ADB CTF Proposal - Mezzanine Finance for Climate...
Transcript of ADB CTF Proposal - Mezzanine Finance for Climate...
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ADB Mezzanine Finance for Climate Change
(CTF Dedicated Private Sector Program)
1. Country
/Region
India, Indonesia, Philippines, Thailand, Vietnam,
Bangladesh, Cambodia, Lao PDR, Maldives,
Mongolia, Nepal, Pacific Region, Papua New
Guinea, Tajikistan
2. CIF Project
ID#
(CIF AU will
assign ID.)
3. Investment Plan (IP) or
Dedicated Private Sector
Program (DPSP)
4. Public or
Private
5. Project/Program Title ADB Mezzanine Finance for Climate Change
6. Is this a private sector
program composed of sub-
projects?
7. Financial Products, Terms and Amount
USD
Grant $ 1,500,000
Fee on grant $ 100,000
MPIS (for private sector only) $ 400,000
Equity
Subordinated debt/mezzanine instruments with convertible features $ 33,000,000
Convertible grants and contingent recovery grants
Contingent recovery loans
First loss Guarantees
Total $ 35,000,000
8. Implementing MDB(s) Asian Development Bank (ADB)
9. National Implementing Agency N/A
10. MDB Focal Point Private Sector CIF focal point:
Ms. Janette Hall
Principal Investment Specialist,
CTF focal point:
Mr. Jiwan Acharya,
Senior Climate Change
Specialist,
11. Brief Description of Project/Program (including objectives and expected outcomes)
This program involves establishing a mezzanine finance1 facility with CTF funds for co-financing high
development impact mitigation projects in tandem with ADB’s climate equity investment program, Asia
Climate Partners (ACP)2. ACP is a joint venture fund that will undertake commercially-oriented private
equity investments across a variety of environmental segments, including climate mitigation and adaptation,
with the intention of demonstrating attractive risk-adjusted returns for investments in these areas. It aims to
scale up climate equity investments in developing countries in Asia and the Pacific alongside large
institutional investors, pension funds and public sector institutions. The mezzanine facility would expand
the scope and range of potential investments under ACP, and catalyze financing for projects that would
ordinarily face difficulty raising sufficient debt and equity to reach financial close. CTF funds would allow
1 Includes subordinated debt, preferred stock and debt with warrants 2 http://www.adb.org/news/new-joint-venture-established-private-equity-investments-climate-related-transactions
Public
Private
Yes No
IP
DPSP
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projects to proceed where commercial lenders are typically dissuaded by the maturity of a sector and/or
country and political risk. The availability of a mezzanine facility as a “sidecar” to ACP is also likely to
enhance the fund’s attractiveness to potential investors, thus enhancing ACP’s fund raising with commercial
and institutional investors and deployment activities. The project will be supported by a $1.5 million
technical assistance (TA) program, administered by ADB, to facilitate the application of requisite
investment evaluation and structuring expertise to the deployment of CTF funds, as well as to cover
establishment costs for the facility and additional diligence and structuring costs for transactions undertaken
by the CTF facility.
Given the absence of mezzanine finance for climate initiatives in developing Asia and the reluctance of local
banks to provide sufficient leverage at a subordinated level, the Program would add a new instrument to
improve the risk/reward return of a range of climate investments. For all transactions CTF mezzanine funds
would be invested alongside ACP equity, and as an investor in ACP, ADB would therefore be taking a
higher risk/return position than CTF in all transactions supported by the facility. The longer term outcome
for this project is to establish mezzanine financing as a third tier for climate investments in emerging
markets. Through replication and scale up, the program is expected to help improve liquidity and to provide
a more diverse array of innovative new financing options for climate projects.
12. Consistency with CTF investment criteria
(1) Potential GHG
emissions
savings
With $35 million of CTF funds, the Program would finance GHG emission
reductions of roughly 4.3 million tCO2e for the estimated 20 year life of projects.
For more information, see Program proposal, page 11.
(2) Cost-
effectiveness Based on GHG emission reductions of 4.3 million tCO2e, the cost effectiveness of
CTF funds would be roughly $8 per tCO2e. For more information, see Program
proposal, page 11.
(3) Demonstration
potential at
scale
Using conservative assumptions, ADB estimates the market potential of mezzanine
finance for climate change to be roughly $10 billion per year globally. The short
term market potential for mezzanine finance for climate change is estimated at
approximately $2.2 billion per year globally. For more information, see Program
proposal, page 11.
(4) Development
impact As one of the largest climate specific investment funds in Asia, ACP expects to
provide wide ranging development benefits and to attract mainstream commercial
investors into the climate space. However, to best utilize funds being raised and to
increase the fund’s geographic coverage, alternative investment vehicles such as
mezzanine financing facilities are needed. Thus, Programs such as this will be a key
step to realizing the full development impact of equity funds such as ACP. See
Program proposal, page 12.
(5) Implementation
potential Initial scoping indicates there is strong demand for mezzanine finance products in
Asia, and given the support the CTF facility would receive from ACP in terms of
pipeline and investment advisory, the implementation potential is likely to be high.
Several projects currently under review by ACP would likely be eligible and able
to draw immediate benefit from inclusion of financing from the CTF facility. The
proposed CTF mezzanine facility is relatively small in comparison to ACP with its
target of up to $750 million, which also makes its potential for implementation high.
See Program proposal, page 13.
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(6) Additional costs
and risk
premium
Additional costs for the Program mainly relate to transaction costs for financing
projects in middle and lower income developing countries where climate
investments are not common and the enabling environments are more difficult to
navigate. Additional transaction costs include the time and resources needed for
fund raising, human resources, legal expenses, obtaining permits and licenses,
travel, and other contingencies. This Program aims to assist projects with access to
mezzanine financing in locations often overlooked by more mainstream climate
investment vehicles, and as such is likely to support projects that incur higher costs
and additional risk. See Program proposal, page 13.
Additional CTF investment criteria for private sector projects/ programs
(7) Financial
sustainability
This history and track record from the US and Europe shows that once first movers
were willing to offer mezzanine finance products, markets responded with strong
demand and now mezzanine instruments have become relatively mainstream in
developed countries. ACP would give the proposed mezzanine facility exposure to
institutional investors, local and international financial institutions, and project
developers in Asia and the Pacific, and would help to established mezzanine
products as a self-sustaining asset class for climate projects. Initial discussions with
potential ACP investees indicate the anticipated demand for the product is high, and
whilst it will be offered on concessional terms through CTF, once it has been
demonstrated, ADB expects commercial financial institutions to fulfil a greater
share of market demand. See Program proposal, page 14.
(8) Effective
utilization of
concessional
finance
Mezzanine capital offers numerous benefits for developers, and is particularly
suitable for companies that have established themselves but lack access to capital,
which is relatively common for climate finance projects in lower and middle income
developing countries globally. In the context of climate finance in Asia, there is
expected to be strong demand for mezzanine products. However, concessionality is
required to offset first mover risks, lower risk premiums on the product and establish
a successful track record of investment before commercial financing will become
available. For more information, see Program proposal, page 14.
(9) Mitigation of
market
distortions
The current market for mezzanine finance in Asia is small, and the market for
mezzanine instruments in climate finance almost unprecedented. In this regard,
there is likely to be very little chance of market distortion from the use of CTF funds
for this purpose. See Program proposal, page 14.
(10) Risks The main risk to the Program appears to be financial risk from deploying a higher
risk financial instrument (i.e., subordinated debt, preferred stock and debt with
warrants) into emerging markets. This will be addressed through extensive due
diligence, and appropriate pricing floors to ensure there is sufficient net income to
the Program to mitigate the risk of potential losses and defaults. The pricing will be
aligned to specific project risks, and will be consistent with the general findings and
recommendations of prior review and analysis of market risks in the target
countries. See Program proposal, page 14.
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13. For DPSP projects/programs in non-CTF countries, explain consistency with FIP, PPCR, or
SREP Investment Criteria and/or national energy policy and strategy.
The non-CTF countries involved in this program have all prioritized climate mitigation as part of their
national strategies (outlined in ADB country partnership strategies): Bangladesh3, Cambodia4, Lao PDR5,
Maldives6, Mongolia7, Nepal8, Papua New Guinea9, and Tajikistan10.
14. Stakeholder Engagement
The Asia Climate Partners team has conducted initial scoping regarding the CTF mezzanine facility with
institutional investors, local and international financial institutions, and project developers, the feedback
from which has been positive. In addition, The Asian Development Bank and ACP teams are exploring the
scope for replicating the structure outlined in this proposal to other relevant sources of multi-lateral donor
funding, with a view to potentially combining these with the CTF funds into a pooled facility where feasible.
15. Gender Considerations
The Program is likely to include gender benefits related to the development of clean energy, energy
efficiency and waste management projects. However, there are no anticipated additional gender elements
for the mezzanine facility in particular.
16. Indicators and Targets
Project/Program Timeline
Expected start date of implementation 2016
Expected end date of implementation 2019
Expected investment lifetime in years (for estimating lifetime targets) 20 years
Core Indicators Targets
GHG emissions reduced or avoided over lifetime (tonnes of CO2-eq) 4,300,000
Annual GHG emissions reduced or avoided (tonnes of CO2-eq/year) 216,000
Installed capacity of renewable energy (MW) 110
Number of additional passengers using low-carbon transport per day N/A
Energy savings cumulative over lifetime of investment (MWh) N/A
Annual energy savings (MWh/year) N/A
17. Co-financing
Please specify as appropriate Amount (USD million)
MDB 1 ADB (equity through ACP, ~25%)
ADB (debt and/or additional equity)
$16.5
$21.0
Government Govt of UK (equity through ACP, ~25%) $16.5
Private
Sector
Robeco and Orix Corp. (equity through ACP, ~50%)
Commercial debt providers
$33.0
$100.0
Total $187.0
18. Expected Date of MDB Approval
Asia Climate Partners received approval in February 2012 from the ADB Board of Directors under its
previous name, Climate Public-Private Partnership Fund (CP3)11.
3 http://www.adb.org/documents/bangladesh-country-partnership-strategy-2011-2015 4 http://www.adb.org/documents/cambodia-country-partnership-strategy-2014-2018 5 http://www.adb.org/documents/lao-peoples-democratic-republic-country-partnership-strategy-2012-2016 6 http://www.adb.org/documents/maldives-interim-country-partnership-strategy-2014-2015 7 http://www.adb.org/documents/mongolia-interim-country-partnership-strategy-2014-2016 8 http://www.adb.org/documents/nepal-country-partnership-strategy-2013-2017 9 http://www.adb.org/documents/papua-new-guinea-country-partnership-strategy-2016-2020 10 http://www.adb.org/documents/tajikistan-country-partnership-strategy-2010-2014 11 45918-014 REG: Climate Public-Private Partnership Fund http://adb.org/projects/details?proj_id=45918-014&page=overview
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DETAILED DESCRIPTION OF PROGRAM
A. Regional, Country and Sector Context
1. Developing countries in particular are facing a rapidly growing climate problem and, in many cases,
are predicted to be worst affected by the impacts of climate change12. These countries are also becoming a
key contributor to emissions due to rapid economic growth; by 2040, non-OECD emissions are projected
to more than double emissions from OECD countries (currently they are 40% greater)13. To address these
problems, many argue there is a need for significant scale up in climate finance globally. To limit the
harmful impacts of climate change, the International Energy Agency estimates $44 trillion in financing
above a business as usual scenario is needed by 2050 ($1.2 trillion per year)14. The World Economic Forum
estimates this figure at $0.7 trillion per year15. In contrast to popular belief that investing in climate related
projects will burden economies with additional cost, many now argue increasing flows of climate finance
will help tackle climate change and result in positive economic growth. For example, the aforementioned
$44 trillion in climate financing is likely to be more than offset by over $115 trillion in fuel savings from
new initiatives by 2050, resulting in net savings of $71 trillion16.
2. Whilst flows of climate finance have been increasing over the last few years to meet this challenge,
current investment is a fraction of what is required. In 2013, the annual flows of global climate finance
amounted to $331 billion17, and thus a climate finance “gap” currently exists of up to $870 billion per year.
Neither the public nor the private sector can arguably bridge this climate financing gap alone, and a
combined approach that makes best use of each sectors’ strengths is becoming an increasingly popular
approach. Using this approach, limited public funds can be used to leverage private finance, and public
institutions as partners and enablers can help developing countries catalyze private investment and attract
private finance at scale. Bearing in mind the challenges and opportunity costs of investing in developing
countries, investors often overlook climate related projects and focus on more profitable sectors such as
construction, real estate, manufacturing, or retail. Thus promoting investment in climate projects is needed
to tackle climate change in a tangible way.
3. Increasing the volume of climate finance is commonly seen as the main aim of efforts to reduce the
harmful impacts of climate change. However, this alone is not sufficient, and secondary goals are also
needed such as developing and reforming financial markets to be able to cater to the needs of investments.
In many middle and lower income developing countries in Asia, financial markets are poorly equipped to
scale up climate finance, and assistance is needed to spur growth in these markets to offer a range of flexible
and innovative financing mechanisms such as mezzanine finance. Whilst mezzanine finance is generally
available in mature capital markets such as those in the US and Europe, its absence in Asia means projects
with debt or equity shortfalls are often unable to be implemented through traditional financing solutions
due to a risk/reward imbalance.
12 IPCC, 2014: Climate Change 2014: Impacts, Adaptation, and Vulnerability. Part A: Global and Sectoral Aspects. Contribution
of Working Group II to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change [Field, C.B., V.R.
Barros, D.J. Dokken, K.J. Mach, M.D. Mastrandrea, T.E. Bilir, M. Chatterjee, K.L. Ebi, Y.O. Estrada, R.C. Genova, B. Girma,
E.S. Kissel, A.N. Levy, S. MacCracken, P.R. Mastrandrea, and L.L. White (eds.)]. Cambridge University Press, Cambridge,
United Kingdom and New York, NY, USA, 1132 pp. 13 International Energy Agency, 2013. World Energy Outlook, OECD/IEA, 2013, Paris, 2013 14 International Energy Agency, 2014. Energy Technology Perspectives 2014: Harnessing Electricity’s Potential. IEA, Paris
2014. 15 The World Economic Forum, 2013. The Green Investment Report The ways and means to unlock private finance for green
growth. A Report of the Green Growth Action Alliance, Geneva, 2013. 16 International Energy Agency, 2014. Energy Technology Perspectives 2014: Harnessing Electricity’s Potential. IEA, Paris
2014. 17 Climate Policy Initiative, 2014. The Global Landscape of Climate Finance 2014, CPI Report, November 2014.
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4. As noted by ADB’s experience financing climate projects in Asia, often promising climate projects
in middle and lower income developing countries are able to attract interest from investors and debt
providers, but fail to raise sufficient financing to reach financial close. For these “marginal” projects,
mezzanine finance can provide developers with additional layer of financial resources in situations where
they would otherwise be stranded. In essence, the mezzanine facility would enable a greater number and
larger size of climate equity investments to proceed to implementation across a wider range of countries,
and would likely increase the return on these investments while not excessively increasing levels of senior
debt or lessening returns on equity.
B. Mezzanine finance
5. The term “mezzanine finance” refers to the layers of financing between a company or project’s
senior debt and common equity. Mezzanine finance may take the form of convertible debt, senior
subordinated debt or private "mezzanine" securities (debt or bonds with warrants18 or preferred stock). As
shown in the following diagram, structurally, mezzanine finance is subordinated in priority of payment to
senior debt, but senior in rank to common stock or equity.
Figure 1 - Mezzanine finance instruments
a) Mezzanine finance can comprise
senior subordinated debt, convertible
debt and preferred stock19
b) The graph below shows the position of different instruments
in terms of risk and reward20
6. Mezzanine finance is useful to project developers in situations where the senior debt sized to meet
minimum financial covenants by the company or project is insufficient and equity contributions cannot be
increased without falling below expected investor rates of returns (or raising dilution issues). It is often an
attractive way to borrow funds for high potential projects beyond the amount that secured senior lenders
will lend. Unlike a traditional bank loan, mezzanine finance is unsecured and thus, requires no readily
marketable collateral. To compensate for this risk, the rate of interest charged by the lender for mezzanine
products is generally higher than that charged on senior debt, and the term of the loan is generally shorter.
18 In finance, a warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed price
called exercise price until the expiry date. 19 Fitch Ratings 20 Nijs, L., 2013. Mezzanine Financing : Tools, Applications and Total Performance. Wiley Finance Series, Somerset, NJ, USA,
October 2013.
REWARD
RISK
CA
SH
WA
TE
RF
AL
L
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Interest is generally payable in regular instalments, but can be flexible. The principal can either be due the
end of the term or be amortized depending on the cash flow profile of the project.
7. Mezzanine finance was developed in US and European financial markets beginning around in the
1980s and has grown significantly since then but has yet to become established in Asia and other emerging
markets. Between 2005 and 2010, mezzanine providers raised $86.4 billion in capital; from this sum, 66%
of funds focus their investments in the US, a further 21% in Europe and the last 13% primarily target
opportunities in Asia and the rest of the world21.
8. The growth and increasing track record in the mezzanine finance market is being driven by three
main factors: (i) increasing market demand from companies and projects, (ii) more financial institutions
willing to make capital commitments for non-traditional but promising investments, and (iii) Basel III
limitations for banks on providing long-term non-recourse debt, especially for sub-investment grade risks22.
Recent market conditions since the global financial crisis of 2008 have re-established mezzanine
financing’s appeal as a tax-efficient source of long-term capital. With the reduction of traditional senior
bank credit and the reluctance of banks to lend under the lenient terms and low rates offered over much of
the last decade, mezzanine is becoming one of the more effective vehicles for developers to fund growth.
However, its use for climate related projects in emerging markets is almost unprecedented.
C. The Asia Climate Partners (ACP) Fund
9. Formerly known as the Climate Public Private Partnership Fund, or “CP3”, Asia Climate Partners
(ACP) was approved in 2012 by the Asian Development Bank’s Board of Directors as the bank’s main
vehicle to scale up climate equity investments in developing countries alongside large institutional
investors, pension funds and public sector institutions. To help build and strengthen private sector climate
financing in Asia, the venture will undertake commercially-oriented equity investments structured to
generate market-driven, risk-adjusted returns and have positive environmental and social impacts.
10. ACP reached an initial first close in November 2014 of $392 million, and is capitalized by its
founding partners the Asian Development Bank ($97 million), the UK government ($94 million), and ORIX
Corporation ($200 million). ORIX Corporation is a leading Japanese financial services group, listed on the
Tokyo and New York stock exchanges. It provides innovative products and services across its lending,
investment, life insurance, banking, asset management, automobile related, real estate and environment and
energy related businesses in 35 countries worldwide. Robeco Institutional Asset Management B.V. has
been appointed as the interim fund manager for ACP, with team resources allocated to the fund by both
ADB and ORIX. Robeco is a Netherlands-based global asset manager with more than $290 billion in assets
under management. The company offers a mix of investment solutions and strategies to institutional and
private investors worldwide and is the center of asset management expertise within ORIX Corporation,
Robeco’s majority shareholder. It is anticipated that the proposed CTF mezzanine financing facility would
be a valuable, catalytic complement to ACP, and by creating a combination of market instruments to better
address financing needs, the impact of the combined investment programs will be amplified.
D. Overview of the Proposed Program
11. The Dedicated Private Sector Program (DPSP), established under the CTF in 2013, was designed
to finance programs or operations that can deliver scale (in terms of development results and impact, private
21 Nijs, L., 2013. Mezzanine Financing : Tools, Applications and Total Performance. Wiley Finance Series, Somerset, NJ, USA,
October 2013. 22 The third Basel Accord (Basel III), developed in response to the deficiencies in financial regulation revealed by the financial
crisis of 2007–08, is a global, voluntary regulatory framework on bank capital adequacy, stress testing and market liquidity risk.
It is designed to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.
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sector leverage and investment from CTF financing) and speed (faster deployment of CTF resources, more
efficient processing procedures), while at the same time maintaining a strong link to country priorities and
CTF program objectives. The Dedicated Private Sector Programs have utilized a programmatic approach
where MDBs collaboratively identified private sector funding opportunities. Phase I of DPSP was approved
in October 2013 (USD 150 million) and phase II was approved in June 2014 (USD 358 million). The
concept paper for this proposal (Mezzanine Finance for Climate Change) was endorsed by the CTF Trust
Fund Committee at the June 2014 CTF meeting in Jamaica23 after being evaluated by the MDB committee
and nominated for consideration. As a mezzanine financing facility for Asia and the Pacific, it is unique
among DPSP endorsed concepts, and therefore has no crossover with other programs.
12. The proposed multi-project facility would be comprised of $33 million of CTF funds in the form
of subordinated debt, preferred stock or debt with warrants to climate mitigation projects receiving equity
investments from ACP that have exhausted traditional fund raising avenues, and need a small portion of
additional financing to reach financial close (“additional” projects). Whilst the term “mezzanine finance”
encompasses several financial instruments, this CTF facility would provide only subordinated debt,
preferred stock and debt with warrants. Funds would be deployed in middle income and low income
developing countries where perceived risks in the country or the sector inhibit commercial investors.
Eligible countries would be Bangladesh, Cambodia, Lao PDR, India, Indonesia, Maldives, Mongolia,
Nepal, the Pacific Region, Papua New Guinea, the Philippines, Tajikistan, Thailand and Vietnam. ACP is
supporting a range of environmental projects, a minority of which may not directly involve GHG emission
reductions24. However, the CTF mezzanine facility would only support those ACP investments with GHG
mitigation potential. The facility would help to catalyze climate investments by adding a third tier of capital
between debt and equity instruments for climate projects in Asia, particularly in countries with additional
sector or country risk where commercial financiers are hesitant to invest. The proposed CTF mezzanine
facility would co-invest alongside ACP equity on a structurally and legally separate basis. That is, CTF
funds would not be co-mingled with ACP’s investment, but deployed by ADB as a separate co-investment
facility with distinct legal agreements, rights and remedies.
13. For all transactions CTF mezzanine funds would be invested alongside ACP equity, and as an
investor in ACP, ADB would therefore be taking a higher risk/return position than CTF in all transactions
supported by the facility. For some transactions, ADB will also co-invest additional equity or senior debt
in relatively smaller amounts (relative to commitments by ACP) primarily aimed at filling any remaining
financing gaps for individual projects. In the case that ADB also provides senior debt, this senior debt,
along with senior debt from other lenders would rank higher in a projects cash water fall than CTF funds
(i.e. in a lower risk position). Whilst the facility’s mezzanine funds would not enjoy the same level of cash
flow seniority as traditional senior debt, it would retain the key characteristics of debt, namely a requirement
for full repayment of principal to lenders, and the delivery of a minimum return in the form of a payment
coupon (repayable over the life of loan). This structure can induce additional senior lenders into a project,
because they maintain priority of available project cash to service their debt (meeting minimum coverage
ratios), while at the same time, providing another funding source that must be paid before investors can
receive dividends from the project.
23
http://www.climateinvestmentfunds.org/cif/sites/climateinvestmentfunds.org/files/CTF%20CRP%202.%20DPSP%20revised%20
decision.pdf 24 The entire scope of ACP covers renewable energy (grid-connected and off-grid wind, solar, hydro, geothermal, biomass etc.),
energy and resource efficiency (including lighting, heating, co-generation, electricity transmission and distribution, building
standards and transportation), and renewable energy and energy resource efficiency supply chains (including the manufacture of
renewable energy technology, monitoring & control equipment, advanced energy storage solutions, new materials, nanotechnology
and bio-materials, sustainable agriculture, environmental service technologies, water and wastewater treatment, recycling, and
waste management).
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14. The following diagram shows how the facility would catalyze investments for projects unable to
reach minimum fund raising requirements. Scenario “A” shows a non “additional” financing structure,
where developers are able to source sufficient financing from debt and equity providers to reach financial
close. For these projects, CTF mezzanine finance would not be utilized. Scenario “B” shows a structure
where financial close is not reached and there are financing gaps. These would be the “additional” projects
where the CTF mezzanine finance is needed to catalyze investments. Scenario “C” shows how the CTF
mezzanine facility would fulfil a catalytic and transformational role through deploying capital to cover
financing gaps, alongside a mix of equity and senior debt.
Figure 2 – How the mezzanine facility will assist projects to reach financial close
*ADB will be invested in all CTF transactions through its equity investment in ACP, and may consider providing additional equity
or senior debt to fill remaining financing gaps in selected transactions.
15. CTF capital deployed for projects would be supported by a CTF funded $1.5 million Technical
Assistance (TA) facility administered by ADB, to cover: (i) the cost of employing a dedicated Mezzanine
Facility Manager and support staff/consultants for administering funds, and (ii) additional costs relating to
project preparation, diligence, structuring and legal fees for deploying CTF funds (for example, deploying
funds as mezzanine products would require separate financing agreements with counterparties). Due
diligence and legal costs for investments undertaken by the CTF facility are expected to be shared with
ACP where feasible. ADB would be responsible for the selection and ongoing management and oversight
of the Mezzanine Facility Manager and support staff/consultants. The latter are expected to have a suitable
professional background in structured debt finance and/or climate finance, particularly relating to the target
countries of the Program. The Mezzanine Facility Manager would work closely with both ACP (in terms
of project sourcing) as well as ADB (in terms of ensuring compliance with ADB’s safeguards standards
and overall approvals process).
16. CTF funds would be deployed according to the principle of minimum concessionality on a case-
by-case basis to catalyze investments that would not otherwise have occurred. Initial identification of
projects suitable for CTF funding would be done by the ACP investment team. These would then be
EQUITY (ACP & other investors) EQUITY
(ACP & other investors)
SENIOR DEBT (Commercial banks, IFIs)
Pro
ject
co
st
~70%
~30%
SENIOR DEBT (Commercial banks, IFIs)
FINANCING GAP
FINANCING GAP
MEZZANINE CAPITAL (CTF)
Scenario A: Typical finance structure (financial close reached)
Scenario B: However, gaps may
occur raising debt and/or
equity in some countries
Scenario C: Mezzanine capital
bridges fundraising gaps
SENIOR DEBT (Commercial banks, IFIs)
ADB debt or equity for
some transactions*
EQUITY (ACP & other investors)
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appraised by ADB (through its Private Sector Operations Department and the dedicated Mezzanine Facility
Manager, as described in the previous paragraph). ADB will undertake necessary due diligence on proposed
Program investments and negotiate terms and conditions for the deployment of CTF funds. Through its
appointment and oversight of the Mezzanine Facility Manager, ADB will play a critical role in assessing
the origination and structuring of the transaction and the justification for any concessionality. ADB’s
Private Sector Operations Department (PSOD) will review the proposed Program investment, and will also
consider committing its own capital (in the form of either debt or equity, as required by the individual
investment) alongside that of CTF and ACP. The Mezzanine Facility Manager will, jointly with the relevant
transaction team in ADB’s PSOD, process CTF funds through ADB’s investment approval mechanism,
including ensuring adherence to ADB’s requirements on environmental and social safeguards. With the
exception of investing CTF funds at a different level of a project’s cash waterfall and pricing CTF funds
differently to ADB funds, as a CTF implementing entity, ADB shall exercise the same degree of care for
CTF funds as it exercises with respect to the administration of its own resources (or any other funds
administered by ADB, for which ADB acts as trustee) and the implementation of projects and activities
using such resources.
E. Key Benefits of the Program
17. From a market perspective, the facility would offer developers a long-term, flexible financing
instrument able to bridge financing gaps. It will enhance ACP’s ability to reach less developed geographies,
fund projects struggling to fulfill financing requirements and fill a recognized market gap. Mezzanine
products are less restrictive than senior debt and would put less strain on projects’ cash flows (more
specifically, the debt service coverage ratio and senior debt to equity ratio). Mezzanine products have a
lower cost than equity, and the Program would reduce the debt and equity fund raising requirements,
allowing investment to occur in new geographic regions or sectors experiencing financial barriers. For
senior lenders, benefits from the program would involve less restrictive financial covenants and would
allow them to maintain priority on contractual cash flows. This was particularly important for the Sarulla
Geothermal project in Indonesia, for example, where a tranche of CTF subordinated debt was used to bridge
a financing gap caused by prohibitively high debt service obligations from lenders’ insistence on certain
levels of contingency for drilling risks (subordinated debt was substituted for senior debt)25. Without the
mezzanine facility, some potential ACP projects would likely not be pursued and/or equity investors for
these may need to increase the size of their equity investments to bridge financing gaps, thus increasing the
overall cost of financing and reducing the scope and impact of climate investments.
18. The facility offers several benefits to the CTF. Primarily, the CTF would benefit from the sizeable
and pipeline of commercial climate projects sourced through ACP, typically not available on a stand-alone
basis to public sector investors with downside protection. The mezzanine facility would also allow ACP to
reach out to a more conservative institutional investor base (from a risk reward perspective) for fundraising
and thus combine investors with different downside protection requirements under the same platform.
Potential ACP investors would gain comfort from their commitments being co-invested alongside a facility
that allows them to potentially take more risk in emerging markets than they would otherwise take. For
investors with strong development considerations, the facility would increase the multiplier effect and allow
ACP to reach to lower income countries. It will combine under the same platform like-minded public and
private sectors investors, committed to promote change and provide scale to climate markets in Asia and
avoid multiplication of often similar and uncoordinated facilities in this space.
25 Further information can be found in the Climate Policy Initiative’s case study on the Sarulla Geothermal Project
(http://climatepolicyinitiative.org/publication/using-private-finance-to-accelerate-geothermal-deployment-sarulla-geothermal-
power-plant-indonesia/)
11
F. Market Transformation
19. The longer term vision for this Program is to establish mezzanine financing as a third tier for climate
investments in Asia and other emerging markets. The aim is to increase the impact of public and private
finances and to build greater depth in financial markets for addressing climate investment gaps. Asia’s
economies are among the fastest growing in the world, and face some of its most significant environmental
challenges including harmful impacts from climate change. Given the significant overlap between
development objectives and climate objectives, particularly in areas such as clean energy supply energy
efficiency and waste management, and the historically low levels of capital deployed in these areas in most
middle and low income countries, investment in these areas has strong potential for market transformation
in Asia over the next several decades.
20. Given the aforementioned estimated climate financing gap of up to $870 billion per year, the
portion of climate finance currently spent in non-OECD countries (40%)26, and an average debt to equity
ratio for projects of 70:30, the required equity investment in countries where mezzanine finance for climate
projects is not available is roughly $104 billion per year globally. Using conservative assumptions, ADB
estimates mezzanine finance for climate initiatives would add an additional layer of financing roughly
equivalent to 10 per cent of the size of equity financing, and on this basis, the long-term upper estimate for
the market potential of mezzanine finance for climate change is roughly $10 billion per year globally.
21. In addition to the long term argument, the potential for market transformation in the near term is
also compelling. The Climate Policy Institute estimated the flows of project level equity and balance sheet
equity for climate projects to be roughly $55 billion in 2013 (Appendix 3). Assuming no growth in climate
finance, and using the same assumptions as above27, the short term market potential for mezzanine finance
for climate change is approximately $2.2 billion per year globally.
22. For ACP, the knock-on effects from the successful demonstration of a large Asian-based climate
equity fund are expected to be significant. The size and wide reach of the fund is expected to have a
replication effect across different jurisdictions, leading to further benefits in terms of GHG reductions at a
country, regional and even global level. It would send a strong message to large institutional investors that
climate related investments can provide attractive risk-adjusted returns and deal appropriately with market,
operational and regulatory risks associated with green investments in emerging markets. In developing
countries, increasing the deal flow would provide authorities with the experience, familiarity and capacity
to manage future similar transactions. Through the provision of long-term investment capital, ADB and
CTF commitments are expected to enhance the range and size of investments and to mobilize additional
capital through lowering the perceived risk of investments. However, it is worth noting that alternative
investment vehicles, such as a mezzanine co-investment facility, are needed to maximize the impact of
these proposed equity investments.
FIT WITH CTF INVESTMENT CRITERIA
1. Potential GHG Emissions Savings
23. With CTF funds of $33 million (exclusive of TA and administration costs), the Program expects to
leverage roughly $66 million in equity from ACP and other investors, and $121 million in senior debt from
local banks and IFIs. This would provide a leverage ratio of roughly 6:1, and assuming full deployment in
26 Climate Policy Initiative, 2014. The Global Landscape of Climate Finance 2014, CPI Report, November 2014. 27 40% of climate finance is spent in non-OECD countries where mezzanine finance for climate projects is not available, and
mezzanine finance provides an addition layer of financing equivalent to 10% of equity financing
12
renewable energy projects, would result in the installation of approximately 110 MW of new clean energy
capacity and the generation of close to 290,000 MWh per year of clean electricity. Emission reductions for
the program are expected to be 216,000 tCO2e per year, or 4.3 million tCO2e for the estimated 20 year life
of projects. More detailed information on the assumptions made in these calculations can be found in
Appendix 2.
2. Cost Effectiveness
24. With total CTF funds of $35 million and estimated emission reductions of 4.3 million tCO2e, the
cost effectiveness of CTF funds is roughly $8 per tCO2e. Including leveraged finance with total funds of
$220 million, the cost effectiveness increases to roughly $51 per tCO2e. More detailed information on these
calculations can be found in Appendix 2.
3. Potential Replication and Scale up
25. Using conservative assumptions, ADB estimates the potential for replication and scale up of
mezzanine finance for climate change to be roughly $10 billion per year globally. The short term market
potential for mezzanine finance for climate change is estimated at approximately $2.2 billion per year
globally. The assumptions for these estimates are outlined in section F of this proposal, Market
Transformation (above).
26. With an estimated final fund size of up to $750 million for ACP, the fund is likely to be one of the
largest climate specific equity investment vehicles in developing Asia over the next few years. As such, it
will likely define a blueprint for subsequent funds tackling climate change at scale. Ventures financed by
the new sources of climate finance may look to ACP as a model for investment, and the addition of a CTF
“sidecar” mezzanine facility would pave the way, not only for mezzanine finance to become more
mainstream in the context of climate projects, but for other alternative investment vehicles and innovative
climate financing tools to enter the market and maximise the use of available funds. It is important to note
that increasing the scale of climate finance alone will not be the most effective use of funds, and innovation
in terms of reforming financial markets and offering new financing products is required to achieve global
GHG abatement goals.
4. Development Impact
27. As one of the largest climate investment ventures in Asia, ACP expects to provide wide ranging
development benefits mainly in the form of economic growth and improved environmental quality. By
financing clean energy, energy efficiency, waste management and other emission reduction projects at
scale, the fund is expected to create new jobs (estimated at a total of 160) and economic opportunity,
improve GDP for individual countries, improve the livelihoods and quality of life for communities
(including through gender-specific benefits), reduce health care and energy costs, and to help host countries
transition to less carbon intense economies to avoid the dangerous impacts of climate change.
28. However, it is worth noting that within Asia, there is significant variation in the risk profile of
different countries and the bankability of projects in different sectors. Currently ACP expects capital raising
efforts for individual projects in some middle and lower income developing countries will be more
challenging than others. Due to exposure limits, lenders’ covenants, and other restrictions, reaching
financial close for some promising projects may not be easy. It is in these circumstances that the mezzanine
facility becomes of use to fill financing gaps and allow the aforementioned benefits of ACP to be delivered
to middle and low income developing countries where this would not have previously have been possible.
In other words, to best utilize funds being raised for climate equity investment programs, alternative
13
investment vehicles such as mezzanine financing facilities are needed, and thus program such this will be
a key step to realizing the full development impact of equity funds such as ACP.
5. Implementation Potential
29. Initial scoping indicates there is strong demand for mezzanine finance products in Asia, and given
the support the CTF facility would receive from ACP in terms of pipeline and investment advisory, the
implementation potential is likely to be high.
30. As mentioned previously, CTF funds would not be co-mingled with ACP’s investment, but
deployed by ADB as a separate co-investment facility with distinct legal agreements, rights and remedies.
CTF funds would be deployed by ADB and will assist in assessing the justification for concessionality and
decisions on where and when to deploy this capital. The decision to use CTF funds would be made by
ADB, and minimum concessionality would be determined on a case-by-case basis to catalyse investments
that would not otherwise have occurred.
6. Additional Costs and Risk Premium
31. Additional costs for the Program mainly relate to transaction costs for financing projects in middle
and lower income developing countries where climate investments are not common and the enabling
environments are more difficult to navigate. Additional transaction costs include the time and resources
needed for fund raising, human resources, legal expenses, obtaining permits and licenses, travel, and other
contingencies. This Program aims to assist projects with access to mezzanine financing in locations often
overlooked by more mainstream climate investment vehicles, and as such is likely to support projects that
incur higher costs and additional risk.
7. Financial Sustainability
32. The market for mezzanine finance in the US and the EU is now considered mature and self-
sustaining. In the 1980s mezzanine financing instruments were established mainly by US insurance
companies and savings and loan associations28. By the 1990's, limited partnerships had entered the market,
and today, investors include pension funds, hedge funds, leveraged public funds, limited partnerships and
insurance companies. Notably, there are now banks in the US and Europe that have established standalone
mezzanine facilities, and mezzanine loans have been included in European CDOs on a regular basis in
recent years29. Mezzanine lenders typically tend to be book-and-hold investors, focused on cash-flow
lending and looking for a minimum term (call protection) and equity participation to generate longer term
results. Unlike traded equity, high-yield debt, and interest rates which fluctuate with economic conditions,
traditional mezzanine finance is a relatively consistent and stable market30.
33. This history and track record from developed countries shows that once first movers were willing
to offer mezzanine finance products, markets responded with strong demand and now mezzanine
instruments have become part of financing toolboxes in the US and Europe. The scale of mezzanine finance
worldwide is now large, with $86.4 billion raised between 2005 and 201031. However the geographic range
28 Silvia Rezessy, S., and Bertoldi, P., 2010. Financing Energy Efficiency: Forging The Link Between Financing And Project
Implementation. Report prepared by the Joint Research Centre of the European Commission, May 2010, Ispra. 29 Fabozzi, F. J., Choudhry, M., 2004. The Handbook of European Structured Financial Products. John Wiley & Sons, Mar 4,
2004. 30 Silbernagel, C., Vaitkunas, D., Giddy, I., 2008. Mezzanine Finance, Bond Capital, NYU Stern School of Business, 2008. 31 Nijs, L., 2013. Mezzanine Financing : Tools, Applications and Total Performance. Wiley Finance Series, Somerset, NJ, USA,
October 2013.
14
shows only 13% of mezzanine funds target opportunities in Asia and the rest of the world (aside from the
US and Europe).
34. These factors, along with the exposure the mezzanine facility would gain to institutional investors,
local and international financial institutions, and project developers from being attached to a $750 million
(target) climate equity fund such as ACP suggest mezzanine finance will become a more established and
self-sustaining asset class in Asian markets for climate projects. Initial discussions with potential ACP
investees indicate the anticipated demand for the product is high, and whilst it will be offered on
concessional terms through CTF, once it has been demonstrated in Asia, ADB expects commercial financial
institutions to fulfil a greater share of market demand.
8. Effective Use of Concessional Finance
35. Mezzanine capital offers numerous benefits for developers, and is particularly suitable for
companies that have established themselves but lack access to capital, which is relatively common for
climate finance projects in lower and middle income developing countries. In contrast to senior debt, which
usually involves a highly structured amortization schedule with relatively short maturities, mezzanine
financing does not require amortization during the term of the debt, allowing companies to use the increased
cash flow for expansion activities. When utilized in conjunction with senior debt, mezzanine capital is
considered a less expensive, tax-advantageous alternative to equity, and reduces the amount of equity
required in a business. Since common equity is the most expensive form of capital and is not tax deductible,
mezzanine finance can create a more efficient structure that lowers the after-tax cost of capital and is less
dilutive than equity financing. Mezzanine financing offers other benefits to companies focused on
optimizing their capital structures and expanding access to funding. Given that subordinated debt finance
can be regarded as a hybrid form of debt, it can improve a company’s credit rating and put it in a better
position to acquire further debt and equity investment. For sustainable energy project developers,
mezzanine finance is cheaper than what would be available on the equity market, does not usually involve
sacrificing control of the company and can allow companies to raise sufficient capital to meet the debt-
equity requirements of senior lenders.
36. In the context of climate finance in Asia, there is expected to be strong demand for mezzanine
products. However, concessionality is required to offset first mover risks, lower risk premiums on the
product and establish a successful track record of investment before commercial financing will become
available.
9. Mitigation of Market Distortions
37. As discussed in section 7, Financial Sustainability, the current market for mezzanine finance in
Asia is small, and the market for mezzanine instruments in climate finance almost unprecedented. In this
regard, there is likely to be very little chance of market distortion from the use of CTF funds for this purpose.
10. Risks
38. Financial Risk. The main risk to the Program appears to be financial risk from deploying higher
risk financial instruments into emerging markets. This will be addressed through a pricing floor to ensure
there is sufficient net income to the Program to mitigate the risk of potential losses and defaults. Pricing
will be defined on a case by case basis according to the principle of minimum concessionality and will be
aligned to specific project risks consistent with the general findings and recommendations of prior review
and analysis of market risks in the target countries. In line with the procedure followed for other DPSP
Phase I proposals, ADB would work with the CTF to ensure financial risks are appropriately managed.
15
Financing plans will be determined for each borrower and reported at financial close in accordance with
CTF guidelines for private sector programs.
39. Further to this, it is worth noting that all ACP investments will need the backing of other investors
and debt providers (including the risk management teams from these organizations) in order to proceed.
Substantial research, analysis and due diligence will be conducted by financiers, independently assessing a
wide range of risks before potential investments would be approved. All funds in the CTF mezzanine
facility would be co-invested alongside equity by ACP, as well as either additional equity or debt from
ADB in some cases.
40. Policy and Regulatory. The enabling environments in middle and low income developing
countries pose risk to the use of relatively new financial instruments. However, mezzanine finance is
considered an accepted asset class by financial institutions internationally, and due to the long history and
track record of mezzanine instruments in the US and Europe, resistance by regulators to their use in target
countries in Asia is unlikely.
11. Performance Indicators
41. The performance indicators outlined below are derived from the CTF Results Measurement
Framework, and will be tracked according to CTF guidelines at least annually.
Table 1 - Program performance indicators32
Core Indicator Performance
GHG emission
reductions
- Annual (tCO2e/year) 216,000
- lifetime (20 year cumulative tCO2e) 4,300,000
Electricity
production
- New RE capacity (MW installed) 110
- Additional Power Generation (MWh/year) 290,000
Cost effectiveness of CTF funds ($/t CO2 ) $8
CTF financial leverage 1 : 6
Employment - Number of new jobs generated 160
32 Other performance targets and indicators quantifying developmental impacts will be included in the formulation of ADB’s
Project Design and Monitoring Frameworks for each individual project to be supported under this program.
16
Appendix 1 - Email from CTF Trustee confirming cash availability for this Program
To be obtained prior to TFC approval
17
Appendix 2 – CTF Investment criteria calculations
Expected financing and leverage for CTF mezzanine facility $
(million)
Senior Debt $ 121
Mezzanine finance $ 33
Equity $ 66
$ 220
Leverage 6 : 1
Emission reductions
Estimated cost (average for all technologies) 2.0 $ million / MW
Estimated installed capacity of Program 110 MW
Estimated capacity factor (average for all technologies) 30%
RE generation 289,080 MWh / year
Grid emission factor (average for eligible countries) 0.75 tCO2e / MWh
Emission reductions
- Annual 216,810 tCO2e / year
- Program life (20 years) 4,336,200 tCO2e
CTF cost effectiveness
CTF Funds $ 35 million
Emission reductions for program $ 4,336,200 tCO2e
Cost effectiveness of CTF funds $ 8 per tCO2e
Program cost effectiveness
Total Funds (CTF + leveraged funds) $ 224
Emission reductions for program 4,336,200 tCO2e
Cost effectiveness of total funds $ 51 per tCO2e
Jobs created from the Program
Jobs per MW
(based on PSOD RE
projects 2013 - 2015)
Share of
Program
(estimate)
MW
(estimated)
Jobs for
Program
Solar 1.9 35% 38.5 72
Wind 0.8 35% 38.5 30
Hydro 1.8 30% 33 60
162
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Appendix 3 – Flows of climate finance 201433
33 Climate Policy Initiative, 2014. Global Landscape of Climate Finance 2014, Venice, November 2014.