Energy Efficiency Finance & Origin of Energy Efficiency Bonds

Industrial revolution which occurred between 1760 and 1840 marked the transition of manufacturing processes from using bio fuels to coal. This caused immense improvement in the efficiency of manufacturing and thereby development in the economy. The key reason for the massive growth of economies in Europe and other major countries around the world was the discovery of new energy sources and using it for industrial processes. With the discovery of petroleum in 1859 the industrial development took a new turn. During the early 20th century petroleum became the biggest source of energy.

With the discovery of petroleum, industrialization gained pace and petroleum along with coal became the source of power for industries, and raw material for electricity generation. With the increase in demand and increase in population, we have reached a point where if energy is not used with caution we may end up without it. This is the point where we reach a need of energy conservation or energy efficiency. Renewable energy and energy efficiency has become a widely discussed topic in the last 10 years.

Energy infrastructure usually has a large capital investment. Due to the high capital costs transition from older technology to new energy efficient technology becomes a difficult decision for companies, be it the energy generation companies or high energy consuming companies. But for achieving higher efficiency in energy usage or generation this investment is inevitable. Thus a new market emerged for financing energy efficiency projects and technology.

Energy Efficiency Bonds

Debt financing has become one of the most effective ways of financing energy efficiency. Though it was looked upon with lot of skepticism during its introduction, now it has proved to be good investment for investors and has become popular.

US government introduced Property Assessed Clean Energy (PACE) loans in 2005 in San Francisco. This allowed renewable energy and energy efficiency projects to be mortgaged. Later the further developments allowed securitization of these loans. In March 2014, the first ever ABS backed energy efficiency bond was introduced in the US. The bonds offered 4.75% coupons with 11 years maturity. This is used in  funding residential renewable-energy and energy-efficient projects – known as Property Assessed Clean Energy (PACE)loans.

The property-assessed clean energy (PACE) model is an innovative mechanism for financing energy efficiency and renewable energy improvements on private property. PACE programs allow local governments, state governments, or other inter-jurisdictional authorities, when authorized by state law, to fund the up-front cost of energy improvements. The local government issues bonds to fund projects with a public purpose.

Steps involved in securitization of energy efficiency projects

  1. Identifying energy efficiency or clean energy projects which has a positive economic impact
  2. Technical analysis of the project- commonly called as a feasibility analysis: This is usually done by engineering consulting companies
  3. Identification of technology and solutions
  4. Capital budgeting of the project
  5. Securitization of the project: This is the stage where with the assistance of an investment bank the project is securitized into bonds
  6. Selling the bonds to investors

(Source: Greenleaf Green Solutions )

Limitations of energy bonds

The protections put in place by such securities, to protect borrowers and existing mortgage holders may result in origination fees between 2-3%. For example, a 1% fee is often charged to cover a third-party technical analysis. This has come down in the recent years and is expected to be further lower soon.

In the case of PACE, several problems have been raised regarding residential PACE, but commercial PACE is far less controversial. This is mainly due to the failure of smaller projects like residential projects. This might not be necessarily due to the failure of the project but due to bad maintenance of projects or lack of regulatory systems for proper disclosure of the performance. With the new and advance technology, the performance is easily monitored and the failure of projects have become nearly zero.

 

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FinTech – Disrupting Traditional Financial Services

(This Blog Post is originally written for an internal blog of University of Edinburgh Business School)

FinTech (Financial Technology) has been a buzz word for the last couple of years in finance industry as well as the tech industry. The rapid growth of online banking services and online transactions have encouraged the best brains in the tech industry to bring out innovative products for financial services.

With high flow of venture capital funds, new technology companies are emerging in the financial sector in the fields of crowd funding, peer-peer lending, wealth management and so on. Goldman Sachs has estimated that the industry has a total worth of $4.7 trillion. Like other disruptive businesses, FinTech companies are growing very fast and the inward flow of investments are growing exponentially. It attracted $12 Billion in 2014 which is 3 times increase in investments from 2013.

The following chart gives an idea of growth in investments in FinTech

Screen Shot 2015-11-09 at 11.38.45 AM

Source: The Economist

Fuelling  FinTech

FinTech is relatively a new sector that has emerged after the financial crisis of 2007-2008 and gained a lot of popularity during the last 3 to 4 years. As in many new businesses the major source of funding in FinTech is also from Venture Capital funds and Angel investors.

Major Venture Capital funds investing in FinTech

  • Sequoia Capital
  • Accel Partners
  • Meritech Capital
  • Baseline Ventures
  • Greycroft Partners
  • Funding Circle
  • FinTech Collective

Apart from Venture capital funding there has been a huge inflow of capital from crowd funding, which comes within the FinTech sector.

A few FinTech companies have done an IPO recently which includes the major companies like Lending club and WorldPay.

Disruption caused by FinTech and How Banks adapt

FinTech is a highly disruptive development in the financial services market. FinTech ventures are changing the way the whole system of financial services. It has made financial services more accessible, cheap and customer friendly. FinTech companies have brought most of the financial services to the customer’s fingertips.

It has created a risk to traditional banking and financial services. Banks and other institutions have started responding to the change in the market by adding new models to their businesses. If the traditional institutions are not pro-active in responding to the changes, FinTech is a serious threat to their future.

There are views that Banks and FinTech have to go hand in hand.  Both banks and FinTech have their strengths and weaknesses, and both will be better off by cooperating and combining the best they can offer to cover each other’s weaknesses. Banks can guarantee rapid scaling with significant funding and access to demand. The FinTech sector can offer the most innovative and efficient solutions for better customer service. Santander, recently in one of the papers they published, used a term called FinTech 2.0. As stated in the paper, while some FinTechs today are focused on the race to build standalone “Unicorns”, FinTech 2.0 represents a far broader opportunity to re-engineer the infrastructure and processes of the global financial services industry

Banks have realized the need of FinTech in their operations. Banks are doing everything possible to adapt to the new scenario. As a result of this, we may anticipate more investments by banks into developing their technology side and more research into efficient operations. We may even expect a few acquisitions of FinTech companies by major banks and financial services companies in the near future. This would be a more efficient way traditional financial services can keep up with the changes in the business environment.

Appendix

A Few Emerging FinTech Companies

Screen Shot 2015-11-08 at 1.59.30 AM

Source : FinTech Future, A Report by UK Government Chief Scientific Adviser

 

Impact Investment

Disclaimer : This blog is originally written for the internal blog in University of Edinburgh Business School


Impact investment is defined as investments made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return. Recently many institutional investors are incorporating an impact investment strategy to their portfolio. Impact investments are gaining much interest among large investors especially after the last economic breakdown.

Major investors in impact investment are High net worth individuals(HNI), Foundations, family offices and so on. As per the report by JP Morgan there is an increasing interest among investors in impact investments. As per the study,  2013 saw an increase of more than 12% in investments in different asset classes which comes within impact investment. A major portion of the funds are invested in sustainability projects with social impact, which includes manufacturing and distribution of  solar lighting and power products to those without access to reliable electricity and thereby transforming lives in the developing world. In 2014 J.P. Morgan and the Global Impact Investing Network studied 125 major fund managers, foundations, and development finance institutions and found $46 Billion is being invested in sustainability projects which is a 20% increase from the previous year.

Debt Financing in Impact Investment

With the growth of investments towards social impact projects, governments and corporates have started issuing bonds to finance such projects. Two examples are given below

  • New York State, Social Finance and Bank of America Merrill Lynch teamed up to launch a social impact bond to reduce recidivism. They raised $13.5 million.
  • IIX Asia, a very innovative platform for impact investment based in Singapore is planning to launch a Women’s Livelihood Bond which will be focusing on women’s development in South-East Asia. They are planning to raise $ 20 million in the first issue. The bonds will be listed on Impact Exchange, worlds first Social stock exchange.

Future of Impact Investment

Studies show a steady growth in social and sustainability Impact investments around the globe. There are predictions that the whole impact investment market will grow to 3 trillion dollars by 2020.

With the growth in impact investments, philanthropy is moving from not-for-profit to for-profit initiative. Sustainability of funding for social causes will be achieved only by making it a for-profit initiative rather than a not-for-profit or donation.

When Venture Capital market exploded in 1980, it changed the industry. Lot of products and services came into the market and it eventually changed the life of everyone. Many people see Impact investments as something which has the potential to bring in change in businesses as Venture capital did in the 1980s.

Impact investment has the potential to bring in the next big change in Entrepreneurship, the society and the life of millions of people.