Investment readiness guidelines

The guidelines are based on the experience of lenders and other financial investors in these markets over the past decade and represent the most fundamental and cross-cutting factors affecting a project’s consideration by investment teams.

They are not intended to supersede firm- or fund-level investment criteria for emerging and frontier markets, and the authors note specific policy prescriptions will vary greatly depending on the economic, legal, political, and financial development of a particular country.

Political and macroeconomic stability and economic growth prospects

Strong institutions with a track record of good governance and the commitment and capacity to provide stable macroeconomic management is a major factor for investors as are sound macroeconomic policies to drive broad-based growth, provide investors with broad assurance of the financial sustainability of their investments. Investors also require reliable data on the macroeconomic state of the economy (banking sector health, employment numbers, etc.) to support their own reporting requirements.

Policy stability

Policy risks, such as expropriation, sovereign breach of contract, or lack of availability or hard currency, are crucially important considerations for investors. Low-carbon projects are particularly vulnerable to policy risk, such as the ability to predict and rely on stable tariffs, due to declining input costs and a reliance on government subsidies. The risk of policy reversals or renegotiations is often the single biggest concern of most investors in developing countries., particularly when such policies can be altered legally with ease by government agencies. These risks can only be partially covered through international political risk insurance.

Financial market depth

The existence of a local bank market that can provide both lending and other financial services, such as currency, interest rate swaps, access to listed markets, and even support for a robust green bond market, are important for international investors. The challenge of limited local commercial banking experience and capabilities, such as the lack of long-term fixed rate non-recourse debt, and limited liquidity in local debt and equity markets can be a hindrance for investors.

Currency stability

Mismatches between the currency denomination of a project’s costs and the denomination of its revenues presents extra costs and risks when neither local nor international markets provide the instruments needed to hedge those risks in sufficient size and tenor. This is particularly problematic in countries with volatile currency exchange rates and where significant current account deficits leave those currencies vulnerable to devaluation. Structures that are available to partially hedge local currencies tend to be inefficient and expensive. The degree to which a country can peg its currency to a hard currency, or denominate project revenues in a hard currency is thus an important consideration.

Government commitment to stable and predictable investment incentives for low-carbon solutions

In addition to strong, public government support, a variety of incentives and policies may signal a favorable business environment for the operator and, therefore, the investor. These signals may include establishing renewable energy targets and strategies, setting emission reduction targets, or revising far-reaching Nationally Determined Commitments (NDCs). Other clear and tangible signals include establishing specific financial incentives, such as tax incentives or preferential treatment on import duties, and the establishment of clearly organized auctions, tenders, or feed-in tariffs.

Political will and execution capacity

Strong policy support and clear rules and regulation are important, but equally important is the willingness, experience, and relevant technical skills to implement those policies and engage with investors. Most developing countries have little experience negotiating and executing international commercial agreements and technical assistance may be necessary until project development, engineering, technical, and commercial experience is gained. The willingness and ability of the host country and its population (pensions, entrepreneurs, SWFs, development banks, etc.) to invest alongside international investors on pari passu or junior terms can also demonstrate local will and execution capacity, as well as local and non-local financial alignment.

Cost reflective energy prices

Ensuring that power generators can charge the necessary cost-reflective tariffs is crucial to enabling private investment to flow to low-carbon sectors. In many cases, this will require the removal of energy subsidies for the incumbent fossil fuel industry such that retail energy prices may rise to reflect their true costs.

Power Purchase Agreements (PPAs) incorporating protections required by international lenders

PPAs must be of sufficient duration to match the tenor of financing required. International public and private sector lenders also often require that off-taker payments are denominated in dollars or euros, which can be challenging for off-takers whose income is in local currency. Additional elements typically required by lenders include agreement to settle any disputes in a neutral, offshore location, and other standard protections for the developer and its lenders. As the market develops, standardization of PPAs across the market becomes increasingly important to investors and developers.

Creditworthy or credit-enhanced off-takers

In most countries, the power off-taker is a government utility requiring some credit enhancement to support its payment obligations to the power producer. Such support may come in the form of partial or full sovereign guarantees (where possible within sovereign debt capacity limits), liquidity facilities, and laws assuring funding for the electricity sector. The stronger the PPA, the more likely the lender will accept something less than a full sovereign guarantee.

Fewer foreign ownership restrictions and local content requirements

In some jurisdictions, foreign investment is limited to minority stakes, whereas investors may seek control. The relative paucity of well-capitalized local partners with relevant experience can be a barrier to developing a successful project. Similarly, restrictive local content requirements, if they materially impinge on the quality or economics of the project, can stymie investment.

Clear and predictable licensing and permitting procedures

The assurance that necessary licenses and permits will be awarded based on a fair, efficient, and predictable process is crucial to developers and their investors. Establishing land titles in markets where traditional land tenure is practiced is often costly and time-consuming, contributing to the uncertainty that is so problematic for investors. In some countries, such as India, governments provide a pre-permitting site, specifications, and license auctioned as part of a PPA.

Enforceability of Contracts

Businesses require predictable local legal frameworks and confidence contracts will be enforced promptly in local courts. Effective dispute resolution mechanisms are also essential to giving business confidence to enter into relationships with new businesses and partners in foreign markets.

Power grid capacity, stability and ability to handle intermittent power

In many countries the national power grid has limited capacity to absorb new power and/or lacks the flexibility to be able to handle the intermittent power that is generated by most renewable energy sources. This can result in renewable energy plants being required to reduce their production, most of the time without compensation for such curtailment. A clear agreement is needed between decision makers who grant permits and licenses, private developers, and grid operators regarding necessary grid improvements, completion dates and relation between those grid improvements and proposed renewable energy projects.

Effective community engagement

Ensuring that local communities are consulted effectively before construction as well as on an ongoing basis is important to the success of a low carbon project. Developers and lenders have conducting their own community engagement, but governments can help de-risk projects ex-ante by taking an active role in facilitating that engagement.

Size of the market and relevant deal flow

Smaller markets do not necessarily present greater risk, but generally offer less opportunity for financial institutions to reach economies of scale in their financing activities. These countries also present less opportunity for development of robust green bond markets. Regional integration may address this challenge, but creates new credit, structuring and legal complexity. An institution’s existing relationship in a smaller country, or the intensity of a small country’s commitment to a particular policy agenda, may offset the difficulty of sourcing deals in a smaller market.