Finextra Research and ResponsibleRisk today hosted Sustainable Finance Live, the first virtual workshop in series of events designed to create actionable ESGtech strategies and build an ecosystem of partnerships that will turn strategy into reality.
This Co-Creation workshop detailed how investment opportunities can transform the greenhouse gas landscape and defined what investors require in order to track and securitise with confidence, and what asset managers need to build portfolios that institutional investors will select.
The crux of this is understanding the veracity of data and zeroing in on reporting ESG and sustainable finance efficiently.
Richard Peers, founder of Responsible Risk and contributing editor for Finextra Research, began proceedings by presenting the audience with an image from Apollo 13 in which NASA controllers attempt to fit a square peg into a round hole. While seemingly impossible at first, by getting together to combine their efforts, the controllers found a way to return the crew safely, which Peers regards as a fitting analogy for how Sustainable Finance co-creation workshops should work.
Another favoured analogy of Peers’ is that of a dam holding back the flow of capital allocated for sustainable purposes. This amounts to some $30 trillion earmarked for investment in achieving the UN’s Sustainable Development Goals (SDGs).
“There’s a difference between an allocation and an investment though,” Peers told the audience.
The goal is to help break this dam down, helping to release the flow of capital into sustainable goals and ensure his $30trn actually becomes an investment.
Solving the integration problem and addressing the financing gap
Providing a use case, Corre Energy CEO and renewables entrepreneur Keith McGrane explored the opportunity that compressed air energy storage (CAES) presents and his frustrations with the integration problem associated with high penetration of variable renewables, in addition to the lack of capital available in this space.
While the market of storing electricity has existed for a long time, using a one-size-fits-all technology will not be sufficient. In order to solve the problems that persist with CAES, the industry must consider how technology fits at different stages of renewable energy integration, especially as we are reaching unprecedented levels of 70-100%.
McGrane explained: “As you move from low levels of renewables to high levels, you start to see a number of major problems manifest themselves on an electricity grid. You see increasing levels of curtailment of wind farms and solar farms, and as the grid cannot absorb these levels, system operators that are asked to maintain the security of the system now have to turn off wind and solar projects at an increasing rate,” McGrane said.
He continues to say that at low levels of renewable penetration, say 10-30%, there is a need for frequency monitoring management response technologies provided by battery technology. However, when moving to higher levels – 30-60% - problems emerge when “the wind is not blowing, or the sun is not shining.”
Battery technology in this case is not as cost-effective and will struggle to reach the same scale that CAES can be delivered on, hundreds of megawatts of storage and durations of minutes into days. Here, large capacity, long duration storage systems should be used.
“Compressed air provides that continuous balancing and integration service, reducing the need to curtail wind and solar farms and turning off these projects.” Discussing 60-100% renewable penetration, McGrane added that this is where we will findourselves between 2028 – 2033. “We need to move to a higher energy density fuel and that is seen as hydrogen.”
The European Commission recently revealed its Covid-19 recovery plan, with energy transition at the front and centre of the announcement and plans to stimulate investments into hydrogen production, utilisation and storage.
This is an issue for investors. Investors that are moving away from subsidised renewables to unsubsidised renewables will now have to consider this new level of risks to the system, and this is where technology can enable hedging of those risks, manage the system security and ultimately, keep the lights on by providing renewables in an affordable way.
McGrane also highlighted the advantages of underground storage and illustrated how the distribution of salt deposits can allow for these projects to be developed at scale.
McGrane’s final point was focused on the impact of large-scale renewable storage, the associated market failure and the subsequent financing gap, “the gap between when you originate a project and after initial feasibility assessment into the mid-stage development. You tend to get stranded, whereby the market won’t invest to get the project to financial close.”
He adds: “At the early stage of initiating these projects, we were able to secure grant funding and seed capital from the more entrepreneurial, visionary investors. This gets us through the first series of major milestones on the project but brings us to the point where we need additional investments.
“That requires a market financing solution, but we end up getting caught between financial close, achieving the permit of the project and moving the project into agreeing the EPC arrangements and long contracts with the customers that are going to pay us for access to the storage.”
This is a pervasive problem, and not just in the energy storage market, right across the infrastructure asset classes in the renewable sector. What is the true cost of not solving this problem?
Development banking to cut through investment risk
Following McGrane, Maya Hennerkes of the European Bank for Reconstruction and Development (EBRD) spoke of the issues and challenges in early stage investing in sustainable projects. The EBRD is an investment bank focusing on projects in emerging or developing economies, whose shareholders are compiled by the governments of 69 countries as well as the European Union.
She describes the high bar that the EBRD must have in place for projects to acquire investment, not only with regard to their environmental and social requirements, but also their prospect for profitability and their effect on portfolios as a whole, which need to remain balanced.
"Projects have to have good prospects of being profitable,” Hennerkes says. “While we’re a development bank, we function like a commercial bank, so we look at credit risk analysis in the same way and we have to provide all our loans to private sector institutions at market conditions.”
There is also the problem of conflicting interests. While a project may have a positive effect in one area, its impact may be extremely negative in another.
“I previously worked with another multi-lateral development bank and was closely involved with some wind projects, which had a great environmental record but important social issues that had to be managed,” Hennerkes says.
Given that projects are always taking place in a member country with a stake in EBRD, host government support is a given, which mitigates certain country or political risks.
The key to addressing such challenges is de-risking the investment, both from the point of view of perceived risk and real risk.
The former can prove problematic given that sustainable projects often involve emerging or new technologies, such as that provided by Corre Energy, which credit departments may not know how to evaluate.
“There are perceived risks that may or may not be real, but if the financing institution doesn’t know or has certain perceptions about risk, then this will prove to an important hurdle” Hennerkes says.
Real risk can however be addressed by the very presence of multi-lateral development banks like EBRD. Given that projects are likely to be taking place in countries that have a stake in EBRD, government approval is unlikely to be an issue, which helps to mitigate country risk or political risk.
The EBRD also has preferred creditor status in its countries of operation, which means that projects could continue undisturbed at all times, even during a financial crisis and certain other privately financed undertakings are not being serviced.
“This helps to provide comfort to our co-investors, be they commercial banks or other institutions,” Hennerkes says.
This means development banks are integral in being first movers in sustainable projects, helping to create a demonstration effect where other entities can follow and replicate this work in other countries or markets.
Datasets and distinguishing different shades of green
Zeroing in on data and reporting within the investment and asset management sector, Elena Philipova, global head ESG proposition, Refinitiv, argues that the “ESG challenge” is not borne from a lack of capital, it is a definitional issue.
“When we speak about ESG it is just three letters, but it actually means so many different things to so many different people.”
She adds that consistent definitions that work for different stakeholders is vital as a foundational building block toward progressing on the ESG journey.
Since 2015, there has been an explosion of ESG regulation specifically targeting this area of disclosure and transparency, with Europe accounting for more than 65% of ESG regulation globally. The 2030 agenda, UN Sustainable Development Goals and the 2016 Paris Agreement are driving the momentum behind this regulatory boost.
Despite this impressive surge, the challenges around achieving consistency remain.
“The challenge with disclosure regulation is that it remains vastly voluntary. It is limited and it is highly qualitative. Therefore, the content produced by different market participants is often narrative in nature, making it difficult to compare and selective.”
In practice this means that companies will largely choose to report on the issues they believe to be relevant or which allow them to present themselves in a positive light, causing significant downstream challenges for the users of this data.
Philipova highlights the EU taxonomy as a use-case to illustrate the value in a framework which – despite currently being a work in progress – can operate as a classification tool to help companies consistently determine whether an economic activity is environmentally friendly and sustainable or not.
The taxonomy provides specific technical thresholds on the environment performance of economic activity in order to be compliant with the framework. Once in place, financial professionals and institutions will have to report on where their performance lies relative to these thresholds across their portfolios and allocations.
In this way, we see a tension appear between the emergence of regulation to promote the adoption of robust ESG reporting and the inconsistency stemming from significant data gaps which will take time to become apparent.
As timeframes will vary between different regions and across activities and asset classes to implement ESG reporting structures, Philipova argues that the key objective is to empower and inform investors before mandatory reporting disclosures come into play. This will allow companies to assess their current exposure to the green economy and to proactively finance their transition rather than having to react to regulatory demands or market volatility.
To conclude, Philipova underlines the argument for consistency in reporting, highlighting the challenge of collating alternative data sets (such as satellite supply chain data) with companies’ self-reported data in such a way that guarantees normalised comparisons and avoids significant differences in data findings.
“Vast differences in these datasets can truly fatally hurt adoption and trust in the direction of shifting towards the green economy. It was can also hurt the trust in taxonomy-related solutions developing within the market and hurt the economy as a whole. We need to find the balance.”
A data access and report redesign are needed in the investment and asset management space. Tomorrow, Sustainable Finance Live will host virtual design-led workshops that will focus on remedying challenges such as:
- Investing in Green Energy Storage and Securitising Green Investments: How best to design new finance for new infrastructure and new models to lower costs and reduce the risk of investing in this asset class, in alignment with project finance and impact investing.
- Impact Investing: Building an impact investment portfolio that evidences the impact, delivers suitable returns and can be created and managed with required ROI.
- Reporting to Build an ESG Portfolio: Building a passive investing index to drive a portfolio for institutional investors using ESG and other data
The learnings from these sessions will be published on the Finextra Research page in due course.