19 February 2015

The EC's plan to unify capital markets can help address climate change

The European Commission's plan to unify capital markets announced this week can benefit renewables and energy efficiency firms, argues Martin Schoenberg

Martin SchoenbergAny low-carbon investor will remember well how in some European countries, as the macroeconomic situation worsened, they made retrospective changes to the payments they had promised investors would receive for generating renewable energy.

This – combined with the general downgrade of their credit ratings – has nearly brought new investment into low-carbon infrastructure to a standstill in those countries. It has had huge ramifications for the ability of these countries to transform and upgrade their infrastructure towards a low-carbon economy and, consequently, for the likelihood of them achieving Europe's recently agreed 2030 climate-energy targets.

So, are we heading for a multi-speed Europe in which some countries can forge ahead ambitiously with their low-carbon infrastructure plans, due to the low or even negative cost of financing these investments, while others are struggling to even keep the old infrastructure alive?

In reality, we are already in the middle of this multi-speed Europe. This has to do with the situation of some banks in the struggling countries – if you can't raise enough debt against your investment, this investment might not stretch enough to make the necessary returns.

Making renewable energy companies capable of competing with the fossil fuel companies will help mitigate the carbon bubble

In the US, capital markets are twice as deep as in Europe, which has helped in the economic recovery: capital markets were able to step in while the banks were consolidating their finances. China – measured against its scale – now also has deeper capital markets.

The European Commission this week announced bold plans to intensify the use of capital markets especially for small and medium-sized enterprises (SMEs), and to counter the increasing fragmentation of these markets. Both these objectives are directly relevant for tackling climate change.

 

Firstly, if you look at the ecosystem of renewable energy companies, you will find very few that are actually huge corporations. Most renewables companies tend to be small to medium-sized. Bringing SMEs further into capital markets will expand the variety of sources of capital renewables companies can tap into, and correspondingly – at least that's the hope – make low-cost capital available.

In competing with fossil fuel companies, renewable energy companies have had the crucial disadvantage that they were in a different asset class – seen as alternative investments rather than the mainstream (to which the fossil fuel companies belong).

Making renewable energy companies capable of competing with the fossil fuel companies, and making those renewable energy assets more frequently traded, will help mitigate the carbon bubble.

The appetite of the main providers of money to capital markets – the big pension and insurance funds – for sustainable investments is enormous, as the global boom of green bonds has demonstrated.

If you are building a renewable energy project, the cost of capital is one of the most important cost drivers – since it requires a sizeable investment up front that yields steady returns over long timespans. The interest you pay on the loan you take out to finance that project, and the returns your investors expect, is crucial.

The appetite of the main providers of money to capital markets – the big pension and insurance funds – for sustainable investments is enormous, as the global boom of green bonds has demonstrated.

Secondly, the capital markets union will tackle regulatory barriers to risk transfer and capital movements across EU countries.

This can help in making it a bit cheaper to build low-carbon infrastructure in the countries that need this investment the most. This can bring the frontrunners in Europe – like Denmark, Germany, Sweden and the UK – and those who have recently been struggling a bit closer together.

 

As an investor, you will of course still expect a higher return for a country that has betrayed its promises in the past (if you choose to invest at all), and you will expect a higher return in a county that is awash with debt.

Making capital flow more easily across European countries will help in lowering the risk of providing deserving opportunities with capital, with sustainable infrastructure being at the top of the list.

As such, the capital markets union floated this week by the Commission is a great initiative that can help the climate change agenda. Levelling the playing field in accessing capital is what the EU should be hard at work doing. It deserves a round of applause.

Martin Schoenberg is head of policy at London-based Climate Change Capital