GLOBAL - Unsupportive environmental policies and financial instruments prevent pension funds from financing green growth initiatives, according to the OECD.

Other barriers to investment include a lack of market liquidity, scale issues, regulatory disincentives and lack of knowledge, track record and expertise among pension funds about these investments and their associated risks, leaving pension funds' asset allocation to green investments at less than 1% at present.

But with $28trn (€21trn) in assets, pension funds - along with other institutional investors - potentially have an important role to play in financing green growth initiatives, according to the OECD working paper 'The Role of Pension Funds in Financing Green Growth Initiatives'.

Green projects include multiple technologies at different stages of maturity - from new technologies to those already deployed on a large scale - requiring different types of financing vehicle. Institutional investors can access such projects via equity, fixed income - notably green bonds - and alternative investments such as direct investment via private equity or through green infrastructure funds, noted the working paper.

The paper said: "Most green investments are currently uncompetitive, partly as they often involve new technologies which require support and have yet to be commercialised. However, they are also uncompetitive due to market failures - with existing, 'black' technologies mispriced due to pollution externalities not being accounted for and fossil fuels still being heavily subsidised."

It added: "Government policies are therefore needed to support the commercialisation of new technologies."

Such policies include research and development tax credits, accelerated depreciation, investment incentives, government support for venture capital funds and output-stage support such as feed-in tariffs and carbon pricing.
The paper further noted the small and illiquid nature of green investments, saying this resulted in a mismatch between pension funds' long-term, low-risk needs and the types of vehicles funding such projects.

"Governments can again play a role to stimulate and develop the market - ensuring that adequate, investment grade-deals at scale come to the market for pension funds to invest in."

The OECD suggested vehicles could be structured in a way to allow governments to burden the "early-stage" risk of from some investments, either through joint ventures or subordinated equity positions.

 "Alternatively, government bodies could provide loan guarantees," it further suggested. "In addition, governments and/or multinational agencies can use so-called public financing mechanisms to provide cover for risks which are new to pension funds or cannot be covered in existing markets such as political risk, currency risk, regulatory and policy risk.

It said that allowing for standard investment approaches and the rating of green investment structures would also be of benefit.

The OECD noted that the green investment space - in the shape of fixed income projects, green infrastructure funds and green investment banks - was already being explored by pension funds including Denmark's ATP, as well as the Dutch fund PGGM and the American public funds CalSTERS and CalPERS.

To increase the role of pension funds in financing green growth initiatives, the paper recommended a number of environmental policies, ranging from the fostering of liquid markets to better education and guidance for investors, as well as improving pension fund governance.