In our work supporting state financing instrumentalities, state energy offices, and local governments in preparing clean energy deployment plans, we have often found ourselves describing the kinds of capabilities and functionalities that we believe public financial instrumentalities must be able to exercise in order to meet their decarbonization and community development goals. While we have described some of these in previous reports, including our Public Developer and Revolving Loan Fund reports, we have not listed them in one place.

Below, we list capabilities, explain how each works, and describe why each is important. We hope this list allows stakeholders and interested partners to better understand everything that a state should be capable of providing to critical decarbonization projects, and why empowering state instrumentalities with these abilities helps serve public goals. Ultimately, we believe that state financial instrumentalities must be more than financial institutions: They should be entities that can balance complex public goals and should be empowered to coordinate among state, nonprofit, and private actors to achieve those goals.

The capabilities and functionalities of state financing instrumentalities should include but need not be limited to:

• Loan issuance. The financing instrumentality should be able to issue loans to finance projects—as any bank would—particularly because many renewable energy projects rely on debt financing.
  
  
• Concessional loans. The financing instrumentality should be able to offer loans at lower interest rates, at longer maturities, and with more forgiving repayment schedules than private loan providers would. Given high private financing costs today, this capability is essential for ensuring that developers can still build otherwise-viable clean energy projects.
  
  
• Bridge loan financing. A project’s construction period, during which it earns no revenue and could face delays, is the riskiest portion of a project for lenders to finance. For this reason, construction bridge loans are more expensive than loans taken to finance a project’s operation period. The financing instrumentality should be able to make construction bridge loans to project developers at better terms than private loan providers; the ability to do so would significantly buttress the cash flow of the borrower.
  
  
• Loan underwriting. The financing instrumentality should invest in building a staff of loan underwriters and internal risk management capacity to enable itself to assess borrower creditworthiness, ensuring that any loans do not place undue risk on the balance sheet of the financing instrumentality or put its solvency under threat. Supporting internal underwriting capacity allows for the instrumentality to engage in deeper financial relationship-building with borrowers, lowering borrowing costs and collateral requirements over time for responsible and sustainable borrowers.
  
  
• Credit enhancements. The financing instrumentality should be able to provide credit enhancements to protect developers and municipalities, raising their creditworthiness and improving the terms on which they can raise financing from other sources. Loan guarantees for developers insure other lenders against those developers’ default risks. Credit enhancement programs for municipalities, such as the Texas Permanent School Fund, which uses bond guarantees to enhance ratings on school district bond issuances, ensure that municipalities can secure cheaper financing to invest in energy projects. Loan loss reserves can fund first-loss guarantees as well to offset a pre-arranged level of developer losses. The financing instrumentality can extend these credit enhancements to municipalities, public developers, and private developers.
  
  
• Equity investment. The financing instrumentality should be able to make targeted equity investments into higher-risk, higher-reward projects, such as experimental technologies, that are socially and environmentally promising but are otherwise unable to secure equity finance at a reasonable expected cost from other sources. A financing instrumentality capable of providing equity support with a desired rate of return lower than private providers might require will attract promising clean manufacturing and technology startups to the state. If so desired, the financing instrumentality could require that its equity investments in firms translate to active or passive governance rights in those firms. Deploying construction equity, in particular, allows the financing instrumentality both to control an investment and reap the benefits of the investment’s potential appreciation in value—as exemplified by the Montgomery County Housing Production Fund’s investments in social housing developments. In high interest rate environments, public equity can preserve vital project developments. The financing instrumentality could also facilitate the ability of another state instrumentality to undertake these investments.
  
  
• Debt-to-equity swaps. The financing instrumentality should be able to swap its debt investment in a project for equity of equal value if the financing instrumentality or other lenders have serious concerns about the project developer’s creditworthiness. This swap would have the financing instrumentality forfeit the project developer’s debt service payments but would give it active or passive governance rights in that developer commensurate with its equity share. Not only could the financing instrumentality execute this swap with a desired rate of return on equity lower than private market participants could, providing the project developer with necessary liquidity, but it could use its governance capabilities to steer the project back toward financial viability. The financing instrumentality could also engage in debt-to-grant swaps, essentially forgiving its loans to developers in adverse circumstances or, alternatively, if developers meet or exceed certain project deliverables and impact criteria.
  
  
• Buyouts. The financing instrumentality should be able to finance a public developer’s buyout of private developers’ contracts to build and supply renewable energy resources to the grid in the event that those developers are reluctant to honor their contracts on account of expensive financing costs or supply chain snarls. A buyout by a public developer—which has a lower cost of debt, higher risk tolerance, and longer time horizon—allows it to build some projects that private developers may not be able to continue work on.
  
  
• Co-financing. The financing instrumentality should be able to co-finance projects alongside other public and private market participants, including but not limited to private banks, community development financial authorities, and pension funds. While co-financing would make the project developer’s capital stack more complex, it allows the financing instrumentality and other lenders to limit their total exposure to the project developer’s balance sheet.
  
  
• Debt issuance. The financing instrumentality should be able to raise debt on capital markets through bond issuances—as all other financial institutions do—to secure working capital for itself independent of state appropriations processes. A public or quasi-public financing instrumentality has the benefit of being able to raise debt at a far lower cost of capital than many private and nonprofit banks could, thanks to most state governments’ high and stable state credit ratings.
  
  
• Revolving loan fund deployment. The financing instrumentality should be able to deploy a revolving loan fund that can quickly and repeatedly finance capital expenditure over longer periods of time by recycling projects’ revenue streams (including elective payments) into seed capital or bridge financing for new projects. A revolving fund set up on the balance sheet of the financing instrumentality or through an off-balance-sheet special purpose vehicle, capitalized through a state grant or bond issuance, would allow the financing instrumentality to operate independent of state appropriations processes.
  
  
• Project preparation and contract structuring. A financing instrumentality should be able to support developers in project preparation and contract structuring. All decarbonization projects will require both financial plans and impact assessments, neither of which a project developer is necessarily capable of doing itself at the speed and scale required. A financing instrumentality that assists developers here will not only be able to reduce its own overhead and due diligence costs when financing projects—likely by pushing standardization of contracts and assessment processes and by building internal due diligence capacity—but will ensure that project developers can also secure financing from other investors, which may be more likely to co-finance decarbonization projects if they know the financing instrumentality has helped structure them in a standardized manner.
  
  
  • Financing instrumentalities should include site identification and preparation services and related pre-development activities in their offerings for developers as well. Identifying suitable land and preparing the regulatory assessments needed to develop projects on it well in advance of developer interest, something federal and state agencies have done for California’s Ten West Link transmission line and Texas’s Competitive Renewable Energy Zone, is the kind of proactive strategy that would significantly ameliorate developers’ regulatory and planning hurdles.
    
    
  • Financing instrumentalities should include tax credit and elective pay advisory services as part of their project preparation capabilities to ensure that developers they work with are choosing the optimal mix of credits, federal and state subsidies, and other incentives—such as the federal Solar For All program—when planning projects.
    
    
  • Financing instrumentalities should also include project labor agreement and community benefit agreement advisory services to ensure that developers it invests in are held accountable to public standards for a just transition and community development, including but not limited to fair wages for workers and support for vulnerable communities.
    
    
• Securitization. The financing instrumentality should be able to securitize its portfolio of assets to raise cheaper financing on the capital market. The financing instrumentality can likely do this through a process known as synthetic securitization, in which it tranches the default risk on a portfolio of its assets and purchases a loan guarantee on each tranche, effectively offloading its default risk and freeing up balance sheet space to issue new loans. This is a different process than true-sale securitization, in which the financing instrumentality would bundle and tranche its portfolio of assets and sell off the rights to those assets’ revenue streams, similar to a mortgage-backed security. While the financing instrumentality could do true-sale securitization, there may be political problems associated with essentially selling publicly financed assets, not to mention coordination problems in the event that these assets are co-financed alongside private partners. In either case, the financing instrumentality should be wary of periods of low market liquidity, during which it may overpay for guarantees or receive inadequate compensation for sales of asset-backed securities. A financing instrumentality empowered to invest, manage risk over a longer time horizon, and warehouse assets for future securitization mitigates these risks. A financing instrumentality aiming to securitize its portfolios would be best served by a federal counterparty such as a National Investment Authority providing a liquid source of financing for the financing instrumentality’s asset-backed securities or a backstop for guarantee purchases.
  

• Central procurement. Because supply chain pressures and input delivery delays present a real threat to timely project development—which in turn increases project financing costs—a financing instrumentality should be able to act as a central procurer of key inputs that might be required across a wide range of capital investments. Through bulk orders of construction and electronics goods and services, a financing instrumentality can build buffer stocks for use during periods of market volatility or supply chain snags, keeping input costs stable for project developers across the state by providing a constant source of demand for input producers.
  
  
• Grants. The financing instrumentality should be able to issue grants to reward developers for certain actions. For example, the financing instrumentality can award grants to developers that meet or exceed project deliverables and impact criteria. The financing instrumentality can also issue grants to early-stage experimental technology developers, firms that are by nature higher-risk but promise significant societal benefits if they succeed at their task.
  

• Partnerships with public universities. The financing instrumentality should work closely with public universities to support energy technology research labs, clean energy finance education programs, planning spaces for just transition and community economic development policymaking, and workforce development and training programs. These four focus areas explicitly instrumentalize state universities’ existing capacity for advancing cutting-edge research, local business development, local policymaking, and vocational education—and financing instrumentality support for these capacities can build a pipeline of interested students, researchers, professors, and workers whose scientific, business, policy, and technical expertise can be directed toward state climate investment goals.
  

The proposed state financing instrumentality should be a public or quasi-public entity—as opposed to a nonprofit entity unaffiliated with the state government—for the following reasons:

• A public or quasi-public financing instrumentality can be given legislative mandates to ensure its investment strategies are accountable to state residents. A state entity ultimately held accountable to the needs of voters will be more prepared to advance economic development goals for vulnerable communities across the state. A public entity with a public mission, accountable governance structure, and egalitarian investment strategy can avoid supporting investments that inequitably exclude vulnerable communities and displaced workers.
  
  
• A public entity can coordinate among state institutions and with federal financing programs to meet economic development goals and target financial support toward vulnerable communities. Through this central coordination, a public entity can more easily integrate and balance climate, development, equity, and justice goals by aligning the missions of its partners. A nonprofit housed outside the state government apparatus may have a harder time executing this balancing act, since it would be less accountable to the state, less able to coordinate the expertise required to meet these goals, and potentially seen as less legitimate than a state actor.
  
  
• A public entity builds state administrative capacity to plan and execute the kinds of complex legal and financial activities needed to prepare clean energy projects, mobilize investment toward them, and provide support to vulnerable communities. To that end, a public entity can work alongside nonprofits and philanthropies. Outsourcing these capacities to a non-state entity means losing the ability not just to directly and transparently monitor the financing instrumentality’s planning, execution, and partnership processes, but to ensure that other state instrumentalities can learn from them.
  
  
• A public entity can take on more risk and think longer-term than its private and nonprofit counterparts could, especially if legislative support provides it with a mandate to do so.  A public entity can also make use of the creditworthiness and bond issuance capacities of the state government when issuing debt and providing credit enhancements. Additionally, a public entity can raise finance for clean energy and infrastructure investment in a centrally coordinated manner.
  
  
• All financing instrumentalities that seek to finance projects alongside private investor partners run the risk of subsidizing those investors and other financial intermediaries, enabling rent-seeking. A public entity that remains politically accountable and that is designed with guardrails to prevent rent-seeking can mitigate this possibility—but a nonprofit with a more opaque governance structure may not be able to.

CPE is supportive of the efforts states are taking to create financial instrumentalities that can target housing and energy challenges and, to that end, we hope this list of capacities remains a useful starting point for state policymakers.