Misperceptions causing institutions to miss out on sustainable co-investments | ESG

A misunderstanding of the role of development institutions could be shutting investors out of lucrative opportunities, in terms of both return and sustainability impacts, according to asset owners and managers in the sector.

One perception is that development institutions may provide investee companies with preferential terms, crowding out opportunities for private investors seeking market level returns alongside the sustainability benefits that come from such projects.

Mark Davis
Norfund

This is not an accurate perception, Mark Davis, executive vice president for renewable energy at Norfund, Norway’s $4 billion development finance fund, told AsianInvestor.

“Much of climate finance is cheap finance but we invest on commercial terms. We’re not the greediest private equity investor but we need to be able to match the market, otherwise we’ll distort the market,” he told AsianInvestor.

Yet attracting private investors to such blended capital projects can be challenging when investors see the presence of development institutions as an indication that investment returns may be inferior, according to Quentin Vaquette, founding partner, Wavemaker Impact.

Wavemaker Impact is a climate tech venture capital investor focussed on Southeast Asia.

MISPERCEPTIONS

Davis argues that perception is mistaken, noting that the development fund approach is no different to the process in developed economies, where domestic governments provide subsidies or invest in the riskier part of infrastructure investments — and generated investors some of the largest returns in history.

“These [emerging] markets don’t have access to [government] capital so the philanthropic capital is [required] to replace the subsidy. So, when we talk about blended capital this is something that every developed market has been founded on – it’s not a new thing. The same has happened to make this iPhone or this computer than I’m on,” he said.

Davis made these comments at the annual review event of British International Investment (BII), the UK’s $9 billion development institution in mid-July.

Vaquette pointed to real estate, agriculture, technology and energy as sectors where investors in developed countries routinely rely on government subsidies to underwrite projects.

Development banks are simply substituting the role of governments in comparable emerging economy projects where national governments lack the resources to provide the subsidy themselves, he said.

Luuk Zonneveld, board chair, Association of Bilateral European Development Finance Institutions (EDFI) told AsiaInvestor the idea that development institutions invest in ‘less lucrative investment opportunities’ was oversimplified and made by a small fraction of investors.

Luke Zonneveld
EDFI

“It’s justified if an investor is only interested in short-term highest profits. In most other cases, development finance can provide private commercial investors with an attractive risk-impact-profit combination. We define ‘lucrative’ in both financial and in development impact terms,” he said.

EDFI’s 15 members, who collectively invested $2.18 billion in Asia in 2022, includes the development finance institutions of the Germany, UK, France, Norway and Sweden.

Zonneveld emphasised the role of development institutions in providing investors with opportunities where none might otherwise exist.

FLEDGLING OPPORTUNITIES

“We’re active where investors are not yet active, which means in pioneer activities; and long-term propositions in fledgling markets, such as forestry, that can potentially attract institutional, patient capital,” he said.

Zonneveld added: “In the first category, risk is high, but so is the return. The second category could be attractive for institutional, patient capital, who are looking for steady returns, rather than short-term high returns.

“In doing so, from a private investor perspective, we are trailblazers. Our investments are interesting for those investors who want to gain an early foothold in a certain sector or geography with the aim of bringing development value while earning a financial return as well.”

Srini Nagarajan
BII

Srini Nagarajan, BII’s managing director and head of Asia, emphasised the role for development institutions in working with governments to develop new sectors to a stage where they will appeal to private investors.

“Investors typically follow developers into any sector and developers get their cues either from the market or from the policy directions of the government,” he told AsianInvestor.

“In order to achieve successful financing, all three – government/ markets, developers and investors – need to be in sync. Policy, regulation and market development are key aspects of government intervention, and these provide cues to developers and investors in new sectors/ business models,” he said.

“Commercial capital tends to flow to where business model and technology are proven,” Nagarajan said, adding that this is true for decarbonisation of electricity and mobility to some extent, which is why they receive the lion share of capital.

“The other emission sectors will also gradually receive more capital, but the sectors need further de-risking before this will happen. In the meanwhile, development focused investors can support both early and late-stage businesses in these segments, filling the gap left by commercial investors.”