How to unlock institutional investor funding for climate action

At the GIIN’s virtual conference last month, Next Normal Now: Re-imagining Capitalism for Our Future, panelists debated the best ways to attract more institutional investors to financing the climate action agenda. The experts agreed that climate action funds needed to expand in size in order to appeal to institutional investor appetite, as well as use their shareholder power to better influence the companies they invest in, but the investors themselves would also need to allocate their capital more efficiently.

Enshrined in the 2016 Paris Agreement is a commitment for developed nations to provide $100 billion annually, from both the public and private sectors, to finance the agreement’s goals. But just six months ago, the UN’s climate action task force released a report revealing shifts in capital flows were lagging far behind their targets and that private-sector finance for climate action remains highly concentrated both sectorally and geographically. Globally, public institutions account for 44% of climate finance, whereas 56% is provided by the private sector. But more private-sector capital is needed to be mobilised from a variety of sources—particularly, at scale, from institutional investors.

Scale, safety and simplicity

In the emerging market context, unlocking institutional investor money for climate action has become “the holy grail”, said Vikram Widge, senior advisor at the Climate Policy Initiative (CPI). There is currently around $600 billion of climate finance flowing annually, of which institutional investors provide just $10 billion. Including private equity and infrastructure funds in that equation would add another $10 billion. “But $20 billion of $600 billion is a tiny fraction, particularly when we know that there are trillions locked up in global savings,” says Widge. “But how to match that availability with the demand?”

One of the biggest problems to addressing that imbalance is scale. “The institutional investors like size, they don’t want to get out of bed for more than $100 million. So if they don’t want to be more than 10% of the deal that means it’s got to be a pretty big deal,” said Widge. “The other thing that matters is the safety of the risk, because in the end they’re managing money for pensioners. And the last thing is simplicity. If we can figure it out and start delivering products that meet these requirements, we can unlock a lot of money.”

Widge pointed to Climate Investor One fund as a good example of how to do that. It raised $850 million in 2019: $50 million for development financing to get the projects to financeable level; and then an $800 million fund that was structured to allow institutional investors to be in the senior tranche, with concessional funding and funding from development finance institutions (DFIs) below them. That allowed the institutional investors to fund a pool of renewable energy projects, which will ultimately be refinanced post-construction with more institutional capital and with less credit enhancement needed.

Capital allocation

But much also depends on the asset class, added Dr Serena Guarnaschelli, partner at Belgium-based impact investor KOIS, with certain asset classes more suitable for institutional investors than others. One such asset class is sustainable forestry. The timber investment management organisations are well established now—with the market increasing from $30 million 20 years ago to over $6 billion today and the fund managers having sufficient track records and expertise. Most of those assets are currently held in the US, Australia and New Zealand, but there are some launching in emerging markets—for example, New Forests’ $170 million Tropical Asia Forest Fund. “But the funds are much smaller in emerging markets because there’s a higher sense of perceived risk,” said Guarnaschelli. “So catalytic capital can play a role in bridging this transition by offering, for example, risk mitigation mechanisms that hopefully—because of the underlying nature of the assets—will not be needed in the longer term.”

Guarnaschelli also called for the institutional investors themselves to change the way they allocate capital. “Right now, a lot of the capital is allocated to climate finance that is mostly aimed at climate change mitigation, but they really need to start allocating capital towards climate change adaptation and nature-based solutions as well.”

Shareholder activism

James Gifford, head of Impact Advisory at Credit Suisse, agreed that capital allocation was one of the best ways to increase institutional investor involvement in climate action, “but only in the early-stage, inefficient end of the spectrum,” he caveated.

The other important mechanism that Gifford believes could turn the dial is shareholder engagement and activism—such as with Climate Action 100+, an investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change. “Large investors should be laser-focused on allocating capital into funds that are really using their investor power to push companies; trying to seed funds that in the liquid markets can deliberately invest in companies that need to improve and then work those companies—inspire them, push them, jump up and down if necessary—to get them to improve, while at the same time increasing allocation to private markets considerably,” he said.

Typically, Gifford said, larger banks and institutional investors don’t do venture capital. But he evidenced a rare example earlier this month where Credit Suisse raised $318 million for a climate-innovation venture-capital fund of funds. “Now that’s highly unusual and includes some very early-stage companies,” he said. “And the way we did that was by pooling the risk so rather than just bringing one fund to our clients—which would’ve been subscale and way too risky—we put it together in a fund of funds structure, which solved a lot of challenges around risk and scale.”

However, one of the typical challenges with funds of funds is the tenor, which often stretches out beyond 15 years. “[But] the great thing about climate is that there are now many many funds in the market and so hopefully that investment period can be much lower than a typical strategy would require.”