pv magazine: Green finance is a buzz word on which many base their hope that the energy transition will accelerate to new speeds. How much is such thinking caused by us living in a “solar bubble” and missing the world outside where the major part of the population, and experts from other industries, don’t witness the fast change to a renewable-powered economy?
Felicia Jackson: What stood out to me the most was the notion of the solar industry being in a bubble, and that's something that is true across the board for every sector. The oil industry is in a bubble, mainstream finance is in one, ESG (environmental, social and governance) practitioners and green finance experts are in another. It's a really important point and one that should be made clearer. Everyone thinks that their own perspective is the only realistic one. And when someone is incapable of seeing beyond ones own expectations, this can become dangerous and myopic. We’ve seen the impact of digitalization on the music industry, AT&T’s failure to address the smartphone, Kodak and the digital camera. The markets remain, for music, for telecoms, for cameras, but they look completely different.
Green finance
There has though been a significant shift in thinking over the last 18 months and the Covid-19 crisis is driving increased focus on the social and health elements of impact investment. Blackrock is the world’s largest fund manager and when Larry Fink writes, as he did in early 2020, that climate change has becoming a defining factor in companies' long term prospects, and starts ESG investment funds, that constitutes a major shift. What I expect to see over the next couple of years is an increasing battle over certification and credibility, but there is no doubt in my mind that a tipping point has been reached. The only question is the impact that the economic devastation we face post-covid may change that.
Larry Fink has been accused of greenwashing, because the firm has huge amounts invested in passive index trackers, which automatically invest in oil and gas. According to sustainability non-profit Ceres, Blackrock was one of the poorest performers in supporting shareholder resolutions around climate change in 2019.
Investor pressure is an important part of getting firms to change their behavior, whether their business is actively damaging to climate change efforts, or simply failing to consider the potential physical and policy risks stemming from climate change. Blackrock was reported to have supported only six out of 52 climate resolutions through proxy voting in 2019. Acceptance of the impact on climate change on corporate performance is an important step, but while the launch of an active ESG fund is a positive sign, much of Blackrock’s nearly US$7 trillion in assets under management is invested in passive tracker funds. These automatically invest in market indices (like the FTSE100 or the S&P500) or particular sectors on an algorithmic basis, and these are usually focused on historically good performers. The finance industry is concerned about the increasing dominance of such funds, given the potential for amplification of market volatility, and the fact that such funds remove the relationship between the shareholder and the company. With climate change, technology development, changing demographics, unsustainable resource use and shifts in global economic power, history is no longer a predictable guide to the future. As individual investors and shareholders grow increasingly concerned about the impact of their investment decisions, it may be a time for a rethink on passive trackers.
One instrument of green finance are green bonds. Now the EU is introducing a green bond standard and is currently discussing a sustainable taxonomy. One argument against big hopes in green bonds is that in using them, one can also easily fund projects that would also been funded without having green targets. What do you think of this argument?
In terms of green bonds funding existing pipelines, the initial challenge was more that green bonds were being raised to finance things defined by countries as green, but isn’t in the assessment of others. This happened, for instance, when China's initial bonds pretty much went to finance railways. China recently confirmed that it will no longer finance ‘clean coal’ through green bonds, which is a significant step in aligning with international standards and could encourage investment in sustainable debt. The issue is standardization, comparability and certification. The next issue is investibility, which brings up the insurance issue.
One of the other questions is, whether there is money missing for a more rapid installation of solar. Maybe it is more the number and volume of projects which has limited the growth of solar installations so far. If this is the case, it is more energy legislation that makes the difference rather than financial legislation.
There is no doubt that energy legislation is what has driven solar growth, but if fundamental capital allocation shifts, finance will drive further policy action. The two tend to go hand in glove. While public sector finance might drive early update, long term policy frameworks and clear direction of travel are what drive large scale private investment. For a long time, investors have referred to the ‘wall of money' waiting to go into green projects – but they couldn't invest because by their investment standards the project didn't qualify as ‘investment ready'. This has been a consistent problem at different stages of development, from solar and wind technology not having had sufficient run times in the early days, to concern about the longevity of policy frameworks, to different expectations of the robustness of capital structures.
It can be difficult to predict but if a green economic framework is put in place, then the solar industry is one of the best placed to grow rapidly. The technology is tried and tested, which is reassuring to investors, it fits the goals of policymakers and ticks-boxes for ESG and climate friendly investors. One challenge it does need to overcome is that of scale. Major investment funds, such as Norway’s sovereign fund, for example, are committed to investment in renewables, but the majority of deals are not yet at a scale which enables them to invest. The sector is scaling fast though and mainstream infrastructure investors are already investing in the market. Solar was expected to show continued growth this year, but if stimulus takes on a green tint, as expected following the announcement of the EU’s green stimulus package, and the continuing trend of transparency regarding externalities and impact in corporate reporting continues, then it could experience a step-change in rates of growth. It’s not just utility scale solar either. An increased focus on local supply chains, domestic manufacturing, integrated projects and the EU’s plans for green hydrogen could affect all levels of the sector. Everything will be dependent on the politics of the recovery, but all the underlying themes and investment trends are coming together.
Doesn’t this lead to a situation where projects are carried out that otherwise would not have had a chance due to their lack of profitability. Therefore again the question: wouldn’t it be more important to change the regulatory and political framework in a way to make sustainable investment more profitable?
The question about the sustainable taxonomy is more complex. I think it is right that a sustainable taxonomy doesn't mean sustainable investment per se, and to an extent there may be an element of lower profitability projects getting funded as margins are squeezed. However, I think this is missing the point. The taxonomy is not expected to be a tool in and of itself, it’s part of a suite of tools that enable investors and corporates alike to assess the impact of their decisions and effectively report on it. They know that if they make an investment or operationally strategic decision, whether or not it sits within the taxonomy, and will therefore enable them to report their actions as sustainable.
I also question what is referred to by lack of profitability. Historically an oil industry investor would consider an investment with a 6-8% return not even worth considering and I believe that's an average rate of return for a solar installation. The question is again the wider context. If the returns formerly available from oil and gas are no longer available, where are pension funds going to get fixed rates of return over 20 years? A lot of the decisions are made based on different types of finance, and the institutions which require different levels of longevity and stability for different reasons. I'm not saying that it is totally wrong to have doubts, but I'm saying I think these arguments show a very narrow view of the changes that are currently taking place in the market and looking at project investment returns in isolation.
How obvious is it, that conditions for green bonds are better than for others?
In terms of green bond return, there is a widespread understanding that there is a premium for green bonds, but it's small. It may increase as certification and comparability increase but again, the world has been turned upside down recently. Research out of the Sorbonne late last year showed an 8 base points average yield advantage on green bond versus normal from U.S. municipalities, which is 0.08 percent points. Part of the problem is that overall yield variance is fairly high, because the credit rating of the bond, AAA versus A or BBB, for example, still plays a significant role in yield and prices. So part of the problem is that bond issuance is a complicated world and people are trying to understand from a simplistic perspective. I doubt we'll have sufficiently robust data to provide a clear analytic answer for a while yet, but the increase in sovereign, corporate and municipal green bonds globally suggests that investor appetite is on the increase.
The EU taxonomy does not really contain additional requirements for solar. There are CO2 targets, but solar is exempted, and even when they do apply, solar plants already fulfill them. Do the solar companies just have to wait for the green money to come or do they have to do something?
I think there will be more money for solar, but what the sector needs to do is make investment easy for new investors. That means not simply ensuring efficient capital structures, risk mitigation, excellent management, and all the usual project elements, but they have to learn to speak to investors in terms they understand, or want to understand. Understanding the strengths and weaknesses of solar within the pantheon of Sustainable Developing Goals, climate investment, low carbon investment, impact, etc. will enable them to report to investors more easily, and to pitch for an increasing amount of green finance. I don't think there is any official documentary requirement, but developers and entrepreneurs need to understand what questions investors are going to be asking, what information they are going to want, and how to provide it to them accessibly, accurately and quickly.
Also professionalization is important as the solar industry will need to change once more mainstream institutions become involved. At the moment, even when big banks are involved it’s usually through a specialist group or fund. Risk assessment in project terms will be vital, and contextually might help companies position themselves to attract funds. The thing is that solar investment is already mainstream but not across the board yet, outside some of the big utilities and funds.
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