The Role of Innovative Finance for Climate Solutions in Cities
By: 2019 SF Fellow Dario Abramskiehn
The importance of sustainable urban infrastructure and the financing gap
Cities are on the front lines of climate change. They are a major contributor to greenhouse gas emissions, accounting for more than 70% of the global total. And with 90% of the world’s urban areas situated on coastlines, they’re also extremely vulnerable to climate change impacts such as sea-level rise and extreme weather events. At the same time, cities drive 80% of global economic output, and will only increase in importance as they continue to grow rapidly. By 2050, an estimated 2/3 of the global population will live in urban areas.
Last year’s landmark IPCC report had stark implications for climate action in cities. The report showed that investing in sustainable urban infrastructure will be critical to achieving the Paris Agreement, and to all realistic long-term climate stabilization pathways. Cities need to not only replace the aging infrastructure of the past, they also need to build enormous amounts of new infrastructure to accommodate their growth, which all must be sustainable.
This will involve transitioning to accessible low-carbon transportation, energy-efficient buildings, clean energy systems, robust water treatment and sanitation, and sustainable waste management — as well as making all infrastructure more resilient to the impacts of climate change.
But at present not nearly enough urban infrastructure will be compatible with a sustainable future. By some estimates, the sustainable urban infrastructure gap today is more than $1 trillion every single year, and the consequences of not making needed investments now grow more severe over time. Closing this gap requires the mobilization of new business models and capital structures that can catalyze the investments and shifts in development to combat climate change.
Barriers to needed investments, particularly in emerging markets
Financing conventional infrastructure is already challenging for a few reasons. Cities lack financial and regulatory autonomy, and they tend to be extremely limited in how they can raise new revenue for infrastructure investment.
In the United States, most cities cannot levy their own income taxes and must generate the bulk of operating revenues from sales and property taxes, and issue bonds for major capital expenditures. In emerging markets where needs are greatest, city governments have even fewer avenues for raising revenue and both municipalities and private project developers struggle to access global capital markets. Most of the world’s cities are not creditworthy or are unrated, and therefore bond issuances for new infrastructure projects are often not possible.
Not only does sustainable urban infrastructure face these same hurdles, they also face a few additional ones. Sustainable infrastructure investments have different risk profiles, payback periods, and capital requirements than conventional infrastructure, making investment at reasonable and scalable terms more difficult.
Innovative blended capital solutions and risk mitigation instruments can overcome these barriers
Given these obstacles, one path forward is to develop and spread new business models that can demonstrate and de-risk emerging sustainable technologies for private investors, particularly in emerging market cities.
The Global Innovation Lab for Climate Finance does exactly this — it helps to crowdsource, develop, and launch innovative climate investment solutions that can overcome market barriers in developing countries. The Lab has launched 41 sustainable investment solutions thus far, which have mobilized nearly $1.9 billion in blended capital investments for climate solutions to date. Eighteen Lab instruments launched so far support innovation in cities directly, and in 2019 the Lab launched a dedicated Sustainable Cities stream to help incubate targeted instruments focused on the most critical urban needs, with two instruments selected for the 2019 current cycle.
Pay as You Save (PAYS®) for Clean Transport is a 2018 Lab instrument that it aims to accelerate investments in transportation electrification in cities, and is currently preparing for potential pilots in cities in Latin America and elsewhere with the support of governments and blended capital providers. It uses an innovative capital structure and leverages the unique strengths and incentives of utilities to overcome key barriers to electric buses, which are competitive with diesel buses over their lifecycles in many markets due to reduced fuel and maintenance costs. But they face high upfront costs and perceptions of counterparty or technology risk that limit their investment from bus operators and financial institutions in many emerging markets.
To overcome these barriers a utility enters into a PAYS contract with a bus operator, and agrees to finance the upfront costs of batteries and charging infrastructure for an electric bus. The operator pays the same CAPEX it would have paid for a new diesel bus towards an electric bus, and repays the utility for batteries and chargers over time through a fixed monthly tariff on its electric bill, that will be less than its operational savings from switching to electric an bus. The transaction leverages the utility’s better access to capital, secure repayment mechanism through its customer’s electricity bill, and strong interest in expanding its revenue base with more EVs to accelerate electrification.
Recently launched Lab instruments also have the potential to drive private finance at scale to climate solutions in emerging market cities once they have launched.
Cooling as a Service was just endorsed by the Lab. It aims to help deploy clean cooling at scale in emerging market cities by overcoming performance risks, upfront costs, and misaligned stakeholder incentives for efficiency — which can otherwise prevent clean cooling investments from happening. Conventional cooling systems pose significant climate risks, in that they both consume large amounts of electricity and rely on HFC gas coolants, that are thousands of times more potent than CO2 in their contribution to global warming. Cooling as a Service seeks to apply a servitization model for clean cooling equipment, that consumes less energy and uses much lower-impact coolants, wherein a customer does not own cooling equipment but instead pays a technology provider for each unit of cooling that they consume in a given month — incentivizing reduction of cooling use to its lowest efficient level. And a technology provider provides the cooling equipment, pays its electricity costs, and covers ongoing maintenance — incentivizing deployment of the most efficient technology and the best maintenance practices possible to reduce operating costs.
Breathe Better Bond was also just developed and endorsed by the Lab. It is a debt instrument for local governments to finance air pollution reduction projects in emerging market cities that also reduce greenhouse gas emissions — for example in clean energy, waste management, transportation, fuel switching, and other sectors. It uses a blended capital structure to provide credit enhancement for cities at the margins of access to global capital markets, and a results-based payment mechanism to ensure that cities raising capital and investing in projects that achieve desired pollution reduction targets receive tangible near-term fiscal benefits.
The Lab is currently accepting new sustainable investment ideas for cities.
The world’s growing cities are not yet on course to achieve the investments needed for a sustainable and vibrant future. But these and innovative financing structures for cities, represent important tools that can help to shift the paradigms of infrastructure finance, catalyze new and needed investment, and accelerate technological and economic transitions towards sustainable cities that are already underway.
Dario Abramskiehn is a former Senior Analyst at Climate Policy Initiative, where he led the Sustainable Cities stream of the Lab (@climatefinlab), and is an 2019 Alumni of Clean Energy Leadership Institute’s Fellowship program. (@Energy_Leaders).
