(This is part 3 of a 3 part series on climate finance for India. Read part 1, 2 here.)
While ideas are all good, high quality execution and ambition of capital is key. Climate finance is needed across sectors with varied business models and financing needs. Each need different evaluation process and operating model. E.g.: Financing a small factory to adopt rooftop solar power requires a distinct approach and loan product. It is different from financing rainwater harvesting projects for buildings. Financing a startup that manufactures energy efficient fans require an alternate evaluation method from traditional corporate loans. A retail financial institution that provides loans to buy solar powered fruit driers needs to be evaluated and funded in a completely different manner. Dealing with all the above, at the beginning, is complex.
Choose the initial set of customer segment and product offerings:
The capital interchange should initially focus on one or two customer segments and one or two product types till it reaches a reasonable asset size.
Some of the potential customer segments to start with are:
- Wholesale NBFC lending for building climate smart portfolio, followed by securitisation of the pools of retail loans created.
- Financing for corporates and their supply chain to adopt climate smart technologies -For example sub-segments within industrial decarbonisation (energy efficiency, water, pollution control, waste management) or industrial and domestic cooling/ heating could be studied to identify a good place to start.
- Climate technology companies at the early commercialisation phase requiring capex or working capital support or support for financing innovations (eg: PayGo, Heating/cooling as a service, etc) to accelerate adoption.
An ideal mix would be to identify one technology and supply chain where there is policy or business pressure to achieve quick scale. Designing financing structures in that area and replicating that process can help in building assets reasonably quickly.
Build prototypes of the intelligence infrastructure:
The next step is to find the metrics and reports that would make it easier to make quick decisions. E.g.: Early warning systems and risk and impact evaluation frameworks are key components. This will serve as the signals and switches that lead to faster decision making. Building low-cost prototypes of these frameworks in the first 1-2 years using spreadsheets and cheap software will help future technology development.
The intelligence infrastructure will be the foundation of the transparent systems that the capital interchange will build to attract investors. While initially the capital interchange will demonstrate skin in the game with its own balance sheet, over time, the intelligence infrastructure should enable greater leverage of the balance sheet.
Bring together the initial set of investors:
It is important to find the first set of aligned investors to invest in the balance sheet of the entity and to make commitments to invest directly intro transactions/deals curated by the interchange. It would be ideal to have an initial consortium of investor partners with representation across the capital spectrum. It would be necessary to have at least one development focussed and one philanthropic investor as investor partners to start off with. It would be useful to bring in at least one commercial investor from amongst pension funds, endowments, financial institutions or insurance companies. The expectation from each investor category is to commit to making direct investments into projects, structured transactions and companies.
The entity will also do well to fast track the process of being eligible of subsidies from the likes of SIDBI or other sources. Access to guarantee facilities at sub-commercial guarantee fee rates would also add significant value.
Create a dual for profit and non-profit structure:
Given the goal of blending both commercial and concessional capital, a dual structure is needed. One would be a licensed for-profit investment arm to focus on capital that seeks financial returns at different levels. The other would be a non-profit arm that would focus on capital for ecosystem and product development, as well as capacity.
The non-profit arm will focus on delivering ecosystem value by conducting sector research and impact evaluation. By sharing anonymized data collected on impact and returns of the transactions, it will seek to establish benchmarks for future investments. It will also carry out work related to project development for new type of deals structures.
The licensed for- profit arm is expected to be an NBFC. The NBFC enables the capital interchange to demonstrate skin in the game and enables it to curate/warehouse pools of assets that will finally move to the balance sheet of long-term investors. Where the asset size is not meaningfully large, fund vehicles may be promoted by the NBFC through a subsidiary.
It must be noted that the capital interchange is NOT an NBFC. It is a risk and impact data intelligence company with the execution skills of an asset management firm. It is an institution that uses legal structures like the non-profit arm, an NBFC and/or funds to demonstrate skin in the game by using the best fit channel to drive capital towards climate solutions. The growth or success of the firm is not to be decided based on the size of the assets that it is on their balance sheet, it should be based on how many times the balance sheet has been leveraged to mobilize a capital for the climate projects.
A climate capital interchange for a resilient economy
Like a well-managed railway interchange converts disconnected routes into a well-functioning transportation network, a capital interchange can ensure that no climate solution is left stranded.
Investors must act now, because climate finance isn’t just about numbers quoted. The billions committed can’t remain empty promises made at conferences held in snowy resort towns. They must translate into real impact, on the ground, today.
(This is part 3 of a 3 part series on climate finance for India. Read part 1, 2 here.)
Avishek Gupta 