By Jagjeet Sareen, Former Assistant Director General, International Solar Alliance and Labanya Prakash Jena, Regional Climate Finance Adviser Indo-Pacific Region, The Commonwealth Secretariat
- Access to capital is hindering the uptake of solar power in emerging and developing economies.
- Pension funds and insurance companies are more suitable investors than banks in the sector.
- International development funds and green institutions could provide needed financial guarantees for renewable energy installations.
If net zero is to be achieved by 2050, the investment gap per year in the renewable energy sector in emerging and developing economies (EMDE) is $ 1.35 trillion. This massive gap is across the renewable energy sector, including solar, which is critical for decarbonising energy systems.
Access to capital continues to be a challenge for solar in EMDE. Like the infrastructure sector, solar is capital intensive and has a long gestation period and generates spillover benefits which for various types of investors is not suitable. In addition, banks – key financiers in the EMDE – are structurally unwieldy for financing solar projects: They limit their long-term loans as their liability duration impedes them from lending to the sector for the long term. There is also a refinancing risk for the borrower if financed by banks, as the solar sector needs long-term debt financing.
In EMDE, solar projects continue to be largely been financed by banks, but to effectively accelerate capital flows to this renewable energy sector, pension funds and insurance companies are more suitable as their long-term investment duration matches their long-term liabilities.
The high cash-flow stability of solar, thanks to high predictability in sales volume and pricing and low and stable cash expenses over the lifetime of the project, make the sector attractive for low-risk seeking investors.
Challenges on the road to solar
However, there are challenges for these institutional investors in the solar sector in EMDE. The three key ones are lack of suitable financial instruments, high risk (real and perceived), and disconnect between investors, policy-makers and solar projects. Institutional investors rarely invest in solar due to the limited availability of traded financial instruments. Owing to their preference for liquid financial assets, they prefer to invest in equity, bond, structured finance, yieldco, etc. Since credit ratings of most of the bonds issued by corporates in the solar sector in EMDE are low in the domestic and international markets, pension funds and insurance companies do not buy these bonds. They invest in low-risk fixed-income securities.
In addition, institutional investors do not have the manpower to assess risk and return propositions of direct investment, so they invest through an intermediary that can assess opportunities and invest on their behalf, like debt funds. Unfortunately, a limited number of specialized financial intermediaries in the EMDE can provide such services.
Stability through international public finance
Policy and regulatory uncertainties in the solar sector, lack of contractual enforcement and foreign exchange fluctuations increase the risk and expected return of financers and consequently make such projects commercially unviable. This warrants the use of risk-mitigating instruments and solutions, which can reduce risks for institutional investors. These instruments could be guarantees, insurance and other credit-enhancement instruments.
The international development and green financial institutions can provide partial credit guarantees that can help the bonds become less risky, thereby improving their credit rating. A guarantee is a better use of scarce public capital as it can attract more private capital than equity and lending.
The other way is setting up a solar debt fund that attracts these institutional investors. A blended finance structure of the fund could be instituted, where public finance is used to provide first-loss protection to private institutional investors in case of default. The first loss of protection can improve the credit profile of the fund, thereby attracting low-risk- and low-return-seeking institutional investors.
International Solar Alliance (ISA) is designing new instruments to mitigate these problems and creating channels for better access to capital from these investors. A blended finance risk mitigation facility has been developed by ISA for the solar sector in the African region that pools capital from both public and private financers. This risk mitigation facility can be replicated and scaled in other areas as well.
Coordination to solve the renewable energy gap
The investment gap has not been bridged because of a disconnect between investors, policy-makers, and projects. Large investors in developed countries find it challenging to invest in solar projects in EMDE as they may not have accessible networks, connections or the time to engage in structuring. This renewable energy disconnect can also be solved through intermediaries who connect capital providers and solar projects. The intermediary can facilitate a greater flow of capital towards the solar sector by sourcing deals, performing preliminary due diligence, structuring and monitoring deals, and providing fiduciary management services to institutional investors.
Besides, there is a need for dialogue, knowledge-sharing and exchange of ideas for effective solar policies and to send the correct signals for investments. Multilateral organizations can set up a platform for dialogues between investors and policy-makers aimed at enabling the exchange of insights, designing policy solutions on shared priorities, and connecting investors, solar developers and policy-makers. The aim is to build strategic partnerships between investors, policy-makers and corporates to accelerate capital flows, particularly in EMDE.
Massive efforts across the system are required to fill the huge renewable energy investment gap needed to overcome the solar financing challenge. An integrated approach to resolving issues and systemic challenges that hinder solar adoption is necessary to accelerate capital flows to the sector.
Innovative instruments and strategies, resolve to achieve the common goal of increasing the use and quality of solar energy and recognising its capability to meet energy needs in a safe, convenient, affordable, equitable and sustainable manner will help achieve the intended targets as set under the Paris Agreement on our path towards achieving net zero.
The article has been sourced from World Economic Forum and can be accessed here