By Euan Marshall, Program Manager, Environmental and Social Development, IFC

Addressing the climate finance gap will require investment across many asset classes. There is a particular need to fund small and growing businesses that are developing innovative low carbon products and services. According to a recent IFC report [PDF], Private Equity (PE) is particularly well suited to channel investments to these businesses.

However, capital market failures have constrained the growth of climate-related PE investment in emerging markets. While climate-friendly investments by PE/venture capitalists totaled $20 billion a year in 2010, less than 10 percent of these deals were in emerging markets. Therefore, in this arena, the PE industry faces key barriers in growing climate related investment. Some barriers include:

• Fund Mobilization – Nascent sectors lack investment track records, which investors use as key inputs for investment decisions. This catch 22 is slowing the rate of fund formation and the ability of teams to successfully close.
• Fund Deployment – Investments from climate funds are restricted for several reasons, each adding to an increase in overall transaction costs: incremental costs accrued by first movers in new markets; additional due diligence expenses with regard to climate related technology and regulations; and smaller than average deal sizes.
  

The report provides an important tool that will help shape the design and structure of public sector interventions to increase climate related PE investment. To support the growth of climate related PE funds, public funds can:

• Provide anchor investment to help incubate new fund management teams
• Support the fund formation process by sponsoring new investment teams
• Provide grants, technical assistance and concessional loans to PE funds to support innovative climate friendly transactions.

By supporting new fund managers, public capital can help create a reinforcing dynamic within the PE industry. Easier fund raising would encourage more fund managers to form. More funds would lead to more investment, building track records and creating investor confidence in the sector. This virtuous circle will:

• Quickly catalyze and leverage additional private sector capital into new climate related PE investments
• Help develop a cadre of new intermediaries in emerging markets who can source and support new climate friendly business opportunities
• Lead to investment in new innovative businesses that will both help create jobs and reduce GHG emissions.

For more information, you can read the report produced by IFC and supported by funding from the Governments of Japan and the UK and the Global Environment Facility.