2. Green Finance: Definition
Use of financial products and services,
such as loans, insurance, stocks, private equity & bonds
in green (or eco-friendly) projects
Green finance is more than climate finance, but
includes land, forests, water, oceans, conservation,
resilience--indeed every type of GEF investment
3. Green Finance: Brief History
Investment in conservation evolved:
19th century: simple public sector financing
(taxes, fees, stamps and government spending)
20th century: mix of public & philanthropic finance
Last 25 years: growing involvement of the private sector
+ the development of new financial mechanisms
E.g. we can use tropical forest assets to generate revenues from
operations in fields of sustainable timber, agriculture and ecotourism
Financial innovations: social policy bonds, crowdsourcing initiatives
(online platforms to mobilize capital) – will transform raising capital
4. Green Finance: Asset Classes
Asset class - group of financial instruments that exhibits similar
characteristics, behaves similarly in the marketplace and is subject to the
same laws and regulations
Main asset classes / financial instruments in green finance:
(1) Equity (=Stocks)
(2) Debt (= Fixed Income)
Guarantees (risk management tool)
also widely used in conservation
5. Equity Financing
Equity - ownership in the business
Common shares (junior equity) vs Preferred shares
- Junior shares are subordinated to preferred shares
- Liquidation: preferred stockholders paid first
- Dividends: different/greater for preferred shares
Public institutions often invest in junior equity absorbs risks
Private investors invest preferred shares (senior shares)
Private Investors, DFIs, IFIs Senior/Preferred Shares, Senior Debt
Public Donors, GEF Junior Shares, Grants
6. Equity in GEF projects
GEF: supporting small scale clean energy projects
GEF invested $4.5m in junior equity of Africa Renewable Energy Fund (AREF):
• bought common shares with return capped at 4%
• Fund invests in clean energy companies/projects
• Fund is managed by the African Development Bank (AfDB)
• AfDB and other donors provided additional $25 million
Result:
• By accepting a capped return, the GEF enables net returns to other
investors to increase by 2-3%
• which will expand the range of potentially investable projects and reduce
the need for enhanced policy incentives to make projects bankable
• expected to attract at least $150 million in co-financing
7. Debt Financing
Notes, bonds, loans, debentures, certificates, mortgages, leases & other agreements
Loan: $ from a bank to a company, with interest payment, over specific time
• collateral to guarantee repayment (if difficult equity preferred)
Bond: $ from the public market to a company
• trade on public market and involve larger amounts (typically min $100m)
Seniority
• Senior debt: greater security (lower risk) & lower interest payment
• Debt is senior to Equity - creditors are paid before shareholders
Private Investors Senior Debt
(Senior Notes, Loans)
Public Donors, GEF Subordinated Debt
(Subordinated Notes, Loans)
8. Debt in GEF projects
GEF provided subordinated debt for energy efficient transport
• The Green Logistics Program, managed by EBRD
• GEF provided $16.4 million in subordinated debt (junior funding)
in projects, together with EBRD investments
• EBRD will invest its own funds in projects that otherwise would
be priced excessively (high interest rate)
• To improve efficiency of freight transport in the Black Sea Region
• To promote energy eff. and lower GHG emissions in the logistics
• Co-financing: $155 million during the project period, and to rise
to $250 million after the project is completed
• Estimated GHG emissions reductions are 9.1 million tons CO2e
9. Guarantees
Reduce the probability of default
Support the flow of private investments - in projects where
investors and lenders are seeking to mitigate risk
• Credit guarantee – covers non payment by private borrowers.
Full or partial guarantee. Partial guarantee – up to a
predetermined amount
• Performance guarantee - agreement between a client and a
contractor for the contractor to perform all of their obligations
under the contract
10. Guarantees in GEF projects
Risk Mitigation Instrument for Land Restoration project (Latin America)
• Inter-American Development Bank
• GEF investment of $15 million, $120 million in co-financing
• Private sector is increasingly looking into restoration of degraded lands
• This requires investments that have longer payback periods & represent
various types of high financial risk making them difficult to finance
• GEF funds will be used to provide guarantees and subordinated loans,
helping catalyze additional public and private sector investments by
reducing risk
• Activities: landscape regeneration; intercropping; shade-grown systems
for coffee and cocoa; timber and non-timber product; improving soil,
water and temperature regulation by improving agricultural land
management
• Benefits: restoration min 45,000 ha, emissions reductions 4.5m tCO2e
11. Source of Capital Structure No. 1 Structure No. 2
Private Investors Debt (Notes) Senior Debt
(Senior Notes, Loans)
DFIs, IFIs Senior Shares Subordinated Debt
(Subordinated Notes, Loans)
DFIs, IFIs Mezzanine Shares
(Hybrid of Debt & Equity)
Senior Shares
Public Donors Junior Shares Junior Shares
Guarantee Grant
Example of Layered Capital Structure
Grant, Junior Equity, Guarantees & Subordinated Debt = Catalytic first-loss capital:
• Catalytic can attract far greater capital than public or philanthropy $
• First-loss absorbs risks, which encourages other investors
12. Barriers for private capital
• High search costs - attractive risk returns, sufficient
and predictable cash flows, bigger projects
• Lack of track record of projects and developers
• Monitoring of conservation impact
• Scalability/replicability for future projects
13. So what’s now?
New types of collaboration btw investors,
NGOs /project developers & public entities
Blending of non-concessionary and
concessionary capital
Addressing the barriers within the GEF framework:
• How do we develop socially beneficial projects which attract
private finance?
• How do we make the project sustainable long term (after the
funding is over)?
• How do we prioritize our work program to attract more capital
14. Investors (GEF and others) Forestry Fund Forestry projects/businesses
The Fund will provide long-term _____ (debt, equity) funding to 5-6 existing
projects to scale them up, so they can further attract _____ (debt, equity) financing
from financial institutions
Other private sector reluctant to invest due to: long payback periods, lack of track
record and uncertainty over product prices
The GEF has taken a ___________ (lower return/higher risk, higher return/lower
risk) position in the fund, which helps lower risks for private sector investors
The interests of __________ (debt, equity) investors are closely aligned with those
of the other shareholders. Investors are incentivized to add value to such businesses
by ensuring effective governance, high environmental, social and governance
standards and well developed strategies
Case 1: Forestry Fund
15. Investors (GEF and others) Forestry Fund Forestry projects/businesses
The Fund will provide long-term equity funding to 5-6 existing projects to scale
them up, so they can further attract debt financing from financial institutions
Other private sector reluctant to invest due to: long payback periods, lack of
track record and uncertainty over product prices
The GEF has taken a lower return/higher risk position in the fund, which helps
lower risks for private sector investors
The interests of equity investors are closely aligned with those of the other
shareholders. Investors are incentivized to add value to such businesses by
ensuring effective governance, high environmental, social and governance
standards and well developed strategies
Case 1: Forestry Fund ANSWERS
16. Will provide long-term ___________ (debt, equity, or debt and equity)
investments to promising enterprises operating in the sustainable wild-
caught seafood and mariculture sectors.
Significant portion of capital to be used for the acquisition of fixed
assets.
GEF invests in _____ (stocks, loans) of 5-7 years and expects to earn
10-15% return.
The Fund will be one of the very few financial institution providing long
term financing in community fisheries.
Case 2: Fisheries Fund
17. Will provide long-term debt and equity investments to promising
enterprises operating in the sustainable wild-caught seafood and mari-
culture sectors.
Significant portion of capital to be used for the acquisition of fixed assets.
GEF invests in loans of 5-7 years and expects to earn 10-15% return.
The Fund will be one of the very few financial institution providing long
term financing in community fisheries.
Case 2: Fisheries Fund ANSWERS
18. Energy Service Companies (ESCOs) - private enterprises that implement improvements to reduce energy
consumptions. Require lending for equipment and process improvements. However they lack access to
________ (commercial credit, capital markets).
The banks conventionally lend against high levels of ______________ (fixed asset collateral or guarantees
from other financial institutions). ESCOs often cannot meet these requirements.
GEF funds will be used to create a____________________________ (performance risk guarantee, credit
enhancement guarantee) program. The program includes creation of the Risk Facility.
The project objective is to develop energy efficiency industry in Country A, through ___________ (risk
sharing, co-investing) with commercial lenders.
The Risk Facility (risk sharing fund) will be used to share the risk with commercial banks. The risk sharing
fund would be paid out to participating banks in the event of a loss or default - partial coverage of banks risk
exposure. Thereby ESCOs can obtain a bank debt with a ______(lower, higher) cost and
a___________(shorter, longer) term.
Banks Final 10% Loss: Banks
Risk Facility Banks Next 80% Loss: Shared equally between Risk Facility and banks
Risk Facility First 10% Loss: Risk Facility
Case 3: Energy Efficiency Program
19. Energy Service Companies (ESCOs) - private enterprises that implement improvements to reduce energy
consumptions. Require lending for equipment and process improvements. However they lack access to
commercial credit.
The banks conventionally lend against high levels of fixed asset collateral. ESCOs often cannot meet
these requirements.
GEF funds will be used to create a credit enhancement guarantee program. The program includes
creation of the Risk Facility.
The project objective is to develop energy efficiency industry in Country A, through risk sharing with
commercial lenders.
The Risk Facility (risk sharing fund) will be used to share the risk with commercial banks. The risk sharing
fund would be paid out to participating banks in the event of a loss or default - partial coverage of banks
risk exposure. Thereby ESCOs can obtain a bank debt with a lower cost and a longer term.
Banks Final 10% Loss: Banks
Risk Facility Banks Next 80% Loss: Shared equally between Risk Facility and banks
Risk Facility First 10% Loss: Risk Facility
Case 3: Energy Efficiency ANSWERS
Editor's Notes
Green Finance is all encompassing area of “sustainable” project financing, and includes many sectors from env to agr to infrastructure and energy. Here we present those relevant to the GEF
Green finance actually covers a very broad set of topics ranging from impact investing to securities regulation to national “green” banks. Most important for the GEF-7 impact programs is to articulate how to encourage investors already taking an interest, and how to attract more. Green finance is more than climate finance, but includes land, forests, water, oceans, conservation, resilience--indeed every type of GEF investment.
Last 25 years: growing involvement of the private sector + the development of new financial mechanisms to raise private sector capital
For the simplicity of the presentation, we will focus only on Main instruments used in Green Finance:
Equity, Debt and Guarantees
If you want to know it all, there are:
Financial assets: securities (stocks and bonds), derivative contracts, and currencies.
Real assets: real estate, equipment, commodities, and other physical assets.
Equity - ownership in the business majority shares provide control of the company
Equity is used to finance new business (for startups) or major purchases (for publicly traded companies)
When Equity financing is preferred
Startup/entrepreneur: Banks will not provide Loans due to high risk of start-up failures, lack of collateral, credit record etc.
Large corporation: cheaper to sell shares than to pay Loan Interest
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HELPFUL INFORMATION on Debt and Equity Financing:
1) EQUITY FINANCING
Advantages
It's less risky than a loan because you don't have to pay it back, and it's a good option if you can't afford to take on debt
You tap into the investor's network, which may add more credibility to your business
Investors take a long-term view, and most don't expect a return on their investment immediately.
You won't have to channel profits into loan repayment.
You'll have more cash on hand for expanding the business.
There's no requirement to pay back the investment if the business fails.
Disadvantages
It may require returns that could be more than the rate you would pay for a bank loan.
The investor will require some ownership of your company and a percentage of the profits. You may not want to give up this kind of control.
You will have to consult with investors before making big (or even routine) decisions -- and you may disagree with your investors.
In the case of irreconcilable disagreements with investors, you may need to cash in your portion of the business and allow the investors to run the company without you.
It takes time and effort to find the right investor for your company.
2) DEBT FINANCING
The business relationship with a debt investor is very different than with an equity investor-- and requires no need to give up a part of your company. But if you take on too much debt, it's a move that can stifle growth.
Advantages
The bank or lending institution (such as the Small Business Administration) has no say in the way you run your company and does not have any ownership in your business.
The business relationship ends once the money is paid back.
The interest on the loan is tax deductible.
Loans can be short term or long term.
Principal and interest are known figures you can plan in a budget (provided that you don't take a variable rate loan).
Disadvantages
Money must paid back within a fixed amount of time.
If you rely too much on debt and have cash flow problems, you will have trouble paying the loan back.
If you carry too much debt you will be seen as "high risk" by potential investors – which will limit your ability to raise capital by equity financing in the future.
Debt financing can leave the business vulnerable during hard times when sales take a dip.
Debt can make it difficult for a business to grow because of the high cost of repaying the loan.
Assets of the business can be held as collateral to the lender. And the owner of the company is often required to personally guarantee repayment of the loan.
Most businesses opt for a blend of both equity and debt financing to meet their needs when expanding a business. The two forms of financing together can work well to reduce the downsides of each. The right ratio will vary according to your type of business, cash flow, profits and the amount of money you need to expand your business.
GUARANTEES
Parties: three parties involved in a guarantee: creditor, debtor and guarantor. Liability: Basic liability of payment of debt falls on the debtor. If he fails to pay then responsibility falls on the guarantor. Interest: Creditor and debtor has interest in the contract but guarantor has no interest in the contract.
When Equity financing is preferred
Startup/entrepreneur: Banks will not provide Loans due to high risk of start-up failures, lack of collateral, credit record etc.
Large corporation: cheaper to sell shares than to pay Loan Interest
-----------------------------
HELPFUL INFORMATION
EQUITY FINANCING
Advantages
It's less risky than a loan because you don't have to pay it back, and it's a good option if you can't afford to take on debt
You tap into the investor's network, which may add more credibility to your business
Investors take a long-term view, and most don't expect a return on their investment immediately.
You won't have to channel profits into loan repayment.
You'll have more cash on hand for expanding the business.
There's no requirement to pay back the investment if the business fails.
Disadvantages
It may require returns that could be more than the rate you would pay for a bank loan.
The investor will require some ownership of your company and a percentage of the profits. You may not want to give up this kind of control.
You will have to consult with investors before making big (or even routine) decisions -- and you may disagree with your investors.
In the case of irreconcilable disagreements with investors, you may need to cash in your portion of the business and allow the investors to run the company without you.
It takes time and effort to find the right investor for your company.
DEBT FINANCING
The business relationship with a debt investor is very different than with an equity investor-- and requires no need to give up a part of your company. But if you take on too much debt, it's a move that can stifle growth.
Advantages
The bank or lending institution (such as the Small Business Administration) has no say in the way you run your company and does not have any ownership in your business.
The business relationship ends once the money is paid back.
The interest on the loan is tax deductible.
Loans can be short term or long term.
Principal and interest are known figures you can plan in a budget (provided that you don't take a variable rate loan).
Disadvantages
Money must paid back within a fixed amount of time.
If you rely too much on debt and have cash flow problems, you will have trouble paying the loan back.
If you carry too much debt you will be seen as "high risk" by potential investors – which will limit your ability to raise capital by equity financing in the future.
Debt financing can leave the business vulnerable during hard times when sales take a dip.
Debt can make it difficult for a business to grow because of the high cost of repaying the loan.
Assets of the business can be held as collateral to the lender. And the owner of the company is often required to personally guarantee repayment of the loan.
Most businesses opt for a blend of both equity and debt financing to meet their needs when expanding a business. The two forms of financing together can work well to reduce the downsides of each. The right ratio will vary according to your type of business, cash flow, profits and the amount of money you need to expand your business.
GUARANTEES
Parties: three parties involved in a guarantee: creditor, debtor and guarantor. Liability: Basic liability of payment of debt falls on the debtor. If he fails to pay then responsibility falls on the guarantor. Interest: Creditor and debtor has interest in the contract but guarantor has no interest in the contract.
Equity: Provider takes most junior equity position: common equity in structures that incorporate preferred equity classes
Grants: Provider covers a set amount of first loss
Guarantee: Provider covers a set amount of first loss. Similar to the grant, except the guarantee has a cost
Subordinated debt: Provider takes most junior debt position in a company
Providers of Catalytic First-loss capital: typically foundations, high net-worth individuals, government & DFIs
Well-designed layered capital structures are often essential for leveraging additional capital while meeting the different expectations of each potential investor. Such structures not only increase the amount of capital available but also diversify risk and investment returns, and add flexibility to the terms (maturity) and uses of the capital.
Mezzanine financing is a hybrid of debt and equity financing that gives the lender the rights to convert to an ownership or equity interest in the company in case of default In the type of capital structures shown in Figure above, junior shares would be the first to bear any capital loss; the higher up in the structure, the more risk protection capital has. The fund can be designed so that returns generated are guaranteed to be first paid to note holders, independent of the profitability of the fund.
Barriers for private capital:
Financial side
- Risk and Return profile
Project side
- High search costs of good risk-return project profiles
- Lack of track record of developers and projects that generate sufficient cash flows
- Scalability/replicability
- Monitoring of conservation impact
- Predictability of underlying cash flow sources
- Lack of cash flow aggregation – few projects are big enough to be stand-alone investment products
