Module 02Climate FinanceLesson 2Risk Mitigation Instruments
Climate Finance Module 2
Presentation Script
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
Welcome to Lesson 2: Risk Mitigation Instruments.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.2 Introduction
In this lesson, you will learn how public finance and risk mitigation instruments can remove barriers to climate finance investment. Specifically, you will better understand the various risks acting as barriers to private sector climate finance investments; the different types of risk categories in low-carbon projects; risk mitigation instruments used as tools to reduce risk, and case studies of risk mitigation in practice.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.3 About Lesson 2
Some key questions that will be addressed during this lesson include: What are the risks in low-carbon investment projects? How are risk mitigation instruments being used? What are the current gaps and trends in risk mitigation instruments? What are examples of utilizing risk mitigation instruments and how have they supported climate finance investment?
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.4 High Perception of Risk in Low-Carbon Projects
Low-carbon projects typically suffer from high perceptions of risk, particularly in developing countries, which can negatively affect climate finance investment and even hinder private sector's participation. Low-carbon project risk factors include a dependence on public policy; the relative immaturity of technologies, markets, and industries; long investment horizons; high upfront costs and a lack of dedicated investors. In order to unlock climate finance investment, policymakers should focus on addressing these risks.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.5 Categories of Risk
In order to better understand risks to climate finance investment, the Climate Policy Initiative has grouped risks into four categories according to their different sources and character. The following slides will introduce each category of risk is more detail.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.6 Political, Policy, Social Risks
The first risk category includes political, policy, and social risks associated with actions by governments and citizens. Political risks are due to illegitimate actions of public authorities discriminating against investors. Policy risks involve legitimate actions of local authorities exercising their power to rule. Social risks are due to actions of private individuals or groups. These risks also include misappropriation of public and private resources. Click on each Example button to read more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.7 Political, Policy, Social Risks in Low-Carbon Projects
These risks are enhanced by the very nature of low-carbon projects. For example reliance on public financial and institutional support; having investment horizons longer than policy cycles; and sometimes cause environmental impacts that lead to social resistance.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.8 Technical, Physical Risks
The second risk category includes technical and physical risks. They are technology-specific or related to the ongoing availability of natural resources. Four examples include; construction and operation risks, physical output risks, environmental impact risks and decommissioning risks. Take a moment to read about these examples in detail.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.9 Technical, Physical Risks in Low-Carbon Projects
In low-carbon projects, these risks are enhanced by the fact that many technologies employed are not yet proven green technologies. This means that such projects lack accurate technology performance data; and suffer from uncertainty over measurements of the natural resources availability.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.10 Market, Commercial Risks
The third risk category includes market and commercial risks. Six examples include currency risks, market risks, financing risks, counterparty and credit risks, and liquidity and exit risks. Take a moment to read about these examples in detail.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.11 Market, Commercial Risks in Low-Carbon Projects
In low-carbon projects, these risks are enhanced by the fact that they incur high upfront costs; long investment horizon and payback periods; financiers' unfamiliarity with green investments; and complexity of infrastructure investments.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.12 Outcome Risks
The last category of risks include outcome risks which are risks perceived by the public sector and are linked to the ability of publicly-supported green projects to meet objectives within expected costs. Outcome risks include emission reduction risks, co-impact risks and budget impact risks. Take a moment to read about these examples in detail.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.13 Outcome Risks in Low-Carbon Projects
In low-carbon projects, outcome risks are typically enhanced by the amount of public support required for such projects to be successful and the budget constraints such projects face.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.14 Categories of Risk Mitigation Instruments
In light of the low-carbon projects risks we just covered, risk mitigation instruments are tools to promote climate finance investment. The Climate Policy Initiative has identified six categories of instruments that directly addresses specific risks or multiple risks at once. Click on the private and public sector buttons to learn which sector uses which instruments. Advance the slide to start learning about each instrument.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.15 Risk Mitigation Instruments: Bilateral Contracts
Bilateral contracts are risk mitigation instruments addressing project risks not related to credit. They are usually provided by private entities to cover technical risks related to the operation phases of projects, or to cover output price risks. For more advanced technologies, like offshore wind farm projects, bilateral contracts can be highly specific with complex drafting, implying high transaction costs. Click on each example on the right to learn more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.16 Risk Mitigation Instruments: Credit Enhancement Instruments
Credit Enhancement Instruments are usually developed by specialized public and private entities to cover commercial and market risks by guaranteeing (partially or in full) the liabilities of a project towards its lenders. Credit Enhancement Instruments improve the quality of loans and bonds issued by the projects by mitigating the borrower's credit risk and enhancing coverage of debt service obligations. Click on each example on the right to learn more. You may also click on a mapping of the World Bank's Risk Mitigation Instruments, mostly focused on guarantees.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.17 Risk Mitigation Instruments: Insurance
Insurance is a well-established risk mitigation instrument, typically provided by private companies. This is in exchange for a premium and upon verification of the liability of the claim. Insurance risk mitigation instruments are very common in mitigating physical, market and political risks. Click on each example on the right to learn more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.18 Risk Mitigation Instruments: Revenue Support Policies
Revenue Support Policies are the public sector's main tool for promoting low-carbon projects by reducing output price risks and offering resources that reduce financing risks, for example tax credit or equity. One drawback is that, as technology deployment increases, revenue support policies become heavier for public budgets, creating incentives for governments to renegotiate them. For investors, this creates the perception of policy risks. Click on each example on the right to learn more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.19 Risk Mitigation Instruments: Direct Concessional Investments
Direct Concessional Investments are risk mitigation instruments from public entities (such as governments' budgets, bilateral and multilateral development banks), dedicated private-equity facilities, and international climate funds. They help mitigate financing risks by providing loans or equity funding that enhances the financial viability of low-carbon projects. Click on each example on the right to learn more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.20 Risk Mitigation Instruments: Indirect Political/Institutional Support
Indirect Political and Institutional Support refers to public, non-financial, interventions that usually target multiple risks, including political, policy and regulatory risks, as well as technical and physical risks. Instruments under this category include technical assistance for sustainable energy policies and capacity building activities, for example, quality certificates. Click on each example on the right to learn more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.21 Current Gaps in Risk Mitigation Instruments
In developing countries, public and private entities provide several risk mitigation instruments yet this does not cover all kinds of risks. For example, instruments only appear to address political risk, not policy risk. Also, financing risks have been mostly addressed with concessional resources, which do not improve the liquidity of investments or attract private finance. And most low-carbon projects supported by public spending weigh heavily on already tight public budgets, furthering the perception of outcome risks. This means that new and innovative risk mitigation instruments are needed.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.22 Trends in New Risk Mitigation Instruments
Currently, two types of new risk mitigation instruments have emerged: Policy Risk Insurance and First-Loss Protection.
Policy risk insurance provides coverage against “retroactive policy risk”, when national governments shift policies in ways that hurt the financial stability of projects. First-loss protection protects investors from a pre-defined amount of financial loss, enhancing the credit worthiness and improving the financial profile of an investment. Click on each new instrument to learn more.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
Policy Risk
Policy risk insurances can indirectly address policy risk. Partial Risk Guarantees can also address policy risk, but only when it is clearly identified in the contract and when a counter-guarantee by the host government is available. Another form of policy risk insurance, such as feed-in-tariff insurance, reduces the impact of policy risk by providing coverage for changes to national policies that would harm the financial stability of existing projects.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
First Loss Protection
To be effective, first-loss protection should address specific investor needs by matching their required risk-adjusted rate of return and allowing securities to obtain an investment-grade credit rating. First loss protection can also address institutional investors' unique circumstances, such as liquidity of a secondary market and mitigation of some specific project-level risks.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.23 Summary
In summary, addressing risks to low-carbon projects helps to unlock climate finance investment. Risks act as barriers to investment, raising the cost of capital and hindering private sector's participation. Organizing risks into the four categories helps to focus risk mitigation efforts. Six risk mitigation instruments are currently being used by the public and private sector, with new instruments emerging to fill the gaps in risk allocation.
The case studies in this lesson highlight the success of risk mitigation in promoting climate finance investment.
You have now reached the end of lesson two. Click next to visit links for additional information.
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Climate Finance Module 2
Module 2: Lesson 2 – Risk Mitigation Instruments Presentation Script
1.24 Key References and Resources
The following links provide key references and additional resources.
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