Financing smart city solutions

smart city financingSmart cities hold out the lure of sustainability and innovative technological solutions to large, previously intractable problems. But such opportunities do not come cheaply. Some of them, such as smart lighting, can be funded from the savings  made in changing technology. But other, larger projects represent much bigger risks, and it has proven hard to persuade investors that  the returns will be worthwhile.

The European Commission has not failed to identify this problem. In 2013, it published guidance to cities setting out the barriers and potential solutions to financing smart city innovative technological solutions. The focus is very much on low-carbon energy and transport, because it is here that the biggest risks lie. This is also where some of the greatest pressure is applied, because of carbon-reduction targets agreed by national governments.

Barriers to funding

The report identifies five key barriers to financing smart city solutions, which are:

  1. Investors have a perception that there is a high risk involved in investing in innovative solutions, and particularly energy efficiency measures.
  2. This is partly because of uncertainty about energy prices, both in terms of policies about renewable and green energy sources, and also fossil fuel prices. The interest in investing in green energy rises when fossil fuel prices are prohibitive, because green energy companies can afford to spend more on development and recoup the costs.
  3. The amount of investment needed in large city projects is also large volume. Bigger projects by definition have more risks and more uncertainty, with more options for things going wrong.
  4. Many low-carbon and transport initiatives have long payback periods, which means a long delay before being able to recoup the investment. This is fine for smaller investors, who may back projects for ideological reasons, but may be a problem for larger investors, particularly if the payback is uncertain.
  5. There is limited option for public funding. Public administrations are generally expected to get more for their money these days, and austerity programmes have bitten deep across Europe. This makes it hard for city authorities to raise money. Investors are more nervous if large public infrastructure projects are not underwritten by public funds, because again, the risk is higher.

Overcoming the problems

The report identifies options and solutions to overcome these barriers. It suggests that one key issue is to identify areas of risk, and reduce both real and perceived risks of investment. For example, providing some grant funding or offering equity to private developers may make the risk more palatable. Alternatively, public authorities might underwrite some areas of the project or provide loans for developers.

It may also be possible to attract long-term finance from specialised sources such as pension funds, which can afford to take a long-term view. Other options include project aggregation, bringing together sizeable investments, but with reduced transaction costs, by tapping into economies of scale. This kind of amalgamation also increases the credit rating of investments, because it makes any single project failure less crucial to the overall investment.

Cities also need to get cleverer with funding mechanisms and models such as public-private partnerships, which have been used to good effect for large infrastructure projects in the past. They need to understand that different investors have different attitudes to risk, and different time horizons, and ensure that they target appeals in the right direction. For example, pensions funds have a much longer time horizon than commercial banks, and venture capitalists have a focus on new and untried ideas, but are looking for big returns on their investment. Public authorities may also issue bonds to encourage investment.

One issue which cities need to address is that of public benefit. This can often not be monetised by developers, but may be sufficient to warrant reasonable amounts of public subsidy; often enough to reduce the costs sufficiently to interest investors. This can be looked upon as a way of charging taxpayers for the future benefits they will receive, and may mean that national or international grants can be made available for innovative developments.

Not all barriers are financial

The report also notes that there are issues which cannot be overcome by changing financing methods and new models of funding. These include regulatory requirements set out by governments. It may, therefore, be necessary for national and regional governments to consider whether they themselves are hindering the growth of smart cities, and take action to address this, rather than complaining that cities are slow to develop new infrastructure and adopt smart and innovative technological solutions.

Image credit: Euro by flickranet

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