Sliced: What Is Credit Enhancement? A Simple Introduction

Listen to this Sliced essay on any of the streaming platforms below.

Last week, we published an in-depth “Our Take” article titled “Global Credit Enhancement Facility” written by our CEO, Sean Penrith, and Nathan Truitt from American Forest Foundation. If you haven’t had the chance to read it yet, you can find it here. Their expert insights shed light on how credit enhancement mechanisms are transforming access to impact capital around the globe.

Inspired by that piece, we wanted to continue the conversation this week but take a step back to explore the fundamentals of this instrument. This article offers a beginner-friendly, “101-level” introduction to credit enhancement and its role in enabling sustainable investments.

At its core, credit enhancement is a financial tool designed to improve the creditworthiness of a financial asset. By reducing the perceived risk of default it reassures investors and increases the likelihood of securing funding. This is crucial for projects that may initially appear risky but hold immense potential for societal or environmental benefits.

Types of credit enhancement include:

Guarantees: These are commitments, often provided by third parties like governments or financial institutions, to cover losses in the event of default. Guarantees provide a safety net that can assuage hesitant investors.
Collateral: Assets such as property or equipment can be pledged as security for loans. This ensures that lenders have recourse if the borrower defaults, lowering their risk exposure.
Insurance Products: Specialized insurance policies can also act as credit enhancement, compensating investors in case of non-payment or unforeseen project risks.

The process of securing credit enhancement typically involves an evaluation of the project’s risk profile by rating agencies or financial experts. Based on this assessment, developers or fund managers may seek guarantees, collateral arrangements, or insurance to align the project’s risk level with investor expectations. These enhancements effectively bridge the gap between a project’s potential and the risk tolerance of its investors.

Credit enhancement provides two key benefits. First, it increases investor confidence by reducing perceived risks, attracting a broader range of investors, including those typically cautious about higher-risk opportunities. Second, it leads to lower borrowing costs, as enhanced creditworthiness often results in reduced interest rates, making projects more financially feasible and impactful.

In impact investing, where the focus is on achieving measurable social or environmental benefits alongside financial returns, credit enhancement is transformative. Climate solution developers, for instance, often face challenges in securing funding due to the inherent uncertainties in new or emerging sectors or technologies. Credit enhancement mechanisms mitigate these risks, enabling innovative projects to flourish.

For example, credit enhancement has been instrumental in financing renewable energy projects, affordable housing, and infrastructure in underserved regions. By making these projects more appealing to investors, it accelerates the flow of capital into areas that align with the United Nations Sustainable Development Goals.

Credit enhancement has been pivotal in various successful initiatives. For example, green bonds have used guarantees from development banks to lower borrowing costs, funding projects like solar farms and wind parks. Similarly, blended finance initiatives leverage credit enhancement to de-risk investments, fostering private sector participation in public-private projects with high levels of impact being achieved.

Credit enhancement is a powerful enabler in the realm of impact investing, bridging the gap between innovation and investment. By reducing perceived risks, it fosters confidence, attracts capital, and ultimately helps to bring transformative projects to life. As the urgency to address global challenges such as climate change intensifies, credit enhancement will continue to play a critical role in driving sustainable investments forward.

For more detailed insights, revisit our original “Global Credit Enhancement Faculty” article here.

Below is a curated selection of standout opportunities brought to you by GKS’s valued clients.

American Forest Foundation: Nature Based Carbon Credits

The American Forest Foundation (AFF) will hold the first auction for the Family Forest Carbon Program’s carbon credits in February 2025.

The American Forest Foundation Carbon Auction — the first of its kind for a U.S. nature-based carbon project — will offer buyers a transparent and streamlined way to secure high-quality carbon credits while supporting rural communities and family forest owners.

To read the full announcement, click here.

To view information on the auction, click here.

ReSeed: Agriculture Carbon Credits

ReSeed partners with smallholder farmers globally, helping to improve livelihoods, protect vital lands, and ensure ecosystem services are properly recognized and rewarded. Through these efforts, ReSeed generates agricultural carbon credits that drive sustainability. Click here to explore their projects.

Savory Foundation: Carbon Removal Credits – Uruguay Grasslands Regeneration Project

The Savory Foundation along with the Savory Institute, Pampa Oriental, and Cultivo are now offering nature-based carbon removal credits from their Uruguay Grasslands Regeneration Project. This groundbreaking project spans 140,000 hectares across 166 privately held properties, employing Savory’s Holistic Management framework to restore grasslands while supporting local communities and ecosystems.

The project, under Verra’s VM0032 Methodology for Sustainable Grasslands, anticipates an annual issuance of around 152,000 credits, beginning in 2026, and addresses the UN’s Sustainable Development Goals – 8: Decent Work and Economic Growth, 13: Climate Action, 15: Life of Land, and 17: Partnership for the Goals.

To learn more about this project and its impact, click here.

If you want to connect about the project, email us here.

U.S. Endowment for Forestry and Communities: Impact Investing Opportunities

The Endowment (supported by Gordian Knot Strategies) will be hosting an informational webinar about their Impact Investing Program on December 18, 2024 at 12pm PST. This webinar will provide an overview of the program in general, including its purpose, past investments, and goals for future rounds. Interested participants should register here (a recording will be made available to registrants).