Note: This post originally appeared in The Globe and Mail.
Leaders from across the globe, representing more than 90 per cent of global greenhouse-gas emissions, are in Paris at COP21. All pledge aggressive emission reductions. Canada’s existing promise to lower emissions 30 per cent below 2005 levels by 2030 is a rock-bottom target for the newly minted federal government. Ontario, Alberta and Quebec have each cranked up their own climate targets. With 2015 set to smash temperature records, the world is poised to move from climate promise to policy. Now, the real work begins.
But governments can’t tackle climate alone. Effective policy mobilizes private capital and unlocks market forces. A price on carbon — whether cap-and-trade or a simple tax — remains the foundation of any serious effort to engage markets. Alberta and Ontario have committed to recycling that revenue into policies that will reduce emissions. The federal government has committed billions for green infrastructure. New York state and Britain, among others, have established “green banks” to accelerate their own low-carbon transitions. Canada and our provinces would do well to follow their lead. An independent green bank, publicly mandated but responsive to market conditions, can dynamically address market gaps unique to low-carbon energy in ways government ministries simply cannot.
For example, pension funds are the biggest source of long-term capital in the country. But they won’t invest in projects without massive scale. Most clean energy projects — efficiency retrofits or energy production — are undersized and so face high capital and transaction costs. A green bank can aggregate these assets by taking on perceived liquidity risk (i.e., the risk an investor can’t resell the asset) while it’s being warehoused. The bank then passes on the aggregated assets to the private sector at scale.
There are lots of other ways to play. A green bank can take a “first loss” position on projects with subordinated debt to unlock commercial bank activity. It might match private funds on hard-to-find project equity for newer technologies. By doing the technical diligence a traditional bank won’t, it can sell well-priced performance insurance. That translates to security for private lenders who worry the project might not spin cash for the long term. Or, it can extend the maturity of available debt to match a project’s lifetime. Or deal in retail financial products that get small businesses and homeowners involved.
A green bank limits its role to market formation. As soon as the private sector is willing to step up, it backs off. And it recycles its capital. As loans are paid off and aggregated assets are sold, that capital goes back through the system.
The range of activities is open-ended, as are the financial tools it can use. Both vary with market conditions. And that’s the point: No government ministry or fund can react to market dynamics the way an arm’s-length institution can. Think of a green bank as a kind of sensor, embedded deep inside the financial sector, able to detect and respond to market signals in a way a government ministry never could. Entrepreneurs bring technical innovation; a green bank brings financial innovation.
There’s lots of precedent. Green banks are a new twist on an old theme — arm’s-length institutions that apply the rigour and creativity of private markets to public mandates. Sustainable Development Technology Canada is a world-class early-stage clean technology funder and a big part of Canada’s lead in clean technology. Export Development Canada is a critical partner to Canadian exporters. And the Business Development Bank of Canada has long provided liquidity to small and medium-sized businesses when the big five banks won’t.
Private markets aren’t perfect, and sometimes need a push. The deep conservatism of capital markets means security and a steady hand, but it’s not the kind of thinking that drives the fundamental economic restructuring climate-risk calls for. Some pumps need priming.
A couple of decades ago, a small and gradually rising price of carbon could have been effective enough to reduce emissions to the extent that we’d have a limited warming of two degrees C. But we no longer have that luxury.
Balancing deep emission cuts with continued economic development means bold and creative action by the public and private sectors. Effectively mandated green banks are a way to help keep Canada’s economy at the forefront during the difficult global economic transformation so critical to a prosperous 21st century.