrics and reporting: Since they form the basis for the financial Saharan Africa. As an academic center, it takes an ecosystem flows of the GOF, the price discovery mechanism, and approach to catalyzing innovative finance initiatives, measurement of success of the fund, the metrics needed to instruments, and research. This also facilitated buy-in from be carefully considered and clearly articulated to all parties different players (private sector, public sector, and civil society) involved. The calculation and reporting methods, including which would have been challenging without a clear market- baseline measurements, needed to be documented and building mandate. The design of the structure benefited from clearly outlined. the ability to mobilize pro bono legal support through local networks, without which it would have been hard to make • A dedicated, hands-on technical partner involved progress efficiently. from the outset: Finalizing the above details on outcome measurement and reporting and ensuring alignment with international best practices are critical tasks that require a dedicated partner with technical expertise. Since this Measuring and technical partner will also be responsible for verifying outcomes, involvement should begin during the design Reporting Outcomes process to ensure consistency throughout implementation. For a structure that makes disbursements based on outcomes, • Ongoing engagement with fund managers to align measuring impact is core to the fund design. The GOF required a expectations and ensure consistency: The GOF set of measurable metrics that can be objectively verified. These operational guidelines ensure that verifiers and fund metrics needed to be broad enough to encompass a range of green managers have a face-to-face inception meeting to clarify impacts, but narrow enough to allow for meaningful aggregation measurement and reporting expectations. This ensures that and price discovery. Each metric is calculated relative to a baseline, data received throughout the pilot is consistent across RFs thereby demonstrating improved impact over time. For example, and impact themes. the number of persons reached by reliable clean energy source is • Balancing rigor and realism: Rigorous monitoring, measured by before and after calculations, based on the number of measuring, and reporting from green SGBs and fund clean energy systems/products/connections installed multiplied by managers is necessary in ensuring accuracy in the GOF the average household size. outcomes payments. At the same time, the GOF does not want to take away from the core work of investees The key considerations for selecting metrics were: and investors. To facilitate this, the full monitoring and • Coverage of green sectors relevant to South Africa’s economy evaluation framework clearly outlines the steps to be taken in measuring outcomes to ensure rigor with minimal and SGBs: green job creation, sustainable agriculture, energy, water, and waste disruption to day-to-day work. It was a core priority for the design team to develop the metrics in close cooperation • Realistic, cost-efficient monitoring, measuring, and verification; with SGBs in order to achieve the right. it was core to the design team that resource constrained SMEs would be able to report on the final outcomes In Brief No. 11 | Page 5 • The potential for innovative, tech-led solutions automated streams of data through connected devices to improving efficiency of measurement: The GOF using IoT technology, linked to key metrics, which reduces recognized the potential for blockchain-like solutions to monitoring costs and supports data-rich impact investments. provide a transparent system of data collection and reporting. The use of sensors and automated data gathering improves As such, an Internet of Things (IoT) system will be tested efficiency, limits opportunities for human error or fraud, and alongside the manual measurement system designed for presents reporting in a clear and aggregated dashboard the GOF. This system will be piloted on top of the traditional to funders. It will contribute to the evolution of impact capture and verification of outcomes, not to replace it, measurement and thereby the impact investing ecosystem but to test a tech-enabled solution. The system will gather at large. See Figure 3. Figure 3: Innovative, tech-led solutions to improving efficiency of measurement In Brief No. 11 | Page 6 • A range of metrics that allows funders to prioritize projects. Three approaches to price discovery are outlined thematic areas: Inclusion of 16 metrics spanning sectors in Figure 4 below. and themes allows funders flexibility in involvement While a private auction/bidding process is most commonly based on their strategic priorities. As an example, the used, because of the nuances in types of outcomes, GOF can accommodate a funder with a specific mandate sectors, and industries, price discovery on portfolio of impactful job creation through the green jobs metrics. construction or a deal-by-deal basis is more applicable for Similarly, the GOF would be well-suited to a funder the GOF. RFs have indicated a preference for the flexibility focused on, for instance, green energy but not waste. associated with the portfolio construction approach, with • Price discovery requires a tailored and flexible the caveat that upfront prediction of specific outcomes is approach: Price discovery, which will form the basis almost impossible. A combination of portfolio construction of future phases of the GOF, is not easily standardized with review at the inception of a new deal will be tested across industries and sectors. A green job, for instance, and refined throughout the GOF pilot. may be more costly if it requires highly specialized skills, or is in a niche sector. Discovering prices on which to Price discovery offers significant benefits in terms of efficient base outcomes payments will need to be an iterative and use of funding around outcomes payments. Understanding engaged process, with clear lines of communication with the true cost of outcomes can effectively channel future individual fund managers to best account for individual concessionary funding to accelerate market growth. Figure 4: Price discovery approaches 1. PORTFOLIO 2. DEAL-BY-DEAL BASIS 3. PRIVATE AUCTION/ CONSTRUCTION BIDDING PROCESS Price discovery would be For each new deal, the RF would bid Fund managers would submit a dependent on funder preferences for an allocation of funding based proposal indicating the anticipated for either (1) the types of on the anticipated costs associated, costs related to the outcomes Recipient Funds or (2) impact which would be evaluated by the achieved through their portfolio of they would like to catalyse. The Investment Committee. Over the green SGBs. This submission would outcomes payments would be course of implementation, discrete require an upfront prediction allocated based on a desired costs would be aggregated and and rationalisation for the figures portfolio construction matrix. evaluated by the Knowledge Partner provided. These would be evaluated to establish price discovery. by the Investment Committee. In Brief No. 11 | Page 7 Table 1: Green Metrics and Measurement Metric Category Green Sector Further Description Calculation Method Green sector direct Job Creation All Number of people employed by the green Difference between before and after figures. jobs created ** enterprise Green sector Job Creation All Number of people employed by the green Difference between before and after figures. indirect jobs enterprise’s distributors created **           CO2-eq Mitigation/ Sustainable Carbon emissions sequestered through increased Project-by-project basis. Difference between sequestrated Diversion Agriculture sustainable land use practices, e.g. soil disturbance before and after figures reduction (no-tillage), conservation agricultural practises, improved crop rotation, increased soil cover, etc.           Persons reached Access Energy Persons reached by clean energy grid (renewable Before and after calculation based on by reliable clean to Clean energy source e.g. solar or wind) who were number of clean energy systems/products/ energy grid/source Energy without prior access to the traditional energy connections installed multiplied by average who were without grid (i.e. non-renewable energy power source). household size prior access to Calculated based on the average number of the traditional people in a household for each clean energy energy grid system installed or connection made. Persons reached Access Energy Persons reached by clean technology grid Before and after calculation based on by reliable clean to Clean (renewable energy source e.g. solar or wind) who number of clean energy systems/products/ energy grid/ Energy already had prior access to the traditional energy connections installed multiplied by average source who had grid (i.e. non-renewable energy power source). household size prior access to Persons switched from traditional energy grid the traditional to clean energy grid. Calculated based on the energy grid average number of people in a household for each clean energy system installed or connection made. Energy Generation Generation Energy Kilowatt-hours of clean energy (renewable energy) Before and after calculation based on listed - Clean energy generated based on listed production values of production of the installed product/system generated the type of product/system installed Energy Efficiency Mitigation/ Energy Energy saved in a building/metering point based Calculations based on Eskom’s deemed - Generic energy Diversion on deemed savings values per technology. energy efficiency savings value spreadsheet saved based Deemed savings are used to define savings values on deemed for projects with well-known and documented savings values savings values across different technology options. In Brief No. 11 | Page 8 Metric Category Green Sector Further Description Calculation Method Waste to landfill Mitigation/ Waste Reduction in waste sent to landfill site Difference between before and after avoided Diversion figures Avoided waste Mitigation/ Waste Reduction in waste incinerated without energy Difference between before and after incinerated Diversion recovery. I.e. reduction in waste burned without figures the capture of heat energy that can be used to generate electric power Waste recycled/ Mitigation/ Waste Quantity of waste recycled/reused Difference between before and after reused Diversion figures Chemical recovery Mitigation/ Waste Chemicals recovered from organic or electronic Difference between before and after Diversion waste and subsequently used productively figures           Water use reduction Mitigation/ Water Water consumption or intake reduced on site Difference between before and after Diversion from a defined source e.g. utility connection, consumption figures (keeping other groundwater, or river variables constant) Wastewater treated Mitigation/ Water Wastewater treated before being returned to the Difference between quality and volumes Diversion environment or system treated before and after Water productivity Mitigation/ Water A measure of the water use intensity of a Global Water Footprinting Standard: Water Diversion business’ processes or products, in comparison to Footprint Benchmark: A measure of water pre-established regional/global benchmarks for productivity of a process or a product. The similar products or processes benchmark is computed as the highest water footprint of a process or product produced most efficiently using the best available practices and technologies for a fixed percentile of production regionally/ globally. http://waterfootprint.org/en/standard/ global-water-footprint-standard Wastewater Mitigation/ Water Water recycled or reused productively on site. Difference between volume of water recycled or reused Diversion Can affect m3 saved if using utility or system reused/recycled before and after meters. Water sourced Generation Water Water sourced from an alternative — and more Difference between before and after from an alternative sustainable — source, e.g. rainwater harvesting, figures resource graywater reuse, sustainable groundwater etc. In Brief No. 11 | Page 9 Green Partnerships: Local fund managers, known as Recipient Funds (RFs) were identified based on their alignment with the GOF as evidenced by their track record, Finding the Right a demonstrable interest in investing in green SGBs, and experience with early stage impact deals. An overview of these RFs is presented in Table 2. Recipient Funds and SGBs Six local funds signed Letters of Intent in engaging with the GOF and committing their own match funding. Initial due diligence and ongoing engagement with the RFs was conducted throughout the design process. Figure 5: Examples of pipeline green SGBs ENERGY EFFICIENCY CLEAN ENERGY GENERATION WASTE-TO-ENERGY LED light component Wind energy generation plant Bio-waste to green energy facility manufacturer Size: ZAR 14 - 94M Size: ZAR 10M Size: ZAR 1-2M Asset class: Equity Asset class: Equity Asset class: Quasi-equity Green Outcomes: Green Outcomes: Green Outcomes: • 305.2GWh of clean wind energy • Generation of clean energy • Energy savings realised from generated per year • Green Sector Job creation due to installing LED lights in place of energy consuming UV lights • Green sector jobs created expansion • New access to energy connections • Reduction in waste to landfill • Green sector job creation in R&D facility and manufacturing plant In Brief No. 11 | Page 10 The six RFs were involved in the GOF design process, providing practical direction and input. As part of this engagement, their portfolios and pipelines were assessed to identify case study projects that could benefit from GOF involvement. A selection of pipeline projects from their portfolios is outlined in Figure 5. CLEAN ENERGY GENERATION SUSTAINABLE AGRICULTURE WASTE-TO-LANDFILL REDUCTION Solar water heater rental company Bio-fuel agriculture farm Organic-waste management firm Size: ZAR 40M Size: ZAR 40M Size: ZAR 40M Asset class: Equity Asset class: Debt Asset class: Debt Green Outcomes: Green Outcomes: Green Outcomes: • Energy savings realised through • Generation of clean fuel from • Reduction in waste to landfill households heating water using agricultural crop quantities through diversion of solar panels • Green sector job creation (70+) incremental 350 tonnes of waste into compost due to labour intensiveness of farm operations • Green sector jobs created in local communities In Brief No. 11 | Page 11 Table 2: Overview of Recipient Funds   Business Inspired Evolution Mergence Edge Tshiamo Social Partners Investment Investment Growth Impact Investment Management Managers Partners Africa Fund Fund investing Fund investing in Infrastructure Existing ASISA ESD New impact New social Description in SMEs that large-scale renewable development fund investing in fund investing investing fund are involved energy and energy fund focusing early stage, high in high growth specialising in developing, infrastructure on social impact growth entities. early stage in social/ manufacturing projects. The fund is sectors such The funds under companies environmental and providing looking to expand its as housing, Edge Growth have across green impact ventures green goods and portfolio to include renewable an enterprise economy, with high services, as well investments in energy and development housing and job creation as businesses that projects/ventures at energy efficiency and supply chain education potential. are implementing the lower end of their programs. Impact development sectors. measures and/or supply chain. investment focus. [ASISA (1&2); technology which focused and GIIRS Vumela (1,2 &3), reduce their adverse rated. Edge Action and impact on the the Edge Venture environment. (Impact) Fund.] Track Over 10 years 10 years 10 years 10 years Experienced Experienced record team in finance team in finance sector sector Deal sizes ZAR 500K-50M ZAR 50-250M ZAR 5M + ZAR 250K - 50M ZAR 1-15M ZAR 80K - 1M Asset Debt, equity, quasi- Equity, quasi-equity Equity, Debt, equity, Debt Debt, classes equity quasi-equity mezzanine quasi-equity Investee Growth stage Growth stage, Growth stage Early stage Early stage Seed stage, very type expanding into early (high-growth) (high-growth) early stage stage Investment Clean technology, Clean energy Renewable Health care, Health, energy, Job creation themes energy efficiency, Infrastructure, energy, energy sector, education, clean education alongside green economy jobs resource efficiency water and energy tech, housing, social and/or efficiency Internet technology, environmental manufacturing impact In Brief No. 11 | Page 12 3.1 Key Lessons From the Partnership Design Process • Taking an ecosystem approach; the importance of multiple from the GOF pilot are applicable to the full market and that and diverse partners: For the GOF to have maximum impact, the GOF as an intervention supports the growth of the green it must span the full market of investors with an interest in SGBs, economy in South Africa, including encouraging the support but requiring assistance or incentives to take on the associated of new fund managers within the sector. It also ensures that risks and costs. The GOF selection of RFs spanned a diverse and price discovery is not distorted, since cost per outcome will broad range of the market in terms of deal size, target sectors, depend on several variables including (but not limited to) the track record, and commercialization (see Figure 6). This portfolio stage of the SGB, the investment type, the deal size, and the approach to fund allocation ensures that the lessons generated commercial mandate of the business. Figure 6: An ecosystem approach to fund allocation Investee Type Seed stage Very early stage Early stage high growth Growth stage RF Distribution Deal Size ZAR 80K ZAR 500K ZAR 500K ZAR 10M ZAR 10M ZAR 10M In Brief No. 11 | Page 13 • Responding to existing barriers to investing in early that underwent baseline due diligence, the GOF offers stage SGBs: The GOF design process included engagement incentives to undertake deals previously inaccessible. with each RF to understand the barriers they faced Additionality of the GOF was tested with the RFs. The GOF preventing investments in green SGBs. Individual meetings is the first local blended finance facility in South Africa were held with each of the local funds to best understand and will initially run as a pilot to gather insights and allow their respective mandates, track record, deal sizes, investee for iterations. The outline and measurement is explained types, investment themes, geographic focus, potential in Table 3. pipeline of green SGBs, and how a blended finance structure like the GOF would add to their business. These discussions • Prioritizing flexibility in allocation of GOF outcomes payments: One of the key innovations of the GOF is highlighted the most prevalent barriers to be: generating lessons about the gaps in the market through • High perceived risks, which are difficult to quantify: “following the money.” By allowing RFs flexibility (within Early stage businesses are inherently seen as high-risk. defined parameters) in how they use outcomes payments, This risk is magnified with new, innovative green models the GOF can identify the most prominent barriers providing that are unfamiliar to fund managers, since the SGB’s finance to green SGBs. Furthermore, since the GOF is business model depends on the viability of the technical designed to span the full ecosystem of relevant funders, aspects. In addition, they present limited track records this flexibility will differentiate needs at different levels and and complicated business models. segments of the market, offering potential for more tailored or targeted support interventions going forward. • High costs: Green SGBs often come with high start-up costs. They also may lack a business background, and • Clear time projections to allow RFs to best benefit from the GOF: One of the intentions of the GOF is to drive often require hands-on business development support or additional private sector capital towards early-stage green technical assistance, which is costly. initiatives. By providing grant capital for outcomes, the GOF • Lack of a high-impact green portfolio to showcase to allows RFs to leverage this in fundraising. Furthermore, potential funders: Without demonstrable success cases, if more established fund managers can successfully it is difficult for fund managers to attract impact funders demonstrate the business case for investing in green SGBs, and raise capital that specifically aims to support the this track record builds the market, assisting new impact green market and combat the effects of climate change. fund managers in attracting capital. However, RFs need to have a timeline in mind when engaging with potential • Ensuring local innovation and additionality: To achieve funders. Delays in the GOF may cause subsequent delays its desired impact of reaching a currently underserved for RFs, hindering the flow of private sector capital towards market, the GOF needs to ensure that its offering is early-stage green initiatives. It is thus necessary to provide additional to what is occurring in the market. For each RF timelines that are as accurate as possible to allow RFs to utilize these in fundraising conversations. In Brief No. 11 | Page 14 Table 3: Additionality of the GOF Instrument/use of funds Explanation Subsidized cost of capital An RF may assess an investment to have the level of risk that requires an X% interest rate, but the to SGBs SGB can only afford Y% (where Y