By Julie Scotto

The new UK coalition government confirmed soon after taking office this summer that a green investment bank will be established. Detailed proposals on the creation of the bank will be published following the comprehensive spending review, currently set for October 20, 2010.

Early clues to how the bank will operate can be found in a report that the Green Investment Bank Commission published in late June entitled “Unlocking investment to deliver Britain’s low carbon future,” which sets out a blueprint for the establishment of the bank. Given that the commission was established by the Conservative party (the majority party in the coalition government) while in opposition, the report is likely to be given utmost consideration.

In its report, the commission recommends that a non-executive chairman be selected by August 2010, and a board (or shadow board) by October 2010. The government has not yet given a timeframe.

Given the current economic climate and the massive cost cutting being undertaken by the coalition government, the establishment of the bank is a politically sensitive issue. Since the publication of the commission’s report, there have been reports of tension between the business department and the Treasury (led by members of Parliament from different parties within the coalition) over the scale of the bank and its precise role. Last month, Andy Rose, the head of the Treasury’s infrastructure finance unit, told an infrastructure conference run by City and Financial that the government is “not pursuing plans for the sale of government-owned assets” and that such financing is “not on the agenda of the current government.”

The establishment of the bank is perceived by the main political parties, and by industry, as a necessity that must be addressed expediently. Given this consensus, plans for the bank are expected to evolve fairly rapidly following the comprehensive spending review in October.

Global Warming
The main driver for the bank is the Climate Change Act 2008 that requires the UK government to reduce greenhouse gas emissions in the UK by 80% by 2050. In addition, recent European Union legislation requires the United Kingdom to ensure that 15% of UK energy comes from renewable sources by 2020.

The new coalition government has acknowledged that climate change is one of the most serious threats currently facing the world and pledged to make this the “greenest government ever.”

The Green Investment Bank Commission estimated that up to £550 billion of investment may be required for the UK to meet its climate change and renewable energy targets between now and 2020. The figure is staggering, not least when contrasted with the £200 billion that the coalition government had said it estimated only days before in the June 22 budget. Given this backdrop, the head of the commission, Bob Wigley, former chairman of Merrill Lynch Europe, argues that “the scale and speed required for financing low-carbon infrastructure, is impossible without government intervention.”

The commission recommended that the bank should use a public-private investment model and address specific market failures and investment barriers. Its report highlighted a series of key barriers to investment that require an immediate response: market investment capacity limits and limited utility balance sheet capacity, political and regulatory risks stemming from a history of changes in government policy affecting expected returns, gaps in confidence among investors resulting from technology risks, a lack of transparency in government policy and the high level of capital required — which the commission called the “confidence gap” — and the challenge of making large numbers of small, low-carbon investments attractive to institutional investors — which the commission called the “aggregation challenge.”

Role and Focus

The bank would have three main functions: to identify and to address market failures that limit private investment in carbon reduction activities, to rationalise existing government-established bodies and funds in order to provide coherence to public efforts to support climate change-related innovation, and to advise on financing issues in central and local government policy making.

As far as the public-private model is concerned, the commission stressed that the bank should not “crowd out” the private sector. The private sector should lead and execute deals wherever viable, and the bank should only operate where the result would otherwise not have been possible.

In its initial phase, the commission recommended that the bank should focus on supporting areas where maximum impact and speed to implementation can be achieved. Examples are scale up of investment in proven energy efficiency projects that can lower the overall development need of renewable energy sources, investment in enabling technology, and support of both proven and high impact third-round offshore wind.

The commission recommended that the initial capitalisation come from three sources: by forcing the private sector and state-owned banks to subscribe for equity, by using part of the revenues generated by the EU emissions trading scheme auctions, and by selling government-owned assets.

There are two options for making banks subscribe for equity. One is to force banks to subscribe to equity through part of the bonus tax, with equity initially being non dividend paying (although, the 50% bonus tax introduced by the previous government lapsed in April 2010, and its replacement seems unlikely). The other is to force only state-owned banks to become shareholders.

The auction of pollution permits under the next phase of the EU emissions trading scheme is expected to raise approximately £40 billion for the UK between 2012 and 2020. The estimates of the total revenues from the electricity power sector alone in Western Europe are in the region of €13 billion a year.

The commission identified a series of government-owned assets that could be sold: the student loan book, the Tote, Dartford Crossing, High Speed 1, airport landing slots and parts of the radio spectrum.

Financing and Governance

The commission identified four sources of funds for financing the ongoing operations of the bank. They are the government funding for disbursement of grants from existing quasi-autonomous non-governmental organizations (quangos) and funds, the issuance of green bonds and green individual savings accounts (ISAs), a debt fund and a levy on energy bills.

The targeted quangos and funds have a similar remit to the bank, and have funds allocated to invest in low carbon technologies. The commission identified three quangos and six funds that could be brought into the green investment bank (such as the Carbon Trust, the International Environmental Transformation Fund and the Ofgem Low Carbon Network Fund). This rationalization process is supposed to create a unified point to advise and inform businesses and investors about how to access grants or participate in government-supported schemes.

The commission envisages using green bonds in two ways: to finance the bank (where it is the issuer) and to lower the cost of debt for projects where the bank or the government provides risk mitigation for the project debt (where the project is the issuer). Green bonds targeted at institutional investors could take the form of single project bonds, providing exposure to specific projects supporting the low carbon transition, bonds directly funding asset portfolios and secondary project finance loans, bought from commercial banks and also bundled by asset class.

Although it is envisaged that institutional investors will provide the majority of funds, the use of green individual savings accounts is the most notable proposal that has been put forward to harness an alternative source of funding — retail savings. Green ISAs are expected to be only a small part of the solution, but they could be a visible and symbolic way for retail investors to make a contribution to the bank.

Institutional investor appetite could be tapped through the development of a fund to invest in UK renewable energy and energy efficiency projects on market-based pricing and terms. Institutional money would co-invest with that of the bank. Such investment may be focused specifically on particular sized projects (or asset types), such as wind or biomass projects of less than £10 million, where the market is not focused for reasons of scale and others, but will necessarily provide a long-term investment opportunity for institutions.

In relation to the proposed levy on energy bills, the commission argued that by providing a guaranteed revenue stream, perhaps 10 years plus a 10-year run off period, the levy could, by securitizing the future receipts, provide a substantial upfront pulse of additional funding for investment.

The bank is expected to be commercially independent and, therefore, not accountable to ministers or to Parliament for individual investment and lending decisions. Key stakeholders (including ministers) are expected to be represented on an advisory council. A board of directors would have responsibility for long-term management. Below the board, a management team would run the bank on a day-to-day basis.

The commission recommended that the bank should limit direct public liabilities by placing its liabilities off the government balance sheet. Further, it warns that the bank should clearly manage the tension between investing in the public interest and the need to be commercial.

From an operational standpoint, the commission envisaged the bank having two core divisions: a UK Fund for Green Growth and a banking division. The UK Fund would administer grants and extend low-interest loans, make equity investments, provide venture capital for technological development and also advise public and private sector bodies. The banking division would offer a secondary market for conventional banks to syndicate or trade green infrastructure loans in order to provide additional liquidity and tackle other market failures.

Product Offering

The bank is expected to offer a range of products, including early-stage grants, equity co-investment, wholesale capital, mezzanine debt, offering to buy completed renewables assets, purchase and securitization of project finance loans, insurance products and long-term carbon price underwriting.

The table on page 37 shows the product range envisaged by the commission.