Namibia's green economy: the potential of guarantees in blended (project) financing
As countries round the world move to decarbonise in line with Paris Agreement commitments, governments are recognising the pivotal role to be played by private capital in meeting growing funding requirements. Approximately USD2.4-trillion is needed each year between now and 2050 for climate action just in emerging markets and developing economies (excluding China) ("EMDEs"). But there are opportunities too – it is estimated that by 2050, the global demand for green hydrogen (as an alternative to fossil fuels) could increase seven times over. To meet this drastic increase in demand, a significant number of projects must become operational in EMDEs such as Namibia and South Africa where conditions for production are favourable.
Blended financing
One of the ways to unlock additional capital for investments into EMDEs is through blended finance, which uses public or philanthropic development capital to attract and enable private finance for SDG-related investments. SDG-related investments in EMDEs may struggle to attract the requisite funding from the private sector for various reasons: the projects are not always able to offer the return on capital required by private capital; the real or perceived risk relating to the country in which the project is undertaken; the lack of balance sheet or credit support which the project is able to offer, or the requirement for a longer tenor of funding.
These and other factors make it difficult for these projects to access the finance which they require, albeit that they are able to deliver impact in the real economy. Where public or philanthropic capital is committed to such a project, this reduces the risk of the project for private investors and offers additional credit support for their investment. Public capital may provide private capital with assurance in respect of country risks relevant to the project. The stacking of capital may also enhance or protect the return earned by private capital, making an investment that may not ordinarily be bankable more attractive to private capital. Combining public or philanthropic capital with private capital also unlocks benefits for the projects themselves, ensuring improved borrowing terms, such as longer tenors or better overall cost of capital.
Guarantees: a key blended finance instrument
One way in which the above may be achieved is through the issuance of guarantees to effectively redistribute the risk, ensuring that private capital's risk in the investment is reduced. Essentially, a guarantee is an agreement where a third party (ie, the guarantor) commits to pay the investor or lender should the investee or borrower be unable to do so. The provision of guarantees on behalf of a borrower can result in a higher credit rating, making the investment viable for private investors and ensuring better interest rates for the borrower. Through the provision of guarantees by credible guarantors, high-risk borrowers or sectors are able to access finance that would previously have been unavailable.
Guarantees address a variety of risks, including political or country risks as well as credit or commercial risks.
There are three parties involved when a guarantee is given in blended financing transactions, namely, the guarantor, the guarantee holder (the investor or creditor) and the client (the investee or debtor). The guarantor enters into a guarantee agreement with the guarantee holder, and into a recourse agreement with the client. In most structures, the guarantee holder pays fees to the guarantor in return for a service, aimed to remunerate the risk taken by the scheme. In case of materialisation of the guaranteed risk (for example, if a borrower cannot repay a loan), the guarantor makes payments to the guarantee holder that the client is unable to make.
Guarantees can vary in many ways, notably the risk they cover and the financing agreement or institution they are applied to. In the context of development finance, the three types of guarantees most often used are:
- Credit guarantees: they protect the lender
from losses in the event of non or late payment of debt
obligations. These are often referred to as credit enhancement
products. Credit guarantees are the most common type of guarantee.
Notably, they are issued by guarantors like GuarantCo – a
PIDG company, the United States Development Finance Corporation
("US DFC"), as well as export credit
agencies and several Multilateral Development Banks
("MDBs").
In the Namibian context, albeit not in the green economy space, in August 2020, the Minister of Finance, Hon. Ipumbu Shiimi, launched the Credit Guarantee Scheme ("CGS") to provide collateral cover of 60% for qualifying Small and Medium Enterprises ("SMEs") that apply for finance from participating commercial finance institutions. The CGS cater for SMEs with viable business plans that lack collateral to obtain loans. Commercial finance institutions require collateral to preserve their capital in the event of businesses being unable to repay their loans. By insuring credit granted to qualifying SMEs, the Scheme substantially reduces the collateral requirement for qualifying SMEs by 60%.
- Risk guarantees or political risk insurance:
they protect investors against pre-defined political risks such as
expropriation, currency inconvertibility, breach of contract, war
and civil disturbance. The World Bank's Multilateral Investment
Guarantee Agency ("MIGA") is a main
issuer of political risk guarantees, together with export credit
agencies.
- Currency guarantees: these protect the lender from losses due to fluctuations in exchange rates. These typically come in the form of "hedges", which are forward agreements on a certain exchange rate between two parties and (unlike guarantees) tradable products on liquid markets. Currency risk management mechanisms are becoming a higher priority in the broader development finance system reform agenda as they are key to mobilising international capital. At present, currency hedges for EMDEs are often expensive as they incorporate high macroeconomic risks.
Other types of guarantees relevant in the context of scaling investments are liquidity extension guarantees, payment guarantees and performance guarantees.
To date, Namibia has not concluded a purely guarantee-based blended financing transaction for the green economy. Nevertheless, the SDG Namibia One Fund, a EUR1-billion blended financing vehicle for green hydrogen investment in Namibia is a key blended financing arrangement in place. Although the platform is predicated on a grant basis as opposed to a guarantee (as discussed above), it remains a laudable blended financing initiative that will see Namibia's Environmental Investment Fund ("NEIF" partnering with two Dutch organisations – Climate Fund Managers and Invest International. It is stated that 100% of the initial funding of EUR40-million, translating to NAD850-million is expected to be provided as grant funding by Invest International. The net effect hereof is that guarantees or risk insurance provided by the public or philanthropic sector, in this case, by Invest International creates an investment opportunity with acceptable risk–return profiles for the private sector by de-risking the investment or improving the risk–return profile of NEIF to bring it in line with the market for capital.
Apart from the SDG Namibia One Fund, comparatively, blended financing models that leverage development finance to crowd in private capital for green hydrogen projects are also eminent in South Africa. The South African and Netherlands Governments launched the USD1-billion South Africa Green Hydrogen Fund ("SA-H2") on 20 June 2023. The SA-H2 Fund will aim to secure USD1-billion in blended financing for the green hydrogen economy through support by Climate Fund Managers, a joint venture between the Dutch development bank, FMO, and South African insurer, Sanlam. In this regard, it is important to point out that, recently the UK-based Blended Finance Taskforce and the Centre for Sustainability Transitions at Stellenbosch University, in collaboration with the Open Society Foundations, launched a report titled "Better Finance, Better Grid: Mobilising capital to scale transmission grid capacity in South Africa to improve energy security, create jobs and support inclusive growth". The report helps identify critical priorities to strengthen energy security in South Africa – with a focus on accelerating the building of transmission infrastructure and, importantly, explores options for unlocking barriers to accessing the required capital.
Given the need to increase the access to capital for transmission investment, four types of models for financing transmission infrastructure outside of the transmission company or government balance sheet are:
- Full privatisation: The full ownership and operation of the network is transferred to a private party for an indefinite period of time.
- Whole of network concessions: A private party is granted the right to develop, build, operate and maintain the country's transmission infrastructure (or portion thereof) for a defined period of time, after which the transmission utility regains control or initiates a new concession.
- Independent Transmission Projects (ITPs): Specific transmission lines are financed and built by private parties under long-term contracts. Different owning and operating structures are possible.
- Specific purpose lines: Generation-linked, industry-driven, interconnectors and merchant lines. Generation-linked lines are directly related to generation building projects. Industry-driven lines are specifically built for industry clusters. Interconnectors enable power flow to and from neighbouring country grids (e.g., Namibia) such that each country can benefit from the other when there is excess or lower cost power. Merchant lines are fully private lines (not open access) that connect an area that has previously been isolated from the grid.
In closing, it is recommended that the next steps for unlocking private capital for the green economy must include scaling up the volume of tailored guarantee instruments. Development finance institutions and bilateral shareholders should seek to considerably increase the volume of guarantees for the green hydrogen industry, and tailor such instruments to accommodate risks specific to the green hydrogen industry. As an example, in accordance with UN SDG 13 on Climate Action, Bank Windhoek, one of Namibia's leading financial services providers, was the first commercial bank to issue and list a Green Bond in Southern Africa in 2018, and later a Sustainability Bond in 2021, and was accordingly awarded the Green Bond Pioneer Award. The potential of these arrangements are evidenced in much detail in the recent report by the UK-based Blended Finance Taskforce titled "Better Guarantees, Better Finance" cited hereinbefore.
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