MLEI Cambridgeshire low carbon investment and delivery model

Transcription

1 MLEI Cambridgeshire low carbon investment and delivery model 1 MLEI Cambridgeshire low carbon investment and delivery model

2 Document type: Client: Client contact: Report Cambridgeshire County Council Sheryl French Other details: Title: MLEI Cambridgeshire low carbon investment and delivery model Date: 31/10/2013 Author: Signature Date: Robert Clark... (hard copy only)... (hard copy only) QA: Signature Date: Duncan Price... (hard copy only)... (hard copy only) Contact details: Robert Clark Telephone: MLEI Cambridgeshire low carbon investment and delivery model

3 Contents Glossary... 4 Executive Summary Project Overview Aims and objectives Research methodology Critique of current and emerging policy How does public investment support the low carbon economy? Cambridgeshire Low Carbon Investment and Delivery Model Next steps Introduction: what are we trying to do? Purpose of this report The aim and scope of the MLEI project Background: why are we trying to do it? Investor views on market constraints: insufficient bankable projects Role of local authorities How can this be achieved? The Cambridgeshire Low Carbon Investment and Delivery Model Cambridgeshire Low Carbon Development Unit Cambridgeshire Low Carbon Investment Fund Programme development Implementation What are the finance options? Introduction What are the potential sources of finance? How public sector can crowd in private investment Market views on the proposed model What are the options for supporting project delivery? Overview Procurement routes Contract structures Conclusions regarding delivery mechanisms Critique of current and emerging local authority policy The need for supportive policies Review of current and emerging policies MLEI Cambridgeshire low carbon investment and delivery model

4 8. Conclusions Key recommendations Next steps Appendix A Investor Discussion Notes Glossary Amortising when a loan is repaid through regular annual payments with interest, similar to a repayment mortgage Asset backed or securitised bonds similar to ordinary bonds but have specific assets whose revenues pay the interest and principal. An ordinary bond s payments are generally guaranteed by the company that issues them. In asset backed or securitised bonds a set of revenue generating assets are put into a special purpose company and these assets pay the bond holder their interest and principal. Bonds can variously be described as IOUs, loans or debts. They are similar to bank loans, but generally last longer (from one year to over 30 years). When institutions, companies, governments and other entities want to raise long term finance but do not want to dilute their shareholdings (or, indeed, cannot issue share capital), they turn to the bond markets. The biggest investors in the UK are the insurance companies and pension funds. They buy bonds to generate return, offset their liabilities, generate income or diversify their portfolios. Bullet Repayment where a loan is repaid with interest only for the duration of the loan and the principal is repaid as a lump sum at the end of the loan term Corporate Finance debt provided by banks to companies that have a proven track record, using on-balance sheet assets as collateral. Most mature companies have access to corporate finance, but have limited total debt loads and therefore must rationalise each additional loan with other capital needs. Cost of Capital the weighted average of an organisation s costs of debt and equity, in turn linked to risk involved in the underlying project or company. From an investment perspective, to be worthwhile, the expected return that an investor receives for putting money at risk must be greater than the cost of capital. Counterparty risk the risk that an investor, lender or organisation entering into a contract perceives in the credit worthiness of the borrower or contract counterparty. Credit ratings there are three major rating agencies, Moody s, Standard and Poor s (S&P) and Fitch. They all have similar rating categories, which reflect the likelihood of default or a rating changing. Debt securities such as bonds, notes, mortgages and other forms of paper that indicate the intent to repay an amount owed. A cash payment of interest and/or principal is made at a later date. This is in contrast to an equity investment where there is an exchange of shares of common stock, or ownership of the company. Debt to Equity this ratio simply indicates the amount of debt from banks and the amount of equity from the various sources in a given project. Owners will generally want to introduce debt into a renewable energy project to reduce the overall cost of funds and enhance their returns, given that debt is cheaper than equity as it takes a lower risk position. 4 MLEI Cambridgeshire low carbon investment and delivery model

5 Discount rate - The discount rate is used to convert all costs and benefits to present values, so that they can be compared. The discount rate which is used in financial calculations is usually chosen to be equal to the Cost of Capital. Equity an investment in exchange for ownership of a company entitled to the earnings of a company after all other investors (e.g. debt-holders) have been paid. Gilt a bond issued by the UK Government Institutional Investors includes insurance companies and pension funds, which tend to invest large amounts of money over a long time horizon with lower risk appetite. Internal Rate of Return (IRR) is used for each potential project as a key tool in reaching investment decisions. It is used to measure and compare the profitability of investments. Funds will generally have an expectation of what IRR they need to achieve, known as a hurdle rate. The IRR can be said to be the earnings from an investment, in the form of an annual rate of interest. Junior debt - Debt that is either unsecured or has a lower priority than that of another debt claim on the same asset or property, also called Subordinated Debt. Mezzanine finance as its name implies, this type of lending sits between the top level of senior bank debt and the equity ownership of a project or company. Mezzanine loans take more risk than senior debt because regular repayments of the mezzanine loan are made after those for senior debt; however, the risk is less than equity ownership in the company. Mezzanine loans are usually of shorter duration and more expensive for borrowers, but pays a greater return to the lender (mezzanine debt may be provided by a bank or other financial institution). A renewable energy project may seek mezzanine finance if the amount of bank debt it can access is insufficient: the mezzanine loan may be a cheaper way of replacing some of the additional equity that would be needed in that situation, and therefore can improve the cost of overall finance and thus the rate of return for owners. Net Present Value (NPV) - NPV is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise long-term projects. The NPV of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows. Non Domestic Energy Efficiency a terms used by the Green Investment Bank and European Investment Bank that refers to an assets class of investment projects covering both energy efficiency and on-site generation technology applied to buildings used for commercial, industrial and civil purpose (and not residential) Non-recourse Project Finance or Limited Recourse Finance debt is borrowed for a specific project, the amount of debt made available will be linked to the revenue the project will generate over a period of time, as this is the means to pay back the debt. This amount is then adjusted to reflect inherent risks, e.g. the production and sale of power. In the case of a problem with loan repayment, rather like a typical mortgage, the banks will establish first charge or claim over the assets of a business, as described above. The first tranche of debt to get repaid from the project is usually called senior debt. Pari-Pasu meaning on the same terms i.e. same interest rate and length of contract as another lender. Private Finance Initiative (PFI) is a way of creating public private partnerships (PPPs) by funding public infrastructure projects with private capital. Developed initially by the Australian and United Kingdom Governments, PFI projects aim to deliver infrastructure on behalf of the public sector, together with the provision of associated services such as maintenance. 5 MLEI Cambridgeshire low carbon investment and delivery model

6 Public-Private Partnership (PPP) a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies. PPP involves a contract between a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. Refinancing this is where a project or a business has already borrowed money but decides, or needs, to replace existing debt arrangements with new ones, similar to refinancing a mortgage. Reasons for refinancing include: more attractive terms becoming available in the market (perhaps as lenders become more familiar with the technology, meaning more money can be borrowed against the asset); or the duration of the loan facility, e.g. loans are often structured to become more expensive over time because of the increasing risk of changes to regulation or market conditions. One of the results of the financial crisis was that banks became extremely reluctant to lend for more than six or seven years, which forced projects that required longer-term loans to refinance in the future, and take the risk of the terms available at that time. Securities - A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into debt securities and equity securities. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, limited partnership units, and various other formal investment instruments that are negotiable and fungible. Commercial enterprises have traditionally used securities as a means of raising new capital. In recent decades, securities have been issued to repackage existing assets. Special Purpose Vehicle (SPV) a discrete business created around a project, in a legal form, to permit lending and equity investments, disconnected from other obligations or activities of a company. For example, a utility forming a joint venture with a partner will use an SPV as a clean legal structure for the enterprise. From a bank perspective providing project finance into an SPV can ensure it has uncontested rights over the assets, an equity investor will invest into an SPV often restricting its obligations to that SPV company and not linking it to the ownership of other activities of the investor. Underwriting and Syndication A lead bank agrees to provide a large bank debt facility to a client for a particular project, but the loan will be larger than the bank itself can provide on its own for the long term. The bank receives a fee from the client for providing, or underwriting, the whole facility at the outset and taking the risk that it can sell pieces of the agreed loan to other lenders required ( syndication ), on terms and pricing already agreed with the client. The underwriting bank takes the risk that it has achieved the right balance of risk and return to attract enough other lenders into the transaction. 6 MLEI Cambridgeshire low carbon investment and delivery model

7 Executive Summary The Mobilising Local Energy Investment (MLEI) project is examining ways in which the Cambridgeshire area can bring forward inward investment in low carbon infrastructure in order to increase energy security, lower energy bills in the area and put Cambridgeshire at the forefront of the low carbon economy. This report outlines a proposed model for delivery against this ambition which has been created and tested iteratively by the project team, external experts and key stakeholders This ambition is being considered against a background of expected cuts in Local Authority budgets and the need to ensure that any investment made by the Local Authorities involved would be both sustainable and cash generative. The potential for low carbon infrastructure growth in Cambridgeshire was demonstrated through the Cambridgeshire Renewable Infrastructure Framework (CRIF) project which identified the scope for 2-6bn of inward investment that would not only improve local infrastructure but also potentially support local economic growth in terms of growing clean tech and green economy companies in the area. The work has been focused on understanding how better use can be made of Cambridgeshire s tangible assets (such as Council owned land and building) and intangible assets (such as its fast growing clean tech sector) in order to support Cambridgeshire s ambitions for the future. The project has examined how the policy landscape across Cambridgeshire might better align activities across all partners in order to support inward investment and local carbon infrastructure development. The project has also explored how Cambridgeshire might support practical activities in the form of a shared delivery team (the CLCDU: Cambridgeshire Low Carbon Development Unit) that could develop the pipeline of projects and investment opportunities. As well as managing the investment programme the CLCDU would play an important role in steering the projects through the Cambridgeshire local authorities processes such as planning, budget setting, asset management, procurement, cabinet approvals, etc. The report outlines the fact that local government is in a unique position to be able to connect complex projects together, de-risk them, and make them more appealing to external investors and it should expect to see a financial return from doing so. The report also examines the potential for local authorities to borrow money or use reserves to make capital investments in energy projects themselves, servicing debt from project revenues and generating free cash to support public services and continue developing a pipeline of projects. Now that a potential model has been described, the next phase of the project will need to develop resource commitments for the delivery phase in parallel with running detailed scenario plans (based on deliverable projects and programmes) in order to understand potential risks and opportunities in more detail. This will be examined further in a second report. 7 MLEI Cambridgeshire low carbon investment and delivery model

8 Key recommendations 1. To develop a model that addresses the primary market constraint that there is an insufficient number of bankable projects available ready for investment at a scale that meets the needs of investors. 2. To develop the business case for a self-financing Cambridgeshire Low Carbon Delivery Unit (CLCDU) to address this need. 3. To augment this through the establishment of a fund that can invest in projects alongside the private sector to generate new sources of revenue to grow the CLCDU and provide returns to investing authorities. 4. To develop further the councils own policies and practices to align with the ambition of releasing a strong pipeline of local energy projects. 8 MLEI Cambridgeshire low carbon investment and delivery model

9 1. Project Overview 1.1 Aims and objectives The Cambridgeshire authorities (Cambridgeshire County Council, Cambridge City Council, South Cambridgeshire District Council and Huntingdonshire District Council plus Peterborough City Council as learning partners) wish to work together to secure investment into local low carbon infrastructure to improve energy security for residents and businesses, mitigate against rising energy bills through the reduction of energy consumption and, in so doing, grow the local green economy by creating and supporting local jobs in clean energy technologies and exporting this expertise outside the county and UK. Affordable, low carbon energy is seen as an essential element of Cambridgeshire s infrastructure as it develops over the next decades. Importantly, this ambition is being considered against a background of expected cuts in Local Authority budgets and the need to ensure that any investment made by the Local Authorities involved would be both sustainable and cash generative. In doing this they wish to address not just what they can do with their own assets but also what can be done to support all relevant sectors within the county. They are ultimately looking to attract 2-6b of renewable energy investment into the county over the next years plus hundreds of millions of pounds to support energy efficiency. There is a short term requirement, linked to the project funding, to deliver 17m of low carbon investment by August The project is being funded by the European Commission s Intelligent Energy Europe programme, Mobilising Local Energy Investment (MLEI) which is intended to establish new finance and delivery mechanisms at a local level. The aim of this document is to summarise the evidence base for a proposed investment and delivery model for energy efficiency and clean energy in Cambridgeshire. The report s authors and the project team (made up of Cambridgeshire City, Districts and County) have developed this evidence in partnership with key stakeholders throughout Cambridgeshire. The work to date has been developed co-productively with this group and also with industry experts (with respect to finance and low carbon technologies) and this report represents a summary of the views and ideas expressed during the course of structured discussions and research with each of these groups. This report addresses the following key questions: Where are we and why are we trying to implement intra-authority low carbon investment and delivery interventions? What interventions are appropriate? How do the public and private sectors need to engage? And are they able / prepared to do so? What model of interventions is recommended? Where can finance come from? What are the options for supporting project delivery? 9 MLEI Cambridgeshire low carbon investment and delivery model

10 1.2 Research methodology The MLEI project model has been created using an iterative approach, working closely with stakeholders. An initial model was developed and described by the project team and then tested and refined in workshops with the project sponsors. The updated model was then: Used as a basis for one to one interviews with industry experts and key stakeholders Discussed in a workshop format with a wider group of stakeholders including elected representatives By combining research and engagement in this way and working co-productively we have been able to ensure that this final report reflects stakeholder views in a more substantive way than might have been possible if we had worked sequentially through design and then engagement. As can be seen in the report the model has been amended in direct response to feedback and as a result we can be confident that the report represents a rounded view of proposed structure of interventions. In the next phase of work we will be taking a similarly co-productive approach to refine and develop the solution. 1.3 Critique of current and emerging policy An essential component needed to align stakeholders to deliver against the shared MLEI objective is to ensure that the policy landscape is complementary where possible. A high level review has been carried out of the status of current and emerging corporate and planning policy within Cambridgeshire by the project team and has been tested with stakeholders via interviews and events. The research with experts and stakeholders outlined in this report indicates strongly that it is imperative that each of the councils have policies and practices that are aligned with the MLEI objectives to support the development of a strong pipeline of projects over time. Without a strong, long term pipeline market confidence will be limited. At present, planning policies are variable across the authorities, however, better alignment could be achieved by setting a clear development context and presenting a comprehensive set of specific requirements with supporting guidance. The authorities should examine the extent to which this is still possible as many of the authorities are actively preparing Local Plan and associated planning documents. In section 7 we highlight opportunities for strengthening planning policies by limiting constraints on renewable energy, bringing forward policies for heat networks and for consequential energy improvements when adapting or extending buildings and requiring low carbon standards in new development. The latter could be linked to a county-wide Community Energy Fund so as to maximise local retention of revenues proposed national policy of Allowable Solutions which will enable off-site delivery of zero carbon standards after At a corporate level, the nature and strength of drivers to deliver major energy investment is variable, with some councils considering them only where they support other key goals, such as revenue generation. Other councils, notably Cambridge City, retain delivery of carbon reduction and energy performance as key strategic outcomes. An important premise of the proposed interventions is to achieve revenue generation or energy costs reductions and as such all authorities should benefit from active engagement. 10 MLEI Cambridgeshire low carbon investment and delivery model

11 There is a mixed picture across the authorities when it comes to ownership of assets. The County Council and Cambridge City Council have access to significant land and building assets that could support the development of pipeline of energy projects; however the pipeline is latent and not yet fully activated. There is also an opportunity to integrate the MLEI interventions into the emerging public sector wide asset management strategy. Part of the county-wide strategy focuses on the efficient development of shared accommodation, which is being delivered through the Making Assets Count (MAC) programme, which principally seeks to co-ordinate the development of new accommodation through disposal, planning, investment and delivery. Thus the MLEI programme could seek to implement low carbon projects through the MAC process, although this will relate to a relatively small number of new developments and probably focus on energy infrastructure such as district heating or generation assets on these development sites. Outside of the MAC programme, individual councils asset management policies, and, in particular, their management practices, should be examined to consider how they could facilitate the development of energy efficiency and energy generation projects, which will provide an opportunity to generate revenue and also support the wider goals of economic growth within the county. Experience of delivering energy efficiency / carbon reduction programmes is variable across the authorities. Most are delivering energy-specific projects on a small, ad hoc basis. Without exception each council has confirmed its resources are insufficient to deliver a major energy investment programme and that additional resources would be required to actively support delivery. 1.4 How does public investment support the low carbon economy? Previous technical analysis has shown that there is huge untapped potential for energy efficiency and renewable energy projects both across the UK and within Cambridgeshire. Furthermore, funders exist that are looking for bankable projects to invest in or to lend to, yet rates of investment are slow. Evidence has been sought from the investor market about the nature of the problem and their views on potential solutions and the conclusion in this report have been discussed and explored in detail. The primary market constraint is that there is insufficient numbers of bankable projects available ready for investment at a scale that meets the requirements of the market. This is a hugely fragmented market with small projects, multiple technologies, small and big players and a mixed track record of success creating a piecemeal approach which is more expensive, risky and can miss opportunities. This is compounded by high perceptions of risk by investors encompassing technology risk, policy risk, counterparty risk and performance risk. Asset owners (such as land and property owners) lack an understanding of how to put together energy infrastructure projects. As a result the sector suffers from high transaction costs and no economies of scale. All these factors point to the need for strategic intervention to facilitate development and funding of projects in order to deliver the scale of investment that is sought. Local government is in a unique position to be able to connect projects together and de-risk them to make them more appealing to external investors. The evidence suggests that local authorities could have four key roles to play: 11 MLEI Cambridgeshire low carbon investment and delivery model

12 1. Setting the investment context through development of local policies that support the creation of an investment pipeline on the basis of expected outcomes including local economic development, the reduction in energy demand, reduced greenhouse gas emissions and alleviation of social problems such as fuel poverty 2. Convening local authorities can bring together the required private, public and third sector stakeholders that are required for successful business models. This can be done formally through procurement or the use of the Greater Cambridge, Greater Peterborough Local Enterprise Partnership (GCGPLEP) or informally through their various networks 3. De-risking through the use of assets local authorities have tangible assets such a buildings and land which can kick-start the required investment pipeline and can also use intangible assets such as brand and the award of contracts 4. Enabling finance local authorities, whilst financially constrained, can use their access to low cost capital to initiate programmes and create an investment return. This return can repay start-up costs and create a long term income that fully finances pre-construction project development costs for a portfolio of projects. Combining low cost capital into projects with acceptance of longer periods of return (than commercial investor would expect) would allow some projects to be brought forward early. This would require transparency and state aid issues to be addressed. 1.5 Cambridgeshire Low Carbon Investment and Delivery Model It is proposed to establish a Cambridgeshire Low Carbon Development Unit to develop a pipeline of investible projects and to co-ordinate investment in support of these. It will draw in public sector funds and crowd in co-investment from the private sector by bundling projects to achieve scale, reducing transaction costs and mitigating project and commercial risks. Acting as a self-financing unit, it will generate income from projects through development / arrangement fees and long term management fees. It will be designed to be fast and nimble, able to navigate the decision making processes of public and private sectors with both finance and project competencies. All Cambridgeshire local authorities, investing or otherwise, will support the unit through bringing forward projects and facilitating delivery. It is also proposed to set up a Cambridgeshire Low Carbon Investment Fund which could be seeded with public money (via prudential borrowing or reserves) and/or other sources of funding. It invests alongside structural funds (e.g. ERDF) and development banks (e.g. EIB, GIB) and levers private sector funding (debt or equity). Funding is provided for a mixture of short, medium and long term projects of up to 25 years. Once the fund has placed its initial investments, the authority can retain the fund to generate income, invest in further projects, grow the fund further, or exit the fund by selling the portfolio of investments (i.e. refinance) via community share offer, bond issue or sale to a fund. The returns from the fund will be available to re-invest in further projects. A key objective of the development unit would be to develop a portfolio of projects in the county across a range of sectors and technologies. Initial focus will be the public sector estate including local authorities, fire, police, health and schools. Working with strong delivery partners and using a range of delivery models, the development unit will establish energy services and performance contracts that are bankable and pass risks to those that are best placed to manage them. It will apply its expertise to 12 MLEI Cambridgeshire low carbon investment and delivery model

13 unlock investment in commercial buildings, energy infrastructure and community renewables, as well as enabling public and private investment into larger scale energy projects. 1.6 Next steps In parallel with the work described in this report, a financial model has been built to inform decisions on the shape, structure and priorities of the development unit and the fund. Through scenario planning this will help test the business case for each with the authorities. The project will then look at a number of other areas including operation, specification and governance; monitoring and verification procedures for the fund; an outline business case for the setup of the delivery unit; the business case for a preferred fund and process for set up of the fund. 13 MLEI Cambridgeshire low carbon investment and delivery model

14 2. Introduction: what are we trying to do? The section outlines the purpose of the report and the aim and scope of the overall MLEI project. 2.1 Purpose of this report The aim of this document is to summarise the evidence base, that has been gathered through discussions and research gathered from local and national experts, for a proposed investment and delivery model for energy efficiency and clean energy in Cambridgeshire. This model was drawn up by a consultancy team led by Verco and then tested iteratively with a range of stakeholders (from public and private sectors) in order to ensure that the final solution reflects both local and national expertise. In this report we set out the background to the project, the aims of the project sponsors and the terms of reference for our work. The report presents a critique of the current and emerging policy within each of the local authorities taking part in the project, covering areas such as planning, corporate policy and asset management. We examine how public sector investment can support the development of the low carbon economy by first looking at the range of funding sources and then the different finance structures that can be used to attract private investment. We present the findings of our discussions with the investment community on what they see as the challenges for investing in this sector before drawing some conclusions on the potential roles for the public sector, and local authorities in particular, in creating demand and smoothing the process for the successful development of low carbon projects. We examine a range of existing and planned delivery mechanisms and their degree of fit with the MLEI objectives. This includes an appraisal of a number of procurement routes and contract types. We complete the report by presenting in outline a proposed solution to the challenges that have been identified before summarising the next steps of our work. 2.2 The aim and scope of the MLEI project The Cambridgeshire authorities (Cambridgeshire County Council, Cambridge City Council, South Cambridgeshire District Council and Huntingdonshire District Council plus Peterborough City Council, as learning partners) wish to work together to secure investment into local low carbon infrastructure to improve energy security for residents and businesses, mitigate against rising energy bills through the reduction of energy consumption and, in so doing, grow the local green economy by creating and supporting local jobs in clean energy technologies and exporting this expertise outside the county and UK. Affordable, low carbon energy is being seen as an essential element of Cambridgeshire s infrastructure as it develops over the next decades. In doing this the Cambridgeshire authorities wish to address not just what they can do with their own assets but also what can be done to support all relevant sectors within the county. In the short term, the MLEI project must deliver at least 17million of investment by August 2015 as part of its contract with the EU. It must also pilot finance and delivery mechanisms that provide a legacy for investment and which will ultimately seek to drive 2-6bn of renewable energy investment plus hundreds of millions of pounds to support energy efficiency over the next These investments can cover: 14 MLEI Cambridgeshire low carbon investment and delivery model

15 Energy efficiency and renewable energy in buildings o Domestic working at community scale, where communities wish to work together to achieve an area approach to energy investment possibly using neighbourhood planning as a means to facilitate investment and deliver in energy efficiency and generation. It has been agreed that a focus on domestic energy efficiency on individual properties generally falls outside the remit of the proposed solution as this is being addressed through another programme based on the Green Deal legislation. To the extent that a mechanism can augment existing programmes, it should be considered. o Non-domestic public buildings such as schools, public services etc. o Non-domestic commercial buildings Heat networks with or without Combined Heat and Power (CHP) Community renewable energy programmes Large scale renewables A critical aim is the aggregation of projects to achieve the scale and longevity of opportunities, which in turn will unlock the significant scale of investment required. Importantly, this ambition is being considered against a background of expected cuts in local authority budgets and the need to ensure that any investment made by the local authorities involved would be both sustainable and cash generative and avoiding fiscal burden. In summary, the report presents the evidence base for a proposed investment and delivery model for energy efficiency and clean energy in Cambridgeshire. The aim of the MLEI project is to establish these mechanisms with a view to their long term use and also to demonstrate their application to deliver at least 17m investment by August MLEI Cambridgeshire low carbon investment and delivery model

16 3. Background: why are we trying to do it? The section outlines provides contextual background to the project and explains why the MLEI project has been established. It summarises investors views on the market constraints for investment in local energy projects and presents high level opportunities for local authorities to support the development of a stronger market. With energy prices and supply become increasingly volatile Cambridgeshire is seeking to position itself at the forefront of the low carbon economy in order to support local residents and businesses. It recognises that energy prices are rising and becoming an increasing burden on local households and businesses. Furthermore, the UK remains committed to delivering against its carbon budgets. Improved energy efficiency and local clean energy generation can simultaneously drive down costs for the economy, secure local energy supplies for critical services, reduce carbon emissions as well as provide local sustainable investment opportunities. The Cambridgeshire Renewables Infrastructure Framework (CRIF) (Verco 2012) established that 2-6bn investment is needed in order to deliver 28% of its energy from local generation for the county to meet its share of the UK carbon targets. In addition, energy efficiency investment potential has been estimated at around 800m, covering both domestic ( 640million) and non-domestic buildings ( 150million) In order to unlock this potential, and crucially, to deliver affordable energy for residents and business it is important that there is action in each sector public, commercial and communities. 3.1 Investor views on market constraints: insufficient bankable projects We sought evidence from a wide range of investor organisations 1 about the nature of the problem (see Appendix A for summary notes of meetings held). It was found that the primary market constraint is that there is an insufficient number of bankable projects available ready for investment at a scale that meets the requirements of the market, rather than there being a lack of available funds. This is a hugely fragmented market with small projects, multiple technologies, small and big players and a mixed track record of success. This is compounded by high perceptions of risk by investors encompassing technology risk, policy risk, counterparty risk and performance risk. Asset owners (such as land and property owners) lack an understanding of how to put together projects. As a result the sector suffers from high transaction costs and no economies of scale. All these factors point to the need for a different approach to developing and funding projects in order to deliver the scale of investment that is sought. Potential investors gave us a consistent message: the primary market constraint is a lack of investment-grade projects. 1 Discussion with the following organisations where held; ANESCO (a service delivery business operating in partnership with a number of investment funds), BBIF, Beetle Capital, European Investment Bank (EIB), Green Investment Bank (GIB), Greencoat, IMPAX, Leapfrog, Pension Corporation, Sustainable Development Capital Limited (SDCL), Resonance and WHEB. 16 MLEI Cambridgeshire low carbon investment and delivery model

17 3.2 Role of local authorities The evidence suggests that local authorities could have four key roles to play to attract finance, create demand and smooth the delivery process. Where the finance sector sees a strong pipeline of investable projects they will justify their own investment in start-up costs and project engagement. The four key roles are: 1. Setting a strong and clear investment context through development of local planning policies together with organisational policies (and practices) that support the creation of an investment pipeline on the basis of expected outcomes including local economic development, the reduction in energy demand and greenhouse gas emissions and alleviation of social problems such as fuel poverty. Section 0 of this report provides a critique of these issues. 2. Convening local authorities can bring together the required private, public and third sector stakeholders that are required for successful business models. This can be done formally through procurement or the use of the LEP, or informally through their various networks. 3. De-risking or building confidence through the use of assets local authorities have tangible assets such a buildings and land which can kick-start the required investment pipeline and can also use intangible assets such as brand and the award of contracts. 4. Enabling finance local authorities, whilst financially constrained, can use their access to low cost capital to initiate programmes, bringing forward projects with lower, longer returns than the commercial sector will typically be prepared to do. This will create returns that can repay start-up costs and create a long term income that fully finances pre-construction project development costs for a portfolio of projects. However, it is recognised that different local authorities might have different aspirations for low carbon delivery and have differing levels of comfort with investment and risk taking. As such it is proposed that there are three levels of engagement in the delivery model: Anchor, Investing and Supporting. Table 3-1. Engagement options for Local Authorities Activity Anchor Investing Supporting Programme management Responsible for implementation of the programme of investment X X Investment Invests, using reserves or PWLB to start the programme and in project funding to generate returns X Governance As investors, part of the governance structure X Pipeline development Responsible for developing pipelines of projects by mitigating barriers (including planning policy), and through pro-active use of own assets and encouragement of other assets to come forward 17 MLEI Cambridgeshire low carbon investment and delivery model

18 In summary, it was found that the primary market constraint is that there is an insufficient number of bankable projects available ready for investment at a scale that meets the requirements of the market. Local authorities could have four key roles to play to attract finance, create demand and smooth the delivery process. These include: setting a strong and clear investment context; convening stakeholders, de-risking or building confidence through the use of their own assets and enabling finance through their access to low cost capital. 18 MLEI Cambridgeshire low carbon investment and delivery model

19 4. How can this be achieved? The section examines a potential investment and delivery model comprising a fund and a development unit. It presents the benefits of a fund, how it would grow and how local authorities could exit. Principles of fund operation are explored along with options for how the fund would invest and lend. Programme development issues are set out including the role of delivery partners, different delivery mechanisms and an approach to implementation. 4.1 The Cambridgeshire Low Carbon Investment and Delivery Model The following sections describe the model of practical intervention that is proposed to deliver the objectives described above. Figure 4-1 provides a graphical description of key elements of this intervention. The graphic shows three levels: Finance, Development and Projects. At the finance level the proposal is to establish a dedicated investment fund with seed funding from local authorities and possible input from other public organisations and private sector investors. At the development level sits a Development Unit (the Cambridge Low Carbon Development Unit) responsible for co-ordinating a programme of project delivery. Programme delivery will be organised across the principal asset classes of public sector energy efficiency (and on-site generation), commercial sector energy efficiency (and on-site generation), heat networks and renewable energy generation (at both commercial and community scale including renewables associated with social housing). CLCDU would have a close working relationship with the investment fund to ensure the two operate in concert. At the project level the individual projects or programmes of projects will be delivered through delivery partners, such as commercial services providers, or through aggregator organisations. 19 MLEI Cambridgeshire low carbon investment and delivery model

20 Figure 4-1. Schematic of the intervention model 20 MLEI Cambridgeshire low carbon investment and delivery model

21 4.2 Cambridgeshire Low Carbon Development Unit In order to ensure a pipeline of investible projects it is proposed that a Cambridgeshire Low Carbon Development Unit (CLCDU) is created by the Cambridgeshire Local Authorities, led by Cambridgeshire County Council. The objectives of the CLCDU will be to coordinate the development of the pipeline as well as aggregate projects where appropriate and to place contracts for their delivery. The unit will need to be fleet of foot, so will need to sit outside of the local authorities once it is established with a sufficient project pipeline albeit that Local Authorities will play a number of roles in the unit. In the short term, it might need to start as an in-house team given the need to develop pipeline quickly to meet the MLEI requirement. It will need to rapidly expand bringing in the skills needed to make it a success. An MLEI workshop was held on 11 July 2013 at the Hauser Centre and hosted by Cambridge Network with active participation by both public and private sectors. One of the key recommendations from workshop participants was that the LCDU should be driven by both public and private sectors. The Local Authorities have a number of roles in facilitating the low carbon economy and the investment in energy infrastructure as described previously. Their engagement with the CLCDU will be established on their adoption of formal anchor, investment or subsidiary roles, with investment running through the Cambridgeshire Low Carbon Investment Fund (CLCIF). Authorities could also be a procured delivery partner. Importantly, the CLCDU needs to become a self-financing unit, generating income from two sources. Firstly it can receive a management fee from programmes that it manages for example, an upfront fee from the development of a building retrofit or a long term fee for organising a community renewable project. Secondly, it will also be possible for Cambridgeshire authorities to invest in the programmes and projects themselves. The intention is that this investment comes through the CLCIF, which will be managed by the CLCDU, enabling it to apply a service charge. These revenues should enable the CLCDU to be self-financing, not only paying its own way but also paying back any start up investments that may be made by investing authorities. With both a fee structure and capital investment return it should, in fact, generate a surplus which investing authorities will be at liberty to choose how they then deploy. Discussions with the Green Investment Bank highlighted the need for a self-sustaining delivery model that is not forever reliant upon grant funding There will be upfront costs to set up the unit and whilst recoverable over a number of years, these costs will have to be covered during the start-up phase. It is anticipated that the majority of these costs will be met through the existing MLEI grant. These might possibly be capital costs if they are lent to a new subsidiary but if it is an in-house unit then they will be revenue costs. The actual size of the start-up costs will be calculated during the next phase of financial modelling work, but it can be expected to need to cover 3-5 people initially plus associated costs. It is important that the unit has expertise in each of the asset classes that it is developing, e.g. non-domestic energy efficiency, ground mounted solar, district heating. The aim would be to secure sufficient grant funding so that all start-up costs were met without the need for further investment from the local authorities. Short term 21 MLEI Cambridgeshire low carbon investment and delivery model

22 working capital facilities may be required for the first year as the unit would be paid upon results and therefore be unlikely to secure project fees until the second year of operation. Whilst the CLCDU might act as fund manager to invest some capital funds from investing authorities (via a specially created fund), the vast bulk of the funding for the programme will ultimately come from the private sector, with the expectation of support funds from EU/EIB, DECC and other sources of public investment or grant funds. The private sector funds will be brought in via the different sector programmes with different types of finance being required for different activities. Equity funding will be required for community renewables, for instance, whilst debt might be more suitable for some building retrofit. 4.3 Cambridgeshire Low Carbon Investment Fund Benefits of a fund Rather than have the investing authorities fund projects in a piecemeal fashion it is proposed that a Cambridgeshire Low Carbon Investment Fund (LCIF) be set up to channel a proportion of the necessary funding. This brings the following potential benefits: 1. Creates a facility to receive funding from a variety of competitive sources (e.g. European structural funds such as ERDF) and potentially private sector sources 2. Creates a model that can be expanded in the future if/when local authority investment is not available 3. Provides an auditable book of investments to support refinancing activities, in particular securing private investment Growth and exit options It is envisaged that there would be three phases for the fund: 1. Short term demonstration Initially the fund would manage the 15m of investments necessary to meet the MLEI requirements. It would focus on the use of local authority money for public sector projects, such as offices, schools or solar parks on farm estates. It would use these projects to demonstrate some of the different contract structures, technologies and building applications that would be required at scale. The aim would be to build confidence and generate immediate revenues to sustain further activity. 2. Medium term growth In the medium term it might grow further towards 30-50m as the overall programme grows. It is expected that part of this growth would involve securing European funding from the LEP, for example by establish the fund as a JESSICA Urban Development and Energy Efficiency fund. This would potentially lower the interest rate chargeable and widen the spread of potential borrowers. The exact rules on eligibility will need to be established through discussion with the LEP and DCLG who control the use of ERDF in the UK. As part of the medium stage growth, it may be a requirement to draw in private co-investment alongside European and local authority funds. 3. Long term public-private fund The investing authorities can explore three options: 22 MLEI Cambridgeshire low carbon investment and delivery model

23 a) Retain the fund as an income generator b) Grow the fund and investment income further c) Exit the fund by selling the portfolio of investments to a low carbon investment fund or pension fund, by issuing a bond or by selling off some, or all, of the fund to local investors. The funds achieved through the exit can be used to fund further projects and any capital gain made can be retained. Option c) (exit) cannot be taken for granted as the finance sector is not currently interested in buying mixed cash flows from multiple low carbon programmes preferring to concentrate on sectors in which they have expertise. However, this may change in the coming years, especially if some form or credit enhancement such as retention of a first loss layer is used, along with an established track-record for the fund. Where this is not possible, the alternatives would be option a) or b) above which leads to no loss for the investing authorities and delivers long term revenues. A notional fund size could be 100m within 5 years, growing thereafter. The model of a local fund mixing public, private and European funding has been successfully demonstrated in London and is being encouraged for replication through LEPs Principals of fund operation Investing authorities will not have to provide all the funds upfront to the CLCIF as the fund will draw down from them as investments are made. Given the nature of the programme, all projects will be cash generating once live, but there will be some time lag between the investments being made and dividends paid or debt payments made. This is something that local authorities will need to allow for in their treasury management plans. The CLCIF will employ no staff and will be managed by the CLCDU with governance from investing authorities. Further details of the proposed structure will be set out in the next report How the fund would invest and lend As well as working with acceptable delivery partners the CLCDU will need to ensure that CLCIF finance can be deployed to the advantage of the programme. Whilst many of these models are work in progress there are a number ways in which this can be achieved: Enabling finance - finance without which projects or programmes would not happen, for example for projects deemed too risky for the private sector to invest on its own or where the rate of return is acceptable for the public sector but not for the private sector Commercial investment opportunities for returns that can be made as a pure investor and which would go ahead with or without LA investment (e.g. The Green Deal Finance Company) Table 4-1 summarises where each of these applies to the different project types or asset classes as well as highlighting the potential revenue sources for the CLCDU in making these deals happen and getting paid for the services it provides. 23 MLEI Cambridgeshire low carbon investment and delivery model

24 Table 4-1. Summary of Low Carbon Investment Fund activity by asset class Enabling finance from CLCIF to support programme Source of revenue for CLCDU Possible investment returns Energy efficiency / microgeneration: LA estate Investment of low cost capital from the local authority ensures maximum returns and /or permits investment into longer payback measures that deliver deeper carbon reductions. The CLCDU could receive arrangement fees for taking projects through particular stage gates (e.g. planning, procurement, financial close) Energy efficiency projects should typically give an internal rate of return of 8-15%. It is possible that business as usual property asset management plans may have assumed some of these projects would have gone ahead but others may be additional leading to a net increase in financial investment and returns Energy efficiency / microgeneration: Other public sector nondomestic Local authority covenants / guarantees may improve the credit worthiness of projects led by organisations with weaker balance sheets (e.g. schools) The CLCDU could receive arrangement fees for taking projects through particular stage gates (e.g. planning, procurement, financial close) Can finance these projects for investment return. Typically they will all be additional to business as usual LA investment plans. Energy efficiency / microgeneration: Commercial retrofit Bundling of public and private sector projects into a combined public/private funding structure has the potential to achieve a greater scale and reduce risk for private investors The CLCDU could receive arrangement fees for taking projects through particular stage gates (e.g. planning, procurement, financial close) LAs could potentially invest in a commercial Green Deal fund (for non-domestic buildings) or other energy efficiency fund for straight return. District heating Provision of debt or equity may be necessary to reduce the cost of capital to ensure project viability, given that project rates of return may be acceptable but modest The CLCDU could receive arrangement fees for taking projects through particular stage gates (e.g. planning, procurement, financial close) District heating projects should typically give an internal rate of return of 5-10%. 24 MLEI Cambridgeshire low carbon investment and delivery model

25 Enabling finance from CLCIF to support programme Source of revenue for CLCDU Possible investment returns Community renewables Provision of preconstruction development capital and equity The CLCDU could take a developer fee for closing a portfolio of projects. Potential on-going revenue stream from generation or local share issue Large scale renewables N/A The CLCDU could potentially play a brokering role between communities and developers LAs could potentially invest in large local projects that are led by the private developers 4.4 Programme development The role of Delivery Partners Different financing and delivery models will be required for different parts of the low carbon programme but all will need to be supported by a delivery sector company, or companies, that has/have a strong balance sheet and capability in the relevant area. The investing authorities (and private sector investors) will require this to minimise the risk of failure in any of these companies. The use of the large delivery companies should not reduce the commercial opportunity for locally based firms or the creation of local jobs. Many of these large companies use a programme management model where they bring in smaller companies. This can be written into any agreement drawn up by the CLCDU supported by the anchor authority. These companies are referred to as Delivery Partners in this report. Investors cited the importance of strong delivery partners that can actively manage project risks A foot in both camps As well as managing the investment programme the CLCDU would play an important role in steering the projects through the local authority processes such as planning, budget setting, asset management, procurement, cabinet approvals, etc. This enabling activity will be important for both work on a local authority s own estate to supporting planning and other activity for private sector properties Delivery Mechanisms The CLCDU will need to choose and continuously evaluate delivery mechanisms for rolling out the projects, feeding a pipeline of projects through to the delivery partners who will build, own and/or operate the projects. There are a range of existing and emerging delivery mechanisms which could be used and are reviewed in section 6. The mechanisms provide a number of supporting roles: project identification, design, contracting, implementing and monitoring, simplifying procurement and potentially offering good value deals due to having an established supply chain and scale of delivery. 25 MLEI Cambridgeshire low carbon investment and delivery model

26 The CLCDU would also have the option to establish new delivery mechanisms to ensure mechanisms fit with the explicit local needs and the benefits of delivery are retained in local area (and the partner authorities) as far as possible. Projects may also be better delivered on an individual basis through bespoke delivery vehicles, as would be the case for an urban district heating scheme. Analysis has illustrated the nature of the contract form associated to the different asset classes. It also identifies where there are existing / emerging aggregating delivery mechanisms that could be applicable and where there are none. 4.5 Implementation The programme has to be delivered in a way that achieves the MLEI targets in the short term and then goes on to attract significantly more finance over the medium to long term. This can be done by creating the CLCDU in-house to focus on developing the pipeline using local authority and other public sector assets, such as schools with the appropriate delivery mechanisms. Whilst this work is underway the unit can also start to prepare for the long term programme through development of individual models and the procurement of private sector partners. This process and timeline will be worked up in more detail at a later stage. In summary, it is proposed that a Cambridgeshire Low Carbon Development Unit (CLCDU) is created to coordinate the development of a project pipeline, aggregate projects where appropriate and place contracts for their delivery with credible partners. It would be self-financing, charging a fee for its work which would be paid for out of the project revenues. The CLCDU would also support investments from a Cambridgeshire Low Carbon Investment Fund (CLCIF). The fund would initially be seeded with local authority investment, matched in whole or in part by European structural and investment funds, allowing the authorities to generate revenue from low carbon projects. Public money would then leverage private investment so that the fund can grow and deliver greater benefits for Cambridgeshire. 26 MLEI Cambridgeshire low carbon investment and delivery model

27 5. What are the finance options? This section describes the range of finance options available and the ways in which public funds can be used to crowd in private finance. It begins by evaluating a range of public and private finance sources against a series of criteria such as recipient, project scope, scale, finance type, security and drawdown arrangements, interest rates and the suitability for use within the MLEI project. It goes on to describe common finance structures for bringing this investment into low carbon projects and feedback from investors on the constraints that they see in the market. 5.1 Introduction Previous technical analysis has shown that there is huge untapped potential for energy efficiency and renewable energy projects both across the UK and within Cambridgeshire. Furthermore, funders exist that are looking for bankable projects to invest in or to lend to, yet investment rates are slow. To understand this better we have begun by reviewing the potential sources of finance. 5.2 What are the potential sources of finance? The following tables (Table 5-1 and Table 5-2) review capital funds that have been considered in some detail. The tables highlight the nature of the funds and the how they might fit with the proposed MLEI interventions. The following funding sources have been considered: European Regional Development Fund (ERDF) /JESSICA Prudential Borrowing from the Public Works Loan Board (PWLB) Community Infrastructure Levy (CIL) Bonds (long terms debt from finance market) Commercial bank finance European Investment Bank (EIB) Green Investment Bank (GIB) Private Sector Funds (e.g. SCDL and Equitix) Commercial Green Deal Finance Leasing finance Roof rental type Carbon & Energy Fund (as example of purchase of receivable model) Community finance In addition to capital funds there is a range of revenue funds that could be used, in particular, to support start-up costs since they are less likely to have prescribed finance return requirements. Revenue funds include top-slicing of general revenue such as CIL and business rates together with 27 MLEI Cambridgeshire low carbon investment and delivery model

28 more specific revenues and existing reserves. The Community Energy Fund (proposed to be set up once the national Allowable Solutions regime is established), Housing Growth Funds, EU Technical Assistance funds and Heat Network Development Unit (HNDU) funding (only available to support district heating) are all sources of funds that would fall into this category. In principal any of these would be of value although each will have particular constraints that will need to be further considered. This will be reviewed in the further detail at a later stage in the MLEI project. 28 MLEI Cambridgeshire low carbon investment and delivery model

29 Table 5-1. Review of possible funding sources (PUBLIC) Evaluation criteria ERDF / JESSICA PWLB CIL Public Funding source Green Deal Finance 2 ECO 3 EIB GIB Recipient Public authority/ housing association possibly through fund manager or LEP. (NB. The Greater Cambridge & Peterborough LEP will receive 64million Structural funds ( ) Local authority Local authority Green Deal Provider (GDP) Property owner or contractor Local authority, credit worthy intermediary, potentially strong SPV Local authority, fund manager, ESCO Project scope Energy efficiency and on-site generation (including renewable energy) in social housing, and non-domestic 4 buildings, district heating Anything in support of policy objectives Infrastructure required for new development as set out in local plans and in the Regulation 1,2,3 list (Domestic green deal projects from TGDFC but not applicable); commercial funds under consideration from existing funds Domestic energy efficiency, especially solid wall insulation large infrastructure, social housing, Non Domestic Energy Efficiency (NDEE) 5 Non Domestic Energy Efficiency (NDEE) 6, district heating, building integrated renewables, waste Scale Circa 50m, matched Up to circa 100m based Scale will be linked to the Commercial funds will be less than Typically 1-10m per 100m, matched pari-pasu 30m min, matched pari- 2 Green Deal Finance can be a mixture of public and private finance through The Green Deal Finance Company 3 Energy Company Obligation (ECO) is funded by licensed energy suppliers but through a levy on energy bill payers so is treated here as public finance 4 Buildings used for commercial, industrial or civil purposes 5 GIB and EIB use this definition that covers both Energy Efficiency and on-site generation including renewables for buildings used commercial, industrial or civil purposes 6 As above 29 MLEI Cambridgeshire low carbon investment and delivery model

30 Evaluation criteria ERDF / JESSICA PWLB CIL Public Funding source Green Deal Finance 2 ECO 3 EIB GIB on precedent from other LA energy programmes scale of local infrastructure required for new developments 50m at start up programme 1-3k per property pasu Limits on scale ERDF allocation to LEP, strategic priorities, number of bidders Political appetite, prudential borrowing business case, borrowing cap? CIL is likely to be limited since it will be anticipated to cover core infrastructure Viability testing for new developments, plus quantum of new developments Availability of funding limited by overall market take-up and specific restrictions on who will be a GDP for CGD; LAs can expand capacity and make returns by investing in funds Funding level based on tco2 abated and /tco2 EIB mandate is more wholesale, large volume transactions. Always lends through intermediary Direct lending to LAs is only for large scale programmes (probably above 300m). Requirement for match funding. Finance type Grant, debt or equity Debt Grant Purchase of receivables Grant / carbon finance Senior debt Equity senior debt or purchase of receivables; matching private sector funds pari-passu Security Mortgage backed corporate lending for low cost loans Secured against council balance sheet None [possible performance bond by LA?] Secured on electricity meter None Depends on requirements of intermediary, typically secured against property +balance sheet Same terms as other funders 30 MLEI Cambridgeshire low carbon investment and delivery model

31 Evaluation criteria ERDF / JESSICA PWLB CIL Public Funding source Green Deal Finance 2 ECO 3 EIB GIB Availability start commercial? Drawdown period 2 years On demand TBC drawdown as projects completed 18 months for first ECO period 3 years Tranches (e.g. project milestones) Typical spend period years 1-25 years TBC years to April 2015 but ECO 2.0 expected years Same terms as other funders Repayment Amortising or bullet Amortising or bullet None Annual amortising None Amortising or bullet, amortising from year 11 Same terms as other funders Rate of return sought 1.75% (half of EIB rate) 0.8% over gilts None 8-12% expected None 3.5-5% Same terms as other funders Project risk profile Depends on funding type Whatever fits prudential borrowing code Whatever required in local plan / infrastructure framework Regulated Green Deal projects only Regulated ECO projects only Low risk projects Low to medium risk where GIB role makes other funders comfortable Opportunity for supporting MLEI Low cost loan possible Low cost, easily accessible Grant funding associated with new developments Investment into CGD fund; potential expansion into non-domestic Green Deal District heating schemes serving domestic customers for CSCO Use EIB to 'crowd in' other funders, e.g. private finance Use GIB expertise to structure funding. Schools, district heating of particular 31 MLEI Cambridgeshire low carbon investment and delivery model

32 Evaluation criteria ERDF / JESSICA PWLB CIL Public Funding source Green Deal Finance 2 ECO 3 EIB GIB interest. Constraints State aid if grant, complex audit requirements, may require specific legal structure Lowest cost source of funds but some authorities have preference for not borrowing at all Investment in energy infrastructure constrained (see CEF report) Not currently available to support nondomestic Green Deal Not available for non-domestic Scale of funding likely to be too large for MLEI. Cannot be used to refinance projects. Pari-pasu lending increases complexity without interest rate advantage 32 MLEI Cambridgeshire low carbon investment and delivery model

33 Table 5-2. Review of possible funding sources (PRIVATE) Private Funding source Evaluation criteria Bonds Commercial bank - secured lending Commercial bank - nonrecourse 7 debt Private sector funds (e.g. SCDL, Equitix) Leasing finance Roof rental type Carbon & Energy Fund Community finance Recipient Bond issuer could be LA, RP or other financial or commercial institution Local authority, credit worthy business, fund manager SPV created for a project Local authority, ESCO Local authorities, other public sector bodies, commercial Local authorities, other public sector social housing, commercial NHS hospitals Local communities constituted as not for profits/coops/mutuals Project scope Social impact projects or anything supported by the bond issuer; refinance of CLCF NDEE, renewables, district heating NDEE, renewables, district heating NDEE; district heating; biomass Equipment driven (LED, boilers, voltage optimisers etc.) Renewable technologies where payments (RHI/FIT) can be separated from energy savings Heating schemes for hospitals Small scale generation and potentially energy efficiency Scale Min 100m but can be subdivided into smaller participations of ~ 1m; smaller unregulated low carbon bonds are now being issued - > 10m Subject to balance sheet strength 20m upwards ~ 1-30m 1k upwards 2k upwards 1-5m per project but Addenbrooke s much greater Up to 1m? 7 This is debt secured by a pledge of collateral but for which the borrower is not personally liable. Where default occurs the lender/issuer can seize monies only up to the value of the collateral, i.e. the lender's recovery is limited. 33 MLEI Cambridgeshire low carbon investment and delivery model

34 Private Funding source Evaluation criteria Bonds Commercial bank - secured lending Commercial bank - nonrecourse 7 debt Private sector funds (e.g. SCDL, Equitix) Leasing finance Roof rental type Carbon & Energy Fund Community finance Limits on scale Transaction costs, scale, market appetite; security of issuer Balance sheet strength of borrower. Debt service cover ratio, transaction costs, fund size Suitable for mid-size projects; too small and high transaction costs - too large and becomes multi bank project Size of GIB fund sets upper limit; transaction costs set lower limit Lower limit - standard packages only; upper limits cost of DD Off the shelf package for low end solar PV; credit worthiness for high end Minimum size set by due diligence costs Ability for local community to manage project and raise finance Finance type Bond (long term debt) Secured lending against balance sheet of borrower with review by bank of project viability Non-recourse project finance, purchase of receivables, balance sheet lending Equity, debt or purchase of receivables HP, finance or operating lease Leasing of roof or other space in return for access to FITs, RHI payments and some payments for energy used Purchase of receivables Equity raise for community venture - potentially supported by LA investment, either at build or for build and then exit or partial exit Security May be asset backed Balance sheet Project assets and receivables; no recourse to parent organisation Project driven; supported by credit strong EPC providers Leasee balance sheet Legal agreement on roof etc.; contract with energy bill payer if required Payment contract between NHS and ESCO Receivables (FITs. RHI, energy savings) Availability start month lead-in 9 month leadin MLEI Cambridgeshire low carbon investment and delivery model

35 Private Funding source Evaluation criteria Bonds Commercial bank - secured lending Commercial bank - nonrecourse 7 debt Private sector funds (e.g. SCDL, Equitix) Leasing finance Roof rental type Carbon & Energy Fund Community finance Drawdown period Immediate Tranches (e.g. project milestones) Tranches (e.g. project milestones) 1-2 years Immediate Immediate for public sector and social housing; poor availability for commercial Immediate Immediate once raised Typical spend period 1-50 years 1-7 years 5-7 years 5-10 years Up to 5 years Up to 20 years 20 years Less than one year Repayment Bullet or amortising Amortising Amortising Amortising Amortising FITs and RHI to equipment owners plus sometimes energy saving payments Amortising Amortising or interest only followed by capital plus interest Rate of return sought 4-10% 5% 7-8% 10%+ 5-10% 12%+ 7-8% 3-7% Project risk profile Risk profile of bondholder more important but low project risk, essentially Whatever fits prudential borrowing code Proven technologies, strong counterparties, strong performance bonds Low risk through energy services company, supported by EPC Balance sheet strength of leasee Legal contract strength and credit strength if additional payments required Project risks and suitability of use of balance sheets Construction and operational risks 35 MLEI Cambridgeshire low carbon investment and delivery model

36 Private Funding source Evaluation criteria Bonds Commercial bank - secured lending Commercial bank - nonrecourse 7 debt Private sector funds (e.g. SCDL, Equitix) Leasing finance Roof rental type Carbon & Energy Fund Community finance Opportunity for supporting MLEI Issue bond to refinance low carbon fund; possible credit enhancement by LA which would impact LA balance sheet Low use for LAs due to normally better rates from PWLB Leverages public finance that might be limited by political appetite; possible off balance sheet solution or where no LA funding role Immediate funding solution for schools and public buildings as match funding in place Funding for range of projects but more expensive than prudential borrowing; enables easy adoption Strong interest for public sector buildings and social housing, but not generate strong returns for investing LAs Supporting hospitals within Cambs; LA can finance and use CEF as delivery mechanism Pipeline driven Constraints Credit rating requirements of any SPV may hinder ring fencing of fund; could issue as unregulated bond Prudential borrowing limits and political appetite for debt High transaction costs, lengthy due diligence, availability more limited than in recent years Maximum limit set on public sector projects. GIB mandate restricts to NDEE as core project; balance sheet issues for recipient depending on technology and how structured High management costs On balance sheet finance for HP and finance leases. Off balance sheet for operating lease for the moment Loss of opportunity income to building owners: Commercial buildings with tenants not seen as suitable by industry Large hospitals only. Question on whether CLCDU can earn fees Local communities ability to organise suitable projects 36 MLEI Cambridgeshire low carbon investment and delivery model

37 5.3 How public sector can crowd in private investment There are a number of ways in which the public sector can crowd in private sector investment. Without private finance the scale of the ambition across Cambridgeshire could not be achieved. This is seen as important given limitations on public finances, a finite appetite for risk and the desire to stimulate the wider private sector economy. In addition, the Intelligent Energy Europe grant funding used to support the Cambridgeshire MLEI project places a requirement (on the Local Authorities that are party to it) of using public funds to lever in significant private funds. The main structural options to achieve bringing in private finance are described below along with an indication of the project types that they would typically support and examples of where they have been used to date Non-recourse 8 project finance Figure 5-1. Non-recourse debt structure diagram This finance structure shown in Figure 5-1 is typically used for mainstream energy projects with low technical risk, strong cash flows and rates of return of at least 10%. It has been used to fund local authority solar PV projects. The project sponsor (shown here as the local authority) provides 30% of the capital in the form of equity with the remaining 70% provided as senior debt from commercial banks. A variant on this model is to introduce a junior debt layer (sometimes referred to as subordinated debt or mezzanine finance) which takes greater risk than the senior debt but also commands a greater interest rate. 8 This is debt secured by a pledge of collateral but for which the borrower is not personally liable. Where default occurs the lender/issuer can seize monies only up to the value of the collateral, i.e. the lender's recovery is limited. Against a project this finance will be limited to a proportion of the capital value of the project to limit the risk of the lender 37 MLEI Cambridgeshire low carbon investment and delivery model

38 The money is invested through a Special Purpose Vehicle (SPV) on a non-recourse basis, meaning that should the project fail, the limit of liability is restricted to the project assets and contracts held by the SPV. The main advantage of this structure is the limited risk exposure for the project sponsor as a result of the SPV structure and because it only has to invest 30% of the project value, not the full 100%. For private investors there would normally be the additional advantage of a lower interest rate from the bank compared with the required return on equity, hence greater leverage of its own investment leading to a greater rate of return on equity. However, this doesn t apply to the public sector where bank finance is typically more expensive than borrowing from the Public Works Loan Board. The other perceived advantage is that the structure potentially sits off balance sheet, meaning that only the LA equity would be public borrowing. The main disadvantages of this approach for the public sector are the higher cost of capital (interest rate) compared with PWLB and the greater set up and transaction costs in the form of legal fees, technical and financial due diligence on behalf of the bank. Due to its contractual nature, it can also take longer to mobilise investment Urban Development Fund This structure (see Figure 5-2) was originally created to support a European Commission supported programme called JESSICA but the model could potentially be replicated in a similar and possibly simpler form. An example of where it has been used is in London where ERDF was matched with investment from the Greater London Authority to create a holding fund, managed on its behalf by the European Investment Bank, accountable to the London Green Fund board. Sub-funds called Urban Development Funds (UDF) have been created for separate asset classes, including waste, social housing and non-domestic energy efficiency. UDF fund managers on-lend the money to borrowers such as housing associations, schools and charities. Unlike the non-recourse project finance described above, the UDF lends direct to the borrower not an SPV, hence takes credit risk on the borrower s full balance sheet and also takes a charge over property assets as additional security. At the point of on-lending, the JESSICA money is blended with private finance or money from the European Investment Bank. This can mean a lower cost of capital for the projects but that will depend on the cost of the EU provided funds. The advantage of this approach is that it combines more than one source of public finance (ERDF and Local Authority) and uses it to leverage private sector finance. The holding fund structure allows the different source of public finance to be managed together, thereby reducing due diligence and management costs compared with separate facilities. Where ERDF is used in a formal JESSICA structure, the interest rates can be very low as ERDF is effectively being turned from a grant into a soft loan. Under European rules, the funds can alternatively be used as equity or a guarantee instead of a loan. The creation of sector-specific UDFs then harnesses the expertise of the fund managers to place the funds in a prudent way. The main disadvantage of this approach is the cost and complexity of setting up and managing multiple legal structures, plus in the case of ERDF, working within strict rules on eligibility. It is worth observing that the London Energy Efficiency Fund has found it challenging to place its 100m in a city with a population of 8 million. Cambridgeshire s population is a tenth of this size therefore it is important that if this structure is adopted then it should be simplified as far as possible in order to avoid incurring excessive administration costs. Of course it also needs to be remembered that although the population of Cambridgeshire is much smaller than that of London, the county has 38 MLEI Cambridgeshire low carbon investment and delivery model

39 greater space and resources for renewable energy than exists in the capital, therefore the scale of investment need not be proportionate to the population. In fact, the CRIF programme demonstrated that there was some 2-6bn latent investment potential in the county. Figure 5-2. Urban Development Fund structure diagram Purchase of Receivables The structure is shown in Figure 5-3. A good example of where this model has been employed successfully is by the NHS Carbon and Energy Fund as a way of removing the need for direct public sector capital investment but still taking advantage of the other qualities that a public sector customer brings to the credit worthiness of a project. A local example is the funding of a new energy centre proposed for Addenbrookes Hospital. In the Purchase of Receivables model the Energy Services Company (ESCO) supplies and installs energy plant (such as a combined heat and power unity) on the site of a public sector client (shown in the figure as a local authority). The ESCO enters into an agreement with the LA to supply heat and power and a guaranteed level of energy savings. The LA is obligated to pay a regular energy service charge (sometimes called a unitary charge) to the ESCO and it is this payment contract and associated cash flow ( receivables ) that the bank purchases. In effect, the project is 100% financed by the bank post-construction. The structure is governed by a pre-approved set of agreements that manages risk to the satisfaction of the bank (i.e. the project is bankable or of investment grade ). Crucially, even though the bank does not lend directly to the local authority, the good credit rating of the local authority is being used to enhance the credit worthiness of the receivables contract, hence the bank is prepared to fund the project. The main advantages of this approach are that the structure has the greatest likelihood of 39 MLEI Cambridgeshire low carbon investment and delivery model

40 sitting off the local authority s balance sheet (albeit this could change under International Financial Reporting Standards 9 (IFRS) rules) and the local authority doesn t need to mobilise any capital for investment and the annual energy savings are guaranteed to be greater than the annual payments. The main disadvantages are the higher cost of capital compared with PWLB, and hence lower returns, and the complexity of administration, especially where standard contracts do not exist. Monitoring and verification of the project in practice is essential for ensuring that the energy savings guarantee is being enforced. Figure 5-3. Purchase of receivables structure diagram Green Deal If a local authority is a landlord, such as with commercially let buildings or academy schools then it would have to make changes to a lease to recover the costs of a building retrofit. To avoid this then Green Deal can be used whereby the tenant, whose bills reduce overall, pays back the costs of works through the energy company in line with the Green Deal legislation. By initiating this model locally, commercial businesses can also be encouraged to retrofit their buildings. Green Deal finance is not currently available in this form but Birmingham City Council, which has an established domestic Green Deal programme, is expected to kick start this market in the autumn MLEI Cambridgeshire low carbon investment and delivery model

41 Green Deal Provider Figure 5-4 Commercial Green Deal Structure Diagram Bond finance This model (see Figure 5-5) has been used by large organisations to access the wholesale capital markets and pension funds. It is generally used to raise capital at large scale and is a model normally arranged by the top level treasury function of an organisation. Examples include large housing associations (e.g. Guinness Partnership, L+Q, Places for People) and intermediaries / aggregators such as The Housing Finance Corporation (THFC). In the example below, we would envisage a local authority issuing a bond to investors in order to bring investment onto its balance sheet. The investors take credit risk on the LA at a corporate level (not a project level). However, the LA would need to be satisfied that it could honour the obligations of the bond, including interest rates and repayment of the principal. The bond could be serviced with the revenues of any part of its activities but in practice it would want to ensure that there was a strong business case at the project level. The advantages of a bond are that they generally secure the lowest cost private money due to the scale of transaction and corporate covenants offered to investors. The disadvantage is that the required scale may be too great for energy-specific activities (normally a bond needs to be at least 100m) unless accessed through an intermediary, in the way that THFC does for the social housing sector and generally low cost borrowing can be achieved through use of the PWLB. 41 MLEI Cambridgeshire low carbon investment and delivery model