Underwriting Guide - Coming soon

Although there has long been some private sector activity in investing in and lending to projects and programmes that are specifically designed to improve energy efficiency of both buildings and industry it is only in recent years that financial institutions have begun to mobilize resources and seriously start to engage with the opportunity of energy efficiency. The scale of investment to date, however, falls short of both what is possible and what is needed to meet climate change targets. Therefore there is a need to build understanding and operational capacity in evaluating both the value and risks presented by energy efficiency projects, either as stand-alone projects or as part of larger projects with other purposes such as building or industrial process refurbishments, or indeed new buildings or industrial plant. This guidance to under-writing energy efficiency projects is designed to be a tool to assist financial institutions, as well as others such as project developers, to build capacity in this important area. It has several purposes including:

  • to help originators, analysts and risk departments within financial institutions better understand the nature of energy efficiency investments and therefore better evaluate both their value and the risks.
  • to provide a standardised framework for evaluating energy efficiency investments and analysing the risks that will allow training and capacity building around standardised processes and understanding
  • to help developers and owners seeking to attract external capital to energy efficiency projects to develop projects in a way that better addresses the needs of financial institutions
  • to foster a common language between project developers, project owners (hosts) and financial institutions

The guide is aimed at several target audiences. Within financial institutions the main audiences are analysts evaluating energy efficiency investments and risk management teams although it should also be useful to originators when evaluating a business plan or funding request. The principles of energy efficiency described within the guide and the framework investing apply equally to public bodies deploying capital into energy efficiency – even if capital is being deployed at below market rate or in the form of grants. The guide is also aimed at project developers and project hosts in order to assist them develop projects that are more in line with the requirements of financial institutions.

Finally the guide could also be useful to CFOs and financial teams within organisations who are looking at funding energy efficiency projects using corporate balance sheet funds. CFOs face many of the same issues as providers of external finance, including a lack of confidence in the projected results and a lack of capacity to properly evaluate investment projects.

Why is a guide needed?

Underwriting, the process of evaluating value and risks prior to making a decision to deploy capital, requires specialist knowledge of the asset class being considered for investment and finance. Building knowledge and capability of underwriting energy efficiency is at an early stage in many financial institutions. In parallel areas such as wind power, or oil and gas, there is a deep knowledge and capability which has been built up on the basis of widely accepted standardised processes and data sets such as are used in P90 analysis for wind power and the Petroleum Resources Management System (PRMS) for oil and gas. No similar standard yet exists for evaluating energy efficiency investments and this guide is a first attempt to develop such a standardised approach.

Even amongst those early adopter financial institutions that are deploying capital into energy efficiency there remains a need to build capacity. Furthermore, much of the capital currently being deployed is on the basis of taking customer credit risk only without any concern for the underlying performance risk of the energy efficiency measures being financed. The issue of performance risk is in fact critical for two reasons, firstly a greater understanding of performance risk will allow it to be managed and priced appropriately – leading to opportunities for new financial products - and secondly any financial institution seeking to aggregate energy efficiency projects into a portfolio and re-finance it through accessing the green bond market will ultimately have to assure bond investors of the environmental performance of the underlying projects that the bond proceeds are allocated to. Therefore we consider it important to discuss performance risk in this guide even though many users may not be taking those risks at the moment.

As well as ensuring the underwriting of specific energy efficiency projects is carried out in a consistent and efficient way the second problem for financial institutions aiming to make an impact is how to ensure energy efficiency is incorporated into „normal“ business. Normal business means normal investing or lending to individuals and businesses building new buildings or industrial facilities, retrofitting existing buildings or industrial facilities or refurbishing buildings or industrial facilities. All of these situations represent opportunities to improve energy efficiency of the underlying asset over and above what would normally be achieved simply through the use of newer, more efficient technology i.e. beyond „Business As Usual“. Financial institutions can have a vital role to play in getting existing customers, their legacy portfolio, to improve the efficiency of their assets through asking the right questions and providing assessment tools. The benefits of doing so to the financial institution include: creating additional markets i.e. deploying more capital, reducing risk by improving the cash flow of customers and risks of stranded assets, aiding Corporate Social Responsibility (CSR) / Environmental Social and Governance (ESG), and moving along a trajectory increasingly being defined by financial regulators based upon greater disclosure of climate-related risks and taking positive action to offset them.

One challenge in making energy efficiency a normal part of day-to-day activity for financial institutions is the gulf in language and understanding between the financial industry and the primarily technically led energy efficiency industry. This guide also aims to start to provide a common language, which can be used by both sides.