How to spend an extra US$600 billion a year on climate finance
Jenya Khvatsky, CleanTek Market | 21 February 2017
Jenya Khvatsky’s start-up company CleanTek Market has been founded to create a global online platform to connect clean technology projects, technologies and organisations with investors, end users and intermediaries. Here’s how he reads the imperatives for such a service.
We are in the midst of a clean technology revolution. There is now widespread acceptance that the global economy is transitioning away from a traditional fossil-based model to one based on sustainable use of resources and energy.
To achieve an orderly transition, the scale of financing required can be counted in the trillions – not billions – of dollars. A widely quoted report by the International Energy Agency estimated that US$1 trillion a year to 2050 is required to finance this transition (IEA, 2015). Yet the cleantech market has averaged US$360 billion a year over the first half of this decade, peaking at US$391 billion in 2014, to be valued at US$5.5 trillion (CPI, 2015). The current scale of the market is impressive – and yet it is some 60 per cent below what is required. A clear market failure.
So what is going on? And, how can we improve this situation?
The massive structural underinvestment in the sector is due to a number of market inefficiencies. These include a lack of clear local, regional and global regulatory signals; poor access to risk capital for new initiatives; poor access to specialist expertise; low visibility; and the small scale of many initiatives.
The Paris Agreement attempts to orchestrate the global cacophony of regulations governing the sector into a harmonised plan of action. But the agreement ultimately pushes the action down to individual countries, where actual adherence continues to be patchy – closer to jazz than symphony. Europe and China are leading the way. Canada is back. The US is likely to backtrack. Australia is still vacillating.
While it’s comforting to blame national and international regulators and legislators, it is also true that the private sector is simply not positioned to deploy an additional US$600 billion a year on cleantech.
Here are some reasons:
Deal flow origination and transaction is mired in 20th century processes. Transactions still largely depend on physical networks of developers, finders and investors. Luck is a key factor in a developer finding an investor with aligned focus on technology type, technology readiness, location and spend, who, critically, also has funds to invest at that point in time. If this is a challenge in the mature economies of Europe, North America and Australasia, it is an impossibility in most emerging economies. Yet this is where clean energy, air and water matter most. It is also where such projects make financial sense without government subsidies.
Using the internet to efficiently match cleantech initiatives with investors and other intermediaries would increase the likelihood of such parties finding each other. Online platforms that efficiently match buyers and sellers already exist in other sectors – employment, real estate, dating, etcetera – and could readily be applied to cleantech.
Deploying US$600 billion a year is something large financial institutions do well. They collectively deploy US$8-10 trillion a year on a managed base of over US$300 trillion (growing at 3-4 per cent a year). These organisations have a minimum spend in the tens of millions to justify their high transaction costs and overheads.
Yet many “clean” technologies are best deployed at relatively small scale, often costing substantially less than US$1 million – for example local or community scale projects around energy and water efficiency, small-scale generation and storage, for example. These projects are the underrated backbone of the clean technology transformation.
While large financial institutions try to get to such projects through private equity and venture capital firms, these “more nimble” investors also have their limitations – minimum spend (again), relatively narrow focus, etcetera – and represent considerable value leakage in their management fees (“2 plus 20” per cent being the norm).
Investment tools that can aggregate small projects, and thereby enable institutional investors to efficiently deploy tens or hundreds of millions of dollars at a time, would dramatically increase the flow of capital into the sector.
Deep tech & information asymmetry
Encouragingly, the rise of fintech is disrupting all financial services – including deal origination and transaction. For example, the rise of crowdfunding for equity and debt is simplifying and democratising the investment process. Blockchain technology is improving the security of transactions and opening the path toward their full automation.
There are, however, reasons that cleantech can be considered challenging. Emerging “deep” technologies (for example storage and advanced biofuels) require specialised technical expertise to evaluate prior to investment. Such information asymmetry is the main reason crowdfunding has not yet penetrated this space.
So there is a need to bring these technologies and projects online in a way that they are either pre-vetted, or so that expertise can be seamlessly brought in to evaluate the technology and/or project.
This suggests that the matchmaking site we sketched out above will require advisors, consultants and other intermediaries who can assist buyers and sellers to find and understand each other.
To address these issues, we need to bring the entire cleantech ecosystem onto a global matchmaking, crowd funding platform. At a global level, the networks effects and the law of large numbers dictate that the more buyers, sellers and intermediaries are participating, the higher the probability of matches and ultimately deals.
So why isn’t there a cleantech marketplace? Actually there is – several, in fact. At last count, there were seven platforms promising to match buyers and sellers. But none of these really address the issues identified above.
Most come from an NGO or not-for-profit background with the aim of improving the market. However, by their pedigree and ethos, they are often too inclusive, with limited quality control to filter out substandard deals – undermining their effectiveness and value. For this reason, they are generally shunned by commercial users.
The more commercial platforms tend to be highly segmented on geography, technology and project type. Their common factor is that they ultimately seek to manage the transaction – inserting the human element, and earning their fees. This simply cannibalises existing dealflow channels rather than growing the whole market.
So what is the solution?
There is a pressing need to bring the whole cleantech ecosystem together on one platform, provide key players with services that simplify the transaction process, and let network effects and the law of large number take their course. In an age of smart algorithms, machine learning and blockchain technology, I believe that we could do better. Specifically, by:
- providing a matchmaking platform that maintains user privacy while efficiently matching buyers and sellers;
providing tools that enable users to screen each other, aggregate into larger buyer or seller groups, crowdfund for equity and debt, visit marketplaces for refinancing, or find multi-party PPAs – all backed up by simple, standardised contracts.
Jenya Khvatsky is chief executive of CleanTek Market.