UK - Pension funds will be a prime investor target group for the UK's proposed Green Investment Bank (GIB).
In its report on Unlocking investment to deliver Britain's low carbon future, the Green Investment Bank Commission warned that between £800bn to £1trn of investment will be required by 2030 to replace, upgrade and decarbonise the UK's infrastructure, and £550bn of this is needed in the next 10 years if the UK is to meet its 2020 target of reducing greenhouse gas emissions by 20% relative to 1990 levels.
The Commission has proposed the establishment of a GIB within six months to "open up flows of investment by mitigating and better managing risk" in climate change projects. This would initially on areas such as investment in smart grids that reduce the cost for other low carbon investments and support of offshore wind projects.
However, the Comission admits that banks are currently unable to deliver the volumes of debt capital required, while new legislation requiring higher capital ratios may further limit their ability to lend.
Instead it suggested institutional investors, "with their long-term liabilities and vast pools of capital could provide a significant proportion of the funds. It is critical that we access these resources. However, this will only happen if they are able to earn adequate risk adjusted returns and if appropriate market structures are in place to access this capital".
The Commission suggested a "properly structured green bond would be one way of accessing institutional resources". But it noted that pension trustees "approach new investment areas cautiously" so work needs to start immediately if the capital is to be available in the required timeframe.
Data quoted by the report noted that direct investments in infrastructure account for less than 5% of pension funds' total allocation, so they are a more likely source of debt financing than equity funding. Meanwhile insurance companies could be another source of investment as green bonds could be used to back annuities if they are sufficiently long-dated and rated appropriately.
The green bonds could be used either to finance the GIB itself, or to lower the cost of debt for projects where the GIB or government provides risk mitigation, with the bonds taking the following forms:
If green bonds were to single-handedly finance the low carbon transition over the next five years, institutional investors would have to allocate up to 5% of their total bond allocation, or 1.7% of total assets to the investment. By 2015 this would lead to pension funds and insurance companies owning on average £265bn of assets in this sector or almost 10% of their total assets.
However the Commission admits that this is an"ambitious target. "Any change will take time and this target will need to be supported by well structured bonds that address the liquidity and collateral issues," it said. It also warned that a green bond market should "broadly reflect the existing bond market so that investors can feel immediately comfortable investing in these important assets".
The report added that all bonds need to have a natural market to be sold successfully and any final solution "must be able to adapt to fill gaps created by new regulation (such as the EU Alternative Investment Fund Managers Directive) on how and where investors can invest".