Development banks can use robust credit ratings to help move developing nations to net zero

Multilateral development banks (MDB) can help developing economies secure backing for clean energy projects by using their robust credit rating in tandem with private finance, according to bankers, investors, and finance officials participating in a recent discussion on financing the net-zero transition.

Such banks should not directly finance individual projects in countries that cannot raise money on their own, Leslie Maasdorp, chief financial officer of Shanghai-based The New Development Bank, said during a 22 September World Economic Forum (WEF) discussion, which was part of the international body's 2021 sustainable impact summit.

But, they can play a key role, he suggested. "Because we are double- and triple-A rated, we can do more credit enhancement. Where, instead of financing projects directly, we take the first loss guarantee piece [of compensation] if you like in the capital stack, and then enable institutional investors to come and take the senior debt piece, which then will be priced lower because of lower risk, and that way we can improve a lot more funding to developing countries," Maasdorp added.

Accelerating the transition to net zero and averting a climate catastrophe will require about $50 trillion of incremental investments over the next 30-40 years, according to the WEF.

MDBs, such as Maasdorp's own bank, which Brazil, China, India, and South Africa founded in 2014, typically provide financial assistance in the form of loans and grants to developing countries to promote economic and social development and enjoy double- and triple-A ratings.

Overcoming decarbonization risks

The US is the largest shareholder in the development bank system, which includes the World Bank, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, and the European Bank for Reconstruction and Development (EBRD).

In August, the US Department of the Treasury directed the MDBs to end international financing for unabated coal-fired generation in line with President Joe Biden's May 20 climate finance order.

At the UN General Assembly meeting on 21 September, Chinese President Xi Jinping also announced an end to international coal project financing.

Maasdorp and other panelists from the public and private sector agreed that it is a challenge for developing countries to overcome the risks that impede large-scale infrastructure spending in those economies that are transitioning to a low-carbon future. With lenders wary, it's tough for these countries to close the investment gap for multi-million-dollar sustainable energy projects as they transition to a net-zero economy.

Evolving role of MDBs

The net-zero transition presents an opportunity for MDBs to revisit their roles and to consider whether their existing business model is being put to optimal use or if there is an opportunity for redesign, Maasdorp said.

Torben Pedersen, CEO of PensionDanmark, which has €36 billion ($42.17 billion) under management, agreed with Maasdorp that MDBs should get involved in helping developing countries.

But he is skeptical about the idea of total redesign, citing the urgency of the situation. "2030 is just eight or nine years away, I don't think we should waste our time with complicated redesigns," Pedersen said.

Pedersen said there should be more public-private partnerships where a sovereign government can back a project, thereby lowering its risk.

HSBC would like to invest in more sustainable infrastructure in developing countries, but "the challenge has been a lack of bankable big sustainable projects," said panelist Celine Herweijer, who is the bank's chief sustainability officer.

Recognizing that traditional MDB financing, which is spread across a number of infrastructure projects, has often been difficult to secure, Herweijer said HSBC is now working with high-profile MDBs to standardize processes that will allow project developers and risk-averse investors to leverage MDBs' balance sheets to raise funds.

In partnership with the World Bank's International Finance Corporation (IFC), the Organisation for Economic Co-operation and Development (OECD), and others, HSBC is creating a financing platform that includes a "fast infra" label that she said will give investors more comfort with the kinds of projects they are investing in and improve access to blended financing by project developers. Blended financing refers to combining public funds with the private capital to back sustainable development, while providing financial returns to investors.

Pooling infrastructure investments

Building on Herweijer's comments, Maasdorp suggested MDBs pool infrastructure investments into a portfolio that will draw more institutional investors instead of asking them to finance a single solar project in Egypt or South Africa. The IFC has such a platform as does the EBRD, he said.

The IFC inked its first certified green loan in Africa in May, which will boost funding for biomass and other renewable projects in South Africa.

Another multilateral agency sought to ramp up climate change adaptation-related investments in Africa earlier this month. Africa Finance Corporation (AFC) plans to raise $2 billion over the coming three years for direct investment in infrastructure projects across the continent that the multilateral agency sees slowing the impact of climate change, it said 14 September.

Banks' role will change

The panelists also agreed that the transition to a net-zero economy will neither be cheap nor easy for emerging and developing economies. And, HSBC's Herweijer noted, it won't be easy for banks that have committed to net zero because that will require a wholesale change in business practices. It will mean engaging with institutional clients about their climate transition plans, judging their plans, plus advising them on what investments to make and where, she added.

In emerging countries, she said, the challenge increases exponentially when conversations revolve around the changing energy mix. "How do you retire coal assets in Asian economies that in some cases are just 10 years old?" Herweijer said.

Although the investment community has made strides to incorporate climate risk into its decision-making, it is still missing a key piece when it comes to energy transition, and that is social inequity, Maasdorp said.

"Social inequity is not seen as a systemic risk going forward," Maasdorp said.

As a South African native, Maasdorp pointed to his country's official unemployment rate, which is hovering around 34.4%, and said the provinces where coal mining and coal-fired generation is the mainstay would be hit hard by the transition to a fossil-free economy.

"I can just see dislocation, the immense economic and social impacts that the climate transition will have in the country where I am from," he said, calling on MDBs to work with developing countries towards a "just transition."

The question is no longer whether the transition to net zero will occur, but rather how quickly, who will lead, and who will be left behind, John Morton, climate counsellor to US Secretary of the Treasury Janet Yellen, observed in his opening remarks at the WEF discussion. "And these are questions not just of environmental consequence, but of tremendous economic consequence," he said.

Posted 27 September 2021 by Amena Saiyid, Senior Climate and Energy Research Analyst