In this edition, climate policy and finance experts talk about issues that go beyond the announcements out of the White House. We also take a look at the rise of private credit in financing climate action; and ask if a different approach to risk management can help drive climate finance to where it is most needed.
Extreme patterns
Over the past five years, a key set of energy transition assets in private markets has generated returns that outpaced their peers in the public markets, according to research by MSCI. These assets, unsurprisingly, are in renewable energy, energy storage, and green mobility-related sectors.
In fact, since Q3 2019, private investments in green mobility have delivered a five-year cumulative return of 290%, compared to 164% for venture capital and 149% for buyout overall, as of Q3 2024, notes Abdulla Zaid, Vice President, Private Capital Research, MSCI.
Asia dominates in private investments in green mobility, such as electric vehicles and their components, accounting for 59% of the underlying assets’ net asset value, considerably surpassing those in North America (28%) and Europe (12%).
But, Zaid also points out, green mobility has since encountered pronounced challenges since peaking in Q4 2021. Between Q4 2021 and Q3 2024, its cumulative return was -50%, compared to a -12% return in venture capital and a 24% gain in buyouts.
Now, with the drastic cuts being announced by the Trump administration, it remains unclear how these sectors will fare.
From NASA (National Aeronautics and Space Administration) to NOAA (the US National Oceanic and Atmospheric Administration), and climate research at Ivy League colleges, not to mention the tens of billions of dollars under the Inflation Reduction Act, no funding that does not align with the Trump administration’s priorities is safe from being cut.
Taken together with slowing growth and rising inflation, this is only exacerbating the trillion-dollar chasm in climate financing.
The industry, especially in the developing world, is already under immense funding strain. Many are startups, and as data shows, are already struggling to raise the continuous flow of capital they need to scale up and make a difference.
It does not help that private capital funding, which would typically go towards innovations and technologies that could help with climate mitigation and adaptation, has tightened as a whole, as many investors find they are yet to reap the returns from their earlier commitments. The ongoing uncertainty – bane of decision makers everywhere – would only make investors and allocators more wary of committing to even what could be game-changing technology or infrastructure.
But, as one industry expert points out, perhaps the bigger issue is tackling what is essentially a long-term, global crisis with far-reaching consequences, with only the resources that are available today.
“The reason these trillions of dollars get estimated is because we tend to think about [the] problems being solved with today’s solutions at today’s prices, at a much larger scale, which is just not going to happen,” Kalpesh Gada, structured credit expert and advisor at Climate Policy Initiative, told GreenStreet.
“We would have never been able to create the kind of resources, especially financial resources, to solve these kinds of massive [climate-related] problems, which to a certain extent, can be solved only with new technologies.”
Perhaps, it is these circumstances that will finally bring to the fore the technology, business models, and change in behaviour, the climate needs.
Giving credit where it is due
One way that investors are seeing opportunities to plug the financing gap is through private credit. The strategy was among the strongest asset classes globally since 2021, buoyed by favourable interest rates over the period. It remains to be seen how managers navigate the interest rate environment ahead.
GPs who are capitalising on the trend include Navis Capital Partners, whose inaugural private credit fund aims to raise $350 million to deploy into areas such as renewable energy, supply chain decarbonisation, sustainable logistics, and sustainable real estate.
As development finance institution British International Investment told DealStreetAsia in a recent interview, private credit comes in particularly useful in Southeast Asia for infrastructure. With the right assets and underwriting, the strategy gives investors peace of mind with predictable cash flows.
On the other hand, that requirement to generate cash flows also means private debt would apply only to a limited set of assets – essentially, businesses that are already reasonably mature. As one industry insider said, startups tend to be asset-light and have little deep tech R&D or intellectual property. Plus, there still lacks a coherent system of evaluating carbon credits. All this translates to higher risk and insufficient collateral for lenders.
Credit advisors also caution against the risk of a business owner taking on debt to avoid a dilution at poor valuations, such as may be the case in today’s environment, but perhaps suffer worse consequences when that debt matures and the business does not turn out as expected.
One way of “effectively financing” early-stage companies is to look at the governance of the business, including who is already on their cap table.
As Aavishkaar Capital partner Abhishek Mittal tells GreenStreet: “These days [lenders] will have to find a new way to assess the governance standards after what happened at eFishery. Incoming investors would be wary of even relying on audited numbers and earlier due diligence reports as it seems the company used two sets of financials to mislead its investors. Many early-stage startups don’t even get their numbers audited on a regular basis.”
Data from MSCI below shows, private credit still accounts for a fraction of the strategies deployed across energy transition assets.
Climate tech deals in Southeast Asia
The month of March saw a slight increase in the number of deals in the climate space from earlier in the year.
Among the transactions were early-stage investments in solar energy and agritech companies, including in Singapore-based Agros, Stride, and SmartSolar in Vietnam, and Okapi in Malaysia.
Investors in these include Wavemaker Impact, Clime Capital, 1337 Ventures, 2degrees, The Radical Fund, and Khazanah.
Wavemaker Impact also seeded a Singapore-based biofertiliser startup, Zentide.
Viewpoint: Aggregate climate risk for better capital allocation
The current risk-adjusted return model would typically layer foreign exchange, sovereign, and political risks, which is fair, because if I’m investing in a project in a geography where all of these risks exist, I would want to factor in all of them when I’m calculating my return profile.
But with climate, it’s slightly different, because I’m not trying to solve just the money-making problem. I’m trying to solve a global good problem, and therefore, my returns, while adjusted to all the risks, cannot be measured against the same parameters.
For example, if my return on investment expectation in Nigeria is 20% and 3% in Germany, that does not make the German project any better from a climate standpoint. What we need is an incorporation of climate impact into the risk assessment models, at least for the climate-positive projects.
We need a risk management mechanism where global risk for climate projects could be aggregated. For example, if there are 100 solar projects across 100 geographies, their risk could be aggregated on a project basis, and then those can be reallocated to entities that can manage them best.
There could be a unified premium that can be paid across the projects, which makes the cost of capital more rationalised for projects in all parts of the world. And we won’t see capital rushing only to the developed OECD countries and China.
Data from the IEA suggests that 70% of climate capital goes to OECD countries and China. Over the next 30-40 years, the energy demand is going to grow in non-OECD and China, so capital needs to flow where the demand is going to grow. If that does not happen, technologies that are fossil fuel-based, which are proven and more readily financed in the conventional system, will get deployed, and that will create lock-ins for the next 30-40 years.
Saarthak Khurana, Senior Manager, Climate Policy Initiative India
