Innovative Financing: EIBs
Pay-for-Success with Environmental Impact Bonds
We often hear from our members about the challenge of securing financing for flood adaptation solutions. Traditionally, local governments have used municipal bonds or federal grants in order to fund infrastructure projects. But as flooding and sea level rise pose new challenges on a new scale, new modes of financing have also emerged.
In 2016, the DC Water and Sewer Authority issued the country’s first Environmental Impact Bond (EIB), the proceeds of which were used to fund green stormwater infrastructure. Since then, Atlanta has issued the first-ever public offering of an EIB, Louisiana’s Coastal Protection Restoration Authority has developed an approach for an EIB in coastal Louisiana, and Baltimore has plans to issue an EIB as well.
What is an Environmental Impact Bond?
An EIB follows a traditional bond structure, but with one major difference: payments to investors are based on the achievement of an environmental outcome. Otherwise known as, “pay for success”.
With a traditional bond, a government entity issues the bond and investors purchase it, effectively loaning the government funds. The issuer (government entity) pays its investors a coupon (interest) at regular intervals and when the bond has reached maturity the issuer repays the investors’ initial investment (principal). In the meantime, the government entity can use the loaned funds to finance projects that serve the public good. A key challenge to this model is that payouts are not tied to performance.
With an EIB, the same basic structure holds, with 2 main differences. First, an EIB’s proceeds must be used to fund a project that is intended to have a measurable positive environmental impact. Second, if the project achieves its environmental goals, investors receive an additional payout (one-time contingent performance payment) in addition to their coupon and principal. EIBs allow issuers to transfer project risk to their investors, thus encouraging them to finance innovative solutions. This makes EIBs attractive when financing new approaches or piloting solutions that have not yet been tested at scale.
How did DC Water use an Environmental Impact Bond?
The problem: Washington D.C. has operated with the same combined sewer system for the last 150 years, meaning stormwater and raw sewage discharge into the same systems and are processed later at a wastewater facility. During heavy precipitation events, the volume of water and sewage exceed the system’s capacity and are discharged into rivers. As a result, this outdated system pollutes the Chesapeake Bay Watershed at a rate of 2 billion gallons annually.
An innovative solution: The Environmental Protection Agency, Department of Justice, District of Columbia, and DC Water entered into a consent decree in 2005, to address the issue. The initial solution created by DC Water was a tunnel system that would capture overflow, a project that would cost $2.6 billion. Halfway through this project, which was originally set to take 20 years, green infrastructure — e.g. rain gardens and permeable pavement — presented a better alternative and more innovative method for reducing the city’s stormwater overflow. The proposed green infrastructure projects also could provide additional benefits, such as reduction in flooding.
An innovative financing approach: Wishing to incorporate green infrastructure midway into the project, DC Water was faced with one issue: green infrastructure had never been implemented on this large of a scale before. This left concerns about whether or not the project would work, and if it was worth the risk to find out. An EIB proved to be the solution to this, and in partnership with Quantified Ventures, DC Water issued a $25 million EIB, the first of its kind.
What does this mean going forward?
DC Water’s Environmental Impact Bond was a big step forward for green infrastructure financing. Though EIBs are still considered experimental, as more entities finance their projects with EIBs they will become an increasingly common practice. The impact of these bonds goes beyond stormwater management, applying to a number of environment-centric projects, including a broad range of approaches that reduce flooding. With projects in the works in places like coastal Louisiana, Baltimore, and Atlanta, the EIB is on the rise. Flood-affected communities are taking notice and will likely see continued innovation in the next few years.
This post was authored by Summer Modelfino, Senior Strategy Associate.
