Contact the SmartLessons program at smartlessons@ifc.org.

SmartLessons in Energy Efficiency Recognizing the vast market represented by cost-effective investment opportunities in energy efficiency, in 1998 IFC began working with the Global Environment Facility (GEF) to address climate change through innovative market-based approaches to greenhouse gas mitigation. This led to IFC’s early initial pilot energy efficiency lending projects, in which IFC partnered with financial intermediaries to develop specialized energy efficiency finance products. Support from GEF and other key donors, including the governments of Austria, Finland, Netherlands, Spain, and the United States has bolstered IFC’s efforts in promoting energy efficiency projects and facilitated replication in increasingly more challenging markets in a self-sustaining manner.

Energy efficiency investment opportunities reside everywhere, in each sector and in every market. They are embedded in virtually every capital improvement project, whether in the industrial, commercial, institutional, or residential sector. They emerge either as stand-alone investment projects or as a component of a larger project. This universe of projects represents a set of investments which typically are highly cost-effective due to a broad set of benefits, including labor cost savings, improved quality and reliability of products and services generated from the projects, reduced pollution and waste, and energy savings which typically provide paybacks ranging from six months to five years. Although IFC’s initial pilot program was primarily donor funded, the leverage of the donor funds employed has consistently and substantially grown.

While energy efficiency opportunities exist as embedded components of larger projects across the entire spectrum of IFC’s core industry sector investment business, perhaps the greatest opportunities for energy efficiency investment exist as smaller discrete projects, including cogeneration systems, lighting renovations, motor retrofits, and control systems. The relatively smaller size of these energy efficiency projects exhibits an inherent mismatch with IFC’s comparative advantage and capacity to invest directly. However, energy efficiency finance has proven to be an excellent market opportunity for many of IFC’s financial intermediary partner banks and leasing companies. And IFC has played an important role in supporting partner financial intermediaries in developing this market.

By providing a package of advisory services and financial products, IFC has made a business of energy efficiency finance for projects which are individually smaller than IFC’s investment threshold but which is scaleable through the financial intermediary partners for whom such projects are a good fit. The advisory services support market development, financial intermediary product development, financial intermediary capacity building, and the building of an initial project pipeline, while the financial products range from long-term credit lines to risk-sharing instruments.

In addition to generating the advisory and investment products which underpin IFC’s energy efficiency finance business, the programs featured in this collection of SmartLessons provide the knowledge platform upon which the IFC business is being built. This includes the IFC professionals who staff these program teams, as well as the materials and resources which will be useful for global teams looking to replicate and adapt these products to their regions.

Russell SturmSustainable Energy Team Leader

IFC Sustainability Business Innovation Group

DISCLAIMER

IFC SmartLessons is an awards program to share lessons learned in development-oriented advisory services and investment operations. The findings, interpretations, and conclusions expressed in this paper are those of the author(s) and do not necessarily reflect the views of IFC or its partner organizations, the Executive Directors of The World Bank or the governments they represent. IFC does not assume any responsibility for the completeness or accuracy of the information contained in this document.

SmartLesson 1 4Working Together to Move Client Relationships from Advice to Partnership in Sustainable Energy Finance by William Beloe

SmartLesson 2 8

My, How You Have Grown! The First Large-Scale Energy EfficiencyMainstream Investment through a Financial Intermediary by Judit Braxatoris

SmartLesson 3 12

Turning Project Delays into Opportunity: Renewable Energy Financingin Peru by Alberto Didoni

SmartLesson 4 15

From Free to Fee - Charging for Advice While Introducing an Innovative Financial Product by Yana Gorbatenko

SmartLesson 5 19

Lending to a “Different Animal”: Energy Efficiency Renovation of Multi-Family Housing Buildings in Hungary by Tibor Kludovacz

SmartLesson 6 22

Lessons in Promoting Energy Efficiency by Eluma P. Obidbuaku

SmartLesson 7 26

Adaptation for Adoption: Mainstreaming Energy Efficiency in FinancialInstitutions by Miles Stump

SmartLesson 8 30

Sustainable Energy Investment Scale-Up and Mainstreamingby Pavol Vajda and Alexandra Glatznerova

4 SmartLessons

Working TogeTher To Move ClienT relaTionships froM adviCe To parTnership in susTainable energy finanCe

WilliaM beloe

IFC has successfully developed sustainable energy projects in a number of emerging markets over the last decade. While each intervention is tailored to its specific markets and the needs of our clients, in general the initiatives have focused on using local financial institutions as aggregating agents to stimulate investment in both energy efficiency and renewable energy, thus reducing operating costs of the client (and improving the clients’ margins) and emissions of greenhouse gas. This Smart-Lesson focuses on the sustainable energy finance project IFC has developed in the Philippines and how we have leveraged more developed projects and ensured a one-IFC approach. It highlights the importance of focused research, listening to and being responsive to clients, and maintaining flexibility and realistic objectives in the program design. This paper is intended for colleagues responsible for developing projects in various business lines and regions, with particular relevance to those involved with either sustainable energy or local financial institutions.

Background

The Philippines Sustainable Energy Finance Project (“Phils SEF” or the “Project”) supports the creation of a commercial financing market for sustainable energy projects in the Philippines. This program assists the Philippines in improving energy security and economic productivity, and promoting private enterprise in the en-ergy sector. Phils SEF covers both energy efficiency and renewable energy projects.

The program is designed to leverage IFC’s capabilities and experience, backed by donor resources to catalyze financing for sustainable energy projects, and is expected to result in: (i) improved access to financing for sustain-able energy projects, which will continue beyond the support of IFC financial instruments and advisory ser-vices; (ii) growth and business development for private enterprises related to energy efficiency and renewable energy projects; and (iii) promotion of more sustainable development, with better use of natural resources and a reduction in projected greenhouse gas emissions. This program also supports the national government, as it im-plements both its national energy efficiency and climate change mitigation campaigns.

The IFC signed cooperation agreements with two of the Philippines’ three largest financial institutions

earlier this year to provide them with the support nec-essary to develop portfolios in the area of sustainable energy (energy efficiency and renewable energy). Phils SEF is an 18-month engagement worth approximately US$650,000 focused on building capacity, pipelines, and portfolios within financial institutions and raising awareness for the business cases behind energy efficiency and renewable energy for the wider community.

The Project went through a number of clear stages before we got to where we are today. These stages are elaborated below and so are the lessons learned.

Lesson 1: While a market opportunity may look obvious to you, it may not to your client. Bringing value to clients is easier once you understand what they want.

The inception of this project, like many others in this space, began with some important work done by IFC’s Environment and Social Development Department (CES). They undertook research three years ago compar-ing various countries in order to ascertain the next mar-ket to roll out an SEF program. This was a key step, and the Philippines was clearly the most appropriate market. Our research showed that there was a strong business

“We don’t see things as they are. We see things as we are.” - Anais Nin

SmartLessons 5

case for SEF. With electricity prices consistently among the highest in the region, over 50 percent of power reli-ant on imported oil, but with a comparatively sophisti-cated local banking industry, government commitment to energy efficiency, and renewable energy, the country had significant potential to see rapid growth in the sus-tainable energy financing market. However, when we took these findings to the local financial institutions, it became clear that, while they were interested in the con-cept, even the most enthusiastic of them were unwilling to invest resources in building internal capacity to lend to this market. While the business case looked clear to us, the local financial institutions needed more detailed data before they would seriously consider investing in the market.

In order to begin work with the financial institutions, we needed to undertake some more detailed, local research to garner the necessary information about the size of dif-ferent market segments, the barriers to developing them, the potential financing opportunities they contained, potential pipelines, deal aggregators, etc.

This gave us a chance to do two things:

1. Establish a clear strategy with our investment services colleagues at IFC’s Global Financial Markets Depart-ment (CGF) as to which clients IFC most wanted to build a relationship with. IFC Philippines investment and advisory services teams had already agreed that the financial markets sector was a key pillar of our country strategy. Working with the investment team to identify and then cultivate relationships with key potential cli-ents allowed advisory services to leverage the stronger relationships that our investment services colleagues had with the local financial institutions’ senior management. Meanwhile, advisory services could offer services to the financial institutions that could help unlock the door to greater interaction with these clients. It also meant that we were working in tandem to develop these rela-tionships. When we met obstacles, we could brainstorm together to work out the best strategies for overcoming them.

2. Based on the joint strategy we developed as a result of the above point, we were able to focus on two or three banks with which to begin the program, and to under-take the research that was of most use to those banks.

Once we had completed these pieces of research, we

shared our findings with the wider financial community. However, our priority clients were the keenest and most enthusiastic to work with us in developing the opportu-nities this research had uncovered and, as such, we were able to leverage the research into engaging with both of them. Both the financial institutions were now willing to invest in allocating a small group of their staff to be tasked with developing the project and delivering on SEF pipeline and portfolio objectives and, in both cases, paying 50 percent of the costs for the specific work that was designed for them.

An additional advantage of the close working relation-ship between advisory and investment services is that by working in the sustainable energy field, investment col-leagues are able to introduce financial products to clients that help mitigate climate change, a key World Bank Group strategic pillar. This provides them with a clear “additionality” role, where IFC is providing a service that is not otherwise available in the market.

Lesson 2: Leveraging success from elsewhere does not mean adopting it in its entirety. Adaptation is a powerful tool.

As we were building relationships with these priority cli-ents, the IFC team, including local as well as regional and global investment teams, advisory services, environment and social development department, and structured fi-nance colleagues, were all on the same page with regard to the model we wished to leverage. We had spent time looking at the models that had been successful elsewhere. We engaged and received valuable support from IFC en-ergy efficiency programs in Central Europe, Russia, and China, as well as from IFC’s headquarters.

The China model in particular was recognized as a suc-cess we wanted to emulate. It included advisory and investment services engagements in lock step. In order for this model to work, financial institutions needed to buy into the opportunity both by paying fees for advice, (and investing their own resources in building capacity and pipelines), and by entering into a financial engage-ment at the same time, before the pipeline had been built. Philippine banks are comparatively sophisticated, compared to other emerging markets. However, they are also comparatively risk-averse. This meant that they

“If we keep doing what we’re doing, we’re go-ing to keep getting what we’re getting.” - Stephen Covey

6 SmartLessons

were unwilling to incur the expenses related to engaging in IFC’s Risk Sharing Facility until they had a greater de-gree of certainty that they were going to fill it with deals.At this point in the project development cycle, the time spent with our investment colleagues in setting priorities paid dividends. As a team we had agreed that these were clients IFC was willing to invest in building a relation-ship with. Together we were able to analyze the invest-ment advisory services could make in beginning these relationships, and the opportunity cost of not being able to use these advisory services resources elsewhere. With country management and regional industry man-agement involvement, a clear decision was made that in this case, advisory services should play a catalytic role in building IFC’s relationships with these priority banks by supporting these financial institutions to build their SEF portfolios before a firm commitment for an investment services product had been made. The advisory services intervention was viewed as a worthwhile investment of IFC’s time and resources, as it provided IFC with an

excellent opportunity to interact more frequently with the clients and get to know them better, and, by provid-ing support in building their pipelines and portfolios, IFC was helping them get a firmer understanding of the true size of the market opportunities, thus developing their appetite for IFC’s financial products.

In both cases, investment services and structured finance colleagues have been increasingly engaged with these cli-ents in talks about both IFC’s Risk Sharing Facilities and other financial products. IFC would not be in this posi-tion if it had not been for the day-to-day interaction our team now has with them.

In developing our strategy at the country, industry, and project levels, and in ascertaining whether IFC should commit advisory services resources without a commit-ted investment project, the framework below proved a valuable tool in ensuring we had a value proposition for the client.

RESULT: STRONGER DEVELOPMENT IMPACT

1. Provide the overall development impact and expected outcomes. 2. Select a set of development impact indicators to measure the project’s impact on stakeholders.

Why has this client chosen to work with us? Describe IFC’s additionality.

The Role of IFC

Client’s Needs 1. What is the client’s strategy given the country and sector context? 2. What does the client need to implement its strategy successfully? 3. Why is the private sector not willing to undertake this project on its own? Why is there a need for IFC?

What do commercial financiers offer this client?

What do we offer to this client? a) Risk mitigation; b) knowledge / innovation; c) standard setting; or d) policy work.

IFC’s Additionality: Unique to IFC

1. Is our money really needed? 2. What risks are we willing to take that others are not? 3. What services are we providing that others are not?

Shared Roles

The Role of Commercial Financiers

The Role of Commercial Financiers

World Bank Group Strategy 1. What is the strategy for the country/sector? 2. What has the WBG done so far in the country/ sector?

Source: WBG Country Assistance Strategy (CAS) and past and present World Bank projects.

IFC Country & Sector Strategy 1. What is IFC’s strategy in the country/ sector? 2. What has IFC done so far in the country & sector?

Source: IFC’s Strategic Directions Paper, Sector Strategy, and your regional & industry economists

IFC’s Client Strategy

1. Why do we want to work with this

client? 2. How does this client or project help IFC achieve our own country/ department/sector strategy?

3. How does the relationship with this client fit with WBG strategy?

Source: Client Relationship Manager

Why have we chosen to work with this client?

Put the client/project in a larger, strategic context.

FIGURE 1: IFC’S ROLE AND ADDITIONALITY – A CONCEPTUAL FRAMEWORK

Maximizing our additionality through strategic selection of the client or project will lead to a stronger development impact. Explain the rationale for your project with the help of the template below.

SmartLessons 7

Lesson 3: Scale up sensibly. Don’t rush to expand; waiting for the right conditions will mean money will be better spent and the project is better placed for success.

Another valuable piece of work that IFC’s Environment and Social Development Department completed at an early stage was to engage the Global Environment Facility (GEF).1 As a result, the GEF earmarked a significant grant for the proposed SEF engagement in the Philippines. This included US$5 million in funds both for advisory services and the introduction of suitable financial products into the market to catalyze the growth of sustainable energy financing.

However, based on a strict implementation of IFC’s ad-visory services pricing policy and an honest assessment of the realistic opportunities for meaningful IFC interven-tion, at the appropriate time to write the project design document, we could not justify using that sum efficiently. As a result, IFC’s Private Enterprise Parternship (PEP)office in the Philippines, having invested some consider-able time and money in developing the project, decided to finance the initial engagement from core funds of PEP Philippines rather than access the larger Global Environ-ment Facility grant. This allowed us to develop an ap-propriate intervention for the current state of the market and its current readiness for the opportunities available.

Having spent the last six months working with our part-ner financial institutions, we now have a firmer grasp of the potential for financial institutions to engage in the field of sustainable energy. Both financial institutions now have healthy pipelines, with a combined value of over US$50 million and with US$25 million in loans already approved. Both are now interested in investigat-ing additional areas under their SEF programs. Further, other financial institutions are beginning to show inter-est. And through our work over the last 18 months, IFC has a much firmer grasp of the other challenges and op-

________________ 1 GEF is the largest funder of renewable energy in the developing world, supporting solar, wind, and other clean forms of energy. It is a joint venture of the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP), and the World Bank.

portunities facing this market in the areas of regulation, new market opportunities, work with service providers and equipment manufacturers, and our development partners. As a result we are now in a much better posi-tion to allocate the Global Environment Facility funds to the most appropriate objectives, and we are much more confident that we know the best ways we can reach those objectives.

Given the encouraging start this program has made, the commitment our clients have demonstrated, the grow-ing awareness of the potential for sustainable energy fi-nance, and the need for greater and wider market aware-ness raising, IFC is now in the right position to, and is working to, design a second phase of this project that will be funded by the Global Environment Facility funds mentioned above. The second phase is likely to cover the following areas: expanded work with current and new partners; work in the policy and regulation space; and work with relevant stakeholders to support the country’s renewable energy development, with particular focus on policies and conditions effecting investment in this area. This moment is opportune because of the imminent pas-sage of a renewable energy bill in the Philippine Con-gress.

Published in August 2008.

About the Author

William Beloe is a Sustainability Program Manager at IFC in the Philippines Office.

“A mediocre idea that generates enthusiasm will go further than a great idea that inspires no one.” - Mary Kay Ash

8 SmartLessons

My, hoW you have groWn! The firsT large-sCale energy effiCienCy

MainsTreaM invesTMenT Through a finanCial inTerMediary

JudiT braxaToris

The main challenge to energy efficiency finance is that business volumes are typically too small to be considered mainstream business for IFC. The vast majority of energy efficiency projects are under $5 million, making them ineligible for project financing because IFC is not equipped to efficiently handle numerous small-size projects. A more commercially viable ap-proach for IFC is to wholesale energy efficiency financing through its partner financial intermediaries, allowing economies of scale while scaling up a new product. However, this method requires the participation of an institution that can help create a critical mass of investment demand.

Project Background

The energy efficiency project in Hungary (the project) entails an IFC investment of up to US$125 million in a risk-sharing facility with a local Hungarian bank (the Bank) to support up to US$250 million local currency equivalent in energy efficiency improvement loans for sub-sovereign educational institutions in Hungary. The project is also co-funded by a grant of US$2.5 million from the Global Environment Facility (GEF) to cover subordinated risk obligations.1 Additional GEF support are also available for advisory services.

The US$250 million loan facility is extended to a private energy services company (the Company) that will imple-ment energy efficiency projects primarily for munici-pal educational institutions. The Company will receive lease payments from the participating sub-sovereign educational institutions over the life of the improve-ments. Therefore, IFC is taking the credit exposure of the participating sub-sovereign institutions. The project is implemented as part of the Hungarian Government’s “Szemunk Fenye Program” (SF Program, literally trans-lated into English as shining eyes of children), which is a large-scale educational facilities renovation finance pro-gram to be implemented through a public-private part-nership and financed on the basis of energy savings. The project sponsors – a consortium led by the Bank and

________________ 1 GEF is the largest funder of renewable energy in the developing world, supporting solar, wind, and other clean forms of energy. It is a joint venture of the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP), and the World Bank.

the Company – won the national concession to develop and implement the program to renovate all participating schools through competitive tender.

The SF Program supports renovations such as updat-ing lighting to required national standards, and modern heating systems. The bulk of the schools that will ben-efit are expected to be smaller, rural schools, many of which have not had capital improvements for decades. (The photo below shows a local school after a lighting reconstruction improvement.)

Neighboring countries, as well as regional energy ef-ficiency finance sponsors, are keenly watching the pio-neering SF Program for potential replication possibilities in other countries in the region, with IFC as the partner of choice.

The project was completed in a joint venture between two teams of IFC comprising of Subnational Finance and the Financial Markets departments.

SmartLessons 9

Rocky Start—Challenges to the Retail Approach

The project is the first energy efficiency transaction to receive widespread recognition within IFC. It leverages years of experience in energy efficiency finance product development and testing under the Commercializing Energy Efficiency Finance (CEEF) partial guarantee pro-gram. Funded by IFC and GEF, the CEEF program was created to stimulate commercial energy efficiency finance through financial intermediaries, and had teams on the ground in six Central and Eastern European countries.

The initial characteristics of the guarantee product and the program procedures caused some frustration. Origi-nally, the energy efficiency guarantee product provided little flexibility, and consequently, IFC could not adjust the pricing of the guarantee to prevailing market condi-tions. In addition, the pari passu structure was not nec-essarily the best financial product for energy efficiency finance support. The maximum guarantee size occasion-ally proved to be too low, and the guarantee maturity was limited to seven years versus the common 10-12–year payback period in this industry. The small size of the typ-ical guarantee facility, i.e. €4-5 million per bank, resulted in high transaction costs. Finally, the long guarantee ap-proval processes and laborious legal documentation un-der the program made business development even more challenging.

Following extensive internal debate, key program and product features were aligned with market demand, re-sulting in a more streamlined approval, delegated author-ity, larger guarantee sizes, lower fees in some countries, and the introduction of a portfolio guarantee product, all of which contributed to a significant increase in in-vestment volume. With a more refined product to mar-ket, the program team also began to aggressively pursue a wholesale approach to the energy efficiency program, together with key local banks and energy services compa-nies, as in the transaction discussed here.

How did the team identify and close the transaction?

Lesson 1: Intensive advisory services and good client management build the road to booking a sustainable finance deal.

CEEF provided extensive advisory services to financial intemediaries in the region, and they led to opportu-

nities for the team to establish solid relationships with project developers, equipment vendors, nonprofit and nongovernmental organizations, and, most important, partner financial intemediaries. Engaging any financial intemediary to work with IFC in energy efficiency fi-nance takes time and effort, but we discovered that it is much easier when they are already IFC clients. IFC is aware of its portfolio banks’ strategies, clientele, mar-ket positioning, and competitive advantages. In turn, these clients appreciate IFC’s potential value-added role in sustainable energy finance. Advisory services offered to financial intemediaries under this program typically included strategy development, staff training, market-ing support, product development, and project support. This work helped to establish IFC’s good reputation in the region as a sustainable energy financier, and was one of the reasons the Bank was interested in partnering with IFC on such a large-scale project.

Lesson 2: Creative investment structure and persistent negotiation may increase the investment size – even by 50 times (USD2.5 million –› USD125 million).

The Bank began its partnership with IFC in 2001, when it joined the partial guarantee program. From 2001 to 2006, IFC provided 16 partial guarantees for energy ef-ficiency street-lighting projects through the Bank, using a third-party finance structure.

In 2004, the CEEF Hungary team developed a financial structure together with the Bank to support a company involved in energy efficiency reconstruction projects for municipal institutions, but IFC was not requested to provide a guarantee for any of the loan transactions. IFC’s participation proved to be redundant at this stage, because the company implemented energy efficiency in-vestments mainly for larger and financially stronger mu-nicipalities. Then in 2006, the government launched the SF Program, a public-private partnership. This finally provided room for IFC to engage, and negotiations be-tween the Bank-Company led consortium and the pro-gram team began. At this point, because the scale of the proposed SF Program exceeded the limits of the CEEF facility framework, colleagues from IFC’s headquarters were asked to join the discussions.

The Structure: Getting the client interested in a signed agreement was not easy. Initially, the Bank intended to absorb the risk of the weaker and smaller municipalities with IFC, while not requesting any IFC coverage for the

10 SmartLessons

stronger ones. This was because the Bank was hesitant to lend to lower-rated local governments, since it did not have a track record in this type of credit risk and there were no historical data available in the market to estimate the probability of default. While IFC was willing to take a subordinate role in the financing structure if there was a similar commitment from the consortium’s side, IFC opposed the Bank’s “cherry-picking” approach.

IFC was at the same time moving closer to committing a US$2.5 million first-loss fund, with two conditions: that (i) IFC provide risk sharing for the entire portfo-lio (not restricted to poorer credits) – basically tripling the originally offered portfolio size and (ii) the two par-ties develop an acceptable structure for sharing the first-loss position. The Bank’s desire was to benefit from the CEEF guarantee product, which included a first-loss pool to cover the expected losses of the future portfolio of the company.

In a multi-step dialogue, the Bank and IFC agreed to a mutually satisfactory mechanism to share the first loss-es. The IFC-GEF subordinated pool was protected by liquidity reserve accounts that were ensured by the end-user sub-sovereigns. Should any loss occur in the portfo-lio, two further subordinated tranches would precede the utilization of the IFC senior pari passu guarantee.

In the resulting transaction structure, the Company is the borrower of the entire US$250 million credit line from the Bank. To address concerns about its large expo-sure to a single borrower, the Bank agreed to an IFC pari passu risk-sharing facility, resulting in an IFC investment of up to US$125 million.

Leveraging the GEF funds in this case was an essential tool to scaling up commercially sustainable energy ef-ficiency financing, with the subsidized element in the financial structure representing only 1 percent of the ex-pected total project volume.

Lesson 3: Performance-based pricing/lower margins will be the stimulus in selling energy efficiency fi-nance.

Applying IFC’s pricing guidelines in a growing num-ber of emerging markets has been a challenge. High fees, including a guarantee fee, almost depleted the Bank’s margin. The pricing impediment could have

been a deal breaker. Nevertheless, creativity, innovation, and belief in the transaction helped the team overcome this obstacle.

Fees: The consortium-led project finance approach lim-ited the available front-end cash flows and could not support standard IFC front-end fees typically associated with a US$125 million local currency equivalent Risk-Sharing Facility during the project ramp-up stage. In response, the IFC team worked with the consortium to develop a structure that accommodates the consortium’s constraints and yet compensates IFC for “forgone” fees during the project’s later years – safeguarded with can-cellation penalties. As a result, the project did not waive the standard fees, but instead adjusted the fee timing.

To ensure IFC’s front-end costs are adequately compen-sated over the project life, the consortium also agreed to provide IFC with a somewhat larger guarantee fee than originally contemplated based on credit requirements.

On the other hand, to provide some financial stimulus to the consortium, IFC offered the Bank a performance-based pricing structure. The guarantee fee is proposed to have a reduction mechanism based on the achievement of both portfolio volume and underlying good portfolio performance.

Positive or negative performance fees were applied in almost all other energy efficiency finance-related invest-ments within IFC’s Global Financial Markets subsequent to this transaction, and they have proven to be a very successful sales strategy.

Results to Date

In 2007, the first of five investment years, utilization was lower than expected. However, as of May 2008, US$ 58 million was disbursed for approximately 200 projects. Up to now, lighting reconstruction loans have dominated the portfolio; these are typically smaller size investments, whereas heating upgrades tend to involve larger transac-tions. This partially explains the initial underutilization. Another reason for the slower ramp-up is the expectation of numerous market participants of European Union (EU) grant inflows. Several of the Company’s pipeline projects are temporarily on hold, anticipating EU sup-port.

SmartLessons 11

Conclusion

This SmartLesson has focused on the efforts and busi-ness activities of the project team, and not on the favor-able market-enabling environment that resulted from the role of the Hungarian government – i.e., in this case, the large-scale centralized public tender was the backbone and inevitable prerequisite of the project’s success. How-ever, the team believes that this approach may be repli-cated without the state’s intervention (potentially on a smaller scale) if sufficient investment demand is created by one or more energy service companies and/or other private sector players.

Published in April 2008.

About the Author

Judit Braxatoris was a Program Officer with IFC’s Commercializing Energy Efficiency Finance program in Hungary.

12 SmartLessons

Background

IFC recently disbursed a US$30 million loan for energy efficiency to BBVA Continental, the second largest com-mercial bank in Peru. The line was originally conceived for two main purposes: i) to boost the productivity of local SMEs by increasing the efficiency of their opera-tions through reducing energy costs (and consequently reducing CO2 emissions) and ii) supporting Peruvian Micro, Small and Medium Enterprises’ efforts to convert to natural gas, which is less polluting and more efficient than traditional power sources.

Given BBVA’s relative inexperience in energy efficiency financing, IFC’s investment and advisory services groups teamed up to support the transaction by providing BBVA with a package of advisory services, including an initial market assessment and training for loan officers. To maximize knowledge transfer, an external consulting firm was hired to work for over a year with the financial institution to develop this new line of business.

Why wait?

The project experienced some initial difficulties, mainly due to a delay in hiring the consulting firm. This was due to the strong focus on closing the investment transac-tion which happened just before the Christmas holiday season in Peru. By the time all parties were ready to focus on the advisory services program, two months had passed. The IFC procurement process added another two months, resulting in a four-month gap between in-

vestment closing and the start date for the consultants. Once they had been selected, it took the consultants an-other three months to complete the initial market as-sessment to identify promising clients and partners (i.e., vendors, energy services and consulting companies, etc.). The bank was therefore sitting on the IFC loan for sev-eral months without really having the possibility to kick-start the promotional and disbursement phases of the project.

Upstream Generator

Pressured by top management to move forward, and waiting for the consultants to complete the market assessment, BBVA officials asked IFC whether the criteria of the line could be adjusted to include renewable energy investments. A promising financing opportunity – a run-of-the-river hydroelectric plant in the southern part of Peru – had in fact emerged, but the bank was ill prepared to assess the technical, social, and environmen-tal aspects of the operation. While hydropower plant financing is a rewarding business, it can also be challeng-ing, even for strong commercial banks with established risk assessment systems. Thus, in addition to the criteria adjustment, the bank sought guidance from IFC on how to assess those major risks.

As part of its effort to promote climate change initiatives, IFC aims to offer a new set of financial products to its clients. Promising initiatives are being developed in the areas of energy efficiency, renewable energy, biodiversity, cleaner technolo-gies, and carbon finance, among others. Despite all the positives that come with this effort, proposing a new financial product to an existing client is a delicate matter, and if not done properly, it can worsen the working relationship with the client. This SmartLesson shows the importance of allowing for some flexibility in designing both the financial criteria and the advisory services package of an innovative project to mitigate some of those relationship risks.

Turning proJeCT delays inTo opporTuniTy:reneWable energy finanCing in peru

alberTo didoni

SmartLessons 13

Lesson 1: Leaving some room for flexibility on IFC new financial products is key to meeting the needs of the client.

To meet the client’s needs, IFC decided to support the bank’s request by including renewable energy investments in the line and devoting some resources of the advisory services package to build BBVA’s capacity to analyze the risks. The decision was made to develop a knowledge transfer process, with the purpose of building the bank’s capacity to undertake future assessments on its own.

BBVA officials were under pressure to start disbursing the credit line, but concepts such as energy efficiency fi-nancing take time to be fully absorbed by financial insti-tutions. Allowing the bank to include renewable energy investments in the IFC sustainable credit line and redi-recting part of the advisory services resources to evaluate the deal allowed IFC to: i) build upon existing opportu-nities to satisfy the client’s needs, ii) alleviate the pressure from BBVA top management for immediate disburse-ment; and iii) allow more time to absorb the core con-cepts of energy efficiency financing.

The criteria for defining energy efficiency investments were somewhat flexible and allowed IFC to interpret them to include renewable energy investments without going through a legal waiver. Moreover, the advisory ser-vices component of the project allowed for some flex-ibility in the use of the financial resources. Provided that additionality could be demonstrated, the use of the re-sources was made very flexible, thus making it possible for the advisory services team to hire the consultants in only three weeks, the time limit required by the client to close the financial transaction.

Lesson 2: Including key personnel of the client is cru-cial for the knowledge transfer process.

Consultants were selected to show BBVA how to validate the feasibility studies prepared by the client (owner of the hydro-plant). The focus of the assignment currently underway is to examine technical, social, and environ-mental aspects of the proposed hydro-plant and to check their compliance with local environmental and social re-quirements as well as IFC’s Performance Standards and Environmental, Health and Safety (IFC EHS) guidelines. Compliance with the latter is requested, given that, if ap-proved, the investment will be partly financed through the IFC credit line.

BBVA officials – both the environmental expert and the credit officers – stayed involved through all the phases of the selection process for the consulting firm. They collaborated with the IFC advisory service team in: i) drafting the terms of reference for the assignment, ii) se-lecting the appropriate consulting firm, and iii) holding final talks to fine-tune the methodology and the bank’s requirements before carrying out the assignment. As a result, both parties were satisfied. The client put more weight on the evaluation of the technical risks of the op-eration. Meanwhile, IFC’s main goal of executing correct evaluation of the social and environmental aspects of the deal was fulfilled.

Despite its firm commitment to comply with interna-tionally recognized environmental standards, the client had only recently started to move toward implementing an official environmental policy. In particular, it only had one environmental expert to look over the entire portfo-lio of the bank. It had been therefore crucial to involve key personnel of the client through the whole process in order to guarantee a successful knowledge transfer.

Lesson 3: Advisory services are necessary when intro-ducing innovative financial products such as renewable energy financing and energy efficiency.

Both renewable energy and energy efficiency financing are innovative financial products, and financial interme-diaries do not necessarily possess the in-house expertise for a rapid disbursement of funds. In over-collateralized environments such as Peru, financing modalities based upon a future stream of cash flows or future energy sav-ings are not necessarily easy to implement. A good pack-age of advisory services is therefore necessary to assure the client’s uptake and mitigate the risks of loan repay-ment.

Micro-hydro-installation

14 SmartLessons

IFC has long-standing expertise in financing hydro-plants with its own financial resources. It is therefore prepared to evaluate the risks of those deals such as la-bor and working conditions, community health, safety and security, land acquisition, biodiversity, etc. Meeting BBVA’s need represented an interesting opportunity for IFC to provide a very basic, project-specific set of guide-lines to the client for it to conduct its own environmen-tal and social due diligence. It is a clear example of how IFC is uniquely positioned to provide tailored advisory services to clients by leveraging its expertise in such in-novative fields.

Published in October 2007.

About the Author

Alberto Didoni is an Operations Officer with IFC’s Advisory Services Office for Latin America and Caribbean region, and is located in Peru.

froM free To fee - Charging for adviCe

While inTroduCing an innovaTive finanCial produCT

yana gorbaTenko

SmartLessons 15

Initial reaction

“Energy efficiency is a public good, and IFC should not charge for it.”

“A bank incurs its own costs to develop sustainable energy finance product; we should not have an extra charge.”

Investment Officers, IFC’s Global Financial Markets Department

“It’s the first time I’ve seen an international organization asking us to pay for technical assistance.”

“IFC should pay us to develop those products that you want.”

Partner Banks

Nonetheless, in early 2007 the Program committed to implement the pricing policy. Far from being a barrier to development, pricing helped catalyze RSEFP. Results were better than anyone might have hoped. The team professionalized the advisory offering and built strategic relationships with top management in the client banks. Over the following 12 months, six financial institutions signed advisory service agreements and cumulatively committed US$175,000 in cash contributions. As a re-sult, the RSEFP team is delivering on its commitment to help clients grow their energy efficiency lending portfoli-os. The program is on track to meet the collective target of US$60 million of energy efficiency lending in FY08.

In the process, the project team learned a number of les-sons that may be useful to other programs considering charging for innovative products in advisory services but are unsure of the process or the implications of doing so. The themes of our takeaways are (a) forming and posi-tioning the advisory package; (b) leveraging relationships with the clients’ top managers; and (c) setting a reason-able price level.

Lesson 1: The advisory package should take into ac-count the challenges imposed by innovation.

Early in the program, our approach to working with fi-nancial institutions consisted of introductory training on energy efficiency finance and project assessments for banks and their clients. The training often created initial interest among credit officers, but that excitement quick-ly dissipated under the pressure of their daily routine. Credit officers rarely asked the program for follow-up consultations, and showed little enthusiasm to originate specific energy efficiency loans.

We recognized the need to change the way we work approximately at the same time that IFC introduced its pricing policy. We realized that three success fac-tors for energy efficiency finance are: (a) signals from the top managers to staff that energy efficiency fi-nance is important; (b) the right context and incen-tives for credit officers; and (c) the confidence of cred-it officers that can only come from the experience of

When IFC announced the introduction of a new pricing policy for advisory services, the initial reaction of IFC’s Russia Sustainable Energy Finance Program (RSEFP or the Program) was that the market was not ready yet, and that such a move would make the program less attractive for potential clients. Energy efficiency was struggling as a mainstream finance concept in Russia, and RSEFP was offering training and support to client banks free of charge in the hope of encouraging uptake. It was unclear how to migrate these relationships to a fee-paying basis or what the consequences of doing so would be. IFC investment officers suspected that pricing would increase the overall cost to clients and consequently make the energy effficiency product less attractive. Besides, the European Bank for Reconstruction and Development (EBRD) was of-fering advisory services for energy efficiency finance free of charge. In short, few people considered this to be a smart idea.

16 SmartLessons

closing actual deals.1 Our initial experience of working with financial institutions taught us the importance of realistic time tables. It takes at least six to nine months (longer if a bank has a lengthy internal approval process) to develop the bank’s product, train credit officers, help them generate a good pipeline, and convert it to vol-ume.

The team designed a clear client engagement plan, with the deliverables and triggers for payments. Our advisory services package was based around a 12-month engage-ment combining product development (internal docu-ments, targets, incentives, internal communication), training, and client engagement support activities (work-ing with industrial enterprises on energy efficiency). All outputs were quantifiable and structured on a realistic time table. In short, we packaged a change management product ready for a price tag.

Box 1. From advisory menu to advisory package:

Lesson 2: Pitch the business case, and contract clear de-liverables.

Pricing moves the IFC pitch from one of potential subsidy to one of potential cost. In persuading banks to pay for IFC services, it wasn’t enough to talk about the development need. Clear commercial benefits had to be demonstrated. This meant we had to understand the commercial motivation for our clients to intro-duce an energy efficiency finance product, and how this might differ by institution. How would this product improve their bottom line or build their customer base? ________________1 For more information on this, see SmartLesson “Adaptation for Adoption: Mainstreaming Energy Efficiency in Financial Institu-tions” by Miles Stump on page 26.

One bank might view energy efficiency as an opportunity to enter a new market segment. Another might see the opportunity to provide value-added services to existing clients. A third might seek to enhance its reputation for sustainability or to differenti-ate itself from its competitors.

At the same time, in the contract we clearly spell out advisory work plan, specific deliverables, and triggers for payments. For example, in the advisory agreement we make a commitment to conduct three seminars for cred-it officers, support the bank’s staff in up to 100 site visits to potential borrowers, help to write up to five success stories, grant rights to use the Energy Efficiency Calcula-tor developed by IFC, etc. When you combine upside potential with straightforward deliverables, the client is able to see clear value for money.

Lesson 3: Position advice as product with a standalone value that is no longer available for free.

Banks tend to add up all IFC fees. If you were to take this approach, the advisory fee of US$40,000-50,000 frequently translates into 20-25 basis points on top of the agreed cost of funding, making IFC less competitive on price. More-over, energy efficiency credit lines can be perceived as less attractive even com-pared with other IFC-funded products.2 Even though we make the pitch to the

banks jointly with our investment col-leagues, positioning advisory service as a distinct service with a separate contractual relationship is crucial. The fact that we have two client financial institutions that only pay for advice and don’t have IFC credit lines proves our case for stand-alone value of advisory services. It is also important for the investment client to have an op-portunity to say no to our advisory proposal and choose other options.

Even though every single client was shocked by the re-quirement to pay, when we explained that it’s a recently established IFC policy and we cannot provide our ser-vices for free, this was accepted. We managed to estab-lish four new relationships and transfer two client banks ________________2 Credit lines to banks are either tied to energy efficiency lending or have multiple purposes, but achievement of volume in EE lending is incentivized by a small step-down of 20-25 basis points. The step-down is granted when a bank achieves the agreed volume.

Initial advisory menu Advisory package (for fee-based contract)

• Introductory training • Seminars for borrowers (upon request) • Transaction support (upon request)

Introductory workshop for core group Product description and procedures Internal communications Promotion materials Credit officer training Seminars for borrowers Transaction support

Legend:

Modified Added

SmartLessons 17

from working for free to fee-based cooperation.

Lesson 4: Use agreement to leverage top managers’ commitment throughout the relationship.

When we approach a new client we do not proceed un-less we secure top management’s commitment to develop the product. The Chief Executive Officer (CEO) of the bank should agree to sign the advisory services agree-ment and pay the fee, as well as contribute resources, staff time, and in some cases his personal time to explore this new business opportunity. This expectation should be very clearly conveyed during negotiations.

Once the CEO makes his/her decision on IFC’s proposi-tion, she or he is committed to it, and you have an open channel to the top throughout the engagement. Our team members brief client CEOs regularly on progress and raise any significant issues regarding implementa-tion. The IFC team has an objective view on how well adoption of the product is going within a bank and is able to provide this feedback directly to top manage-ment. For example, we frequently see that credit of-ficers are not interested in developing the new product. The fact that the bank is paying a fee is not important to them, because they see no personal incentive. We need the CEO and other high-level managers to con-sistently communicate that energy efficiency lending is important to the bank, and to reinforce this message by recognizing top performers. Continuous commitment of the CEO makes a big difference.

Lesson 5: Price is driven by client cost-benefit calculation.

One of the most difficult questions we had to answer while introducing pricing was, “How much should we charge?” Even though the Private Enterprise Partnership (PEP) program had already been charging for advice in corporate governance and other mature products, IFC had no precedent in pricing for energy efficiency advice.

As energy efficiency is a relatively new topic in Russia, we recognized the market demonstration effect of the program. We thought it fair to ask banks to pay 50 per-cent of direct IFC costs through cash contributions. In addition, each client bank committed staff time and paid for advertising materials and promotional events. IFC covered all costs related to public good activities: market

reports, surveys, awareness raising initiatives, and work on public policy.

The Program fees for an advisory package delivered dur-ing the 12-month period range from $20,000 for smaller regional banks to $40,000-50,000 for banks with larger networks. We found that banks compare the advisory fee with the additional volume they need to generate to off-set this cost, and if they see that the volume is realistic, they are ready to pay. The rule of thumb from our expe-rience is that the advisory fee should not exceed 25-30 basis points of the volume the bank plans to achieve in the first 12-18 months of operation.

Box 2. Actual IFC advisory costs with one client:

Advisory fees can increase as the market grows and more financial institutions enter the segment. It is much easier to prove that volume targets are achievable when there is an established track record by other financial institu-tions. For the next round of clients we are aiming for at least full IFC direct cost recovery and are considering charging market rates. This would send a clear quality message that IFC advisory services create added value for business.

It’s worth noting that the perception of pricing by invest-ment officers and partner banks evolved as well.

Conclusion

Experience in the Russia Sustainable Energy Finance Pro-gram demonstrates that it is possible to charge advisory fees even when introducing an innovative product with a high development impact. The success factors are: (a) advisory package valuable to clients; (b) reasonable price; and (c) strong relationship with top managers. The team

Type of Activity

No. of activities delivered

Total costs, including

travel

Introductory workshop 1 US$450

Front office training (8 hours) 4 US$7,900

Debriefing for branches (2-hours) 5 US $1,500

Seminars for borrowers 2 US $1,800

Joint visits to clients and other deal support 170 hours US $10,500

TOTAL (These results were achieved 7 months down the road out of 12 months)

US $22,150

18 SmartLessons

made a focused effort and in less than a year we closed six advisory contracts with cumulative cash contributions of US$175,000.

Pricing forced us to raise our game, and it turned out to be the best thing that happened to the Program.

Charging and closing an advisory services agreement is just the first step in cooperation. The bigger challenges emerge when you start work with the client to promote real changes in operational thinking.

About the Author

Yana Gorbatenko is a Deputy Program Man-ager working with the Russia Sustainable En-ergy Finance Program at IFC Advisory Services in Eastern Europe and Central Asia, and is lo-cated in Russia.

Published in May 2008.

Current feedback on pricing strategy

“$40,000 is nothing for a top-20 bank in Russia; you should charge at least $100,000; anything less than that is dumping.”

IFC’s Global Financial Markets Department

“For all the work you are doing for us, we are not paying you very much, are we?”

Partner Bank

lending To a “differenT aniMal”: energy effiCienCy renovaTion

of MulTi-faMily housing buildings in hungary

Tibor kludovaCz

SmartLessons 19

What is meant by a “block house”?

Block houses are multi-family housing buildings located mostly in urban areas across Eastern Europe and the for-mer Soviet states. In Hungary, a large portion of these buildings (more than 20 percent of the total housing stock) was constructed in the 1970s and 1980s using panel technologies that are by today’s standards outdated and in need of renovation. Inefficient energy use in an environment of escalating energy prices places a huge burden on the population in these buildings.

Since home ownership is predominant in the region, most of these buildings are owned by the people who live in them. In Hungary particularly, apartments are owned by tenants, and common areas of the buildings, such as the staircase, elevators, front portal, gardens, energy sys-tems, etc., are commonly owned by the community of tenants.

The Bank and IFC have spent a considerable amount of time and effort developing a viable business model to address the needs of these block houses, and the most important lesson learned is that the block house is a “dif-ferent animal” when it comes to lending, so you need a special approach to do it.

What is meant by a “different animal”?

Different purpose: Block houses are not profit driven, and they lack financial sophistication. They exist simply to manage the expenses related to the maintenance of assets commonly owned by the tenants. They distribute these

expenses among the tenants, and their budgets balance out to zero by the end of each year. No profits, no sav-ings, one bank account, and no real financial records.

Block Houses in Hungary

Block Houses in Hungary

Lack of collateral: Block houses manage the expenses re-lated to the common assets, but ownership belongs to the community of tenants. Normally, there are no finan-cial buffers or assignable assets in the system that banks could get access to. Designing a financial scheme with recourse to tenants is not an option, since by lending at the tenants’ level instead of at the condominium level, banks would lose scale and have to deal with a credit

Commercializing Energy Efficiency Finance (CEEF) is a regional partial credit guarantee program co-funded by IFC. The program has issued guarantees for €93 million in commercial loans for energy efficiency transactions across multiple sectors. The Global Environment Facility (GEF), the largest funder of renewable energy in the developing world, is active in Hungary, the Czech Republic, Slovakia, Latvia, and Lithuania. A substantial part of this portfolio is committed to a multi-family housing renovation program with a Hungarian Bank (the Bank) under which more than 500 small block house renovations have been completed since February 2006. To date, no defaults have been recorded.

20 SmartLessons

review of a much larger number of individual house-holds.

A problematic decision-making process: Each decision, es-pecially ones relating to entering into a long-term loan agreement, requires the consensus of many people. This is difficult and lengthy to arrive at. Furthermore, there is a serious mismatch between the beneficiaries of the loan (the individual tenants) and the entity that is responsible for repaying the loan (the block house).

Lack of financial skills: Block houses tend to have one employee only – usually a tenant who has some free time but no specific financial skills as such. The banks need to find a new language to communicate with these clients.

Lesson 1: Existence of a Few Enabling Factors

Aggregator with a legal format: Tenants of the building must form some kind of legal entity that gets its man-date from them and acts on their behalf. This aggregator needs to have a legal format, and its operations need to be subject to enforceable regulations so that banks can lend to them. Without the aggregator, banks can only lend to the individual tenants, but that’s not block house lending. In Hungary, tenants of multi-apartment build-ings are required by law to form legal entities called “housing associations” for the management of the com-monly owned assets of the building. This regulation is quite common in many other countries as well. Housing associations are similar to private companies in the sense that they can enter into all sorts of agreements and can be taken to court if they do not meet their obligations.

The aggregator concept also works in markets where reg-ulation similar to the Hungarian model does not exist. The aggregator can simply be established by the volun-tary action of the tenants, or it could be a utility or any other company that has a billing relationship with the tenants.

In countries where the enabling environment is absent, however, advisory services can help the governments de-velop the favorable legal framework.

Periodic contributions from tenants to the aggregator: There must be a financial link between the tenants and the ag-gregator to ensure that tenants are funding the opera-tions of the aggregator. The aggregator must also have leverage to enforce payment of such contributions. In

Hungary, tenants of apartment buildings are obliged by law to contribute financially on a monthly basis (“com-mon cost payments”) just by the fact that they own prop-erty in the building. The regulator even determines the minimal level of these contributions. And housing as-sociations have a powerful tool in their hands to enforce payments: they have the right to originate a mortgage on the property of nonpayers.

Loans to housing associations are non-recourse to ten-ants in Hungary. Therefore, it is the association that is accountable to the bank. The bank does not have the right to go after the tenants if there is a default. As a result, it is the association’s responsibility to collect from tenants, and its right to exercise a mortgage ensures a strong common cost payment discipline.

Demand: One of the key drivers of the market is the de-mand from tenants. In Hungary almost 70 percent of the apartment buildings were built 30 to 50 years previously, back in the Soviet era, and they contain old-fashioned, inefficient technology. The increasing cost of energy is drawing attention to energy efficiency, and energy ben-efits are maximized if tenants act as a community and address the whole building envelope. Furthermore, by renovating the buildings, not only do the tenants benefit from better insulation and more cost-efficient energy use, but the value of their property increases and the quality of their living environment improves.

Availability of technical solutions locally: A wide range of relatively cheap and simple technology should be avail-able locally, from building envelope insulation upgrades (including window replacement) to internal renovation of the heat distribution network (heat exchangers, pipes, radiators, etc.) and installation of heat regulation and metering devices to allow tenants to manage their con-sumption. Existence of well-supplied and qualified lo-cal contractors is also a must for low-cost, high-quality services.

Lesson 2: Creative Financial Structuring

Cash-flow based lending: A lending scheme was imple-mented that required the association to put in place a valid decision of the assembly of tenants to increase their monthly common cost payment obligation to a level where on aggregate they cover the monthly installments of the loan. This is then assigned and channeled through the bank on a monthly basis for debt service.

SmartLessons 21

IFC guarantees for collateral: To address the lack of col-lateral, IFC guarantees were added to the equation. IFC’s product was designed along the principle of making sure that the bank’s and IFC’s interests were aligned and each party was comfortable with the risks taken. Apart from the IFC guarantee, the only collateral the bank has is a drawing right on the account(s) of the block house.

Application of available grant programs: Being a key social issue, the housing sector will always attract government attention. This usually translates into various types of support programs. Incorporating these into the financing scheme opens the door to a larger number of clients.

The Hungarian market has many such programs which were integrated into the block house program. While some features of state grants that complemented the in-vestment structure of the program played a significant role in the expansion of the portfolio, their availability is not a precondition to requiring similar facilities. As long as they are available, clients will always want to use them, but the structure is still viable without them. CEEF pro-gram has done many projects with grants incorporated but also many without any, thus illustrating that the fi-nancing scheme can be applied without subsidies.

Lesson 3: Standardization

Streamlining procedures: When lending involves a large number of tiny yet similar transactions, the natural choice is to standardize and streamline your operations as much as you can. The Bank developed low transac-tion cost procedures based on simple checklists and pre-determined boundary conditions. All transactions that meet the eligibility criteria make it into the portfolio automatically. IFC’s guarantee product was designed to meet the same requirements. Underwriting is based on pre-arranged criteria and is fully delegated to the bank.

Monitoring energy savings: When it comes to energy ef-ficient products, there must be a system in place to de-termine if the loan is financing energy efficiency or not. Such information could have considerable marketing value. However, many banks carrying energy efficiency products face challenges when it comes to monitoring energy saving due to lack of internal capacity to do so. Subcontracting is time consuming and cost-intensive and contradicts the concept of standardization. In response, the Bank requires that the block houses attach an energy audit to their credit application.

This solution is not ideal, as there will always be a trade-off between the quality of the audits and streamlining. This is quite typical for the retail type of energy efficien-cy programs. The better the audits, the more they slow down projects or even exclude block houses unable to bear the costs. The goal is always to find the right balance of making sure that what we call energy efficiency really is energy efficiency, without overburdening the deal with additional transaction costs.

Lesson 4: Creative Marketing

One of the most important factors in developing block house lending into a mainstream business line was the local Hungarian Bank’s creativity in designing and im-plementing marketing programs.

Educate your clients: The bank has been conducting sev-eral types of workshops, seminars, road shows, and cli-ent events in all major cities of the country. The events are aimed at not only distributing information about the product but also educating housing representatives about basic financials, explaining to them how to apply, what documentation is needed, how to manage the loan during the tenure, etc. IFC has continuously supported this effort by participating in the events and providing financial support from CEEF’s advisory services budget for them.

Word spreads like wildfire: Another quite unexpected aid-ing factor has been the high visibility of the renovated buildings. Word on the availability of financing spread like wildfire among tenants when they saw the renovated buildings in their areas.

Published in May 2008.

About the Author

Tibor Kludovacz is a Program Officer work-ing with IFC’s Energy Efficiency Group and is located in Hungary.

22 SmartLessons

lessons in proMoTing energy effiCienCy

Eluma P. Obibuaku

Background

The following paragraphs summarize the structure, re-sults, and lessons learned from various IFC programs such as the Hungary Energy Efficiency Co-financing Program (HEECP), the Hungary Energy Efficiency Co-financing Program 2 (HEECP2), and the Commer-cializing Energy Efficiency Finance (CEEF) Program. HEECP2 and CEEF were combined into a regional pro-gram which focuses on six countries: Hungary, Czech Republic, Slovakia, Lithuania, Latvia, and Estonia.

The goal of each of these programs is to promote and enhance commercial financing of energy efficiency projects by local banks and leasing companies, thereby

Figure 1.

reducing greenhouse gas emissions. The project objec-tives are pursued through the provision of (1) financial products to local financial institutions that make loans for energy efficiency projects and (2) advisory services for capacity building to financial institutions, energy services companies, and project hosts. Figure 1 below shows interaction of IFC and Global Environment Fa-cility (GEF) with financial institutions (guarantees and advisory services) as well as energy services companies and end-users. GEF is the largest funder of renewable energy in the developing world, supporting solar, wind, and other clean forms of energy. It is a joint venture of the United Nations Development Programme (UNDP), the United Nations Environment Programme (UNEP), and the World Bank. Note: Advisory services is referred to as Technical Assistance, as formerly called, in Fig 1.

Over the past ten years, IFC’s Environment and Social Development Department has initiated a number of energy efficien-cy programs in emerging markets designed to promote local financing of energy efficiency projects and to reduce greenhouse gas emissions and consumption of energy. These projects accomplish their objectives by stimulating demand for energy ef-ficient products and services in markets that show a potential for energy efficiency uptake. This SmartLesson discusses IFC’s experience with three distinct but related energy efficiency initiatives, the last of which is currently under implementation, and is intended for IFC staff developing projects in various business lines and regions - especially those working on energy efficiency projects.

End User

End User

ESCO

IFC provides the Local Financial Institution a Guarantee Facility Agreement

IFC provides Technical Assistanceto the Local Financial Institution,

End User or ESCO

LocalFinancial Institution

IFC/GEF

IFC Services

IFC Program Structure

End User

End User

ESCO

IFC provides the Local Financial Institution a Guarantee Facility Agreement

IFC provides Technical Assistanceto the Local Financial Institution,

End User or ESCO

LocalFinancial Institution

IFC/GEF

IFC Services

IFC Program Structure

SmartLessons 23

Although the focus of this paper is on advisory services, the results discussed below encompass both advisory ser-vices and investments (financing). The advisory services component is a necessary but nevertheless insufficient condition for success.

The advisory services provided through each project were designed to strengthen or build the capacity of financial institutions, energy end-users, and energy services com-panies. They assisted financial institutions in developing specialized financial products, helped end-users and en-ergy efficiency companies build “bankable” energy effi-ciency projects, and developed institutional capacity in the Hungarian energy efficiency and financial services industry. They also provided support to end-users inter-ested in conducting energy audits to help determine if energy efficiency would be a viable option. With regard to content, the advisory services often involve skilled personnel (either IFC staff or outside consultants) who provide support for market research, due diligence, in-vestment appraisal, and training services.

Results

Collectively, HEECP, HEECP2, and CEEF have direct-ly influenced the operations of 14 financial institutions, two of which were nominees for the 2007 Financial Times Emerging Markets Sustainable Bank of the Year award. The programs have also resulted in the creation of several hundred energy efficiency projects and significant energy savings. The CEEF Program has generated energy savings of 1080 tera joules annually or dollar savings of US$30 million/year assuming $0.1/kwh in average elec-tricity prices. The CEEF initiative has led to direct CO2 reductions of 52,800 tons per year. These guarantee proj-ects are estimated to have led to the implementation of an additional 144 projects valued at US$79.6 million with CO2 reductions of 159,649 tons per year. Over the

estimated ten year life of these efficiency improvements, they will generate more than 2 million tons of CO2 re-ductions.2 In spite of the successes recorded above, IFC’s energy efficiency experience has not been without imple-mentation challenges. First, the projects have not been successful in every country of intervention—two of the five target countries for CEEF (six target countries, if we include Hungary) have yet to generate traction because of the characteristics of these markets. Second, each of the programs had difficulties tracking the level of energy efficiency transactions completed without IFC guaran-tees and the associated energy savings. Third, though the energy service companies and financial institutions in-terviewed indicated that the advisory services provided under HEECP1, HEECP2, and CEEF have been very valuable, an assessment of the effectiveness and efficiency of the advisory services is impossible because there is not sufficient information available on the actual results of many of the advisory services activities.

Lessons Learned

Due to the evolution of IFC’s energy efficiency experience and the fact that the above three pro-grams were implemented in se-quence, the lessons that were generated in HEECP1 were built into HEECP2 and CEEF. Most of these lessons apply to almost any program within the World Bank Group. The following paragraphs will focus on the lessons from the

advisory services components of these projects.

Necessary Conditions for Success:

There are certain conditions without which a favorable outcome for market-based energy efficiency initiatives is unlikely. First, the energy pricing should not be subsidy intensive, or where subsidies exist, they should be very selective. Energy subsidies tend to dull the incentive to use energy efficiently or conserve it. Second, project de-velopers need to be active in these markets. They are the vehicle for identifying opportunities to improve efficien-cy in factories or homes, can be used to retrofit existing inefficient systems, and have access to equipment suppli-ers. Third, loan financing stimulates energy efficiency in-vestments because, although energy efficiency improve-ments generally have short payback periods, consumers

Services of the IFC Implementation Team Recipients of ServicesDevelop strategy for energy efficiency (EE) Financial institutionsAssist in preparing/creating “bankable” projects Developers/Financial

InstitutionsConduct market assessment and awareness raising Individual EE investmentsCapacity building/training/external consultant engagement

ESCO/ Financial Institu-tions

Monitoring legal, regulatory, and institutional environment to identify barriers to investment.

24 SmartLessons

may not be able to afford the up-front costs of these systems. For this reason, high interest rates and unso-phisticated financial intermediation will tend to hurt the growth of energy efficiency. Finally, economic sectors that are extremely energy intensive also tend to provide opportunities for energy efficiency improvements.

Tracking Advisory Services Results:

Although an integral component of each program, the success of advisory services was not rigorously tracked. The monitoring efforts were devoted to the overall goals of the project and the degree to which environmental benefits are achieved. To directly assess the impact of ad-visory services, appropriate tracking systems that capture the importance of these activities to the clients on the one hand and the outcome of the project on the other must be established. Where rigorous tracking is not im-plemented, the value of advisory services, which may be apparent to direct project participants, cannot be com-municated to relevant stakeholders. Furthermore, since the advisory services efforts cannot be independently as-sessed, potential improvements in project design may be lost.

Building Flexibility into Advisory Activities:

For advisory services that are expected to be adminis-tered over several years, it is valuable to build flexibility into the project structure. This allows for changes to the content of the program as market conditions change. In certain markets, IFC’s energy efficiency program was ad-justed to take advantage of opportunities to market to Block House renovation initiatives, an unanticipated op-portunity. In others, the program closed operations be-cause deal flow was limited due, in part, to unfavorable market conditions.

Limits to What Training Alone can Accomplish:

Advisory services should go beyond training the clients/financial institutions to perform new tasks or introduce new services. Businesses need to be assisted in changing their behavior and deploying new knowledge. A degree of hand-holding is often warranted to broker partnerships between financial institutions, project developers, and equipment suppliers. It should also include structuring actual transactions involving these parties. For example, our advisory services team (a) sensitizes financial institu-tions about energy efficiency opportunities through mar-

ket studies; (b) teaches them how to assess energy effi-ciency credit risks; and (c) works with project developers, equipment suppliers, and financial institutions to struc-ture and deliver on individual investments. After these practical interactions, the financial institutions, project developers and others would gain the confidence to in-dependently pursue similar business initiatives, thereby embedding the learning from the advisory services into routine business practices.

As advisory service providers, we are often tempted to of-fer potential clients one or two advisory services that we believe are best suited to their needs. However, the client is very knowledgeable about its business, current capabil-ities and growth trajectory, and might opt for completely different services than the ones we suggest if the various services we offer are understood. It is therefore useful to offer clients a menu of advisory services and explain the benefits and costs of each of them. The clients may then select the service or mix of services that best meets its needs based on a good understanding of the merits of our advisory services. Implicit in the above is that if we offer only one or two advisory services, the client may de-cline our service offer as it may not be suited to its needs.

Financing Alone is Not Enough:

Where IFC has worked with financial institutions to ex-pand the availability of loans to support energy efficiency investments, we have found that pari-passu guarantees (loan guarantees with equal risk sharing) alone do not provide adequate incentive to make financial institutions offer energy efficiency loans. Strong advisory services and a close working relationship with the financial institu-tion are often required. The loan guarantee product is not seen as very valuable unless it is complemented by advisory services, which often enable/help the bank as-sess the risks associated with the underlying loan product and other aspects of individual energy efficiency transac-tions.

Advisory Services and Clients’ Existing Strategy:

Advisory services can be especially valuable if they sup-port a financial institution’s business or strategic direc-tion. Before advisory service are offered to any entity, it is best to understand the strategy of the entity as well as the market challenges it faces. The assistance should be designed around the direction a business has set for itself rather than offering advisory services that divert a

SmartLessons 25

client’s attention away from its established priorities. A fi-nancial institution that is marketing a range of mature loan and other financing products and is interested in expand-ing into other areas might be a good candidate for energy efficiency-oriented advisory service, since this will repre-sent a new and unexplored opportunity — provided that the necessary conditions for success of an energy efficiency program exist. If a bank is only offered a limited guaran-tee facility, and operating that facility has high transaction costs, then it will not focus on this business opportunity. Figure 2.

Published in June 2007.

Status as of June 2007: As the demand for sustainable energy programs has increased within IFC, it is essential that we learn from these lessons and build them into current and future program designs. The adaptive management style employed allied to regular management review meetings has meant that CEEF has modified its systems and approach to increase its impact. The following top three lessons have been incorporated into the design of IFC’s newest energy efficiency programs - the Russia Sustainable Energy Finance (RSEF) initiative, and the China Utility Based Energy Finance Program (CHUEE):

Monitoring of advisory activities:•    RSEF has an extremely robust monitoring system which is care-fully managed. A database tool has been created to help the team with acquisition of informationFinancing alone is not enough:•    In RSEF and in CHUEE, more attention has been paid to market development activities that go beyond just working with the financial institutions.Menu approach:•    The Russia team has developed a structured approach for working with financial institutions to identify which items from the menu they need and then have a memorandum of understanding (MoU) that states what each party will do.Adoptive management•    : With the benefit of working with financial institutions on energy effi-ciency projects over several years, IFC has learned to exploit the competitive advantage of financial institutions in processing small transactions—the typical deal size of energy efficiency projects. IFC has adapted its energy efficiency products and services to the capabilities and needs of financial institutions. The result, depicted in Figure 2 above, shows how changing our project review pro-cedure through delegating credit appraisal responsibilities to partner financial institutions enables the completion of a much larger volume of transactions without compromising credit quality. This change brought about a 2.5-fold increase in the volume/value of deals competed in the 2005-2006 timeframe, a trend that has continued into 2007.

CEEF Guarantees 1997- 2007 (as of 26 January 2007)

0

6,36

7,95

0

15,2

67,0

34

5,84

2,67

7

3,65

0,56

7

1,54

1,60

9

128,

702

154,

528

931,

184

34,2

17

130,

583

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007Year

Guar

ante

e in

US$

CummulativePer Year

About the Author Eluma P. Obibuaku was a Monitoring and Evalu-ation Specialist with IFC’s Environment and Social Development Department in Washington, DC.

26 SmartLessons

adapTaTion for adopTion:MainsTreaMing energy effiCienCy in finanCial insTiTuTions

Miles sTuMp

In 2005, IFC launched an energy efficiency finance product in Russia that was immediately challenging on two fronts: the product was brand new in the market, and it dealt with energy efficiency, a topic that had been traditionally neglected in Russia. IFC’s Russia Sustainable Energy Finance Program (RSEFP, or the Program)1 showed that in order to secure ac-ceptance of a new product in the banking market, it must first ensure that the product is widely accepted and implemented within each partner institution. Tailoring the product to each financial institution is required to inspire confidence in the product, then institutionalize and iterate it widely.

Background

IFC launched RSEFP to popularize energy efficiency fi-nance among financial institutions. The program helps Russian financial institutions conduct energy efficiency lending through advisory services and dedicated energy efficiency. IFC saw enormous opportunity for energy ef-ficiency lending in Russia. In 2003, Russia consumed 16 times more energy per unit of gross domestic product (GDP) than Denmark. The Russian market, however, did not view it in the same way. Russia’s vast energy resources and subsidized tariffs had created a laissez-faire attitude toward energy efficiency. At the same time, Rus-sian banks were focusing their resources on developing more conventional products, such as consumer lending and mortgages.

Since its launch in 2005, the Program has worked with eight financial institutions, and that experience has yield-ed some important insights into gaining acceptance of an innovative product like this. The technology adoption curve (see diagram) helps put the challenge into context. Innovators (like IFC) pioneer the product, which is then taken up by a few early adopters who quickly grasp its value. However, for broader adoption by the more con-servative early and late majority, the product then needs to be tailored and adapted to meet their specific needs.

Since most financial institutions are very conservative, how could the program gain wide acceptance of an in-novative product like energy efficiency? A three-step ________________1 To learn more about this program, visit: www.ifc.org/russia/energyefficiency.

process of adaptation was required to secure participa-tion from the chief executive officer (CEO) down to lo-cal branch credit officers.

Step One: Inspire Confidence in the Product

The RSEFP had one early adopter of energy efficiency finance who understood the value of the product – the Chairman of IFC client Center-Invest Bank. He vowed to pioneer energy efficiency with IFC in Russia, and his efforts were recognized at the 2007 Financial Times/IFC Sustainable Banking Awards. However, most of our clients were part of the more conservative early majority, and even if they agreed to try the product, it did not mean that they had fully accepted it. In fact, we had seen how support for the product had faltered with some of our initial clients when top management was not fully committed. Those working on energy efficiency in the financial institution could feel the lack of management support and were unable to commit the time and effort to developing business with the product.

In March 2007, we were discussing energy efficiency

From E.M. Rogers, Diffusion of Innovators, Fourth Edition (New York: The Free Press, 1995)

SmartLessons 27

with a new IFC client (loan and equity bank) and one of Russia’s largest private banks. The challenge was to infuse the bank with confidence about energy efficiency finance and get a commitment to do a large-scale rollout of the product.

While top managers were initially very positive about the product, doubts began to creep in with some of them, a reflection of how difficult it is to fully grasp the value proposition of an innovative product. Despite discus-sions in which these concerns were addressed, we came away convinced that to secure a firm commitment, it was essential to approach the head of the bank. Our presenta-tion to the CEO focused on what we anticipated would be his three key concerns: the size of the opportunity, the strategic fit for the bank, and the market readiness of the product.

Here we benefited from the RSEFP programmatic ap-proach, which also includes market awareness efforts, capacity building with energy service companies, and public policy work. For example, our survey of 625 industrial enterprises was invaluable in presenting a clear picture of the size of the market and specific opportuni-ties for financial institutions. Impressed by our portrayal of the opportunity, and con-

vinced that energy efficiency was a good strategic fit, the CEO of the client bank gave his approval for the prod-uct. We proceeded to sign a fee-based advisory agree-ment that formalized his support – the first and essen-tial step toward achieving full acceptance and adoption within the bank.

Lesson 1: Identify what is needed to inspire confidence in your new product, package it accordingly, and then close the deal.

Step Two: Institutionalize the Product

Energy efficiency finance began to “run out of gas” at each of our first four client financial institutions because each financial institution had not fully committed its re-sources to selling the product. Only at Center-Invest had the CEO fully bought into energy efficiency finance, dis-bursing its initial US$4 million credit line within three months. But even there, momentum waned as its credit line was fully utilized and there was less urgency to bring in projects. Despite early enthusiasm by the managers and credit officers in our partner financial institutions, lack of institutional support marginalized the product.

CEO commitment sends an important message to the whole financial institution about the importance of the product, and a fee-based ad-visory agreement puts that commitment into action and keeps it a top priority. The agreement sets in mo-tion a process that requires mobilization of significant organizational and financial resources. Training, staff time, incentives, travel, ad-vertising and promotion, and advisory fees amount to a serious investment. The financial institution must also allocate credit resources to finance projects.

A good example of this process is our work with another bank. After the advisory agreement was signed, we rec-ommended setting up a cross-discipline group within the bank to produce an official product policy (that provides a description and instructions for processing), a budget, a promotional plan, and sales targets. This process cul-minated in making the product available to all the bank’s 47 branch offices throughout Russia.

Questions that emerge as barriers to developing business with a new product

1) What is the product? 2) Why should we be doing this? 3) Why do we need it if money is already flying out the door? 4) Why a special energy efficiency product? 5) We do so much training; why spend more time on this? 6) Shouldn’t IFC be paying us to implement some- thing on its agenda?

Getting the Bank on Board

1) Identify the size of the opportunity and market.2) Identify how the product is a strategic fit for the bank.

Center-Invest Chairman demonstrates new boilers, financed through an energy efficiency loan from his bank, to clients.

28 SmartLessons

Beyond the organizational framework and resource al-location, institutionalization happens through formal training in the product. With this bank, over 50 credit officers from all over Russia underwent an entire day of intensive training on how to sell energy efficiency to cli-ents as well as how to help them identify and evaluate energy efficiency projects. While the RSEFP had trained credit officers at all its other clients, it takes on a differ-ent meaning when done in the context of an officially approved product with sales targets, incentives, and na-tionwide advertising.

Lesson 2: Institutional commitment of resources and an official product description open the door to widespread adoption. Step Three: Iterate the Product

The main task remains getting the majority of credit of-ficers throughout the country to use the product over and over in their interaction with clients – you need to stimulate widespread iteration. While CEO buy-in and institutionalization are important, they just form the foundation for adoption by the majority.

In February 2007, we reviewed the energy efficiency product with the five Center-Invest Bank credit officers who had financed all the bank’s energy efficiency proj-ects to that point. We identified three key findings that would help us improve our product. The first was that out of 40 credit officers trained, only those five early adopters had done deals – the rest had not taken the ini-tiative to try the new product, and just continued selling products that they already understood. Second, the five credit officers had all found energy efficiency daunting initially, but easy once they got started. Finally, none of those credit officers was aware of the deals that their col-leagues had done.

As we prepared to engage new financial institution cli-ents, the Center-Invest experience led us to take several initiatives to enhance our advisory offering and ensure that energy efficiency gained wider adoption within our financial institution clients. While Center-Invest clearly needed to improve its institutionalization of the prod-uct, we felt that the real key to getting beyond the early adopters and reaching the early and late majority within the bank (and other financial institution clients) was to make the product more accessible and user-friendly for them.

The first step was to make our training of credit officers more interactive so as to simulate what they would face in the field, but in an environment where they could make mistakes and also consult with an expert on things that they did not understand. The RSEFP team incorporated case studies and role playing to simulate introducing the product to clients and identifying and evaluating poten-tial projects.

Next, the RSEFP developed an energy efficiency calcula-tor that would form the backbone of our training and help credit officers in their operational work with the product. The calculator was designed to show the energy savings of any project, and to translate those savings into CO2 reductions.

We also developed a detailed process map in the next page to show credit officers how to work with the prod-uct, including what data to gather and when to bring in an outside technical consultant. This structure gives them a simple map to navigate through the process with their first clients.

Finally, we needed to give credit officers popularized in-formation that would help them feel comfortable with the product. In addition to success stories that showed them how others have done projects before them, the Program developed a special laminated “cheat sheet” on energy efficiency that gave useful facts and definitions for quick reference.

Lesson3: Enhance your product to make it more accessible and user friendly for the conservative majority, and they will use it over and over.

Russian manufacturing companies use machineries that are often 25-50 years old.

SmartLessons 29

Fig 1. Framework of energy efficiency project operations

Conclusion

When introducing an innovative product, it is crucial to remember that most people will not immediately under-stand its intrinsic value. To be successful, your product must be modified so that those you are trying to reach clearly understand how it can benefit them.

If you are trying to get a product up the adoption curve inside a financial institution, the RSEFP experience shows that it is important to tailor it to inspire top man-agement, define it to achieve institutionalization, and finally popularize it to ensure iteration.

Published in December 2007.

About the Author

Miles Stump is an Operations Officer at IFC Advisory Services in Eastern Europe and Cen-tral Asia, and is located in Russia.

1ST CONTACT

EE CRITERIA

YES

REGULAR LOAN

NOYES YES

NONO

EFFECT CALCULATION

EE POTENTIAL YES

PROJECTQUESTIONNAIRE

EE CALCULATOR

EE GUIDE

EE LOAN

FINISH

FI CRITERIA

NO

CERTIFICATEPRELIM INFO

PRODUCT DESCRIPTION

SUPPORT NEEDED

DEAL STRUCTURING

TECHNICAL REVIEW

ENERGY AUDIT

DATA ANALYSIS

ADVISORY SUPPORT

30 SmartLessons

susTainable energy invesTMenT sCale-up and MainsTreaMing

pavol vaJda and alexandra glaTznerova

The Commercializing Energy Efficiency Finance (CEEF) program is the first attempt by IFC to develop commercially viable financial and advisory products to promote sustainable energy projects by financial intermediaries. Acquisition of scaling-up/mainstreaming experience was probably one of the most important ideas behind the CEEF program. After five years of operation in six different countries with almost 20 different financial institutions, we have learned more about the complexity of this task and can draw some conclusions which could be applied in pursuing business opportunities in sustainable energy.

Background

Since its launch in 2003, the program has developed numerous innovative financial products and advisory approaches in cooperation with commercial banks and leasing companies in Central Europe. The evolution of the program (see graphic below), including its pilot phase in Hungary, and shows the development from a fully donor-funded operations to commercial financial products and advisory services.

The CEEF project portfolio includes, among others, residential housing retrofits, district heating upgrades, gas-fired cogeneration projects, street lighting retrofits,

renewable energy generation such as wind, small-hydro, solar, and biomass projects.

Developed risk-sharing financial products range from in-dividual pari passu partial credit guarantees to more so-phisticated portfolio pari passu guarantees with the first loss guarantee component. Advisory services products include consulting, research, and training at the level of individual project/sponsor/developer, individual finan-cial intermediary, or the market/country/region.

Project Results

Although the program has achieved quite impres-sive financial results (taking into account the na-ture of the business) and has supported US$67 million in guarantees over 600 sustainable energy projects of total value—almost US$300 million without any guarantee call until now—its ma-jor value lies in its potential to provide solutions, which can be replicated and scaled up in IFC

SE Investments by Countries(US$ 296 million in total)

Hungary 71%

Latvia 2%

Estonia 0%

Czech Republic

22%

Lithuania 1% Slovakia

4%

SE Investments by Countries(US$ 296 million in total)

Hungary 71%

Latvia 2%

Estonia 0%

Czech Republic

22%

Lithuania 1% Slovakia

4%

CEEF Program Funding and Evolution SchemeMillion US$

87

75

CEEF

IFC Commitment

12

0Year 3 1997 Hungary 2001 Hungary 2003 2005 2008

4Czechia

Global EstoniaEnvironmental HungaryFacility CEEF Latvia

Commitment LithuaniaSlovakia

15

18Million US$

Donor-funded guarantee

No IFC investmentFirst loss guaranteeDonor-funded AS

12M $ IFC investment

GEF counter-guarantee 1 : 3

First loss guarantee Donor-funded TA 75M$ IFC investment

GEF counter-guarantee 1 : 5

Pari passu guaranteeAS w/ cost-sharing

SmartLessons 31

mainstream business. In order to determine some more general lessons, we have looked at the investment results from the perspective of the respective countries and fi-nancial institutions.

First of all, the investment results vary substantially from country to country, despite the fact that we deal with a relatively “homogeneous” group of new European Union member states with a similar historical background. These countries have made transitions from centrally planned economies through market-oriented reforms to the current free market status. The country distribution of guaranteed investment volumes is shown in the pie chart on page 30.

The general country investment environment and the maturity of its sustainable energy market have a substan-tial impact on investment outcome. The major part of the portfolio is in Hungary, where a pilot project started five years ahead of the other countries. On the other hand, it is worth noting that more than 90 percent of the Hungarian portfolio was booked just over the last three years. At the opposite end of the scale is Estonia, where the existence of a government-subsidized lending plan has prevented any kind of commercial lending via financial intermediaries that would require IFC guaran-tee products. The same diversity of results is also evident within each country market, especially in those countries where we have worked with several financial institutions. About 90 percent of the total loan volume is concentrated in three partner banks, of which only two have reached invest-ment volumes that could be considered substantial from an IFC mainstream point of view.

The three most successful commercial banks typically have a strong focus on certain market segments - the resi-dential housing segment of Raiffeisen Bank in Hungary, the renewable energy segment of Ceska Sporitelna in the Czech Republic, and the gas-fired cogeneration segment of Erste Bank in Hungary. The remaining banks with less focused approaches have not achieved substantial lend-ing volumes through IFC guarantees. What are the major general conclusions we are able to draw from the above results?

Lesson1: Identification of the right partner financial in-stitution is a must.

This general rule is surely not exclusive to sustainable en-ergy projects (energy efficiency and renewable energy), but translated into the sustainable energy business real-ity, it means that it is not enough to have just a “good” bank to work with; instead, the bank has to have a very focused approach to the sustainable energy market. In other words, it means that the bank internally, and espe-cially at the senior management level, has decided to stra-tegically capture the business opportunity and is ready to allocate the necessary resources to achieve real impact. IFC’s role in this phase of strategic orientation can be quite important in helping to articulate the sustainable energy strategy and the respective business targets.

Is there any possibility of formulating a “best practice” on how to identify the partner financial institutions with the highest sustainable energy impact/investment poten-tial? The above results show that you need to work with a relatively large number of financial institutions to be able to identify and help build up an sustainable energy finance “champion.” The one major feature of the best performers was a demand-driven nature of cooperation with IFC. Services provided by IFC were in alignment with the specific business needs of the financial institu-tion. Therefore the nature of cooperation was focused on “how to implement it and what the best tools are to do it with” rather than on “why cooperate and how to per-suade the financial institution of the benefits.”

Lesson 2: Customization of financial and advisory ser-vices for the partner financial institution is essential.

When talking about “sustainable energy financial and advisory products” we mean mostly standard, more or less sophisticated financial products which are custom-ized according to the sustainable energy projects and the financial institution’s need. This leads us to obvious questions: What are the financial institution’s needs in funding, risk mitigation, or know-how? And what is ac-ceptable for IFC from the point of view of its role and the risks involved?

We have observed that the partner financial institutions appreciate many more products with a relatively higher IFC risk, although the absolute amount is quite small. The best example is the pari passu portfolio guarantee prod-

32 SmartLessons

uct with a small (under 5 percent) first-loss component, which was very successfully used in the housing renova-tion sector in Hungary. Until now, about US$900,000 placed in the first-loss position has triggered sustainable energy investment loans of US$44 million, and the le-verage factor (now almost 50) is still on the increase with a growing portfolio. The same effect is also noted in a related school renovation project in Hungary, where the first-loss guarantee leverage factor is supposed to reach almost 100 at portfolio closure. In both cases, IFC was able to address the concrete business needs of its partner financial institution and to add value where it was needed and expected, although it must be mentioned that it was only possible thanks to available donor funding provided in both cases by the Global Environmental Facility. So the perception of risk is working not just on the financial institution side but also internally for IFC.

In the nonfinancial advisory services area, the greatest demand was for advisory service on different sustain-able energy technologies. Provided initially by the CEEF staff, later it was increasingly provided by private sector advisors.

Finally, it is worth noting the size distribution of the sup-ported projects/loans and the respective guarantees. The bar chart above shows that 88 percent of projects have a guarantee size of less than US$100,000, and that only 2 percent of projects have a guarantee size greater than US$1 million.

The data confirm that a substantial part of business op-portunities in the sustainable energy sector are micro, small, and medium-size projects, and the only feasible way for IFC to access the market is to partner with com-mercial banks and other financial intermediaries. What are the consequences?

Lesson 3: Delegation of investment decisions to finan-cial institutions and outsourcing of advisory services are preconditions for substantial scale-up.

We have experienced from our own portfolio growth that the most effective way to boost the investment vol-umes has been the delegation of project approval author-ity from the credit point of view to the partner financial institution. This, in combination with an independent technical review of projects, has led to the fast growth of the sustainable energy portfolios with excellent perfor-mance without project defaults. Outsourcing of credit processing capacity to financial institutions and advisory services to the private sector providers in combination with IFC’s internal advisory capacity (of Private Enter-prise Partnership program), especially at the beginning of the partnership, seems to be the only way to achieve substantial growth of IFC’s sustainable energy invest-ments in the upcoming period.

The ability and willingness of IFC to delegate credit ap-proval authority were based on detailed knowledge of the financial institution credit approval criteria and risk management system in place, but more importantly on first-hand experience with how the procedures and sys-tems are applied in the financial institution project ap-proval cycle. Only financial institutions with a positive track record were eligible for credit approval delegation.

Regarding technical due diligence of sustainable energy projects, we have used two types of approaches. Few banks have built up their own technical and engineering capacity, especially in cases when they focused on relatively larger projects applying project finance techniques. However, the majority of financial institutions were outsourcing technical assessment of the projects to “proven” reliable private sector providers, and they were able to move from subsidized advisory services provided by program staff or consultants at the beginning to fully commercial services available in the market. The latter approach seems to be the way to go for smaller projects; moreover it has a built-in “sustainability mechanism” to continue sustain-able energy investments after direct IFC involvement with the bank has ended.

Published in February 2008.

1%

68%

19%

9%1% 2%

0%

10%

20%

30%

40%

50%

60%

70%

Rel

ativ

e Sh

are

by #

of

Pro

ject

s

< 1 1-50 51-100 101-500 501-1000 >1000

Guarantee Size in $000s

SE Guarantee Size Distribution(606 projects including portfolio projects)

About the Authors

Pavol Vajda is a Senior Operations Manager at IFC Advisory Services in Eastern Europe and Central Asia, and is located in Russia.

Alexandra Glatznerova is a Program Assistant for IFC Global Financial Markets Group in Slo-

vakia.

SmartLessons is an awards program to enable IFC clients, partners, donors, and staff to share lessons learned in their day-to-day work. This brochure introduces a new kind of knowledge sharing. Instead of lengthy academic articles and formal reports, it presents first-hand and straightforward project stories with pragmatic useful analysis, written by professionals and for professionals. Through the prism of their own experience, good and bad, these authors aim to capture practical insights and lessons that could help advance development-related operations for private sector-led growth across the globe.

While IFC supports private sector development both by investing and by providing advisory services that build businesses, this brochure focuses primarily on the topic of energy efficiency in both investment and advisory services. IFC advisory work aims to support small and medium enterprises, to improve the business enabling environment, to accelerate private participation in infrastructure, to increase access to finance, and to strengthen environmental and social responsibility. Much of IFC’s advisory services work is conducted through facilities managed by IFC but funded through partnerships with donor governments and other multilateral institutions.