Moving from “billions to trillions;” tapping private-sector finance for climate-resilient, developing country infrastructure

The transition to a global, low carbon, and climate resilient energy future may require an investment of nearly $7 trillion per year, over the next 15 years.[1] About $3.9 trillion of this total arises from developing countries, which are currently spending $1.4 trillion annually, leaving an “investment gap” of $2.5 trillion. Private sector financing is often touted as the only viable source of capital to fill that gap. As a result, development finance institutions (DFIs)[2] are committed to increasing private sector financial participation to meet climate-related energy and infrastructure goals. The most likely sources at this scale are called institutional investors - insurance companies, pension funds and sovereign wealth funds. But these investors have been relatively disengaged from this type of investment.

One motive to engage these investors is their size. Institutional investors in OECD countries alone control about $92 trillion in assets.[3] To put this in context, official development assistance (ODA) from traditional multilateral and bilateral sources is about $147 billion annually. This is less than 1% of the assets on the balance sheets of institutional funds, and just 5% of the developing country investment gap mentioned above. According to a recent OECD publication, Mobilizing Institutional Investor Capital for Climate Aligned Development,[4] DFIs now face an excellent opportunity to engage institutional investors, if they take the right approach.

Institutional investors appear ready for partnerships with DFIs. Large investors are collaborating more with like-minded partners, and several priorities behind the collaboration fit DFI strengths: to get closer to investments (to better assess and manage risks), to increase deal flow, and to reduce expenses from intermediaries, due diligence and monitoring. These priorities could be met by DFIs, which would open the door to a mutually helpful arrangement. The big investors do not appear too exclusive about their partnerships, meaning synergies with DFIs are certainly possible.

According to the OECD authors, there is another group of investors, to whom the DFIs should pay attention, especially as a model. Green Investment Banks (GIBs) and Strategic Investment Funds (SIFs) have been the most effective at mobilizing private capital for climate-related purposes, including from institutional investors. Both are quasi-governmental entities that are embedded within a local community and have a strong private-sector mentality. GIBs are publicly capitalized entities with a mandate to facilitate privatesector investment for low carbon initiatives.[5][6] SIFs are equity investment organizations, typically established to achieve a policy objective and often to target private finance partners.[7]

One key to the success of GIBs and SIFs has been their “localness,” most importantly manifest in their ability to assess and manage local risk. Infrastructure investments are necessarily local, and it is famously difficult to understand local risks from afar. Both GIBs and SIFs are established and networked inside local business and political communities; and they possess an intimate understanding of market and regulatory frameworks that govern the energy sector in their neighborhoods. So, not only can they identify and assess project risks, but they also have a better ability to monitor and manage those risks through the stages of project development and service delivery, than someone overseeing the investment from a distance.

Further, GIBs and SIFs are governed by private sector financial principles and managed by private finance professionals. By contrast, DFIs are governed and managed from a public finance perspective. The differences can be felt in terms of investment decision making, the speed and agility by which decisions are made, and the viability of projects in the investment pipeline. The authors of the OECD article suggest several strategies for DFIs to more closely emulate these local organizations; I summarize them here:

1. Involve private sector investors early in the project development process. Too often private investors are brought into the process at the end, with little opportunity to affect the project.
2. Staff up with people who speak the language of finance and risk. MDBs are often staffed by people with sector specific experience. Hiring those who can bridge the communications gap will be helpful.
3. Move to a “pull” strategy. Institutional investors have a fiduciary mandate for the funds they manage. Rather than push institutions toward projects they are skeptical about, DFIs should actively seek investors’ concerns about development initiatives, and then co-create strategies with them to overcome their concerns.
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These adjustments may be difficult to make, but the rewards could be significant; and they may be necessary to move from delivering “billions to trillions” in climate-related finance.

[1] Halland, Dixon, In, Monk, and Sharma. 2021. OECD Development Center, “Mobilizing Institutional Investor Capital for Climate-Aligned Development.” Available at: https://www.oecd-ilibrary.org/finance-and-investment/mobilising-institutional-investor-capital-for-climate-aligned-development_e72d7e89-en.

[2] DFIs include the World Bank, the Asia, Africa and Inter America Development Banks, EBRD, their investment arms plus others; they also include climate finance organizations such as the Green Climate Fund, the Global Environmental Facility, and others.

[3] Halland, Dixon, In, Monk, and Sharma. 2021. OECD Development Center, “Mobilizing Institutional Investor Capital for Climate-Aligned Development.” Available at: https://www.oecd-ilibrary.org/finance-and-investment/mobilising-institutional-investor-capital-for-climate-aligned-development_e72d7e89-en.

[4] Ibid.

[5] The Green Bank Network. 2016. “Green and Resilient Banks; How the Green Investment Bank Model Can Play a Role in Scaling Up Climate Finance in Emerging Markets.

[6] To date, most GIBs have been established in OECD countries, but several developing and emerging economies are actively exploring opportunities to establish a GIB or a GIB-like entity.

[7] Lin, Halland and Wang. 2018. “A New Approach to Infrastructure Finance.” Project Syndicate. Available at: https://www.project-syndicate.org/commentary/attracting-private-infrastructure-investment-by-justin-yifu-lin-et-al-2018-03.