Climate Finance Module 2

Module 02

Climate Finance
Lesson 2

Risk Mitigation Instruments

Presentation Script

Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

Presentation Script

Welcome to Lesson 2: Risk Mitigation Instruments.

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

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1.2 Introduction

In this lesson, you will learn how public finance and risk mitigation instruments can
remove barriers to climate finance investment. Specifically, you will better understand
the various risks acting as barriers to private sector climate finance investments; the
different types of risk categories in low-carbon projects; risk mitigation instruments
used as tools to reduce risk, and case studies of risk mitigation in practice.

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

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1.3 About Lesson 2

Some key questions that will be addressed during this lesson include: What are the risks
in low-carbon investment projects? How are risk mitigation instruments being used?
What are the current gaps and trends in risk mitigation instruments? What are examples
of utilizing risk mitigation instruments and how have they supported climate finance
investment?

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

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1.4 High Perception of Risk in Low-Carbon Projects

Low-carbon projects typically suffer from high perceptions of risk, particularly in

developing countries, which can negatively affect climate finance investment and even
hinder private sector's participation. Low-carbon project risk factors include a
dependence on public policy; the relative immaturity of technologies, markets, and
industries; long investment horizons; high upfront costs and a lack of dedicated
investors. In order to unlock climate finance investment, policymakers should focus on
addressing these risks.

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

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1.5 Categories of Risk

In order to better understand risks to climate finance investment, the Climate Policy
Initiative has grouped risks into four categories according to their different sources and
character. The following slides will introduce each category of risk is more detail.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.6 Political, Policy, Social Risks

The first risk category includes political, policy, and social risks associated with actions
by governments and citizens. Political risks are due to illegitimate actions of public
authorities discriminating against investors. Policy risks involve legitimate actions of
local authorities exercising their power to rule. Social risks are due to actions of private
individuals or groups. These risks also include misappropriation of public and private
resources. Click on each Example button to read more.

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

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1.7 Political, Policy, Social Risks in Low-Carbon Projects

These risks are enhanced by the very nature of low-carbon projects. For example
reliance on public financial and institutional support; having investment horizons longer
than policy cycles; and sometimes cause environmental impacts that lead to social
resistance.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.8 Technical, Physical Risks

The second risk category includes technical and physical risks. They are technologyspecific or related to the ongoing availability of natural resources. Four examples
include; construction and operation risks, physical output risks, environmental impact
risks and decommissioning risks. Take a moment to read about these examples in detail.

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

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1.9 Technical, Physical Risks in Low-Carbon Projects

In low-carbon projects, these risks are enhanced by the fact that many technologies
employed are not yet proven green technologies. This means that such projects lack
accurate technology performance data; and suffer from uncertainty over measurements
of the natural resources availability.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.10 Market, Commercial Risks

The third risk category includes market and commercial risks. Six examples include
currency risks, market risks, financing risks, counterparty and credit risks, and liquidity
and exit risks. Take a moment to read about these examples in detail.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.11 Market, Commercial Risks in Low-Carbon Projects

In low-carbon projects, these risks are enhanced by the fact that they incur high upfront
costs; long investment horizon and payback periods; financiers' unfamiliarity with green
investments; and complexity of infrastructure investments.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.12 Outcome Risks

The last category of risks include outcome risks which are risks perceived by the public
sector and are linked to the ability of publicly-supported green projects to meet
objectives within expected costs. Outcome risks include emission reduction risks, coimpact risks and budget impact risks. Take a moment to read about these examples in
detail.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.13 Outcome Risks in Low-Carbon Projects

In low-carbon projects, outcome risks are typically enhanced by the amount of public
support required for such projects to be successful and the budget constraints such
projects face.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.14 Categories of Risk Mitigation Instruments

In light of the low-carbon projects risks we just covered, risk mitigation instruments are
tools to promote climate finance investment. The Climate Policy Initiative has identified
six categories of instruments that directly addresses specific risks or multiple risks at
once. Click on the private and public sector buttons to learn which sector uses which
instruments. Advance the slide to start learning about each instrument.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.15 Risk Mitigation Instruments: Bilateral Contracts

Bilateral contracts are risk mitigation instruments addressing project risks not related to
credit. They are usually provided by private entities to cover technical risks related to
the operation phases of projects, or to cover output price risks. For more advanced
technologies, like offshore wind farm projects, bilateral contracts can be highly specific
with complex drafting, implying high transaction costs. Click on each example on the
right to learn more.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.16 Risk Mitigation Instruments: Credit Enhancement Instruments

Credit Enhancement Instruments are usually developed by specialized public and private
entities to cover commercial and market risks by guaranteeing (partially or in full) the
liabilities of a project towards its lenders. Credit Enhancement Instruments improve the
quality of loans and bonds issued by the projects by mitigating the borrower's credit risk
and enhancing coverage of debt service obligations. Click on each example on the right
to learn more. You may also click on a mapping of the World Bank's Risk Mitigation
Instruments, mostly focused on guarantees.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.17 Risk Mitigation Instruments: Insurance

Insurance is a well-established risk mitigation instrument, typically provided by private

companies. This is in exchange for a premium and upon verification of the liability of the
claim. Insurance risk mitigation instruments are very common in mitigating physical,
market and political risks. Click on each example on the right to learn more.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.18 Risk Mitigation Instruments: Revenue Support Policies

Revenue Support Policies are the public sector's main tool for promoting low-carbon
projects by reducing output price risks and offering resources that reduce financing risks,
for example tax credit or equity. One drawback is that, as technology deployment
increases, revenue support policies become heavier for public budgets, creating
incentives for governments to renegotiate them. For investors, this creates the
perception of policy risks. Click on each example on the right to learn more.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.19 Risk Mitigation Instruments: Direct Concessional Investments

Direct Concessional Investments are risk mitigation instruments from public entities
(such as governments' budgets, bilateral and multilateral development banks),
dedicated private-equity facilities, and international climate funds. They help mitigate
financing risks by providing loans or equity funding that enhances the financial viability
of low-carbon projects. Click on each example on the right to learn more.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.20 Risk Mitigation Instruments: Indirect Political/Institutional Support

Indirect Political and Institutional Support refers to public, non-financial, interventions

that usually target multiple risks, including political, policy and regulatory risks, as well
as technical and physical risks. Instruments under this category include technical
assistance for sustainable energy policies and capacity building activities, for example,
quality certificates. Click on each example on the right to learn more.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.21 Current Gaps in Risk Mitigation Instruments

In developing countries, public and private entities provide several risk mitigation
instruments yet this does not cover all kinds of risks. For example, instruments only
appear to address political risk, not policy risk. Also, financing risks have been mostly
addressed with concessional resources, which do not improve the liquidity of
investments or attract private finance. And most low-carbon projects supported by
public spending weigh heavily on already tight public budgets, furthering the perception
of outcome risks. This means that new and innovative risk mitigation instruments are
needed.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.22 Trends in New Risk Mitigation Instruments

Currently, two types of new risk mitigation instruments have emerged: Policy Risk
Insurance and First-Loss Protection.
Policy risk insurance provides coverage against retroactive policy risk, when national
governments shift policies in ways that hurt the financial stability of projects. First-loss
protection protects investors from a pre-defined amount of financial loss, enhancing the
credit worthiness and improving the financial profile of an investment. Click on each
new instrument to learn more.

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Module 2: Lesson 2 Risk Mitigation Instruments

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Policy Risk

Policy risk insurances can indirectly address policy risk. Partial Risk Guarantees can also
address policy risk, but only when it is clearly identified in the contract and when a
counter-guarantee by the host government is available. Another form of policy risk
insurance, such as feed-in-tariff insurance, reduces the impact of policy risk by providing
coverage for changes to national policies that would harm the financial stability of
existing projects.

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Module 2: Lesson 2 Risk Mitigation Instruments

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First Loss Protection

To be effective, first-loss protection should address specific investor needs by matching

their required risk-adjusted rate of return and allowing securities to obtain an
investment-grade credit rating. First loss protection can also address institutional
investors' unique circumstances, such as liquidity of a secondary market and mitigation
of some specific project-level risks.

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Module 2: Lesson 2 Risk Mitigation Instruments

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1.23 Summary

In summary, addressing risks to low-carbon projects helps to unlock climate finance

investment. Risks act as barriers to investment, raising the cost of capital and hindering
private sector's participation. Organizing risks into the four categories helps to focus risk
mitigation efforts. Six risk mitigation instruments are currently being used by the public
and private sector, with new instruments emerging to fill the gaps in risk allocation.
The case studies in this lesson highlight the success of risk mitigation in promoting
climate finance investment.
You have now reached the end of lesson two. Click next to visit links for additional
information.

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Climate Finance Module 2

Module 2: Lesson 2 Risk Mitigation Instruments

Presentation Script

1.24 Key References and Resources

The following links provide key references and additional resources.

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