Briefings

Green Investment Bank: Q&A

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Green Investment Bank: Q&A

1. Why is the GIB needed?

An investment of £750 billion is needed by 2025 to help decarbonise the UK economy. The Green Investment Bank (GIB) is required to help secure this investment. It can achieve this at least cost to the taxpayer and can act as a catalyst for green growth.

2. How would the GIB work?

It should work with the market to identify and address market failures that limit private investment in low carbon infrastructure and businesses. It would do this by providing financial advice to Government, technical advice to projects/businesses, and by developing financial products to share risk and lever in private capital.

3. Why can’t the private sector deliver the low carbon investment needed without the GIB?

The risks involved (technology- and policy-related) combined with the scale of capital required over a relatively short time period compared to the balance sheets of the traditional finance providers (including banks and utility companies) mean the capital needed to decarbonise the UK will not be forthcoming.

Analysis by Ernst and Young indicates that for the energy sector, for example, only 10−20 percent of the capital required to 2025 will be secured without a GIB to facilitate capital flows.

4. Why not create another fund or quango?

Government has a long track record of developing a variety of ad hoc responses to investment challenges such as the CCS Competition, the UK Innovations Investment Fund, TIFU − that have failed to effectively address the underlying issues. Some stand-alone initiatives have also failed at very significant cost to the public purse, for example, the Metronet PPP, which was bailed out by the Government to the tune of ~£2bn in 2008.

Infrastructure UK’s National Infrastructure Plan supports this view noting that for the last few decades the Government’s approach to infrastructure investment has been “timid, uncoordinated, incremental and wasteful” and that this must change.

A GIB fund or quango also can’t reach the scale needed because it can’t issue bonds to leverage its capital base (see next point). A fund or quango would also lack the range of professional expertise required to address uncertainty in the investment challenges that lie ahead. The low carbon transition will be a multi-decade process of change delivered through the deployment of new assets that carry significant risks. It will also occur over several business cycles through which we can expect to see contractions in capital availability, while momentum is still needed. A permanent and responsive capability in the form of the GIB is needed to build on our learning from (Public Finance Institute) PFI and public-private partnerships structures and ensure greater value for money for the taxpayer is delivered in future.

5. How much private sector capital could the GIB leverage?

The GIB could leverage many times its capital base. There are no fixed rules about how much private sector capital could be leveraged by the GIB. However, using existing public banks as examples, using shareholder capital:

Caixa Geral de Depositos in Portugal (equity of €7.16bn) leverages x17.

ICO in Spain (equity of €2.38bn) leverages x22.

KfW Bankengruppe in Germany (equity of €13.1bn) leverages x31.

France’s Caisse De Depots et Consignations (equity of €23.5bn) leverages x10.

All these organisations then achieve a further round of leverage through co-investment in projects with the private sector.

To illustrate, assuming the GIB leverages £4−5bn provided by the Government as equity by ~ x20 over the first 10 years it will raise ~£80bn in bonds from private sector investors and lever in an additional ~£260bn in private capital through co-investments. This will go a long way to closing the low carbon energy finance gap.

6. Does the GIB need to raise its own bonds?

Yes. Requiring all the capital to be channelled from Government funds is inefficient and unwieldy − it also compromises the operational independence of the GIB from Government. Bonds are an efficient way for the GIB to access the vast pools of lower cost institutional investors capital; other European public banks regularly use such bond issuances to back their investment plans. To help close the low carbon investment gap the GB must have the power to issue its own bonds.

7. Will GIB bonds compete with gilts?

Once it is fully established and has its own Statute defining its day to day operational independence from Government, the GIB is expected to carry an AA or A rating. This lower rating means GIB bonds will not be competing with AAA-rated gilts, appealing instead to investors looking for investment grade products with slightly higher yields.

In the early years, however, it will be desirable for very modest issuances of GIB bonds (a few billion) to carry a statutory guarantee to establish them in the marketplace: in this case they will be AAA rated. Any conflict that may arise between issuances of GIB bonds and gilts can be managed through the Government’s Debt Management Office (which issues gilts) being contracted by the GIB to raise GIB bonds for it. This will ensure a coordination of UK debt issuances and offer cost savings to the GIB via outsourcing this function to experts.

8. Will the GIB crowd-out private investment?

No. Defined by the principle of additionality the GIB would have a mandate to invest only in assets the private sector currently does not invest enough in. In addition, a cap (perhaps 30−50%) could be placed on the amount of capital the GIB can invest in any single project. The GIB could also have a policy of refinancing assets with private sector capital once the riskier construction phase is complete and assets are operational with stable cash flows.

9. Will it be on HMG’s balance sheet?

Off-balance sheet treatment for the GIB can be technically achieved from day one but it carries significant risks because it will limit the ability of the GIB to raise its own capital and will not send the strong signal required by the financial community that the Government is seriously committed to decarbonising the economy. Over time the GIB could be designated off-balance sheet − and so it should be designed with this in mind. Requirements for longer term off balance sheet treatment include: independence from Government set out in Statute to clearly limit Government liabilities; an independent management team; a clear and auditable investment policy; and sufficient capitalisation.

In its early phase the GIB should be set up as an on balance sheet institution with the ability to issue a modest amount of bonds that are guaranteed by the Government to create confidence despite the lack of an investment track record. As the GIB develops an investment track record and a rating, explicit Government support can be removed and other investors invited to become shareholders and the ‘mature’ and off balance sheet GIB created.

10. Isn’t Government taking on large potential liabilities by setting up a GIB?

No. We expect risk would be spread over a wide portfolio of projects − none of which individually is big enough to bring down the bank.

11. How quickly could a GIB be set up?

A ‘Shadow GIB’ could be established as a limited company within months and begin the work of setting up the GIB. This will involve making practical arrangements for setting up the institution and preparing to recruit staff but also working with Government to finalise the design of the mandate, policies, business plan and products that will be needed to address specific market failures. The Shadow GIB could be ‘open for business’ and making investments by the end of 2011. In parallel a Bill should be making its way through Parliament to establish the GIB in Statute so that the GIB is launched in full in 2012.

12. Does the GIB need an Act of Parliament?

Yes. An Act of Parliament is required to ensure full accountability to Parliament in terms of how public funds are spent by the GIB in the pursuit of delivering the UK’s carbon targets. It is also needed to ensure the GIB operates independently of Government and that risk is properly managed.

The Statute gives the GIB protection from short-term Government interference that might mean it is pressured into investing inappropriately. The Statute’s function is to lock down strong governance structures and operational policies that manage the tension between being a political creation but needing to act commercially. It is also necessary to achieve the medium term aspiration to have a GIB that is off balance sheet − independence from Government is one of the key requirements.

13. Won’t the GIB lead to an increase in public spending?

In the short term the GIB is likely to appear on the Government’s balance sheet. But spending on the GIB is different to public spending on welfare or even school or hospitals − it is backed by assets that can be recycled to the private sector for profit. There is no such thing as a jobless recovery. Following the very significant cuts announced in October’s Comprehensive Spending Review, 2.5m private sector jobs must be created over the next 5 years to support the growth on which the Government’s budgetary forecasts are based. This will require an investment and export boom on a scale not seen since post Second World War reconstruction.

A strong evidence base links infrastructure investment to growth, and jobs. Any short term impact of the GIB on the UK’s balance sheet must be seen in the context of being backed by assets delivering growth, jobs and tax receipts to the Treasury. Government investment in the GIB will more than pay for itself. The GIB can be the catalyst for economic recovery and a green jobs boom.

14. Is the GIB needed for the Green Deal?

Yes. The sheer volume of funds needed (upwards of £7bn per year) in a short time period to support Green Deal investment are too vast compared to the balance sheets of the energy utilities and banks who might fund it and who have competing calls on their capital. As highlighted in analysis by Ernst and Young, these traditional providers of finance can provide only 10−20% of the capital required.

In addition, the Green Deal has no financial track record and is not well understood by investors – so it is generally regarded as unsecured consumer finance. This perception is a barrier to raising capital and will push up the returns expected: this means the Green Deal is regarded by many investors as either un-financable ¬or financeable only in the context of high returns, which will make the loans more expensive for householders.

A variety of measures could be used by the GIB to address these issues including providing initial finance, offering loan warehousing facilities and reactiviting the securitsation markets. All these measures can help bring down the cost of capital and so reduce the cost of the loans to consumers. This is critical if the loans are to bring down the energy bills of consumers.

This Q&A is also available to download at TransformUK .

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