Spotlight on... Climate Change
Stranded assets and investment in a greener world
Investors are raising significant concerns about the future profitability of conventional investments like fossil fuels. Investment strategies towards ‘stranded assets’ now face the dilemma of maintaining and increasing yields while meeting climate change mitigation commitments. While divestment from fossil fuel stocks would reduce exposure to such risky assets, the concentration of portfolios could negatively affect returns.
Divestment also needs to be a gradual process to reduce the risk of negative macroeconomic consequences such as increased volatility in commodity markets. Maintaining positions in fossil fuel investments could allow investors to encourage the adoption of social and environmental best practices, but exposes them to reputational and economic risks.
Continued reliance on fossil fuels runs counter to the December 2015 Paris climate agreement, and will face stricter environmental regulations and higher operational costs. An attractive and profitable alternative investment sector is renewable energies. Investors should progressively incorporate ‘green’ investments into their portfolios to offset the risks from exposure to fossil fuel assets. More capital should be allocated to investment opportunities designed for a low-carbon economy, such as sustainable infrastructure and clean technology. Besides the environmental and societal benefits, such investments are very likely to lead to high and stable returns, even in comparison to conventional energy investments.
Sources
https://www.towerswatson.com/en-GB/Insights/IC-Types/Ad-hoc-Point-of-View/2015/01/Fossil-fuels-Exploring-the-stranded-assets-debate
http://www.businessgreen.com/digital_assets/8779/hsbc_Stranded_assets_what_next.pdf
Green bond issuance estimated to reach record high in 2016
The ratings agency Moody’s expects record issuance of green bonds of $50 billion in 2016, exceeding the $42.4 billion of green bonds issued in 2015 and setting a record high since the first such bonds were issued in 2007. China’s green bond market in particular is expected to expand rapidly. This is due to the People’s Bank of China’s incentives for institutional issuers, such as collateral eligibility and interest subsidies, which are not available in other countries. Moody’s predicts green bonds to attract increasing investor attention internationally, as meeting emissions reduction targets agreed in international climate negotiations will require huge amounts of public and private sector capital.
The structure of green bonds do not differ from that of conventional bonds; however, green bonds must finance low-carbon and generally environmentally-sound projects. Examples include renewable energy, green transport and sustainable wastewater treatment. Investors should note the developments in the green bond market and keep an eye out for lucrative opportunities to become involved. This market will also be aided by the development of common standards and increased transaction transparency, which are currently under way in order to mainstream the market. London’s financial markets already encourage insurance and pension funds to invest in green bonds in order to create a solid framework for the sector.
Source
http://www.ftseglobalmarkets.com/news/moodys-says-green-bond-issuance-could-exceed-$50bn-this-year.html
http://news.trust.org/item/20160202142601-acm4ehttps://www.moodys.com/research/Moodys-Green-bond-issuance-could-exceed-50-billion-in-2016–PR_343234
UK Green Investment Bank in £423 million wind farm deal with BlackRock
The UK Green Investment Bank’s Offshore Wind Fund, partnering with BlackRock, has concluded a £423 million deal in February 2016 to buy the Glid Group of wind farms from multinational utility provider Centrica. Ownership of the 194 megawatt Lynn and Inner Dowsing offshore wind farms in Lincolnshire has been divided between the two funds, with GIB taking a 61% stake and BlackRock-managed funds owning the remaining 39%. Centrica estimates its net share of the proceeds from the deal at £155 million.The deal represents the ability of the Offshore Wind Fund to capitalise on opportunities in the UK offshore wind sector, and emphasises the growing commitment of large asset managers and investment firms to renewable energy. BlackRock now owns and manages 66 wind and solar projects in Europe and North America on its clients’ behalf. According to Rory O’Connor, Managing Director of BlackRock, the renewable energy sector can “provide opportunities for less correlated, inflation-linked, long-duration income and attractive risk-adjusted returns“ for investors.
Sources
http://renewables.seenews.com/news/centrica-eig-to-sell-uk-wind-farms-in-gbp-423m-deal-511828
http://www.businessgreen.com/bg/news/2445406/gib-and-blackrock-acquire-glid-wind-farms-from-centrica
YieldCos: financing renewables
Renewable energy and power companies are increasingly interested in YieldCos, a new yield-based structure offering investors high returns while raising capital for sponsor companies. A YieldCo is a publicly traded company that generates income from a group of assets such as solar power projects to provide investors with stable and increasing dividends. The advantage in YieldCos is that they do not have technical restrictions on asset or income composition. Investment in such companies are attractive to shareholders due to the possibility of low-risk returns that are projected to increase with time. The capital raised can be used to pay off debts or to finance new project at lower rates than those available through tax equity finance.
However, critics of YieldCos have raised concerns regarding the impact and risks of rising interest rates, weak oil price and uncertainties regarding the economics of renewables. Furthermore, there are also questions surrounding YieldCos’ actual rate of returns and their potential for long-term growth.First publicly listed 2013, the YieldCo structure is relatively new. Projects related to renewable energy face some uncertainties during the development stage, but tend to produce low-risk cash flows once they are operational. In exchange for investment in relatively low-risk assets, YieldCo investors typically receive 3-5% returns and long-term dividend growth targets of 8-15%. Under the right implementation and with an adequate asset base, YieldCos can enable companies to access public capital for future growth and gain an international investor base. Investors interested in investing in clean energy projects should check whether they match the characteristics required for successful YieldCo investments.
Sources
http://www.ey.com/Publication/vwLUAssets/ey-yieldco-brochure/$FILE/ey-yieldco-brochure.pdf
http://www.institutionalinvestor.com/article/3448778/banking-and-capital-markets-corporations/yield-cos-we-love-you-youre-perfect-now-change.html#/.Vrs8QMdH2lIhttps://financere.nrel.gov/finance/content/deeper-look-yieldco-structuring
Managing climate risk through catastrophe bonds
Human-induced climate change, which leads to severe weather conditions and environmental catastrophes, is one of the most critical issues facing society today. The insurance industry is developing innovative risk financing mechanisms like catastrophe bonds to improve disaster and climate risk resilience. ‘Cat bonds’ allow insurance companies to better manage the risks they face in case of catastrophic events. These high-yield debt instruments allow risks to be diversified and transferred to multiple investors. In case the insured catastrophe does not occur, the insurance company pays an interest coupon to investors. If the catastrophe does occur, the company uses the money to pay the insured parties.Investor demand for cat bonds is growing rapidly due to the high yields generated, as returns are uncorrelated to stock market developments.
Currently, most cat bonds are sold in developed economies such as the United States, where insurance to natural catastrophes are well understood. The market is likely to expand to emerging economies in the near future, as they are increasingly affected by climate change-induced natural disasters, bringing new risks to the market. This development is clearly important for investors, who should closely observe this burgeoning market and generate value-creating opportunities by working proactively with clients and stakeholders to manage climate risks effectively. In each instance, investors already engaged in long-term assets need to consider the financial risks associated with climate change.
Sources
http://www.un.org/climatechange/summit/wp-content/uploads/sites/2/2014/07/RESILIENCE-Promoting-Disaster-and-Climate-Risk-Resilience-Through-Regional-Programmatic-and-Risk-Financing-Mechanisms.pdf
http://www.economist.com/news/finance-and-economics/21587229-bonds-pay-out-when-catastrophe-strikes-are-rising-popularity-perilous-paperhttp://www.ceres.org/press/press-releases/dozens-of-new-insurance-products-emerging-to-tackle-climate-change-and-rising-weather-losses
About Freya Buck-Emden
I am an MSc in Environment and Development student at LSE and have a particular interest in the relation of the financial economy, the environment and climate change. She is a member of the sub-committee as external communications officer of PRIS.
