LSE Institute of Global Policy
Sustainable Infrastructure and Development Requires Financial Innovation
Torben Möger Pedersen
CEO of Pension Denmark
Jens Lundsgaard
Board member of the European Bank for Reconstruction and Development (EBRD)
Torben Möger Pedersen
Jens Lundsgaard

Preventing devastating climate change will require large scale investments in renewable energy, smarter cities, buildings, and many other assets. Part of these investments will be in advanced economies, but to effectively tackle climate change and achieve other Sustainable Development Goals, large capital flows between advanced, emerging and developing economies are needed.

As estimated by the Global Commission on the Economy and Climate, a total of USD $90 trillion investments in infrastructure is needed globally over the 2015-30 period – roughly doubling past investment levels and delivering more than the world’s entire current infrastructure stock. This will hardly happen without financial innovation. Hence the G20 Eminent Persons Group on Global Financial Governance has, rightly, emphasized that significantly greater private investments could be mobilized, including by building a sustainable infrastructure asset class with sufficient scale and diversification to attract institutional investors.

We would like to share Denmark’s experience on how to do so in practice.

Take the case of wind energy. Wind farms have financial properties that are well suited for placing considerable pension savings while offering a relatively stable cash-flow over the 25-30 years of service life. Building on the pioneering investments made more than ten years ago, we have therefore now seen pension funds not just in Denmark but all over Europe invest in wind farms.

The key enabler for this development has been an adequate distribution of risks between the producers of turbines, energy companies and investors. With the right incentives in place, operational efficiency has improved dramatically. Over the past year, several auctions for off-shore windfarms in Germany have been won by zero-subsidy bids as companies consider they will be able to produce electricity from wind at costs that are at par or even below the market price of electricity based on nuclear, gas or coal-fired power plants.

A total of USD $90 trillion investments in infrastructure is needed globally over the 2015-30 period

The first investments were characterised by institutional investors taking limited risk exposure, essentially providing financing at a guaranteed return. But as experience accumulates, investors have become more comfortable with assessing the risks and other financial properties of sustainable infrastructure – like for properties, shares, corporate bonds and other assets. Moreover, new types of market participants have emerged, such as a EUR 7 billion fund dedicated to investment in the development, construction and operation of renewable energy assets like on- and off-shore wind farms (a “club” with more than 40 institutional investors, including the EIB, and managed by Copenhagen Infrastructure Partners).

All this can be replicated in emerging and developing economies – both for renewable energy and other assets related to sustainable development. A first condition is that the right regulatory environment must be put in place: to attract capital, foreign investors must be able to rely on well-defined ownership also for these types of assets. Moreover, regulations of utilities and energy markets must be transparent and stable to mitigate risks. International financial institutions would have an important role to play here since economic reforms and the rule of law are as important for sustainable development as for other investments.

As more experience is gained with sustainable infrastructure assets, the natural aspiration would be that such assets could be traded with more liquidity in financial markets. Ultimately, it is only by leveraging the inherent abilities of the financial sector and markets to assess, pool and diversify risk that the necessary investments can be achieved. Public support can be useful to overcome first-mover disadvantages and to underpin the establishment of standardised data that can reduce uncertainty and transaction costs in financial markets. As such, the challenge is similar to that of developing financial markets in general in transition economies around Europe, where the EBRD has deep experience.

In fact, Europe’s financial history is a rich source of inspiration. During the 19th century, industrialisation entailed a strong private-sector build-up of infrastructure assets financed via the exchanges in notably London and Paris. By the 1840’s railways accounted for more than a quarter of private investment in England, and in the 1850-60s, the construction of the Suez Canal was financed by stocks sold to 40,000 investors on the Paris exchange. Still today, this canal caries over 10% of the global maritime transport, giving immense CO2-savings compared to sailing south of Africa on the way from Asia to Europe.

As estimated by the Global Commission on the Economy and Climate, a total of USD $90 trillion investments in infrastructure is needed globally over the 2015-30 period – roughly doubling past investment levels and delivering more than the world’s entire current infrastructure stock.

So, if financial markets could handle this asset class in the 19th century, could financial markets learn to do it again? We believe so. And profitable investments in support of the sustainable development goals can also be made outside infrastructure. Last summer, the Danish SDG Investment Fund was launched. By blending private capital from institutional investors with that of the Danish government’s Investment Fund for Developing Countries, the purpose is to spear-head commercial investments that can promote sustainable development in locations where perceived risks would otherwise deter private investors. While more data is still needed, experience suggests that the actual risks are often more manageable than perceived by markets and many analysts.

With millennials making up a rising share of investors, private banks and fund managers are also increasingly interested in assets with a positive global footprint. Combining these forces, private investments and ingenuity can bring the solutions needed to avoid global climate change and to promote our global Sustainable Development Goals.

Torben Möger Pedersen is CEO of PensionDanmark – a position he has held since the organization was established in 1992. Torben Möger Pedersen holds a number of board and investment committee memberships including Arbejdernes Landsbank, University of Aalborg, Danish Insurance Association, Copenhagen Infrastructure Fund I, II, III Danish Climate Investment Fund, Danish SDG Investment Fund, Center for Pension Research (PeRCent) at Copenhagen Business School and Danish Society for Business and Education. Torben Möger Pedersen is also a member of UN’s Green Climate Fund’s Private Sector Advisory Group and World Economic Forum’s Global Agenda Council on Investments as well as part of the Steering Committee of the World Economic Forum’s Council on Investment.

Jens Lundsgaard is a board member of the European Bank for Reconstruction and Development, and founder of Lundsgaard Economics & Strategy. Previously he was an economist at the OECD and served as Deputy Permanent Secretary in Denmark’s Ministry of Industry, Business and Financial Affairs.