Our Take: Venturing Where Others Won’t

Photo: James Wheeler

What can an American economist, ancient Mesopotamia, a Republican senator from New York, OPIC, and MIGA teach us about urgently mobilizing credit enhancement to support massive flows of investment in natural climate solutions?

In 1990, Harry Max Markowitz, an American economist, received the Nobel Memorial Prize in Economic Sciences. Despite his curiosity in physics and philosophy at school, Markowitz specialized in the field of economics at the University of Chicago. For his dissertation, he elected to apply mathematics to the analysis of the stock market. As he explored the field of stock market pricing that largely centered on John Williams’ analysis of stock prices as reflecting their “intrinsic value,” Markowitz realized that the prevailing theory lacked the analysis of the impact of risk. This fundamental insight caused him to develop his recognized theory of portfolio allocation under uncertainty, published in 1952 by the Journal of Finance.

Markowitz’s continued work in the field led to his modern portfolio theory (MPT), or mean-variance analysis, that is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is humorous to note that the topic was so novel that, while Markowitz was defending his dissertation, Milton Friedman, another economist and statistician, is said to have argued that Markowitz’s contribution was “nice work, but … not economics.”

Markowitz’s contributions not only transformed investment theory but also influenced risk assessment and management practices across various industries, including finance, insurance, and beyond. His important insights provided a structured approach for understanding and managing financial risk, which remains a cornerstone of contemporary finance and risk management strategies. Credit enhancement and investment risk assessment are closely tied within the realm of financial markets, particularly in the context of fixed-income securities and debt instruments.

Credit enhancement is a strategy used to mitigate credit risk, which is a type of investment risk. The concept of credit enhancement has been employed in various forms throughout history, particularly in the context of lending and borrowing. A historical example of credit enhancement was the use of collateral in lending arrangements. Collateral, such as valuable assets or property, has long been used to secure loans and reduce the lender’s risk of default. This practice effectively enhanced the creditworthiness of the borrower by providing a tangible asset that serves as a form of credit enhancement. In ancient civilizations, such as Mesopotamia and Greece, collateral was often used as a way to secure loans and ensure repayment. For example, in Babylon, merchants could use land as collateral for loans, and failure to repay would result in forfeiture of the land.

The concept of credit enhancement has evolved over time with the development of financial markets and instruments. In modern finance, credit enhancement encompasses a wider range of mechanisms beyond collateral, such as guarantees, insurance, and credit derivatives, all aimed at reducing credit risk and enhancing the credit quality of an investment.

Formed in January 1971, the Overseas Private Investment Corporation (OPIC) was borne out of the realization by U.S. policymakers that private investment was a powerful generator of economic development and that there was an appropriate credit enhancement role for government in encouraging private investment engagement. OPIC achieved its mission by providing investors with financing, political risk insurance, and support for private equity investment funds where commercial financial institutions often were reluctant or unable to lend. Impact investing was also a key priority for OPIC, supporting efforts that sought to produce positive social impacts while generating financial returns sufficient to make these projects sustainable. Established as an agency of the U.S. government in 1971, OPIC managed to operate on a self-sustaining basis at no net cost to American taxpayers.

In the words of Senator Jacob Javits (R-NY) during the Congressional debate preceding the establishment of OPIC back in 1969, OPIC was the “first really big initiative that has come along in the foreign aid field almost since it began, which goes back to 1948 and 1949 … this corporation will for the first time apply business methods and business accounting procedures to the business operations of project development, investment, insurance, guarantees and direct lending—that is, to private activities which are sensitively and directly geared into the development of the less-developed areas which we propose to help in the foreign aid program.”

OPIC of course was not without its critics from both sides of the political aisle. Conservative Republicans condemned what they saw as corporate welfare. Liberal Democrats complained that public resources were being used to support investors instead of projects that helped disadvantaged communities. Opposition came from those who were critical of government involvement in private sector activities abroad. These critics believed that the government should not be directly involved in promoting or supporting private investments overseas. They argued that the private sector should operate without government intervention, even in international markets. Others raised concerns about the potential environmental and social impacts of certain projects that received OPIC support. Overall, OPIC was generally viewed as having made a positive contribution to promoting U.S. investments in developing countries and supporting economic growth.

In 2019, under the BUILD Act the United States International Development Finance Corporation (DFC) was established as a development finance institution following the merging of OPIC with the Development Credit Authority (DCA) of the United States Agency for International Development (USAID). The DFC now carries on the work of OPIC with a $60 billion agency portfolio (up from OPIC’s $29 billion) and also operates with the intention of achieving financial sustainability through the fees and returns generated by its investments and financing activities.

The Build Act transferred the Development Credit Authority from USAID to the DFC. The DCA offers direct loans and guaranties (typically 50%, but as high as 100%) of up to $1 billion for tenors as long as 25 years. These guarantees are intended to encourage private lenders to extend financing to underserved borrowers in new sectors and regions. In 2014, the DCA guaranteed USD 134 million of commercial loans that the Althelia Climate Fund issued to support forest conservation and sustainable land use, helping to remove 100 million tons of carbon—the equivalent of 18.5 million cars—from our atmosphere. This guarantee enabled the flow of private capital to finance sustainable land use models that delivered livelihood improvements, ecosystem uplift, and climate change mitigation outcomes.

OPIC’s slice of the market had declined in recent years, with investors turning increasingly to the World Bank Group’s Multilateral Investment Guarantee Agency (MIGA) that has substantially less restrictive eligibility requirements.

MIGA is the other player in the credit enhancement field. As an international financial institution MIGA also offers political risk insurance and credit enhancement guarantees. MIGA promotes foreign direct investment by providing political risk insurance and credit enhancement to investors and lenders against losses caused by noncommercial risks. MIGA was established in 1988 as an investment insurance facility to encourage confident investment in developing countries. MIGA insures long-term debt and equity investments as well as other assets and contracts with coverage lasting up to 15 years with a possible five-year extension depending on a given project’s nature and circumstances.

MIGA too has faced some negative sentiment from those that argued its impact has been hindered by regulatory bottlenecks, corruption, and inadequate infrastructure. Others have voiced equity concerns coupled with transparency issues on the assessment of potential environmental and social impacts of projects. That said, MIGA has successfully managed to promote direct private sector investment in countries that might be considered riskier due to political or economic instability. MIGA’s guarantees have helped mitigate risks for investors, making investments in these regions in sectors that include infrastructure, energy, agriculture, and financial services which are crucial for economic growth and development. MIGA has also developed innovative products and tools to address emerging challenges in investment, such as environmental and social risks.

Results from a 2010 survey that MIGA conducted found that political risk is the most important deterrent of long-term foreign direct investment in developing countries, even more than economic uncertainty and poor public infrastructure.

When we examine the deterrent that inhibits achieving a total investment in nature of $8.1 trillion between now and 2050 called for by the 2021 State of Finance for Nature report for us to have a chance at addressing our global climate, biodiversity, and land degradation challenges, it is imperative for companies and financial institutions to participate by sharing the risk and increasing investments in nature-based solutions. The mobilization of private capital for natural climate solutions is a key challenge over the coming decade. For context, the private sector delivered investment in nature-based solutions to the tune of $18 billion in 2018. The report found that using 2020 data, approximately $133 billion/year currently flows into natural climate solutions space, with public funds making up 86 per cent and private finance 14 per cent of that total.

One cannot dismiss the financial risks facing the intrepid impact investor wanting to marshal the resources to support natural climate solutions. In contemplating mitigation solutions such as reforestation, afforestation, sustainable land management, soil carbon sequestration, and the preservation of ecosystems like wetlands and mangroves impact investors have to navigate long payback periods, uncertainty on returns, regulatory and policy risks, and the vagaries of emerging nature-based markets that don’t have the benefit of track records, clear monetization pathways, and transparent pricing mechanisms.

To succeed at our goal of tripling investments in nature-based solutions by 2030 with 60% – 70% coming from the private market, we need to venture where others won’t. Specifically, we need to learn from others that blazed a path in the field of foreign aid, such as OPIC, DFC, and MIGA but for nature this time. This critical mission needs to be accomplished in a manner that crowds in private capital, creates innovative financing mechanisms, promotes public-private partnerships, and serves as crucial risk mitigation mechanism for our planet.

P.S. We have ideas….

The Data Economics Company and Gordian Knot Strategies highlight deployment of Enkrateia to support The Integrity Council for the Voluntary Carbon Market

Enkrateia’s Lydion-powered data network facilitates the Integrity Council’s Core Carbon Principles and Assessment Platform for the voluntary carbon market

Los Angeles, August 8, 2023 —The Data Economics Company (DECO) and Gordian Knot Strategies (GKS) announced the deployment of Enkrateia to support the effort of setting and enforcing a definitive global threshold for high quality carbon credits undertaken by the Integrity Council for the Voluntary Carbon Market (Integrity Council).

The Integrity Council is an independent governance body for the voluntary carbon market that has developed the Core Carbon Principles (CCPs) and Assessment Framework (AF) that set new threshold standards for high-quality carbon credits, provide guidance on how to apply the CCPs, and define which carbon-crediting programs and methodology types are CCP-eligible.

The Core Carbon Principles (CCPs), developed with input from hundreds of organizations throughout the voluntary carbon market, set out fundamental principles for high-quality credits that create real, verifiable climate impact, based on the latest science and best practice. The Integrity Council published the first part of its Assessment Framework in March of this year, which provides detailed program-level criteria for assessing whether carbon-crediting programs are CCP-eligible.

“The CCPs establish a global benchmark for high-integrity carbon credits leveraging the solid science and expertise available” said Penrith, CEO for GKS. “They address vital elements of credit quality and integrity such as emissions impact, effective governance, and sustainable development. The Assessment Platform reflects the full set of detailed criteria and associated questions for assessing carbon-crediting programs and is another significant step towards bringing transparency to the market.”

Enkrateia runs on DECO’s patented Lydion® Engine, software that facilitates the secure, private packaging, exchange, and productization of valuable data assets. This allows carbon programs to easily and securely access the Assessment Framework on the Assessment Platform and apply to the Integrity Council for CCP-eligibility.

“We’ve taken another step, with The Integrity Council and Gordian Knot Strategies, to clarify Data Economics and its relevance to climate change,” said DECO Chief Product Officer and Managing Director Sirtaj Brar. “We’re making the value of data more legible based on the outcomes it measures and what it enables. We’re doing this by packaging data so its value is better understood and valued. Enkrateia brings better Data Economics to a market of intangibles that we need to better understand, act on, and ultimately encourage higher ambition in the realm of climate solutions.”

The Lydion® Engine, developed by DECO, is an operating system for decentralized applications. It powers secure, private Lydion Data Vaults that enable people and companies to package and productize their data as valuable digital assets called Lydions. With Lydion-based platforms and applications, users can control, utilize, share, transact, and monetize their Lydions over private networks without losing ownership or control of the underlying datasets.

About Gordian Knot Strategies

Gordian Knot Strategies is a strategic problem-solving consulting company with a focus on natural climate solutions and expertise in climate finance, impact funds, and carbon markets, and has developed numerous go-to-market plans in these areas. GKS advises on impact fund structures, carbon acquisition portfolios, climate financing mechanisms, and domestic and international carbon policies. More at GordianKnotStrategies.com.

About The Data Economics Company

The Data Economics Company’s mission is to pioneer and propagate the field of Data Economics by leading science and research; developing the mathematical, economic, and software frameworks and toolsets to power implementation; and continuing to advance commercialization of the Lydion® Engine. The Lydion® Engine powers secure, private Lydion Data Vaults that enable people and companies to package and productize their data as valuable digital assets.

The Data Economics Company and Gordian Knot Strategies Highlight Deployment of the Enkrateia Platform for More Strategic [CG1][GU2] Investments in U.S. Forests


 

First public use of Enkrateia’s Lydion-powered data network facilitates Innovative Finance for National Forests grants for sustained impact   LOS ANGELES, June 8, 2023 — The Data Economics Company (DECO) and Gordian Knot Strategies (GKS) announced the deployment of Enkrateia’s Traro tool in support of the $2.2 million Innovative Finance for National Forests (IFNF) grant program for 2023. The program is co-managed by the U.S. Forest Service (USFS) and U.S. Endowment for Forestry and Communities (Endowment).  

IFNF announced eleven new grants for projects from California and Arizona, to the Great Lakes Region, Utah, and east to Maine. These partners and project developers are assessing, piloting or scaling work to connect public and private capital to unfunded environmental challenges in National Forests and surrounding landscapes across the United States. The awards represent the third round of funding from IFNF.  

“In the same way we recognize the utility of a FICO score when it comes to taking out a mortgage or leasing a car, we really need a FICO score to predict winning climate investments and funding,” said Penrith. “We have established this by improving the systematic rigor taken for screening of climate investment and funding opportunities. Scoring IFNF proposals on the seven critical elements of the Arch Framework – problem, payors, partners, practices, co-creation, data and measurement, and policy – helps achieve this.”  

Enkrateia and Traro run on DECO’s patented Lydion® Engine, software that facilitates the secure, private packaging, exchange, and productization of valuable data assets. Traro allows for the efficient and easy use of GKS’ Arches Framework developed in 2021 to evaluate and improve the design of conservation finance projects.  

The IFNF grant program promotes the development and implementation of innovative finance models that leverage private and public capital to enhance the resilience of the National Forest System and surrounding lands, and deliver commensurate returns to stakeholders.  

GKS and DECO partnered with the USFS and the Endowment to support the 2023 round of the IFNF grant program, using the Traro screening tool co-developed by GKS and DECO. Free access was provided to Enkrateia’s Traro application to help IFNF grant applicants identify and receive feedback on the seven critical elements needed to effectively design and implement high impact conservation finance projects.   

When all elements are included, the Enkrateia platform facilitates go-to-market plans for organizational growth, program implementation, impact fund structures, carbon acquisition portfolios, conservation financing options, and domestic and international carbon policies.  

“Data Economics – the value of data based on the outcomes it measures and utilities it enables – can be clarified by packaging data so its value is better understood, and can be transacted,” said DECO Chief Product Officer and Managing Director Sirtaj Brar. “The IFNF program and Enkrateia are bringing better Data Economics to a market of intangibles that we need a better grasp of to solve big problems in the U.S. and globally.”  

The Lydion® Engine, developed by DECO, is an operating system for decentralized applications. It powers secure, private Lydion Data Vaults that enable people and companies to package and productize their data as valuable digital assets called Lydions. With Lydion-based platforms and applications, users can control, utilize, share, transact, and monetize their Lydions over private networks without losing ownership or control of the underlying datasets.  

About Gordian Knot Strategies  

Gordian Knot Strategies is a strategic problem-solving consulting company with a focus on natural climate solutions and expertise in climate finance, impact funds, and carbon markets, and has developed numerous go-to-market plans in these areas. GKS advises on impact fund structures, carbon acquisition portfolios, climate financing mechanisms, and domestic and international carbon policies. More at GordianKnotStrategies.com.

About The Data Economics Company  

The Data Economics Company’s mission is to pioneer and propagate the field of Data Economics by leading science and research; developing the mathematical, economic, and software frameworks and toolsets to power implementation; and continuing to advance commercialization of the Lydion® Engine. The Lydion® Engine powers secure, private Lydion Data Vaults that enable people and companies to package and productize their data as valuable digital assets. More at TheDataEconomicsCompany.com.

The Data Economics Company and Gordian Knot Strategies Announce Enkrateia Climate Investment Decision Support Platform

First public use of Enkrateia’s Lydion-powered data network benefits the Innovative Finance for National Forests grant program 

LOS ANGELES, February 7, 2023 —The Data Economics Company (DECO) and Gordian Knot Strategies (GKS) announced the launch of the Enkrateia Climate Investment Decision Support Platform. The first public implementation of the tool supports applicants to the Innovative Finance for National Forests (IFNF) grant program co-managed by the U.S. Forest Service (USFS) and U.S. Endowment for Forestry and Communities (Endowment).  

“Enkrateia’s’ Traro screening tool is now being used in the third round of the IFNF process and is the first public element of the full Climate Investment Decision Support Platform,” said GKS CEO Sean Penrith. “The key to evaluating, tracking and measuring a return on investment is taking in diverse types of data, including quantitative and qualitative measures, and preserving the relationships these data have to each other, and to an investor’s objectives. Decentralized digital platforms such as this will vastly incentivize and accelerate new capital into the climate solutions space. We’re looking forward to further announcements as additional elements of Enkrateia launch.”  

The IFNF grant program served by Enkrateia supports the development and implementation of innovative finance models that leverage private and public capital to enhance the resilience of the National Forest System and surrounding lands and deliver commensurate returns to stakeholders.  

GKS and DECO partnered with the USFS and the Endowment to support the 2023 round of the IFNF grant program, using the Traro screening tool co-developed by GKS and DECO. Free access was provided to Enkrateia’s Traro application to help IFNF grant applicants identify and receive feedback on seven critical elements needed to effectively design and implement high impact conservation finance projects.

Enkrateia and Traro utilize DECO’s patented Lydion® Engine that facilitates the secure, private packaging, exchange, and productization of valuable digital assets. Traro allows for the efficient and easy use of GKS’ Arches Framework developed in 2021 to evaluate and improve the design of conservation projects.  

When all elements are included, the Enkrateia platform facilitates go-to-market plans for organizational growth, program implementation, impact fund structures, carbon acquisition portfolios, conservation financing options, and domestic and international carbon policies.

“We see data from a multitude of sources – that can be independently audited and verified – as a key component in assessing the impact of climate and conservation finance initiatives,” said DECO managing director Sirtaj Brar. “We’re excited to complete the first steps toward that vision with Traro and Enkrateia.”  

The Lydion® Engine, developed by DECO, is an operating system for decentralized applications. It powers secure, private Lydion Data Vaults that enable people and companies to package and productize their data as valuable digital assets called Lydions. With Lydion-based platforms and applications, users can control, utilize, share, transact, and monetize their Lydions over private networks without losing ownership or control of the underlying datasets.  

About Gordian Knot Strategies  

Gordian Knot Strategies is a strategic problem-solving consulting company with a focus on natural climate solutions and expertise in climate finance, impact funds, and carbon markets, and has developed numerous go-to-market plans in these areas. GKS advises on impact fund structures, carbon acquisition portfolios, climate financing mechanisms, and domestic and international carbon policies. More at GordianKnotStrategies.com. 

About The Data Economics Company  

The Data Economics Company’s mission is to pioneer and propagate the field of Data Economics by leading science and research; developing the mathematical, economic, and software frameworks and toolsets to power implementation; and continuing to advance commercialization of the Lydion® Engine. The Lydion® Engine powers secure, private Lydion Data Vaults that enable people and companies to package and productize their data as valuable digital assets. More at TheDataEconomicsCompany.com.

Indaba Update – May 2020

Indaba header

 

May 2020  in·​da·​ba | \in-ˈdä-bə: noun. Origin 1827, Zulu nation
Discussion of matters, affairs, strategies, and accounts of import relating to climate finance.  
Sean Penrith – Gordian Knot Strategies
Credit enhancement hiding in plain sight


I remember reading the piece by Curley and Haislip in 2014 that covered the innovative use of a credit enhancement. It began, “On August 13, 2013, the state of New York set an important legal precedent that could help to retard climate change and reduce greenhouse gas (GHG) emissions in the United States.” Enraptured, I digested the anatomy of how a bond issued by the New York State Energy Research and Development Authority (NYSERDA) was secured by a financial guarantee provided by the New York Clean Water State Revolving Fund. The transaction that funded residential energy efficiency measures was such a milestone that it was recognized as the National Deal of the Year by the Bond Buyer, the authoritative publication in the public finance industry. The transaction was lauded for its significant reduction of the bond debt service and establishment of a nationally replicable model. I was convinced that it would indeed be replicated across the country. Not the case.

CWSRF is a federally supported and state-run financial assistance program overseen by the EPA that supports water quality improvement projects in this country. SRFs have been capitalized from federal appropriations and 20% state matching contributions and retained earnings since inception. With a total capitalization of approximately $51 billion through 2018, CWSRFs are are authorized to provide financial assistance by making loans, purchasing debt obligations, securitizing financings, and providing financial guarantees. Non-point source projects are eligible under the CWSRF program. Under federal authority, eligible recipients include municipalities, farmers, non-profit organizations, individual home owners, commercial businesses, and many more. Eligible projects include those that deliver ecosystem services, including source water protection, water conservation, and projects or programs that mitigate the emission of air pollutants such as mercury and nitrogen that impair water quality.

Over 96% of the financial assistance has gone to sewage treatment plants. The remaining 4% has gone almost exclusively for agricultural non-point source water pollution reduction projects. Under Title VI of the Water Quality Act of 1987, states are given several options to finance clean water projects. For example, §603(d)(1) provides that they can make direct loans for terms of up to 30 years. Paragraph (2) authorizes SRFs “to buy or refinance the debt obligation of municipalities and inter-municipal and interstate agencies within the State.” And, Paragraph (3), which is the most important and yet underutilized provision, authorizes SRFs “to guarantee, or purchase insurance for, local obligations where such action would improve credit market access or reduce interest rates.”

Generally speaking, available resources, provided from new appropriations and dollars recycled from prior project commitments are encumbered by new projects. This fuels the common perception that such encumbrances leave no resources that can be dedicated to expanding SRF product offerings to additional forms of financial assistance such as financial guarantees.

However, future project encumbrances are not a limitation on increased SRF utilization. Often there are sufficient SRF resources that could be pledged to support guarantees that would qualify for triple-A claims-paying designation. Most SRFs have pledged cashflows supporting triple-A ratings for their pooled bond indentures that are in excess of that needed to support such ratings given required rating agency stressed loss assumptions. An SRF guarantee product can be positioned as a pledge relying on a subordinate lien on the equity turnover from the bond indenture. Repayments of direct loans held on the SRF balance sheet could also be added to the credit assessment which would only deepen guarantee capacity. For most if not all programs in the country, the assumed net of loss cashflows required to establish lending program triple-A credit support plus the pledge of available equity balances should provide ample resources to support a top rated SRF guarantee product that could serve market-based solutions for cost effective investment in water quality protection and nutrient mitigation.

I am convinced there is an opportunity to access the credit enhancement in a ground breaking manner to support natural climate solutions in this country while positively impacting water quality and quantity. In 2014, the EPA Financial Advisory Board (Board) produced a report that analyzed the potential of CWSRFs to provide credit guarantees to support projects not traditionally targeted by the lending program, given priority considerations. Specifically, the report evaluated the prospects for tapping the federal authority granted by Title VI, Section 603(d) of the Act to support such projects by providing financial assistance in the form of credit guarantees for Green Infrastructure projects. The goal was to identify a mechanism by which states could expand overall financial assistance capacity that would further national clean water goals.  
 
The conclusion of the Board’s report was clear. They found that CWSRFs have the capacity to offer credit triple-A rated guarantees. They determined that for each dollar of recycled CWSRF program equity, $3 to $14 of CWSRF guarantee capacity could be provided to fund projects in addition to current project funding levels. The Report concluded that leveraging recycled dollars in this manner could support as much as $50 billion in guarantee capacity if all programs took advantage of it nationwide.
 
The central premise to this finding is that the current strength of SRF balance sheets can enable SRF administrators to use the guarantee to meaningfully expand funding capacity without reducing current levels of lending activity. On behalf of one of our clients, American Forest Foundation, we are actively exploring how to structure just such a guarantee to support their Family Forest Carbon Program. 

The prospect that SRFs could offer guarantee products to provide financial assistance to underserved project categories without diluting the capacity of the established below-market lending program is significant. It is a powerful credit enhancement tool hiding in plain sight.

On The Road


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Sheltering in place in Portland Oregon for a while still.
Our Expertise:


  • Climate finance mechanisms
  • Carbon acquisition portfolio design
  • Impact funds
  • Carbon markets and policy
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Contact us for more information

 * Financing Options for Nontraditional Eligibilities in the CWSRF Fund Programs. Report

 * CORSIA Eligible Emissions Units. Report

 * Running the Risk: How Corporate Boards Can Oversee ESG Issues. Report

 * COVID-19 pandemic jeopardizes Art. 6 negotiations. Report

 * Emergence of heat and humidity too severe for human tolerance. Report


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