Carbon Trust Public Sector financing of Low Carbon Programmes- v1

Introduction ............................................................................................................................... 2 Funding versus cash flows ...................................................................................................... 2 Value for money, balance sheet accounting and procurement ................................................ 4 Value for Money ..................................................................................................................... 4 Balance Sheet Accounting ..................................................................................................... 4 Procurement .......................................................................................................................... 5 Overview of current sources of funding for Public Sector organisations ................................. 6 Internal sources of funding to an organisation ..................................................................... 6 External sources of funding ............................................................................ 6 Sources of internal funding ............................................................................ 7 Sources of external public sector and mixed funding ............................................. 8 Central Government Departments ................................................................. 8 Local authorities, police forces and fire services ............................................... 9 NHS Trusts .............................................................................................. 9 Schools ................................................................................................. 10 Universities and HE Colleges ....................................................................... 11 Further Education Colleges ........................................................................ 11 Specific sources of low carbon external funding .................................................. 12 European Funding ....................................................................................... 12 Other Grant Funding ............................................................................................................ 15 Working with the Private Sector ............................................................................................. 16 Energy Services Contracting ................................................................................................ 16 Lease Arrangements ............................................................................................................. 19 Private Finance Initiative (PFI) ............................................................................................ 20 Community Health Partnerships .......................................................................................... 21 Bringing in private sector finance at scale ............................................................................. 22 Finance over the lifetime of a project ................................................................................ 22 Risk and Return .................................................................................................................... 24 Sources of Private Sector Funding ....................................................................................... 25 Blending finance .................................................................................................................. 28 The role of public bodies in accessing private sector finance ............................................... 29 Convening power.................................................................................................................. 29 De- risking ............................................................................................................................ 29 Enabling finance .................................................................................................................. 29 Accessing the finance .......................................................................................................... 30 Sourcing private sector finance ........................................................................................... 30 Appendices .............................................................................................................................. 32 Appendix A: Procurement, Contracting and implementation............................................. 33 Appendix B: Assessing the costs ......................................................................................... 35 Appendix C: Building a Business Case.................................................................................. 38 Appendix D: Sources of funds open to public sector organisations .................................... 41

Introduction
The aim of this document is to help public bodies access potential sources of energy efficiency and renewable energy finance for their building stock and to assess the costs, risks and benefits of doing this. It is intended to help sustainability professionals in the public sector to understand the different ways to finance low carbon projects, how to put together a business case and what to consider when procuring and implementing a project. It was put together by the Carbon Trust with assistance from Marksman Consulting and SKM Enviros, alongside valued input from a number of external reviewers. This is important as we are now at a time at which the financing of low carbon projects is undergoing a shift away from smaller one-off projects to the delivery of larger scale initiatives with the corresponding need to investigate whether to attract private sector finance. This shift is being driven by a number of factors including increased pressure on internal budgets, rising energy prices, concerns about energy security and increasing urgency around emissions and energy use reduction. A further factor is the current shift away from grant funded government support to cash flow mechanisms such as Feed in Tariffs or Green Deal, which offer a payment stream to underpin the financing of projects. As a result the scale of funding required for projects is often going beyond the financing capacity of individual organisations, leading to new low carbon financing models.

Funding versus cash flows

A essential part of understanding how to finance a project, whatever the source of funding, is to identify how the finance will be repaid out of the future cash flows associated with your project. Examples of cash flow include the savings created from energy efficiency projects, electricity or heating sold from generation projects and the support provided by financial incentives such as feed in tariffs.

Figure 1 Sources of finance and sources of cash flow

It is important to understand and quantify the sources of cash flow for any energy efficiency and renewable energy programme. These can come from both the obvious energy cost savings, but also from other sources such as reduced maintenance costs, personnel savings, or increased longevity of the equipment. Quantifying all of these in a cash flow analysis showing that investments create long term benefits is critical to the success of fund raising.

Cash flow from a Green Deal programme

The Green Deal legislation allows upfront investments to be made in public sector buildings, commercial buildings and private and social housing by a financing vehicle. The debt is paid off via the utility bill over a period of up to 25 years. As the utility bill remains with the building, the debt will transfer between tenants or between building owners. Thus a public sector body can invest in energy efficiency in buildings even though it may not be confident that it will own or occupy the building at the end of the payback period. The legislated Golden Rule says that the bill payer should not be worse off from taking on the programme. The income generated therefore has to cover both the loan interest and the management of the programme

Cash flow from feed-in tariffs

As of April 2010, individuals and organisations that install low carbon electricity generating technologies have been eligible to receive Feed-in-Tariffs (FITs), which reduce payback periods from renewable energy schemes. In addition to carbon emissions reduction, the installation of renewable energy technologies can create local jobs and contribute to the local economy. Setting up FIT schemes can help public bodies to maximise income streams, reduce carbon emissions and tackle fuel poverty in both their own building stock and in local businesses and households. However, the revenue from feed-in tariffs is now close to the cost of capital following the 2011 FIT review and so each project has to be carefully analysed. There are three ways that public bodies can roll out solar PV programmes: - Self-financing through own borrowing - Mixed financing of prudential borrowing and bank finance - Roof-rental models whereby building owners lease their roof space to third party companies/financers who finance the installation. The companies provide benefits through access to zero cost electricity during daylight and sometimes sharing of the revenues received by the company from the FITs

Cash flows from Renewable Heat Incentives

Renewable Heat Incentives (RHI) will provide annual payments to householders and other building owners for the delivery of renewable heat to their property from their own installed measures. The amount will vary according to the technology used. The scheme for non-domestic is now open for applications, and some finance companies are exploring roof-rental type programmes for biomass projects.
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Value for money, balance sheet accounting and procurement

Value for Money
When considering what type of finance will be suitable for financing a particular project against future cash flows, there are three important considerations to keep in mind as you read this document, value for money, how the finance will be accounted for on the balance sheet of your organisation and the procurement approach. Value for money there are three elements to value for money as defined by the Treasury (HMT): 1. quality and suitability of the service for the individual project 2. long-term implications or whole-of-life costs 3. wider outcomes for society and the state When considering value for money, you will need to consider the cost of resourcing and project set up, the maintenance and capital cost of the equipment, and the cost of different sources of finance (or the cost of capital as it is often referred to). As a part of this assessment you will also need to take account of the allocation of human resource and where risk is being taken. For assessing the value for money issues around private finance it is important to read the 2006 HMT1 guidance to help you to consider the risks and benefits

Balance Sheet Accounting

The balance sheet is a summary of what an organisation owns and owes at a specific point in time and is a key way for the finance team to report on the organisation. The way finance (debt) is recorded on the balance sheet of your organisation may have an impact on whether or not your organisation is able to finance a project. Projects financed directly by your organisation will be on balance sheet. Projects financed through service agreements or by the private sector in some cases can be off balance sheet. However the rules of public sector accounting make off balance sheet options harder to achieve and it is important that you understand how your particular organisation deals with this issue. Whether a project is on or off balance sheet will also affect the value for money assessment that needs to be made. If the project is on balance sheet your organisation will need to weigh up the benefit of funding your project against the other funding requirements it has. If your project is privately financed then your organisation will also need to compare the cost of using the private sector finance against what it would cost to finance this from your own funds, to check whether this offers good value for money. Whilst the cost of capital will be higher than using internal or public funds there may still be good reasons to do this such as a shortage of funds, the benefit of external resource and expertise or the transfer of
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risk to a 3rd party. There are also ways of using energy service contracts to keep finance off the balance sheet (see section on energy services contracting).

Procurement
The final area for consideration when in reading this document is how the procurement regulations that govern the public sector will affect your project. The rules that govern the way that the public sector purchases goods and services can have a significant impact on the different options for financing energy efficiency and renewables. The management of procurement processes in particular for large-scale programmes can have a significant cost attached and require specialist resource and expertise. It is always worth considering whether there are compliant frameworks that might be suitable for use in your project to reduce the cost of delivering the project. Examples include London RE:FIT and the purchase of energy through public buying organisations. The key questions to ask are: - How will my organisation pay for this project and how does that affect procurement? - Do the financial limits require a full OJEU tender process or can you follow the general principles of public procurement? - Are there any procurement frameworks that my organisation could access to deliver this project? Procurement and contracting is covered in more detail in Appendix A.

Overview of current sources of funding for Public Sector organisations

Internal sources of funding to an organisation
As with other business expenditure, energy efficiency projects can and have been funded in the past through an organisations revenue and capital budgets. Revenue budgets cover the running costs of the organisation related to the budget year, such as staff, rent, energy consumption, consumables and services. Some low carbon projects, mainly energy efficiency ones, will have been funded as part of the on-going maintenance of properties in this manner. Capital budgets are used to purchase assets, construct or improve infrastructure including buildings, plant and equipment for which benefits will accrue over a number of years. Organisations generally cannot borrow to fund revenue expenditure but they can do so to fund capital projects, or they can draw down or use their reserves. These sources of funding are covered later in this document. In this context, the concept of invest to save for low carbon programmes is an important part of putting together the business case for financing low carbon projects. This is when an investment is made justified on the basis of future cash flows from energy efficiencies made. For example, a heating system within a public sector building could be at the end of its useful life and constantly breaking down. It would then be replaced on the basis of its poor delivery. If on the other hand a heating system was still functional, but replacing it with a more efficient system would save significant energy costs then the replacement could be justified on an invest to save basis if the financial savings over future years outweighed the costs of the new equipment that would not otherwise be purchased.

External sources of funding

Public sector funding. There is a range of public sector funding sources available to public sector organisations, some of which are specifically targeted at low carbon initiatives. In some cases there are capital grants that may require some form of match funding but do not need to be repaid, such as EU grant funds. Alternatively these sources of funding will need to be repaid either at a preferential rate or as a repayable grant, which acts as an interest free loan. Some general sources of funding can be used for low carbon investments. For example, local authorities can borrow from a central government facility called the Public Works Loan Board (PWLB) charged at 1% above central government borrowing as long as it fits the requirements of prudential borrowing, which in essence requires that it will be repaid in the agreed period through identified cash flows (savings) from the project. See the section on External Sources of Public and Mixed Funding for more information. Private sector funding - Because capital grants are limited and sources of public sector funds including borrowing are constrained, the managers of public sector low carbon projects are increasingly being asked to assess the business case for
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accessing private sector finance, as well as looking at their existing internal sources of funds. Private sector finance covers a range of sources of funds from direct bank loans, to project finance from banks, to infrastructure and equity funds where investors invest with funds where returns are less certain than those achieved through lending. The return on equity investments is recovered through dividends or sale of assets. See the section on Working with the Private sector for more information. It is vital to understand how this type of finance will be accounted for in the organisation accounts. The public sector is governed by a number of specific rules in regard to accounting for expenditure, financial commitments and assets and often when private sector funds are used the accounting treatment is still on balance sheet. Private sector partnerships and service contracts private funding may take the form of an energy services or performance contract (EPC). Private sector partners can provide energy efficiency projects as a service, which can include technical assistance, upfront finance, and guaranteeing the future energy savings. The cost of the finance and guarantees are paid for out of the project savings. This is covered in more detail in the ESCO section on page 16. Partnerships with the private sector can further cover joint public/private sector funded programmes, for example through the private finance initiative. With this approach it is important to understand who is taking the risks in any specific arrangement, and how this is accounted for by your finance department and the resulting cost of capital to the organisation.

Sources of internal funding

Because the need to demonstrate value for money for public expenditure is a key driver in the public sector it is important to start by assessing what internal resources are available. Making the case for internal funding- where it is availableis a good place to start as the financial business case for many energy efficiency opportunities is very strong, and this often allows the public body to realise a larger share of the savings given their low cost of finance. Below are some areas where internal funds might be identified. Your finance department will be able to guide you on the detail and often they will suggest that it is their role to find the right internal source of funds, and it is the role of others to come up with suitable projects on which these funds could be spent. Unspent capital cash brought forward from previous years; Cash associated with the charge for depreciation; Receipts from asset disposals; In year surplus Foundation Trusts and Universities have greater freedom to invest these; Cash released from movement in debtor/creditor balances.
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In order to secure some of this funding you will need to have a thorough understanding of how your organisations business planning process works and how capital expenditure is approved, for example through a capital investment committee/group. It is vital to approach your finance team prepared with an outline business case, and an explanation of why your projects should be prioritised. Larger projects will need a full business case- see appendix C for more on this. Use of the following metrics will help you to gain internal buy in: payback period; net present value/ lifecycle cost; internal Rate of Return; regulatory and compliance benefits, for example CRC or meeting targets; operational benefits reputational benefits delivery of desired organisational outcomes Opportunities that pay back within one year should not need separate capital funding, as they will pay for themselves out of in year revenue budgets. It is sensible to prioritise short payback projects first, so that savings can be demonstrated to fund larger or longer payback projects later. It may be possible to set up an internal revolving invest to save fund along these lines. This is a process by which the initial funds are recovered over a given period but instead of being returned to the funder or to your organisational budget, they are used to deliver further projects. Thus an upfront investment is reused again and again on multiple projects. Some projects may be justifiable on the basis of ancillary benefits, despite having longer payback period. For example, the replacement of old, unreliable equipment may increase resilience and reduce the likelihood of breakdowns.

Sources of external public sector and mixed funding

If you are not able to secure funding internally then you can look for external sources of public sector funding. Some of these are specific to the type of public sector organisation, some are financed on preferential terms and some are grant funding. Please see Appendix D for more information on which types of finance are open to which public bodies.

Central Government Departments

Managing Public Money - at http://www.hm-treasury.gov.uk/psr_mpm_index.htm sets out some of the core principles. Departments are allocated Departmental Expenditure Limits, which they are not allowed to exceed. However, they may borrow at sub commerical rates from the National Loans Fund with agreement from the Treasury.

Local authorities, police forces and fire services

These are governed by the Prudential Code, introduced in 2004. This code allows local authorities and others to borrow to finance capital investment in fixed assets provided they can demonstrate that they are acting in a financially prudent and sustainable way. This will require an assessment of the impact of the investment across all the years that this investment will financially impact the authority The prudential code requires these bodies to apply due process to setting budgets, limits and indicators. When setting prudential indicators these authorities need to take account of the implications to taxes or rents, the implications of borrowing, value for money, asset management, strategic planning and the practicality of delivery. For more information http://www.cipfa.org.uk/pt/prudential_framework.cfm The Public Works Loan Board lends money to local authorities and other public sector bodies. The funds sit on the organisations balance sheet, but carry a very competitive rate of interest. Energy efficiency measures are eligible, but prior approval is needed for all loans from CLG. More information on the scheme is available at http://www.dmo.gov.uk/index.aspx?page=PWLB/Introduction Tax Increment Financing applies only to local authorities. It is a relatively new approach, and proposes to allow local authorities to borrow against predicted growth in their business rates, in order to finance capital projects. It is generally designed to be used when the new income will be from large scale development projects and thus not suitable for funding such things as existing building retrofit. The Community Infrastructure Levy is a new levy that local authorities in England and Wales can choose to charge on new developments in their area. The money can be used to support development by funding infrastructure that the council, local community and neighbourhoods want - for example transport schemes, flood defences, or schools. The system applies to most new buildings and charges are based on the size and type of the new development. For more guidance see http://www.pas.gov.uk/pas/core/page.do?pageId=122677

NHS Trusts
Public Dividend Capital from the National Loans Fund (NLF) is available to NHS Trusts. Unlike loans, threre is no fixed repayment period, but Department of Health (DH) can require repayments e.g. for excess capital receipts. The assets purchased attract a capital charge of 3.5% on the net book value (the value of the asset will be offset by the outstanding principal value of the loan). The DH considers cases for exceptional PDC where a Trust has a zero or low prudential borrowing limit and/or where a major capital scheme forms part of the financial recovery of the Trust. All DH loans are over a fixed term at the National Loan Fund rate with regular repayments of capital.
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Non-foundation NHS Trusts can only borrow from the Department of Health. Foundation Trusts can borrow from the Foundation Trust Financing Facility (FTFF) and also from commercial banks subject to a Prudential Borrowing Limit (PBL) that is re-visited annually by Monitor, the independent regulator of NHS Trusts. The PBL is made up of two elements: The first is the long-term borrowing limit. Monitor sets this annually based on an assessment of the FTs financial risk and it forms part of the FTs terms of authorisation. Monitor sets what is known as a tier 1 limit for FTs, based on their annual plans and in accordance with certain ratios. In certain appropriate circumstances however, Monitor may set a tier 2 limit to allow for affordable major investments. FTs may apply to Monitor for a tier 2 limit if their plans suggest that they will breach their tier 1 limit. The second element is any working capital facility approved by Monitor. This is an additional level of short-term borrowing which may be used for short-term cash flow management. It should not be treated as prudential borrowing for other uses such as investments in carbon reduction.

For a Foundation Trust the key requirement is that they can cover the interest payments on any loan out of the operating surplus and that the repayments of the loan can be made without breaching the Prudential Borrowing Limit.

Schools
Schools are divided into Local Authority owned, Academy schools and Free Schools. Local Authority controlled schools access all funding via the Local Authority; some of the funding is core education budget and some such as asset management comes from other Local Authority budgets.The funding for academies comes in the form of a grant, known as the General Annual Grant (GAG), paid by the Young People's Learning Agency (YPLA). YPLA will issue formal notification of grant funding for each school in the month prior to the date of conversion. The GAG is made up of different elements; School core funding - by far the largest element of GAG, known as its delegated budget share. This will be the same as the school's current budget share received from the LA. YPLA make small adjustments to reflect any reduced business rates, paid by an academy as a charitable trust, and for insurance, which is paid separately in GAG. Local authority central spend equivalent grant (LACSEG) - this is additional money to cover those central services the LA no longer provides which includes asset management.

The annual revenue funding for Free Schools in 2011-12 will be based on the average funding received by maintained schools and Academies in the same local authority using a simple and transparent formula.

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LA funded schools cannot access private sector loan finance without secretary of state approval. This includes finance leases, hire purchase and any form of lending.

Universities and HE Colleges

Higher Education institutions are funded in part through grants/student fees, but also have commercial income streams from R & D and can borrow directly from commercial banks or the European Investment Bank (EIB) to finance projects. In some cases the Higher Education Funding Council England (HEFCE) will need to approve borrowing if annualised servicing or interest costs as a proportion of income are above a certain level. This is set out in the Model Financial Memorandum between HEFCE and institutions, Annex F: Consent for Financial Commitments2 and include instances where long term or higher risk financial arrangements are proposed or where certain ratios are exceeded. Universities have also on occasion issued bonds for large projects such as the development of student halls of residence. Their ability to use these funds to finance energy efficiency and renewable energy programmes will depend on the range of competing projects looking to access funds.

Further Education Colleges

Colleges can borrow within the terms and conditions of the Financial Memorandum between the college and the Skills Funding Agency. Colleges are expected to have treasury management policies in place for the management of the colleges cash flows, its banking, money market and capital market transactions, the effective control of the risks associated with those activities, and the pursuit of optimum performance consistent with those risks. Short term borrowing for temporary revenue purposes is typically authorised by the College Principal. Such arrangements are restricted by limits in the colleges Financial Memorandum. All other borrowing requires the authorisation of the Colleges governing body and has to comply with the requirements of the Financial Memorandum. The size of a colleges total borrowing and its approach to interest rates needs to be calculated to ensure a reasonable cushion between the total cost of servicing debt and operating cashflow. The Skills Funding Agency (SFA) offers capital and renewal grants for further education bodies. This aims to promote renewal and modernisation of estates, economic growth and skills specialisation with particular reference to helping to meet apprenticeship targets especially in support of growth industries; carbon reduction and sustainability and improvements in running cost efficiency. Colleges are required to match fund grants. For more information; http://propertyservices.skillsfundingagency.bis.gov.uk/capitalfunding/

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Specific sources of low carbon external funding

Salix- Most Public sector bodies are able to apply for interest free invest to save loans from Salix. Salix is an independent, not for profit company, limited by guarantee funded by DECC through the Carbon Trust. Salix delivers interest free funding to accelerate investment in energy efficiency technologies across the UK public sector. It provides loans for a wide range of energy efficiency technologies, for either individual projects or larger multi project programmes that reduce energy bills and carbon emissions, provided those schemes meet certain carbon and financial criteria. More information is available at http://www.salixfinance.co.uk Carbon Trust/ Siemens loans scheme - this provides commercial loans and leases, from Siemens Finance, of almost any size, with payments offset against energy cost savings. Projects need to be assessed by the Carbon Trust in order to verify they will deliver real cost and carbon savings. More information on the scheme is available at http://energyefficiencyfinance.co.uk/ Partnership for Renewables is a Carbon Trust enterprise providing finance to the public sector for investment in renewable energy projects. It covers all renewables but the main focus is on 2 -10 MW onshore wind turbines. They will fund development costs including identifying sites, screening, feasibility and project development. More information is available at http://www.pfr.co.uk/ The Green Investment Bank (GIB) - scheduled to start in 2012, is expected to provide funding for large scale energy efficiency measures, though full details are yet to be announced. It is expected that it will only fund commercially viable projects alongside private sector finance - via funds rather than directly into projects. It will be able to trade off its double bottom line between carbon savings and financial return, but it will still have to make that financial return. Revolving Green Fund- administered for higher education bodes by HEFCE, this provides repayable energy efficiency grants for these bodies, which is essentially an interest free loan. More information on the scheme is available at http://www.hefce.ac.uk/lgm/sustain/rgf/

European Funding
European Investment Bank (EIB) The EIB is the long-term financing institution of the European Union and its mission is to help implement the EU's policy objectives. The Bank operates on a "not for profit maximising" basis and borrows on the capital markets. Protecting and improving the environment and supporting sustainable, competitive and secure energy supply are two of the EIBs core objectives. Public sector organisations can borrow directly from EIB or may access funds via some of the other initiatives listed below.
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The EIB will need to see evidence of a bankable project as any bank would, but they are likely to be able to offer more favourable terms for energy efficiency projects such as a lower interest rate or longer fixed term. However, they generally prefer straight forward lending arrangements directly with public bodies, rather than public private partnerships. Projects normally have to normally be over 100m in size and the bank can lend 50% of the total project value. The EIB UK office is based in London. For more information http://www.eib.org. European Regional Development Funds (ERDF) provide grant funding that aims to strengthen the competitiveness and attractiveness of all regions in the UK through public sector led economic regeneration projects. The funding is currently available until 2013 and comes from European Structural Funds. A wide range of public sector organisations can apply including government departments, local authorities, higher and further education establishments. Other public bodies and the private sector can also apply. Management of ERDF programmes outside London has transferred from Regional Development Agencies to locally-based CLG teams, who will run any future funding rounds. The London programme is administered by the GLA. Projects will need to provide varying levels of match funding. Each region has its own operational programme and priorities but the overall objectives are to: promote innovation and knowledge transfer with the intention of improving productivity; stimulate enterprise and support successful business by overcoming barriers to business creation and expansion; ensure sustainable development, production and consumption. A change to the European Structural Funds ERDF Regulation to allow the inclusion of energy efficiency measures in social housing as activity eligible for support under ERDF programmes was approved in May 2009. 4 million ERDF funds was made available for the call. For more information http://www.communities.gov.uk/regeneration/regenerationfunding/europeanregi onaldevelopment/ EULife+ - has a budget of 2.143 billion for the period 2007-2013. There is an annual funding call and projects such as energy production and distribution, green buildings, and eco friendly homes have been funded previously. However, projects targeting waste and natural resources have received the bulk of the funding. The projects are intended to be pilots to develop innovative policy ideas, technologies, methods and instruments. Defra is the National Competent Authority for Life+ in the UK. Beta Technology (www.betatechnology.co.uk) acts as the UK National Contact Point and provides a screening service to check eligibility. Defra then transmit all eligible applications to the European Commission.
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For more information http://ec.europa.eu/environment/life/funding/lifeplus.htm The Intelligent Energy Europe (IEE) - programme is designed to give a boost to clean and sustainable solutions. It supports their use and dissemination and the Europe-wide exchange of related knowledge and know-how. Targeted funding is provided for creative projects putting this idea into practice. The 2012 call has a budget of 67m. The Energie Helpline (www.energiehelpline.co.uk) provides the UK National Contact Point. The projects help to further the three main objectives: Promoting energy efficiency and encouraging the rational use of energy sources Increasing the use of new and renewable energy sources as well as encouraging energy diversification Stimulating energy efficiency and renewables in the field of transport. More information can be found at http://ec.europa.eu/energy/intelligent/ European Local ENergy Assistance (ELENA) provides up to 90% of the costs of the technical support that is required to prepare, implement and finance an investment programme. This would include elements such as feasibility and marketing studies, setting up programmes and business plans, energy audits and tender preparations that will enable a public authority to get a project investment ready for either the European Investment Bank or other investment. As with other EU funds the financing must be partially or wholly repaid if the planned investments do not take place. They require 20:1 capital leverage so that for every 1 received for technical assistance, 20 has to be invested in the projects. For more information http://www.eib.org/products/technical_assistance/elena/index.htm The European Renewable Energy Fund I (EREF I)- offers financial support from the EIB of up to around 40 million. It makes equity investments in European renewable energy projects and business. The majority of the clean energy projects in which EREF I will invest will be primary assets. It is expected these will be mostly in wind technology, though other technologies are eligible to be funded. For further information http://www.eib.org/projects/pipeline/2009/20090199.htm JESSICA (Joint European Support for Sustainable Investment in City Areas) - is an initiative of the European Commission developed in co-operation with the European Investment Bank (EIB) and the Council of Europe Development Bank (CEB). It supports sustainable urban development and regeneration through financial engineering mechanisms providing loans to suitable programmes. In the UK as well as supporting London there are programmes in the North West and Scotland http://www.eib.org/products/technical_assistance/jessica/

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The London Energy Efficiency Fund (LEEF) - has been set up by the GLA as part of the JESSICA programme with finance from European funding via the ERDF in partnership with private sector financial institutions to provide energy efficiency and decentralised energy loans to public sector bodies in London. This provides semi commercial loans, at slightly below market rates, repayable over a number of years from the energy savings made. The fund has 100m to invest in energy efficiency retrofit to publicly owned or occupied buildings, either directly to the public body or via an ESCO or landlord supplying the public body. The fund will lend in tranches of between 1m and 20m, and projects should deliver at least 20% annual carbon savings. Visit http://www.leef.co.uk/ for more information. Similar funds exist outside London; for example Manchester has a similar fund, the Evergreen Fund, and Scotland has SPRUCE (www.ambergreenspruce.co.uk). Wales has set up The Regeneration Investment Fund for Wales (http://www.rifw.co.uk) . European Energy Efficiency Fund (EEE F) - launched in July 2011 to finance energy efficiency, small-scale renewable and clean transport projects. The fund can be accessed by public and private entities, including private entities acting on behalf of public authorities. The fund will offer a wide range of financial products loans, guarantees and equity investments, at commercial rates. There is also a technical assistance facility similar to ELENA but it differs in that EEE-F technical assistance funding obliges the recipient to use EEE-F loan financing. EEE-F targets programmes under 50m, whereas ELENA is intended for programmes over 50m. The fund is managed by Deutsche Bank. For more information http://www.eeef.eu/

Other Grant Funding

Sources of grant funding are somewhat limited but worth pursuing. The term grant funding includes any funds that do not need to be repaid and are not generated from internal sources. Known sources of funds include: Regional Growth Fund A 1.4bn fund which is designed to encourage enterprise, growth and job creation in the regions, but efficiency savings in public sector bodies are eligible as they could help to save or create jobs. The results of the second round have recently been announced. Regional Growth Fund money can be used as match funding for ERDF and some Local Enterprise Partnerships may be able to help with this. http://www.bis.gov.uk/policies/economic-development/regional-growth-fund Philanthropic and Charitable funds trustees might be persuaded that investments in local projects that specific benefits in line with their objectives are worthy of investment and are within scope. However, the general practice for such funds is not to invest where they think that is the role for the public sector.

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Working with the Private Sector

If the internal and external funding described above are not available, you might like to consider alternative financing models such as: Energy Service/ Performance Contracting Leasing Private Finance Initiative (PFI) Local Improvement Finance Trust (LIFT)- NHS only Operating lease arrangements The key element of all the above is that private sector partners/providers provide both the initial finance to create an asset and importantly take on the majority of the risk.

Energy Services Contracting

Essentially, this allows organisations to access some or all of the following from third party organisations which provide energy efficiency and other energy services as a service rather than something that has to be paid for up front. Their services can cover the following; External expertise Procurement frameworks for goods and services, including the purchase of fuels on behalf of government procurement services Performance guarantees on equipment peformance or savings to be generated so reducing or removing risks Finance for energy efficiency measures Energy Services contracts may provide off-balance sheet finance, as you are buying a service - either in the provision of energy bought or energy savings made rather than an asset. This, however, should not be taken as given and will need to be reviewed by your accountants and legal team. If the programme is set up as a joint venture between the public sector and an ESCO (Energy Services Company) to deliver an energy service programme, it could cover the delivery of heat and/or power as well as the provision of energy efficiency investments. It is important to consider three further factors: The level of risk that the public body is exposed to, which could be based on the requirement that savings pay for the costs, the capability for the ESCO to deliver the service and the latters balance sheet strength. Just because a company provides a guarantee for 10 years, does not mean it will be around in ten years time to underwrite the benefits. How the public sector body can maximise the carbon saving and cost savings from the arrangement and where risk lies within the contract. How the service is going to be paid for and procured. It is important to get procurement advice.
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It is important to be aware of how much risk you are transferring to a third party via Energy Performance Guarantees (EPG), or via third party ownership and operation of the assets. You will need to be clear about the terms of any performance guarantees, and about exactly what outputs are guaranteed under the contract. It is equally important to be aware of how much you are paying for this risk transfer. Competitive tendering is likely to be needed for large contracts to ensure value for money and to comply with procurement law. ESCOs are not new with organisations like Dalkia, Mitie and Cofely active in the market for many years and with a growing market in the USA. There is a good risk register in publication GPG 377 on the Carbon Trust website. An ESCO often approaches potential clients with proposals for energy saving projects and performance contracts. Initial research and investigation determines areas where cost savings are feasible and is usually free of charge. The first output is normally a feasibility study which the ESCO will expand upon in a proposal and detailed design. There are various funding structures that can be used in an agreement between an ESCO and a public sector body: ESCO provides all equipment and in return receives a percentage of the energy savings. The savings can be guaranteed or variable. Small investments such as variable speed drives or voltage optimisers often fall into this type of agreement; ESCO provides energy management services guaranteeing energy savings. Capital spend still sits within the public sector body, meaning this is more a way of de-risking energy cost savings than of financing carbon reduction; ESCO provides and operates new generating plant including the purchase of fuel and provides energy at a fixed price or value. Such arrangements may well keep both the asset and the finance off the balance sheet, especially for technologies like CHP and biomass heat which are relatively easy to physically isolate.

The public body and the private sector partner can set up a joint venture ESCO to provide energy to the public sector organisation and other customers at agreed prices. This would only be suitable for larger schemes such as Combined Heat and Power. The profits from the arrangement can then be shared between the public and the private partner, but the public body might retain balance-sheet exposure to the venture.

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Case Study 1 Woking Borough Council- how a public body and a private partner can establish an ESCO to provide energy services. Figure 2:

Any public sector organisation which wants to emulate the model in figure 2 should not assume that this can be done off-balance sheet without first taking advice. NHS Carbon and Energy Fund NHS Carbon and Energy Fund-is a 200m fund currently run by NHS Shared Business Services. It provides long term finance (to be repaid over 10 years plus) for large projects (over about 750,000) for NHS bodies, but the model could be extended to the rest of the public sector. The funds money comes from the Co-operative Bank and it provides some or all of finance, procurement frameworks, performance guarantees and technical expertise. The fund makes agreements with NHS Trusts to finance and build large projects such as CHP or biomass heat schemes. Energy cost savings are guaranteed by the fund, and the Trust pays for the asset out of these savings. Most of the funds projects are able to sit off the Trust balance sheet, as the asset is owned by the fund rather than the Trust. More information on the fund is available at http://carbonandenergyfund.net/

Case study 2 NHS Carbon and Energy Fund Crawley Hosptial The hospital is a 60's style tower block with all the normal problems that go with that type of building. It was heated by large old oil boilers, the upper floors required new windows and domestic hot water were not within legionella temperatures. An investment of 2.5m was made, to be repaid over 12 years through guaranteed savings. The upper floors were also fitted with new PVC windows at no cost to Trust and the central boilers and unsightly chimneys removed. http://carbonandenergyfund.net/content.php?page=crawley_hospital
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RE:FIT RE:FIT is a procurement framework set up by the Greater London Authority (GLA) for the delivery of energy services in public sector buildings in London. An OJEU compliant framework of 12 energy service providers has been procured in a way that allows all public sector organisations in the UK, not just in London, to access the framework. The framework went live in January 2010 for 3 years with an option to extend for a fourth year. The public sector buyer identifies a portfolio of buildings they would like to retrofit, writes a project brief, runs a mini-competition and then selects an ESCO from the RE:FIT framework. The supplier installs energy contract measures (ECM) in identified buildings and guarantees annual energy savings over an agreed payback period. The public sector buyer pays up front for the capital cost of installing the ECMs from its own funds. This energy performance contracting model transfers the risk of performance of the ECMs to the ESCO for the term of the Agreement. The RE:FIT programme has therefore been aimed at building owners who have access to funding for energy efficiency programmes either from their own reserves or other sources (eg. debt). However, projects may also be able to access finance via the London Green Fund and LEEF. More information is available at http://www.lda.gov.uk/projects/refit/

Lease Arrangements
Having identified a piece of equipment that will reduce carbon emissions, it is possible to consider a lease rather than outright purchase. It is paid for out of revenue expenditure budgets rather than capital budgets. However, this will not keep the debt off balance sheet unless it can be clearly shown that the lease is not for the purpose of financing an asset (i.e. it is an operating lease rather than a finance lease). Operating leases leave ownership with the provider of the equipment. However, operating leases are normally only possible for short time periods, and it is important to ensure they represent value for money compared to buying the asset outright using public funds. Under an operating lease the finance provider is not required to disclose how they have calculated residual value at the end of the contract, this can be an area where they generate additional profits when organisations wish to retain the assets after the end of the contract.

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By definition an operating lease is one where the majority of risks (e.g. maintenance, asset value) remain with the provider. The minimum lease payments should normally be significantly lower than the value of the assets. If your organisation is in effect paying for the asset in instalments, it is unlikely to be an operating lease, and will need to be shown as debt on the balance sheet. Your finance department will be aware of the latest accounting standards and tests that apply. It is also important to secure the revenue expenditure budget to cover the regular payments over the lifetime of the asset.

Private Finance Initiative (PFI)

The suitability of Private Finance Initiatives is currently being reviewed for value for money based on concerns that these activities have a cost of capital far higher than that from public sector financing, and it is unlikely that many new PFI schemes will launch in the near future. However, we have included them in this report to ensure the full range of options are covered. Most PFI schemes have a funder (bank), builder (creator of the asset and part investor) and operator (who will manage the asset once created and may or may not be the builder). The end product is an asset that the public sector will have the benefit of using for a specified period of time at an agreed cost. The process is time consuming, really only for large infrastructure schemes, and requires central government approval. According to HM Treasury The objective of PFI procurement is to provide high quality public services that represent value for money for the taxpayer. It is therefore value for money, and not the accounting treatment, which is the key determinant of whether a project should go ahead or not. Purchasers should focus on how procurement can achieve risk transfer in a way that optimises value for money and must not transfer risks to the operator at the expense of value for money. The complexity of PFI and other similar projects requires that procurement follows the Competitive Dialogue approach, in which all bidding contractors are required to design the facilities up to a high level of detail, prior to selection. The purpose of this is to prevent the cost creep between contractor appointment and the finalised plans. A contract and procurement process is already in place for this procurement route and is vital for the success of any PFI arrangement. The public sector body normally appoints its own team to manage the procurement process, which will have an internal time and cost implication. As part of the PFI procurement, the public sector organisation can describe required energy performance in the output specifications alongside other required outcomes. These should not be limited to simple GJ per cubic metre measures but include performance on heat generation, lighting measures, temperatures, operating hours etc. This should then be regularly measured against parameters established in the output specification.

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It is important that the payment for the use of the PFI asset is adjusted for performance by the PFI operator. The latest contract documentation reflects a gain share type arrangement whereby the operator is incentivised to operate the PFI facility optimally rather than just pass through any energy costs. The energy efficiency of any facility should not be allowed to be fixed at its design level and continuous improvement should be an essential part of the contract. The following guidance is also relevant to PFIs: Department of Health (DH) PFI guidance - Standard form of agreement is maintained by the Capital Investment Department (and Private Finance Unit). A full suite of documentation is available, guiding NHS Trusts through the procurement. Design Development Protocol - This advises of the design process to be followed, requirements in relation to plans to be prepared and submitting by bidders. The Green book - This details the particular requirements in relation to PFI agreements.

Community Health Partnerships

Community Health Partnerships (CHP) deliver the NHS Local Improvement Finance Trust (LIFT) initiative, on behalf of DH, through the establishment of LIFT Companies. These are limited companies with the local NHS, CHP and the private sector partner all as shareholders. This limited company - the LIFTco - owns and maintains the building and leases the premises to NHS Trusts, GPs, Local Authority Social Services, dentists, pharmacists, etc. The funding sourced from Trust Capital or local authorities is 20% with the remainder from CHP and the private sector partner. NHS LIFT is flexible in respect of the type of buildings it provides, and allows the building design to reflect the needs of the services. To date LIFT has provided a range of building types including re-provision of GP premises, one stop primary care centres, integrated health and local authority service centres, and community hospitals. The LIFT company manages the development, from design through to build. The Trust typically appoints an internal Project Manager to manage internal design etc requirements. The LIFT Guidance may be helpful Lift guidance on the DH website The Trust will be required to reflect, within its specification, the desire to achieve carbon savings, and will need to ensure the private sector partners share this as a joint objective. This should be written into design requirements and standards. Where the LIFTco develops a new facility, it is important that guarantees of the energy performance of the building are written into any rental/lease contract between the Trust and LIFTco, ideally with penalties for poor performance.
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Bringing in private sector finance at scale

When you explore the funds available to deliver projects using your own sources of finance or specialist funds, you may find that what is available is not sufficient to meet your requirements. This could be because the project is larger than the organisation is prepared to fund, despite being a good project in other ways. With this result you may choose to explore whether you can raise funds from the private sector. However, the general principle set out in Managing Public Money3 always applies. Public sector organisations may only use private sector funds if they are able to achieve good value for money in so doing. The private sector option will only be value for money if the savings outweigh the additional finance cost, a suitable level of risk can be allocated to the private sector finance partner and lower cost finance is not available as an alternative. It is worth noting not all public sector bodies have this option available to them. Schools and the NHS are not able to use private sector finance. A summary of which bodies can access the different types of finance is available in Appendix D. In reviewing how to work with bespoke private sector finance it is important to understand that organisations in this area generally work on large-scale programmes and projects. They do this to spread due diligence and operational costs, so that they would far rather work on one 50m project than ten 5m projects. This presents a challenge to public sector bodies on how they can deliver this scale and often requires organisations to work together or to pool projects.

Finance over the lifetime of a project

In order to understand the how to bring in private sector finance it is firstly important to understand how an investor will look at financing your project The financing of projects, including low carbon projects, can be broken into 3 key phases; deployment, building track record, and exit, with increasing certainty on project outcomes being developed over time. See figure 3 below

http://www.hm-treasury.gov.uk/d/mpm_whole.pdf 22

Figure 3 Financing over the lifetime of a project Deployment. This is the first phase of financing a project where you are starting to implement a renewable energy or energy efficiency project. If the project is, say, a wind turbine this would include everything from the point you begin to prepare the site and network, purchase of equipment, installation and commissioning of the system. This can be a high risk stage because the system has not yet demonstrated it can operate successfully. The finance available at this stage of a project reflects the risks associated with financing it and can come in various mixes of equity and debt, and will cost more (ie cost of capital) to compensate finance providers for the risks taken. Many projects finance this first phase of a project using more expensive capital with the aim of building track record to refinance to a cheaper source of capital down track when the outputs are proven. Building track record. Continuing the example of the wind turbine, once the turbine is erected and commissioned it will begin to generate power and financial returns. The financial returns will be through power sold including incentives such as feed in tariffs. In the process of building up the business case for financing the turbine, feasibility and technical estimates will have been made on the expected returns. However until this cash flow actually starts to appear in the bank account of the project it is still an estimate, and so is not proven throughout the time required to finance the project. With wind projects, this is the time that a site moves from estimates to actual delivery based on how the wind blows and the turbine operates. Whoever has financed the project will be monitoring the project to ensure they receive the payments they are expecting. The project manager will also be monitoring the returns from the project to ensure it is delivering as planned, and that they can continue to service the finance requirements. This stage is about
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developing track record and ironing out teething problems, which is the evidence required to show a future investor that the project is proven and not just theoretical. Once you can show evidence of the financial returns your project is considered less risky than when you were starting out. Steady state/exit/refinance. The length of time it takes to develop track record varies between projects, with shorter periods for proven technologies and longer periods for newer or larger projects. When cash flows are stable, you can consider refinancing your project. The project would then be considered to be in a steady state and it is not uncommon for investors to then talk about an exit stage. In the case of providing project finance it is often the intention of a finance provider to fund the first phase with the expectation that the organisation they are funding will look to refinance once the project is proven. This therefore provides an exit route to the initial investor so that they can get their money back. For an investor to exit there must be sufficient track record to enable another investor to put their money in to the project, normally at a lower required return due to the decreased risk. The project needs to be in this steady state where cash flow is predictable and the operational risks are well known and mitigated against. It is the reliability of the cash flow and the understanding of risk that enables the next investor to provide finance at a lower cost of capital, which reduces the overall cost to the project. For a public sector funder, the refinance stage enables them to refinance the programme into the private sector so providing some replacement finance to use on new projects without stretching borrowing requirements. Using this approach you receive funds back much more quickly than with a revolving fund and it reduces overall liability. If you are considering a project where you and/ or the private sector investors might wish to refinance during the project lifetime, it is crucial to start with that end in mind. This means understanding what potential investors at the refinance stage will need, such as proven cashflows, reliable equipment with robust warranties, suitable contracts and management of long term risks.

Risk and Return

When assessing the business case for investment, an investor will look at the underlying risks of a project to determine what they would need as a return. High risk projects will be financed by those investors looking for a higher return on the capital invested to compensate for the extra risk taken in funding the project, conversely lower risk projects will be able to secure investment at a lower cost of capital. There are 5 key risks an investor will consider when they are looking to provide finance: Technology -this will include whether the technology is proven to perform at the scale required but also what warranties and guarantees there are in place on installation and performance; Deployment - this includes the availability and competence of the internal teams and external contractors to deliver the project to the required specification. It includes the ability to deliver the pipeline of projects
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required if the financing is for a programme of activity rather than a single project. For example if you were financing energy improvements to houses, it is the ability of the organisations responsible for delivering the project to sign up sufficient homes. In the case of district heating it would be the ability of the delivery organisation to connect up the required number of properties; Operations - this will include looking at what resources and competencies there are to monitor and manage the programme throughout its life. Investors will need to be confident that the systems and governance are in place to ensure that the project or programme continues to deliver cash flow as planned. This will include the delivery of maintenance and repair programmes; Supply - the consideration of supply side risks is about understanding what inputs a project is reliant on to make the necessary financial returns. For instance in the case of biomass heat you need a reliable supply of biomass/ wood. The investor will need to have confidence in the supply of those inputs, and at a cost that will ensure you make the necessary returns; Demand - the final area to consider is demand. Who will be purchasing or using the output of the project and how can you guarantee that level of demand over the lifetime of the financing so as to guarantee the cash flows? This is important, for instance, in the funding of decentralised energy where investors will be concerned that long term supply contracts may not be honoured should a buyer go out of business.

Private sector investors will need you to consider these risks - but it is also a useful way to assess the viability of your project in order to put together a robust business case for your own finance department. Further information about building a business case can be found in Appendix C.

Sources of Private Sector Funding

This section covers the different sources of private sector funding that can be used for low carbon programmes, in some cases without the liability being taken by the public sector organisation. These funds are accessed either directly by your organisation, or more likely through the creation of a separate financing and delivery vehicle. Before looking at private sector finance it is important to have in mind the difference between debt and equity finance. Debt, or loan, finance is where money is invested in a project with return being provided by regular repayments over a specified time, which includes repayment of the original sum and interest. Equity finance is the finance that is at most risk and is provided by investors who take a share of ownership in the company and expect a suitable return for the risk they are taking on. They do not require scheduled payments as required by debt providers but expect in time to make a return through increased value of the company, realised through the sale of the company, or payment of dividends when there is suitable build up of funds.

Banking lending
Secured lending the bank lends money for a project with security provided by the public sector organisation. This can be through a bank guarantee or against
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particular assets financed through asset finance companies such as Siemens. This will impact the balance sheet liabilities of the public sector organisation which means it needs to fall within its overall borrowing limits.

Project finance
Equity investors and banks will provide the finance to a Special Purpose Vehicle (SPV) or company specifically created to deliver a programme. This means that the cash flows out and back from the SPV are ring-fenced and with liabilities limited for the funders to the money they have provided. Equity for projects can be raised through the following sources: Private direct investment private individuals can invest into a company Infrastructure funds these invest in projects where the technology is proven and finance is required to roll out measures such as wind farms. They will look for pre-tax returns of about 15% IRR. Private equity funds these buy into or buy out existing companies and are not generally applicable to new low carbon finance vehicles Venture capital venture capital funds can put some of their funds into a programme although more often they are looking for companies into which they can invest. They will generally look for a 30% return on investment (IRR) and invest when a business is cash generating, but before it is profitable. Tax efficient private investor funds such as Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS) generally look for lower returns and some are looking for investment in energy efficiency and renewable energy projects.

Debt can be provided through a range of sources Non- recourse debt - Non-recourse project finance debt from banks is secured against future cash flows from the programme (i.e. the security for the loan is not provided directly by the public sector organisation). Given the risks to the lender, this generally comes with some quite tough conditions and due diligence to ensure savings will be realised. The cost of this due diligence is high and most banks will not consider lending unless the size of the debt is at least 25-40m. Furthermore that loan is always protected from first loss risk by equity finance or a slice of first loss (higher risk) debt. The ratio of debt to equity is usually high (perhaps 70% debt: 30% equity) so that the 40m debt leads to a project of at least 60m. Banks will fix the interest rate for this lending, but probably for no more than 15 years. There are some specialist low carbon lenders such as Triodos and the Cooperative Bank who are more open to smaller scale financing, so it is possible to explore whether they might finance projects. However, they may want security on the debt in addition to that from the project and they only have a limited amount of funds. Mezzanine finance this finance sits between the debt layer and the first loss equity layer. In this situation, the standard debt is paid back first (lowest risk to the lender), followed by the mezzanine debt and finally the equity. It is often more expensive than straight lending but cheaper than
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equity. It can be structured in a number of ways, for instance debt can convert into equity. There is not always mezzanine finance in a programme. Junior debt this is debt that is paid after the senior debt has received its due payments. There is not always junior debt in a programme. Debt funds. There are not many debt funds available although this new area is slowly growing given the lack of financing by banks. These generally lend to low risk projects and take a higher return than banks. Venture debt funds fund new companies to take them through to being cash positive and debt funds generally fund projects that roll out proven technology. Sometimes debt funds are used to supplement bank finance. Not many funds are active in energy efficiency projects although some are financing renewable energy.

Bond finance
Bonds are tradeable investment products where investors buy the rights to future cash flows from the issuer of the bond. For the issuer, they are similar to borrowing money with an upfront agreed interest rate and repayment schedule. Local authorities can issue bonds to finance their balance sheets, but most other organisations might consider project bonds which finance specific projects. These are not common but universities have issued them to finance student accomodation. Retail bonds of say, 15m, can be used to target the private investor. However, they are often bought out of customer/brand loyalty (eg Ecotricity) rather than straight investment returns and so the issuer needs to be suitably strong in this area. Bonds are not generally suitable for the initial direct financing of low carbon vehicles given that they require track record on performance. They, however, could be used to refinance large scale projects (or bundles of projects such as a whole building/ estate retrofit) or to bring in additional finance should there be sufficient certainty of cash flows. There are two types of bonds that could be considered at this stage Corporate bonds or Asset Back Securities issued by the financing vehicle with a track record. These are large, liquid bonds that are tradable in the market and need to be 300-500m in size. Private bonds these are smaller bonds targeted at the institutional investor market and can be less than 100m. However, there are a limited number of buyers in this market and it would therefore be challenging to use these to raise finance

Social finance
Social finance is an emerging class of investment made by High Net Worth investors and foundations. They should be viewed as investors who want to receive a return on their funds but want their investments to deliver social and environmental benefits. They may accept lower returns than with other investments and there are three ways in which their capital can be used: Loan finance provision of low cost loans
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Social finance bonds purchase of bonds where bond payments are made contingent on delivery of social and environmental benefits Equity finance as with equity above.

Blending finance
All these types of finance can be mixed into finance vehicles to create funds for financing low carbon projects. Investors create stacks with the highest risk investments on the bottom shielding lower risk- and cheaper- debt on the top. The aim is to keep the weighted average cost of capital (WACC) as low as possible. This blending of finance in a vehicle is illustrated below.

Figure 4 example of blended finance This finance is often invested into an SPV created to finance the project. If finance is to be provided for SPVs, then this generally has to be done at scale. The costs for the finance sector in setting up programmes in legal and project management fees can be quite high which means that they would often be looking to fund projects or a programme of 50-100m minimum. For public bodies who want to bring in private sector finance this can be a challenge and requires grouping of projects to achieve this scale. There are some banks that might lend to smaller programmes but often they will want security so bringing the venture onto the public sector balance sheet. Some public sector organisations can also lend to these independent or subsidiary ventures alongside private sector money. See Appendix D for information on which organisations can lend to a 3rd party. They might do this in order to share risk with the private sector and provide finance to areas where there might be limited appetite from the private sector. The interest rates at which public bodies can do this will be subject to state aid rules and the risk profile of the venture and this is discussed in the next section.
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The role of public bodies in accessing private sector finance

A significant part of unlocking the flow of private capital into low carbon investment is creating programmes and investment opportunities for private sector investors at the right scale. It is worth reviewing the public sector strengths when it comes to creating sizeable investment opportunities for the private sector.

Convening power
Public and not for profit bodies have the ability to work across sectors. For instance local authorities can convene programmes across their own buildings and those of fire, social housing, police and maintained schools. They also have the ability to work across boundaries and adopt common processes and practices. Central government procurement procures energy on behalf of all central departments and a range of other public sector organisations It is the public sectors ability to do things in a common way because bodies are not in competition with one another that allows them to create programmes with the underlying consistency needed to aggregate a number of individual projects together to achieve sufficient scale. Grouping projects so that finance is raised for a suite of projects across different buildings or organisations means that the needs of finance programmes to achieve scale and spread risk can be met, making finance cheaper and more easily available. The public sector also has relationships across a large number of other organisations including business and community interests. This provides the ability to broker solutions that cross public and private sector interests. They do this through activities such as managing Local Enterprise Partnerships, running procurement programmes and the simple approach of getting the right people into the right rooms to meet and discuss the issues. Public and not for profit bodies have the independence and staying power to help see this through.

De- risking
With any investment programme it is important to understand the key risks to the finance provider and the public body, and put in place ways to minimise those risks. In particular when you are considering creating large-scale programmes one of the key risks is how to generate sufficient demand. The public sector has the ability to reduce the risks associated with creating a programme of sufficient scale. It can do this by using public assets, by providing long term contracts for maintenance or supply and through the convening power to engage other potential project partners. With these activities banks might be persuaded that less of the expensive equity or mezzanine might be required in a programme, and that they can put in more low cost lending. These activities might reduce the overall cost of finance of a project, improving value for money

Enabling finance
The public sector can often borrow at a lower rate and on more favourable terms. In some cases this borrowing is from central government, in other cases it is from banks such as the European Investment Bank (EIB). It can use this finance to
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populate parts of the programme that is not attractive to investors. This may mean that it takes a higher risk position than would normally be expected for the return it receives, but that can be justified by the broader environmental and social outcomes required, as well as the need to show private investors that the public body believes the savings are real. As well as lending to a programme, perhaps into an SPV alongside private sector finance, public bodies can use their revenue accounts to pay for legal and other fees, issue warranties on debt instead of providing the debt, and use European funds as grants or finance that has to be repaid for technical costs.

Accessing the finance

All these activities are important because to access much of this private sector finance, something needs to be created into which the private sector will invest or to which it will lend. This is generally through an SPV as described above. Investors want to know what the funds will be used for, how they will make a return and how the risks will be managed. If they cannot or will not finance the public sector body itself, then they need something else to finance and this entity has to be created, often specifically for this role. With that in mind and with a strong business plan covering the long term cash flows out and back into this entity then an investors interest can be caught. They will want to carry out significant due diligence, to understand where they stand in the pecking order in the stack (figure 4) and how their funds will make a return. Investors invest in specific projects and will only show vague interest whilst your thinking is progressing. However, the creation of a business plan and investable project with real specifics will mean that you can have a more detailed conversation. When public sector finance and other support are provided to these programmes then it may be necessary to carry out a review of state aid issues. European rules on state aid require that public sector should not distort free market competition and so any public sector intervention will need to demonstrate this is not the case. If most of the programmes are directed at public sector buildings and programmes, then this will be less of an issue. However, if the solutions provide support into private sector programmes then advice should be sought.

Sourcing private sector finance

Sources that can put you in touch with the some or all of the range of finance providers discussed above include: Banks with which your organisation has relationships Consultancies, legal and accountancy firms with which your organisation has relationships Organisations such as the Carbon Trust and Energy Saving Trust who have contacts in the market

At the Carbon Trust please contact [email protected]

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Case study 3 - Birmingham Energy Savers Birmingham City Council (BCC) is using a large scale innovative programme to enable the financing of energy efficiency programmes for a range of public sector buildings, leveraging a domestic energy efficiency programme to do this. The programme, developed with the Energy Saving Trust and Marksman Consulting, uses the ability of public sector organisations to borrow as a means of accessing early stage project finance. This investment is repaid through savings made, using the Green Deal as a means of collecting payments via the electricity bill. The finance is deployed through a procured delivery partner from the private sector who is responsible for signing up householders and public sector building managers, having the measures installed and collecting the payments via the delivery partners back into the finance process. The finance vehicle is wholly funded from the participating public sector bodies who in turn access finance from prudential borrowing or use of reserves. Technically private sector finance could also be provided as equity from infrastructure funds or from the delivery partner, or as debt from commercial banks, but given the costs of doing this and resulting governance issues this was not seen as attractive in the base business case. Whilst BCC provides necessary scale required to attract private sector interest, it was decided that this should be offered out to other public sector bodies in the West Midlands. This means twenty-two other local authorities, eleven housing authorities, two policies forces and one fire service also came forward to provide finance to the process with amounts ranging from Birminghams initial 75m to those as low as 100,000. The initial size of the programme is 275m but the objective is to extend this to 1.4b should the first phase go well. The plan is to refinance the programme, bringing in private money to reduce the debt on the public balance sheet, through either the issue of a bond or the use of a banking warehouse which aggregates loans and in turn issues a bond. This model demonstrates three core attributes for attracting private sector finance; Use of local authority convening power to bring together a programme that brings scale Provision of own assets to provide certainty to the private sector of strength of pipeline Use of local authority finance to provide project finance for subsequent refinancing by the private sector using the bond market

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Appendices
Hopefully this guide has provided a useful overview of the funds available to the public sector, considerations of scale of financing and some advice on bringing in private sector finance. The following appendices provide more detail Procurement and contracting Assessing costs Building a business case Summary of which organisations can access the different types of finance.

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Appendix A: Procurement, Contracting and implementation

There is a mass of advice and guidance on the procurement, contracting and implementation processes. The purpose here is to give some insight into the various procurement processes and provide advice on how they can be optimised to deliver the anticipated carbon reductions.

Overview
Whatever the procurement and contracting process there are several common factors to consider: Be specific about the design and performance that you need Get specialist input to advise on design Make sure you can measure the performance you are achieving Use whole life costing and carbon analysis when evaluating bids and tenders Build in penalties where actual solution does not meet the design specification Provide incentives to the supplier to deliver carbon and cost savings Consider carbon emissions during construction phase Ensure carbon reduction is a continuous process. If you are a tenant, you are effectively procuring a building and its associated energy services for your landlord and you will therefore need their agreement, and good procurement will be key to achieving energy efficiency and carbon savings.

Traditional procurement
Traditional procurement is usually used to reflect the process where the organisation retains management and control over the whole procurement cycle, employing specialist technical staff to design, tender and procure any assets or service. For larger schemes the public body may need to appoint a design team under competition to work on its behalf. However, an internal Project Director is still usually necessary. The following guidance may be helpful: Capital Investment Manual - this provides guidance on procurement steps, business case requirements and preparation and post project evaluation; Green Book guidance - The Treasury Green Book sets out the core principles on which all public sector economic assessment is based. See Appendix C for more details; Office Government Commerce Achieving Excellence in Construction: provides detailed guidance on procurement steps for construction projects (setting up teams, roles and responsibilities, evaluation etc). OGC guidance details appropriate Gateway reviews (checks at key milestones), to establish project is on track as per client requirements, and thus opportunity to abort commitment if not meeting client requirements;
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Health Building Notes - HBNs detail the space and area requirements for the departments. These are summarised as Departmental Cost allowance Guides (DCAG), which are used in determining the size of the facility and ultimately the cost; Healthcare capital investment Summary DCAGs to build-up costs per department; Framework guidance for the Estates content of business cases sets out relevant Estate detail required for a capital investment business case.

The following methods are available to reflect carbon and energy in procurement. The key requirement is to include all requisite elements as selection criteria in the appraisal process: Procurement - use electronic tendering system; Product specification - set out lowest carbon products as a project selection criteria. Tender return documentation to require details of product selection as noted. In addition, tenderers to be encouraged to propose alternative energy provisions. Study of options, detailing whole life benefits, to include sustainability, financial and lifecycle costings to demonstrate benefit of investment with payback; Construction phase - note energy / utility usage as a key selection criterion. (issues relating to construction waste management are standard requirements); Operational phase - detail projected operational period energy consumption as selection criteria; General note - energy usage and carbon reducing mechanisms to be detailed in a separate tender return document, for appraisal and assessment . Competitors to be encouraged to be innovative and propose alternate solutions.

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Appendix B: Assessing the costs

The table below shows some of the typical revenue and capital considerations to look at for different categories of carbon reduction projects:

Revenue considerations Energy/fuel/transport/waste savings in financial terms. One off installation or commissioning costs that cant be capitalised. Annual running costs. On-going maintenance costs or savings. Potential for income generation. External services or consultancies employed. Internal manpower. Comms/PR materials.

Capital considerations Purchase/ build cost. Project management, commissioning and installation costs capable of being capitalised. Lifetime of the asset (lifecycle costs perhaps insert a footnote here about what lifecycle costs are). Residual value of asset at end of life. Any metering or other long term assets. IT systems, infrastructure or other equipment needed to support changes. Additional costs to meet carbon standards. Options for exceeding minimum standards. Possible depreciation on released assets.

As a minimum it is recommended that you complete a table such as the one below that summarises the cash flow implications of each carbon reduction opportunity/project. The number of years you need to project forward will depend on the nature of the opportunity and the life of any assets purchased/built. Get advice from your finance department about whether to factor in general inflation, to discount future cash flows, and what rate to use.

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Year 0 Capital cash flows Purchase of asset () Revenue cash flows Installation () Maintenance () Energy savings electricity kWh price per kWh (pence) Savings () Carbon savings (tonnes) Annual cash flow () Cumulative cash flow () Discounted at 3.5% () Cumulative DCF () -24000 -24000 -24000 -24000 9.00 -2000 -22000

Year 1

Year 2

Year 3

Year 4

Year 5

300 60000 9.45 5670 31.4 5970 -18030 5768 -18232

200 60000 9.92 5954 31.4 6154 -11876 5745 -12487

200 60000 10.42 6251 31.4 6451 -5425 5818 -6669

200 55000 10.94 6017 28.8 6217 792 5418 -1251

100 55000 11.49 6318 28.8 6418 7210 5404 4153

Figure 5 - Example of basic financial data required for an opportunity This analysis shows the simple payback for the opportunity. In the example shown the opportunity pays back in year 4, with savings being made both on maintenance and on energy costs. Consult the finance department about what the payback needs to be for this type of opportunity in your organisation. They will also need you to provide some high level details to support the figures quoted and in particular the basis of the savings / reductions quoted. This will give your case more credibility, and enable you to monitor savings against the proposed plan. For larger expenditure items, and for longer term projects, HM Treasury recommends using discounted cash flow analysis to realistically assess the whole life cost, or net present value (NPV) of the opportunity. Discounted cash flows take inflation into account, so that the total net benefit (or cost) of the project over its lifetime is expressed in todays money. The method is covered in detail in the Treasury Green Book http://www.hm-treasury.gov.uk/data_greenbook_index.htm In the bottom two rows of figure 2, the simple cash flows have been discounted by 3.5% (the discount rate recommended by HMT) to show both annual and cumulative discounted cash flows. You can see that, on the basis of discounted cash flows, the opportunity pays back in year 5 rather than year 4. If the asset had a five year life, the net present value (the sum of the discounted cash flows) would be 4,153. If it had a ten year life, the NPV would be considerably higher.
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Project prioritisation
In financial terms, any capital spend that pays back in less than 5 years is likely to be a good investment. However, many projects have a significantly quicker payback- Carbon Trust experience of working with the public sector suggests that about a third of opportunities identified by public sector bodies pay back in less than a year. Examples include simple controls and sensors, BMS tuning, energy profiling, metering and targeting, and awareness and waste campaigns. It is important to prioritise these projects for implementation first, both to achieve rapid carbon reductions and to make the most rapid efficiency savings. Larger projects will require the net present value of the project to be calculated over the project lifetime as described above. Lifecycle costing can be a very powerful tool for making the business case for larger invest to save carbon reduction projects, as they often generate significant savings over the project lifetime. It is also very useful for ensuring value for money and energy efficiency when making significant purchases, such as new buildings, cars and energy using equipment. Another financial tool that is sometimes used to prioritise projects is the project Internal Rate of Return (or IRR). This is defined as the discount rate at which the net present value (NPV) of the project is zero, and is a measure of the rate at which the project pays back its initial cost. IRR is less simple to calculate than payback and NPV, and should not be necessary unless your organisation has a policy of using IRR. Projects can also be prioritised on tonnes of carbon saved per pound invested, if carbon reduction is the principal objective. Remember that a project saving 100 tonnes of carbon in one year is better than a project saving 100 tonnes over 10 years, as the savings occur sooner. Lastly, remember that many carbon and energy projects have ancillary benefits beyond energy cost reduction and carbon reduction. These can include: Greater resilience and reliability of equipment Greater compliance with legislation such as CRC and carbon reduction targets Improvements in the environment for building users (for example students and patients) Reduced maintenance costs (as in the example in Figure 2 above) It is important to factor these into the business case as well as explained in Appendix C.

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Appendix C: Building a Business Case

The Treasury Green Book 4 states that All new policies, programmes and projects, whether revenue, capital or regulatory, should be subject to comprehensive but proportionate assessment, wherever it is practicable, so as best to promote the public interest. The term proportionate is relevant here and it is important that you determine whether formal Strategic Outline Cases (SOC) or Outline Business Cases (OBC) are required. They are unlikely to be necessary for smaller projects- your Finance Director should know the limits above which formal business cases are required. There will also be internal requirements contained within your Standing Orders and/or Standing Financial Instructions about the appropriate business case process that should be followed. It is recommended that you follow the 5 case model developed by HM Treasury 5 for all opportunities although smaller initiatives will only need a relatively short summarised case to be made. The five cases are: Strategic case supported by a robust case for change Economic case - optimise value for money Commercial case - commercially viable Financial case - financially affordable Management case achievable and with senior level commitment.

The nature of the business case will vary according to the type and size of the opportunity. You will need to be aware of your organisations Standing Orders and Standing Financial instructions and the requirements of the relevant guidance e.g. NHS Capital Investment Manual 6, Treasury Green Book 7, PFI guidance 8. A full exposition of the business case process is not appropriate here and is well documented (see above references). In particular the Treasury Green Book sets out how to model various opportunities using a variety of techniques such as Monte Carlo simulation and uncertainty analysis.

The Green Book HM Treasury - http://www.hmtreasury.gov.uk/data_greenbook_guidance.htm 5 Public Sector Business Cases using the Five Case Model: a Toolkit HM Treasury http://www.hm-treasury.gov.uk/d/greenbook_toolkitguide170707.pdf 6 Capital Investment manual NHS 1994 7 HM Treasury Green Book - http://www.hmtreasury.gov.uk/data_greenbook_guidance.htm 8 NHS PFI guidance http://www.dh.gov.uk/en/Aboutus/Procurementandproposals/PublicPrivatePartnership/Pr ivateFinanceInitiative/PFIGuidance/DH_4015889 38

A key element of any business case for carbon management opportunities will be the anticipated carbon savings. Manufacturer claims can sometimes be optimistic so it is recommended that hard evidence of implementations at other organisations is obtained and that the savings are sense checked by independent carbon management consultants.

Types of Business Case

There are 3 stages to a business case. Depending on the size of your project you may not need to do all 3. Your finance department will be able to advise you. 1. Strategic Outline Case (SOC) 2. Outline Business Case (OBC) 3. Full Business Case (FBC) Strategic Outline Case (SOC) The SOC is a brief, preliminary document of no more than 5 or 6 pages that introduces the basic project concept and contains enough detail to support an informed decision on whether to proceed to an OBC. It should include a preliminary assessment of strategic fit, options, value for money, affordability and achievability. Key elements in a SOC include: the project concept and rationale for public sector intervention; initial statements of strategic aims, business need and project objectives; relevant management considerations, including necessary stakeholder consultations and legal issues; high level consideration of possible options; very preliminary assessment of costs, benefits, risks and funding and affordability. Subject to agreement to invest further time in the business case an Outline Business Case (OBC) would be your next step.

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Outline Business Case

1. On SOC approval appoint team to prepare Outline Business Case (OBC) 2. To take forward long list of options and establish shortlist 3. Set benefits, selection criteria and weighting and identify preferred option. 4. Depending on project and approach (traditional, PFI/PPP, P21 etc) undertake design with users, progress local authority planning 5. Develop costs of project, detailing all capital and revenue implications 6. Set out proposed and projected carbon savings 7. Where appropriate, secure outline planning permission 8. Write Outline Business Case and seek approval 9. Seek appropriate approval (e.g. Board, sponsoring Government Department) 10. When move to full Full business Businesscase. Case (FBC) The final stage,approved if required, is the

Full business case and implementation

1. On OBC approval re-appoint team and proceed to Full Business Case (FBC) Finalise any outstanding design elements Prepare contract documentation, specifications, tender documents, etc. This bundle of documents is often referred to as PIN project information notification. Proceed to full planning Tender project Collate price and prepare FBC Start early enabling works if required and where confident of support to FBC (i.e. supportive dialogue with SHA / DH) 2. On FBC approval Sign and complete contract Begin works Monitor as appropriate 3. On completion of contract works Undertake works Complete technical commissioning tasks (tests etc) Handover of facility Occupation 4. Complete Post Project evaluation after 1 year

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Appendix D: Sources of funds open to public sector organisations

General financing
General financing is when the public sector body uses its own balance sheet to finance specific projects such as invest to save. This borrowing is managed by treasury functions within finance departments who will access funds in the most optimal away across all projects and core activities. It is not expected that sustainability professionals would apply for this type of financing directly.
Balance sheet funding e.g. internal cash or reserves Central government departments Local authorities NHS From central budgets Central government Local taxes Central government funding Borrowing for projects National Loans Fund From commercial banks, PWLB and EIB Tax Incremental Financing From commercial banks if Foundation Trusts Public Dividend Capital and Capital Investment Loans Foundation Trust Financing Facility From commercial banks and EIB From commercial banks From commercial banks and PWLB All schools need secretary of state approval to borrow Able to issue bonds, but generally not seen to be an efficient approach Bonds

Higher Education Further Education Police and fire service Schools

From student loans and central government funding Research and commercial income From local authority funds From local authority funds From local authority funds if LA owned Academies from General Annual Grant (GAG), paid by the Young People's Learning Agency (YPLA) Free Schools via DoE using a formula as with academies

Able to issue project bonds underwritten by the establishment

Specific project financing

These are source of funds that might be available for specific projects. It is important to ensure that the necessary scale is in place for the source of funds. Grants Generally small grants for technical assistance costs towards large projects Invest to save funds Sources of funds for small projects ESCOs with private sector finance Sources of funds for larger projects Financing of ventures with third party capital This describes whether public sector bodies are able to provide finance to third party companies, at times alongside private sector finance

Central government departments

ERDF

Partnership for Renewables Carbon Trust/Siemens loans scheme LEEF for London bodies EEE-F Salix Partnership for Renewables Carbon Trust/Siemens loans scheme LEEF for London bodies EEE-F Salix Partnership for Renewables Carbon Trust/Siemens loans scheme LEEF for London bodies EEE-F Salix

London REFIT

Local authorities

European ERDF ELENA IEE EEE-F Life+

London REFIT

Allowable and underway

NHS

NHS Carbon and Energy Fund London REFIT

Community Health Partnerships via Local Improvement Finance Trust PFI

London REFIT

Off balance sheet PPP e.g.

Grants Higher Education ERDF RGF

Invest to save funds Partnership for Renewables Carbon Trust/Siemens loans scheme LEEF for London bodies Revolving Green Fund EEE-F Salix Partnership for Renewables From local authorities Carbon Trust/Siemens loans scheme LEEF for London bodies EEE-F Salix Partnership for Renewables Carbon Trust/Siemens loans scheme LEEF for London bodies EEE-F Salix Partnership for Renewables Carbon Trust/Siemens loans scheme LEEF - for LA owned schools only EEE-F Salix Partnership for Renewables Carbon Trust/Siemens loans scheme EEE-F

ESCOs with private sector finance

Financing of ventures with third party capital partnership with construction company and facilities manager to build student accommodation

London REFIT

Further Education

ERDF SFA

Police and fire service

London REFIT

Schools LA controlled

ERDF

London REFIT for LA owned schools only

Schools Academies and Free Schools

ERDF