Using capital markets to finance sustainable infrastructure

To finance the low-carbon energy transition to adapt to the risks of climate change, the International Energy Agency and other global watchdogs predict that massive capital will be needed. The Glasgow Financial Alliance for Net Zero, formed ahead of COP26, estimates that $125 trillion will be needed to close the 1.5 degree scenario gap to the year 2050, also known as net zero. Specifically, from 2021 to 2025, $2.5 trillion is needed each year and $4.5 trillion from 2026 to 2050, more than four times more than today. [i]

At COP26, the Glasgow Alliance, financiers with $130 trillion in assets under their control, plan to take their portfolios to net zero by 2050, a huge undertaking.[ii] Some big players have admitted they don’t know how to get there. That is the real truth. In their roadmap scenario on climate and sustainability related finance opportunities, the idea of ​​blended finance is posed for infrastructure projects that are typically financed by the public sector; blended finance, they suggest it uses public funds to leverage private sector capital and is well suited to the needs of developing countries where the risk profile is higher. In terms of infrastructure funds, the Alliance estimates that $972 billion is the necessary or potential amount it could support to achieve net zero goals, much of which is focused on power infrastructure.[iii] Developing countries still need all other forms of infrastructure for water, waste, transport, etc. Many net-zero roadmaps focus more on industry sectors touching the low-carbon energy space.

Off the sideline

The disproportionate amounts of capital needs put forward beg the question: who will pay for this global low-carbon campaign and the interconnected Sustainable Development Goals? The Glasgow Alliance estimates that 70% of net zero funding can come from the private sector. While many types of financiers have obvious roles to play in theory, in practice we need an approach that will motivate and incentivize private capital to come off the bench.

Public-private partnerships (PPPs) based on capital markets are one approach that recognizes the need for a shared financing approach. Simply put, since large sums of capital will be required, an approach to project(s) based on the financial feasibility that capital market discipline would bring offers a way forward. We cannot afford to waste resources and time. The urgency communicated by scientists on the need to reduce emissions as soon as possible implies that the financing of such an energy transition must be effective, with an optimal match between capital and timing.

Global capital markets offer a viable source of diversified funds, promote better governance, and can bring efficiency and transparency to the challenge of financing infrastructure. Experiences to date with privatizations and securitizations suggest that a ‘market finance’ approach to traditional PPPs with ‘contract finance’ can create immediate private ownership of public investment projects among diverse groups of stakeholders. investors. Ultimately, this can lead to more efficient and successful infrastructure development. Market-based financing solutions can help bring more rational economic decision-making to infrastructure projects and the “real” economy. Projects should be based on a cost-benefit analysis for which public and private sector actors have an important oversight role.

A role for the markets

Project financing should be guided by the invisible hand of global financial markets to determine the economic value of an infrastructure project and provide the resources necessary for construction, operation and maintenance. In this more genuine form of public-private partnership, the government focuses on project identification and facilitation, then allows the private sector to create an efficient and sustainable public works asset that offers financial reward to risk takers and to its owners. When contractors and trades drive project development, as with typical infrastructure projects led by the public sector versus investors, their incentives often outweigh performance and profitability.

Recent research has shown that public institutional infrastructure investors who are signatories to the Principles for Responsible Investment (PRI) perform worse than private infrastructure investors. This is partly based on the fact that they invest in marginal transactions.[iv] For any new large-scale infrastructure project, project-specific securitizations or IPOs of project securities can be designed with financial innovations. This would create diversification, liquidity and alleviate many of the problems that accompany existing approaches to infrastructure financing. Above all, it would promote transparency.

Financial innovations in the securities offering can have both a deterrent and an incentive effect. For example, including event risk clauses in project bonds can deter politicians from making unwanted policy changes, fostering a more investment-friendly environment that developing countries often seek. Good, transparent management will bring its own reward through increased value of the project to the community and the economy as a whole. Ultimately, the explicit costs of infrastructure debt financing would be lower. Of great consequence, the invisible hand of capital markets may prove more capable of setting infrastructure project agendas that span varying jurisdictions and political agendas.

This approach would bring real public and private sector participation in the Sustainable Development Goals. This would ensure sufficient funding, strong interest and awareness of a project on a global scale. Managerial incentives could be more aligned with productivity, reducing widespread problems of cost overruns and inefficiency. Government – at central, state and local levels – could be allocated project guarantees to achieve real public-private ownership.

Market-based PPPs can address investor reluctance due to political risks and profitability issues, bring projects online faster, and attract long-term institutional investors. This funding approach can also be applied to groups or consortia of new, smaller-scale projects. An example of this is an IPO that includes an entire value chain from production to end-consumer in the carbon capture space. A sustainable complex of energy projects focused on renewable biofuels is one possibility, or a large-scale energy system specific to a particular geography or situation would be a candidate.

The sustainable transformational mission suggested by the net zero commitments of various global stakeholders requires a new approach, based on the existing structures of financial markets. To reach this 21st decarbonization challenge of the century, a market-based public-private partnership has the ability to complement sustainable development with sustainable finance.

Dr. Andrew Chen is Professor Emeritus of Finance at Southern Methodist University’s Cox School of Business and Jennifer Warren is Director of Concept Elemental, a sustainable resource consultancy and energy writer.


[i] https://www.gfanzero.com/netzerofinancing/

[ii] https://www.wsj.com/articles/financial-system-makes-big-promises-on-climate-change-at-cop26-summit-11635897675

[iii] https://www.gfanzero.com/netzerofinancing/

[iv] https://www.unpri.org/pri-blog/the-underperformance-of-public-institutional-investors-in-infrastructure/8625.article