One in every five dollars invested professionally in the US is now invested sustainably. And while investment in projects that reduce greenhouse gas emissions are rising globally, the market for energy efficiency remains under-satisfied compared to its potential and the market for renewable energy investment. Here’s why.
The size of the market
It can be confusing for beginners. There are green bonds; sustainable, responsible and impact investing (SRI); and environmental, social and governance (ESG). But whatever you call it, more and more investors are seeing the benefit of putting their money into sustainability.
According to the last Global Sustainable Investment Review, at the start of 2016, global sustainable investment assets reached US$22.89 trillion (AU$29.47t), a 25 per cent increase from 2014. Europe accounted for over half of these assets (53 per cent) and the United States 38 per cent.
The market size of SRI investing in the United States alone was US$8.72 trillion (AU$11.23t) as of 2016 – double what it was just four years previously – representing one in every five dollars invested, according to SIFMA, an association of broker-dealers, banks and asset managers for businesses and municipalities.
How it works
Impact investing refers to investments “made into companies, organisations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return”.
The Global Impact Initiative is a global champion of impact investing, dedicated to increasing its scale and effectiveness around the world. It was founded by Giles Gunesekera in 2015. Speaking alongside last month’s Cayman Alternative Investment Summit he said he started it “to provide investors – foundations, family offices, pension funds, endowments – with bespoke solutions that would allow them to allocate to impact investing strategies”.
“We map these bespoke impact investing strategies to the UN Sustainable Development Goals (SDGs) and utilise professional investment managers alongside social impact investment firms to ensure the strategies we build for clients meet their financial and social impact targets.”
Schemes often use the ESG framework:
- Environmental: How is the company disposing of hazardous waste? Is it managing carbon emissions? To what extent is it meeting environmental regulations?
- Social: Does the company support philanthropic and community-focused initiatives? Are employees provided with access to health care and other key benefits? Is leadership promoting diversity?
- Governance: Are company leaders appropriately qualified for the role, and are they communicating a coherent strategic vision? Are their compensation packages appropriately aligned with performance? Is the C-suite communicating effectively, and transparently, with shareholders?
Gunesekera says that pension funds hold the key to doing impact investing at scale. Australian and US pension funds are behind those in Europe and Canada when it comes to embracing impact investing because their trustee boards behave very conservatively due to their size. But he adds that “it will only be a matter of time before they catch up”.
His colleague Don Raymond of Alignvest Investment Management believes that “impact investing should be integrated across all investments, and not just part of a separate portfolio.”
Increasing demand and the problem with energy efficiency
While all are in agreement that impact investing is increasing, it must be driven by demand, part of which is the issuing of green bonds by, for example, municipalities to promote investment in energy efficiency.
According to Steven Fawkes of the Investor Confidence Project (Europe), this too is increasing, but he says that “more investing in energy efficiency is going on outside of the green bonds market because green bonds themselves are limiting in terms of what you can use the money for”.
There are also greater transaction costs, principally in terms of verification. Fawkes cites by way of example the fact that in the US “many more buildings are constructed according to the LEED gold standard (the highest certified standard for new energy efficient buildings) than are publicised because while the standard in itself is open access certification is expensive and it is easier for developers not to bother to certify”.
Investment in these projects would not be recognised by impact investment or green bond statistics because they would likely be financed in a more conventional investment market.
For the market to grow, therefore, transaction costs need to be reduced and offerings become more investor-friendly.
It is presently much easier for investors to invest in a renewable energy project than an energy efficiency one because the capital investment, project management, technology and return on investment (ROI) are much more easily accountable. This is partly because the ROI on energy efficiency is less predictable due to the influence of human behaviour on the outcomes.
This is exemplified by the following graphs:
The growth of the portfolio of the GCPF and the types of projects invested in. Renewable energy investments have secured more than double the CO2 savings of those in energy efficiency (buildings and industrial processes), according to their annual report for 2016, (although this is by outcomes not by investment type, which the report does not quantify).
Moreover, especially in developing countries, which are typically way behind in terms of understanding and implementing energy efficiency, the early rewards for implementing an energy efficiency program typically yield between seven per cent and 50 per cent returns in just a few months – without any capital investment at all. The savings come from changes in behaviour. Fine for the company, but of no interest to investors.
Yet this is where the greatest potential lies. Non-OECD economies have a higher energy intensity than OECD economies, partly because they tend to be more focused on growth at all costs, and on energy-intensive industries such as the manufacturing sector.
Returns can be even better than 50 per cent. According to Bettina Schreck, a project manager for the South American industrial energy efficiency program of the United Nations (UNIDO), in Ecuador “a government macroeconomic study assessed the cost-effectiveness of its monetary contribution to an industrial energy efficiency program in terms of direct energy savings by analysing the average savings for all sizes of industries”. This was based on her organisation’s experience in other countries.
“Whether the viewpoint was from private or public sector, and calculated over the three years of the project or the lasting benefits beyond, the internal rate of return ranged from 50 per cent to 170 per cent and the payback period was approximately one year. The conclusion was that investment was beneficial from both social and private enterprise perspectives.”
For any investor, that would be a massive benefit.
The size of the market for energy efficiency
The potential size of the market for energy efficiency is huge compared to other sectors in impact and climate finance. The global energy efficiency opportunity will require global investments of around US$50 billion (AU$64.4b) a year over the next few decades according to the Global Climate Partnership Fund (GCPF). It also represents a lower cost investment for the same emissions reduction than other types of investment such as renewable energy.
There are many global trends requiring such investment: the increase in energy demand management, storage, renewable and on-site generation, and net metering; the development of value chains in climate-friendly technology; sustainable cities; reducing wastage in the water sector; the growth of the circular economy; and the growth of digitisation – cheaper metering and sensors, the Internet of Things (IoT), cloud computing and big data analytics.
But there is a huge challenge to make unlocking energy optimisation easier than it currently is. It is not always investor-friendly.
In a recently conducted survey, the Global Climate Partnership Fund investment manager responsAbility asked green lending experts from the developing world about their expectations and experiences in the area of green lending. They found that the main drivers were client demand and international support – green branding and regulatory incentives.
Awareness has also improved.
“The most important change is in the knowledge of clients. Previously, most of them had no idea what energy efficiency financing is. Now they know a lot more about it,” head of green lending Luke Franson said.
A lack of green lending expertise was perceived among survey respondents as the greatest threat to scaling-up energy efficiency finance – not, surprisingly, low fossil fuel prices.
“The mindset of entrepreneurs who see capital expenditure as a waste and not a measure to drive efficiencies is a challenge,” said Gustavo Adolfo Calderón Palma of Banco Pomerica.
Impact investment tools are constantly being refined and developed to make these transactions and their attractiveness easier and easier to see.
UNIDO, for example, is working on a more standardised assessment method for projects with cost-benefit analysis at national and business levels, and ways of measuring the non-economic benefits of EnMS implementation at both levels to build the business case. This will include a software tool for companies to identify multiple sources of added value.
The benefit of an EnMS
For energy efficiency, it is vital that a company or organisation has an energy management system (EnMS) in place that uses the ISO 50001 standard.
ISO 50001 was designed “to enable an organisation to establish the systems and processes necessary to improve energy performance, including energy efficiency, use and consumption”.
It is applicable to all types and sizes of organisations irrespective of other conditions and can be applied in all sectors. It dovetails with other management standards such as ISO 9001 (quality management) and ISO 14001 (environmental management).
Although the introduction of EnMS always leads to no-cost and low-cost savings, long-term and larger energy savings will come about through investment projects. According to Marco Matteini, another UNIDO project manager who also worked on developing this standard, “Adopting ISO 50001 can help boost investment by better preparing firms to receive external investment as well as optimising capital expenditure. The use of EnMS also improves the ongoing monitoring of project performance after investment.”
This is because having an EnMS helps management to recognise the value of energy efficiency, therefore making approval of energy saving capital projects more likely.
Presently only 10 per cent of energy efficiency projects are externally financed, and industrial companies often find difficulties with decision making in areas beyond their core business. According to UNIDO’s Rana Ghoneim this means that a desirable tool for investment in the future will be “some kind of underwriting toolkit and templates for energy efficiency investment”.
One new tool is a new version of the European SRI Transparency Code, which is geared towards guiding asset managers to meet relevant requirements for their products in SRI. It’s been developed by Eurosif to be in line with the recommendations made by the Task Force on Climate-related Financial Disclosure.
A free, online database for investors and financial advisors has also just been published by Impact Assets, a subsidiary of Calvert Impact Capital, listing 50 private capital fund managers that deliver social and environmental impact as well as financial returns. If you’re new to this, then it’s a good place to start to begin research on the impact investing sector.
Impact investment is clearly growing, from being a small kid on the block to a major player.
A version of this piece appeared in The Fifth Estate on 6 March 2018
David Thorpe’s two new books are Passive Solar Architecture Pocket Reference and Solar Energy Pocket Reference. He’s also the author of Energy Management in Building and Sustainable Home Refurbishment.