How to make the national wealth fund work
The national wealth fund must do more than just plug funding holes, through targeted and successive interventions it can help a project to reach a growing number of investors and momentum until finally it is no longer needed, says Zvi Wohlgemuth
So far, many investors and equity and debt providers to energy transition projects in the UK have welcomed the national wealth fund (NWF).
With 131 new contracts and a goal of mobilising tens of billions of institutional capital into carbon light UK investment it appears to be attracting attention from private capital for decarbonisation and other growth infrastructure projects. It can also help unlock global investment into the UK and simplify the investment landscape. Importantly, to maximise its impact, the fund can enhance the risk profile of projects to maximise liquidity from pension funds, private equity and other investors.
To achieve this objective, the NWF should be ambitious in its risk approach and in how and where it chooses its decarbonisation projects.
What could that look like from the perspective of institutional investors as well as longer term capital providers and when would it be time to recycle capital (should the NWF be a long term investor)?
From our extensive experience as an adviser and financier on decarbonisation projects both in the UK and internationally we feel that a proposal for the lifecycle of a NWF investment opportunity could be as follows:
Stage one: Enabler
A proven, clean technology and business plan — but one that has yet to be industrialised— is funded by the National Wealth Fund. Typically such projects attract little institutional investment at this early stage of its development. For example, let’s say the NWF funds a £15-25m pilot plant as an industrial proof of concept.
Stage two: Catalyst
Once the technology and industrial case is made, the project becomes financeable with private capital. However this may be a challenge because the current supply chain or market size may not be mature enough to generate an adequate operating margin. Government support may be required (e.g. in the form of a contract for difference), at least until the project has moved along its experience curve and reduced its cost level.
Some private funding may be achievable at this stage but a large number of private investors (in particular those less familiar with the UK) may be hesitant to rely on a particular regulatory framework that is subject to change. This is where a co-investment from the NWF can be the necessary catalyst and can potentially offer guarantees to unlock liquidity. With “skin in the game”, the NWF demonstrates that the project is aligned with the long-term strategy of the country and investors can rely on stable regulatory and political environment.
In all fairness, UKIB for example, has already demonstrated additionality across a number of projects prior to the inception of the NWF. However, with the right approach, the NWF can become a project enabler across a much wider range of projects alongside private equity and debt providers comfortable with pre-completion project risk (such as project finance banks), which have proven to be the main source of financing for start-up in clean technology. With a more significant risk enhancement, such as the NWF taking a first-loss tranche or providing an insurance wrapper, a wider pool of senior debt providers could be attracted to such projects as well as maximising liquidity from project finance banks.
Stage three: Recycling capital
Once the project has been built and is successfully up and running, its risk profile has improved. It becomes attractive to a new type of equity and debt providers with less (or no) credit enhancement as well as a large number of infrastructure sponsors seeking long term investment generating stable yield. A number of pension companies and insurers are also seeking such investments (debt and equity) as a higher yielding investment versus, for example, gilts.
Long term debt and equity and a first mover advantage also helps those leading the new project to invest confidently in growth and to transform its equity story. The UK has a number of advantages housing a number of long term capital providers as well as one of the most reputable public equity markets in the world. Both can greatly assist growth projects in meeting a broad investor community. At this point, the NWF has succeeded and can recycle its capital for more nascent projects.
In general, a national wealth fund adds the most value when it plugs funding holes that cannot be filled by the private market alone due to technology or regulatory risks.
But through targeted and successive interventions the NWF can help a project to reach a growing number of investors and momentum until finally it is no longer needed. It can then redeploy its resources to other new projects.
Investment projects can help accelerate the energy transition but much effort will be required on the structuring and design of the programme to maximise capital and not only help the UK catch up to the US but create benefit for global investors.
With an ambitious approach, the government can create additional capacity for investment in the UK for the benefit of global financial markets and attract more interest from investors in the UK and from overseas. A further element to consider is the size of the NWF. £7.3bn over five years is a relatively small number compared to the size of the need to achieve net zero. This further strengthens the need to attract investment from the private markets (Government expects £3 of investment for every £1 deployed) and for the recycling of capital as highlighted above.
In doing so, the national wealth fund can meet its double objective of increasing decarbonisation investment into the UK and its ambition to become a global leader in the energy transition, while driving British economic growth.
Zvi Wohlgemuth is head of global banking and advisory UK for Societe Generale