The question of how to finance renewable energy infrastructure is all the rage. How do we mobilise private sector savings? What role should government play? Can we be sure we can allocate project risks to the parties best placed to manage them?

The Australian Conservation Foundation (ACF) recently released a report on funding the transition to a low-carbon economy. It recommended the establishment of a clean energy finance corporation (or green investment bank), that would utilise the federal government’s “AAA” credit rating to support and induce private sector investment.

Various other countries, the UK in particular, have been discussing the merits of a green investment bank, so the ACF report is timely and it puts some more rigorous thinking around the concept.

Back in July, I wrote an article outlining some of the key issues that the designers of a green investment bank would need to cover for it to work, such as the impact of the project financing cycle, locating the natural investors at various project stages and key challenges to overcome. It is a simple idea but surprisingly more complex in practice.

What is now becoming clear, when we think about private savings mobilisation, is the issue of investment product. There have been buyers of environmentally friendly investment products for many years. These are funds that typically apply a set of values to their investment criteria and this style is often referred to as ethical or socially responsible investing.

But there is more to it than that. There is a much wider range of ‘mainstream’ investors out there who are not values driven. Some have, in the interests of prudent risk management, commenced the process of systematically analysing environmental factors in their everyday investment practices.

The upshot is that ethical funds are differentiated by their investment style. For example, in an equity or bond portfolio they may exclude coal mining companies because they disagree with a business model based on burning coal; whereas mainstream investors have a broader range of investments to pick from, seeing the challenge as one of understanding the risk inherent in the security and pricing accordingly.

What’s all this got to do with the concept of a green investment bank? For many, there is a fundamental assumption that new investment markets will provide a substantial source of funding for renewable energy investment. Retail investors have been identified as having demand for ‘green’ bonds that are linked to the environmental cause along with funds that take an ethical approach to investing. These markets are not yet fully tested and their funding capacity is unknown.

The assumption may turn out to be valid but it is not without risk. Most large superannuation funds offer an ethical-based investment option and the average take-up rate by members has hovered around the 2 per cent level. So the challenge for a green investment bank strategy is to stimulate demand and create new markets in which to issue these bonds.

A much lower-risk approach is to issue bonds that fit the mainstream investor market. After all, that is where the real money is. These investors are not overly sensitive to the environmental cause; they are looking for certain features in the bonds they buy, such as the return relative to similarly rated bonds, bond maturities that fit their portfolio requirements and good liquidity. If they like the bonds on offer, they’ll turn up with big money.

Bonds issued under the ACF’s clean energy finance corporation model would carry an “AAA” rating and mainstream investors would expect some level of extra return because it is not a direct form of government risk and the bonds are likely to be less liquid than government bonds.

A green investment bank could diversify its funding base and maximise its fundraising ability by forming strategies for both of these markets. Ethical funds and retail investors may be motivated by the branding of the bond offering and underlying cause, whereas mainstream investors will make clinical risk and return assessments. There are two distinct markets out there and delivering the right product to the right market will be part of the challenge in mobilising private sector savings.

Phil Preston is the Principal of Seacliff Consulting, a firm offering specialised consulting services in the financial and responsible investment fields. His prior work includes 17 years of financial research and portfolio management in the funds management industry.