07Funding and Finance
Over the last two decades there has been growing emphasis on the role of innovative and private finance in economic development both in the UK and internationally. Historically, the approach has been for the public sector to ‘buy-out’ market weaknesses by offering subsidies to firms and projects that cannot attract private investment. The latest international thinking and practice has sought to move away from this approach towards a ‘market making’ approach which addresses all aspects of the market for investment, and provides longer term incentives for the market to respond.
Building this framework presents some challenges for the public sector in the way that it thinks and operates. The experiences of UK cities such as London, Manchester and Glasgow over a number of years suggests a number of key principles that should be adopted if the leverage of commercial funds into low carbon projects is to be maximised and sustained:
- Leveraging private finance is a commercial activity which demands an entrepreneurial approach by local authorities, as well as organisational structures to encourage and facilitate this
- Public sector interventions must be flexible and capable of adaptation to reflect different circumstances and different points in the investment cycle
- Public sector involvement should move away from grant aid transactions for single deals towards public financial participation in portfolios and specialists funds
- The public sector should continuously work with investors and recipients to identify and test the merits of new and existing business and investment opportunities
- ‘Market failure’ is not only about supply-side issues. Priority should be placed on stimulating and sustaining a continuous level of good quality propositions
- Experience and lessons – good and bad should be evaluated and proactively shared.
Case study 13: Cities across the UK – Energy Co-operatives
By harnessing the power of communities, councils can do much more than they could on their own and can ensure public services such as energy provision benefit citizens. For example, co-ops across the country are increasingly investing in energy efficiency, energy provision and building retrofit through flexible investment models. Community Energy Warwickshire invested in solar energy for a local hospital; Bristol Energy Co-op is investing in community assets; and the Carbon Co-op in Greater Manchester invests in whole home retrofits. Because these co-ops are embedded within the community, they can reduce the costs of identifying projects and building community support for them.
But while co-ops and community investment models offer many benefits, in reality the UK has had a slow take up relative to other EU countries, especially Germany. Whilst there were 31 co-ops managing local energy projects in the UK in 2012, Germany has over 600 co-operative energy groups, and Hamburg residents recently voted to buy back their energy grid from the private sector.68
With support from local councils, co-ops could play a greater role in providing cheaper utilities emitting less carbon. The support required is often quite small but can be critical, especially in the early stages. For example, providing opportunities for project trialling including within public buildings (for example using a school roof to test photovoltaic panels); or providing planning and environmental information to support emerging community schemes.
Key questions for cities
- What can be provided at little or no cost by local government to help co-ops grow?
- Does the council have skills, spare meeting space, networks or information a co-op may need to be successful and grow?
Case study 14: London – Co-investment model
Low carbon projects can encounter significant barriers to their development due to being innovative or high in set-up costs. These barriers include access to finance, sharing risk, and policy uncertainty. Because of these challenges, green projects are often on the margins of viability for private investors and developers. Urban Development Funds (UDFs) tackle these problems by using a co-investment model matching the different approaches of public and private partners.
The benefits of co-investment funds like UDFs include:
- The different risk and return appetites of public and private funders are matched at various stages of the investment process. Risk-averse and institutional investors fund the UDF, while investors seeking a higher return invest at the project level.
- The Fund allocates money for multiple projects and investments, hedging risk and building confidence for investors at the project-level.
- Fund managers provide the interface between the public and private partners, investors and developers, and drive the project from conception to completion.
London has three UDFs that focus on the low carbon agenda. The London Energy Efficiency Fund, for example, has £100 million to invest in retrofitting public and voluntary sector buildings such as universities, hospitals and schools to make energy efficiencies. Each UDF is run by a Fund Manager (a single institution or consortium of partners) who helps source potential projects, manage legal and financial due diligence for each project, contract projects and subsequently monitor project performance.
None of the projects funded through the London Green Fund (LGF) would have been brought forward if left to the market, because the returns cannot be fully internalised by investors and the risk profiles would be hard to manage for any single partner. But, by setting up a transparent, formal arrangement, the LGF is bringing forward investment in green projects that provide financial, environmental and social returns.69
Key questions for cities
- What are the benefits and drawbacks to co-investment models?
- What market failures could be overcome through co-investment?
Moving away from grants: rewarding innovation
Innovation prizes provide rewards for measurable outcomes rather than funding a process. They have been used by cities to inspire citizens and businesses to find solutions to public problems, but without bearing the up-front costs and risks faced by grant programmes. A report on NESTA’s Big Green Challenge prize found the programme helped focus communities on specific problems, identified and involved new talent and excellent ideas then mobilised new capital by attracting financial and non-financial support to the participants.70
Cities can use innovation prizes to encourage new ideas and find solutions to local problems. Even with limited resources, they mean councils are getting value for money by paying for outcomes. The Innovation Hub from Gauteng in South Africa has inspired and rewarded projects that have inexpensively reduced water waste, developed waste-to-heat energy platforms and even mobile apps for energy efficiency, all with the top prize receiving £15,000.71
As with all forms of funding, innovation prizes have their limitations. The NAO found that a UK government innovation prize for carbon capture did not sufficiently gauge the business risk and cost structure associated with the project, which led to its dismantling years later.72
In turn, cities can offer innovation prizes to support creative solutions to green issues, but the goals and risks of the prize must be taken into account and the rewards should match accordingly.
Key questions for cities
- What small scale or scalable innovative solutions can address local challenges and support cities in reducing their CO2 emissions?