Climake Newsletter #27: Asset Finance, Climate Adoption's Secret Weapon
Climake Newsletter #27: Asset Finance, Climate Adoption's Secret Weapon
The Climake Newsletter offers quick digests and insights around what is happening in climate finance. While Climake’s current focus of work is India-centric, we capture a global perspective of climate finance in this newsletter on a fortnightly basis.
Winter is coming in North India, which means air pollution, and this year’s season counts for one of the worst witnessed in recent times. Stubble burning of paddy crops in neighbouring states comes in the spotlight, and with it the debates on who is responsible, and more importantly, how do we tackle it.
Solutions to address it are present. Companies like PRESPL and Takachar offer machines and equipment that make paddy wastes into valuable bio-products, which would actually make the extraction and processing of stubble wastes valuable and disincentivize its burning. States like Haryana are taking steps to incentivize the adoption of such equipment and machinery as policy interventions to reduce stubble burning.
But the cost of purchasing such equipment is often the biggest barrier for the many thousands of farmers to tackle arguably our most high-profile unintended consequences. This is the focus of this edition’s Big Read - how financing can address arguably the biggest problem for India’s climate entrepreneurs: how do we scale solutions?
In our numbers snapshot, as the world gets into COP mode, we look at topics and themes that need to be more highlighted than they usually are when the annual heavyweight discussions of the summit come to town.
Climate Finance by the Numbers
USD 387 billion
“Underfinanced. Underprepared.” The title of UNEP’s latest report on the global adaptation finance gap does not mince words on how far adaptation finance is lagging. To contextualize that number, the need for adaptation finance is 10 to 18 times more than our current annual spend.
The call to increase adaptation finance has been increasing as we experience the adverse effects of global temperature rises. Extreme rains, flooding and multi-year droughts are fast becoming our current reality rather than futuristic scenario that we can experience. But this call is not being met. In fact, public adaptation finance to developed countries dropped by 15%, to US$21.3 billion in 2021.
Adaptation finance will keep facing mobilization issues until loss prevention and its impacts to avoid or mitigate are clearly understood by funders. Studies show that USD16 billion invested in agriculture per year would prevent about 78 million people from starving or chronic hunger because of climate change impacts. Similarly, the UNEP report found that every USD 1 billion invested in adaptation against coastal flooding leads to a USD 14 billion reduction in economic damages. But yet mobilization is slow.
Adaptation finance also has a disbursement issue. The UNEP report found that international public adaptation finance over the past 5 years has only had a 66% disbursement rate of funds mobilized, as compared to 98% for overall development finance disbursement. Adaptation projects face barriers in receiving capital, either due to the nature of projects or proponents being ill-suited for risk capital (almost 62% of public adaptation finance was deployed through loans), or available financing instruments not being aligned towards the needs of adaptation.
Adaptation is going to rely on public finance to start making leaps to bridge the gap, before any meaningful private sector financing can flow - only about USD 1 billion was mobilized from private finance for adaptation in 2020 and 2021. A lot of stock for adaptation finance is being placed on progress at COP28 on the long-discussed loss-and-damage fund for developed countries to pool capital for developing countries to manage adverse effects of climate change impacts. If it works is bound to be a significant boost, but given that it is a subject that has stretched on since Bali’s COP13 in 2007, the case for building adaptation financing likely has to become more diverse.
USD 5 billion
The amount of climate blended finance deployed globally in 2022
Blended finance is presented as holding the key to unlocking climate investments and overcoming the risk barriers associated with climate solutions, and the perceived poor returns compared to comparable investments.
At its root, blended finance derisks these climate solutions for private capital looking for market returns investments by combining (or blending) their capital with concessional capital from DFIs and philanthropic institutions that prioritise climate impact for reduced or even no financial return. Blended finance has been specifically targeted to mobilize private sector investments specifically on several key areas supporting climate action: 1) making adaptation finance more viable ; 2) mitigating currency risk from developed to emerging economies; 3) funding technical assistance for new climate action projects, and; 4) reducing financing costs for private investors.
The USD 5 billion funded in 2022 reflects a 55% drop in climate blended finance capital from the previous year, which seems to go against the promise and hype the structure offers (to the earlier number on adaptation finance gaps and the potential for blended finance is yet to be significantly established as as only 15% of deals have been for adaptation, while the more commercially reliable mitigation accounts for 70% of all deals from 2013. Convergence attributes this to macroeconomic challenges that have impacted financing flows to emerging and developing countries, where blended finance is most needed.
The need for blended finance is clear but has received limited participation of the private sector - where lending has declined from $7.13 billion between 2017-2019 to $5.87 billion between 2020-2022 (which cannot be explained as a COVID-19 factor). The call for private sector capital is clear: more risk-sharing and greater public or philanthropic sector willingness to shoulder potential loses.
South Asia has been one of few bright spark for climate blended finance. Financing flows have significantly increased, with the USD 1.9 billion deployed in 2022, being significant orders of multiples higher than the USD 0.4 billion in 2021. Overall, the region has attracted a low amount, but trends such as this highlight the potential for climate blended finance. Importantly, it gives a chance for climate blended finance in the region to account and address the experiences and difficulties of climate investing to mobilize capital, and of past blended finance approaches specifically. For instance, we are aware of a dedicated institution being set up in India primarily for the purpose of building the case and mobilizing climate blended finance, an institutional step which will help to strengthen the case and ecosystem for climate blended finance in the country.
11
Number of blue bonds issued in 2022
The world’s ocean and marine systems - the blue economy - directly employs 350 million ocean-related jobs, feeds the diets of about 3 billion people, and supports an economy valued at about US $3 trillion annually, making it the world’s seventh largest economy based on GDP. Oceans also happen to be our largest carbon sinks, responsible for absorbing 25% of the world’s GHG emissions and 90% of the excess heat from these emissions.
Its ability to sustain these are being affected by a confluence of issues from pollution, over-exploitation of marine stocks, and the consequences of rising temperature on marine ecosystems.
By 2030, USD 175 billion needs to be invested annually. Sustainable ocean finance today is largely the purview of bi-lateral or multi-lateral government aid, development finance, or philanthropic capital, which in 2019, mobilized around USD 16.1 billion - development finance contributed 80% of this funding. Failing to invest over the long-term is expected to lead to losses of between USD $200 billion to USD $1 trillion a year by 2100, never mind the unquantifiable and untold natural, human, and societal damage, which will be considerable.
Even with increased scrutiny and commitments - such as the 30×30 Campaign which pledges to protect at least 30% of the ocean by 2030 - financing the blue economy needs private sector involvement, which has been lacking. Despite the very tangible and real economic losses that can motivate private capital to act, the ocean suffers from an “out of sight, out of mind” problem - 60% of the world’s oceans is outside national jurisdictions - and its vastness seems to diminish problems associated with it, including the urgency for private capital to invest.
That is where blue bonds can come in as one example of an instrument to attract private finance. 26 blue bonds have been issued since the first one issued in 2018, amounting a total of USD 5 billion raised, and the 11 in 2022 - the most in a year - is a signifier for growing interest of commercial returns being delivered through our oceans, albeit likely with some concessions.
We are quite at the bottom with blue economy financing, and the only way really should be up. Blue bonds is not a panacea, it is just one route (of more that need to be incentivized) for private finance to participate in cleaning and restoring our oceans.
THE BIG READ
Asset Finance, Climate Adoption's Secret Weapon
India’s most pressing issue for its net-zero journey is not an innovation problem, it is a scale problem. More specifically it is the lack of affordability for solutions that hinders adoption. Addressing how we make solutions accessible ultimately revolves around rethinking how we fund and finance these innovations. One such way is through climate asset financing. From energy efficiency, cooling, agritech, to decarbonizing industrial processes, climate asset finance has the potential to make the expensive affordable, if done correctly and appropriate to the contexts of solution providers and users.
As a way to introduce new climate financing approaches for India, Climake has been piloting a climate asset leasing structure targeted at supporting new innovations that have potential but limited track record, and/or beneficiaries and users that can see impact and income benefits but cannot afford to pay for the assets upfront and are not likely to pass traditional credit checks.
This article is an update of an Op-Ed we had written for Forbes India’s Climate Issue released on June 2022, that outlines how asset leasing and financing structures can be deployed to tackle that great big problem for our net-zero journey: how might we get more climate-positive solutions to be adopted.
The year 2021 proved to be a pivotal one for advancing action against climate change in India. For the first time ever, the country announced a net-zero target—the commitment to get to zero carbon emissions by 2070—at the Glasgow COP 26 conference.
2022 has seen a slight dip in private investments in climate innovation, with equity investors deploying USD 4.70 billion compared to USD 7.15 billion in 2021. If debt and green bonds are included, total climate investment in India is estimated to around USD 22 billion. Despite the reduction in equity financing, 2021 saw more diversified bets in more emerging areas - electric mobility, agritech, and circular economy - beyond climate’s traditional powerhouse of renewable energy (solar and wind power) which still attracted 48 percent of all climate equity investment.
However, India still needs significant capital to enable the adoption of climate tech solutions. To achieve our goal of net-zero emissions, we need to move climate action from an emergent niche sector towards a mainstream activity. The challenge is not the lack of innovation; it is the lack of affordability of physical and asset-heavy solutions, especially those developed for new market segments by early-stage startups.
The climate tech financing gap
Forty percent of the country’s GHG emissions, used for powering our infrastructure, equipment, buildings and a lot more, can be addressed by a transition to renewable energy. Solar and wind companies are able to deploy solutions at scale by accessing a maturing and diverse range of financial instruments (equity, debt, bonds) developed over the last 20 years, with relative ease.
The other 60 percent of India’s GHG emissions come from activities and products that consumers and businesses rely on and use, such as transport, agriculture, and industrial and manufacturing processes. The solutions needed to tackle these emissions are also known as demand-side climate tech, a relatively nascent sector compared to renewable energy.
Adopters of demand-side climate tech solutions either replace existing assets (e.g. energy-efficient fans) or buy new, untested solutions (e.g. IoT solutions to reduce power consumption). They need to commit to an upfront capital cost that is usually more expensive than non-climate friendly alternatives, and hope that this additional cost will be recovered either from the cost-saving benefits or increased income from using the asset. There are two challenges here.
The first is that a large segment of India’s customers—individuals and small businesses—are unable to pay for capital investments upfront. In such cases, some customers can afford to make smaller regular payments over a period of time (something that EMI schemes have made familiar to them), especially if payments are linked to the additional income or cost saving realised.
But this brings up the second problem: Even when customers can afford a new product, climate tech startups face a long and arduous process in getting a buy-in for solutions that are relatively untested and have a limited track record. Even if a small enterprise, such as a kirana store, has suitable funds, they tend to be averse to risking it to purchase a device, such as a newly introduced solar refrigerator, that in their minds may or may not work.
This leads to a delay or avoidance of purchase decisions, which when occurring at the early-stage of adoption, often determines success or failure for a startup.
Climate asset financing can help scale adoption
The answer to our customer’s dilemma is asset finance. It is a time-tested tool of finance for buying homes, cars and electronics. Even in solar energy, asset financing is a common instrument; customers sign a power purchase agreement and, instead of buying the asset upfront, pay for the results of setting up the power plant.
If we can create similar financing structures for energy efficiency, alternative heating and cooling solutions, and decarbonised industrial processes, climate adoption can scale rapidly. However, the reason we do not see a mushrooming of climate asset financiers is due to two key challenges.
The first is that of credit and default track records. Home finance companies and vehicle financiers are able to quite accurately predict expected losses and defaults, from decades of data and experience in customer behaviour and loan repayments. As climate assets and markets are new, no such data exists for these solutions; it is more convenient to classify them as high risk, making the lending rates unaffordable.
The second challenge is the lack of performance data over long periods for the assets themselves. If we cannot accurately predict how an asset will perform in a few months or years, the asset financiers cannot put a value to any assets they reclaim on default, or build an active second-hand market to redeploy those assets.
These challenges create an opportunity for risk capital and early investors, and needs to go beyond just the availability of capital. The climate innovation startup and the asset financier can work together to create an integrated ecosystem, namely:
A credit guarantee from impact funders or grant providers to kickstart asset financing for new segments and to build a track record of credit performance to a point where it is large enough for commercial credit.
Buyback and redeployment contracts with climate startups until an active second-hand market can be developed for climate assets, where, in the event of non-payment by a customer, the asset can be redeployed to another adopter.
India is going to need more than $120 billion in climate investment every year until 2030. This investment is going to be one of the most critical and foundational steps towards achieving net-zero targets. For adoption at scale to happen faster, the key financing instrument will be asset financing, not private equity. Affordable asset financing is where India’s climate finance focus needs to shift towards.
That’s it for Edition #27 of our newsletter.
As always, send all feedback, compliments and brickbats our way. And of course, we do appreciate you spreading the word about this newsletter.
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Best,
Simmi Sareen and Shravan Shankar