Business Case and Intervention Summary (July 2013)

Transcription

1 Business Case and Intervention Summary (July 2013) Intervention Summary Title: Global Climate Partnership Fund (GCPF) What support will the UK provide? 1. The proposal is to provide a 30 million capital returnable investment in the Global Climate Partnership Fund (GCPF) from the Department of Energy and Climate Change s (DECC) allocation of the International Climate Fund (ICF), with a further 150,000 for evaluation. GCPF is an innovative public-private partnership with the objective of increasing the flow of finance to small and medium enterprises (SMEs) and households for energy efficiency projects, and to a lesser extent renewable energy, by mobilising private finance. Targeting projects across developing and emerging economies, it aims to deliver greenhouse gas emissions savings and support local development. 2. GCPF was established by the German Government (BMU) and development agency (KfW), who are well-regarded and trusted partners. It has been operating successfully since 2011 and is open ended with no set close date. As the fund is in operation the UK s investment will be able to deliver results quickly. Although there will be an ability to steer the strategic direction of GCPF, we will be unable to change the fundamental setup of the project. 3. GCPF is a Fund that is commercially run by Deutsche Bank (who won the competitive tender to be Investment Managers). The majority (at least 70%) of the Fund will be used to provide local financial institutions with credit lines, with which they in turn offer market rate loans to SMEs/households for renewable energy or energy efficiency projects. A smaller part of the Fund, up to 30%, will make direct investments (equity or debt) in similar projects. GCPF has a complementary technical assistance facility for local financial institutions to introduce or enhance innovative climate change oriented loan products to facilitate new and protect existing investments of the Fund. Although the UK will not directly support the technical assistance facility, it will do so indirectly given that a portion of the revenues of the Fund are used to finance the facility. 4. The private sector (both local financial institutions and the wider capital markets) has a lack of experience and hence confidence in providing finance for small-scale renewable energy and energy efficiency projects. This means that appropriate finance is either not available to SMEs and households, or that lending is offered at prohibitively expensive rates to compensate the high risk that is perceived due to lack of experience of this type of lending. This is a particular issue in developing countries. GCPF aims to address this by using public funds to take a greater level of risk with a lower rate of return than commercial investors would accept in order to mobilise investment in to the Fund. By demonstrating that low carbon investments can be economically attractive and sustainable GCPF aims to accelerate and attract additional capital at scale into climate financing. GCPF does not offer finance at concessional rates to local financial institutions which helps ensure the development of a sustainable market. GCPF s approach is in line with the ICF investment strategy of testing innovative approaches, working with the private sector and aiming to achieve a transformational impact through its scale and global reach. 5. The Fund is structured into 3 tranches of shares, A, B and C, see figure A. The UK s investment would be in C-shares. The UK and other donors C-shares act as a risk cushion for A and B shares. All shares are investments structured to provide annual returns and the process for paying returns from the revenues accrued follows a waterfall principle, see figure B: A-share returns are paid first, then B, then C, followed by the investment manager performance fees, a contribution to fund the technical assistance facility, and if sufficient revenues allow complimentary dividends for A and B shares. Any losses or loan defaults would similarly be borne first by the junior C shares, then B and finally A shares (although we have assessed the risk of loss to be low, see risks section). In this way C-shares act as a risk buffer for the mezzanine tranche (B-shares), and, in turn C & B-shares act as a risk buffer for senior tranche A- 1

2 shares. To note as the Fund matures it is envisaged that a super senior tranche can be developed in the form of time-bound notes that also targets institutional investors. The addition of notes will leverage further investment and increase the value for money from a C-share investment. Figure A: GCPF Fund structure Figure B: GCPF payment waterfall 6. The different tranches target different investors with C-shares targeting public finance, and, A, B- shares and notes targeting private investors with the return rates reflecting their expectations. It should be noted that it is expected that B share investors are likely to predominately be development financial institutions. Current target dividend rates are at least: A shares USD LIBOR 6 months + 1.5%, B shares USD LIBOR 6 months + 2.5% and C shares dependent on 2

3 remaining profits are USD LIBOR 6 months but capped at up to 2.2%. Additional complimentary dividends will be paid to A and B shareholders if revenues are sufficient, as outlined in para 4. To note that the target rates of return for A, B and C shares can be changed by agreement of the GCPF Board. C-shares are concessional in nature as they get lower rates for the higher risk position than commercial investors would accept and have been ruled to be eligible as Official Development Assistance (ODA) by OECD-DAC 1. The UK s investment in C-shares would gain annual returns of LIBOR 6 months and up to 2.2% that would be recapitalised back into the Fund (this rate is subject to review if it does not adequately reflect the inflation). These returns, as well as the recycling of the investment through repayment of loans (with an average tenor of 5-7 years) and returns from direct investments, will allow the UK investment to deliver additional results and better value for money. 7. The Fund structure and target return rates have been designed based on previous experience, modelling and consultation in order to further test this innovative public-private partnership approach to attract private investors and maintain the sustainability of the Fund. The current 3 tranche setup and target return rates follows the experience of a similarly structured Fund (see section of the business case) that has attracted private sector investment, experienced no defaults or losses and has delivered development objectives such as creating jobs. GCPF s target minimum return rates for A, and B shares, are currently slightly below what commercial investors would expect for the estimated risk, and therefore a successful track record needs to demonstrate it is lower risk in order to attract private investors. Bearing this in mind the initial investors are likely to be socially oriented before a wider group of institutional investors can be targeted, or to invest in notes. In fact, GCPF confirmed its first private sector investor in December 2012 with an investment of $30m in notes. 8. If we made an investment, the UK would become a Director of the Board that currently has three other Directors (two representing KfW and one for IFC) and would have an equal vote with other Directors to be able to influence the strategic direction of the Fund. The Fund currently has a total of $204m ($49.7m, $34m, $120m in C,B, and A shares respectively) committed from the investors shown in Figure A. The UK s 30m (c.$48m) investment would be in C-shares, which are the only shares that are ODA eligible, and once those funds are invested this would make the UK a shareholder in the Fund. Assuming all C-shares are invested the UK would hold 49% of total C-share investments, with the German Ministry of Environment holding a similar share (43%) and the Danish a lesser share (8%). If all existing capital commitments were invested this would give the UK 23% of the voting rights and significant control of the fund. Why is UK support required? 9. Developing countries need support to enable them to access their potential to both use energy efficiently and deploy renewable energy to follow low carbon development paths in order to avoid dangerous climate change. Energy efficiency measures and renewable energy generation can also deliver welfare and productivity improvements to households, SMEs and larger firms and the wider economy through energy efficiency measures reducing energy bills and productivity, and renewable energy and energy efficiency measures leading to an improved more stable on-grid electricity supply (from additional supply and reduced demand). These in turn can contribute to wider economic and human development - there is significant evidence that enabling economic growth has a strong positive link with poverty alleviation when appropriately implemented. 10. Despite the benefits available from energy efficiency and renewable energy there are a range of market failures and barriers to their uptake. In particular a lack of information and knowledge from end users and financial institutions, and the access to appropriate finance are the most pronounced barriers in developing countries and particularly applicable to deterring uptake from households and SMEs There are a number of interventions that aim to support energy efficiency and renewable energy in developing countries to address the identified key barriers. However, there is still a need to test 1 See 2 Sorell et al,

4 a range of approaches to tackling the barriers. In particular, there is a gap amongst the current interventions on focusing on accelerating the availability of appropriate finance by improving knowledge and information of local financial institutions. Specifically, there is a gap in interventions that have the combined characteristics of: a. being non-concessional in nature a non-concessional intervention is required to accelerate the progression to a sustainable market for small-scale low carbon investments, that is not dependent on subsidies and is able to function without public sector Funding. Whilst non-concessional interventions exist for larger projects (for example CP3), they are not available for smaller projects. However, they would offer greater value for money to donors than concessional schemes and would have greater positive demonstration of the financial and returns to climate investments by the private sector; b. operating at scale operates across several countries, whereas many of the existing interventions that support small scale low carbon investments are only at the national scale. An intervention that works across a number of countries has a greater potential to mobilise significant volumes of finance in to renewable energy and energy efficiency projects, and spread context specific best practice; and c. focusing on smaller scale projects (i.e. SMEs, households) as set out above market failures are particularly acute in these sectors. 12. GCPF tests these characteristics, as it is a multi-national intervention focusing on accelerating and scaling up private finance by offering market rate finance to SMEs and households. The UK s investment will allow GCPF to build on progress to date to further test the uptake of nonconcessional lending for energy efficiency and renewable energy from local financial institutions and SMEs and households. GCPF is a good fit with the ICF priorities and private sector strategy by delivering low carbon and development benefits and innovatively mobilising private sector finance. 13. GCPF has had two years of operation that has successfully disbursed Funds and delivered emissions savings. However to achieve the identified pipeline and expand the Fund by attracting in commercial investors, additional C-shares investment is needed. This is because the current C-share public sector investments are fully committed to loans to partner institutions. The additionality of the UK s investment would be to help GCPF realise its transformational potential by enabling the Fund to grow and thus accelerate and expand the progression to a sustainable market for low carbon investments. 14. Without UK support, the business as usual scenario is expected to be a constrained and very limited expansion of GCPF alongside other existing activities to support energy efficiency and renewable energy projects. In this scenario there would be a limited focus on testing support for SMEs and households via non-concessional lending and aggregating across a range of countries, and GCPF would fail to scale up and achieve significant visibility and greater positive demonstration of successful private investment in energy efficiency and renewable energy. What are the expected results? 15. The Fund is established already delivering results and will be able to deliver results from the UK investment quickly. As of June 2012 GCPF had attributed accumulated savings of 10,765 tco 2 and disbursed $90m to partner institutions who have on-lent $10.1m to 311 SMEs/households. 16. The UK s investment is expected to result in the greenhouse gas emissions savings set out below. This is ensured through the investment guidelines that all energy efficiency investments need to deliver a minimum average of 20% reduction in energy usage or CO 2 emissions against the baseline of the current situation. There are guidelines for renewable energy investments (which will tend to be small-scale and under 10MW) their emissions savings are assessed on a case by case basis. 17. UK Investment in GCPF is expected to: 1. Contribute to a scale up of the GCPF to an estimated total fund size of $500m by 2014 to $780m by 2017 on central forecasts (relative to current levels of $204m). 4

5 2. Mobilise additional private climate finance estimated at approximately $110m to $220m of by 2017 on central forecasts (based on assumed leverage ratios of 1:4.1 to 1:7 and reflecting results attributable to UK only). 3. Leverage co-finance from MDBs and other donors estimated at approximately $50m. 4. Build a track record of successful low carbon investments and demonstrating that there are not high risks associated with these investments to additional investments in the future. 5. Result in expected lifetime greenhouse gas emissions savings ranging from 3 to 8 MtCO 2 e, on central forecasts. This is composed of emission savings directly related to investment from UK spend (0.8 to 1.5 MtCO 2 e) and significant emission savings delivered by mobilised private finance. 6. Have a transformational impact in mobilising and scaling up finance and investments in EE and RE in the near term to avoid risk of lock in to high carbon infrastructures. 7. Provide a return on UK investment repayment of the initial capital 30m and returns estimated around m for a 5 year investment, up to $3-11.5m over a 15 year investment horizon (based on a range of returns of 0.54% to 2.2%). 18. The Fund s investments also contribute to local economic and human development. This is achieved by investing in energy efficiency and renewable energy that can contribute to welfare benefits, energy stability, and increased productivity for SMEs and households. There is a social and environmental management system and mandates to safeguard these benefits. What are the key risks? 19. GCPF is an innovative public-private partnership and whilst attracting private sector investment is key to GCPF s success, failing to do so is also one of the risks and would significantly reduce the value for money of UK spend. The current assessment of this risk is moderate to high with the expectation that it will reduce over time. GCPF is still in an early phase of development and it was always envisaged that a successful track record would be required before seeking private sector investment. Deutsche Bank have recently begun fund raising for private sector investors. In December 2012 the first private sector investor was confirmed with an investment of $30m in notes. In addition, there is evidence of a similarly structured fund successfully attracting private sector investment. 20. We therefore believe that the level of risk is acceptable given to test this innovative potentially transformational approach: Under a worst case scenario of absolute failure the expected VfM of an investment in ICF is poor (partial BCR of , the low end range reflecting no repayment of UK C-Share investment which is considered extremely unlikely). The upside risk is high VfM if the project is successful (partial BCRs conservatively estimated at 4-12) and also wider transformational impact. 21. The UK investment as C-shares - will be taking a first loss position, however we consider the actual risk of loss to be low. The UK s exposure is capped at the amount we invest and experience of GCPF over the past 18 months and a similarly structured Fund over 7 years has shown that the first loss position has never had to be called upon. In fact the GCPF made a small net profit in The UK s investment itself will both generate returns that will be recapitalised back in to the Fund (increasing the number of C-shares) as well as be recycled as onward loans (average tenor 5-7 years) are repaid and returns from direct investments are received. Furthermore, we are confident that incentives are aligned with other shareholders, the Fund manager, and partner institutions to protect our investment. This is because other C- shareholders are in a similar position, and A and B shareholders will only receive complementary dividends above their target rates if the Fund has revenues remaining after paying C-share dividends (see para 4). Deutsche Bank s performance fee is only paid if there are remaining Funds after C-share returns. Finally, partner institutions bear the loss of individual project losses and GCPF only bears the loss if partner institutions default. 22. The UK investment in C-shares would subsidise the A and B share investments from development financial institutions (KfW and IFC). The KfW and IFC investments were required to establish the fund and build its track record to enable it to attract private sector investment. As development financial institutions are prepared to invest in development and climate funds but are required to gain a certain level of returns in order to maintain their credit rating that meant that 5

6 investment in C shares by KfW and IFC was precluded. Given that GCPF will now be focusing on seeking commercial investment we are confident that UK s investments will not be unnecessarily subsidising development financial institutions investments. 23. We are confident that the UK investment will not be over-subsidising A and B share investments. At least 95% of GCPF credit lines are debt and therefore there is a reasonably high degree of certainty in the maximum returns from the Fund s investments. Based on the current and pipeline investments the maximum margin from debt is 6.5%. Using this as a guide we would not expect the Fund to have overall revenue on the funds invested significantly above 5%. Scenario modelling has shown that with a fund revenue of 5% in all expected fund size scenarios A and B shareholders would not get a greater return than 5% and therefore not over-subsidising their investment. 24. Sufficient demand from partner institutions, and SMEs and households for finance products for energy efficiency and renewable energy is necessary for GCPF to be successful and is a further risk. However, GCPF has a technical assistance facility that works with partner institutions to stimulate demand and, where necessary, to help them to develop appropriate products. It should be noted that the UK s investment in GCPF does not directly address the informational and knowledge barrier from partner institutions, and SMEs and households for the uptake of energy efficiency and renewable energy projects but the associated technical assistance facility and other complementarily interventions do. 25. GCPF is already established and the UK will be able to steer its strategic direction but not have full control over its decisions and its setup. The Board of Directors oversees the Fund s activities and is responsible for its strategic decisions. The UK will be a member of the small (currently 3 but can be up to 7) Board for GCPF that operates by a majority share with a two-thirds majority needed to pass. This would mean that the UK would not be able to veto proposals but would have the opportunity to significant input into the Fund s strategic direction. Furthermore, financial incentives are aligned through the structure of the Fund, see para 19, and our climate and development objectives are shared by the other Board members (IFC and KfW). 26. To mitigate the risk of GCPF investments not aligning with ICF priorities, the UK will make our funding conditional: within 36 months GCPF will build up a portfolio equivalent to DECC s investment in priority countries that DECC chooses (this is to be in countries that are non-european and not upper middle income countries, see Annex A). additional text is added to the investment guidelines to strengthen the additionality assessment for every investment. Additionality is covered in the investment guidelines but we would like to strengthen the text in recognition of the importance of this assessment. This is in order to avoid a crowding out of other private financing sources and will be that GCPF will refrain from investing if other offers from private commercial financiers with the same characteristics exist for the proposed investment. within 36 months GCPF will build up an additional portfolio equivalent to DECC s investment that is excluded to apply for certified emissions reductions (i.e. CERs from the Clean Development Mechanism). It is noted that for direct investments an exclusion of carbon credits is easier to handle and that projects to date and projects in the near term are not expect to have interacted with carbon markets. Equivalent value is used in these conditions as UK funds are blended with other funds so they can t be attributed to certain investments in certain countries or with exclusions to the use of applying for carbon market credits. A timeframe of 36 months is selected as that is the timeline expected for GCPF to disburse the value of funds. The fund revolves so once invested the UK contribution cannot be attributable. We are still in discussion with KfW to agree the exact value of the additional portfolio that these conditions on priority countries and CERs will apply to. We are pushing for a multiple of the DECC investment to reflect the leverage UK investment in C-shares will provide, at the very least the minimum agreed amount is $45m. 6

7 27. The UK would become a significant shareholder and have significant control over the Fund. Amendments to the issue document (the Mission Statement, the Investment Policy, the Payment Waterfall, the Risk Ratios or the fee structure) are proposed by the Board and need a 75% Board majority and require a 75% shareholder majority. Assuming all existing commitments were invested the UK would hold 23% of the shareholder voting rights. Furthermore, B and C- shareholders, who are expected to be development financial institutions or donors and to have aligned interests, will hold a minimum of 60% of shareholder votes. Furthermore, as the fund has no set close date as a shareholder if the UK disagrees with a proposed amendments the UK s shares can be redeemed and no penalties incurred. 28. In general, it is worth noting that GCPF is an innovative approach that tests a certain approach. We believe it has the potential to be transformational by accelerating and scaling up support for energy efficiency and renewable energy projects. It aligns with ICF priorities by aiming to achieve this by mobilising private finance and delivering benefits to SMEs and households. We recognise there are risks relating to the Fund and that it does not attempt to tackle every single barrier to providing finance for small-scale renewable energy and energy efficiency projects. However, given that it has already operated successfully for two years, that there are no other viable options in the same area where UK funding can have results quickly, and that the DECC ICF team does not have the resource to design and implement an alternative fund or facility ourselves, we believe an investment in GCPF would be a good use of ICF funding and offers good value for money. Furthermore, we would learn lessons from this innovative approach that will inform future projects for example whether the ambition of 20% as a threshold for emissions savings for investments should be higher. 7

8 Business Case Contents 1 Strategic Case Context and need for ICF intervention The need and benefits from energy efficiency and renewable energy in developing countries The barriers to greater deployment of energy efficiency and renewable energy in developing countries The gap in current activities The proposed intervention Global Climate Partnership Fund The need for ICF support and GCPF progress to date Impact and Outcome that we expect to achieve Evidence and experience to support the theory of change What would happen without UK support for GCPF? Appraisal Case What are the feasible options that address the need set out in the strategic case? Summary of the Qualitative Option Appraisal Qualitative Options appraisal: Assessing the strength of the evidence base for each feasible option Quantitative appraisal of preferred option: What measures can be used to assess Value for Money for the intervention? The expected portfolio of GCPF investments Cost-Benefit Analysis Summary Value for Money Statement for the preferred option Commercial Case Why is the proposed funding mechanism/form of arrangement the right one for this intervention, with this development partner? Value for money through procurement Financial case What are the costs, how are they profiled and how will you ensure accurate forecasting? How will it be funded: capital/programme/admin? How will funds be paid out? What is the assessment of financial risk and fraud? Risk of financial loss given the first loss position Risk of fraud Risk of over-subsidy How will expenditure be monitored, reported, and accounted for? Management Case What are the Management Arrangements for implementing the intervention? What are the risks and how these will be managed? What conditions apply (for financial aid only)? How will progress and results be monitored, measured and evaluated? Monitoring and measuring

9 5.3.2 Evaluation References Annexes Annex A Guidelines for GCPF investment Types of GCPF investments Environmental, social, and development guidelines Annex B GCPF performance to date Finances Investments Emissions savings Historical USD LIBOR 6 month maturity rates Annex C GCPF Pipeline for future investments Annex D: Summary of Economic Appraisal Scenarios and Key Sensitivities Annex E: Scenario modelling for financial flows of GCPF Context and the current situation Scenarios modelled Results Conclusions from these scenarios Conclusions from further testing Annex F: Risk Potential Assessment:

10 1 Strategic Case 1.1 Context and need for ICF intervention The need and benefits from energy efficiency and renewable energy in developing countries 1. The UK is committed to taking action at home and abroad to support limiting global average temperature rise to within 2 C above pre-industrial levels. However, the most recent IEA World Energy Outlook s (WEO) central scenario suggests that current emissions projections follow a trajectory of a temperature increase of 3.5 C 3. This is in part due to a projected 33% increase of energy demand by 2035 resulting in a 20% increase in CO 2 emissions from energy. Urgent action is needed to decrease energy demand and decarbonise energy supply: IEA analysis on the risk of locked-in emissions from existing infrastructure suggests that without coordinated global action or rapid deployment of energy efficiency technologies there would be full lock in by Given that 90% of the projected growth in energy demand over the next 25 years is from non-oecd countries 4 it is key to provide support for developing countries to both use energy efficiently and renewable energy to follow a low carbon development paths in order to avoid dangerous climate change. 2. Energy efficiency measures have the potential to offer quick and cost-effective opportunities to help decrease energy demand and reduce greenhouse gas emissions, with the greatest potential for this in the developing world (Fig.1). IEA analysis suggests that energy efficiency can delay lock-in of CO 2 emissions permitted under a 2 C trajectory until 2022, buying five extra years. It has been estimated that without further technological advances, application of proven technologies and best practices on a global scale could save 30-40% of energy consumption across many sectors and countries 5. In developing countries it has been predicted that the potential to increase energy productivity through energy efficiency could reduce energy demand in 2020 by 25% compared with business as usual - equivalent to more than the current total energy consumption in China 6. Despite the benefits, energy efficiency potential remains largely untapped (~ 66% in period to ), especially in developing countries (Fig.1). This is due to a variety of market failures and barriers. Further interventions are needed to overcome these. Figure 1: End-use energy demand abatement in 2020 by region 1 3 IEA, World Energy Outlook ibid 5 World Bank, Farrell & Remes, Promoting energy efficiency in the developing world. 7 IEA, World Energy Outlook

11 3. Renewable energy decreases the reliance on fossil fuels and enables developing countries to meet their increasing energy demand whilst minimising the increase in greenhouse gas emissions. It is particularly important during the development and emergence of economies in order to avoid lock in of high carbon infrastructure. In 2010, renewable energy sources had continued to grow and supplied an estimated 16.7% of global final energy consumption 8. However, it has been estimated that there is potential for almost 80% of global energy supply to be provided by renewables by 2050 if backed by the right policies 9. There is therefore a need for greater and continued support for renewable energy, especially in developing countries. 4. Energy efficiency measures and renewable energy plants - in addition to avoiding GHG emissions through reducing energy demand and increasing low carbon electricity generation respectively - can in turn contribute to economic and human development. Wider benefits include: a. Lowering spend on energy. This can increase disposable income with direct welfare benefits for households to either increase their spend on energy or wider needs, and increase the productivity of firms. b. Improving energy stability. For example, in places where blackouts are common renewable energy can add capacity and energy efficiency measures can reduce the burden on existing grids, alleviating the demand-supply imbalance. c. Improve energy security through diversifying the energy mix and reducing demand for imported fuels, with may be volatile in price and exchange rate risk. d. Enabling economic growth, productivity and competitiveness by improving energy efficiency and meeting energy demand. e. Creating jobs through developing an industry around energy efficiency and renewable energy. The benefits listed above demonstrate how energy efficiency and renewable energy can contribute to decoupling economic growth with increases in greenhouse emissions. There is significant evidence that enabling economic growth has a strong positive link with poverty alleviation when appropriately implemented Activities and interventions in support of renewable energy have been increasing over the last decade. 118 countries now have renewable energy targets, of which more than half are in developing countries. Additionally, there has been a dramatic increase in investment in renewable energy in developing countries from under $0.5bn 11 in 2004 to $89 billion in However, there is need for a significant scale up of investment to tackle the urgency of acting on climate change: the IEA estimates that to decarbonise energy supply to the extent to meeting the 2 C target transformational levels of investment will be needed to the level of $197 billion of additional capital investments by In addition, there needs to be greater diversification in terms of the countries that receive investment and in the size of renewable projects financed in 2011 the vast majority (80%) of investment was spread between China ($52 bn), India ($12 bn) and Brazil ($7 bn), and largely focused on large-scale projects. Greater flows of finance are needed that reach beyond large scale interventions in a few major emerging economies. 6. By comparison, investment in energy efficiency is often overlooked 14 and increased finance is needed to realise the potential climate and development benefits. It is hard to ascertain current levels of investment to support energy efficiency but assessments suggest that additional annual investments of $90 billion are required to install currently cost-effective energy efficiency measures, with developing countries often offering the best value for money The proposed intervention focuses on supporting energy efficiency measures for households and small and medium enterprises (SMEs) and to a lesser extent renewable energy projects in a range of developing and emerging economies. This meets the need identified above for greater 8 REN21 Renewable Energy Policy Network, Renewables Global Status Report. 9 IPCC, 2011: IPCC Special Report on Renewable Energy Sources and Climate Change Mitigation 10 Dollar & Kraay, Growth is good for the poor. World Bank 11 REN21 Renewable Energy Policy Network Renewables 2005 Global Status Report. 12 IEA, World Energy Outlook 13 IEA, World Energy Outlook. 14 Sarkar & Singh, 2010; Farrell & Remes, Farrell & Remes,

12 support for energy efficiency and renewable energy, especially in developing countries. It also targets households and SMEs as many existing schemes are large scale and do not focus on these end users with small-scale projects 16. This aims to deliver greenhouse gas emissions savings and contribute to supporting local development (in particular d and e of para 4) The barriers to greater deployment of energy efficiency and renewable energy in developing countries 8. Despite the benefits available from, and often being cost-effective, there are a range of market failures and barriers to the uptake of energy efficiency and renewable energy projects (see examples in Figure 2 for energy efficiency). Reviews of the literature and evidence from intervention evaluations suggests that lack of information & knowledge from end users and financial institutions, and the access to appropriate finance for end-users are the most pronounced barriers in developing countries 17. There are many additional demand and supply side barriers that need to be considered (such as those outlined in Figure 2) but the intervention described here focuses on addressing the barriers highlighted above, whilst working complementary to interventions that focusing on other issues such as policy dialogue. Figure 2: Barriers to Investments in Energy Efficiency These two barriers are particularly applicable to deterring uptake from households and SMEs and experience from intervention evaluations suggests they are most effective when focus on specific energy-user categories 19. For example, the lack of access to suitable and affordable finance is a particular constraint to households and SMEs. Compared to larger businesses, they are less able to afford the capital required, are not suitable for equity investment and hence are reliant on bank lending to provide the required finance. In addition, providing finance in developing countries is considered riskier than more developed economies. This is further heightened for low carbon investments as there is limited experience from financial institutions to provide finance and limited awareness from users who may favour approaches that are low in capital. 10. End User ( demand ) Barriers a. There is often a low level of awareness and information available 20 for companies and individuals about the benefits of implementing energy efficiency and small scale 16 IEA, World Energy Outlook 17 Sorell et al, ADB, IEA, 2011b 18 Sarkar & Singh, ADB, 2012a. ADB, UNFCCC, Sorell et al, ADB,

13 renewable energy projects. This can lead to a low demand for energy efficiency and renewable energy measures. b. High upfront costs for equipment compared to energy savings or energy profits that are spread over time. This means that even small projects are likely to require debt or equity finance. This can deter investors as they are focused on the costs in the initial phase. c. In the case of smaller projects (especially relevant for households and SMEs) there are high transaction costs for projects compared to the net benefits. Up-front costs for the evaluation and implementation of energy efficiency/renewable energy projects such as costs for energy audits, consulting or the use of internal resources to set up projects are often fixed. d. Low electricity prices reduce the incentives to implement energy efficiency measures. A major driver for the uptake of energy efficiency measures is the energy price of the country. In some countries low or subsidized energy prices may limit the attractiveness of energy efficiency measures. e. Poor access to affordable finance (see below) 11. Financial market failures and barriers ( supply ) a. Lack of experience and imperfect information within local financial institutions can result in excessive conservatism in providing finance for energy efficiency or renewable energy projects and misperceptions of risk. This is due to failures in correctly evaluating the real risks of a project. b. Lack of technical expertise for producing suitable financing options 21, specifically those tailored to energy efficient and renewable energy investments. c. Linked to the above barriers is that local financial institutions in developing countries can have difficulty in obtaining capital market finance, in particular long-term financing, due to their credit ratings. Examples of countries with some liquidity issues are South Africa and Ukraine. Therefore, finance accessed tends go to traditional, higher return and lower risk projects with little incentive to develop experience and capacity for new sectors. 12. It should be noted that there are differences to the extent that the barriers impact implementation of energy efficiency and renewable energy projects. For example, renewable energy projects are more likely to be hampered by high-upfront costs, lack of a local supply chain (particularly in developing countries) and early stage risks around construction. In comparison many energy efficiency schemes suffer more from relatively high transactions costs, and low awareness and interest from end-users and financiers. This lack of awareness and interest from financiers, see para 11, can be explained by energy efficiency loans often being low value and whilst other tried and tested projects with a low risk and high return are available there is little incentive for financiers to extend finance for energy efficiency (especially to small-scale and dispersed endusers such as households and SMEs) The gap in current activities 13. There are a range of interventions that aim to support energy efficiency and renewable energy in developing countries to address the identified key barriers of lack of appropriate finance for endusers and lack of knowledge and experience for end-users and local financial institutions. They are considered in order to identify whether there is a need for further interventions to address the barriers. These can be categorised into three broad types of interventions: those that focus at the country level (often offering concessional finance to end-users and/or local financial institutions); regional/global schemes (with a focus on larger, commercial projects); and capacity building projects. Examples of the three types that HMG are supporting are listed below. a. National and concessional schemes i. Several schemes are supported by the ICF through the Clean Technology Fund (CTF) e.g. Mexico, Colombia and South Africa. These typically include concessional funding (through lower rate interest loans for energy efficiency projects e.g. in Mexico 22 ) to local financial institutions to on-lend to end-users 21 Blyth & Savage, Climate Investment Funds,

14 and/or combined with a grant incentives to end-users (e.g. for energy efficiency projects in Turkey). In addition technical assistance to local financial institutions and/or end-users is sometimes offered. End-users for the schemes range from households to large scale industry. This national level approach is also used extensively by EBRD and has been successful across south eastern Europe by providing concessional funding and technical assistance to local banks and onlending to end-users. 23 ii. GET Fit is a scheme that has been approved for ICF funding. It consists of results-based support to get some planned small-scale, private-sector, on-grid renewable energy projects (1-20 MW) in Uganda to completion. It offers grant finance through a top-up to the existing feed-in-tariff so as to make projects financially viable. In addition, there will be capacity building component with the Ugandan energy regulator and an off-taker guarantee (paid for by project developers) with the World Bank. b. Regional/global programmes, with a focus on larger/commercial projects iii. CP3 Platform 24, which is supported by the ICF, focuses on large scale equity investments. It consists of two new commercial private equity funds, which are expected to bring in at least 30 of private capital for every pound provided by the UK (taking into account the fund of funds level, sub funds and projects). The funds will invest in to a wide range of climate-friendly projects that encompass renewable energy and energy efficiency in emerging and developing countries including Africa and Asia. iv. Green Africa Power (GAP) 25 is a project approved for ICF funding. It will invest in renewable energy projects in Africa, by providing capital (quasi-equity) and lines of credit to cover specific risks. It will also enter a policy dialogue with host Governments to help move the country towards cost-reflective tariffs. c. Capacity building v. DECC (not through the ICF) supports the renewable energy and energy efficiency programme (REEEP) which has a strong focus on providing information and facilitating sharing best practice between interested parties. It achieves this by providing web-based information resources and supports effective champions via sub-networks such as Sustainable Energy Regulation Network (SERN) 26. vi. Technical assistance is also integral in many of the other interventions. For example, CP3 includes a 20 million technical assistance facility that will help develop the pipeline of projects and sub-funds by tackling market failures in lower income countries, new technologies and first-time fund managers. 14. Some of the key learning s and evaluations from the above interventions and others for energy efficiency and renewable energy schemes are (see also section 1.2): 27 Interventions that target specific end-users or sectors can have the greatest impact Capacity building and technical assistance are importance across throughout the chain including local financial institutions and end-users Promoting commercial financing can be generating demand for energy efficiency products. Combining credit lines and technical assistance can increase the efficacy of funding Appropriate energy use measurement and verification systems should be incorporated in the project design. 15. There are a range of interventions that aim to support energy efficiency and renewable energy in developing countries to address the identified key barriers. There is still a need to try and test a range of approaches to tackle the barriers and there is a gap amongst the current interventions to contribute to addressing the key identified barriers by focusing on accelerating the availability of appropriate finance at scale and thus improving knowledge and information of local financial institutions. In particular having the combined characteristics of: d. being non-concessional in nature a non-concessional intervention is required to 23 EBRD, REEP, ADB, 2011, ADB, 2012, IEA, 2011b, EBRD,

15 accelerate the progression to a sustainable market for small-scale low carbon investments, that is not dependent on subsidies and is able to function without public sector Funding, by helping to align the incentives with partner institutions and endusers. Whilst non-concessional interventions exist for larger projects (for example CP3), they are not available for smaller projects. However, they would offer greater value for money to donors than concessional schemes and would have greater positive demonstration of the financial and returns to climate investments by the private sector; e. operating at scale operates across several countries, whereas many of the existing interventions that support small scale low carbon investments are only at the national scale. An intervention that works across a number of countries has a greater potential to accelerate the ability to mobilise significant volumes of finance in to renewable energy and energy efficiency projects and spread context specific best practice; and f. focusing on smaller scale projects (i.e. SMEs, households) as set out above market failures are particularly acute in these sectors and these offer local development benefits A multi-national intervention focusing on scaling up private finance by offering market rate finance to SMEs and households would be innovative, target the key barrier of lack of access to appropriate finance and complement existing activities. 16. Currently, there are no ICF funded projects that are operational and focus specifically on energy efficiency, despite this being recognised as a priority area in the ICF low carbon development Investment Strategy. There are two proposals in the pipeline for 2013, but they do not address the characteristics identified above: a. To support the Emission Reduction Investment programme in Indonesia that will operate on a national scale to provide loans to SMEs at slightly concessional rates, combined with technical assistance both for financial institutions and SMEs. b. To support energy efficiency through large scale building retrofitting across South East Asia (in particular Malaysia, Thailand and Vietnam). 17. The characteristics identified fits with the following ICF priorities: a. demonstrating that building low carbon, climate resilient growth at scale is feasible and desirable; b. offering development benefits by focusing on supporting SMEs and households; and c. partnering with the private sector. 18. More specifically it fits with the following objectives of the ICF private sector strategy: a. To identify and implement financial instruments and solutions, that has transformative potential and potential to be replicated at scale. b. To mobilise private sector engagement and finance in specific sectors and/or technologies that experience difficulties in accessing private finance. c. The fit with ICF priorities will be drawn out in more detail in the section below that outlines the proposed intervention The proposed intervention Global Climate Partnership Fund 19. The proposal is to provide a 30 million returnable investment to the Global Climate Partnership Fund (GCPF). GCPF aims to address the lack of available and appropriate finance for SMEs and households for renewable energy and energy efficiency projects in developing countries. The market failure causing this situation is that the private sector (both local financial institutions and the wider capital markets) has a lack of experience and hence confidence in providing finance for these projects. This means that finance is either not available to end users, or that they are charged prohibitively expensive rates given high misperceptions of risk / lack of understanding of rewards. Investment in energy efficiency and renewable energy are therefore not at the scale or being taken up with the speed required to meet the 2 degree goal. The fund facilitates investments through the provision of information and stimulating the provision of loans through providing dedicated credit lines in particular focusing on energy efficiency loans (although renewables projects are within its scope the progress to date has been supporting energy 15

16 efficiency). GCPF does not offer finance at concessional rates to partner institutions and is commercially run, which helps ensure the development of a sustainable market 20. GCPF s objective is to deliver greenhouse gas emission reductions directly through its investments and longer term having a transformational effect by the structure of the fund contributing to accelerating the development of a sustainable market for further low carbon investments. The greenhouse gas savings are ensured by the fund s investment criteria (more details in Annex A). All energy efficiency investments need to deliver a minimum average of 20% reduction in energy usage or CO 2 emissions against the baseline of the current situation. The emissions and energy savings are monitored and reported for each project, which fits with best practice (see para 24), more info is available in management case. There are guidelines for renewable energy investments (which will tend to be small-scale and under 10MW) their emissions savings are assessed on a case by case basis. The additional emissions savings attributed to the project are calculated based on emissions from the current situation versus the emissions after the project. In this way the emissions savings accumulate over the entire lifespan of each investment (typically years). 21. The fund s investments also contribute to economic and human development. Additionally, the fund targets final beneficiaries to be households, home owner associations, leasing companies, SMEs (including energy service companies and small renewable energy companies) as well as municipal entities in developing countries. Furthermore, the larger scale direct investments have to follow a development mandate that the project should be a local landmark transaction promoting the use of sustainable energy. This is a considered on a case by case basis but means that project should involve significant local input (e.g. employment of local companies or financial institutions, job creation), implement sustainable energy use into a wider economic chain (e.g. utilizing organic waste of a chicken poultry farm), and support regional energy self sufficiency. 22. The fund provides support in three ways (see Figure 3): a. The majority of the fund will be used to provide local financial institutions with credit lines, with which they in turn offer market rate loans to SMEs/households for renewable energy or energy efficiency investments. b. Up to 30% of the fund will make direct investments (also at market rates) in sustainable energy projects. c. Technical assistance to local financial institutions to introduce or enhance innovative climate change oriented loan products to facilitate new and protect existing investments of the Fund. 23. The Fund is structured into 3 tranches of shares, A, B and C, see figure 3. The UK s investment would be in C-shares. The UK and other donors C-shares act as a risk cushion for A and B shares. All shares are investments structured to provide annual returns and the process for paying returns from the revenues accrued follows a waterfall principle (see Figure 4): A-share returns are paid first, then B, then C, followed by the investment manager performance fees, a contribution to fund the technical assistance facility, and if sufficient revenues allow complimentary dividends for A and B shares. Any losses or loan defaults would similarly be borne first by the junior C shares, then B and finally A shares (although we have assessed the risk of loss to be low, see risks section). In this way C-shares act as a risk buffer for the mezzanine tranche (B-shares), and, in turn C & B-shares act as a risk buffer for senior tranche A- shares. To note as the Fund matures it is envisaged that a super senior tranche can be developed in the form of time-bound notes that also targets institutional investors. The addition of notes will leverage further investment and increase the value for money from a C-share investment. 16

17 Figure 3: GCPF Fund structure Figure 4: GCPF payment waterfall 24. The different tranches target different investors with C-shares targeting public finance and, A, B- shares and notes targeting private investors with the return rates reflecting their expectations. It should be noted that it is expected that B share investors are likely to predominately be development financial institutions. Current target dividend rates are at least: A shares USD LIBOR 6 months + 1.5%, B shares USD LIBOR 6 months + 2.5% and C shares dependent on remaining profits are USD LIBOR 6 months but capped at up to 2.2%. Additional complimentary dividends will be paid to A and B shareholders if revenues are sufficient, as outlined in para 4. To note that the target rates of return for A, B and C shares can be changed by agreement of the GCPF Board. C-shares are concessional in nature as they get lower rates for the higher risk position than commercial investors would accept and have been ruled to be eligible as Official 17

18 Development Assistance (ODA) by OECD-DAC 28. The UK s investment in C-shares would gain annual returns of LIBOR 6 months and up to 2.2% that would be recapitalised back into the Fund (this rate is subject to review if it does not adequately reflect the inflation). These returns, as well as the recycling of the investment through repayment of loans (with an average tenor of 5-7 years) and returns from direct investments, will allow the UK investment to deliver additional results and better value for money. 25. In the first two years of operation ( ) GCPF had 13 target countries that are all ODA eligible developing and emerging economies and 8 of which fit with the ICF low carbon development priority countries (see Figure 4 and para 32). The rationale for the country choice is related to the overall energy use and greenhouse gas emissions in the country, the potential to increase energy efficiency across all economic sectors, economical benefit from energy efficiency increases and comparative analysis of energy security with untapped potential for energy efficiency and renewable energy measures. Furthermore, when selecting projects economic factors such as risk and return considerations and the demand for productions are considered to ensure that all selected countries: permit the sustainable use of funds; ensure that climate change solutions are pursued on a sustainable basis; and create a significant positive impact by integrating in the social and economic drivers of the respective country. It should be noted that the Fund is able to invest in non-target countries that are developing and emerging economies but these must be approved by the Investment Committee. 26. The initial two years of operation of GCPF ( ) was focused on 13 target countries and not specifically targeting illiquid banks. This is because illiquid banks have a higher risk of default and thus would undermine the objective of GCPF of creating a successful track record. However, for 2013 onwards GCPF has refined its strategy for selecting partner institutions and the geographic scope in order to ensure the finance it provides is additional. 27. GCPF s geographic scope has widened and will consider investments in any emerging and developing countries that have been approved by the investment committee. This includes almost all OECD eligible ODA countries with the exception of those with political instability or EU trade bans such as Myanmar, Eqypt etc. In order to reflect the different development levels of the financial markets in emerging and developing economies and to ensure the finance provided is additional and adding value there is two tier approach for the type of financial institutions that GCPF will partner with: In more developed financial markets (e.g. Chile, Brazil, Turkey, China, Morocco and certain regions of India) only tier 2 (smaller banks but collated these banks make up >10% of the market share) and 3 (basic local institutions) will be considered. Whilst in less developed financial markets (e.g BBB countries such as Mexico, South Africa and Tunisia and the "other" regions within India) tier 1 banks (offer the full range of products, operate regions in the country, and collated these banks have 50-60% of the market) are targeted. 28. An accompanying Technical Assistance Facility has been established. To date this is funded by existing donors directly and going forward from profits from the fund (up to the value of 0.2% of assets) subordinate to the annual dividend payments to the shareholders. This is to provide Technical Assistance, primarily to assist local financial institutions of the Fund in their development and growth as well as to facilitate new (these may be direct investments so also to SMEs and ESCOs) and protect existing investments of the Fund as required. The services delivered by the Facility are therefore complementary to the Fund's objectives. The costs of technical assistance projects are generally shared between the recipient and the Facility. Examples of activities that can be funded through the Facility include business development support, technical appraisals of potential initiatives, and implementation of sustainable energy businesses within financial institution. 28 See 18

19 Figure 5: Target Countries of GCPF Countries in red are those that have not been identified as a priority for ICF low carbon development support. Attracting private finance 29. Expected returns to investors across all tranches reflect three main components: a. The USD LIBOR 6 month rate to reflect market conditions. This is currently tracking at a decade low of 0.5%. The current 2012 average is 0.7%, whereas rates have been above 5% over the past decade (see Annex B, Section for chart of historical rates). b. A target dividend rate (paid above the USD LIBOR Rate) varied by share class. c. A complementary dividend (paid above the target rate) paid out upon success of the fund (see further detail and estimated rates in the Financial case). 30. The structure of the fund targets different types of investors for each tranche of shares and notes. a. C shares have a current target rate of USD LIBOR 6 months but capped at up to 2.2%, which is automatically recapitalised back in to the facility. As the only share in GCPF that qualifies as ODA, these are aimed at the public sector. b. B shares (currently the target dividend rate is USD LIBOR + 2.5% with complimentary dividends available if the fund is successful see more detail in section 3.2) and these will in the future target individual and institutional investors. c. A shares (currently the target dividend rate is USD LIBOR + 1.5% with complimentary dividends available if the fund is successful see more detail in section 3.2) target private sector investors; socially orientated institutions, high net worth individuals and institutional investors with currently fixed returns of 1.5%. d. Super senior notes don t exist in the current structure of the Fund, but may be offered in the future, when GCPF is fully established. They would also target A share investors. The target rates have been determined by modelling carried out by the Investment Manager based on the expected risk portfolio and to achieve sustainability of the Fund. It is worth noting that the Board of Directors are able to change the target return levels in the future. 31. Current the A and B share investments are primarily from development financial institutions (KfW and IFC). The KfW and IFC investments were required to establish the fund and build its track record to enable it to attract private sector investment. Development financial institutions are prepared to invest in development and climate funds but are required to gain a certain level of returns in order to maintain their credit rating, which precludes investment in C shares. We are confident that UK s investments will not be unnecessarily subsidising development financial institutions investments. 19

20 32. As well as the potential returns available, it is GCPF s scale and diverse portfolio approach that makes it a credible investment opportunity for (global) private sector investors. Aggregating credit lines to local financial institutions in different countries creates a large enough investment vehicle through which private investors can deploy finance at scale. Without this scale, they would not be interested in deploying their capital in this way. The diverse portfolio helps limit the exposure. 33. The fund is only just beginning to seek private sector investment in A and B shares after building a successful track record and pipeline. This is because the returns offered for A and B shares are slightly under the current market rate for the considered risk 29. Bearing this in mind, at the inception of GCPF it was anticipated that the fund would take time to develop a successful track record in order to decrease the risk as it would no longer by initial stage fund and attract private investment. It is expected that the institutional investors for A, and B, shares would be initially limited to corporate social responsible funds and that these will be sought after building a successful track record of 6-12 months, given a suitable investment environment. Once a strong pipeline for the next 12 months is demonstrable, as well as successful track record, it is expected that GCPF would then also target a wider group of private sector investors including high net worth individuals and socially oriented institutions. 34. GCPF has developed a successful year of operation but given the tough investment environment the investment manager has only recently begun seeking these private sector investors. The first private sector investment was secured in December 2012 with a $30 m investment in notes(see on progress to date). 35. The overall aim of GCPF is to not only demonstrate that risks are lower than perceived in order to encourage commercial investors, but in the longer-term, to create a sustainable market at scale. As a track record is created, it is expected that a smaller risk cushion will be needed to attract private sector investment, which will mean that the proportion of investment of C-shares decreases (i.e. no further C-share investments but A and B share investments continue to be sought) and no further public sector funding will be needed. Assuming that the fund continues to operate successfully, in time, and as local Financial Institutions gain experience in making loans or direct investments, GCPF will not be needed at all and the transition towards a functioning market (i.e. without public sector support) would be achieved The need for ICF support and GCPF progress to date 36. GCPF was initiated in December 2009 by the German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety and KfW Entwicklungsbank (KfW), and has since established the fund and mobilised significant funding commitments. Deutsche Bank was appointed as the investment manager, following a competitive tendering process, and the fund was legally established at the end of Sekerbank (Turkey) was the first local financial partner confirmed in April There have been $204m commitments to the facility to date: $49.7 m in C-Shares ($42 m from the German Ministry for Environment + $7.7m from the Danish Ministry of Foreign Affairs through DANIDA), $34m in B-shares ($15m each from KfW and IFC, and $4m from Deutsche Bank), and $120m in A-shares ($60m each from IFC and KfW in A shares). The first private sector investment was secured in December 2012 with a $30 m investment in notes. 37. GCPF has successfully developed a pipeline of appropriate investments, disbursed funds and delivered greenhouse gas emission savings. By the end of June 2012 GCPF has approved $105m of loans in Turkey, Ecuador 30, Vietnam and Ukraine, with $90m having been dispersed to 29 GCPF is targeting: (a) a niche area (SME/household renewable or energy efficiency projects); (b) in developing countries; (c) where there is no track record of investments; and (d) through a unusual instrument (an equity type of arrangement that provides debt) The perceived risk of investment in the facility would therefore be high (and not commensurate with the expected returns) were it not for the first loss position of the C-shares which effectively brings down the level of risk to viable levels for investors in the B and A shares. 30 Ecuador is not a GCPF target country so Board approval was required to pursue this opportunity and the country assess for suitability with GCPF fit. 20

21 financial institutions, and 311 loans totalling $10.1m lent to households and SMEs. An accumulated total of over 10,000 tco 2 e has been saved through the investments to date. 31 One renewable energy direct investment has been approved of $2.51m loan for a 1MW South Africa solar photovoltaic installation. There is a pipeline of investments for the end of 2012 and Further details on the progress to date are in Annex B, the pipeline of investments in Annex C and a case study of GCPF investment is illustrated below. 38. GCPF is constrained in offering further loans and meeting its target size by a shortfall in C-shares. Expected investors for C-shares are public sector ODA investments given that the risk/return profile offered does meet development finance institutions 32 or other investors shareholders expectations. All $49.7m C-shares are currently committed to be on-lent to partner institutions, whilst there are A+B share commitments that have not currently been drawn upon. In addition, further investment in C-shares would give the fund greater flexibility for future loans. There is a notional target size of the GCPF by 2014 to have reached $500m and in order for the fund to grow beyond its target size (for example, to expand its reach of countries), an investment in C- shares would be needed. It is worth noting that GCPF has no set close date so the funds will be revolved until the fund is wound up. 39. An investment of 30 m (c.$48m) from DECC s share of the ICF in the ODA eligible C-shares is proposed. This would be a similar level of investment as the German Ministry ($42m) and the expectation of a conservative improvement in leverage potential to raise A&B shares this would allow the fund to surpass its 2014 target (see appraisal case below for more details), If the UK were to make such an investment we would become a key shareholder (49% holder of C-shares and 23% of the voting rights assuming all commitment funds invested) and be able to influence decision making (more detail on this is in the Management Case). The technical assistance facility is not capital constrained and hence there is no need for further UK funds, although the facility and the investments will continue to work complementarily. 40. The remit of the fund has a strong strategic fit with the ICF: a. It focuses on low carbon development, see para 19 and Annex A for more details about the investment criteria. b. The fund targets developing and emerging countries. Conditional on the UK s investment is that within 36 months GCPF will build up a portfolio equivalent to at least DECC s investment in priority countries that DECC choses (this is to be in countries that are non-european and not upper middle income countries). c. Investments have to comply with a development mandate (see Annex A) d. It creates a new partnership with the private sector and uses public funds to leverage in greater amounts of private finance with the aim to decrease and withdraw the need for public funds to facilitate these investments in the longer-term e. It is a new and innovative approach (it is the only global fund of its kind that targets SMEs and households through local financial intermediaries and is unlimited in duration), and has the potential to be transformational through replication and scaling up. f. It supports country-level action through working through local financial institutions. By building capacity and increasing confidence, it aims to build new markets. 41. GCPF also fits with the ICF Private Sector Strategy, in particular the objectives: a. To identify and implement financial instruments and solutions, that have transformative potential and have potential to be replicated at scale b. To test innovative approaches to mobilising private climate finance to better inform future UK or other international initiatives and spending on key factors of success (or failure) c. To mobilise private sector engagement and finance in specific sectors and/or technologies that experience difficulties in accessing private finance or which pose long term financial risks. d. Comply with carbon market principles as there will be limitations on the eligibility of 31 GCPF, Q2 Quarterly report. Figure based on annual results not expected emission savings over lifetime of technology/measure. 32 Development finance institutions have a AAA credit rating that they desire to maintain and constraints their lending will expect certain returns 21

22 GCPF investments to apply for certified emissions reductions Case study of GCPF investment Sekerbank, Turkey A total of $25m has been provided to Sekerbank in Turkey for a 5 year period to support energy efficiency loans. The average loan size is $31,890 with an average length of 3 years. Progress to date is shown in Table 1 with $12.69m in total being lent to agricultural (164 loans) and building owners (234 loans). These loans have been for energy efficiency measures in the buildings (mostly insulation for apartment blocks) and replacing inefficient old tractors, an example is shown in Table 2. Table: Building investments to date Sector No. of loans Disbursed loans (USD) Primary energy savings CO 2 emissions savings MWh/yr MWh t/yr t Buildings 234 $9,602, ,901 3,117,041 26, , Impact and Outcome that we expect to achieve 42. The theory of change for this intervention is represented in Figure 5. This illustrates how public sector ODA funding is used to induce the output of attracting other sources of investment by derisking investments (details of how GCPF s structure with C-shares achieves this is in section 1.1.4) and the outcome of increased private sector and other climate finance flows and building a track record through demonstrating the viability of low carbon. This is coupled with the outcome of increasing the knowledge and awareness of financial institutions through providing the output of technical assistance to help them develop appropriate products. These two components combined lead to the output of offering appropriate finance for SMEs and households helps deliver the outcome of building their awareness and knowledge to deliver emissions savings through the uptake of energy efficiency measures and renewable energy. Together these outputs and outcomes contribute to the impact of developing sustainable markets for investments to support low carbon investments in developing countries that do not require public sector funding support. 43. GCPF will test the assumptions in the business case that: A portfolio of investments have low failure rate / appropriate risk-return rate to ensure 22

23 success of GCPF and positive demonstration impact to attract further finance for similar projects; (i.e. achieving 1:7 leverage (C:A+B shares in long term and higher longer terms to support a sustainable fund). Experience with low carbon investments from local financial institutions and for SMEs, and households will increase their information and knowledge. In turn through the demonstration effect local financial institutions will realise the potential of low carbon products and develop products in the future. Assisting local financial institutions to develop appropriate finance products at comparable rates to other loans on the market for SMEs and households will have sufficient demand. 44. The theory of change is supported by some of the key learning identified from evaluations from other projects, see para 24, however it will contribute to building the evidence base. In particular that commercial finance is an effective way of creating a market, the combination of offering credit lines and technical assistance offers good value for money, and the effectiveness of focusing on an end-user group. 45. The theory of change is based on a few assumptions that should be noted but are not considered further as these are the focus of complementary projects: a. Technology and the associated services are available to provide the energy efficiency measures and renewable energy. b. Other interventions focus on developing the supporting policy and regulatory requirements (such as REEEP noted in section 1.1) c. Other interventions focus on raising demand side awareness, behavioural and knowledge (to some extent such as REEEP and some those under the CTF) Evidence and experience to support the theory of change 46. Evidence to support the theory of change of public sector funds being used to de-risk investment and generate flows of private finance can be derived from experience of the European Fund for Southeast Europe 33. This fund - also run by KfW - was established in 2005 and aims to foster economic development and prosperity in the Southeast Europe region through offering long-term funding instruments to qualified partner lending institutions for lending to under-served sectors; micro and small enterprises and low-income private households. It is structured similarly to GCPF with three tranches of shares reflecting a payment waterfall. Public sector funds are in the C-share junior tranche to de-risk investments and facilitate flows of private finance. The fund has not had any defaults to date. This means that the first loss position of the junior tranche has successfully leveraged private finance without these funds actually being called upon. By June 2012 there was 305m invested in the junior tranche C-shares, which had successfully leveraged 564m in A+B shares and notes from international financial institutions and private investors, a leverage ratio of 1:1.85. Furthermore, the fund is on track to continue to increase private investors contribution without further public sector funds as it has demonstrated a successful track record and decreased the perceived risk of investments. The ability to disburse and value for money of the fund is demonstrated by a total of 319,636 sub-loans having been offered and a disbursement total of 2.0 billion (this is greater than the fund investments as has been disbursed to end-borrowers by June 2012 since December 2005). 47. The success in developing credit lines for energy efficiency and renewable energy in developing countries that are attractive for local financial institutions and end users can be illustrated through the track record of GCPF to date and CTF programmes. a. By the end of June 2012 GCPF had lent $10.1m to 311 SMEs and households at market rate through one partner institutions and had resulted in excess of 10,000 tco 2 saved and the majority of investments have resulted in 60% emissions reductions (see Annex B for more info). 34 b. An evaluation of a Turkey CTF programme that provided concessional finance to and through two local banks for large scale energy efficiency ($50.3m for 15 projects) and 33 European Fund for Southeast Europe, GCPF, Quarterly Fact Sheet as of 30/06/2012. Available 23

24 renewable energy ($40.4m for 14 projects) has expected saving of 1.3MtCO 2 /yr 35. GCPF and the Turkey CTF programme target different scales, with GCPF focusing at the smallscale whilst Turkey CTF programme targets large projects, and these take different forms of finance (market vs. concessional); nonetheless they illustrate the successful uptake of finance to deliver emissions savings through loans to end-users. 48. Given the understanding of the barriers to scaling up energy efficiency and renewable energy investments in developing countries and the evidence highlighted above we believe the GCPF has a credible theory of change. Effective monitoring of the intervention will develop and test the evidence and effectiveness of the uptake of market rate loans and leverage private finance using this fund structure. Note that it is expected that the intervention may not be applicable to all settings with some countries requiring further assistance before there would be successful uptake of market rates loans for energy efficiency (for example Indonesia as local financial institutions are very reluctant to engage in small scale low carbon investments). The complementary technical assistance facility and other concessional interventions will help develop the market in these settings What would happen without UK support for GCPF? 49. The additionality of UK support for GCPF is to help realise its transformational potential by accelerating the progression to a sustainable market for low carbon investments by enabling the fund to grow (more detail on quantified results in covered in the appraisal). GCPF is currently constrained by a limiting number of C-share s and the need for a higher initial C-share ratio during the fund s infancy period. UK support to increase the volume of available C-Shares will leverage private finance and is expected to increase the scale and improve the leverage ratio (from lowering the risk of the fund), assist partner financial institutions to develop their low carbon knowledge and experience, and support energy efficiency and renewable energy projects in developing countries. A business as usual scenario would involve existing activities to support energy efficiency and renewable energy projects, examples of which are outlined in However, there would be a limited focus on testing support for SMEs and households via nonconcessional lending and aggregating across a range of countries. (See Appraisal case for further details of a Do Nothing scenario). 35 Eberlein, C and Hebb, M Climate Finance in Turkey: The contribution of the World Bank Clean Technology Fund to transforming the Turkish energy sector. 24

25 Figure 6: Theory of Change for GCPF (note ICF funds will only indirectly fund the TA component). 25

26 2 Appraisal Case 50. The approach for this appraisal is two-stage (given the variety options and limitations in the available evidence base prevent options to be fully appraised through cost-benefit analysis and consistently compared): a qualitative appraisal of the range of feasible options drawing on a set of strategic criteria to assess the potential success of an intervention in unlocking the key market failures, and strategic fit with the ICF. a quantitative appraisal to assess the Value for Money (VfM) case of the preferred option relative to the do nothing counterfactual. We look at the additionality and impact of the preferred option, and the associated costs and benefits in order to undertake a simple and partial cost benefit analysis based on the expected GHG emission savings. The analysis is tested under range of sensitivities to assess the robustness of the expected result and conclusions. 2.1 What are the feasible options that address the need set out in the strategic case? 51. There are a wide range of potential options for UK support that may address the needs set out in the strategic case in particular, the need to: Tackle barriers to the uptake of energy efficiency and renewable energy measures: i. demand side barriers; low awareness of opportunities due to lack of information, high upfront capital costs and poor access to affordable and suitable financing, owing to; ii. capital market barriers: lack of experience and information in local financial institutions to identify energy efficiency opportunities, misperceived high risks to financing in energy efficiency projects, low expertise of local FIs to evaluate and execute loans for energy efficiency. b. Fit with ICF priorities, private sector strategy, risk appetite, and ODA eligibility. (See section and in Strategic Case for wider elaboration) 52. The potential options can be assessed against the following strategic criteria: a. Appropriateness of intervention in tackling key barriers: access to finance & information (see para 46) b. Ability to significantly stimulate and accelerate the mobilisation of finance by c. Strategic fit with UK International Climate Fund to secure VfM through: i. Fit with ICF priorities & ODA eligibility, i.e. country and technology scope, transformational (see para 35) ii. Fit with private sector strategy, leveraging / capital repayment & return / sustainability (see para 36) iii. Fit with ICF risk appetite, d. Practical considerations: Timeliness to Disburse. e. Value for Money 53. The range of potential options considered in this appraisal are outlined in turn below. Option 1: Do nothing - the business as usual counterfactual. 54. In the absence of any UK support, the total size of the GCPF is expected to remain at the level achieved to date $204m 36, rising to an estimated $320 by 2014 based on attracting approximately $116m of private finance (total leverage from C-shares of 1:5.4). Beyond this, the assumption is that the GCPF will continue to be constrained by the level of C-Shares (currently $49.7m). (See section in Strategic Case for wider elaboration). The level of funding for C-Shares is not expected to increase in the near term without UK funds as; the German Ministry for Environment are already the main investor and would become over leveraged as a single entity if they 36 $204m is the current level achieved to date, but excludes two private sector investments expected by end of

27 significantly increased their share. Other donors are unlikely to contribute in the near term (given the current economic climate, fiscal constraints and low ambition to increase climate finance). 55. Under this do nothing scenario the GCPF will fail to reach its notional target size of $500m by To meet a $500m target by 2014 based on existing C-Shares would require immediately high effectiveness of mobilising finance at a leverage ratio of 1:9.1, compared to the current level of 1:3.1. This is not considered realistic in particular given the infancy of the fund. 56. The investment and uptake of energy efficiency and renewables is expected to be significantly sub-optimal both in scale and timing relative to the urgent level of investment and action required to be consistent with meeting a 2 degree trajectory (see section for supporting evidence, and given the list of barriers outlined in the strategic case, section 1.1.2). In addition to the climate change mitigation benefits, there are also a number of financially cost effective investments and wider co-benefits that would go unrealised. 57. It is however important to recognise that there are a growing number of other donor and recipient country interventions (see section for those that HMG are involved with) now targeting barriers to the uptake of energy efficiency and renewables. In additional, current market conditions are delivering some business as usual improvements in energy efficiency and reductions in technology costs, and a proportion of existing and future loans may classify as eligible for GCPF but this is not enough to match the urgent need for action on climate change. The additionality of GCPF relative to these business-as-usual trends is considered in the appraisal case. Option 2: UK Contribution of 30m to support the expansion of the GCPF. 58. The UK is considering contributing 30m (c.$48m 37 ) of ICF funds towards C-share investments in the GCPF on the expectation for this investment to unlock the current C-share constraint by almost doubling the level of available C-shares and allow the GCPF to expand. The exact scale of impact of UK funding is uncertain dependent on the effectiveness of the GCPF design in leveraging future financing (predominately private finance) in A&B-Shares which would be expected to evolve overtime as GCPF becomes more established. A range of scenarios can be envisaged, described below (and see table 1 for): a. Conservative Short-term Scenario: UK financing is expected to leverage in an additional $150m, contributing to a minimum total fund size of approximately $400m by based on the current leverage ratio of C-shares to A&B-Shares of 1:3.1. This low level of leverage is considered conservative, to reflect the early stage of the fund which is yet to mobilise private finance (two private investments into the existing GCPF are near close but reflected in this current ratio). The expectation going forward is that the GCPF will predominately focus on private finance (i.e. in this scenario a 1:2.1 C-share:Private A-shares). b. Central Short-term Scenario: The effectiveness of GCPF in attracting A&B- Shares increases to a leverage ratio of 1:4.1 by the level required to meet the notional target of $500m. This is considered feasible (compared to the high immediate leverage rate of 1:9.1 needed to achieve the target without UK funds) and based on anticipated mobilisation of A&B shares of approximately $150m in private sector funds and $48m from MDB/other donors. c. Central Longer-term Scenario: UK funds could in the longer term leverage in an additional $340m of finance, contributing to an overall GCPF fund size of approximately $780. In the longer term (i.e. 5 years, to 2017), the effectiveness of the GCPF is expected to strengthen as awareness and the track record of GCPF improves. The level of improvement and future size of the fund is difficult to forecast. KfW and Deutsche Bank, drawing on their knowledge and experience in similar funds, anticipate a longer-term level of effectiveness and leverage rate of 1:7 (The fund structure is currently limited to this maximum with a ratio of 1:1:6 of C:B:A shares to enable sustainability of the fund). 37 Based on exchange rate: to $ exchange rate of from DECC GHG Appraisal guidance. Ranging from $ m based on low-high range in historical exchange rates from past year (OANDA). On central exchange rate UK would hold 49% of shares from a 30m contribution, ranging from %. 27

28 d. High Longer-term Scenario: The effectiveness and leverage ratio could, in an extreme case scenario be higher still. A scenario of a leverage ratio of 1:10 leading to additional finance of up to $480m by 2012 is considered. 59. Indicative impacts, costs and benefits, and VfM of a UK investment in the GCPF are explored in the quantitative appraisal section (see section 2.3). In summary UK funds are expected to: a. mobilise wider finance (as outlined above), b. finance a number of energy efficiency and renewable investments through the GCPF design, c. lead to carbon savings and wider co-benefits, and finally, d. accrue a financial return to the UK. Table 1: Scenarios for leveraging finance ACTUAL Current Financing Levels Existing infant leverage rate Conservative Short-term FORECASTS To meet $500m target Central Short-term Leverage Ratio of 7 Central long-term High Leverage Ratio of 10 High range long-term $m $m $m $m $m Total (A, B & C-shares) * 500* 785* 1,079* A & B Shares (private & MDB/other donors) * 402* 687* 981* C-Shares C-share investors: German Ministry for Environment Danish Ministry of Foreign Affaires UK Contribution ( 30m) Leverage Ratio (A&B to C) Finance Leveraged by UK funds (both public and private) This reflects current investments: $60m in A-shares from IFC and KFW each, $15m in B-shares from IFC and KFW each, and $4m from Deutsche Bank. *Estimated from assumed leverage ratio the assumption is that additional finance is predominately private. Option 3: UK Contribution to the Technical Assistance (TA) Facility of the GCPF. 60. The GCPF has a small technical assistance facility to support local banks in the provision of loans (see para 28). One option is for UK financing to directly contribute to this and directly target the informational and knowledge barriers limiting local financial institutions, SMEs, and ESCOs in making energy efficient and renewable investments/loans. 61. The GCPF TA facility as it is currently operating is not currently capital constrained and there is no need for further funds (an investment in GCPF indirectly Funds the TA Facility with up to 0.2% of assets contributed each year, see Figure 4.). As such this option would not lead to an additional use of UK funds and not represent a VfM investment. Secondly only financing the existing TA facility of the GCPF would not meet the strategic need outlined to urgently scale up investments. Furthermore, DECC does not have programme spend (RDEL) available. 62. A wider consideration is for UK to commit resources to scale up the existing GCPF TA facility or establish a new TA scheme to target end-users more directly, and stimulate greater demand for finance, and for SMEs to mobilise their own finance. There is a wide range of evidence to suggest that TA is key to additionality. Whilst this may represent a VfM option, this is considered complementary to the existing GCPF scheme, and at the point of decision making on the GCPF today it is not a feasible option as would take additional resource and time to work up (and would also require R-DEL spend if to be established by DECC). In addition, whilst scaling a TA facility may lead to additionality and VfM, it does not address the need to urgently stimulate and accelerate private investment in energy efficiency and renewables at scale by

29 Option 4: UK Contributions to other existing schemes: 63. As an alternative to UK support to the GCPF the UK could provide further lending to MDBs, for example through the Clean Technology Fund (CTF) or bilaterally support national projects. a. A UK replenishment to the Clean Technology Fund is currently under consideration as a separate DECC ICF business case. The CTF has a combined energy efficiency /renewable energy focus, however the core strategic objectives of the CTF differ to those outlined in the strategic case of this business case, in particular the CTF does not aim to significantly scale up of private investments per se, nor target informational and capital access barriers at the household and SME level, and so would not be a targeted option. b. UK support to National Projects (see para 19). The UK could bilaterally support national energy efficiency projects, such as a contribution to the KfW Indonesia project (to be reconsidered at an ICF approvals panel in 2013) or a contribution of an energy efficiency scheme in South East Asia (an ICF business case to be considered in 2013). These projects could be considered to target more specific local barriers, whilst the GCPF is more generic in targeting barriers at the global scale and so likely to achieve demonstration at a larger and more visible scale. 64. Overall UK support to the GCPF should be considered complementary rather than an alternative or duplicative to either UK support to the CTF or national projects. (To ensure additionality in future schemes we note however the need to ensure no direct overlap between projects i.e. an SME should not have the option of both finance from GCPF and a bilateral scheme). Option 5: UK Contribution to the GCF Private Sector Facility 65. As an alternative to the GCPF the UK could provide funding to the private sector facility (PSF) of the Green Climate Fund (GCF). The PSF could then provide finance for small-scale EE and RE, either itself or through an intermediary. Given that the GCF is expected to be a large-scale, multidonor fund, it has the potential to work across many different countries and offer a wide range of facilities. However, the GCF is still in early stages of development (i.e. the design work has yet to commence) and is unlikely to be ready for receiving money in the near future. Further, it is has not been agreed by the GCF Board what the vision and priorities for the PSF are. There is no guarantee that it will address the need as set out in the strategic case, or address it in a way that is effective and offers value for money. It is therefore suggested that a contribution to the PSF is not a feasible option to consider at this stage. Option 6: UK to establish a bilateral scheme to target informational and capital access barriers 66. As an alternative to the GCPF the UK could establish a similar private sector fund that seeks to mobilise private climate finance through tackling informational and access to capital barriers but without taking a first lost position. For example, though taking B-Shares or lending on a Pari- Pasu basis (as CP3). Such a bilateral scheme would take a number of years in order to develop the design and implementation processes to be an appropriate and effective model. It would require significant resource to do so (which against current head count constraints is not considered feasible). It would be questionable whether a B-Share position would be ODA eligible (it is not currently the case under the GCPF) Summary of the Qualitative Option Appraisal 67. In comparing the six feasible options, it is evident that the criteria of timeliness to disburse and ability to stimulate and accelerate investment by 2017 are key discriminators. In particular, the need to disburse ICF funds within the budget period 2012 to financial year 2014/15 rules out options on contributing to the GCPF TA facility (given there is no immediate need for funding), and also rules out options to await the establishment of the GCF Private Sector Facility or to design a new UK Bilateral Fund. And this is reinforced by the objective to invest in a fund that will lead to significant stimulation and acceleration of investment by 2017 in order to avoid risks of lock in to high-carbon pathways. 29

30 68. As such, a contribution to the GCPF to invest in C-shares, a contribution to existing MDB schemes or national projects remain the only leading options. Within this, the contribution to the GCPF meets all the key strategic criteria in terms of fit with the ICF priorities, private sector strategy (through leveraging and providing a return on capital), in addition to appropriately targeting the barriers outlined in the business case and providing a feasible option to stimulate and accelerate investment by The weakness of the option is in its fit with the ICF risk appetite, where by design UK funds are exposed to financial risk (in taking a first loss position). However given the track record of the GCPF to date this risk is considered low. In comparison the UK could invest in the CTF or similar national schemes targeting EE or RE investments. Whilst this may meet the ICF priorities in terms of technology and country risk, and be low risk, other schemes may not focus on the private sector so specifically, or offer a lower likelihood of being able to stimulate and accelerate investment by 2017, and so are unlikely to be VfM or transformational. 69. In summary, through its ability to target the key barriers identified in the strategic case, on the expectation of a significant stimulation and acceleration of investment, its fit with ICF priorities and the ICF private sector strategy, and on the assumption that the rewards are significant, potentially transformational and outweigh the financial risks (to be scrutinised in the following section), a UK contribution to the existing GCPF is considered the preferred option, subject to proof of Value for Money. 30

31 2.2 Qualitative Options appraisal: Assessing the strength of the evidence base for each feasible option Options Appropriateness in tackling key barriers Ability to Stimulate and Accelerate Investment by 2017 ICF priorities & ODA eligibility: technology and country scope Key Strategic Criteria Strategic fit with UK International Climate Fund ICF Private sector strategy; Leveraging, capital repayment & return, sustainability ICF risk appetite Timeliness to Disburse 1 Do nothing x Sub-Optimal investment x x x x 2 Contribution to GCPF C- shares 3 Contribution to GCPF TA Facility 4 Contribution to other existing schemes, i.e. the CTF or other bilateral schemes 5 Contribution to GCF Private Sector Facility 6 UK establish new bilateral Fund Targets informational, knowledge and risk misperceptions to correct capital access barriers Current scheme tackles informational and knowledge but does not tackle risk misperceptions key barriers identified to mobilising private finance. CTF doesn t focus on key barriers to SMEs and Hhld (less than 10% of portfolio). Bilateral national schemes likely to be more focused on local barriers and not achieve global scale demonstration. This is open to design the UK is a number of donors however so the UK s objectives may not always be core. This is open to design UK could establish this fund to directly target the key barrier, though it is unclear whether not taking as first loss position will hinder this. Investment into existing scheme where increase in scale and C-shares expected to mobilise significant finance: Central forecast - leverage 1:4.1 by 2014, 1:7 by Additional TA may support scale up longer term but will not immediately stimulate and accelerate investment at urgent rate needed. Slow disbursement rates of CIFs unlikely to lead to scale up by Bilateral schemes may take time to establish, unlikely to be fully operational until Unlikely to be operational and build a positive track record to significantly mobilise funds by Unlikely to be operational and build a positive track record to significantly mobilise funds by ODA eligible, focuses on EE and RE, on a number of ICF priority countries (but would need to ensure UK finance not used to expand into non-priority. ODA eligible, focuses on EE and RE, on a number of ICF priority countries (but would need to ensure UK finance not used to expand into non-priority. ODA eligible and focused on EE and number of ICF priority countries, national schemes could be more targeted than regional. Open to design UK one of many donors however so the UK s objectives may not always be core. Open to design - as a fund established by UK it can be assumed these objectives will be targeted Potential for good to very good leverage rates in long term(3-10), capital repayment with return expected, expectation that this will be sustainable that C-share component to investments will reduce overtime. Potential to be transformational. Contribution to GCPF TA will not additionality mobilise private finance and increase size of GCPF in near term, and not result in a repayment or return to UK investment. Longer term, may prove additional in generating demand, and sustainable in providing capacity for SMEs to mobilise own finance. But difficult/high transaction costs to target households. UK investment in CIFs is on a grant basis no return is expected, and private sector mobilisation is not a core objective. UK investment in national schemes would be determined on a case by case basis. Open to design as a private sector facility it is assumed these objectives will be targeted however the UK is one of many donors, so the UK s objectives may not always be core. Open to design as a private sector fund established by UK it can be assumed these objectives will be targeted ICF Board s appetite is for low financial risk whilst a UK contribution to the GCPF takes a first loss position in C-Shares, the current track record is zero defaults thus this is considered within the risk appetite (see section 4.4.1). Financial and investment risk are low, however reputational risk (where appetite is low-medium) may be medium-high in supporting only the TA facility where there is no funding need.. In supporting the CTF or other national funds, risks are low. High reputational risk, (where appetite is low-medium) as this is not yet established. High reputational risks in establishing a new fund quickly - as well as high financial risks in aiming to establish a fund bilaterally these may give the UK high exposure (design dependent). GCPF established - able to absorb UK funds immediately. GCPF established but TA facility is not currently capital constrained therefore UK funding not in need and would not be drawn on immediately. Establishing new scheme /extension would take time to set up. Other funds are established or in development - evidence of slow disbursement rates with CIFs a concern The GCF is currently underdevelopment, it will take a number of years before the private sector facility is fully developed and ready to take funding. It would take a number of years to establish a new fund (for example CP3 took over 2 years) and ensure the design is right. It would not be possible to disburse under the ICF Budget timeline. 31

32 2.3 Quantitative appraisal of preferred option: What measures can be used to assess Value for Money for the intervention? 70. The preferred option has been assessed on the basis of a simple cost benefit analysis drawing on the best available evidence to consider whether a UK contribution to the GCPF represents value for money (VfM). This quantified analysis is subject to uncertainty and partial, it can provide only an illustrative assessment of VfM based on an indicative forecast of investments supported under the GCPF and attributed to the UK s support. Ultimately, minimum VfM will need to be secured through 1) the safeguards on the expected repayment of capital and return on UK investment and 2) the investment criteria (see Annex A) for the fund which will drive the ambition for the GHG emission reduction benefits and wider benefits. The true net benefits and value for money of UK funds will be determined by the specific investments supported, and vary on a case by case basis. 71. The methodology adopted for this appraisal is to forecast the range of key impacts of UK support to the GCPF notably GHG emission reductions - based on modelling scenarios for the expansion in the size of the fund, the expected portfolio of additional GCPF investments and assumptions the efficiency at which greenhouse gas emission savings are achieved. These impacts are adjusted to consider the additionality of UK funding. From this, a quantified costbenefit analysis is carried out to assess the VfM case, with a range of scenario and sensitivity analysis to ensure the robustness of the results The expected portfolio of GCPF investments 72. This section outlines the indicative portfolio of GCPF investments from expansion of the GCPF. 73. Size of the Fund: There is uncertainty over the effectiveness of the GCPF in mobilising private finance and co-finance from MDBs and other donors into A&B shares and ultimately the size of the fund. This appraisal considers a range of scenarios for the size of the fund, based on assumed leverage ratios and target time horizons (as outlined in para 45). In order to assess the impact of UK intervention, we isolate only the expected impacts from an expansion in GCPF attributed to the UK. This is estimated by assuming: i. The majority of A&B-shares are from private investment, in line with the objective of the GCPF (but assuming a share of MDB/other co-finance estimated at a leverage ratio of 1:1), ii. Attributing 49% of mobilised private finance directly to the UK s support, as UK has a 49% investor share in C-shares that are considered the key factor for mobilising finance. (No attribution of impacts from MDB/other finance is assumed), iii. A 25% share of private funds mobilised toward onward lending to FIs loans to households and SMEs are not additional - as there may some existing loans that are re-classified, and assuming 25% of the private finance to direct investments is not additional and crowding out other finance that would happened as part of BAU. (see more detail on additionality in later sections). Table 2: Expected Increase in Size of the Fund ($m) scaled up by UK contribution Existing infant To meet $500m Leverage Ratio High Leverage Extreme Low leverage rate target of 7 Ratio of 10 Conservative Shortterterm High range long- Central Shortterm Leverage Central long-term Low Leverage 1:2 Leverage Leverage Leverage 1:4.1 1:7 1:3.1 1:10 Total Fund Size ,073 Increase attributed to UK Of which: UK C-Shares MDB/Donor Co-finance in A&B Private Finance Mobilised

33 Of which additional private finance (75%) GCPF Investment Portfolio: 75. The GCPF can invest in two types of instruments: investments into financial institutions for onward lending (min. 70%), or, direct investments (both debt and equity limited to a maximum of 5% of the fund), to project developers, energy service companies, and small scale renewable energy and energy efficiency service and supply companies limited to 30% of the portfolio). 76. These instruments can invest in two types of investments standard and non-standard projects in Energy Efficiency or Renewable Energy (see Annex A). The current fund managers (Deutsche Bank) forecast that the GCPF portfolio will be split equally across these investments. Standard investments are small, standardised projects in SMEs and households that fall into 8 classifications (lighting, buildings envelope, space heating systems, cooling, solar thermal panels, electrical appliances, fans and pump motor replacements). Non-Standard projects are relatively large in scale, unique and/or highly complex projects for example renewable projects (small scale 5-10MW), industrial efficiency projects and agricultural projects. 77. The GCPF has 13 target countries that are all ODA eligible (see strategic case above) these include: Brazil, Chile, China, Mexico, Morocco, Tunisia, Ukraine, Turkey, Vietnam, Philippines, South Africa, India, Indonesia but will also consider other countries that fit with the investment criteria if opportunities arise (and are approved by the board). 78. Investment criteria: GHG emission savings are ensured by the fund s investment criteria (more details in Annex A). All energy efficiency investments need to deliver a minimum average of 20% reduction in energy usage or CO 2 emissions in relative terms (assessed against the baseline of the current situation). All renewable energy investments most provide energy from renewable sources (hydro, biomass, solar, wind) and will be assessed on a case by case basis. (smallscale, less than 10MW, need to provide decentralised energy supply). 79. There is uncertainty over the exact nature, location and types of projects that will be supported through the GCPF and UK funding as is inherent with any private sector fund. Fund managers do not forecast and target specific investment opportunities identified ex ante (or where they do this information is commercially sensitive and not publically available), but instead consider potential opportunities as they arise (see Annex C for this). There is also limited information on the current GCPF portfolio and expected results, given it has only been running a year. 80. In practice, the investment manager for the GCPF (currently Deutsche Bank) is responsible for determining whether potential projects meet the GCPF s investment criteria and carries out due diligence process which involves political, economic and risk analysis, financial evaluation, social and environmental assessment (more detail in the management case). On this basis it is assumed that ex ante the onward lending to financial institutions or direct investment projects are 1) expected to be commercially viable and attractive and 2) expected to comply with the investment criteria and realise at least 20% greenhouse emission savings relative to current levels as required. 81. It may be the case that ex post projects are not financially viable and lead to defaults. Failure of direct investments (~30% of the fund) would impact on the GCPF, but the risks are expected to be low, and over a portfolio of investments are not expected impact the overall level of the fund. Failure in loans from onward lending are managed by FIs and do not impact on the GCPF (except in the extreme case of insolvency of FI). 82. It may also be the case that projects do not lead to a minimum level of 20% GHG emission reductions ex post either due to project failure, or because these savings are not additional relative to business-as-usual trends (the investment criteria assesses 20% compared to current levels). This is considered in more detail in the appraisal below. 33

34 83. A forecast for the location and types of projects that may be invested in by an expanded GCPF is informed based on current GCPF investments and potential future investments outlined below. 84. Current GCPF Investments: As of June 2012 the GCPF has invested in the following locations and types of projects (see table 3 and annex B). Table 3: GCPF approved investments (capital calls) - as of June 2012 Country $m Financing to: Investment Types Turkey 25 (28%) households and SMEs seeking to improve their energy efficiency Vietnam 10 (11%) SME, energy intensive industry insulation, small scale renewable energy solutions (i.e. solar water heaters) renewable energy and energy efficiency, manufacturing processes Ukraine 30 (33%) Focuses on industrial Ecuador 25 (28%) households and SMEs seeking to improve their energy efficiency. & SME, energy intensive industry renewable energy and energy efficiency, manufacturing processes insulation, small scale renewable energy solutions (i.e. solar water heaters) & renewable energy and energy efficiency, manufacturing processes Total $90m 85. The GCPF Annual Report outlines the following level of energy and greenhouse gas emission savings for 2011 from a small sub-set of these investments ($6.5m). The latest quarterly report 39 ( nd Quarter), suggests a level of cumulative sub-loans of $10m, of which 69% are residential and 31% to SMEs and cumulative carbon savings over 10,000tCO 2 e to date (reflecting first 1-2 years and not the full lifetime carbon savings). Annex B contains further information on progress to date. Table 4: Results from GCPF 2011 No. of Total Sub MWh tco2 Average Upfront Investment Sector Sub Loans Loan Volume ($) saved in 2011 saved in 2011 % CO 2 savings Cost per tonne abated (tco 2e) 40 SME 152 2,864,409 2, % 186 Residential of which Apartment/ Building Manager/ home owner Association of which Households / Private Entrepreneurs 48 3,599,936 10,379 2,159 60% ,584,637 9,696 2,033 60% , % 36 Totals 200 6,464,346 12,581 2,717 Approx. Weighted Average: Expected future investments 41 in the immediate pipeline for 2012 bring the total scope of investments to above the $204m of funds currently in the GCPF (see table 6): Table 5: Pipeline of GCPF investments for Q Tier 1 Projects that GCPF expect to execute quickly Total $m Type & Country 30 FI Brazil 3 Direct Investment - PV plant South Africa 15 FI Mongolia 10 FI Paraguay FI Philippines See para 84 for definition of investment cost per tonne relative to other conventional cost-effectiveness metrics. 41 From Deutsche Bank. 42 Note investments in countries that are not GCPF s target country set can be approved by the Board after a country assessment is carried out. 34

35 Tier 2 Projects, that are less certain Total 25 FI India 15 Vietnam GCPF fund managers are currently in discussions with other FIs for potential investments post These are in Brazil, Mongolia, Paraguay, Sri Lanka, India, China, Philippines, and range from investments in energy efficiency across households, SMEs, industry and small and large scale renewable energy projects. In summary, investment opportunities in addition to EE investments outlined as standard investments (see para 63), non-standard investments may range from EE in Agricultural and Industrial sectors, power generation efficiencies, clean cook stoves and a range of small scale renewable investments. (This detail that is drawn on to forecast the expected portfolio and derive impacts for the appraisal below). The table in Annex C provides further detail of what projects and investment types are currently being discussed or presented by the banks that Deutsche Bank are currently in more concrete negotiations with Cost-Benefit Analysis 88. This appraisal section assesses the VfM of UK ICF spend. In comparing the costs and benefits of this intervention, it is important to focus only on the net impacts (taking into account transfers) and compare only the social benefits (and wider social costs) attributed to UK spend. 89. UK investment in GCPF is an upfront cost to the UK - this mobilises additional finance into GCPF and the fund in turn provides onward lending and direct investments. These investments are expected to be financially viable and commercially attractive, leading to a repayment and return in particular given the significant energy savings from energy efficient investments. In this respect, energy savings and financial benefits from increased renewable supply are in part considered a transfer from end users/loan recipients to FIs and onward to the GCPF A&B share investors and to recapitalise C-shares (leading to potential iterative cycles of re investment). The investments also lead to positive social externalities notably GHG emission savings, but also wider welfare, productivity and environmental benefits. Simplified Presentation of Key Costs, Benefits and Transfers from UK Investment in GCPF The evidence base is not sufficiently sophisticated to comprehensively quantify and monetise all direct outcomes, transfers and impacts of the expected investments arising from UK ICF funds, nor quantify and value all wider social, economic and environmental benefits (such as productivity benefits, air quality benefits and health benefits). Instead the CBA focuses on the key monetised 43 Simplified presentation abstracts from detail, for example; that onward lending and direct investments will also lead to net changes in operating and maintenance costs (in addition to energy savings), and that there will also be transaction costs at each stage of investment. 35

36 costs and benefits UK investment & GHG emission savings but it is also necessary to place importance on the unvalued impacts described qualitatively in the section below as well as the scenario and sensitivity analysis given uncertainty in forecasting and valuing impacts. (See Annex D for an outline of the key modelling and appraisal assumptions). 91. There are two main drivers of value for money of UK s spend and having transformational impact: 1) additionality of impact per dollar of investment, and 2) scale in terms of mobilising and accelerating private investment into EE and RE. The CBA below considers the implication of both, providing an adjustment for additionality, and modelling various scenarios for the level of private finance mobilised and level of reflows into the fund. Monetised impacts: 92. UK Investment Cost and Expected Return: The UK is considering an upfront investment of 30m 44 in the GCPF. This investment will generate annual returns, at a dividend rate of USD LIBOR 6-month flat, maximum capped return of 2.2%. The fund is structured such that C-share dividends are not paid out to investors but retained in the fund to increase the C-Share balance. Whilst there are no plans/ target dates to withdraw UK investment this investment remains an asset to the UK and upon close of the fund the total C-share investment would be returned to the UK, and so can be considered a key future benefit. (See financial case for more detail). 93. Given uncertainty over the varying rates of return and lifetime of the investment, the potential range of compound returns to the UK and total capital investment is estimated around m for a 5 year investment, up to $3-11.5m over a 15 year investment horizon (based on a range of returns of 0.54% to 2.2%). In the social appraisal, since the expected returns paid out to the UK s investment are at a lower rate than the social discount rate (10%) and assumed inflation rate (2.5%), the financial benefit from these returns in present value terms does not outweigh the initial upfront investment cost and declines significantly over the length of investment (as shown in the second line of the table below). Table 6: Forecast of UK C-share Investment (Initial Investment + Expected Financial Return) ( m, nominal except PVB), central forecast shaded Rate of Return 45 One Year (End 2013) Five Year (End 2017) 10 Year (End 2022) 15 Year (End 2027) Central: 2012 Average USD LIBOR 6M Rate 0.716% PVB of central scenario at different years of withdrawal 2012 Low USD LIBOR 6M Rate 0.536% High USD LIBOR 6M Rate 0.812% Fund Max. 2.2% 2.2% Note this modelling does not reflect any exchange rate differentials between the year of investing (2012) and year in which a return is received. 94. GHG Emission Savings: Each investment facilitated through the GCPF will result in direct GHG emission savings the magnitude of which is driven by 1) the initial size of the fund 2) the efficiency at which the GCPF delivers emission reductions (the upfront investment cost per tonne which itself will depend on the type and location of the investment, and degree of additionality), and 3) the level of reflows and reinvestment in the fund (driven by the commercial success of the scheme). 95. The section above outlined the expected future increase in the size of the fund and current portfolio and expected pipeline investments that the GCPF is likely to support. Informed by this, forecasts of the expected GHG emission savings have been derived from an assumed representative portfolio of investments, assuming a 50:50 split between standard and nonstandard investments, and assuming standard investments are predominately EE measures in 44 Minus the subscription fee 45 Rates as of 5-Nov All bbalibor rates are quoted as an annualised interest rate. This is a market convention. Source: 36

37 households and SMEs, whilst direct investments are assumed as a 45%:55% mix between EE and small scale renewable investments. 96. Efficiency of the GCPF in delivering GHG emission savings: the level of investment required to deliver a tonne of GHG emission savings provides the metric to assess and forecast the efficiency of GCPF in delivering emission reductions. Evidence is taken from: The portfolio of current GCPF investments where evidence is available (currently only $6.6m). This suggests an average upfront investment cost per tonne of $63/tCO 2 e, ranging from $30-$186/tCO 2 e 46 for standard investments. (See table 4 detail). Capital Investment costs per tonne for small scale renewable projects ranging from $4-148/tCO 2 e across investment types, on average $22/tCO 2 e drawing on IEA on capital cost and plant characteristics and grid emission factors This cost-effectiveness metric reflects upfront investment costs per tonne of GHG abated (without consideration of additionality). This differs from the social cost-effectiveness estimates conventionally drawn on in UK appraisal, which reflect net social costs and benefits per tonne of additional GHG abated, or unit costs conventionally presented in Marginal Abatement Cost Curves which reflect net costs and benefits per tonne typically derived from a private perspective excluding wider costs and benefits. 98. Additionality of GCPF: As highlighted above, additionality is one key driver of VfM. Whilst the GCPF has clear investment criteria, energy auditing and governance, since the 20% minimum GHG emission or energy saving is assess relative to current levels and without consideration of rebound impacts there is concern that not all these savings will be additional. (Though of detail available on the existing portfolio, SME investments are expected to provide 24% savings and household investments 60%). 99. In order to be conservative in this appraisal, on top of assuming that only 75% of private finance mobilised is additional (see para 44 & 60) it is further assumed that only 50% of a project s expected GHG emission savings are additional: In the case of renewable energy generation projects it is likely that projects in part displace fossil fuel generation (leading to emission savings) but in part satisfy previously un-met suppressed demand. In the case of energy efficiency projects it may be that some improvements energy efficiency (and emission savings) would have been realised as part of BAU technology improvements, and also that emission reductions are in part eroded by rebound effects 48. This adjustments is also considered to reflect a conservative expectation of project failure (approximately 5%). The 75% and 50% additionality adjustments are crude assumptions made in the absence of more detailed project specific information and evidence, it is applied as a conservative estimate (and stress-tested in the sensitivity analysis below) Scale of Investments: The second key driver of VfM is the ability to mobilise private finance (described in sections above) and achieve scale. The later is driven by the level of reflow and reinvestment of the fund capital once returns are paid. Reflows are expected after 5-7 years of initial investment (reflecting the average tenure of loans). Reflecting the uncertainty over the level of reinvestment three main scenarios are considered 1) no reflows, 2) one round of reflows, 3) three rounds of reflows Overall, additional GHG emission savings attributable to the UK support to GCPF are expected to range from 2.6 to 8.4 MtCO 2 e on central forecasts over the technology lifetimes. This 46 Assumptions to forecast the expected impact of CP3 suggested an average upfront investment cost per tonne of $6.6 tco 2e for EE investments (based on CHUEE Energy Efficiency Data). This is considered an extreme low range, and not drawn on in the appraisal itself, given the available evidence base that is specific to GCPF. 47 Considered over a range of countries and regions (China, India, Brazil, Middle East and Africa), across a range of plant types (Biomass power, Biomass co-firing, Small scale biomass CHP, Biomass waste incineration, Small Scale Hydro, Solar PV and wind). Emission factors from DFID s draft Climate Change Appraisal Guidance. 48 Rebound effects limit energy savings and emissions reductions, given initiatives that save energy or fuel (e.g. energy efficient light bulbs or more efficient cars) reduce energy costs which can lead to increased consumption, partially offsetting the initial reduction in energy use. Rebound effects also produce welfare benefits by allowing additional consumption. In most cases data is unlikely to be available to estimate this impact. Empirical estimates of the direct rebound are broad. A number of estimates (for developed countries) suggest that they tend towards a range of 25-30% for consumers. Insufficient studies have been carried out for producers. 37

38 is composed of emission savings directly related to investment from UK spend (0.8 to 1.5 MtCO 2 e) and significant emission savings delivered by mobilised private finance. The wide range highlights the key role of private finance and successful refinancing round of the fund. This central range reflects a leverage ratio of 1:4 to 1:7 and zero to one round of refinancing. With reduced efficiency in delivering GHG emission savings (higher cost per tonne), this range is expected to fall to 1.1 to 3.7 MtCO 2 e, and with low leverage rates of 1:2 to 1:3, the expected GHG emission savings would be lower at 0.6 to 3.9 MtCO 2 e across the range of refinancing and cost assumptions. Table 9: Summary of Expected Additional GHG Emission Savings (MtCO 2 e) attributed to UK investment (from UK investment and mobilised private finance) central forecast shaded Central $/t (average $52/t) High $/t (average $148/t) Fund Scenarios No Reflow One Round No Reflow One Round Extreme Low (1:2) Existing 'infancy' leverage rate To meet $500m target (1:4.1) Anticipated Leverage 1: Extreme High Leverage 1: Full table of scenarios is presented in Annex D. 2.4 Summary Value for Money Statement for the preferred option Partial CBA Results & Wider/Non-Monetised Benefits: 102. There are two main drivers to the value for money of UK spend 1) additionality per dollar of investment, and 2) scale in mobilising and accelerating private investment into EE and RE. In practice, delivering results through the private sector involves a trade-off between imposing stringent investment criteria to maximise additionality per dollar of spend vs. attracting private finance at scale without deterring investment by increasing transaction costs and lowering commercial returns. With respect to the GCPF, this appraisal recognises that additionality per spend may be low (taking a conservative approach, reducing GHG emission savings by 63% to reflect non-additionality). The appraisal demonstrates that the VfM case for supporting the GCPF is through scale through mobilising significant private finance to deliver emission reductions, and supporting a fund that will reinvest, become sustainable, and have a long-term transformational impact and avoid risk of lock-in to dangerous climate change Assuming GCPF is successful in attracting private finance, a UK investment in GCPF is expected to represent high value for money based on monetised GHG emission savings and the returns to UK investment alone, with partial benefit-to-cost ratios (BCRs) ranging from 4 to 12 on central forecasts (see table 10 below). This assumes the GCPF can mobilise finance at ratios of 1:4.1 to 1:7 (the higher end reflecting Deutsche Bank s objective), and assumes zero to one round of re-investment (where GHG savings are attributed to UK, this more than doubles the expected benefits 49 ) GCPF is still expected to represent value for money under this scenario even if the efficiency in delivering GHG emission reductions is significantly reduced (i.e. a high investment cost per tonne of 148/tCO 2 e, compared to central scenario of 52/tCO 2 e): BCR are estimated at 2 to 6, excluding wider welfare and productivity benefits, and the transformational benefits (described in section below) It is estimated that the level of additionality would need to fall to less than 2 to 4% overall on the central range (compared to 38%) in order for GCPF to represent at least poor value for money (partial BCR less than 1 excluding wider benefits). The low level highlights the key role of scale in delivering VfM and also that UK expects to receive a return on its investment Whilst refinancing is based on the same initial level of investment, monetised benefits increase at an increasing rate and more than double with each round of reinvestment as a consequence of higher carbon values overtime that increase at a rate greater than the discount rate. 50 As an extreme sensitivity (and to highlight the additionality vs. scale trade-off, additionality would need to be at least 3-12%to ensure VfM should returns to UK investment not be included. 38

39 106. The risk of investing in GCPF is that the fund fails to mobilise private finance. Under a failure scenario GCPF is expected to represent moderate value for money, assuming UK funds are used to finance investment but with no refinancing (i.e. UK funds repaided after the initial round)- partial BCR is 1.7. However, if there was no repayment and return on UK investment, absolute failure of GCPF is likely to represent poor VfM: the BCR would fall to 0.99 (negative NPV of 0.3m). Furthermore, if the efficiency of delivering GHG emission reductions was reduced (high cost per tonne) the BCR would fall to 0.5 (negative NPV of 16m). These BCRs are only partial - there are likely to be wider welfare and productivity benefits from our investments not reflected in these monetised numbers - but given the limitations in the evidence it s a judgement whether these will be greater than m, and sufficiently high to make this a good VfM project (i.e. $100m+) A key reason for why the VfM/BCRs are so low in these failure scenarios is that scale is not achieved to drive the benefits. Relative to less risky non-private sector projects, GCPF is less efficient at delivering GHG emission reductions and poverty benefits - as investment decisions are primarily driven by the need for a commercial return, and GHG emission reductions are guaranteed by minimum standards and additionality per dollar of spend is not necessarily maximised. A lower risk option would be to spend 30m on investment projects that seek to maximise the direct climate and poverty benefits to a greater extent (and to do so even on a grant basis) - but this would not have the potential to attract the private sector and lead to a wider transformational benefit or achieve significant scale to reduce risks of lock in of have the same upside risk of very high VfM Whilst it is not in the UK s gift to change the GCPF investment criteria immediately (we are considering joining an existing scheme), if the UK were to invest in GCPF then as a member of the board it could seek to influence to improve additionality and VfM in the longer term. A key issue is whether the minimum 20% saving criteria is set at the appropriate level. Evidence would be needed to assess what the appropriate rate is, taking into account the trade-off between additionality of delivering emission reductions and attracting private finance. Practical outputs of further evidence would need to consider either a more appropriate minimum standard, or identify characteristics of non-additional investments to provide a basis for exclusion. Table 10: Summary of Expected Partial Benefit to Cost Ratios, central forecast shaded Central $/t High $/t No Re- No Re- One Round Fund Scenarios Investment Investment One Round Failure No Private Finance Mobilised Extreme Low Low Short-term Existing 'infant' minimum leverage rate Short-term To meet $500m achievable target Central long-term Anticipated ambition Leverage Ratio of High range longterm ambition Ratio of 10 High Leverage Full table of scenarios is presented in Annex D. Table 11: Summary of Net Present Value Components for Central Forecasts ( m,2012, PV) Present Value Costs To meet $500m target Leverage Ratio of 7 No Re- Investment One Round No Re- Investment One Round PV HMG Project Costs ( 30m in 2012) Present Value Benefits PV Valued CO2 Emission Savings PV UK Return of Investment & Dividends* BCRs & NPVs Benefit to Cost Ratio CR (=PVB/PVC)

40 Net Present Value (=PVB-PVC) *PVB of return on UK investment substantially lower, as repaid at a later date and so more heavily discounted (see para 80). Wider Benefits & Non-Monetised Impacts: 109. There are also expected to be a significant level of wider benefits that are notquantified/monetised and reflected in the CBA. These include: Improved awareness, knowledge and capacity in FIs to make EE and RE investments. Welfare benefits to households 1) increased energy efficiency leads to savings to energy bills, these may be above the level of loan repayments and so a direct benefit to households and may result in a direct or indirect rebound effect. 2) additional renewable energy generation leads to benefits from improved more stable electricity supply avoided unmet electricity demand. Productivity benefits to SMEs and suppliers and wider economic benefits: For example the IEA WEO 2012 estimates that investment in energy efficiency of $12 trillion is more than offset by fuel savings and triggers cumulative economic growth of $18 trillion. Returns to Private & MDB Investment: investment in A&B-shares are expected to accrue an additional return to investors (as outlined in the strategic case). These returns are uncertain and difficult to forecast. Since the returns are expected to reflect market conditions, and given the innovative nature of the fund, these are not valued and considered to be significant additional benefits as not considered above other market rates (or as an opportunity cost to investors). Transformational impact and avoided lock-in to high carbon infrastructure: The chart below illustrates not only how GCPF delivers VfM from near term outcomes (based on leverage of private finance and initial and one round reinvestment), but also how GCPF if successful can in the longer term achieve significant scale in emission reductions through continued reinvestment leading to a sustainable fund. If scale is achieved this will lead to significant GHG emission savings beyond the direct benefits outlined above leading to a transformational change and avoided lock-in to high carbon infrastructure. Chart 12: Illustrating Scale up of GHG Emission savings, owing to increase in level of finance leveraged and increases in rounds of reinvestment (attributed to UK). 40

41 3 Commercial Case Indirect procurement 3.1 Why is the proposed funding mechanism/form of arrangement the right one for this intervention, with this development partner? 110. The Global Climate Partnership Fund S.A., SICAV-SIF is a société d investissement à capital variable governed by Luxembourg law of February 13, 2007 (as amended) and was initiated by the German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety and KfW Entwicklungsbank. GCPF is already set up so there are no alternative providers GCPF is the delivery partner with KfW the initiator of the fund, key shareholder and directors, see the Management case for more info. It is therefore important that KfW and GCPF are judged to be a reliable delivery partner. KfW have significant previous experience with climate change funds 51 and with a similarly structured funds (EFSE, see section 1.2.1). For example typical financing approaches to encourage large numbers of smaller investments and achieve a broad impact include the credit lines for renewable energies and energy efficiency in places like the Balkans and Ukraine. In particular they have previous experience of a similarly structured fund, the European Fund for southeastern Europe, that has been running since 2005 and there have been no defaults and has successfully attracted private finance Although KfW has significant relevant experience, KfW and GCPF have undergone an independent external review. The delivery partner review considered the management structures, policies and procedures of KfW and the GCPF wider team to ensure they facilitate effective, efficacious and appropriate delivery of the activities and objectives. In particular the experience to date with GCPF was considered A standard checklist is used and the main aspects a review are: Strategic performance management (e.g. effective leadership and governance) financial resource management (e.g. financial accountability and counter fraud controls) cost and value conscious (e.g. challenges value for money, controls admin costs) partnership behaviour (e.g. relationship management) transparency and accountability (e.g. publishes documentation, follows IATI) skills and resources (e.g. appropriate skills and resources) 114. The findings of the Delivery Partner Review illustrated that KfW and GCPF have adequate and appropriate policies and procedures. Potential weaknesses noted are KfW s transparency, which they are in progress of implementing a plan to improve this. For GCPF, weaknesses noted were a lack of a disclosure policy and no mechanism to complain. This is because they rely on those procedures provided by the investment manager s organisation. Additionally, GCPF prepares 3 year rolling financial plans but can make investments with a tenor up to 15 years. DECC would seek to encourage longer-term planning. Thus, DECC is confident that KfW and GCPF are competent and appropriate delivery partners. 3.2 Value for money through procurement 115. KfW does not charge any administrative fees to GCPF investors but there is a one-off subscription fee. This is to cover the resource and finance involvement of KfW and IFC in establishing the GCPF and the significant use of the respective resources. There are no direct comparisons but the subscription fee is considered to be acceptable in comparison to the admin fees of funds run by development banks. 51 See 41

42 116. KfW has appointed an investment manager for GCPF and as a German public institution KfW must adhere to procurement rules, which are similar to those governing UK Government, including for the procurement of the implementation consultant. KfW international standard procurement policy: KfW applies international standards in its procurement policy. More specifically, KfW adopts the following procurement principles: a. Transparency: Calls to tender must be published; award decisions must be transparent and accountable. b. Fairness: Calls to tender must allow for fair competition. Discrimination against or preferential treatment for individual bidders is not permitted. c. Equal opportunities: Regardless of the origin or headquarters of the enterprise, all bidders may take part in Financial cooperation-financed calls to tender. d. Economic efficiency: The contract is awarded to the bid gauged to be the most economically advantageous following the appraisal. Contracts may only be awarded to professional and efficient bidders An open international competition tender was run according to the EU procurement rules for the investment manager. Deutsche Bank won after the 2 step evaluation process which considered separate technical and financial proposals. 7 companies applied and 4 companies prequalified. An evaluation committee consisting of EIB, IFC and KfW analysed the proposals resulting in Deutsche Bank as the winner. The contract is initially for 3 years (until August 2013) and will then be reviewed and renewed for a rolling 3-year contract, with termination by exception The current management fee is 0.8% per year of the funds invested to Deutsche Bank and is drawn from the revenues following operating costs, see figure 4. This is considered good value for money when compared with other funds, as a general benchmark is 0.5-1% for management fees for similar funds. For comparison the average management cost from PIDG s (Private Infrastructure and Development Group) facilities is 1.8% of all funds invested (although this is only roughly comparable). Furthermore, value for money for the management of the fund is incentivised through the waterfall structure, see Figure 4. The performance fee is only paid after all the shares are capitalised and the technical assistance facility replenished with the fee limited to 1.0% if the funds invested and capped as 50% of the cash available These safeguards of following the appropriate procedures, comparison with other funds, and the performance structure of the fund reassures that value for money has been achieved through procurement. This has been considered in the delivery partner review and will be monitored through the ICF performance management of the project. 42

43 4 Financial case 4.1 What are the costs, how are they profiled and how will you ensure accurate forecasting? 120. We propose that the UK 30m investment will be deposited in entirety in Summer 2013 (following approval), and there are no further payments envisaged. The currency of the fund is USD and the investment will be converted on payment. The investment will include a one off structuring fee to KfW and IFC. All the funds will be transferred at once as the UK is making an investment as a shareholder. Furthermore, all current C-share investments are invested, so to enable the fund to grow with the greatest flexibility additional C-shares are required (funds commitments and loans/investments to date are detailed in Annex B) In general, investments are made in USD and partner institutions convert them to the local currency as required and hence take the foreign exchange rate risk. However, operating administrative expenses for the Fund are often paid in EUR and due to the European Financial Association bookkeeping that is followed an exchange rate net of gain can be seen on the profit and loss sheet. Following the procedures $250,000 is allocated each quarter and then expenses reimbursed accordingly, usually in EUR, and there can be an exchange rate difference. EFA Operating expenses are circa $1m so the net or loss will be limited The projected payment schedule is shown in Figure 7 and an example waterfall payment is shown in Figure 8. Note the management costs (0.8%/yr of funds invested) and revenues are distributed annually, see Figure 4. In 2011 in GCPF s first year of operation it turned a small profit ($8,200) and generated an income of approx. $1,000,000, which more than covered the management costs ($200,000), see Annex B for more info on performance and expenses for Figure 7: Projected finances for

44 Revenues $9m Costs Operating expenses e.g. travel expenses, board meetings, legal advice Investment management fee Annually paid to Deutsche Bank Notes Interest and principal A-shares Target dividends, target dividend deficiencies, NAV deficiencies B-shares Target dividends, target dividend deficiencies, NAV deficiencies Estimated GCPF budget USD 1,000,000 Fee (0.8%) USD 1,600,000 No notes A-share ($139m) dividends USD 2,780,000 B-share ($12m) dividends USD 360,000 C-shares Capitalised TA facility contribution Performance fee for Investment Manager Complimentary dividends A-shares and B-shares C-share ($49m) dividends USD 245,000 TA Fee (0.2%) USD 400,000 Performance Fee (1.0%) USD 2,000,000 Complimentary dividends A-Shares USD 524,448 (0.37%) B-Shares USD 90,552 (0.75%) Figure 8: Example waterfall payment with a portfolio of $200m, and a revenue of 4.5% Assumptions: Target dividends are as presented in Figure 4. USD LIBOR 6 m =0.5% 123. GCPF has no set close date so the investment will be able to continue to leverage finance to provide low carbon investment as loans are repaid and any annual profits are recapitalised. The estimated and target leverage ratio for the fund is 1:7 (based on C:A+B shares) and the average loan period is 5-7 years There is a pipeline of loans/investments for 2012 and Up to $113m is estimated for the end of 2012, with those outlined below. There is a pipeline of up to $190m of GCPF investments for 2013 detailed in Annex C. The proposed investments are: Brazil ($30m) Cronimet solar photovoltaic plant - South Africa ($3m) Mongolia ($15m) Paraguay ($15m) Philippines ($30m) India ($25m) Vietnam ($15m) 125. Accurate forecasting will be ensured through the monthly, quarterly and annual reports and quarterly meetings (see section 4.5 for more details on these reports). 4.2 How will it be funded: capital/programme/admin? 126. All the funds will be capital (CDEL) and funded from DECC s ICF share. 4.3 How will funds be paid out? 127. The UK, as an investor would sign a subscription form, and a direct transfer of funds would follow. This would make the UK a shareholder in the fund. DECC Finance and HMT have confirmed they are comfortable with an investment in shares and HMT have indicated that there is no policy prohibiting this approach. 44

45 128. The UK s investment in C-shares will generate annual returns that will be recapitalised into C- shares allowing the fund to further expand. The dividend rate for C-shares is a flat rate of LIBOR 6M and is capped at 2.2% (this rate is subject to review if it does not adequately reflect the inflation). The fund is of unlimited duration but if the fund closes the investment will be returned to HMT and can be diverted to an appropriate ODA-eligible investment. This would need to be monitored as the flows would count as negative ODA and we HMT and DECC Finance have been consulted to ensure this would be accounted and management in the most appropriate manner. 4.4 What is the assessment of financial risk and fraud? Risk of financial loss given the first loss position 129. The UK investment would be in C-shares and following the waterfall structure, C-shares are both the last to receive revenues and are used as a risk cushion (by taking first loss) in order to leverage private finance flows, see Figure 6. This means that if there was a loss on one individual loan this would be unlikely to destabilise the entire fund. Despite the UK investment being in a first loss position we believe the risk of financial loss is low due to the appropriate safeguards and structure of the fund and drawing on relevant experiences. In addition, it is worth noting that as the fund matures the fund and the risk cushion should expand as the annual profits from C-shares are recapitalised The key GCPF investors have the same interests as the UK; GCPF was initiated by KfW, on behalf of the German Ministry of Environment, and they are the largest shareholders, with $75m (A+B shares) and $42m (C-shares), respectively. GCPF is also structured so as to align the interests of the fund manager (Deutsche Bank) with A,B & C-share investors. They were required to make an investment (in B-shares) to GCPF on appointment and have actually invested $4m in B shares, the maximum allowed as the investment managers. Furthermore, Deutsche Bank is incentivised not to make risky investments given that their performance fee is conditional on the A,B and C shareholders getting their dividends first, see Figure Financial institutions that are lent money from GCPF also have aligned incentives. In the first instance all approved loans have an upfront fee of 0.8% or 1% and then a fixed or variable interest rate that is non-concessional. For example, for Sekerbank (Turkey) the $25m loan including an upfront fee of 1% and interest rate of LIBOR plus 2.5%. The local financial institutions bears the risk of its on-lent loans to individual SME/household loans defaulting i.e. they have to manage any exposure themselves and it is only in the case of a local bank s bankruptcy that GCPF might lose money. There are monitoring thresholds in place to ensure that the loss of a loan is unlikely and that the loan is building a portfolio, e.g. at 6 months after the loan is disbursed at least 25% needs to be on-lent, and after 24 months this should be at least 95%. If these thresholds are not met GCPF can demand the loan to be partially or fully repaid, a penalty payment is enforced or action plan to achieve greater disbursement is drawn up Experience of GCPF to date and from similar lending structures have been successful and resulted in no financial loss. GCPF has been operating for over 18 months and has experienced no losses and in fact generated a small profit in its first year of operation under difficult investment environment (see Annex B). EFSE is a similarly structured fund that was initiated by KfW and managed by Deutsche Bank and was operating in South Eastern Europe post-conflict on infrastructure investments that were considered to be risky (similarly to energy efficiency and renewable energy investments in developing countries). This fund has resulted in no defaults on loans since 2005 (see section 1.2.1) Financial modeling suggests that the fund would be financially sustainable over 10 years even if it did suffer losses. The modeling assumed a portfolio of 15 investments with a credit rating of BB and BB- and a 22.6% default (higher than the experience above suggests), which thus requires a minimum annual return of 2.2% to maintain its value over a 10 year period. Note that the current portfolio of 5 investments has a better credit rating of 17% BBB+, 33% BB and 50% BB-. A pari-passu fund would require an annual return of 7.2%/yr and this exceeds the costs that 45

46 local financial institutions in developing countries could bear. By structuring the fund in differential risk positions this achieves sustainability against financial loss of the fund, as A and B share returns offered are 1.5% and 2.5%, much lower than 7.2% The due diligence on each investment before going to the investment committee includes, country analysis as well as financial checks (this include assessing 3 years of financial statements, balance sheet scoring, audits by the big 4, return on equity etc.). Furthermore, the risk exposure is limited by GCPF only being liable to loss of their investment if the bank defaults. In GCPF and the similarly structured EFSE fund there have been no defaults. Note that the current investments range in ratings of B+ to CCC, see Table 1. Potential losses are mitigated by diversification and there are limits on investments: Max 15% volume of the fund in one investment Max 20% volume of the fund in one country Max 15% volume of the fund in subordinated debt Max 5% volume of the fund in equity 135. Financial risk will be monitoring through the reporting and management arrangements (see 4.5 and Management Case) Risk of fraud 136. The reliability of the partner institutions provides confidence that fraud risk are low. The key partner institution is KfW as the initiator of the fund, key shareholder and directors, and they are an international renowned trusted partner, see Commercial case. Deutsche Bank are the investment manager of the fund and also have a good reputation and have won a competitive tender process that assessed their capabilities. Additionally, a delivery partner review carried out by external auditors will be done to ensure GCPF has the appropriate policies, procedures and management to ensure financial and fraud risk is low, see Commercial Case We believe fraud risk is sufficiently mitigated given the procedures for partner institutions. GCPF has appropriate investment criteria and due diligence procedures for assessing the appropriateness of partner institutions for loans and for direct investments, see Figure 8. For example, it requires organisations to present a stable financial performance as reflected by profitability, capital, portfolio and liquidity ratios, and present an adequate risk management system, organisation and quality. The use of the funds is monitored and needs to be transparent during the loan as they are require to show invoicing/receipts or physical installation of equipment at defined premises. Module 1 Module 2 Module 3 Module 4 Selection of Financial Institutions Loan facility negotiation Loan operations Monitoring & reporting a) For loans Selection of banks Due Diligence Determination of TA needs Negotiation of lending facility Final approval by Investment Committee Signing of loan agreement Set up of loan administration, transaction management and technical support Monitoring / potential work out Combined financial / environmental / social reporting 46

47 Module 1 Module 2 Module 3 Module 4 Project sourcing Project evaluation Project approval & disbursement Monitoring & reporting Sourcing from: Financial Institutions Global / local ESCOs Manufacturers Project developers Portfolio fit assessment Environmental & developmental evaluation Financial & legal evaluation Technical evaluation Final approval by Investment Committee Signing of documentation Set up of necessary administration, transaction management b) For equity investments Figure 9 Investment processes with local financial institutions Monitoring / potential work out Combined financial / environmental / social reporting Risk of over-subsidy 138. Illustrative returns to each shareholders and the investment manager has been modelled and are shown in the Annex E. a) The modelled scenarios show: b) The fund needs over 2.5% revenue for all shareholders to receive returns c) The fund needs over 5% for the investment manager to be able to achieve their full performance fee or a greater volume of funds invested are needed. d) The income shown is the maximum that the fund manager can receive from the performance fee, and it varies between 0-14% of total fund revenue. e) A-shareholders are not deemed to be over-subsidised in any scenarios (ie receive a return greater that the % revenue of the fund) f) B-shareholders only receive more than 10% higher returns than the revenue of the fund only based on the low fund size (the current investments), with high LIBOR (5%) and fund revenues (10%) At least 95% of GCPF credit lines are debt and therefore there is a reasonably high degree of certainty in the maximum returns from the Fund s investments. Based on the current and pipeline investments the maximum margin from debt is 6.5%. Using this as a guide we would not expect the Fund to have revenues of funds invested above 5% The expected scenario is with a moderate fund size using a leverage of 1:1:3 for C:B:A funds invested and LIBOR at 1% and the revenue of the fund to be 5%. In this scenario A-shareholders would get 3.15% return on invested funds, B 4.8%, C shareholders 1% and the investment manager 0.65% as a performance fee. As a guide, if we assume that the private sector could achieve the same level of return as the fund achieves by taking all the risk (5%) this suggests that as the A-share returns are lower at 3.15%, it is not oversubsidising. When considering the C- share return we need to consider the cost of capital and LIBOR is used as proxy in the fund s structure, see Q5 for more information on this. 4.5 How will expenditure be monitored, reported, and accounted for? 141. The GCPF Board and Investment Committee receive from the investment manager (Deutsche Bank) a monthly report, a quarterly report and an annual report. a. Monthly Fund Report - The Monthly Fund Report is an uncommented standardised portfolio information delivered to the Investment Committee and Board members. b. Quarterly Fund Report - The Quarterly Fund Report displays the current status of the Fund, including investments by country, sector, purpose, maturity, loan volume. The Quarterly Fund Report will also indicate if the Fund is in compliance with its Investment Guidelines and requirements and report on the achieved energy/co 2 emission savings. 47

48 c. Annual Fund Report - The Annual Fund Report analyses the development of the Fund over time in terms of strategy and portfolio. It will provide a more detailed view of the current portfolio in comparison to the Quarterly Fund Report and contain explanations of the Fund s strategy and aims for the future. The Annual Fund Report will also deliver a broader view of the achieved energy/ CO 2 emission savings. With regards to the social and environmental performance of the Fund, the Annual Fund Report shall contain at least a written report prepared by the Investment Manager, evaluating the social and environmental performance of the Fund and the partner institutions for the previous fiscal year. This will describe in reasonable detail the implementation and operation of the Fund s social and environmental management system, the environmental and social performance of the partner institutions; and as applicable, compliance by partner institutions with any applicable corrective action plans. 48

49 5 Management Case 5.1 What are the Management Arrangements for implementing the intervention? What are the risks and how these will be managed? 142. The management arrangements of the fund are: a. Shareholders - The investors of the A, B and C share tranches are shareholders. To date these are KfW, IFC, DANIDA, German Ministry of Environment, Deutsche Bank (see section 1.1.5). Each share has one voting right with different tranches having different share prices $150,000, $25,000 and $50,000 respectively for A, B and C shares. Thus a UK investment and no further investments would give the UK 19% of the volume of the fund and 23% of the voting rights. b. Board of Directors - The Fund s Shareholders are represented by the Board of Directors, the GCPF legal representative, which oversees the Fund s activities and is responsible for strategic decisions. The Board of Directors have exclusive power to administer and manage the Fund, and appoints the Investment Committee which approves investment decisions proposed by the Investment Manager and monitors the other activities of the Investment Manager. c. Investment Committee - The committee approves investment decisions proposed by the Investment Manager and monitors the other activities of the Investment Manager. Shareholders can put forward members for the Investment Committee, which are approved by the Board. Currently, both members were nominated by KfW. a. Investment Manager - The Investment Manager conducts the Fund s business on behalf of the Board of Directors and the Investment Committee. b. Technical Assistance Facility Committee - This Committee represents the Facility s Donors and the Investment Committee, in order to ensure that the Fund s technical assistance directly supports Fund s objectives and investment activities. Similarly to the investment committee donors can put forward members for the committee and currently both members are from KfW. c. Technical Assistance Facility - The Investment Manager also manages the Technical Assistance Facility at arm s length, an activity overseen by the Technical Assistance Facility Committee. They assess technical assistance applications and appoint consultants as required If the UK make a contribution to GCPF, we can put forward a representative to be a member of the Board (under category iii below in para 115) and be able to influence the strategic direction of the fund (see further details in 5.2 below). There are currently three members of the Board: Monika Beck (KfW), Claudia Arce (KfW) and Ritu Kumar (TERI-Europe, put forward by IFC). The UK would also be able to put forward a member of the Investment committee (currently two members of KfW). However, given the resource constraints of the DECC ICF team we would not suggest this A Board member for GCPF needs to have a track record with relevant and appropriate skills and experience. DECC Commercial have confirmed there are no suitable individuals. We request funds of up to 50,000 from 2013 to 2016 to cover the procurement and contract for a suitably qualified individual to represent the UK on the Board of Directors The Board makes decision by majority vote and will have between 3 and 7 members with the below restriction so the fund continues to follow the objectives set and continues to be run in part by KfW: i. two directors from a list of candidates submitted by KfW; ii. up to three directors from the lists of candidates submitted by the three largest Class B Shareholders (determined by the number of issued Shares 49

50 held), other than the Investment Manager and the Shareholders having already submitted a list of candidates as above; iii. up to one director from the list of candidates submitted by the Class C Shareholders (determined by the number of issued Shares held), other than the Shareholders having already submitted a list of candidates as above; and iv. up to one director from a list submitted by the other Shareholders The senior responsible officer will be Pete Betts, DECC. GCPF will require FTE management requirement from the international climate finance team to manage and monitor the project GCPF is already established and the UK will be able to steer its strategic direction but not have full control over its decisions and its setup. The UK will be a member of the small (currently 3 but can be up to 7) Board for GCPF that operates by a majority share with a two-thirds majority needed to pass. This would mean that the UK would not be able to veto proposals Amendments to the issue document (the Mission Statement, the Investment Policy, the Payment Waterfall, the Risk Ratios or the fee structure) are proposed by the Board and need a 75% Board majority and require a 75% shareholder majority and by design C shareholders hold a minimum of 20% of votes, B-shareholders (DFIs with aligned interests) a min of 40% and A- shareholders a max of 40% of votes As with the Board structure, the rationale behind giving B shareholders a greater proportion of shares than A shareholders, is the expertise and ability of the former, combined with their ability to represent donors. It was stated that in order to attract in private sector investors, it was important that GCPF was not seen as being under public control (and thus at the whims of political, as opposed to commercial, considerations). It was suggested that DFIs bridged the gap between a pure commercial perspective and public policy objectives Whilst veto votes of shareholders are not possible, in practice it was unlikely that a decision would be pushed through by other shareholders that the UK disagreed with. This is because of the ability for any shareholder to redeem their shares and exit the fund, in the case of disagreement with changes with the issue document (see Q8). Whilst this would be an extreme measure (and in KfW s experience, this has never happened in any of their funds), the threat of it ensures that there is an effort to reach consensus on all issues Table 8 shows the key risks for GCPF s success and more detail is provided in the risk potential assessment in Annex F. Table 7: Key risks to the success of GCPF investments Risk Description Mitigating actions Assessment Local energy policy Medium Financial stability of partner banks Energy policy in various developing countries is in flux as a result of deregulation of power sectors and public support for renewable energy. Subsidies and other government incentives, but also regulatory improvements such as energy standardisations can significantly alter the incentives and interest for taking forward energy efficiency and renewable energy projects. The international finance crisis has weakened the stability of banking groups. Refinancing of the banking sector has become more expensive. The ability of banks in A thorough national review is done before investments are approved, see GCPF annual report for recent assessments. GCPF will closely monitor new markets and use insights for marketing, TA and support to its partners An assessment of partner institutions is done for each investment see Figure 7. There is a pipeline for 2012 and 2013 investments suggested finding Medium 50

51 General economic situation Lack of private sector investment Low levels of demand Loss of UK Investment developing countries to pay back loans has therefore been weakened. This increases the risk of losses in the fund. Global economic growth has slowed, and even in relatively fast growing developing economies enterprises are cutting back on medium to long term investments. This could stifle demand for GCPF from both local financial institutions and end users. Ascertaining private sector investors for A and B shares, and in the future potentially notes, is key to the success at GCPF in leveraging greater flows of finance and transitioning towards a sustainable market Financial institutions and end-users often lack the knowledge, experience and awareness of providing finance for energy efficiency and renewable energy. In order for GCPF to be successful it needs to partner with financial institutions to develop and successfully provide financial products to SMEs and households. Building a track record for low carbon investments that decreases the associated perceived risk is key for GCPF contributing to the development of a sustainable market for these investments. A loss of UK investment would occur if there were substantial defaults on the loans to partner local financial institutions. suitable partners will not limit investments. The outlook for many regions, particularly Asia and Latin America looks good and growth sufficient to absorb the Fund s target investment size. A pipeline for 2013 has been developed by the investment manager.. The Investment Manager is confident of securing private sector investment in the fund and one this has yet to be realized as the fund has not begun extensively looking for these investments. There are two private sector investors that are expected to completed by Dec 2012 and the investment managers assures there has been more interest. Additionally, the EFSE similarly structured fund, successfully managed to ascertain private investment. The technical assistance facility will help support financial institutions to develop knowledge and appropriate products. Experience from the first 18 months of operation where a pipeline of potential investments has already been found suggests that demand is high. See Annex C. Demand is assessed in the identification process of target countries. Previous experience of similar lending undertaken by KfW in South Eastern Europe has resulted in no losses and progress to date has experienced no losses.. Annual profits are recapitalized in the fund, which expands the fund and risk cushion. See Annex F for risk analysis of loss. Countries and local financial institutions are Investment managers is incentivised via performance fee to make sound investments. Low High expected to drop to Medium Low Low 5.2 What conditions apply (for financial aid only)? 152. The UK as a Director on the Board will be able to steer the investment strategy. In particular we would want to ensure that the types of investment ensure additional greenhouse gas 51

52 emissions savings and align with ICF principals and priorities. The current investment criteria is that investments deliver 20% energy or emissions reduction based on the current situation (see Annex A) and additionality is not explicitly addressed. In our analysis we assume 50% additional savings The investment strategy outlined does align with the ICF priorities, however, in order to mitigate the risk of misalignment or future changes, the UK will make our funding conditional that: a. within 36 months GCPF will build up a portfolio equivalent to DECC s investment in priority countries that DECC choses (this is to be in countries that are non-european and not upper middle income countries). b. text is added to the investment guidelines to ensure additionality is assessed for every investment. This is in order to avoid a crowding out of other private financing sources and will be that GCPF will refrain from investing if other offers from private commercial financiers with the same characteristics exist for the proposed investment c. there are limitations on GCPF supported projects to apply for certified emissions reductions We have negotiated these conditions with KfW and have agreement in principle we will still need to negotiate the exact value of the additional portfolio that these conditions on priority countries and CERs will apply to. As a next step we will take forward work with DECC legal advice and KfW as to whether these conditions will be included in the subscription form or a separate agreement will be needed. 5.3 How will progress and results be monitored, measured and evaluated? 155. The table below sets out the key short term milestones for GCPF. Monthly reports will be provided but these are not included and these will provide clearer pipeline dates for investments. Key Milestone Brazil investment $30m to be confirmed and disbursed Completion Date November/December 2012 Private sector investors to be confirmed December 2012 South Africa PV Croinmet 3m investment to close December 2012 Annual review for 2012 by GCPF January 2013 Disbursement of $15m of Vietnam loan March 2013 Quarterly report of progress private sector investors expected to be April 2013 confirmed DECC to invest in GCPF Summer 2013 GCPF quarterly report July 2013 Quarterly report of progress October 2013 GCPF Annual report January 2014 Six monthly review by DECC March 2014 Quarterly report of progress April 2014 Quarterly report of progress July 2014 Annual review by DECC September 2014 Quarterly report of progress October 2014 Detailed evaluation specification expected from BMU November 2014 Annual review for 2014 Aim to meet $500m volume of Fund January 2015 Expected BMU evaluation to begin February 2015 Six- monthly review by DECC March 2015 Annual review by DECC September 2015 Table 8: Key milestones Monitoring and measuring 52

53 156. As part of the environmental monitoring of GCPF s activities, the web application Carbon curve ( has been developed by Deutsche Bank. It addresses the high transaction costs barrier where for many small projects, it is too costly to perform energy audits in order to assess the expected energy and greenhouse gas emission savings. Carbon curve allows GCPF s partner institutions to calculate the expected savings for a series of standardized projects with minimal effort and accessible information, see Annex A for list of standardized project types. Key benefits are that it: a. Enables the financing of smaller projects that were previously not economically viable b. Provides a scalable and automated project evaluation platform that can grow with the partner institution s needs c. Allows anyone to perform analysis on pro forma energy savings projects 157. The Investment Manager will ensure that all projects comply with the terms and conditions agreed upon prior to the investment. This includes regular (quarterly and/or annual) review of the financial, social and environmental performance. Potential work out scenarios, restructurings, terminations and any other potential follow-up issues will be performed by the Investment Manager. Minimum reporting will include quarterly reporting of: a. Electricity production (also in comparison to forecasts) b. Energy savings calculations and CO 2 savings in comparison to baseline calculations c. Main activities in maintenance and repairs d. Cost tracking of operational expenditures e. Overall financial performance f. Financial statements (annually) 158. Monitoring of energy savings and CO 2 emissions including energy audits and impact analysis as necessary is included in the management arrangement of investments with partner institutions. Comprehensive energy audits and impact analysis can be financed in addition through the TA facility. In addition, there is the possibility to undertake a verification of the social and environmental criteria by an external consultant every three years. The progress of investments will be reported in quarterly reports. Figure 10: Carbon Curve measurement tool CarbonCurve CO 2 measurement tool Project Complexity: Complexity Standard Projects Non-Standard Projects EE/RE Project Type: Small sized, standardised projects Large scale, unique and/or highly complex projects Measurement: Automated, online questionnaire and calculations with instant approval Full energy audit via utility bill, or Full energy/carbon simulation Verification: Customized audit procedure to check data accuracy as per clients required thresholds Detailed energy audit, or Constant monitoring via smart meters Reporting: Consolidated emissions reduction progress across all project types Pipeline reporting by region, product and time period Automated distribution to approved stakeholders Deutsche Bank Asset Management 10/23/2012 6:13:09 PM 13 53

54 159. Table 10 identifies the ICF key performance indicators that are relevant and will be reported against for the GCPF including detail on expected frequency of reporting and any adjustments that are needed to ensure consistency with the KPI methodologies. 54

55 Influence and Leverage Environment People Table 9: ICF Key Performance Indicators KPI Level Type Relevant to GCPF 1. Numbers of people supported by ICF Output Quantitative NO Not Adaptation programmes to cope with the effects of climate change 2. Number of people with improved access Outcome Quantitative NO No on grid to clean energy as a result of ICF connections (as the existing programmes methodology is based). 3. Number of forest dependent people with Output Quantitative NO Not Forestry livelihoods benefits protected or improved as a result of ICF support 4. Number of people with improved resilience Outcome Quantitative NO Not Adaptation as a result of ICF support 5. Number of direct jobs created as a result of ICF support. 6. Change in Greenhouse Gas (GHG) emissions as a result of ICF support 7. Level of installed capacity of clean energy as a result of ICF support 8. Number of hectares where deforestation and degradation have been avoided through ICF support 9. Number of low carbon technologies supported (units installed) through ICF support 10. Value of ecosystem services generated or protected as a result of ICF support 11. Volume of public finance mobilised for climate change purposes as a result of ICF funding 12. Volume of private finance mobilised for climate change purposes as a result of ICF funding 13. Level of integration of climate change in national planning as a result of ICF support 14. Level of [institutional knowledge or awareness] of climate change issues as a result of ICF support 15. Extent to which ICF intervention is likely to have a transformational impact Approach proposes supplementary evaluation work to strengthen the assessment. Output Quantitative NO - Not directly. There may be some jobs impact, but this is not considered a key objective or outcome. Outcome Quantitative YES key outcome of GCPF. Expect regular reporting of average emissions savings and of cumulative savings based in the Carbon Curve calculations. Adjustments for additionality and attribution required for consistency with the KPI methodology. Output Quantitative YES but there are no specific targets Output Quantitative NO Not Forestry Output Quantitative YES - proxied through number of loans details provided in quarterly and annual reports. Outcome Quantitative NO Not Forestry Output / outcome Output / outcome Outcome Output Outcome Quantitative YES captured by contributions to GCPF details provided in quarterly and annual reports. Quantitative YES key outcome of GCPF. Expect regular reporting in quarterly and annual reports. Adjustments for additionality and attribution required for consistency with the KPI methodology. Qualitative NO (scorecard) Qualitative (scorecard) Qualitative (scorecard) YES - to be testing during the evaluation YES to be testing during the evaluation 55

56 5.3.2 Evaluation 160. Regular monitoring and reporting will provide a wealth of information to evaluate GCPF. The regular reporting will cover % of reduction of emissions/energy savings (relative to current levels/assumed baselines), greenhouse gas emissions savings accumulated (estimated from the energy savings forecast based on assumed emission factors), private sector and other investment secured, no. of partner institutions and no. of loans. This information will be available for DECC to use to feed in to cross-cutting ICF evaluations and also to the DECC project manager to investigate In addition to the regular monitoring GCPF itself may carry out evaluations, that DECC will have access to. At the request of any Investor or with the consent of the Board, but not more frequently than every three years, a report from a third party consultant (to be selected by the Fund on terms and conditions specified in the SEMS) to verify that the Fund is in compliance with the Social & Environmental Criteria and the SEMS GCPF is funded by Germany s International Climate Initiative (ICI) from BMU (Germany Ministry of Environment) and BMU have indicated they would welcome a joint evaluation where DECC would be involved in steering the evaluation. It is expected that this will take place in 2014 or 2015 when it is possible to see first results (with regard to CO 2 emissions savings in the countries, private sector participation in the fund etc.). We have earmarked up to 150k to contribute to the evaluation run by BMU Key questions/themes that we would add are: a. The development benefits (methods such as surveys and questionnaires and country level statistics), example questions are: i. Did end-users have an increased disposable income? ii. Were there rebound impacts from the energy efficiency measures? b. Transformational impact (which we would expect to be ascertained through questionnaires and surveys with financiers and local financial institutions), example questions are: i. Did partner institutions feel they had greater knowledge and understanding to assess and design low carbon products? ii. Did they develop low carbon products beyond GCPF? 164. GCPF will also be covered in the cross-cutting ICF evaluation studies. 56

57 6 References Asian Development Bank, 2012a. Evaluation Knowledge Brief Review of Energy Efficiency Interventions Management Response and Development Effectiveness Committee Chair s Summary, Asian Development Bank, Review of Energy Efficiency Interventions. Available at Blyth, W. and Savage. M Scaling-up Financing of Energy Efficiency through Provision of Targeted Risk Management Products. Oxford Energy Associate final report for EBRD. Available at: %20Final%20Report.pdf Climate Investment Funds, Clean Technology Fund Investment Plan for Mexico. Available at 01_16_09_web.pdf Eberlein, C and Hebb, M Climate Finance in Turkey: The contribution of the World Bank Clean Technology Fund to transforming the Turkish energy sector. Available at Dollar & Kraay, Growth is good for the poor. World Bank European Fund for Southeast Europe, Accessed Sept Farrell & Remes, Promoting energy efficiency in the developing world. Available at Global Climate Partnership Fund, Quarterly Fact Sheet as of 31/03/2012. Available at IEA, World Energy Outlook IEA, World Energy Outlook IEA, World Energy Outlook IEA, 2011b. Joint Public-Private Approaches for Energy Efficiency Finance Policies to scale-up private sector investment. IPCC, 2011: IPCC Special Report on Renewable Energy Sources and Climate Change Mitigation REEP, Accessed September REN21 Renewable Energy Policy Network, Renewables Global Status Report. REN21 Renewable Energy Policy Network Renewables 2005 Global Status Report. Sarkar & Singh, Financing energy efficiency in developing countries lessons learned and remaining challenges. Energy Policy Volume 38, Issue 10, October 2010, Pages Available at Sorrell,S., Mallett A., and Nye S Barriers to industrial energy efficiency: A literature review. UNIDO. DEVELOPMENT POLICY, STATISTICS AND RESEARCH BRANCH WORKING PAPER 10/2011 UNDP, TOWARDS AN ENERGY PLUS APPROACH FOR THE POOR: A review of good practices and lessons learned from Asia and the Pacific. UNFCCC, 2007, Investment and financial flows to address climate, UNFCCC Report World Bank, 2012 Inclusive green growth: The Pathway to Sustainable development. 57

58 7 Annexes 7.1 Annex A Guidelines for GCPF investment Types of GCPF investments GCPF provides finance for energy efficiency and renewable energy projects with the aim to decrease greenhouse gas emissions. In the case of energy efficiency projects they must result in the reduction of energy consumption of at least 20% in relative terms; or in the case of renewable energy projects, in the provision of energy from renewable sources, such as moving water (hydro), biomass (including bagasse, rice husk, wood waster), solar energy, wind energy and energy derived from municipal solid waste. There are five types of investments with different criteria that are outlined below. Note the additionality assessment and attributable calculation of emissions saved from funding equipment replacement needs to consider the business as usual situation. Energy Efficiency: Standardized investments Loans to residential or small commercial clients usually finance standardized products with known energy demand. Therefore, a simplified standardized analysis can suffice to obtain a close estimate of energy and CO2 savings. Criteria Recipients Loan size Savings targets Pre-project evaluation Post-project evaluation Eligible measures Restrictions Eligibility Households, home owner associations, SMEs (including ESCOs and small renewable energy companies); as well as municipal entities Smaller than USD 150k per measure (in case of combined measures) Portfolio of Sub-Loans financed by GCPF should lead to minimum average energy savings and/or CO2 reduction of 20% in relative terms The credit officer of the FI and loan recipient will fill out self audit questionnaire for planned measures. Standard appliances and equipment lists will be outlined for each country and included in the CO2 Monitoring and Reporting Tool. These lists serve as a basis for definition of standardized measures. The credit officer will enter relevant measures via the CO2 Monitoring and Reporting Tool and thereby calculate anticipated energy savings and corresponding CO2 emissions reductions. Simplified verification through the credit officer of the FI via invoice/receipt data for measures undertaken (e.g. reduction of energy bill pre and post installation, proof of instalment via invoice from a contractor or similar, random sample checks). Comparison of verification with pre-project calculation results calculated by the CO2 Monitoring and Reporting Tool. When deviations are found, the FI will be asked to provide more technical documentation. Including, but not limited to: building envelope upgrades (e.g. thermal insulation, replacement of doors/windows), lighting systems air handling systems service hot water systems heat distribution (e.g. electronic pumps for heating systems), decentralized electricity/heat generation (e.g. replacement of diesel motors at production sites with solar systems) replacement of major appliances At least 75% of each loan (including labor, taxes and incidental materials) should be spent on energy efficiency or renewable measures. The remaining portion of the loan should be directly in support of the energy efficiency or CO2 reduction measures 58

59 Energy Efficiency: Non-Standardized investments SME, commercial and large residential projects require less standardized equipment increasing the need for verification input taking into account the specific surroundings of the investment. Criteria Recipients Loan size Savings targets Pre-project evaluation Post-project evaluation Eligible measures Restrictions Eligibility Households, home owner associations, SMEs (including ESCOs and small renewable energy companies); as well as municipal entities Smaller than USD 500k per measure (in case of combined measures) Portfolio of Sub-Loans financed by GCPF should lead to minimum average energy savings and/or CO2 reduction of 20% in relative terms Energy savings analysis by the FI based on equipment specification /technical data intended to be used for the measure (assuming existing engineering know how of the personnel of the FI). For complex measures or when FI s know how is insufficient, energy audit to be submitted with the loan application. Verification through the credit officer of the FI via invoice/receipt data for measures undertaken (e.g. reduction of energy bill pre and post installation, proof of instalment via invoice from a contractor or similar, random sample checks). Comparison of verification results with pre-project calculation result of the energy audit. When deviations are found, the FI will be asked to provide more technical documentation. Including, but not limited to: building envelope upgrades (e.g. thermal insulation, replacement of doors/windows), commercial refrigeration systems lighting systems air handling systems service hot water systems heat distribution (e.g. electronic pumps for heating systems), decentralized electricity/heat generation (e.g replacement of diesel motors at production sites with solar systems) At least 75% of each loan (including labor, taxes and incidental materials) should be spent on energy efficiency or renewable measures. The remaining portion of the loan should be directly in support of the energy efficiency or CO2 reduction measures Energy Efficiency: Comprehensive investments Larger more complex investments where the energy saving benefits need to be calculated individually (eg. transportation sector in large cities, mid to large scale electricity generation. modernisation of the production process) allow little standardization and are capital intensive. Audits will be performed before and after the investment to analyze savings. Criteria Recipients Loan size Savings targets Pre-project evaluation Post-project evaluation Eligible measures Restrictions Eligibility Households, home owner associations, SMEs (including ESCOs and small renewable energy companies); as well as municipal entities Larger than USD 500k Portfolio of Sub-Loans financed by GCPF should lead to minimum average energy savings and/or CO2 reduction of 20% in relative terms Independent investment grade audit performed by certified ESCO/engineering company or by the FI itself (assuming existing engineering know- how and know- how with implementation of non standardised measures) analyzes potential and validity of the project. Verification through the FI via invoice/receipt data for measures undertaken (e.g. reduction of energy bill pre and post installation, proof of instalment via invoice from a contractor or similar, random sample checks) or verification by the energy auditor for complex projects, where deviations are likely to occur. All feasible EE measures At least 75% of each loan (including labor, taxes and incidental materials) should be spent on energy efficiency or renewable measures. The remaining portion of the loan should be directly in support of the energy efficiency or CO2 reduction measures 59

60 Small-scale Renewable Energy Small-scale renewable energy can be used for decentralized energy supply. It requires a pre-project estimate of electricity production, financial savings/revenues compared to current cost structures and regular updates on the production capacities. Criteria Recipients Loan size Savings targets Pre-project evaluation Post-project evaluation Eligible measures Restrictions Eligibility Households, home owner associations, SMEs (including ESCOs and small renewable energy companies); as well as municipal entities No minimum or maximum loan size. Not applicable. Savings will be measured against applicable baseline calculations. Pre-project due diligence should include a detailed business plan review, cost estimates for investments, estimates of energy savings in comparison to local baselines. CO2 emission reductions will be communicated via CO2 Monitoring and Reporting Tool. Verification via amount of electricity produced/consumed/fed into electricity grid. Updates are regularly provided to CO2 Monitoring and Reporting Tool. All feasible RE measures, including but not limited to moving water (hydro) of less than 10MW, biomass (including biogas, rice husk, wood waste and municipal solid waste) of less than 10MW, solar energy of less than 5MW, wind energy of less than 10MW At least 75% of each loan (including labor, taxes and incidental materials) should be spent on renewable energy measures. The remaining portion of the loan should be directly in support of the renewable energy measures Renewable energy direct investment Technology Minimum criteria At least 18 months of measurements taken on site at a height of at least 30 metres, Wind preferably at hub height. Data of minimum years. Large-scale hydropower plants according to the definition of the World Commission on Dams are excluded (height of 15 meters or Hydro more from the foundation or, if the height is between 5 and 15 meters, having a reservoir capacity of more than 3 million cubic meters). Analysis of existing fuel supply: Due diligence will include careful assessment of sustainability, long term supply risks (production, distribution, price etc.). The projects with onsite availability of biomass (e.g. farms) will be preferred. If the project includes crops also used for local food supply, the Fund shall ensure that the regional food self Biomass sufficiency is not endangered by the project. If the project does not have a contractually committed supply of fuel over the investment period (for debt investments), the available market for fuel should have at least 3x the capacity required by the project. For projects larger than 0.5MWp, combined satellite and local reference station data, and if possible on-site measurements, which should be analyzed by a qualified Solar independent engineer to estimate energy yield and uncertainty. Depending on the technology, a minimum degradation rate of 1% should be assumed. Geothermal Test drillings proving the existence of resources, no acceptance of drilling risks Environmental, social, and development guidelines All investments must adhere to the follow environment, social and development criteria that are outlined below. Environment & Social guidelines/climate definition: projects for the production of bio-liquids or bio-fuels. For the avoidance of doubt, the Borrower may use proceeds from Loans to invest in bio-gas or bio-mass projects; projects involving large scale land acquisitions or in areas which are either protected or have known environmental and social concerns projects involving resettlement of people projects having adverse impacts on indigenous people hydropower plants with a dam height of greater than 15 meters (from the fundament) or 5-15 meters dam height and a water reservoir of more than 3 million m 3 ; cross-border trade in waste and waste products unless compliant with the Basel Convention and the underlying regulations or waste incineration (other than forestry or agricultural waste 60

61 used for biomass power schemes) and processing of toxic waste (other than landfill gas waste-to-energy schemes or flaring), provided that where waste incineration related to forestry or agricultural waste used for biomass power schemes and processing of toxic waste related to landfill gas waste-to-energy schemes or flaring is envisaged: (i) extensive due diligence is performed in order to avoid any reputation risk to the Lender and its investors, (ii) additional studies and project monitoring are performed; nuclear power projects; instruments (including, but not limited to, financial instruments) that would result in engaging, directly or indirectly, in speculative investments such as, amongst others, commodities, commodity contracts or forward currency contracts, unless for hedging purposes against currency risks. Development mandate criteria The project should be a local landmark transaction promoting the use of sustainable energy. Ideally, the project involves significant local input (e.g. employment of local companies or FIs, job creation). The project should also implement the sustainable energy use into a wider economic chain (e.g. utilizing organic waste of a chicken poultry farm) and support regional energy self sufficiency. These criteria shall be used to prefer certain projects over others and guide the decisionmaking processes of the Investment Manager and the Investment Committee. They shall not be binding and be re-evaluated for each project. 61

62 7.2 Annex B GCPF performance to date GCPF began to mobilise finance from the end of 2010 and the first partner institutions (Sekerbank in Turkey) was approved in April Three quarterly reports are available on the website for Q4 2011, Q1 and Q and 2011 s an annual report. Additionally we have sought the latest information from the fund manager in August Finances There are commitments totalling $204m with the split across shares and organisations shown in Figure 9. Figure 9 shows there are funds committed that have not yet been disbursed and further lending to local financial institutions can be made using these. Note that the uncommitted investments are A and B shares and additional C-shares would enable more flexibility in seeking further partner institutions as more favourable loan conditions would be acceptable to meet the fund s required returns. A UK investment of 30m (c.$48m) would provide the UK with 19% of the investments committed (currently $204 + UK investment $48 = $252m) to GCPF and of the 49.5% of the C-shares (this would total $49m. Figure 11 GCPF subscriptions The annual report shows that GCPF turned a small profit its first year ($8,236.17) with a total income of just under $1m, and a 94% increase in assets, see Table Annual report 62

63 Table 10: Profit and Loss of GCPF for Investments The investment managers have provided the most up to date information of loan investments, see table. It shows $105m has been approved by the Investment Committee to five banks in Ukraine, Turkey, Ecuador (two banks) and Vietnam. $90m has been disbursed to 5 partner FI s and in Turkey 413 loan with a value 13m have been lent to local SME s in Turkey and Ecuador, with the average loan size is approximately $30,000. There have been no defaults to date. Table 11: GCPF credits to date There has been only one renewable energy direct investment approved by the Investment Committee to date. This is a direct investment into a PV installation in South Africa to Cronimet. Table 12 Renewable energy investment in South Africa 1 Location Thabazimbi Region, South Africa 2 Capacity 1 MW 3 Annual Electrical Production 1840 MWh/annum 63