A case in point is the recent announcement that the Ontario Teachers’ Pension Plan (OTPP)with C$140.8 billion in net assets as of December 31, 2013 and Canada’s Public Sector Pension Investment Board (PSP) with C$99.5 billion of net assets under management are teaming up with Spain’s Banco Santander S.A. Pursuant to the terms of their agreement, Banco Santander will identify, prepare, and evaluate potential wind, solar and water infrastructure investments and the two Canadian pension funds will serve as a de facto in-house financing arm for at least a portion of the total project cost. The first round of projects financed under this scheme is valued at $2 billion, but “significant additional amounts” are expected to be invested over the next five years.
- “This investment directly supports our focus on investing in platforms that provide access to development opportunities globally," said Andrew Claerhout, Senior Vice-President, Infrastructure at Teachers.
- "This investment fits well with our strategy of deploying capital in sizeable opportunities that offer long term revenues and growth potential along with solid partners. It also allows PSP Investments to continue to develop its portfolio of private energy assets while contributing to environmentally sustainable energy production," said Bruno Guilmette, Senior Vice-President, Infrastructure Investments at PSP Investments.
This seems to be an ideal division of labor. The pension funds will focus on their comparative advantage which is providing long term capital. At the same time, the pension funds will outsource the project identification, preparation and monitoring to Banco Santander, which has the requisite in-house skills for these tasks, skills which are noticeably missing from pension fund staffs.
Green bonds, aka climate bonds, are another interesting innovation which seems to have come of age in 2014. Total green bond issuance was $11 billion in 2013, $36 billion in 2014, and is expected to be close to $100 billion in 2015. Compared to today's green bond market, the first green bonds issued by the World Bank in 2008, designed in partnership with Skandinaviska Enskilda Banken (SEB), were a relatively timid affair, albeit path breaking for their time. Institutional investors channeled their money to the World Bank which used the proceeds to finance green investments identified, prepared, and supervised by the World Bank. Pension and sovereign wealth funds were taking World Bank AAA credit risk; rather than the credit risk of the individual green projects which were the ultimate beneficiaries of their capital. They were financing the World Bank in the first instance and green projects only indirectly.
From those rather modest beginnings, the green or climate bond market has grown rapidly into a financial market juggernaut. Today, all sorts of institutions ranging from private companies, to multilateral organizations like the EIB and IFC, to states and cities to universities are issuing their own green bonds to finance green projects identified and prepared by the issuers. Repayment is coming from a variety of sources, ranging from the issuer's balance sheet to revenues generated exclusively from the green projects themselves.
What is so innovative and important about these recent financial market innovations? Two features seem especially important. First, these financial instruments are generating new conduits for channeling funds from institutional investors to green projects. Second, they are bundling groups of small projects into larger scale financial packages which are inherently more interesting to large institutional investors.
When Prince Charles convened the initial P8/P80 meetings in 2006, pension and sovereign wealth fund representatives explained that they didn't have the ability to find, evaluate, and monitor smaller scale projects. They also explained that they needed to invest relatively large chunks of money and couldn't be bothered financing a large number of comparatively small projects.
Fund-of-funds mechanisms like the IFC's Catalyst Fund and the EIB’s Global Energy Efficiency and Renewable Energy Fund (GEEREF), were developed in part to address this concern. Pension and sovereign wealth funds would invest large amounts in a fund of funds which, in turn, would invest relatively smaller amounts in a variety of smaller scale private equity funds, which at the end of the day, would invest in individual green projects. This was a disaggregation financial mechanism -- funds of funds would disaggregate large investments from institutional investors into a larger number of smaller investments. For a while, funds of funds seemed to be the dominant game in town.
However, as the green bond and Canadian pension fund examples suggest, the financial markets have been innovating and finding new ways to aggregate or bundle smaller investments into larger financial package. Moreover, instead of putting the project identification and due diligence burden on pension and sovereign wealth funds, a task for which they are singularly ill equipped, issuers are taking responsibility for identifying, preparing and evaluating projects, which independent third parties then certify meet the investors' "green criteria.