STUART THEOBALD: SA institutions risk being crowded out of green financing

In theory, SA will benefit from billions in global investment to fund the decarbonisation of our economy. If that happens (and there is some way to go to turn intentions into reality), what will it mean for the local financial sector? SA could build a vibrant green financing capacity on the back of the transition, but there are also considerable risks that the opposite happens: that the domestic sector is simply crowded out of transition financing.

The development buzzwords internationally are “mobilising” and “catalysing” investment. The aim is to use various forms of concessionary funding to crowd in other investors and increase the overall amounts available to fund the huge infrastructure investment needed. Much global focus, from the World Bank to the philanthropy sector, is being placed on achieving such mobilisation.

But there is a different risk — that of crowding out the domestic financial system. SA is well known for having a sophisticated financial sector, with liquid, deep capital markets, high levels of domestic savings and an effective banking sector. It has better international integration than many other middle-income countries, and global investors can smoothly channel funds into domestic capital markets or the banking sector. This is a considerable economic strength. As global capital mobilises, and SA aims to tap into it — which it will be doing at COP28 at the end of November — the country could become a big investment destination.

But it matters how this funding reaches end projects. For example, billions of rand must be invested in utility-scale renewable energy plants. The money for these could be intermediated by SA banks, specialist infrastructure fund managers or the domestic capital markets, or they could be funded directly by foreign multilateral development funders and other government institutions.

If funded directly, projects are effectively financed outside the domestic finance ecosystem. Banks and other local investors can be squeezed out of opportunities, either because they are undercut by concessionary rates or because deals are struck at a global level without SA institutions in the room. The result is a missed opportunity to develop the local financial system and, at worst, a blow against its development.

Catalytic role

We often talk about ensuring localisation occurs on the back of large-scale renewable energy development. Such conversations, though, are usually about industrialisation, such as the opportunities for domestic manufacturing of renewables components. This is important and should be a part of transition planning, but the localisation of financing mechanisms should also be considered. If foreign capital is to catalyse and mobilise, it should do so by unlocking domestic capital flows and by building domestic financing capacity.

So far, the role of foreign funding has been mixed. Some has been highly positive: in the first round of the Renewable Energy Independent Power Producers Programme in 2010, foreign development funders played a catalytic role. As these were the first renewable energy projects, local financiers had limited experience with the financial modelling and risk management for projects. Several foreign development funders joined local banks in consortiums, bringing their technical expertise to the table and sharing it with local institutions. In subsequent rounds local institutions took on more of the finance arrangements and foreign funders withdrew. It was a good example of catalysing the domestic sector and building capacity.

Serious damage

There have also been examples of domestic institutions being undercut by foreign funding. When concessionary finance, often enabled by foreign governments, is used to distort domestic markets and squeeze out local institutions, it amounts to a form of dumping. It is the financing equivalent of dumping low-cost goods onto the local market, doing serious damage to domestic manufacturing capacity. A flood of foreign funding that is not intermediated by the local financial sector and not calibrated to catalyse the development of domestic funding can cause long-term damage.

At COP28 we will see the SA government advance the Just Energy Transition Investment Partnership, which envisages $8.5bn of foreign funding support. There is still some way to go to line up the plethora of foreign funding that has been promised, but good work has been done on how such flows can be directed to support transition. However, there has not been a comprehensive analysis, that I’m aware of, of how such flows can support long-term development of the domestic financial sector and ensure there is not crowding out.

SA banks, private equity firms, capital markets, finance arrangers and others could turn SA into the hub of green finance (and other use-of-proceeds funding instruments such as social bonds and sustainability-linked bonds) for the continent. That can happen if the financing value chains are built through transition funding.

Foreign funders should ensure they don’t just back a green project but do so through instruments issued on local markets and arranged by SA institutions. They should partner with domestic funders, crowding them into deals rather than out of it.

At COP28 in Dubai, I hope that undoubtedly necessary global funding flows are tapped in a way that maximises domestic capacity building.