The incremental ramping up of climate commitments through Nationally Determined Contributions (NDCs) is creating the need for significantly more financing to fund the low-carbon transition. This is coupled with a growing sense of urgency – especially from the emerging and developing economies most vulnerable to global warming. For example, whereas Hurricane Harvey is expected to cost the U.S. around 1% of its GDP, Hurricane Irma’s devastation is likely to cost some Caribbean Islands in excess of their total GDP. Slowing the effects of climate change is, therefore, the principal concern – and this can be achieved by mobilizing both public and private finance to fund the transition to a low-carbon economy, across all regions. As such, three key financing trends to consider in 2018 are: an expanding sovereign green bond market; diversification of the green finance market (through new financing tools, not just green bonds); and a greater use of blended finance – a combination of capital from public, national development bank, and private sources.
Sovereign green issuance to expand in 2018
Following Poland’s inaugural US$800 million issuance in late-2016, the sovereign green bond market came into its own last year. Marking the first issuance by a G7 member, France’s US$7.5 billion bond (with a 22-year maturity), provides further liquidity for the embryonic sovereign green bond market. Subsequently, Fiji and Nigeria were the first issuers of a sovereign green bond by a developing country and an African nation, respectively. Looking ahead, we expect sovereign issuance to increase as governments embark on ambitious plans to construct carbon-reduction infrastructure, and undertake other climate-related schemes.
This seems especially true as countries continue to expand their green commitments. For example, China, France, Mexico, and Switzerland have all enacted recent reforms: Mexico has implemented new environmental tax and subsidy regulation, whereas China’s 13th five-year plan lays out enhanced environmental policies, including those supporting the development of electric vehicles. Such changes at the state level – and their potential or actual supplementation by sovereign issuances – are further validating the relevant nations’ Paris agreement NDCs.
Moreover, there is a robust market appetite for sovereign green bond issuance; as with other green bonds, they have been oversubscribed and traded at a premium on the secondary market. Nevertheless, willingness to increase budgets and debt burdens is limited – and will likely not be able to accommodate the vast costs necessary to keep global warming from rising above the 2˚C limit. Instead, governments will use a wide range of actions to meet green targets; they will play a key role in mobilizing private sector funds alongside their own efforts, such as potential legislative initiatives.
Private green finance reaches beyond green bonds
Private sector financing has accounted for an increasingly high proportion of the total green bond market – with issuance from corporates, banks, and originators of structured finance products representing two-thirds of the market in 2017 (see chart: Green Bond Issuance by Issuer Type). And although bonds are likely to remain the most-widely used type of green financing instrument, a diversification of the market place is taking place. Issuers are exploring new ways of making green investments – through green loans, green equity portfolios, and green securitizations (financial products whose underlying collateral or assets are green or which reinvest their proceeds in green technologies).
The development and market use of more green financial products reflects private issuers’ readiness to explore new business opportunities arising within the green finance space. In particular, green lending and green securitization have been on the rise over the last two years – reaching a record-high of approximately US$36 billion of issuance in 2017. This was bolstered significantly by U.S. issuer Fannie Mae’s US$25 billion mortgage-backed security, which aims to improve the energy and water performance of U.S. properties.
Supported by existing state and government programs, as well as positive momentum in collateralized loan obligations, the U.S. is set to remain the market leader for green securitization in 2018. And despite the current geographic concentration of the structured green products market, there is substantial growth potential for green lending across a broader range of geographies, including emerging and developing markets.
Blended finance opportunities and other initiatives
As the appetite for green finance grows in both public and private markets, there will likely be more opportunities for capital availability via blended finance – that is, the provision of both public and private funding from a range of different sources, including sovereign, development, and multilateral lenders as well as private entities. Blended finance relies on financing structures where public entities provide hedging and credit enhancement mechanisms to reduce risks for private-sector funders. In parallel, the private sector can bring liquidity and sizing through standardization and securitization. In October 2017, the OECD estimated the number of new blended finance facilities created between 2000 and 2016 to be 167 – representing US$31 billion in financing commitments. The deployment of blended financing solutions will likely play an increasing role in climate financing going forward (see Chart: Number Of New Blended Finance Facilities Launched Per Year).
For example, potential capital to help fill the current dearth of funding for climate change projects could come from development finance institutions (DFIs). However, the 2017 Global Landscape of Climate Finance, published by the Climate Policy Initiative (CPI), estimates the average financing levels over 2015 and 2016 from DFIs (national, bilateral, and multilateral) at US$123 billion – less than 2.5% of the total implementation costs found in the NDCs.
So, by using a blended approach of development finance institutions (DFIs) and private capital, multilateral development banks may be able to achieve a multiplier effect whereby, for every dollar invested directly by a multilateral development bank in private sector operations, between US$2-$5 are mobilized in additional private investment. And because the depth of the private markets is significant compared to either sovereign or multilateral development bank markets, it is likely that blended finance initiatives could prove crucial in helping countries to meet their NDCs.
Clear legislative incentives from the public sector and sovereigns may influence the overall success of these efforts to mobilize private sector finance – especially considering that the mounting regulatory pressure so far has pushed private entities to accelerate the financing of green projects. Indeed, combatting climate change has become an increasingly noteworthy economic trend. For example, the renewable energy sector saw US$263 billion invested in 2016 – about 90% of which came from private sources.
2018 could continue to see rising investment in renewable energy, as well as in other new, environmentally-friendly and cost-competitive technologies such as battery storage and energy-efficiency mechanisms. Concurrently, levels of both public and private green capital should increase as green investment environments may become more favourable. In turn, as political drive translates into concrete action – and so more investment is enabled for climate finance – the transition to a sustainable, low carbon economy is likely to accelerate.