Common interest – the key to investing in life-supporting assets

Sergio Oceransky

During most of the year on the Isthmus of Tehuantepec in Mexico, the difference in air pressure between the Gulf of Mexico and the Pacific propels the wind through a narrow gap in the mountain range that stretches from Alaska to Patagonia, toppling corn crops and, at times, lifting heavy trucks on its way to the sea. This wind energy is a colossal natural resource and offers a ripe opportunity for impact investment. The trouble is, such opportunities are often exploited for the benefit of the investors, not for the local community. However, in Tehauntepec, an innovative business model is evolving where communities, investors and natural resources come together on the basis of common interest.

In contrast to Europe or the US, Mexico does not offer direct financial incentives (such as tax credits or a subsidized price for green energy) to wind farm developers. But the wind is so strong and constant that large companies, such as Wal-Mart, CEMEX (Latin-America’s largest cement producer), or the all-powerful Mexican Coca-Cola bottling company FEMSA, have decided to source their electricity from private wind farms, rather than from the public utility.

The Isthmus of Tehuantepec is home to deeply rooted indigenous communities. As in many places, they have been driven to live in the inhospitable margins and have fully adapted to these places, preserving the natural resources which are not only important environmentally but are also of growing economic value. Most of the land is also collectively owned. It is a perfect context for impact investment, where sustainability can be combined with collective social transformation. However, in most cases, the construction of wind farms is eroding indigenous rights, producing explosive social tensions and fierce resistance to private wind farms. This has recently resulted in the violent death of a man at a road blockade against a project in construction, and the representative of a large wind developer being locked up (and almost lynched) together with the mayor by more than 1,000 angry indigenous farmers. They were released only after the mayor publicly destroyed the permit required to start building a large wind farm financed by, among others, the Climate Investment Funds through the Inter-American Development Bank.

This resistance is not directed against wind power, but against the takeover of indigenous land and resources. In contrast, when the business model puts communities at the centre, the sun shines brightly on wind farms, as exemplified in the Zapotec community of Ixtepec.

The general assembly of this 30,000-strong community decided not to lease any land to developers, and instead sought to develop a community wind farm. The Yansa Group is partnering with them to help them channel this resource for their social and economic benefit and on the basis of their continued collective control over their territory and resources. In the long term, this is a better business model than supposedly higher-margin private wind farms, since local common ownership provides an unparalleled level of resilience and investment security. However, it requires financial innovation, based on an understanding of what differentiates this sector from business as usual.

The social idiosyncrasy of life-supporting sectors

The troubles of private wind developers in Mexico are illustrative of the conflict between corporations trying to obtain access to territories rich in natural resources and communities asserting control over their territory in defence of their culture and livelihood. This pattern repeats itself in investments related to life-supporting assets such as renewable energy, water and food production, particularly in developing and emerging countries.

In these sectors, assets are bound to living territories and to the communities that keep them alive. The relationship between stakeholders is normally very unequal, with the more powerful interests applying mainstream financial thinking and, in particular, conventional notions of risk and reward which often leads to abuse and exploitation. This is not just ethically wrong, it is ultimately also bad business for investments that are long-term by nature.

Investments usually start with speculative capital under different names (venture funds or, in the wind sector, ‘developers’), whose primary concern is getting hold of assets as cheaply as possible, in order to flip them over quickly for a good profit. This often results in exploitative arrangements that are passed, together with the assets, as a ticking time bomb. It is only a matter of time before communities start to feel cheated, and fight back for full territorial control.

In principle, this is an area where the emerging impact investment sector should have a competitive advantage over speculative capital. A primary focus on the creation of social value should result in more resilient and sustainable business practices. Unfortunately, the extent to which this happens is limited, because most impact investors replicate conventional practices on key issues such as ownership, value extraction and accountability, and take a flawed approach to risk and return.

Impact investment’s flawed answers

Most so-called impact investors are ‘financial-first investors’: they expect to obtain market (or above-market) returns and still generate positive social returns. However, in life-supporting assets, you cannot have your cake and eat it too.

Even investors that are primarily committed to the creation of social value (so-called ‘impact-first investors’) often strengthen flawed investment practices. A common strategy known as ‘capital blending’ attempts to multiply impact by structuring deals in terms that attract financial-first investors, therefore leveraging additional capital. This gives financial-first investors a powerful voice in the definition of return expectations, and usually results in equity-based ownership of rights and assets, and in accountability practices that are primarily (if not exclusively) focused on investors. Most of the time, impact-first investors expect to exit the investments early on, in order to leverage further impact elsewhere, leaving financial-first investors alone in the driving seat.

When entering capital blending structures, impact-first investors often accept more exposure to risk without financial compensation, or accept a lower return in order to increase the return of other investors, or both. They do so due to the widespread, though often incorrect, assumption that impact investment carries more risk than conventional investments because it involves investing in economically disadvantaged communities.

Capital blending therefore ignores the most important factor distinguishing impact investment from business as usual. A key advantage of businesses that create social or environmental value is that, if properly structured, there is a common interest in their success, shared by many stakeholders beyond the investors. Common interest reduces risk significantly, but it also requires unconventional structuring of ownership and accountability, and modest financial return expectations.

Risk and reward vs common interest

Common interest is eroded when social businesses are owned and controlled primarily by investors who expect to maximize profit margins and/or seek profitable exit opportunities. It tends to disappear when the role of the community is reduced to an economic factor (supplier of workforce or natural resources) and accountability is skewed towards investors.

Capital blending, while leveraging additional capital, often results in an increased eye to profit, which compromises social objectives, erodes the potential to cultivate common interest in the success of the social business, and therefore unnecessarily increases the risk of investments. Conventional risk and return concepts cannot be applied uncritically to investments in life-supporting assets in territories inhabited by disadvantaged communities. Here, investment failure is not just a problem for the investor. It adversely affects vulnerable social sectors and/or ecosystems, which might not be in a position to endure the consequences.

The investors’ concept of risk and that of the communities’ are worlds apart. Losing control over an area may be no big deal for investors who transfer many kinds of assets on a regular basis. For indigenous communities, it represents a threat to their culture, livelihood and sense of dignity. Even the understanding of ‘success’, or of common interest, differs: for communities it often includes intangible aspects that cannot be added to conventional business plans or contractual arrangements.

This cultural mismatch is painfully obvious in the Isthmus of Tehuantepec. Developers often disregard the relationship of indigenous peoples to the land and blame local resistance on vested interests attempting to stop progress. Their response to protest is often to request repressive measures from government, bribe local strongmen or foster internal conflict within communities. Instead of understanding and nurturing common interest, they undermine it.

Although common interest is of greatest importance at local level, it has consequences at national level too. A case in point is the evolution of feed-in tariffs (FITs) for renewable energy in Spain and Germany. In Spain the primary beneficiaries of FITs have been utilities. In Germany, communities actively participate in renewable energy production as a result of a deliberately inclusive policy. When FITs were cut back in Spain, the sector was unable to mobilize allies. In contrast, Germany’s FITs enjoy widespread support.

In order to cultivate common interest and to reduce investment risk for the community impact-first investors need to change the terms on which they relate to other investors. This requires financial innovation, since most capital blending practices have the opposite effect: they de-risk investments for other investors and worsen the terms of the deal for the local community.

Strengthening resilience and community involvement

At the Yansa Group, when we decided to engage in large-scale social value creation and empowerment through the development of utility-scale community wind farms, we needed a financial model that lowers risk and reduces the cost of capital, and also places the community at the heart of value creation and management. We are building it by changing the terms and the timing in which investors with different motivations enter the project, and through a community-based approach to accountability and ownership of rights.

Investors receive no equity at any point, and they will only receive a part of the financial returns produced by the wind farm. There are three investment phases with decreasing levels of risk, but with the same level of financial return. Such a counter-intuitive structuring is not only possible, but it may well prove to be a much more adequate strategy for investment in life-supporting assets. Here, briefly, is how it works.

We are working on a 100 MW, US$200 million wind farm in the community of Ixtepec. A Community Interest Company (CIC), limited by guarantee and constituted in partnership with the community, will own the project.

In the development phase of the project, we are sourcing our finance from impact-first investors who want to promote financial innovation. They invest relatively small amounts through low-interest, high-risk loans to produce a financial model that is, by design, bound to devote a significant percentage of future profits to the creation of social value, and has a strong potential to be scaled up and attract very large flows of capital.

In the construction phase, which we expect to start in mid-2012, we will source finance from impact investors interested in a risk-adjusted social return. They will invest once we sign a 20-year power purchase contract with the utility and a turnkey contract with a reputable wind turbine manufacturer and construction contractor, and have all required permits and licences. They will constitute and own an investment vehicle that will give a loan to the Community Interest Company that owns the wind farm. They will receive a decent financial return and an extraordinary social return.

The difference between the profit generated by the wind farm and the interest paid to investors will be divided in two. Half will go to a local trust, devoted to create social value according to the long-term vision of the community. The other half will be invested in a guarantee fund that will cover this wind farm and future community wind farm projects under the same financial model. This will enable us to decrease the risk of future investments, and attract further capital.

Once the wind farm has been in successful operation for two or more years, the level of risk will be very low. We expect several institutional investors (pensions and sovereign funds) to be interested in taking over the investment vehicle, with the same financial return offered to previous investors. We also expect some of the impact investors to then move their money into the next community wind farm.

Throughout its life cycle, the territorial control and the productive assets will remain under the control of a structure that is primarily accountable to the community, but also to investors, since they have recourse to the wind farm in case of default. Community ownership and balanced accountability boost local support for the project, reducing risk and financial costs in a process that we expect to eventually attract substantial long-term institutional investment.

True sustainability and resilience are required to mobilize significant resources into life-supporting sectors. Community-based financial innovation is a key part of this process. At Yansa, we hope that growing numbers of investors will play an active part in this process.

Sergio Oceransky is CEO and founder of the Yansa Group. Email

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