Thursday, 21 October 2010

Macro Level Trends – UK Eco Investment – Incorporating Green Banking

In the midst of a Comprehensive Spending Review which markedly alters the relationship of the state and the British economy, the ideology of a new state sponsored 'Green Investment Bank' dedicated to eco-commerce has understandably shrunken. The overtly grand aspirations for eco-tech that were set before the financial crisis – and which swallowed massive sums in direct and indirect aid - has had to be trimmed to reflect the new financial and political reality.

The headline (figure) of which has been a reduction in available monies from £6bn to £2bn. But such adaption of size, scope and roles of various systemically critical economic agents is, in the Green Bank's case, not necessarily such a bad development. As with much else of Chancellor Osborne's policy, the core action is consolidation of effort and finances for greater applied force, consequential influence and ultimate achievement.

From a global eco-competitiveness standpoint, the UK undoubtedly lags; given the progress made in Asia (ie Japan, S.Korea), Europe (ie Germany, France) and the US. It is said that the global market is worth $3 trillion, of which the UK holds less than 5%. Current UK exports equal £10 billion, versus Germany's £50 billion. And by 2020, it is estimated that more Germans will be working in Eco-commerce than within its car industry. [NB investment-auto-motives suspects German policy is to use its own auto-industry as a technical and organisational 'spring-board' toward that aim]. Thus the “ability to share risk and foster innovation” is noted as key.

The structure and methods of a Green Investment Bank was explored between January-July 2010 via a team led by (ex-Merrill Lynch) Bob Wigley, with Lord Stern advising, and a broad selection of contributors. As perhaps the prime vehicle for attaining the 2050 CO2 reduction goal of 80%, the objectives of that Conservative party generated Commission were to:

- Recommend a bank funding mechanism which includes both 'Green Bonds' and Private Capital
- Ascertain the likely value/size of funds to be managed (using a US model with 10:1 ratio)
- Identify the Bank's investment criteria centred around high-growth and low-carbon companies.
- Offer guidance on Bank Governance relative to any differences in Public & Private Oversight.
- Understand how to ensure an appropriate geographic balance of investment

To summarise the Commissions findings were:

- That £550 billion is required by 2020 to achieve a sustainable low carbon economy.
- Interventionism should be used to overcome 'market failures & investment barriers'; primarily:
“market investment capacity limits”, “limited utility balance sheet capacity”, “political & regulatory risk given policy-driven returns expectations and the history of changing policy”, “confidence gaps for investors linked to technology risks / policy transparency / high capitalisation levels”, “the challenge of making numerous but individually small projects attractive to institutional investors”.
- Interventionism tooo also be used to: “ensure de-carbonisation targets are met”, “energy security & growth”, “reduction to exposure of high/volatile fuel prices”, “creation of a large number of businesses and jobs”, “address underlying externalities”.
- Operationally it should work under strict guidelines so as to not 'crowd-out' the private sector:
“to leave the private sector to open and execute all viable deals, only acting as a public partner in deals that necessitate involvement to attract private investment” (for the overall public good),

Thus the Green Investment Bank (GIB) seeks to alter the eco-investment landscape, by managing & ideally mitigating investor risk, rather than increasing the current hi-risk / hi-reward quotient.

Such a mandate comes as no surprise, though free-marketeers may be rightly concerned about the level of interventionism plied: at what point does positive interventionism become state direction ?

Yet, the call for co-ordination and the under-pinning of investor confidence to create tomorrow's 'eco world' is hard to fault; especially given the recent past. Creating an investor environment of relative stability via a more harmonious PESTEL equation seems to be key.

As seen by the financial crisis and bursting of the housing bubble, for far too long the tail of the capital markets wagged the dog of the real economy. These still recent events and their consequential concerns re-highlight the very rationality behind the call for stability that brought about the creation of the original (olde worlde) capital markets. Then newly formed capital markets in Persia/Levant, Florence, Amsterdam and London that had to deal with the task of major economic reform given changing PESTEL conditions. Their remit: to create a commercial and trading environment in which harmonious relationships would serve all stakeholders - banking, commerce and the nation at large.

Of course, the changing landscape of events in diplomacy, trade routes, new goods, adapted and new vessels aswell as the core enterprise organisation and the very nature of competition honed investor perception, much as these and many more factors do today. But objective fundamentals largely ruled even if short-lived 'land-grab' and 'commodity' bubbles periodically arose from the overt entwined polemics of disingenuous over-enthusiasm and self-interest feeding off of greed. But during those periods, a level of damage limitation prevailed, generally within the circumscribed and circumspect circles of wealthy merchants, Lloyds names and such. People who could afford to 'venture' portions of their wealth. Today's capital markets are made-up for the most part by the paper-wealth of those many millions who realistically cannot afford to 'venture' – the 1929 crash being the stepping-stone between these 2 worlds. Thus whilst the dynamic of the investment foreground appears similar, the background is not.

Today, more than ever, the requisite harmony between banking, commerce and the nation is critical, done so set against the prevailing disruptive yet opportunistic winds of macro and micro change.

Beyond the prime aim of assisting in reaching CO2 reduction targets (80% by 2050), surely this is the philosophical remit of the new 'UK Green Investment Bank', such sentiment behind its very ethos, structure, capability and delivery.

Yet, how best to achieve this is the hot-topic of the day, with two ministerial level camps emerging debating the prime aspects of Role & Responsibilities', 'Bank Funding Methods' and 'Marketable Products'.

[NB To the layman recent press reports tend to infer that the split may appear to be over 'free-markets' versus 'overt-interventionist' ideologies*. (See Post Script below). Though as seen by the report, this not in actuality the case given the 'PPP' format the GIB takes].

The devil then instead appears to be in the detail of the recommendations:.

Roles & Responsibilities:
1) To amalgamate and centralise the efforts of CO2 relevant quangos, retaining core skills.
2) To absorb recommendations from the recent National Audit Office Report
3) Further analysis of the role of GIB across the UK and the use of devolved administrations
4) Implications of GIB for Government Policy; esp regards Infrastructure UK.

Funding Methods:
A) Gov't Funding for dispersion of Grants,
B) Operational Funding via Green Bonds, Green ISAs, GIB Debt Fund, Levy on Energy Bills
C) Initial GIB Capitalisation to support A & B, via Private & State-Owned Bank capital injections, Use of Bank Levy and Bank Bonus Taxes, Proceeds from Sale of Government Assets and UK Revenues from EU ETS Auctions.

Financial Products offered:
1) Early Stage Grants,
2) Equity Co-Investment,
3) Wholesale Capital,
4) Mezzanine Debt,
5) Purchase Offers for Competed Renewable Assets,
6) Purchase & Securitisation of Project Finance Loans,
7) Insurance Products,
8) Long-Term Carbon Price Underwriting.

Such debate is of course very necessary as part of a process to exactly hone the very nature of the enterprise. To enable its efficient start-up (via an Act of Parliament) and be capital markets relative and sensitive. It had been hoped that process would have completed by early October, ahead of the Comprehensive Spending Revue, but no so; it is far more important to create the right form of entity than to hit nominal reporting deadlines.

The political and bureaucratic debate will continue, yet whilst creating the right framework for the GIB is vitally important, equally so will be its ability to act as an efficient investment catalyst when formed, in situ and operational.

Critically, the GIB must be seen to be highly intelligent regards the commercialisation fields of eco-tech and eco-service, and not simply as a second-hand recipient of knowledge (right or wrong) from private investor circles. This will of course span the various sub-sectors by which the CO2 reduction task is classified, including atmospheric discharge across: Energy Generation / Domestic / Industrial / Transport etc arenas..

Here, along with other eco-tech spheres, the importance of GIB knowledge regards the UK and global auto-industry will be critical. Knowledge that delves far deeper than the headlines of CO2 discharge responsibility levels. As both an incorporator of self-developed technology, an adopter of transferred technology, aswell as its potential as a tech-disseminator to other sectors, the industry must be recognised as a central enabler and facilitator toward the CO2 reduction ambition.

But behind the emotionally charged rhetoric and diatribe must be objective knowledge to understand the complexity of the issue.

Given the level of 'green-wash' and 'green-mania' previously apparent, the emergence of a green-tech bubble seemed inevitable, indeed investment-auto-motives believes that new entrant players in the western auto-industry today still enjoy a level of press-driven exposure which massages popular perception thus in turn intendedly 'over-drives' a company's market capitalisation levels which by supposed virtue of credibility then attracts government grants. Thus playing the 'capital markets game' which stalls on promises year after year, delivering little to actually 'save the planet', yet maintaining an illusion of progress.

The following cases provide an overview:

Tesla Motor has sold just over 1000 units of an 'eco-bling' novelty car with little functionality which has had a truly miniscule real-world impact, yet vaults its MktCap at near $1.8bn since it IPO'd 12% of the company in mid 2010; all on the promise of tomorrow. A recent SEC release states that it will run a JV with Toyota for a RAV4 EV, a replay of something Toyota did a decade ago which foundered.

At the opposite end of scale, as GM's IPO relisting approaches the new revelation is that Volt is in reality a hybrid vehicle, something that investment-auto-motives always suspected, so as to deliver a tenable car. The Volt hype spanned years, the new revelation thus demonstrates a cynical play on the public's and capital markets' 'naïve green consciousness' to date. Volt as a hybrid is technically and commercially more feasible, but gains no competitive edge versus leaders Toyota or Honda, instead essentially playing slow catch-up to the pack-leaders further the limited in-roads made by hybrid-Siverado, hybrid-Vue, hybrid-Malibu.

Nissan's Leaf EV compact sedan will be coming to market in late 2011/12, essentially trying to follow in the footsteps of the original 1997 Prius, but moving the eco goal-posts further. It too has had enjoyed massive PR exposure, but the reality is that whilst being based on a standard platform (bad technically but good commercially) it will represent only a small fraction of that platform's volume output. As an example the Sunderland UK plant manufactures 400,000 units p.a, exporting four-fifths. The accompanying satellite battery-pack plants set-up have a capacity of 40,000 units, yet it is expected that the first 3 years will see a real average output of 10,000 'married' bodies and packs; so approximately 2.5% of the Nissan factory's output – not (for the foreseeable future) the overnight game-changer that has massaged public understanding, nor indeed has set high-expectations for economic regeneration areas such as Sunderland.

The latter twin of Jaguar Land-Rover has had sporadic in-house access to hybrid technology for nearly 2 decades as part of the then Rover Group and Ford. There was chief engineer discussion regards the cross-brand learning and applicability of Mini Metro based 'series' and 'parallel' hybrid formats. This tech was considered as the ideal solution for Land Rover's military customers, providing little or no 'thermal signature' that could be traced for a vehicle in combat conditions. As to where such efforts sit today is of course confidential.
However, the Jaguar lag in developing an in-house or even bought-in hybrid system for use on XJ and XF has been disappointing. Execs with point to the instability caused by Ford's disposal of Jaguar on R&D policy, and by the financing concerns TATA Group had when it took-on JLR, but in truth Jaguar should have done far more far sooner as part of its own premium brand catch-up strategy.
The XJ LimoGreen project has been operating for some years now, yet even a very recent press article highlights that no introduction date has been identified, only that whilst the 'range-extender' (in reality read hybrid) technology is operative, the question is scale and so component piece price - the chicken and egg cycle. In reality it appears that progress on LimoGreen (which includes Lotus Engineering and Caparo Engineering) accords to the influx of government funds.
Many years ago investment-auto-motives openly recommended that as an interim 'saviour step' Jaguar ought to ally (formally or informally) with Toyota's Lexus to obtain much needed, speedy market differentiation, packaging hybrids into 'more classically sculpted counterparts' to a more contempoary Lexus. Instead Jaguar aesthetically mimicked Lexus in aspects of form and detailing, whilst directing efforts at modern diesels thus severely lagging in the hybrid stakes against the Japanese and relative to hybrid-demanding US, Chinese and Japanese customers. The recent article seems to indicate only more of the same expectancy for TATA-Jaguar to rely on government funds; funds which are now severely restricted.

Such initiatives when well intended and executed are indeed welcome as part of a multi-solution Eco reduction strategy. But it cannot be denied that the reality of CO2 step change will be smaller and more conventional than typically imagined, and primarily concerns ongoing eco-development of the ubiquitous, globally economically integrated and so value-adding, internal combustion engine.

These aforementioned 4 examples of 'tomorrow's world' must be objectively seen to suffer at best from corporate over-statement for brand differentiation, middling a reliance on government funds for eco-progression, and at worst, open to accusations of manipulation of eco-investor enthusiasm.

History illustrates that such investor-directed, auto-sector-disruptive, 'jam-tomorrow' enterprises are by no means without precedent; and every industry has had its cases promising radically new tomorrow's. The important matter today for the UK, the US and Europe is that industry-directed investment funds from whichever sources - institutionals, private equity, SWFs or even hedge funds - must be allied to truly plausible, reduced risk offerings across the vertical value-chain, and in both final product and service realms.

As the catalyst of conventional risk-averse investor consciousness, the new UK Green Investment Bank must demonstrate itself able to see through the 'eco-haze' so as to set UK and global eco-development on a firm footing. GIB must demonstrate its own credibility as an intelligent lender in this undeniably important field.

The long-term ambition of GIB must surely be to move from public ownership to private ownership via a private treaty sale or perhaps floatation in the years to come, when the more radical of the innovations and sub-sectors it backed becomes near mainstream, so leaving plenty of meat on the bone for the latter-day buyer(s).

Thus, it would appear an obvious step forward to provide the UK Green Bank with a 2-step growth path.

Initially, between 2011 and say 2015 limiting itself to the role of 'simple' grant, loan and other basic provider so a stable conduit toward larger eco-commerce, with an accordant in-built level of risk-aversion with perhaps covenant-heavy capital availability that implies. With latterly, 2015 onwards tranche by tranche disposal into private hands, developing as a broader 'sophisticated' products provider. Thus by implication of greater freedoms, broader access to UK and international capital markets, with a seemingly greater level of risk exposure theoretically counter-balanced by a more robust global economy and by then an engrained consumer eco-behaviour that is far less timid, and more exploratory than perhaps today.

Post Script*

To have delineated the new Green Bank as a copy+ of a conventional investment bank, it would have acted as market reactive conduit between the spectrum of capital markets and the commercial end-user. So obtaining liquidity at a market rate (LIBOR, other reactive-rate or bond-rate), and selling-on the available liquidity with either no a given margin, no doubt dependent upon the health of the market 'push', the commercial demand 'pull' and the required demands of the Treasury in its efforts to plug the UK debt deficit. This approach no doubt thus providing a sense of real-world 'eco-commerciality' whilst also demonstrating the UK's desire to be seen as a friend of the capital markets (so assisting credit-ratings) aswell as possibly presenting a Green Investment Bank vehicle / model / format which the UK could promote across the world; itself promoting the innovative spirit of the UK's financial services sector.

In contrast, to have delineated the GIB as simply a re-organised government entity, now with far less though centralised financial muscle, would have led to a sense of even greater incredibility both within Whitehall, but especially across the capital markets and industry / commerce. Yes, it would have no doubt had greater 'non-negotiable' powers regards regulation and interventionism, but interaction with the external business world would have undoubtedly suffered, so in effect pseudo-control without the real power to alter the direction, structure and growth pace of the UK economy].