Innovative funding instruments for environmental technologies

Abstract

The objective of the project at the outset was to come up with innovative funding instruments that could help utilize the scarce resources in the best possible way and aid the development of environmental technologies. We started by analyzing as to how urgent is the need for work in climate change area and the indications from the IPCC’s fourth assessment report are that if concrete steps are not taken for climate change mitigation then we might cross the point of no return. Thereafter we studied what mechanisms of funding exist as of today for environmental technologies. We found that the most common mechanisms comprise of Public equity, Private equity (existing funds, new funds), Bonds, Commercial loans/debt, Risk management instruments, Public - private partnerships, Consumer/retail investment products, Micro-finance, Real estate and Direct project investment. These were the mechanisms in open market and faced many impediments due to factors such as prices, market externalities, asymmetric information and various form of risk. Thereafter we turned our attention to one of the biggest forms of financing in the area of environment related projects – The Global Environment facility (GEF). The GEF aims to fund projects worldwide and provides incentives to the projects that demonstrate low carbon development and mitigation of greenhouse gas emissions through the public and private sectors. The GEF funding model is based on the system of co financing wherein the GEF provides funds as a stimulus to a project and the rest of funding or leverage comes from co financing. The biggest co financers are National Governments, Quasi Governmental organizations, Private Companies, Non Governmental Organizations (NGOs), Local and National Banks giving loans, DFIs and International Agencies. In the GEF funding system, because of co-financing leverage is one of the most important parameters to analyze. The leverage of projects varies from as low as 1 to as high as 90. When GEF is giving its funds as a trigger, it would want to derive maximum leverage because that will help the project achiev e a better output and better effectiveness. We selected the energy efficiency projects in the climate change portfolio for analysis as these are the most developed portfolio of GEF. After analyzing various factors of these 55 projects we reached a conclusion that tangibility, scale and probability of failure of the project are the most important criteria determining leverage and tangibility is the most important one. We tested our findings by an empirical case based approach on three biodiversity projects and found that the suggested parameters affecting leverage hold true on these projects too. We also suggest a leverage grid that can help GEF analyze future projects as they come for approval and then decide what should be the range of the projects leverage. On a broad level the leverage is high for a project of its tangibility is high; similarly a higher scale and low failure probability also positively affect leverage. Interplay of these factors determines the final leverage. Having seen what determines leverage we saw that some of the projects receive low leverage and typically these projects would either be small scale, or have high risks associated with them or benefits will not be tangible and will be derived over long periods of time. So the focus should now be on simulating these low leverage projects that are more in the biodiversity area. Our suggestion is that the funds provided by GEF should be used for market creation. When the leverage is high this purpose is automatically achieved. Whereas when the leverage is expected to be low then one needs some innovative instruments to help create market. The GEF funds can be used for risk premium reduction.