Energy Efficiency Finance

Contact the SmartLessons program at smartlessons@ifc.org.

SmartLessons in Energy Efficiency Recognizing the vast market represented by cost-effective investment opportunities in energy efficiency, in 1998 IFC began working with the Global Environment Facility (GEF) to address climate change through innovative market-based approaches to greenhouse gas mitigation. This led to IFC’s early initial pilot energy efficiency lending projects, in which IFC partnered with financial intermediaries to develop specialized energy efficiency finance products. Support from GEF and other key donors, including the governments of Austria, Finland, Netherlands, Spain, and the United States has bolstered IFC’s efforts in promoting energy efficiency projects and facilitated replication in increasingly more challenging markets in a self-sustaining manner.

Energy efficiency investment opportunities reside everywhere, in each sector and in every market. They are embedded in virtually every capital improvement project, whether in the industrial, commercial, institutional, or residential sector. They emerge either as stand-alone investment projects or as a component of a larger project. This universe of projects represents a set of investments which typically are highly costeffective due to a broad set of benefits, including labor cost savings, improved quality and reliability of products and services generated from the projects, reduced pollution and waste, and energy savings which typically provide paybacks ranging from six months to five years. Although IFC’s initial pilot program was primarily donor funded, the leverage of the donor funds employed has consistently and substantially grown.

While energy efficiency opportunities exist as embedded components of larger projects across the entire spectrum of IFC’s core industry sector investment business, perhaps the greatest opportunities for energy efficiency investment exist as smaller discrete projects, including cogeneration systems, lighting renovations, motor retrofits, and control systems. The relatively smaller size of these energy efficiency projects exhibits an inherent mismatch with IFC’s comparative advantage and capacity to invest directly.

However, energy efficiency finance has proven to be an excellent market opportunity for many of IFC’s financial intermediary partner banks and leasing companies. And IFC has played an important role in supporting partner financial intermediaries in developing this market.

By providing a package of advisory services and financial products, IFC has made a business of energy efficiency finance for projects which are individually smaller than IFC’s investment threshold but which is scaleable through the financial intermediary partners for whom such projects are a good fit. The advisory services support market development, financial intermediary product development, financial intermediary capacity building, and the building of an initial project pipeline, while the financial products range from long-term credit lines to risk-sharing instruments.

In addition to generating the advisory and investment products which underpin IFC’s energy efficiency finance business, the programs featured in this collection of SmartLessons provide the knowledge platform upon which the IFC business is being built. This includes the IFC professionals who staff these program teams, as well as the materials and resources which will be useful for global teams looking to replicate and adapt these products to their regions.

Russell Sturm Sustainable Energy Team Leader IFC Sustainability Business Innovation Group

DISCLAIMER IFC SmartLessons is an awards program to share lessons learned in development-oriented advisory services and investment operations. The findings, interpretations, and conclusions expressed in this paper are those of the author(s) and do not necessarily reflect the views of IFC or its partner organizations, the Executive Directors of The World Bank or the governments they represent. IFC does not assume any responsibility for the completeness or accuracy of the information contained in this document.

SmartLesson 1 Working Together to Move Client Relationships from Advice to Partnership in Sustainable Energy Finance by William Beloe

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SmartLesson 2 My, How You Have Grown! The First Large-Scale Energy Efficiency Mainstream Investment through a Financial Intermediary by Judit Braxatoris

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SmartLesson 3 Turning Project Delays into Opportunity: Renewable Energy Financing in Peru by Alberto Didoni

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SmartLesson 4 From Free to Fee - Charging for Advice While Introducing an Innovative Financial Product by Yana Gorbatenko

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SmartLesson 5 Lending to a “Different Animal�: Energy Efficiency Renovation of Multi-Family Housing Buildings in Hungary by Tibor Kludovacz

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SmartLesson 6 Lessons in Promoting Energy Efficiency by Eluma P. Obidbuaku

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SmartLesson 7 Adaptation for Adoption: Mainstreaming Energy Efficiency in Financial Institutions by Miles Stump

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SmartLesson 8 Sustainable Energy Investment Scale-Up and Mainstreaming

by Pavol Vajda and Alexandra Glatznerova

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Working Together to Move Client Relationships from Advice to Partnership in Sustainable Energy Finance William Beloe IFC has successfully developed sustainable energy projects in a number of emerging markets over the last decade. While each intervention is tailored to its specific markets and the needs of our clients, in general the initiatives have focused on using local financial institutions as aggregating agents to stimulate investment in both energy efficiency and renewable energy, thus reducing operating costs of the client (and improving the clients’ margins) and emissions of greenhouse gas. This SmartLesson focuses on the sustainable energy finance project IFC has developed in the Philippines and how we have leveraged more developed projects and ensured a one-IFC approach. It highlights the importance of focused research, listening to and being responsive to clients, and maintaining flexibility and realistic objectives in the program design. This paper is intended for colleagues responsible for developing projects in various business lines and regions, with particular relevance to those involved with either sustainable energy or local financial institutions.

Background

earlier this year to provide them with the support necessary to develop portfolios in the area of sustainable energy (energy efficiency and renewable energy). Phils SEF is an 18-month engagement worth approximately US$650,000 focused on building capacity, pipelines, and portfolios within financial institutions and raising awareness for the business cases behind energy efficiency and renewable energy for the wider community.

The Philippines Sustainable Energy Finance Project (“Phils SEF” or the “Project”) supports the creation of a commercial financing market for sustainable energy projects in the Philippines. This program assists the Philippines in improving energy security and economic productivity, and promoting private enterprise in the energy sector. Phils SEF covers both energy efficiency and The Project went through a number of clear stages before renewable energy projects. we got to where we are today. These stages are elaborated The program is designed to leverage IFC’s capabilities below and so are the lessons learned. and experience, backed by donor resources to catalyze financing for sustainable energy projects, and is expected to result in: (i) improved access to financing for sustainable energy projects, which will continue beyond the support of IFC financial instruments and advisory services; (ii) growth and business development for private enterprises related to energy efficiency and renewable energy projects; and (iii) promotion of more sustainable development, with better use of natural resources and a reduction in projected greenhouse gas emissions. This program also supports the national government, as it implements both its national energy efficiency and climate change mitigation campaigns.

Lesson 1: While a market opportunity may look obvious to you, it may not to your client. Bringing value to clients is easier once you understand what they want.

“We don’t see things as they are. We see things as we are.” - Anais Nin

The inception of this project, like many others in this space, began with some important work done by IFC’s Environment and Social Development Department (CES). They undertook research three years ago comparing various countries in order to ascertain the next marThe IFC signed cooperation agreements with two ket to roll out an SEF program. This was a key step, and of the Philippines’ three largest financial institutions the Philippines was clearly the most appropriate market.

Our research showed that there was a strong business 4 SmartLessons

case for SEF. With electricity prices consistently among the highest in the region, over 50 percent of power reliant on imported oil, but with a comparatively sophisticated local banking industry, government commitment to energy efficiency, and renewable energy, the country had significant potential to see rapid growth in the sustainable energy financing market. However, when we took these findings to the local financial institutions, it became clear that, while they were interested in the concept, even the most enthusiastic of them were unwilling to invest resources in building internal capacity to lend to this market. While the business case looked clear to us, the local financial institutions needed more detailed data before they would seriously consider investing in the market.

shared our findings with the wider financial community.

However, our priority clients were the keenest and most enthusiastic to work with us in developing the opportunities this research had uncovered and, as such, we were able to leverage the research into engaging with both of them. Both the financial institutions were now willing to invest in allocating a small group of their staff to be tasked with developing the project and delivering on SEF pipeline and portfolio objectives and, in both cases, paying 50 percent of the costs for the specific work that was designed for them.

1. Establish a clear strategy with our investment services colleagues at IFC’s Global Financial Markets Department (CGF) as to which clients IFC most wanted to build a relationship with. IFC Philippines investment and advisory services teams had already agreed that the financial markets sector was a key pillar of our country strategy. Working with the investment team to identify and then cultivate relationships with key potential clients allowed advisory services to leverage the stronger relationships that our investment services colleagues had with the local financial institutions’ senior management.

Meanwhile, advisory services could offer services to the financial institutions that could help unlock the door to greater interaction with these clients. It also meant that we were working in tandem to develop these relationships. When we met obstacles, we could brainstorm together to work out the best strategies for overcoming them.

“If we keep doing what we’re doing, we’re going to keep getting what we’re getting.”

- Stephen Covey

An additional advantage of the close working relationship between advisory and investment services is that by working in the sustainable energy field, investment colleagues are able to introduce financial products to clients In order to begin work with the financial institutions, we that help mitigate climate change, a key World Bank needed to undertake some more detailed, local research Group strategic pillar. This provides them with a clear to garner the necessary information about the size of dif- “additionality” role, where IFC is providing a service that ferent market segments, the barriers to developing them, is not otherwise available in the market. the potential financing opportunities they contained, potential pipelines, deal aggregators, etc.

Lesson 2: Leveraging success from elsewhere does not mean adopting it in its entirety. Adaptation is a This gave us a chance to do two things: powerful tool.

As we were building relationships with these priority clients, the IFC team, including local as well as regional and global investment teams, advisory services, environment and social development department, and structured finance colleagues, were all on the same page with regard to the model we wished to leverage. We had spent time looking at the models that had been successful elsewhere.

We engaged and received valuable support from IFC energy efficiency programs in Central Europe, Russia, and China, as well as from IFC’s headquarters.

The China model in particular was recognized as a success we wanted to emulate. It included advisory and investment services engagements in lock step. In order for this model to work, financial institutions needed to buy into the opportunity both by paying fees for advice, 2. Based on the joint strategy we developed as a result of (and investing their own resources in building capacity the above point, we were able to focus on two or three and pipelines), and by entering into a financial engagebanks with which to begin the program, and to under- ment at the same time, before the pipeline had been take the research that was of most use to those banks. built. Philippine banks are comparatively sophisticated, compared to other emerging markets. However, they Once we had completed these pieces of research, we are also comparatively risk-averse. This meant that they SmartLessons 5

were unwilling to incur the expenses related to engaging in IFC’s Risk Sharing Facility until they had a greater degree of certainty that they were going to fill it with deals.

At this point in the project development cycle, the time spent with our investment colleagues in setting priorities paid dividends. As a team we had agreed that these were clients IFC was willing to invest in building a relationship with. Together we were able to analyze the investment advisory services could make in beginning these relationships, and the opportunity cost of not being able to use these advisory services resources elsewhere.

With country management and regional industry management involvement, a clear decision was made that in this case, advisory services should play a catalytic role in building IFC’s relationships with these priority banks by supporting these financial institutions to build their SEF portfolios before a firm commitment for an investment services product had been made. The advisory services intervention was viewed as a worthwhile investment of IFC’s time and resources, as it provided IFC with an

excellent opportunity to interact more frequently with the clients and get to know them better, and, by providing support in building their pipelines and portfolios, IFC was helping them get a firmer understanding of the true size of the market opportunities, thus developing their appetite for IFC’s financial products.

In both cases, investment services and structured finance colleagues have been increasingly engaged with these clients in talks about both IFC’s Risk Sharing Facilities and other financial products. IFC would not be in this position if it had not been for the day-to-day interaction our team now has with them.

In developing our strategy at the country, industry, and project levels, and in ascertaining whether IFC should commit advisory services resources without a committed investment project, the framework below proved a valuable tool in ensuring we had a value proposition for the client.

FIGURE 1: IFC’S ROLE AND ADDITIONALITY – A CONCEPTUAL FRAMEWORK Maximizing our additionality through strategic selection of the client or project will lead to a stronger development impact.

Explain the rationale for your project with the help of the template below.

Why has this client chosen to work with us?

Describe IFC’s additionality.

Why have we chosen to work with this client?

Put the client/project in a larger, strategic context.

Client’s Needs

IFC’s Client Strategy

1. What is the client’s strategy given the country and sector context?

2. What does the client need to implement its strategy successfully?

3. Why is the private sector not willing to undertake this project on its own? Why is there a need for IFC?

The Role of Commercial Financiers What do commercial financiers offer this client?

1. Why do we want to work with this client?

2. How does this client or project help IFC achieve our own country/ department/sector strategy?

3. How does the relationship with this client fit with WBG strategy?

Source: Client Relationship Manager

The Role of IFC

What do we offer to this client? a) Risk mitigation; b) knowledge / innovation; c) standard setting; or d) policy work.

IFC Country & Sector Strategy 1. What is IFC’s strategy in the country/ sector?

2. What has IFC done so far in the country & sector?

Source: IFC’s Strategic Directions Paper, Sector Strategy, and your regional & industry economists

The Role of Commercial Financiers

Shared Roles

IFC’s Additionality: Unique to IFC 1. Is our money really needed?

2. What risks are we willing to take that others are not?

3. What services are we providing that others are not?

World Bank Group Strategy

1. What is the strategy for the country/sector?

2. What has the WBG done so far in the country/ sector?

Source: WBG Country Assistance Strategy (CAS) and past and present World Bank projects.

RESULT: STRONGER DEVELOPMENT IMPACT 1. Provide the overall development impact and expected outcomes.

2. Select a set of development impact indicators to measure the project’s impact on stakeholders.

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Lesson 3: Scale up sensibly. Don’t rush to expand; waiting for the right conditions will mean money will be better spent and the project is better placed for success.

“A mediocre idea that generates enthusiasm will go further than a great idea that inspires no one.”

- Mary Kay Ash

portunities facing this market in the areas of regulation, new market opportunities, work with service providers and equipment manufacturers, and our development partners. As a result we are now in a much better position to allocate the Global Environment Facility funds to the most appropriate objectives, and we are much more confident that we know the best ways we can reach those objectives.

Given the encouraging start this program has made, the commitment our clients have demonstrated, the growing awareness of the potential for sustainable energy finance, and the need for greater and wider market awareness raising, IFC is now in the right position to, and is working to, design a second phase of this project that will be funded by the Global Environment Facility funds mentioned above. The second phase is likely to cover the following areas: expanded work with current and new partners; work in the policy and regulation space; and However, based on a strict implementation of IFC’s ad- work with relevant stakeholders to support the country’s visory services pricing policy and an honest assessment of renewable energy development, with particular focus on the realistic opportunities for meaningful IFC interven- policies and conditions effecting investment in this area. tion, at the appropriate time to write the project design This moment is opportune because of the imminent pasdocument, we could not justify using that sum efficiently. sage of a renewable energy bill in the Philippine ConAs a result, IFC’s Private Enterprise Parternship (PEP) gress. office in the Philippines, having invested some considerable time and money in developing the project, decided to finance the initial engagement from core funds of PEP About the Author Philippines rather than access the larger Global EnvironWilliam Beloe is a Sustainability Program ment Facility grant. This allowed us to develop an appropriate intervention for the current state of the market Manager at IFC in the Philippines Office. and its current readiness for the opportunities available.

Another valuable piece of work that IFC’s Environment and Social Development Department completed at an early stage was to engage the Global Environment Facility (GEF).1 As a result, the GEF earmarked a significant grant for the proposed SEF engagement in the Philippines. This included US$5 million in funds both for advisory services and the introduction of suitable financial products into the market to catalyze the growth of sustainable energy financing.

Having spent the last six months working with our partner financial institutions, we now have a firmer grasp of the potential for financial institutions to engage in the field of sustainable energy. Both financial institutions now have healthy pipelines, with a combined value of over US$50 million and with US$25 million in loans already approved. Both are now interested in investigating additional areas under their SEF programs. Further, other financial institutions are beginning to show interest. And through our work over the last 18 months, IFC has a much firmer grasp of the other challenges and op-

Published in August 2008.

________________ 1 GEF is the largest funder of renewable energy in the developing

world, supporting solar, wind, and other clean forms of energy. It is a joint venture of the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP), and the World Bank.

SmartLessons 7

My, How You Have Grown! The First Large-Scale Energy Efficiency Mainstream Investment Through A Financial Intermediary Judit Braxatoris The main challenge to energy efficiency finance is that business volumes are typically too small to be considered mainstream business for IFC. The vast majority of energy efficiency projects are under $5 million, making them ineligible for project financing because IFC is not equipped to efficiently handle numerous small-size projects. A more commercially viable approach for IFC is to wholesale energy efficiency financing through its partner financial intermediaries, allowing economies of scale while scaling up a new product. However, this method requires the participation of an institution that can help create a critical mass of investment demand.

Project Background

the Company – won the national concession to develop and implement the program to renovate all participating The energy efficiency project in Hungary (the project) schools through competitive tender. entails an IFC investment of up to US$125 million in a risk-sharing facility with a local Hungarian bank (the The SF Program supports renovations such as updatBank) to support up to US$250 million local currency ing lighting to required national standards, and modern equivalent in energy efficiency improvement loans for heating systems. The bulk of the schools that will bensub-sovereign educational institutions in Hungary. The efit are expected to be smaller, rural schools, many of project is also co-funded by a grant of US$2.5 million which have not had capital improvements for decades. from the Global Environment Facility (GEF) to cover (The photo below shows a local school after a lighting subordinated risk obligations.1 Additional GEF support reconstruction improvement.) are also available for advisory services.

The US$250 million loan facility is extended to a private energy services company (the Company) that will implement energy efficiency projects primarily for municipal educational institutions. The Company will receive lease payments from the participating sub-sovereign educational institutions over the life of the improvements. Therefore, IFC is taking the credit exposure of the participating sub-sovereign institutions. The project is implemented as part of the Hungarian Government’s “Szemunk Fenye Program” (SF Program, literally translated into English as shining eyes of children), which is a large-scale educational facilities renovation finance program to be implemented through a public-private partnership and financed on the basis of energy savings. The project sponsors – a consortium led by the Bank and ________________ GEF is the largest funder of renewable energy in the developing

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world, supporting solar, wind, and other clean forms of energy. It is a joint venture of the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP), and the World Bank.

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Neighboring countries, as well as regional energy efficiency finance sponsors, are keenly watching the pioneering SF Program for potential replication possibilities in other countries in the region, with IFC as the partner of choice.

The project was completed in a joint venture between two teams of IFC comprising of Subnational Finance and the Financial Markets departments.

Rocky Start—Challenges Approach

to

the

Retail nities for the team to establish solid relationships with

The project is the first energy efficiency transaction to receive widespread recognition within IFC. It leverages years of experience in energy efficiency finance product development and testing under the Commercializing Energy Efficiency Finance (CEEF) partial guarantee program. Funded by IFC and GEF, the CEEF program was created to stimulate commercial energy efficiency finance through financial intermediaries, and had teams on the ground in six Central and Eastern European countries.

The initial characteristics of the guarantee product and the program procedures caused some frustration. Originally, the energy efficiency guarantee product provided little flexibility, and consequently, IFC could not adjust the pricing of the guarantee to prevailing market conditions. In addition, the pari passu structure was not necessarily the best financial product for energy efficiency finance support. The maximum guarantee size occasionally proved to be too low, and the guarantee maturity was limited to seven years versus the common 10-12–year payback period in this industry. The small size of the typical guarantee facility, i.e. €4-5 million per bank, resulted in high transaction costs. Finally, the long guarantee approval processes and laborious legal documentation under the program made business development even more challenging.

Following extensive internal debate, key program and product features were aligned with market demand, resulting in a more streamlined approval, delegated authority, larger guarantee sizes, lower fees in some countries, and the introduction of a portfolio guarantee product, all of which contributed to a significant increase in investment volume. With a more refined product to market, the program team also began to aggressively pursue a wholesale approach to the energy efficiency program, together with key local banks and energy services companies, as in the transaction discussed here.

How did the team identify and close the transaction?

Lesson 1: Intensive advisory services and good client management build the road to booking a sustainable finance deal.

project developers, equipment vendors, nonprofit and nongovernmental organizations, and, most important, partner financial intemediaries. Engaging any financial intemediary to work with IFC in energy efficiency finance takes time and effort, but we discovered that it is much easier when they are already IFC clients. IFC is aware of its portfolio banks’ strategies, clientele, market positioning, and competitive advantages. In turn, these clients appreciate IFC’s potential value-added role in sustainable energy finance. Advisory services offered to financial intemediaries under this program typically included strategy development, staff training, marketing support, product development, and project support.

This work helped to establish IFC’s good reputation in the region as a sustainable energy financier, and was one of the reasons the Bank was interested in partnering with IFC on such a large-scale project.

Lesson 2: Creative investment structure and persistent negotiation may increase the investment size – even by 50 times (USD2.5 million –› USD125 million).

The Bank began its partnership with IFC in 2001, when it joined the partial guarantee program. From 2001 to 2006, IFC provided 16 partial guarantees for energy efficiency street-lighting projects through the Bank, using a third-party finance structure.

In 2004, the CEEF Hungary team developed a financial structure together with the Bank to support a company involved in energy efficiency reconstruction projects for municipal institutions, but IFC was not requested to provide a guarantee for any of the loan transactions.

IFC’s participation proved to be redundant at this stage, because the company implemented energy efficiency investments mainly for larger and financially stronger municipalities. Then in 2006, the government launched the SF Program, a public-private partnership. This finally provided room for IFC to engage, and negotiations between the Bank-Company led consortium and the program team began. At this point, because the scale of the proposed SF Program exceeded the limits of the CEEF facility framework, colleagues from IFC’s headquarters were asked to join the discussions.

The Structure: Getting the client interested in a signed agreement was not easy. Initially, the Bank intended to CEEF provided extensive advisory services to financial absorb the risk of the weaker and smaller municipalities intemediaries in the region, and they led to opportu- with IFC, while not requesting any IFC coverage for the SmartLessons 9

stronger ones. This was because the Bank was hesitant to lend to lower-rated local governments, since it did not have a track record in this type of credit risk and there were no historical data available in the market to estimate the probability of default. While IFC was willing to take a subordinate role in the financing structure if there was a similar commitment from the consortium’s side, IFC opposed the Bank’s “cherry-picking” approach.

been a deal breaker. Nevertheless, creativity, innovation, and belief in the transaction helped the team overcome this obstacle.

Fees: The consortium-led project finance approach limited the available front-end cash flows and could not support standard IFC front-end fees typically associated with a US$125 million local currency equivalent RiskSharing Facility during the project ramp-up stage. In response, the IFC team worked with the consortium to develop a structure that accommodates the consortium’s constraints and yet compensates IFC for “forgone” fees during the project’s later years – safeguarded with cancellation penalties. As a result, the project did not waive the standard fees, but instead adjusted the fee timing.

IFC was at the same time moving closer to committing a US$2.5 million first-loss fund, with two conditions: that (i) IFC provide risk sharing for the entire portfolio (not restricted to poorer credits) – basically tripling the originally offered portfolio size and (ii) the two parties develop an acceptable structure for sharing the firstloss position. The Bank’s desire was to benefit from the CEEF guarantee product, which included a first-loss To ensure IFC’s front-end costs are adequately compenpool to cover the expected losses of the future portfolio sated over the project life, the consortium also agreed to of the company. provide IFC with a somewhat larger guarantee fee than originally contemplated based on credit requirements.

In a multi-step dialogue, the Bank and IFC agreed to a mutually satisfactory mechanism to share the first loss- On the other hand, to provide some financial stimulus es. The IFC-GEF subordinated pool was protected by to the consortium, IFC offered the Bank a performanceliquidity reserve accounts that were ensured by the end- based pricing structure. The guarantee fee is proposed to user sub-sovereigns. Should any loss occur in the portfo- have a reduction mechanism based on the achievement lio, two further subordinated tranches would precede the of both portfolio volume and underlying good portfolio utilization of the IFC senior pari passu guarantee. performance.

In the resulting transaction structure, the Company is the borrower of the entire US$250 million credit line from the Bank. To address concerns about its large exposure to a single borrower, the Bank agreed to an IFC pari passu risk-sharing facility, resulting in an IFC investment of up to US$125 million.

Leveraging the GEF funds in this case was an essential tool to scaling up commercially sustainable energy efficiency financing, with the subsidized element in the financial structure representing only 1 percent of the expected total project volume.

Positive or negative performance fees were applied in almost all other energy efficiency finance-related investments within IFC’s Global Financial Markets subsequent to this transaction, and they have proven to be a very successful sales strategy.

Results to Date

In 2007, the first of five investment years, utilization was lower than expected. However, as of May 2008, US$ 58 million was disbursed for approximately 200 projects.

Up to now, lighting reconstruction loans have dominated the portfolio; these are typically smaller size investments, Lesson 3: Performance-based pricing/lower margins whereas heating upgrades tend to involve larger transacwill be the stimulus in selling energy efficiency fi- tions. This partially explains the initial underutilization.

Another reason for the slower ramp-up is the expectation nance. of numerous market participants of European Union Applying IFC’s pricing guidelines in a growing num- (EU) grant inflows. Several of the Company’s pipeline ber of emerging markets has been a challenge. High projects are temporarily on hold, anticipating EU supfees, including a guarantee fee, almost depleted the port.

Bank’s margin. The pricing impediment could have 10 SmartLessons

Conclusion This SmartLesson has focused on the efforts and business activities of the project team, and not on the favor- able market-enabling environment that resulted from the role of the Hungarian government – i.e., in this case, the large-scale centralized public tender was the backbone and inevitable prerequisite of the project’s success. However, the team believes that this approach may be repli- cated without the state’s intervention (potentially on a smaller scale) if sufficient investment demand is created by one or more energy service companies and/or other private sector players.

About the Author Judit Braxatoris was a Program Officer with IFC’s Commercializing Energy Efficiency Finance program in Hungary.

Published in April 2008.

SmartLessons 11

Turning Project Delays into Opportunity: Renewable Energy Financing in Peru Alberto Didoni As part of its effort to promote climate change initiatives, IFC aims to offer a new set of financial products to its clients.

Promising initiatives are being developed in the areas of energy efficiency, renewable energy, biodiversity, cleaner technologies, and carbon finance, among others. Despite all the positives that come with this effort, proposing a new financial product to an existing client is a delicate matter, and if not done properly, it can worsen the working relationship with the client. This SmartLesson shows the importance of allowing for some flexibility in designing both the financial criteria and the advisory services package of an innovative project to mitigate some of those relationship risks.

Background

vestment closing and the start date for the consultants.

Once they had been selected, it took the consultants anIFC recently disbursed a US$30 million loan for energy other three months to complete the initial market asefficiency to BBVA Continental, the second largest com- sessment to identify promising clients and partners (i.e., mercial bank in Peru. The line was originally conceived vendors, energy services and consulting companies, etc.). for two main purposes: i) to boost the productivity of The bank was therefore sitting on the IFC loan for sevlocal SMEs by increasing the efficiency of their opera- eral months without really having the possibility to kicktions through reducing energy costs (and consequently start the promotional and disbursement phases of the reducing CO2 emissions) and ii) supporting Peruvian project.

Micro, Small and Medium Enterprises’ efforts to convert to natural gas, which is less polluting and more efficient than traditional power sources.

Given BBVA’s relative inexperience in energy efficiency financing, IFC’s investment and advisory services groups teamed up to support the transaction by providing BBVA with a package of advisory services, including an Upstream Generator initial market assessment and training for loan officers.

To maximize knowledge transfer, an external consulting firm was hired to work for over a year with the financial Pressured by top management to move forward, and waiting for the consultants to complete the market institution to develop this new line of business. assessment, BBVA officials asked IFC whether the criteria of the line could be adjusted to include renewable Why wait? energy investments. A promising financing opportunity The project experienced some initial difficulties, mainly – a run-of-the-river hydroelectric plant in the southern due to a delay in hiring the consulting firm. This was due part of Peru – had in fact emerged, but the bank was ill to the strong focus on closing the investment transac- prepared to assess the technical, social, and environmention which happened just before the Christmas holiday tal aspects of the operation. While hydropower plant season in Peru. By the time all parties were ready to financing is a rewarding business, it can also be challengfocus on the advisory services program, two months had ing, even for strong commercial banks with established passed. The IFC procurement process added another risk assessment systems. Thus, in addition to the criteria two months, resulting in a four-month gap between in- adjustment, the bank sought guidance from IFC on how to assess those major risks.

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BBVA officials – both the environmental expert and the credit officers – stayed involved through all the phases of the selection process for the consulting firm. They collaborated with the IFC advisory service team in: i) To meet the client’s needs, IFC decided to support the drafting the terms of reference for the assignment, ii) sebank’s request by including renewable energy investments lecting the appropriate consulting firm, and iii) holding in the line and devoting some resources of the advisory final talks to fine-tune the methodology and the bank’s services package to build BBVA’s capacity to analyze the requirements before carrying out the assignment. As a risks. The decision was made to develop a knowledge result, both parties were satisfied. The client put more transfer process, with the purpose of building the bank’s weight on the evaluation of the technical risks of the operation. Meanwhile, IFC’s main goal of executing correct capacity to undertake future assessments on its own. evaluation of the social and environmental aspects of the BBVA officials were under pressure to start disbursing deal was fulfilled. the credit line, but concepts such as energy efficiency financing take time to be fully absorbed by financial insti- Despite its firm commitment to comply with internatutions. Allowing the bank to include renewable energy tionally recognized environmental standards, the client investments in the IFC sustainable credit line and redi- had only recently started to move toward implementing recting part of the advisory services resources to evaluate an official environmental policy. In particular, it only had the deal allowed IFC to: i) build upon existing opportu- one environmental expert to look over the entire portfonities to satisfy the client’s needs, ii) alleviate the pressure lio of the bank. It had been therefore crucial to involve from BBVA top management for immediate disburse- key personnel of the client through the whole process in ment; and iii) allow more time to absorb the core con- order to guarantee a successful knowledge transfer. cepts of energy efficiency financing.

Lesson 1: Leaving some room for flexibility on IFC new financial products is key to meeting the needs of the client.

The criteria for defining energy efficiency investments were somewhat flexible and allowed IFC to interpret them to include renewable energy investments without going through a legal waiver. Moreover, the advisory services component of the project allowed for some flexibility in the use of the financial resources. Provided that additionality could be demonstrated, the use of the resources was made very flexible, thus making it possible for the advisory services team to hire the consultants in only three weeks, the time limit required by the client to close the financial transaction.

Lesson 2: Including key personnel of the client is crucial for the knowledge transfer process.

Consultants were selected to show BBVA how to validate the feasibility studies prepared by the client (owner of the hydro-plant). The focus of the assignment currently underway is to examine technical, social, and environmental aspects of the proposed hydro-plant and to check their compliance with local environmental and social requirements as well as IFC’s Performance Standards and Environmental, Health and Safety (IFC EHS) guidelines.

Compliance with the latter is requested, given that, if approved, the investment will be partly financed through the IFC credit line.

Micro-hydro-installation

Lesson 3: Advisory services are necessary when introducing innovative financial products such as renewable energy financing and energy efficiency.

Both renewable energy and energy efficiency financing are innovative financial products, and financial intermediaries do not necessarily possess the in-house expertise for a rapid disbursement of funds. In over-collateralized environments such as Peru, financing modalities based upon a future stream of cash flows or future energy savings are not necessarily easy to implement. A good package of advisory services is therefore necessary to assure the client’s uptake and mitigate the risks of loan repayment.

SmartLessons 13

IFC has long-standing expertise in financing hydroplants with its own financial resources. It is therefore prepared to evaluate the risks of those deals such as labor and working conditions, community health, safety and security, land acquisition, biodiversity, etc. Meeting BBVA’s need represented an interesting opportunity for IFC to provide a very basic, project-specific set of guidelines to the client for it to conduct its own environmen- tal and social due diligence. It is a clear example of how IFC is uniquely positioned to provide tailored advisory services to clients by leveraging its expertise in such innovative fields.

14 SmartLessons

About the Author Alberto Didoni is an Operations Officer with IFC’s Advisory Services Office for Latin America and Caribbean region, and is located in Peru.

Published in October 2007.

From Free to Fee - Charging for Advice While Introducing an Innovative Financial Product Yana Gorbatenko When IFC announced the introduction of a new pricing policy for advisory services, the initial reaction of IFC’s Russia Sustainable Energy Finance Program (RSEFP or the Program) was that the market was not ready yet, and that such a move would make the program less attractive for potential clients. Energy efficiency was struggling as a mainstream finance concept in Russia, and RSEFP was offering training and support to client banks free of charge in the hope of encouraging uptake. It was unclear how to migrate these relationships to a fee-paying basis or what the consequences of doing so would be. IFC investment officers suspected that pricing would increase the overall cost to clients and consequently make the energy effficiency product less attractive. Besides, the European Bank for Reconstruction and Development (EBRD) was offering advisory services for energy efficiency finance free of charge. In short, few people considered this to be a smart idea.

Initial reaction “Energy efficiency is a public good, and IFC should not charge for it.”

“A bank incurs its own costs to develop sustainable energy finance product; we should not have an extra charge.”

Investment Officers, IFC’s Global Financial Markets Department “It’s the first time I’ve seen an international organization asking us to pay for technical assistance.”

In the process, the project team learned a number of lessons that may be useful to other programs considering charging for innovative products in advisory services but are unsure of the process or the implications of doing so.

The themes of our takeaways are (a) forming and positioning the advisory package; (b) leveraging relationships with the clients’ top managers; and (c) setting a reasonable price level.

Lesson 1: The advisory package should take into account the challenges imposed by innovation.

Early in the program, our approach to working with financial institutions consisted of introductory training “IFC should pay us to develop those products that you on energy efficiency finance and project assessments for want.”

Partner Banks banks and their clients. The training often created initial interest among credit officers, but that excitement quickly dissipated under the pressure of their daily routine.

Nonetheless, in early 2007 the Program committed to Credit officers rarely asked the program for follow-up implement the pricing policy. Far from being a barrier consultations, and showed little enthusiasm to originate to development, pricing helped catalyze RSEFP. Results specific energy efficiency loans. were better than anyone might have hoped. The team professionalized the advisory offering and built strategic We recognized the need to change the way we work relationships with top management in the client banks. approximately at the same time that IFC introduced Over the following 12 months, six financial institutions its pricing policy. We realized that three success facsigned advisory service agreements and cumulatively tors for energy efficiency finance are: (a) signals from committed US$175,000 in cash contributions. As a re- the top managers to staff that energy efficiency fisult, the RSEFP team is delivering on its commitment to nance is important; (b) the right context and incenhelp clients grow their energy efficiency lending portfoli- tives for credit officers; and (c) the confidence of credos. The program is on track to meet the collective target it officers that can only come from the experience of of US$60 million of energy efficiency lending in FY08.

SmartLessons 15

closing actual deals.1 Our initial experience of working with financial institutions taught us the importance of realistic time tables. It takes at least six to nine months (longer if a bank has a lengthy internal approval process) to develop the bank’s product, train credit officers, help them generate a good pipeline, and convert it to volume.

The team designed a clear client engagement plan, with the deliverables and triggers for payments. Our advisory services package was based around a 12-month engagement combining product development (internal documents, targets, incentives, internal communication), training, and client engagement support activities (working with industrial enterprises on energy efficiency). All outputs were quantifiable and structured on a realistic time table. In short, we packaged a change management product ready for a price tag.

Box 1. From advisory menu to advisory package:

One bank might view energy efficiency as an opportunity to enter a new market segment.

Another might see the opportunity to provide valueadded services to existing clients. A third might seek to enhance its reputation for sustainability or to differentiate itself from its competitors.

At the same time, in the contract we clearly spell out advisory work plan, specific deliverables, and triggers for payments. For example, in the advisory agreement we make a commitment to conduct three seminars for credit officers, support the bank’s staff in up to 100 site visits to potential borrowers, help to write up to five success stories, grant rights to use the Energy Efficiency Calculator developed by IFC, etc. When you combine upside potential with straightforward deliverables, the client is able to see clear value for money.

Lesson 3: Position advice as product with a standalone value that is no longer available for free.

Banks tend to add up all IFC fees. If you were to take this approach, the advisory  Introductory workshop for core group  Product description and procedures fee of US$40,000-50,000 frequently • Introductory training  Internal communications translates into 20-25 basis points on top  Promotion materials • Seminars for borrowers (upon request)  Credit officer training • Transaction support (upon request) of the agreed cost of funding, making  Seminars for borrowers  Transaction support IFC less competitive on price. MoreLegend: over, energy efficiency credit lines can  Modified be perceived as less attractive even com Added pared with other IFC-funded products.2 Even though we make the pitch to the banks jointly with our investment colLesson 2: Pitch the business case, and contract clear de- leagues, positioning advisory service as a distinct service liverables. with a separate contractual relationship is crucial. The fact that we have two client financial institutions that Pricing moves the IFC pitch from one of potential only pay for advice and don’t have IFC credit lines proves subsidy to one of potential cost. In persuading banks our case for stand-alone value of advisory services. It is to pay for IFC services, it wasn’t enough to talk about also important for the investment client to have an opthe development need. Clear commercial benefits had portunity to say no to our advisory proposal and choose to be demonstrated. This meant we had to understand other options. the commercial motivation for our clients to introduce an energy efficiency finance product, and how this Even though every single client was shocked by the remight differ by institution. How would this product quirement to pay, when we explained that it’s a recently improve their bottom line or build their customer base? established IFC policy and we cannot provide our ser________________ vices for free, this was accepted. We managed to estab1 For more information on this, see SmartLesson “Adaptation for lish four new relationships and transfer two client banks Adoption: Mainstreaming Energy Efficiency in Financial Institu________________ Initial advisory menu

Advisory package (for fee-based contract)

tions” by Miles Stump on page 26.

16 SmartLessons

Credit lines to banks are either tied to energy efficiency lending or have multiple purposes, but achievement of volume in EE lending is incentivized by a small step-down of 20-25 basis points. The stepdown is granted when a bank achieves the agreed volume.

2

from working for free to fee-based cooperation.

reports, surveys, awareness raising initiatives, and work on public policy.

Lesson 4: Use agreement to leverage top managers’ commitment throughout the relationship.

The Program fees for an advisory package delivered during the 12-month period range from $20,000 for smaller regional banks to $40,000-50,000 for banks with larger networks. We found that banks compare the advisory fee with the additional volume they need to generate to offset this cost, and if they see that the volume is realistic, they are ready to pay. The rule of thumb from our experience is that the advisory fee should not exceed 25-30 basis points of the volume the bank plans to achieve in the first 12-18 months of operation.

When we approach a new client we do not proceed unless we secure top management’s commitment to develop the product. The Chief Executive Officer (CEO) of the bank should agree to sign the advisory services agreement and pay the fee, as well as contribute resources, staff time, and in some cases his personal time to explore this new business opportunity. This expectation should be very clearly conveyed during negotiations.

Box 2. Actual IFC advisory costs with one client: Once the CEO makes his/her decision on IFC’s proposition, she or he is committed to it, and you have an open No. of Total costs, channel to the top throughout the engagement. Our Type of Activity activities including delivered travel team members brief client CEOs regularly on progress Introductory workshop 1 US$450 and raise any significant issues regarding implementation. The IFC team has an objective view on how well Front office training (8 hours) 4 US$7,900 adoption of the product is going within a bank and is Debriefing for branches (2-hours) 5 US $1,500 able to provide this feedback directly to top manageSeminars for borrowers 2 US $1,800 ment. For example, we frequently see that credit officers are not interested in developing the new product.

Joint visits to clients and other deal support 170 hours US $10,500 The fact that the bank is paying a fee is not important TOTAL to them, because they see no personal incentive. We US $22,150 (These results were achieved 7 months down the road out of 12 months) need the CEO and other high-level managers to consistently communicate that energy efficiency lending is important to the bank, and to reinforce this message by Advisory fees can increase as the market grows and more recognizing top performers. Continuous commitment of financial institutions enter the segment. It is much easier the CEO makes a big difference. to prove that volume targets are achievable when there is an established track record by other financial instituLesson 5: Price is driven by client cost-benefit tions. For the next round of clients we are aiming for at calculation. least full IFC direct cost recovery and are considering charging market rates. This would send a clear quality One of the most difficult questions we had to answer message that IFC advisory services create added value for while introducing pricing was, “How much should we business. charge?” Even though the Private Enterprise Partnership (PEP) program had already been charging for advice in It’s worth noting that the perception of pricing by investcorporate governance and other mature products, IFC ment officers and partner banks evolved as well. had no precedent in pricing for energy efficiency advice.

As energy efficiency is a relatively new topic in Russia, we recognized the market demonstration effect of the program. We thought it fair to ask banks to pay 50 percent of direct IFC costs through cash contributions. In addition, each client bank committed staff time and paid for advertising materials and promotional events. IFC covered all costs related to public good activities: market

Conclusion

Experience in the Russia Sustainable Energy Finance Program demonstrates that it is possible to charge advisory fees even when introducing an innovative product with a high development impact. The success factors are: (a) advisory package valuable to clients; (b) reasonable price; and (c) strong relationship with top managers. The team SmartLessons 17

made a focused effort and in less than a year we closed six Pricing forced us to raise our game, and it turned out advisory contracts with cumulative cash contributions of to be the best thing that happened to the Program.

US$175,000.

Charging and closing an advisory services agreement is just the first step in cooperation. The bigger challenges Current feedback on pricing strategy emerge when you start work with the client to promote real changes in operational thinking. “$40,000 is nothing for a top-20 bank in Russia; you should charge at least $100,000; anything less than that is dumping.”

About the Author IFC’s Global Financial Markets Department Yana Gorbatenko is a Deputy Program Manager working with the Russia Sustainable En“For all the work you are doing for us, we are not ergy Finance Program at IFC Advisory Services paying you very much, are we?” in Eastern Europe and Central Asia, and is located in Russia.

Partner Bank

Published in May 2008.

18 SmartLessons

Lending to a “Different Animal”: Energy Efficiency Renovation of Multi-Family Housing Buildings in Hungary Tibor Kludovacz Commercializing Energy Efficiency Finance (CEEF) is a regional partial credit guarantee program co-funded by IFC. The program has issued guarantees for €93 million in commercial loans for energy efficiency transactions across multiple sectors. The Global Environment Facility (GEF), the largest funder of renewable energy in the developing world, is active in Hungary, the Czech Republic, Slovakia, Latvia, and Lithuania. A substantial part of this portfolio is committed to a multi-family housing renovation program with a Hungarian Bank (the Bank) under which more than 500 small block house renovations have been completed since February 2006. To date, no defaults have been recorded.

What is meant by a “block house”?

expenses among the tenants, and their budgets balance out to zero by the end of each year. No profits, no savBlock houses are multi-family housing buildings located ings, one bank account, and no real financial records. mostly in urban areas across Eastern Europe and the former Soviet states. In Hungary, a large portion of these buildings (more than 20 percent of the total housing stock) was constructed in the 1970s and 1980s using panel technologies that are by today’s standards outdated and in need of renovation. Inefficient energy use in an environment of escalating energy prices places a huge burden on the population in these buildings.

Block Houses in Hungary

Since home ownership is predominant in the region, most of these buildings are owned by the people who live in them. In Hungary particularly, apartments are owned by tenants, and common areas of the buildings, such as the staircase, elevators, front portal, gardens, energy systems, etc., are commonly owned by the community of tenants.

The Bank and IFC have spent a considerable amount of time and effort developing a viable business model to address the needs of these block houses, and the most important lesson learned is that the block house is a “different animal” when it comes to lending, so you need a Lack of collateral: Block houses manage the expenses respecial approach to do it. lated to the common assets, but ownership belongs to the community of tenants. Normally, there are no finanWhat is meant by a “different animal”? cial buffers or assignable assets in the system that banks Different purpose: Block houses are not profit driven, and could get access to. Designing a financial scheme with they lack financial sophistication. They exist simply to recourse to tenants is not an option, since by lending at manage the expenses related to the maintenance of assets the tenants’ level instead of at the condominium level, commonly owned by the tenants. They distribute these banks would lose scale and have to deal with a credit SmartLessons 19

Hungary, tenants of apartment buildings are obliged by law to contribute financially on a monthly basis (“common cost payments”) just by the fact that they own propA problematic decision-making process: Each decision, es- erty in the building. The regulator even determines the pecially ones relating to entering into a long-term loan minimal level of these contributions. And housing asagreement, requires the consensus of many people. This sociations have a powerful tool in their hands to enforce is difficult and lengthy to arrive at. Furthermore, there is payments: they have the right to originate a mortgage on a serious mismatch between the beneficiaries of the loan the property of nonpayers. (the individual tenants) and the entity that is responsible Loans to housing associations are non-recourse to tenfor repaying the loan (the block house). ants in Hungary. Therefore, it is the association that is Lack of financial skills: Block houses tend to have one accountable to the bank. The bank does not have the employee only – usually a tenant who has some free time right to go after the tenants if there is a default. As a but no specific financial skills as such. The banks need to result, it is the association’s responsibility to collect from find a new language to communicate with these clients. tenants, and its right to exercise a mortgage ensures a strong common cost payment discipline.

Lesson 1: Existence of a Few Enabling Factors Demand: One of the key drivers of the market is the deAggregator with a legal format: Tenants of the building mand from tenants. In Hungary almost 70 percent of the must form some kind of legal entity that gets its man- apartment buildings were built 30 to 50 years previously, date from them and acts on their behalf. This aggregator back in the Soviet era, and they contain old-fashioned, needs to have a legal format, and its operations need to inefficient technology. The increasing cost of energy is be subject to enforceable regulations so that banks can drawing attention to energy efficiency, and energy benlend to them. Without the aggregator, banks can only efits are maximized if tenants act as a community and lend to the individual tenants, but that’s not block house address the whole building envelope. Furthermore, by lending. In Hungary, tenants of multi-apartment build- renovating the buildings, not only do the tenants benefit ings are required by law to form legal entities called from better insulation and more cost-efficient energy use, “housing associations” for the management of the com- but the value of their property increases and the quality monly owned assets of the building. This regulation is of their living environment improves. quite common in many other countries as well. Housing associations are similar to private companies in the sense Availability of technical solutions locally: A wide range of that they can enter into all sorts of agreements and can relatively cheap and simple technology should be available locally, from building envelope insulation upgrades be taken to court if they do not meet their obligations. (including window replacement) to internal renovation The aggregator concept also works in markets where reg- of the heat distribution network (heat exchangers, pipes, ulation similar to the Hungarian model does not exist. radiators, etc.) and installation of heat regulation and The aggregator can simply be established by the volun- metering devices to allow tenants to manage their contary action of the tenants, or it could be a utility or any sumption. Existence of well-supplied and qualified loother company that has a billing relationship with the cal contractors is also a must for low-cost, high-quality services. tenants. review of a much larger number of individual households.

In countries where the enabling environment is absent, Lesson 2: Creative Financial Structuring however, advisory services can help the governments deCash-flow based lending: A lending scheme was implevelop the favorable legal framework. mented that required the association to put in place a Periodic contributions from tenants to the aggregator: There valid decision of the assembly of tenants to increase their must be a financial link between the tenants and the ag- monthly common cost payment obligation to a level gregator to ensure that tenants are funding the opera- where on aggregate they cover the monthly installments tions of the aggregator. The aggregator must also have of the loan. This is then assigned and channeled through leverage to enforce payment of such contributions. In the bank on a monthly basis for debt service.

20 SmartLessons

IFC guarantees for collateral: To address the lack of collateral, IFC guarantees were added to the equation. IFC’s product was designed along the principle of making sure that the bank’s and IFC’s interests were aligned and each party was comfortable with the risks taken. Apart from the IFC guarantee, the only collateral the bank has is a drawing right on the account(s) of the block house.

This solution is not ideal, as there will always be a tradeoff between the quality of the audits and streamlining.

This is quite typical for the retail type of energy efficiency programs. The better the audits, the more they slow down projects or even exclude block houses unable to bear the costs. The goal is always to find the right balance of making sure that what we call energy efficiency really is energy efficiency, without overburdening the deal with additional transaction costs.

Application of available grant programs: Being a key social issue, the housing sector will always attract government attention. This usually translates into various types of Lesson 4: Creative Marketing support programs. Incorporating these into the financing One of the most important factors in developing block scheme opens the door to a larger number of clients. house lending into a mainstream business line was the The Hungarian market has many such programs which local Hungarian Bank’s creativity in designing and imwere integrated into the block house program. While plementing marketing programs. some features of state grants that complemented the investment structure of the program played a significant Educate your clients: The bank has been conducting sevrole in the expansion of the portfolio, their availability is eral types of workshops, seminars, road shows, and clinot a precondition to requiring similar facilities. As long ent events in all major cities of the country. The events as they are available, clients will always want to use them, are aimed at not only distributing information about but the structure is still viable without them. CEEF pro- the product but also educating housing representatives gram has done many projects with grants incorporated about basic financials, explaining to them how to apply, but also many without any, thus illustrating that the fi- what documentation is needed, how to manage the loan during the tenure, etc. IFC has continuously supported nancing scheme can be applied without subsidies. this effort by participating in the events and providing financial support from CEEF’s advisory services budget Lesson 3: Standardization for them.

Streamlining procedures: When lending involves a large number of tiny yet similar transactions, the natural Word spreads like wildfire: Another quite unexpected aidchoice is to standardize and streamline your operations ing factor has been the high visibility of the renovated as much as you can. The Bank developed low transac- buildings. Word on the availability of financing spread tion cost procedures based on simple checklists and pre- like wildfire among tenants when they saw the renovated determined boundary conditions. All transactions that buildings in their areas. meet the eligibility criteria make it into the portfolio automatically. IFC’s guarantee product was designed to meet the same requirements. Underwriting is based on About the Author pre-arranged criteria and is fully delegated to the bank.

Tibor Kludovacz is a Program Officer working with IFC’s Energy Efficiency Group and is Monitoring energy savings: When it comes to energy efficient products, there must be a system in place to delocated in Hungary. termine if the loan is financing energy efficiency or not.

Such information could have considerable marketing

value. However, many banks carrying energy efficiency Published in May 2008. products face challenges when it comes to monitoring energy saving due to lack of internal capacity to do so.

Subcontracting is time consuming and cost-intensive and contradicts the concept of standardization. In response, the Bank requires that the block houses attach an energy audit to their credit application.

SmartLessons 21

Lessons in Promoting Energy Efficiency Eluma P. Obibuaku Over the past ten years, IFC’s Environment and Social Development Department has initiated a number of energy efficiency programs in emerging markets designed to promote local financing of energy efficiency projects and to reduce greenhouse gas emissions and consumption of energy. These projects accomplish their objectives by stimulating demand for energy efficient products and services in markets that show a potential for energy efficiency uptake. This SmartLesson discusses IFC’s experience with three distinct but related energy efficiency initiatives, the last of which is currently under implementation, and is intended for IFC staff developing projects in various business lines and regions - especially those working on energy efficiency projects.

Background The following paragraphs summarize the structure, results, and lessons learned from various IFC programs such as the Hungary Energy Efficiency Co-financing Program (HEECP), the Hungary Energy Efficiency Co-financing Program 2 (HEECP2), and the Commercializing Energy Efficiency Finance (CEEF) Program.

HEECP2 and CEEF were combined into a regional program which focuses on six countries: Hungary, Czech Republic, Slovakia, Lithuania, Latvia, and Estonia.

The goal of each of these programs is to promote and enhance commercial financing of energy efficiency projects by local banks and leasing companies, thereby

reducing greenhouse gas emissions. The project objectives are pursued through the provision of (1) financial products to local financial institutions that make loans for energy efficiency projects and (2) advisory services for capacity building to financial institutions, energy services companies, and project hosts. Figure 1 below shows interaction of IFC and Global Environment Facility (GEF) with financial institutions (guarantees and advisory services) as well as energy services companies and end-users. GEF is the largest funder of renewable energy in the developing world, supporting solar, wind, and other clean forms of energy. It is a joint venture of the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP), and the World Bank. Note: Advisory services is referred to as Technical Assistance, as formerly called, in Fig 1.

Figure 1.

IFC Program Structure

End User

IFC/GEF

Local Financial Institution ESCO

End User

IFC Services IFC provides the Local Financial Institution a Guarantee Facility Agreement

22 SmartLessons

IFC provides Technical Assistance to the Local Financial Institution, End User or ESCO

Although the focus of this paper is on advisory services, the results discussed below encompass both advisory services and investments (financing). The advisory services component is a necessary but nevertheless insufficient condition for success.

estimated ten year life of these efficiency improvements, they will generate more than 2 million tons of CO2 reductions.2 In spite of the successes recorded above, IFC’s energy efficiency experience has not been without implementation challenges. First, the projects have not been successful in every country of intervention—two of the five target countries for CEEF (six target countries, if we include Hungary) have yet to generate traction because of the characteristics of these markets. Second, each of the programs had difficulties tracking the level of energy efficiency transactions completed without IFC guarantees and the associated energy savings. Third, though the energy service companies and financial institutions interviewed indicated that the advisory services provided under HEECP1, HEECP2, and CEEF have been very valuable, an assessment of the effectiveness and efficiency of the advisory services is impossible because there is not sufficient information available on the actual results of many of the advisory services activities.

The advisory services provided through each project were designed to strengthen or build the capacity of financial institutions, energy end-users, and energy services companies. They assisted financial institutions in developing specialized financial products, helped end-users and energy efficiency companies build “bankable” energy efficiency projects, and developed institutional capacity in the Hungarian energy efficiency and financial services industry. They also provided support to end-users interested in conducting energy audits to help determine if energy efficiency would be a viable option. With regard to content, the advisory services often involve skilled personnel (either IFC staff or outside consultants) who provide support for market research, due diligence, investment appraisal, and training services.

Lessons Learned Services of the IFC Implementation Team Develop strategy for energy efficiency (EE) Assist in preparing/creating “bankable” projects Conduct market assessment and awareness raising Capacity building/training/external consultant engagement Monitoring legal, regulatory, and institutional environment to identify barriers to investment.

Recipients of Services Financial institutions Developers/Financial Institutions Individual EE investments ESCO/ Financial Institutions

Results Collectively, HEECP, HEECP2, and CEEF have directly influenced the operations of 14 financial institutions, two of which were nominees for the 2007 Financial Times Emerging Markets Sustainable Bank of the Year award. The programs have also resulted in the creation of several hundred energy efficiency projects and significant energy savings. The CEEF Program has generated energy savings of 1080 tera joules annually or dollar savings of US$30 million/year assuming $0.1/kwh in average electricity prices. The CEEF initiative has led to direct CO2 reductions of 52,800 tons per year. These guarantee projects are estimated to have led to the implementation of an additional 144 projects valued at US$79.6 million with CO2 reductions of 159,649 tons per year. Over the

Due to the evolution of IFC’s energy efficiency experience and the fact that the above three programs were implemented in sequence, the lessons that were generated in HEECP1 were built into HEECP2 and CEEF. Most of these lessons apply to almost any program within the World Bank Group. The following paragraphs will focus on the lessons from the advisory services components of these projects.

Necessary Conditions for Success:

There are certain conditions without which a favorable outcome for market-based energy efficiency initiatives is unlikely. First, the energy pricing should not be subsidy intensive, or where subsidies exist, they should be very selective. Energy subsidies tend to dull the incentive to use energy efficiently or conserve it. Second, project developers need to be active in these markets. They are the vehicle for identifying opportunities to improve efficiency in factories or homes, can be used to retrofit existing inefficient systems, and have access to equipment suppliers. Third, loan financing stimulates energy efficiency investments because, although energy efficiency improvements generally have short payback periods, consumers

SmartLessons 23

may not be able to afford the up-front costs of these systems. For this reason, high interest rates and unsophisticated financial intermediation will tend to hurt the growth of energy efficiency. Finally, economic sectors that are extremely energy intensive also tend to provide opportunities for energy efficiency improvements.

Tracking Advisory Services Results: Although an integral component of each program, the success of advisory services was not rigorously tracked.

The monitoring efforts were devoted to the overall goals of the project and the degree to which environmental benefits are achieved. To directly assess the impact of advisory services, appropriate tracking systems that capture the importance of these activities to the clients on the one hand and the outcome of the project on the other must be established. Where rigorous tracking is not implemented, the value of advisory services, which may be apparent to direct project participants, cannot be communicated to relevant stakeholders. Furthermore, since the advisory services efforts cannot be independently assessed, potential improvements in project design may be lost.

Building Flexibility into Advisory Activities: For advisory services that are expected to be administered over several years, it is valuable to build flexibility into the project structure. This allows for changes to the content of the program as market conditions change. In certain markets, IFC’s energy efficiency program was adjusted to take advantage of opportunities to market to Block House renovation initiatives, an unanticipated opportunity. In others, the program closed operations because deal flow was limited due, in part, to unfavorable market conditions.

Limits to What Training Alone can Accomplish: Advisory services should go beyond training the clients/ financial institutions to perform new tasks or introduce new services. Businesses need to be assisted in changing their behavior and deploying new knowledge. A degree of hand-holding is often warranted to broker partnerships between financial institutions, project developers, and equipment suppliers. It should also include structuring actual transactions involving these parties. For example, our advisory services team (a) sensitizes financial institutions about energy efficiency opportunities through mar-

24 SmartLessons

ket studies; (b) teaches them how to assess energy efficiency credit risks; and (c) works with project developers, equipment suppliers, and financial institutions to structure and deliver on individual investments. After these practical interactions, the financial institutions, project developers and others would gain the confidence to independently pursue similar business initiatives, thereby embedding the learning from the advisory services into routine business practices.

As advisory service providers, we are often tempted to offer potential clients one or two advisory services that we believe are best suited to their needs. However, the client is very knowledgeable about its business, current capabilities and growth trajectory, and might opt for completely different services than the ones we suggest if the various services we offer are understood. It is therefore useful to offer clients a menu of advisory services and explain the benefits and costs of each of them. The clients may then select the service or mix of services that best meets its needs based on a good understanding of the merits of our advisory services. Implicit in the above is that if we offer only one or two advisory services, the client may decline our service offer as it may not be suited to its needs.

Financing Alone is Not Enough: Where IFC has worked with financial institutions to expand the availability of loans to support energy efficiency investments, we have found that pari-passu guarantees (loan guarantees with equal risk sharing) alone do not provide adequate incentive to make financial institutions offer energy efficiency loans. Strong advisory services and a close working relationship with the financial institution are often required. The loan guarantee product is not seen as very valuable unless it is complemented by advisory services, which often enable/help the bank assess the risks associated with the underlying loan product and other aspects of individual energy efficiency transactions.

Advisory Services and Clients’ Existing Strategy: Advisory services can be especially valuable if they support a financial institution’s business or strategic direction. Before advisory service are offered to any entity, it is best to understand the strategy of the entity as well as the market challenges it faces. The assistance should be designed around the direction a business has set for itself rather than offering advisory services that divert a

client’s attention away from its established priorities. A financial institution that is marketing a range of mature loan and other financing products and is interested in expanding into other areas might be a good candidate for energy efficiency-oriented advisory service, since this will represent a new and unexplored opportunity — provided that the necessary conditions for success of an energy efficiency program exist. If a bank is only offered a limited guarantee facility, and operating that facility has high transaction costs, then it will not focus on this business opportunity.

About the Author Eluma P. Obibuaku was a Monitoring and Evaluation Specialist with IFC’s Environment and Social Development Department in Washington, DC.

Published in June 2007.

Figure 2.

CEEF Guarantees 1997- 2007

Cummulative

(as of 26 January 2007)

Per Year

40,000,000

30,000,000

25,000,000

128,702

2001

2002 Year

5,842,677

154,528

2000

3,650,567

931,184

1999

1,541,609

34,217

1998

15,000,000

10,000,000

5,000,000

0

130,583

20,000,000

1997

2003

Guarantee in US$

6,367,950

15,267,034

35,000,000

2004

2005

2006

0 2007

Status as of June 2007: As the demand for sustainable energy programs has increased within IFC, it is essential that we learn from these lessons and build them into current and future program designs. The adaptive management style employed allied to regular management review meetings has meant that CEEF has modified its systems and approach to increase its impact. The following top three lessons have been incorporated into the design of IFC’s newest energy efficiency programs - the Russia Sustainable Energy Finance (RSEF) initiative, and the China Utility Based Energy Finance Program (CHUEE): • Monitoring of advisory activities: RSEF has an extremely robust monitoring system which is carefully managed. A database tool has been created to help the team with acquisition of information • Financing alone is not enough: In RSEF and in CHUEE, more attention has been paid to market development activities that go beyond just working with the financial institutions.

• Menu approach: The Russia team has developed a structured approach for working with financial institutions to identify which items from the menu they need and then have a memorandum of understanding (MoU) that states what each party will do.

• Adoptive management: With the benefit of working with financial institutions on energy efficiency projects over several years, IFC has learned to exploit the competitive advantage of financial institutions in processing small transactions—the typical deal size of energy efficiency projects. IFC has adapted its energy efficiency products and services to the capabilities and needs of financial institutions. The result, depicted in Figure 2 above, shows how changing our project review procedure through delegating credit appraisal responsibilities to partner financial institutions enables the completion of a much larger volume of transactions without compromising credit quality. This change brought about a 2.5-fold increase in the volume/value of deals competed in the 2005-2006 timeframe, a trend that has continued into 2007.

SmartLessons 25

Adaptation for Adoption: Mainstreaming Energy Efficiency in Financial Institutions Miles Stump In 2005, IFC launched an energy efficiency finance product in Russia that was immediately challenging on two fronts: the product was brand new in the market, and it dealt with energy efficiency, a topic that had been traditionally neglected in Russia. IFC’s Russia Sustainable Energy Finance Program (RSEFP, or the Program)1 showed that in order to secure acceptance of a new product in the banking market, it must first ensure that the product is widely accepted and implemented within each partner institution. Tailoring the product to each financial institution is required to inspire confidence in the product, then institutionalize and iterate it widely.

Background

process of adaptation was required to secure participation from the chief executive officer (CEO) down to loIFC launched RSEFP to popularize energy efficiency fi- cal branch credit officers. nance among financial institutions. The program helps Russian financial institutions conduct energy efficiency Step One: Inspire Confidence in the Product lending through advisory services and dedicated energy efficiency. IFC saw enormous opportunity for energy efficiency lending in Russia. In 2003, Russia consumed 16 times more energy per unit of gross domestic product (GDP) than Denmark. The Russian market, however, did not view it in the same way. Russia’s vast energy resources and subsidized tariffs had created a laissez-faire attitude toward energy efficiency. At the same time, Russian banks were focusing their resources on developing From E.M. Rogers, Diffusion of Innovators, Fourth Edition (New York: The Free Press, 1995) more conventional products, such as consumer lending and mortgages.

The RSEFP had one early adopter of energy efficiency Since its launch in 2005, the Program has worked with finance who understood the value of the product – the eight financial institutions, and that experience has yield- Chairman of IFC client Center-Invest Bank. He vowed ed some important insights into gaining acceptance of an to pioneer energy efficiency with IFC in Russia, and his innovative product like this. The technology adoption efforts were recognized at the 2007 Financial Times/ curve (see diagram) helps put the challenge into context. IFC Sustainable Banking Awards. However, most of our Innovators (like IFC) pioneer the product, which is then clients were part of the more conservative early majority, taken up by a few early adopters who quickly grasp its and even if they agreed to try the product, it did not value. However, for broader adoption by the more con- mean that they had fully accepted it. In fact, we had servative early and late majority, the product then needs seen how support for the product had faltered with some to be tailored and adapted to meet their specific needs. of our initial clients when top management was not fully committed. Those working on energy efficiency in the Since most financial institutions are very conservative, financial institution could feel the lack of management how could the program gain wide acceptance of an insupport and were unable to commit the time and effort novative product like energy efficiency? A three-step to developing business with the product. ________________ To learn more about this program, visit: www.ifc.org/russia/energyefficiency.

1

26 SmartLessons

In March 2007, we were discussing energy efficiency

with a new IFC client (loan and equity bank) and one Step Two: Institutionalize the Product of Russia’s largest private banks. The challenge was to infuse the bank with confidence about energy efficiency finance and get a commitment to do a large-scale rollout Getting the Bank on Board of the product.

While top managers were initially very positive about the product, doubts began to creep in with some of them, a reflection of how difficult it is to fully grasp the value proposition of an innovative product. Despite discussions in which these concerns were addressed, we came away convinced that to secure a firm commitment, it was essential to approach the head of the bank. Our presentation to the CEO focused on what we anticipated would be his three key concerns: the size of the opportunity, the strategic fit for the bank, and the market readiness of the product.

1) Identify the size of the opportunity and market.

2) Identify how the product is a strategic fit for the bank.

Energy efficiency finance began to “run out of gas” at each of our first four client financial institutions because each financial institution had not fully committed its resources to selling the product. Only at Center-Invest had the CEO fully bought into energy efficiency finance, disbursing its initial US$4 million credit line within three months. But even there, momentum waned as its credit Here we benefited from the RSEFP programmatic ap- line was fully utilized and there was less urgency to bring proach, which also includes market awareness efforts, in projects. Despite early enthusiasm by the managers capacity building with energy service companies, and and credit officers in our partner financial institutions, public policy work. For example, our survey of 625 lack of institutional support marginalized the product. industrial enterprises was invaluable in presenting a clear picture of the size of the market and specific opportuni- CEO commitment sends an important message to the ties for financial institutions.

Impressed by our portrayal of the opportunity, and con- whole financial institution about the importance of the Questions that emerge as barriers to product, and a fee-based addeveloping business with a new product visory agreement puts that 1) What is the product? commitment into action 2) Why should we be doing this? and keeps it a top priority.

3) Why do we need it if money is already flying The agreement sets in moout the door? tion a process that requires 4) Why a special energy efficiency product? mobilization of significant 5) We do so much training; why spend more time organizational and financial on this? resources. Training, staff 6) Shouldn’t IFC be paying us to implement sometime, incentives, travel, adthing on its agenda? vertising and promotion, Chairman demonstrates and advisory fees amount Center-Invest new boilers, financed through an energy efficiency loan from his bank, vinced that energy efficiency was a good strategic fit, the to a serious investment. The to clients.

CEO of the client bank gave his approval for the prod- financial institution must also uct. We proceeded to sign a fee-based advisory agree- allocate credit resources to finance projects. ment that formalized his support – the first and essential step toward achieving full acceptance and adoption A good example of this process is our work with another bank. After the advisory agreement was signed, we recwithin the bank. ommended setting up a cross-discipline group within the Lesson 1: Identify what is needed to inspire confidence bank to produce an official product policy (that provides in your new product, package it accordingly, and then a description and instructions for processing), a budget, a promotional plan, and sales targets. This process culclose the deal. minated in making the product available to all the bank’s 47 branch offices throughout Russia.

SmartLessons 27

Beyond the organizational framework and resource allocation, institutionalization happens through formal training in the product. With this bank, over 50 credit officers from all over Russia underwent an entire day of intensive training on how to sell energy efficiency to clients as well as how to help them identify and evaluate energy efficiency projects. While the RSEFP had trained credit officers at all its other clients, it takes on a different meaning when done in the context of an officially approved product with sales targets, incentives, and nationwide advertising.

The first step was to make our training of credit officers more interactive so as to simulate what they would face in the field, but in an environment where they could make mistakes and also consult with an expert on things that they did not understand. The RSEFP team incorporated case studies and role playing to simulate introducing the product to clients and identifying and evaluating potential projects.

Lesson 2: Institutional commitment of resources and an official product description open the door to widespread adoption.

Step Three: Iterate the Product The main task remains getting the majority of credit officers throughout the country to use the product over and over in their interaction with clients – you need to stimulate widespread iteration. While CEO buy-in and institutionalization are important, they just form the foundation for adoption by the majority.

Russian manufacturing companies use machineries that are often 25-50 years old.

Next, the RSEFP developed an energy efficiency calculaIn February 2007, we reviewed the energy efficiency tor that would form the backbone of our training and product with the five Center-Invest Bank credit officers help credit officers in their operational work with the who had financed all the bank’s energy efficiency proj- product. The calculator was designed to show the energy ects to that point. We identified three key findings that savings of any project, and to translate those savings into would help us improve our product. The first was that CO2 reductions. out of 40 credit officers trained, only those five early adopters had done deals – the rest had not taken the ini- We also developed a detailed process map in the next tiative to try the new product, and just continued selling page to show credit officers how to work with the prodproducts that they already understood. Second, the five uct, including what data to gather and when to bring credit officers had all found energy efficiency daunting in an outside technical consultant. This structure gives initially, but easy once they got started. Finally, none of them a simple map to navigate through the process with those credit officers was aware of the deals that their col- their first clients. leagues had done.

Finally, we needed to give credit officers popularized inAs we prepared to engage new financial institution cli- formation that would help them feel comfortable with ents, the Center-Invest experience led us to take several the product. In addition to success stories that showed initiatives to enhance our advisory offering and ensure them how others have done projects before them, the that energy efficiency gained wider adoption within our Program developed a special laminated “cheat sheet” on financial institution clients. While Center-Invest clearly energy efficiency that gave useful facts and definitions for needed to improve its institutionalization of the prod- quick reference. uct, we felt that the real key to getting beyond the early adopters and reaching the early and late majority within Lesson3: Enhance your product to make it more the bank (and other financial institution clients) was to accessible and user friendly for the conservative majority, make the product more accessible and user-friendly for and they will use it over and over. them.

28 SmartLessons

Fig 1. Framework of energy efficiency project operations ADVISORY SUPPORT

DATA ANALYSIS

ENERGY AUDIT

DEAL STRUCTURING

1ST CONTACT

TECHNICAL REVIEW

PRODUCT DESCRIPTION YES

FI CRITERIA

YES

EE POTENTIAL

YES

SUPPORT NEEDED

EFFECT CALCULATION

NO

PRELIM INFO

NO

FINISH

EE CRITERIA

YES

EE LOAN CERTIFICATE

EE CALCULATOR

PROJECT QUESTIONNAIRE

NO

REGULAR LOAN

NO

EE GUIDE

Conclusion About the Author

When introducing an innovative product, it is crucial to remember that most people will not immediately understand its intrinsic value. To be successful, your product must be modified so that those you are trying to reach clearly understand how it can benefit them.

Miles Stump is an Operations Officer at IFC Advisory Services in Eastern Europe and Central Asia, and is located in Russia.

If you are trying to get a product up the adoption curve inside a financial institution, the RSEFP experience shows that it is important to tailor it to inspire top man- agement, define it to achieve institutionalization, and finally popularize it to ensure iteration.

Published in December 2007.

SmartLessons  29

Sustainable Energy Investment Scale-Up and Mainstreaming Pavol Vajda and Alexandra Glatznerova The Commercializing Energy Efficiency Finance (CEEF) program is the first attempt by IFC to develop commercially viable financial and advisory products to promote sustainable energy projects by financial intermediaries. Acquisition of scaling-up/mainstreaming experience was probably one of the most important ideas behind the CEEF program. After five years of operation in six different countries with almost 20 different financial institutions, we have learned more about the complexity of this task and can draw some conclusions which could be applied in pursuing business opportunities in sustainable energy.

Background Since its launch in 2003, the program has developed numerous innovative financial products and advisory approaches in cooperation with commercial banks and leasing companies in Central Europe. The evolution of the program (see graphic below), including its pilot phase in Hungary, and shows the development from a fully donor-funded operations to commercial financial products and advisory services.

renewable energy generation such as wind, small-hydro, solar, and biomass projects.

Developed risk-sharing financial products range from individual pari passu partial credit guarantees to more sophisticated portfolio pari passu guarantees with the first loss guarantee component. Advisory services products include consulting, research, and training at the level of individual project/sponsor/developer, individual financial intermediary, or the market/country/region.

Project Results

CEEF Program Funding and Evolution Scheme Million US$ 87

Although the program has achieved quite impressive financial results (taking into account the nature of the business) and has supported US$67 million in guarantees over 600 sustainable energy projects of total value—almost US$300 million without any guarantee call until now—its major value lies in its potential to provide solutions, which can be replicated and scaled up in IFC

75

12M $ IFC investment GEF counterguarantee 1 : 3 First loss guarantee Donor-funded TA

IFC Commitment

CEEF

75M$ IFC investment GEF counter-guarantee 1:5 Pari passu guarantee AS w/ cost-sharing

Donor-funded guarantee No IFC investment First loss guarantee Donor-funded AS

12

0

Year

3

1997

Hungary

2001

Hungary 2003

2005

2008

4 Global Environmental

CEEF

Facility Commitment

Czechia Estonia Hungary Latvia Lithuania Slovakia

15 18 Million US$

The CEEF project portfolio includes, among others, residential housing retrofits, district heating upgrades, gas-fired cogeneration projects, street lighting retrofits, 30 SmartLessons

SE Investments by Countries (US$ 296 million in total) Lithuania 1% Slovakia Latvia 2% 4% Czech Republic 22%

Hungary 71%

Estonia 0%

mainstream business. In order to determine some more general lessons, we have looked at the investment results from the perspective of the respective countries and financial institutions.

Lesson1: Identification of the right partner financial institution is a must.

The three most successful commercial banks typically have a strong focus on certain market segments - the residential housing segment of Raiffeisen Bank in Hungary, the renewable energy segment of Ceska Sporitelna in the Czech Republic, and the gas-fired cogeneration segment of Erste Bank in Hungary. The remaining banks with less focused approaches have not achieved substantial lending volumes through IFC guarantees.

When talking about “sustainable energy financial and advisory products” we mean mostly standard, more or less sophisticated financial products which are customized according to the sustainable energy projects and the financial institution’s need. This leads us to obvious questions: What are the financial institution’s needs in funding, risk mitigation, or know-how? And what is acceptable for IFC from the point of view of its role and the risks involved?

This general rule is surely not exclusive to sustainable energy projects (energy efficiency and renewable energy), First of all, the investment results vary substantially from but translated into the sustainable energy business realcountry to country, despite the fact that we deal with a ity, it means that it is not enough to have just a “good” relatively “homogeneous” group of new European Union bank to work with; instead, the bank has to have a very member states with a similar historical background. focused approach to the sustainable energy market. In These countries have made transitions from centrally other words, it means that the bank internally, and espeplanned economies through market-oriented reforms to cially at the senior management level, has decided to strathe current free market status. The country distribution tegically capture the business opportunity and is ready to of guaranteed investment volumes is shown in the pie allocate the necessary resources to achieve real impact. chart on page 30.

IFC’s role in this phase of strategic orientation can be quite important in helping to articulate the sustainable The general country investment environment and the energy strategy and the respective business targets. maturity of its sustainable energy market have a substantial impact on investment outcome. The major part of Is there any possibility of formulating a “best practice” the portfolio is in Hungary, where a pilot project started on how to identify the partner financial institutions with five years ahead of the other countries. On the other the highest sustainable energy impact/investment potenhand, it is worth noting that more than 90 percent of tial? The above results show that you need to work with the Hungarian portfolio was booked just over the last a relatively large number of financial institutions to be three years. At the opposite end of the scale is Estonia, able to identify and help build up an sustainable energy where the existence of a government-subsidized lending finance “champion.” The one major feature of the best plan has prevented any kind of commercial lending via performers was a demand-driven nature of cooperation financial intermediaries that would require IFC guaran- with IFC. Services provided by IFC were in alignment tee products. with the specific business needs of the financial institution. Therefore the nature of cooperation was focused on The same diversity of results is also evident within each “how to implement it and what the best tools are to do country market, especially in those countries where we it with” rather than on “why cooperate and how to perhave worked with several financial institutions. About 90 suade the financial institution of the benefits.” percent of the total loan volume is concentrated in three partner banks, of which only two have reached invest- Lesson 2: Customization of financial and advisory serment volumes that could be considered substantial from vices for the partner financial institution is an IFC mainstream point of view. essential.

What are the major general conclusions we are able to draw from the above results?

We have observed that the partner financial institutions appreciate many more products with a relatively higher IFC risk, although the absolute amount is quite small. The best example is the pari passu portfolio guarantee prodSmartLessons 31

uct with a small (under 5 percent) first-loss component, which was very successfully used in the housing renovation sector in Hungary. Until now, about US$900,000 placed in the first-loss position has triggered sustainable energy investment loans of US$44 million, and the leverage factor (now almost 50) is still on the increase with a growing portfolio. The same effect is also noted in a related school renovation project in Hungary, where the first-loss guarantee leverage factor is supposed to reach almost 100 at portfolio closure. In both cases, IFC was able to address the concrete business needs of its partner financial institution and to add value where it was needed and expected, although it must be mentioned that it was only possible thanks to available donor funding provided in both cases by the Global Environmental Facility. So the perception of risk is working not just on the financial institution side but also internally for IFC. SE Guarantee Size Distribution (606 projects including portfolio projects)

Relative Share by # of Projects

68% 70% 60% 50% 40% 19%

30%

9%

20%

1%

1%

10%

1-50

51-100

101-500

501-1000

The ability and willingness of IFC to delegate credit approval authority were based on detailed knowledge of the financial institution credit approval criteria and risk management system in place, but more importantly on first-hand experience with how the procedures and systems are applied in the financial institution project approval cycle. Only financial institutions with a positive track record were eligible for credit approval delegation.

2%

0% <1

We have experienced from our own portfolio growth that the most effective way to boost the investment volumes has been the delegation of project approval authority from the credit point of view to the partner financial institution. This, in combination with an independent technical review of projects, has led to the fast growth of the sustainable energy portfolios with excellent performance without project defaults. Outsourcing of credit processing capacity to financial institutions and advisory services to the private sector providers in combination with IFC’s internal advisory capacity (of Private Enterprise Partnership program), especially at the beginning of the partnership, seems to be the only way to achieve substantial growth of IFC’s sustainable energy investments in the upcoming period.

>1000

Guarantee Size in $000s

In the nonfinancial advisory services area, the greatest demand was for advisory service on different sustainable energy technologies. Provided initially by the CEEF staff, later it was increasingly provided by private sector advisors.

Finally, it is worth noting the size distribution of the supported projects/loans and the respective guarantees. The bar chart above shows that 88 percent of projects have a guarantee size of less than US$100,000, and that only 2 percent of projects have a guarantee size greater than US$1 million.

Regarding technical due diligence of sustainable energy projects, we have used two types of approaches. Few banks have built up their own technical and engineering capacity, especially in cases when they focused on relatively larger projects applying project finance techniques. However, the majority of financial institutions were outsourcing technical assessment of the projects to “proven” reliable private sector providers, and they were able to move from subsidized advisory services provided by program staff or consultants at the beginning to fully commercial services available in the market. The latter approach seems to be the way to go for smaller projects; moreover it has a built-in “sustainability mechanism” to continue sustainable energy investments after direct IFC involvement with the bank has ended.

About the Authors

The data confirm that a substantial part of business opportunities in the sustainable energy sector are micro, small, and medium-size projects, and the only feasible way for IFC to access the market is to partner with com- mercial banks and other financial intermediaries. What are the consequences?

Lesson 3: Delegation of investment decisions to financial institutions and outsourcing of advisory services are preconditions for substantial scale-up.

32 SmartLessons

Pavol Vajda is a Senior Operations Manager at IFC Advisory Services in Eastern Europe and Central Asia, and is located in Russia.

Alexandra Glatznerova is a Program Assistant for IFC Global Financial Markets Group in Slovakia.

Published in February 2008.

SmartLessons is an awards program to enable IFC clients, partners, donors, and staff to share lessons learned in their day-to-day work. This brochure introduces a new kind of knowledge sharing. Instead of lengthy academic articles and formal reports, it presents first-hand and straightforward project stories with pragmatic useful analysis, written by professionals and for professionals. Through the prism of their own experience, good and bad, these authors aim to capture practical insights and lessons that could help advance developmentrelated operations for private sector-led growth across the globe.

While IFC supports private sector development both by investing and by providing advisory services that build businesses, this brochure focuses primarily on the topic of energy efficiency in both investment and advisory services. IFC advisory work aims to support small and medium enterprises, to improve the business enabling environment, to accelerate private participation in infrastructure, to increase access to finance, and to strengthen environmental and social responsibility. Much of IFCâ&#x20AC;&#x2122;s advisory services work is conducted through facilities managed by IFC but funded through partnerships with donor governments and other multilateral institutions.