With clock ticking for GCF to start delivering, board meets in Korea to discuss how it will leverage billions in private funds
There has been a steady evolution of the Green Climate Fund’s business model over the past 18 months.
The Private Sector Facility (PSF), widely regarded as one of the innovative features of the Fund, has started to take shape with the board confirming that private sector intermediaries can be accredited to deploy the Fund’s resources.
Such entities, the Board decided, will have a choice of financial instruments that includes equity and guarantee instruments alongside grants and loans.
This will increase the effectiveness of the PSF in partnering with the private sector and mobilising its capital.
It has also been clarified that the PSF will start operating at the same time as other parts of GCF’s structure.
The PSF offers potential to play a far-reaching role in catalysing the private sector through supporting investments that range from increasing access to affordable finance for micro-enterprises to mobilising long-term institutional investors.
One of the key tasks for the Board this week will be to progress several outstanding issues that will enable the PSF to fulfil and demonstrates this potential in 2015.
The last year has been busy one for the GCF’s Board and the newly formed Secretariat.
Much of the attention has focused on the process for accrediting implementing entities and financial intermediaries through which the Fund will initially operate.
Along with a programme of support for strengthening countries readiness to access the GCF, these have rightly been prioritised as necessary first steps for operations to begin this year.
Several other elements essential to the Fund’s business model also moved forward.
Following the successful $10.2bn of pledges to the Fund at the 2014 Lima climate conference, these now need to be finalised to ensure the GCF is fully operational this year.
In particular, clarifying the sub-criteria and methodology for applying the Fund’s investment framework is essential to guide countries and their nominated implementing entities on the design of public and private sector programmes and investments that will ensure greatest transformational impact of GCF resources.
Private Sector Facility
By allowing for a range of instruments, including equity and guarantees, to be deployed by accredited entities with relevant expertise and experience, the PSF has potential to go beyond what is currently available within the existing multilateral climate finance architecture.
This will require flexibility in the determination of financial terms and conditions of the Fund’s instruments so that these can be tailored to manage specific risks and overcome barriers that will inevitably vary across country, sector and technology and financial market contexts.
Allowing insurance instruments to be deployed by accredited entities would also help increase private sector adaptation measures.
As a general principle minimum levels of concessionality should always be applied by accredited entities, with instruments being used in a subordinated or first loss position when that is identified as the most effective use of resources.
The Fund will therefore need to heavily rely on the expertise, local knowledge and risk-management processes of accredited entities when determining terms and conditions.
This point should also be acknowledged within the Fund’s risk-management framework.
This week the Board will also consider analysis of the potential role and impact of the investment portfolio across the Fund’s structure, including the PSF.
Suggesting calls for proposals on high impact areas, this has clear implications for whether the Board can incentivise innovative private sector programmes during the Fund’s initial phase.
The Fund’s risk appetite must also allow for a portion of the portfolio to be used for higher risk investments that may be harder to implement but are likely to have greater transformational impact and opportunity for collective learning.
Local private sector
The GCF’s Private Sector Advisory Group met twice in 2014 to consider the role and design options for the Fund’s PSF.
Advice and specific recommendations on two particularly innovative roles of the PSF were provided.
First, the importance for ensuring the Fund supports the local private sector in developing countries, particularly small and medium sized enterprises (SMEs) for both mitigation and adaptation activities.
The paper going to the Board this week reflects much of the PSAG discussions on these issues and proposes a very specific and actionable outcome that would effectively carve out $100m of funding for an SME pilot programme for which the Secretariat would issue calls for proposals.
The focus on SMEs recognises the important role these private sector actors have within the economy of all countries but particularly small island states, least developed countries and Africa.
A programme-based approach is proposed whereby the PSF would address lack of access to financial markets by providing concessional resources through accredited entities to SMEs, including grants for strengthening their capacity.
The draft terms of reference indicate that applications to the call for proposals could request a line of credit for blending or on-lending to SMEs, or for creating a vehicle which would manage and invest GCF resources for financing SMEs.
National project pipelines
The other potentially innovative role for the PSF is on mobilising funds at scale.
The paper for this Board meeting identifies a range of ways in which different private sector resources could be mobilised through various instruments, suggesting calls for proposals could come forward soon.
Yet the specific steps by which the Fund will achieve this are less clear.
Recognising the relative novelty and complexity of some of the issues involved in mobilising funds at scale, the PSAG set out in very simple terms some specific steps which would enable the PSF to begin such operations in 2015.
Given the scale of the climate related investment challenge, accelerating the participation of institutional investors within the financing of countries’ mitigation and adaptation programmes was emphasised.
At this stage it would not be legally or financially viable for the GCF to issue green bonds given the Fund’s current governance and lack of an investment track record.
For the same reasons it is unrealistic to expect that institutional investors would contribute to the capital base of the GCF in this initial phase.
Instead, the PSAG recommended that the Board issues a call for proposals for a vehicle to mobilise finance for matching country or regional programmes and project pipelines.
Through the tendering process the Board would not only identify an entity that represented best value in terms of leverage – or debt or equity finance mobilised – but also for ensuring appropriate delivery channels to support countries’ mitigation and adaptation programmes and projects.
As any tendered vehicle would be established off the Fund’s balance sheet, the investments, associated risks and any potential losses would be ring-fenced, having no direct impact on the rest of the GCF’s portfolio or risk-appetite.
Similar approaches are being taken forward through bilateral climate finance initiatives such as the KFW-led Global Climate Partnership Fund and the UK initiated Climate Catalyst Fund which is managed by IFC as an off-balance sheet financial vehicle.
The Bank of America Catalytic Finance Initiative includes similar activities through facilitating blending of finance from different providers of capital with differing risk and return expectations.
However, no multilateral climate finance initiatives are currently operating in this space.
The opportunity for the GCF to pilot such approaches would help build understanding of how finance mobilised from institutional investors can be effectively matched with country owned strategies and programmes.
What to look out for this week
A number of issues up for consideration by the Board this week can be seen as a barometer of the PSF’s potentially innovative role. Namely:
– Acknowledging the need for engaging the private sector for piloting (and building familiarity) of innovative ways for risk-managing the transformation to low carbon and resilient paradigms. Ensuring a portion of the Fund’s investment portfolio is used to do this across a range of country and sectoral contexts will clearly signal the PSF’s potential role in catalysing the financial innovation required for delivering global transformation.
– Recognising within the Fund’s risk-management framework that as the Fund will operate through accredited entities it should heavily rely on these partners’ risk assessment and management processes. Through the accreditation process – that ensures robust fiduciary standards and stringent environmental and social safeguards – the Fund can ensure intermediaries exercise the highest standard of care in managing risks and minimising potential losses.
– Providing flexibility for accredited entities to apply their expertise and knowledge of the country, sector, technology and financial market contexts to increase the PSF’s ability for catalysing the private sector whether these are micro-enterprises that are perceived high risk due to lack of a credit-profile or very risk-averse institutional investors. As above, oversight through the accreditation process is likely to be more effective than trying to define a pricing methodology that may be difficult to apply across the wide ranging contexts in which the Fund should operate.
– Issuing calls for proposals on high impact programmes and investments would provide the Board with ability to initiate innovative pilot programmes for mobilising the private sector this year. Agreement to this as a principle would allow calls for proposals to be issued for implementation of the proposed SME pilot programme alongside a similar pilot programme for mobilising funds at scale.
– Reinforcing the Fund’s intent for working through a diverse range of implementing entities and financial intermediaries by accrediting at least one private sector intermediary during this first round of accreditations. Further accreditation of private sector entities or public ones that have a track record of partnering with the private sector at the next meeting would further signal that the PSF is very much ready to operate.
Taken together, the above issues will all influence the extent to which the PSF can fulfil its innovative potential.
Their progression this week will allow the PSF to start piloting its catalytic role for growth of domestic markets and scaling up of finance both of which are essential for facilitating countries smooth transition to low carbon and resilient paradigms of development.
Amal-Lee Amin is Associate Director of E3G and leads the International Climate Finance team. Follow her on twitter @AmaleeAmin