The Clean Energy and Bond Finance Initiative or CE+BFI (www.cebfi.org) just released a paper about the state and city level innovations in clean energy finance, especially the new creative uses of bonds to support clean energy. The CE+BFI is joint alliance of the Clean Energy Group and the Council of Development Finance Agencies, dedicated to expand the use of bond finance for clean energy through a national partnership of clean energy and public finance officials across the country.
The paper, "Reduce Risk, Increase Clean Energy: How States and Cities are Using Old Finance Tools to Scale Up a New Industry," makes a simple point: to make the old new again; that is the future of clean energy finance. The paper identifies several financing strategies at the state and municipal level that can be adapted and implemented to accelerate the clean energy finance revolution in other states and cities, and at the federal level.
States and cities are showing us that we don't need entirely new financing models to scale up clean energy. With tried and true financial instruments, clean energy projects can access low-cost, long-term capital markets, and investors will be able to purchase investment grade securities that meet their financial and environmental requirements.
As we know, innovation is often the driver of the most profound business and financial successes. Across the country, state and municipal leaders have begun to embrace a finance innovation that might well be the key to sustained growth of clean energy. And for one of the most technologically advanced industries in the world, it's surprisingly low tech.
Financial innovation is offering one of the best hopes for scaling the clean energy industry. But it's not the invention of an entirely new class of complex tradeable securities that's beginning to accelerate the industry's growth. It's the innovative use -- at the state and local level -- of a set of rather commonplace and long-established financial tools that support bonds and other debt instruments by reducing financial risk.
But one critical change has to happen for this to work. Energy policy makers must figure out ways to support the transfer of conventional credit enhancement tools to the clean energy sector.
Credit enhancements, simply put, are ways to reduce the financial risk of a project, to make the lender more secure that they will be repaid. Not flashy but often complicated to explain to those outside finance, they have been used in virtually every other sector to raise capital to scale. They are the bridge, the linchpin financial instrument, to get projects to capital markets.
Just as America financed its established infrastructure, its roads and bridges and airports, the clean energy sector is following suit. It is moving from an emerging industry strategy that was driven solely by the need to reduce technology and production costs, to one that must reduce risk -- especially financing risk.
The goal of these innovations is to firmly establish credit-enhanced clean energy bonds as a new asset class for institutional investors who could begin to invest in a clean energy asset that has an equivalent credit risk/return profile as any other similarly rated asset.
The paper also makes some recommendations for how other states and cities can advance the use of bonds for clean energy.
- In each state, the energy agencies and bonding authorities should develop a state partnership to create new public/private finance tools for clean energy.
- Rather than only offering grants and rebates, states should use new finance tools that work to reduce financial risk in clean energy deals.
- States with utility system benefit charges for energy efficiency or clean energy should consider a Hawaii-type structure that uses a dedicated utility surcharge to provide credit-enhanced bond financing. This bond structure can access the capital markets with an investment grade security that does not require the state's general obligation guaranty.
- To finance solar installations on public buildings, states and municipalities should consider adopting Morris Model-type bond issuances that combine bond finance and solar leasing in New Jersey.
- To address weather-related power outages, states should consider a New York proposal to provide credit enhancement to private lenders and lease financing entities that finance power resiliency improvements in critical public and private infrastructures.
- To access capital markets, state energy officials should consider various securitization strategies, such as working with state water bonding authorities that, under new EPA approval, can provide credit enhancement for energy efficiency loan pools to be sold to Wall Street.
The paper also proposes a new federal strategy to accelerate state-level financial innovation in clean energy.
- Congress should consider passing a new credit enhancement program such as the State Clean Energy Finance Initiative (SCEFI) that would provide federal funds to state clean energy programs as credit enhancement to encourage state innovation for finance programs of the states' choosing. The SCEFI proposal is modeled after the State Small Business Credit Initiative that Congress enacted in 2010.
- DOE should establish a funded and dedicated program with the specific purpose of devising program and funding support for state clean energy finance initiatives.
- Whether or not Congress enacts clean energy finance legislation, DOE, if it can or with legislative approval, should use the remaining DOE loan guarantee authority to fund state credit enhancement programs for clean energy or offer a modest credit subsidy in exchange for standardizing contracts and creating data for bond ratings.
- As part of that effort, DOE should consider providing more program funding and technical support to states to help them devise clean energy credit enhancement programs, which would leverage existing federal dollars but also additional public and private capital.
The ultimate success for clean energy investment is to create finance products that can be bought and sold on Wall Street like any other publicly traded marketable security. Bonds and other fixed-income securities are not a replacement for equity investment in clean energy, but a source of needed borrowed funds that leverages and increases the profits of equity investors.
This is a new challenge for the clean energy sector. It means moving away from the heavy reliance on tax equity-driven, one-off transaction way of financing clean energy, with its attendant high transaction costs. Instead, financing clean energy has to start looking more like the bond market for other traditional infrastructure projects, such as highway and water treatment projects.
Most important is the need to reduce risk at each step of the finance value chain, from project development through the bundling and sale of securities to the institutional investor.
Credit enhancement is the key to the public infrastructure finance world; it is used to strengthen thousands of transactions every day by reducing financial risk for lenders. The construction of the nation's roads, bridges, hospitals, airports -- virtually every large infrastructure project in America -- relies on credit enhancement.
It is now that these time-tested tools need to be applied at scale to clean energy finance.