Understanding Climate Change Project Financing with the Green Climate Fund

1. Module 5 –Climate change projects from a financing perspective

2. Content • How the GCF works • Financing Instruments • Implications for project development • (In-depth financing example) • Lessons learned

3. How the GCF works

4. An analysisofGCF projectfinancing • A total of 102 approved projects • Of all approved projects, in 44% the main GCF contribution was grants • In the remaining 44% of projects, the main GCF contribution was loans, 2% was guarantees, 8% was equity and2% were results-based payments • Of the 52 projects receiving mainly grants, only 3 were fully financed by the GCF; all others were co-financed, in 37 cases by government of the country • In 16 of the 52 projects, GCF provided less than 50% of budget to the project • 3 projects have been fully financed (Namibia; Senegal; Antigua and Barbuda/ Dominica/Grenada)

5. International accredited entities under the GCF … that are financial institutions

6. Whydoesthe GCF follow thispattern? GCF aims to catalyse a flow of climate finance to invest in low-emission and climate-resilient development, driving a paradigm shift in the global response to climate change. How? Co-financing mechanisms by governments, donors and other sponsors Governments Donors / Private Sponsors

7. Why does the GCF follow this pattern? • Attracting investors and banks to contribute to projects is an important part in GCF’s work. • To understand how the GCF works, we need to unterstand the logic of bankable projects, and the financing instruments which the GCF provides.

8. Challenge „The critical barrier to achieving an uplift in infrastructure investment in emerging and developing economies is not a lack of available finance, but an insufficient pipeline of bankable projects ready to be implemented.“ (Statement by the Heads of the Multilateral Development Banks and the IMF on Infrastructure) Source: http://www.worldbank.org/en/news/press-release/2014/11/13/statement-heads-multilateral-development-banks-imf-infrastructure

9. NDCs, yeah, but wherearetheprojects?

10. What is a bankable project? A bankable project has to… …convince the lender that his investment is profitable and not too risky. & If a project is bankable … ... depends on the kind of financing instrument used.

11. In the end it is a question of: RISK REWARD

12. Operational Risk What type ofrisks do bankersperceive and consider? Credit Risk Liquidity Risk Market Risk Reputational Risk Political Risk Constructional Risk Legal Risk

13. Risk assessment and allocation Banks assess the risks based on the information available the more transparent a project is, the easier banks can assess risks As sources for information a banks considers all the previously mentioned documents: • Information about the application entity • Benefits of the investment • Sector analysis • Business Plan • Financial Plan • Feasibility study • Audit reports • Environmental audit report • etc.

14. What do these risks result in? Resulting in: Risk premium Fees Base fee Credit risk Operational risk Market risk Liquidity risk Reputational risk Construction risk Legal risk Political risk

15. The GCF as a riskmitigationtool • GCF greatly considers risk: It mitigates risks, but also requires risk assurance. • takes higher risks than banks • allows for longer time frames (more than 20 years) • decreases market barriers by providing topping up and de-risking for banks Bringing in GCF as a partner for climate investment contributes to scaling impact of low-emission and climate-resilient development.

16. Investments are not onlyaboutrisk but also aboutscale Bankers areinsterested in making large investmentsinsteadofinvesting in smallprojects in orderto… • Reducetransactioncosts • Achieve high returns The GCF can assume an important role in aggregating a number of small transactions to reduce overall transaction costs and ensure returns that attract other financing institutions

17. Financing Instruments

18. Grants & the GCF • In case a project has a business case, a grant might not be considered appropriate, especially in emerging market countries. • One ambition of the GCF is incentivizing or de-risking financing instruments issued by banks – aiming at creating sustainable markets for “green” financing products and leveraging funds. • Therefore, understanding banks and their interests, as well as key financing instruments is important to assess all funding options for a project idea.

19. Financing Instruments − Overview - Loan Industry Financial Institution or Corporate Loan application Enterprise wants to make an investment Loan Repayment of the borrowed loan amount along with interest

20. Loans • Bank loans have a fixed time period for repayment, and fixed or variable interest rate payable periodically. • Usually, the repayment starts immediately after loan is taken out by a recipient. In some cases there might be a moratorium period during which no repayments are required but interest continues to accrue. • Two types of loans: • Secured loans (the assets of a recipient are provided as security or collateral) • Unsecured (in case no security is provided). • Loan repayment gets priority over equity and others in the case of dilution or bankruptcy of the company.

21. Uniform periodic payments. Increasing proportion of principal repayment and decreasing proportion of interest payments over time Returns from Bank Loans: Uniform periodic payments € t 0 1 2 3 4 5 n … Loan financing Interest Principal repayment Bank loan financing in period 0 The bank usually gets a fixed amount every year which includes an interest component and a principal repayment component.

22. Mongolia: Business Loan Programme for GHG Emissions Reduction (FP028) Financing Instruments − GCF-Project Examples - Loan Grant USD 0.5 million Loan Payback EBRD GCF Loan USD 15 million • Implementing Agency: • Xac Bank LL Loan Payback Provide SMEs with loans for low-carbon projects Investment: USD 60 million Loan USD 19.5 million Loan USD 5 million Private Lender: DWM Securitizations Global Climate Partnership Fund Loan Payback Loan Payback SMEs repay loan obtained from Xac Bank Loan USD 20 million

23. Financing Instruments − Overview - Equity Equity investments include financing provided to the finance recipient by an investor in exchange for partial or full ownership of a for-profit company by acquiring its shares. Investor Enterprise Invests in enterprise Becomes shareholder of enterprise based on an agreed upon valuation At a later stage, shareholder sells shares to another investor or back to the enterprise Enterprise may also pay periodic cash payments (dividends)

24. Non-uniform returns (depending on point of sale). Mostly capital gains. Dividends may or may not be paid over the years Returns from Equity Financing: Non-uniform returns ! Enterprise’s performance fluctuates, and returns depend on the price at point of sale. € The equity holder can sell the shares at any time, at the price at this point in time. 0 n … 1 2 3 4 5 Equity financing t Dividends Equity financing in period 0 Potential capital gains Shareholder may have expectations on returns based on several assumptions ex ante, but the actual performance might turn out to be very different.

25. South Africa: Greening MSMEs (FP029) Financing Instruments − GCF-Project Examples - Equity GCF DBSA Implementing Agency: SCF Capital Solutions Provide SMEs with loans to realize EE / RE projects. Total investment: USD 34.1 million Equity USD 2.2 million Small Enterprise Finance Agency of South Africa) Equity USD 12.2 million SCF Capital Solutions Equity USD 0.07 million Equity USD 12.2 million Shareholders sell shares to another investor or back to the enterprise Private Investor Equity USD 7.4 million SMEs repay loan obtained from SCF with fees

26. Financing Instruments − Overview - Guarantee The provision of guarantee can reduce market barriers. Example: GCF provides topping up and de-risking for banks, ultimately stimulating financing institutions to provide more climate finance for scalable projects. Guarantees repayment of one enterprise’s share if one of the businesses cannot cover pay back loan Guarantee Financial Institution Investments rated risky Loan applications One enterprise fails to repay Enterprises Enterprise 2 Enterprise 4 Enterprise 5 Each want to make an EE investment Enterprise 3 Enterprise 1

27. Energy Efficiency Green Bonds in Latin America and the Caribbean (FP006) Financing Instruments − GCF-Project Examples - Guarantee Steps in if an enterprise fails to repay GCF IADB Guarantee USD 20 million • Implementing Agency: • Inter-American Development Bank (IADB) Loan Payback Loan USD 50 million Grant USD 2 million Provide an alternative financing mechanism for EE projects through green bonds. Investment: USD 334.5 million Equity USD 37.5 million Guarantee USD 56 million CTF Private Sector Sell shares or gets dividends from profits Guarantee USD 19 million Bond USD 150 million Helps out in case an enterprise can’t pay Interest Payback, then loan payback EE project-implementing businesses pay back initial loans provided by IADB

28. Institution Enterprise What is common among many of these models? Borrowed money has to be paid back (potentially plus interest) Invests in enterprise Loan Bond Equity Makes an investment Investment paid with borrowed money needs to generate a Cash Flow!

29. In the end think along the lines of Loans to enterprises, public households or public entities Guarantees for projects and investments, often to incentives private entities like commercial banks to give a loan Equity for enterprises and sometimes projects Grants to start and accelerate markets

30. Project size vs. financing instruments Project size €50 €10,000 €500,000 €100m €2,000 €100,000 €10m Micro Finance Grant Corporate Loans Equity Guarantees

31. Investment size Time horizon Impact Security / Collateral Risk Appetite And always keep in mind what stakeholders expect Other aspects Expected return Large investment amount SMEs Financial Source Financial security High security Long term Donors Low risk High impact Public Sector High impact Shareholder International obligations High returns Short time horizon Risk Management Low risk

32. Market Research Steps for financial instrument development Financing elements Pre-feasibility study GCF XY XY XY Operating & Business Model XY XY Official approvals Feasibility Study Processes & Procedures Launch Structuring of financing Distribution Operation & Maintenance Stakeholder Management

33. NDA • Accredited • Entity GCF GCF In the end it is a puzzle, which takes patience and persistence … Accredited Entity NDA Project Developer Co- Financier Project Developer patience Co- Financier Initiator Initiator persistence lots of energy

34. Key take-awaymessages The focus of the GCF is not so much on grants but rather on other financial instruments (loans, equity etc.). It is therefore important to understand the mechanisms of these financial instruments. Bankers are mainly concerned about minimizing risk and investing in large projects (scale). The GCF can take a risk mitigation role and help aggregate smaller investments to attract private capital. Setting up projects with financial instruments other than grants requires the involvement of a variety of stakeholders with different interests and priorities. Balancing out these interests takes a lot of coordination effort and time.

35. Thank you for your attention!!!

36. List of references and recommended readings: CDKN, 2015. A Guide to INDCs – Intended Nationally Determined Contributions https://www.transparency-partnership.net/sites/default/files/u2055/cdkn-ricardo-aea-guide-to-indcs_final_web.pdf EIB, 2006. Bankability http://www.eib.org/epec/g2g/i-project-identification/12/123/index.htm (accessed 19 October 2017). GCF, 2017. Projects And Programmes http://www.greenclimate.fund/what-we-do/projects-programmes (accessed 19 October 2017). Sonntag-O`Bryan & Usher, 2004. Mobilising Finance for Renewable Energies http://www.ren21.net/Portals/0/documents/irecs/renew2004/Mobilising%20Finance%20For%20Renewable%20Energies%20(fonte%20www.renewables2004.de).pdf (accessed 07 November 2017) Worldbank, 2014. Press Release: Statement by the Heads of the Multilateral Development Banks and the IMF on Infrastructure http://www.worldbank.org/en/news/press-release/2014/11/13/statement-heads-multilateral-development-banks-imf-infrastructure (accessed 19 October 2017).