Impact Investment Funds for Cities: Insight from the EU’s JESSICA program

Sustainable cities have become a high profile global issue, no longer a luxury of the developed world and increasingly a source of urgency in the developing world. My fellowship at Smart Cities Advisors has illustrated how dialogue, policy and capital often don’t connect. Even so, it’s clear that values-driven, mission-oriented private capital has to be the catalyst for inclusive and sustainable urban investment in the rapidly growing cities of the developing world. This entails investment for affordable, comprehensive housing and community development, as well as social and community infrastructure for health, education and culture.

The challenge is how to incentivize conscious, long-term urban infrastructure investments for the majority – investments that generate private and public goods. This differs from short-term, opportunistic real estate plays or investments that generate exclusively private goods for upper income groups. In the United States, for example, community development finance has channeled complex combinations of capital and creativity – private and public – into public-private partnerships (P3s), tax-credit driven housing investments and projects for energy efficiency, brownfield rehabilitations and other urban regeneration initiatives. These projects and investments have benefited from hybrid structures that mix grant, debt, equity and tax credits – similar to the “layer cake” structures highlighted by the impact investment universe.

An evolving urban initiative in Europe spearheaded by the European Commission and the European Investment Bank (EIB) promises another step toward sustainable urban investment.  JESSICA (the Joint European Support for Sustainable Investments in City Areas initiative) aims to promote private investment in inclusive and sustainable cities. JESSICA enables member states to channel EU grant funds into privately managed, geographically focused urban development funds (UDFs) with sustainable urban development mandates.

The JESSICA framework envisages specific urban “sustainability theme” funds as prototypes, as for energy efficiency, infrastructure, environment, smart cities, and brownfield redevelopment. Importantly, UDF funding can be deployed for a whole range of investments rather than focusing solely on lower income housing. Investments can include infrastructure, heritage or cultural sites, office space for small and medium enterprises, university buildings like medical and biotech facilities, and energy improvements.

It’s striking that the JESSICA framework reflects an impact investment framework while promoting sustainable urban investment by emphasizing:

  • Private sector expertise and creativity in the management of UDFs;
  • Flexibility in deploying JESSICA funds to leverage grant, guarantee, debt and equity investments from public and private shareholders to achieve triple bottom line returns;
  • Social and environmental sustainability via conditionality that JESSICA funding can only be deployed for projects consistent with an integrated plan for sustainable urban development;
  • Leverage and risk mitigation to attract private investment and normalize returns for otherwise lower return, unbankable projects that will generate both private returns and public goods; and
  • Recycling of funds to return capital for reinvestment in future projects, which facilitates longer-term commitments over opportunistic investments that return capital over short horizons.

Any form of subsidy to investment returns vs. normal market expectations has to be justified by a project’s positive externalities. By law, this support must pass an economic balancing test to prevent returns on investment for private investors from exceeding a “fair rate of return” due to government subsidies. A subsidy can be justified 1) by serving a common interest, 2) by ensuring appropriate risk/return incentives for private investors, and 3) by being proportional to lost economic returns directly related to compensating social and/or environmental benefits.

Even though there’s no strict impact measurement mandate as yet, JESSICA support requires that concrete triple bottom line returns are illustrated. Guidance on metrics include:

  • Number of jobs created
  • Number of newly created companies;
  • CO2 reductions achieved;
  • Renewable energy production (in MWh);
  • Private financing leveraged at project level (as a % of the sum invested);
  • Private financing leveraged at fund level (as a % of the sum invested);
  • Brownfield land redeveloped (m2 of areas recycled);
  • Amount of new/upgraded floor space;
  • Increase in the use of public transport;
  • Increase in tourist flow to the relevant urban/regional area;
  • Increase in m2 of social housing;
  • Improved standards of public health, public education or cultural life of the relevant urban/regional area; and
  • Conservation of listed/historic buildings.

It’s encouraging to see impact investment fund concepts embedded into urban regeneration policy-making and investment frameworks. The initiative envisages a necessary financial cushion, leverages financial engineering, encourages the participation of private managers and promotes increased collaboration between public and private investors. JESSICA even works to build capacity to promote UDFs through Holding Funds (HFs), which can be set up to stimulate the formation and management of multiple UDFs  where there may be limited experience in financial engineering and urban regeneration.

Emerging and developing market cities need similar leadership and seeding of urban investment initiatives to help recover and revitalize marginalized city centers.  Yet, as we’ll examine in coming blog posts, the conditions and needs vary dramatically from the developed cities of Europe.

In particular, as we look at each UDF prototype and their appropriate financial instruments given anticipated projects’ stage of development and risk/return profile, we’ll see that “venture capital” type risks in emerging and developing markets are likely to complicate the potential for similar impact investment promotion structures in those countries.

With editorial input from Lenora Suki, Principal, Smart Cities Advisors

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