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Sources of investment

The private sector provides the lion’s share of global investments in renewable energy, committing around 75% of the total in the period 2013-2020.

The disproportionate flow of investments towards mature technologies/applications and specific markets reflects a key characteristic of mainstream private capital: it favours lower-risk investments and prioritises financial returns over social, environmental, and climate-related gains. For example, in 2020, 83% of commitments in solar PV came from private finance. Meanwhile, geothermal and hydropower rely mostly on public finance; only 32% and 3% of investments in these technologies, respectively, came from private investors in 2020.

Private capital also tends to flow to countries with lower real or perceived risks, or into frontier markets only when effective risk mitigation facilities are provided, while a large portion of the world’s population remains underserved. When capital does flow to higher-risk environments, it generally does so at a much higher cost.

This means that the lowest income populations end up paying the most for (often basic) energy which is universally recognised as essential for alleviating poverty and promoting socio-economic advancement. This necessitates a much stronger role for public financing in these contexts and not fully relying on private capital which may keep widening the disparities.

Public investment flows

Globally, the public sector provided less than one-third of renewable energy investment in 2020.

State-owned financial institutions, national DFIs and state-owned enterprises were the main sources that year, providing more than 80% of public finance.

Multilateral DFIs provided 9% of public finance – in line with their past annual commitments – and accounted for about half of international flows coming from the public sector. Commitments from bilateral DFIs in 2020 fell 70% compared to 2019. This means that multilateral and bilateral DFIs provided less than 3% of total renewable energy investments in 2020.

Public funds are limited, so governments have been focusing what is available on derisking projects and improving their risk-return profiles to attract private capital. Risk mitigation solutions have been used to lower the risks associated with renewable energy projects’ ability to repay obligations. Such risks stem from uncertainties regarding government actions (political, regulatory, policy), macroeconomic conditions (e.g. currency risks), off-taker creditworthiness, force majeure events, and others.

Among risk mitigation instruments, sovereign guarantees have been preferred for lenders looking to obtain a “one-size-fits-all” solution for credit risks. But such guarantees are treated as contingent liabilities by regulators, credit-rating agencies and international institutions such as the International Monetary Fund and may hamper a country’s ability to take on additional debt for critical infrastructure development and other investments. Moreover, sovereign debts are already stressed to their breaking point in many emerging economies grappling with high inflation and currency fluctuations or devaluations in the wake of the COVID-19 pandemic.

In this macroeconomic environment, many countries cannot access affordable capital in international financial markets or provide sovereign guarantees as a risk mitigation instrument.

Given the urgent need to step up the pace and geographic spread of the energy transition, and to capture its full potential in achieving socio-economic development goals, more innovative instruments are needed that help underinvested countries reap the long-term benefits of the energy transition without putting their fiscally constrained economies at a further disadvantage.

Mobilising institutional capital for renewables

Institutional investors, i.e. pension funds, insurance companies, sovereign wealth funds, endowments, foundations and asset managers, can play an important role in scaling up renewable energy investment. This group manages well over USD 100 trillion of assets globally, with significant asset growth occurring in developing and emerging markets.

Renewable energy presents such investors with a unique opportunity to diversify their holdings, benefit from stable, long-term and strong cash flows that match their liabilities, fulfill their fiduciary duties, and minimize risks from stranded assets and adverse regulatory changes.

According to IRENA’s research, however, institutional investors have so far not taken advantage of opportunities presented by renewables, as less than a fifth of such investors have made any renewable energy investments, while only about 1.5% have invested directly in renewable energy projects.

Their current activities indicate a strong preference for indirect investments into renewables, although many are building internal capacities for direct project investments. Over time, institutional investors are showing an increased level of interest, largely owing to the growing competitiveness of renewables, search for higher yield by institutional investors, as well as the increasing availability of capital market instruments that allow for indirect investments into renewable energy, such as green bonds and green funds.

An integrative approach that combines effective regulations and policies (e.g. review of investment restrictions, clarification of fiduciary duties, support for sustainable finance), capital market developments (development of green securities and associated markets, and of bankable project pipelines) and internal changes (development of internal capacities, cooperation with other institutional investors) can lower existing barriers that this important investor group faces in renewable energy and catalyze their greater engagement in this sector.

Green Bonds

Innovative capital-market instruments, such as green bonds, can open up crucial additional avenues through which investors can invest in renewables. Given the strong preference of institutional investors for indirect investments, ideally via listed and rated instruments, green bonds act as a bridge between such providers of capital and renewable energy assets.

According to the Climate Bond Initiative (CBI), the green bonds market has experienced a spectacular growth in the recent past, increasing from USD 36.6 billion worth of issuances in 2014 to USD 167.6 billion in 2018. In developed markets, investment in the energy sector is the second most common use of proceeds for climate-aligned issuers, while in the emerging markets, renewable energy dominates allocations from green bonds.

Given that global bond issuances amount to about USD 1 trillion per year, the green bond market has lots of room for further expansion. For this to occur, continuous effort needs to be put in the further harmonization of the green definition and certifications, collaboration among public and private stakeholders in the issuance process, and continuous development of a pipeline of bankable and de-risked renewable energy assets.