California has been a bellwether state with respect to its climate policies.  Its action plan to fund the state’s infrastructure is bold and ambitious.   And it holds important insights for other markets faced with the challenges of developing and funding sustainable infrastructure.

A recent report based on the research done by Milken Institute Financial Innovation Lab identifies challenges in scaling up capital markets for sustainable infrastructure in the state, as well as recommends action steps.

The recommended action steps and the challenges are very applicable to many emerging market infrastructure investments.  Furthermore, the large scale deployment of climate-aligned sustainable infra investments, we have to look beyond the traditional renewable energy assets.    These include energy-and water-efficient real estate, water and waste-treatment facilities, EV infrastructure buildout, industrial energy and water conservation, circular economy (recycling), clean transport, including transit, marine ecosystem conservation, flood control and adaptation, and green agriculture/ forestry.  Some of these projects may not benefit from market-based revenue models, but rather, are likely to be viable based on the credit of the state entity, which is driven by its tax authority.  In most markets, including California, these projects also often tend to be small to attract institutional investors.

The emergence of sustainable and green investors, combined with the growth of the green bond market, has created an outstanding opportunity to channelize capital into developing and funding sustainable infrastructure.  A lack of consistency across definition of greenness and sustainability performance metrics, combined with limited guidance on reporting and disclosure has hindered the financing of sustainable infra characterized by small size and unrated counterparties.  A properly coordinated set of state or government interventions can address these barriers creating conditions for capital to flow.   Interestingly, EEEIG experience in financing and investing in sustainable infra suggests that emerging markets face similar issues (as CA)  today.  On a positive note, there is a strong degree of “portability” of best practices across markets, both developed and emerging.

The report recommends the following action steps:

1. Reduce the cost of “going green” by educating issuers on the benefits of green capital; by standardizing definitions, performance metrics, and the various processes for verification and audit, reporting and disclosure.  The government could fund such standardization and related issuance and compliance costs via subsidies, philanthropic capital or both, or using the proceeds from the implementation of carbon pricing regimes.  The “issuance infrastructure” could be provided as a “public good,” with the objective of reducing issuance costs and bring transparency for investors and issuers alike.
2. Provide state supported credit enhancement via state -supported insurance, similar to state-supported mortgage insurance, to enable small, unrated infrastructure projects or entities to borrow.
3. Encourage aggregative or pooled issuance structures where small issuers can pool their projects or offering to achieve scale and size for index inclusion as well as to reduce administrative and legal costs.  Additionally, individual credits can be pooled to enhance the overall credit quality of the issuers and counterparties to reduce credit costs.
4. Create a “green bond” bank which could be a state entity acting as an intermediary that  accesses green bond investors, while also aggregating and assisting green issuers in project preparation,  and credit/sustainability diligence.
5. Develop a green taxable muni program to attract investors beyond the tax exempt investors

Points (1) to (4)  apply to most emerging markets.  Point (5) may be relevant for some markets where muni-financed infra is not existent.  Blended finance concepts as well as mission related capital can address market barriers that reduce information asymmetry between issuers and investors especially with respect to taxonomies, “green” audits, reporting and disclosure.  Innovative financing templates such as aggregating issuers and counterparty credits as well as having a state or a privately managed “green bond” investment bank can work in most jurisdictions.  DFI’s can add tremendous value here.  Lastly, EEEIG believes that the increased availability of cost-effective debt capital sources in the market by expanding the investor pool to include green/sustainability oriented investors that care about sustainability and diversified sources of returns, will not only catalyze the debt capital value-chain, but also early and late stage equity formation.  Lower financing costs enhance value of infra assets.

In the words of John Chiang, CA Treasurer, “because California is widely recognized as a leader in environmental sustainability, pioneering efforts to streamline the green bond market can serve as a model for other states and countries. Building public infrastructure with future generations in mind is a must, not just in California, but everywhere on the planet”