Among the myriad efforts that have been made to drum up sufficient climate finance to fund the clean energy transition in developing countries, mobilising the tens of trillions held in pension funds globally has always been a key goal. “Pension funds are the single-largest source of investable capital, and there is a huge need for investment in renewables in Africa [and Asia],” explains Paddy McCully, an analyst at the NGO Reclaim Finance.
Pension funds are pooled monetary contributions established by employers, unions or other organisations, which provide income to people upon their retirement. At the end of 2021, pension assets under management totalled $58.9trn in the OECD, and $60.6trn when taking into account non-OECD reporting jurisdictions. This represents a 7% increase in value compared with the end of 2020.
A key characteristic of pension funds is that they tend to be highly regulated by national financial authorities, with funds typically skewed towards lower-risk, lower-reward assets that protect people’s retirement plans and ensure reliable income. Bonds and equities account for more than half of investments in 35 out of 38 OECD countries in 2021 – but areas including cash and deposits, real estate, unallocated insurance contracts, private investment funds and other alternative investments have all seen their share of pension fund investments gradually increase in recent years, shows OECD data.
The same data shows that countries including Croatia, Switzerland and Romania have loosened restrictions to allow funds to invest directly in infrastructure projects (although there continue to be tight restrictions on the share of investments that can be made in infrastructure and other illiquid projects). The data also shows a high share of pension funds investment abroad in certain jurisdictions including Malta (98% of assets under management invested abroad), Latvia (90%), the Netherlands (89%), Portugal (84%), Estonia (81%), Slovenia (72%) and Italy (69%).
Meanwhile, developing countries – particularly in Africa – are crying out for climate finance to fund their sustainable development. Africa is home to 60% of the best solar resources globally, yet only 1% of installed solar PV capacity. Some 600 million people on the continent – or 43% of the population – do not have access to electricity.
The latest data from the World Bank shows that private infrastructure investment in low and middle-income countries is actually in decline, while other data tracking the sector published in November 2022 showed that only $2.6bn (or 0.6% of the global total) of capital was deployed for new renewable power-generating projects in Africa in 2021, the lowest in 11 years.
Renewables in Africa: pension funds to the rescue?
Could global pension funds offer a solution to this dire status quo? There are certainly many reasons why investing in Africa is an attractive proposition for pension funds.
African economies are some of the fastest growing in the world and investment in Africa writ large represents a massive growth opportunity.
A few pension funds are already capitalising on the investment opportunity that African infrastructure represents.
Ariya Capital Group is a developer and active investor in utility-scale power projects in Africa, in both the renewable and natural gas sector. The company currently has 45 utility-scale solar power plants operating across the continent. Ariya also provides innovative asset management solutions to help get renewable energy projects off the ground.
“Tapping into pension fund money – both in Africa and in the West – has been a holy grail of mine for some time,” says the company’s founder and executive chair, Herta von Stiegel. “If we create the right structures and the right investment opportunities for pension funds, then there are certainly huge opportunities for these funds to directly invest in the real economy and develop clean and renewable energy.”
To prove the concept, Ariya has set up an infrastructure investment fund using solely Namibian pension fund money. Worth N$150m (around US$10m), Ariya has since sold its founding stake to local partners, who continue to invest in renewables with the fund.
“Pension funds are generally speaking a nice pool of savings to be translated into development finance capital, because they represent long-term investments, which is exactly what is also required for infrastructure projects,” adds Sanjeev Gupta, executive director and head of financial services at the Africa Finance Corporation (AFC). AFC is a pan-African multilateral development financial institution that channels both private and public capital, and has to date invested more than $6.6bn into infrastructure projects.
[Link src="https://www.energymonitor.ai/all-newsletters/" title="Keep up with Energy Monitor: Subscribe to our weekly newsletter" font-size="20px"]Rune Gade Holm, head of private markets at PensionDanmark – one of the 50 largest pension funds in Europe – tells Energy Monitor that the fund is invested in renewable infrastructure funds in Africa as well as in other developing country markets. “These funds include the Africa Infrastructure Fund (managed by A.P. Møller Capital), funds managed by the IFU, and Copenhagen Infrastructure New Markets Fund,” he says.
“Contributing to positive change is a cornerstone in all PensionDanmark activities and financing clean energy projects across the globe, including the Global South and Africa, is a part of that, as the green energy transition has to become global to succeed.”
Difficulties investing in Africa
Nevertheless, pension fund money continues to make only a negligible impact on infrastructure developments in Africa: less than 1% of clean energy direct project investments in emerging/developing markets are currently from institutional investors such as pension funds, according to the IEA.
The most recent IEA energy investment report – published in May – also shows that just seven advanced economies accounted for nearly 90% of global pension assets in 2021. The report finds that in the ten largest emerging market and developing economy stock exchanges, the value of fossil fuel companies is on average two and a half times larger than power companies, putting power companies at a disadvantage when seeking investment.
Investing in renewables in Africa usually means investing in smaller, varied projects that large pension funds with billions at their disposal typically do not feel inclined to take on. “Renewable projects in Africa in particular are seen as risky for reasons including unstable governments and economies, and maybe most importantly the perceived lack of creditworthiness of the offtakers,” says Reclaim Finance’s Paddy McCully. “This means that investments in African renewables are likely to be high-risk and high-return – whereas pension funds are most likely to want lower-risk and so lower-return projects.”
Even some of the most progressively minded pension funds are put off by the perceived risks of investing in African clean energy. Anders Schelde, chief investment officer at AkademikerPension, which provides pensions for Danish public sector employees, tells Energy Monitor the fund has a target of 22.5% of its portfolio to be invested in climate-friendly investments by 2030, with 10% of that 22.5% coming from direct infrastructure investment.
“While we have made two investments that are specifically targeting emerging markets, we have not invested in funds targeting Africa specifically,” says Schelde. “Markets here I think are simply too small and immature to have materialised as an investment opportunity for us.
“Our fund managers tell us it is almost impossible to make ends meet in these markets because the risks are too big. To make it work you would need strong government involvement, not only from local governments but also from sponsor governments entering public private partnerships”.
Ultimately this investment landscape paints a complicated picture, which has continued to put pension funds off investing in African infrastructure, either via direct investment or other means like bonds and equities.
“When it comes to attracting pension funds from the US, Europe or Japan into Africa, we can argue that there are returns that can be had, but pension fund trustees and their advisors often battle to accept the risk profile of Africa,” says AFC’s Gupta.
“The opportunity in Africa also tends to run into the billions, rather than trillions, of dollars. So, when I talk to advisors of global pension funds, the general answer I get is: even putting a tiny fraction of our investment would be such a big cheque that you will not be able to absorb it into your requirements – and anything less than that does not really add anything to our portfolio, so is not worth the effort.”
Private capital a distraction?
For all the talk of shifting private capital via initiatives like GFANZ, for Reclaim Finance’s McCully, a more realistic priority should be to shift public finance away from fossil fuel projects.
“The key thing here is less to invent new financing mechanisms, but to ensure that the existing [public finance streams] are derisking the right things,” says McCully. “In other words: stop de-risking fossils and fossil-intensive projects and start de-risking renewable energy and low-carbon industrial infrastructure like green steel mills”.
“In the past decade, there have been calls to ‘mobilise private capital’ to support climate goals, especially in the Global South, but this was politically motivated," adds Melanie Brusseler, senior researcher at the think tank Common Wealth. "Fundamentally, states in the Global North have to redistribute public capital to southern states.
“[Mobilising private finance] is at best a well-intentioned but misguided policy idea in a time where we desperately need to support green electrification and development, and at worst a policy paradigm that some actors push knowing it isn’t realistic or helpful.”
Governments that invest public finance internationally via development finance institutions (DFIs) or export credit agencies are able to absorb greater risk, and can therefore lower the risk absorbed by private financiers on joint projects.
“With governments getting more involved, you can lower risks related to governance and legal rights, and develop more secure financial structures for private investors,” says AkademikerPension’s Schelde. “Then, hopefully, at a later point, these markets will be more mature, and will be able to function in their own right.”
Public finance involvement can also create problems for private investors, however. Charlie Troughton, director of sub-Saharan Africa-focused renewable power developer Buffalo Energy, says that outside of South Africa and Northern African countries, “project finance debt is almost exclusively the domain of the DFIs”, which invest using public finance. He says that DFIs can actually crowd out private finance as they bid at a level that is too cheap for private capital to compete.
Projects looking for investment are therefore hit by both the “bureaucracy and excessively long permitting time” as well as the fact that DFIs “distort markets and the required returns to attract institutional investors”, says Troughton.
New investment mechanisms for pension funds
Whatever the challenges, African infrastructure remains hugely underfunded, and it makes sense from a climate mitigation perspective to design investment vehicles that can attract the needed capital.
At the recent Net Zero Delivery Summit, held by the City of London Corporation in London, AFC CEO Samaila Zubairu said that, from Djibouti to Gabon, his organisation has now developed several investment-grade renewable energy projects across the African continent. “We have developed bankable projects, but the real challenge is we have not been able to mobilise the capital to do all the work that is required,” he said.
“We have a pipeline of over $3bn of projects, but we don't have the money to develop them,” Zubairu added. “There are institutions that have over $100trn of capital under management, with no allocation to Africa.”
[Link src="https://www.energymonitor.ai/author/nickferris/" title="Read more from this author: Nick Ferris" font-size="20px"]AFC’s Gupta adds that there can also be some frustration when there is a difference between “risk perceptions and risk realities”.
“It is the result of the way the continent has been looked at and has been exploited over the past 200 years,” he says. “All we can do is continue to develop bankable projects and gradually hope to change that perception.”
Ariya Capital’s von Stiegel concurs that there is an “imaginary risk premium” that comes with investing in power projects in Africa, adding that the default rate for African projects is actually “considerably” lower than for Western projects. “This is because the projects that are actually developed here in Africa have to jump through so many hoops, that by the time they get commissioned they tend to be really solid,” she says.
If pension funds are to overcome all the challenges detailed above, and finance is to be leveraged in a way that can really make a difference to African renewables and the continent's energy transition, it could come as the result of proposals presented to Energy Monitor.
“Pension funds are not advised to invest in speculative projects, which is why we advise that rather than investing directly in projects when we develop them, they should become an investor in the corporation itself,” says AFC’s Gupta. That way, funds are shielded from the individual risk of projects, but still can support the full infrastructure portfolio.
“The argument has been successful, because we now have six of the largest pension funds on the African continent today invested in AFC,” he adds.
For pension funds in the Global North, which invest the vast majority of global pension fund capital, Reclaim Finance’s McCully makes the case that – even if the risk profile of projects continues to put funds off making primary investments in new infrastructure, “there still would be an important role for pension funds to come in as buyers of portfolio’s projects once they have been built and the offtaker has shown a bit of a good payment record”.
Common Wealth’s Brusseler argues that pension fund capital could be leveraged through “public institution building and reform”, for example by reforming multilateral development institutions like the World Bank into a “quasi multilateral sovereign wealth fund, which can issue passive shares that tap pension funds”.
Energy consultant Patience Bukirwa from the think tank RMI has a more specific suggestion. The securitisation of energy projects and selling them as “renewable energy-backed bonds”, which would be suitable for investment by pension funds. Developing these renewables bonds would require collaboration between African governments, financial institutions and DFIs willing to take on the complex coordination of multiple sources of finance for each stage of project development to generate a portfolio of bond-investable projects.
“It is about finding a quick way to create maturity in certain products – like African renewables – which will in turn make them viable for more risk-averse investors like pension funds to come in and invest,” explains Bukirwa.
For Bukirwa, thinking outside the box to develop financing mechanisms like this is crucial if the dream of sustainable, equitable development in African nations is to become a reality.
“Public funding is great, but it is finite,” she says. “If there were vehicles that could channel institutional finance into portfolios of smaller, modular projects like distributed renewables rather than the conventional large-scale infrastructure approach, then we could begin to see real change.”
