This is an edited transcript of our podcast episode with Marco Monroy, Founder and CEO of MGM Innova Group. He discussed climate change policies, energy efficient incentives, renewables and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Marco’s Background and Career Path
Bilal Hafeez (00:01:46):
Well, Marco, I like to start my conversations with me learning a bit more about my guests’ background. So I kind of like to really go back to your origin story. So what did you study at university? And then how did that take you to where you are today, very much at the center of climate change, sustainability and investment?
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This is an edited transcript of our podcast episode with Marco Monroy, Founder and CEO of MGM Innova Group. He discussed climate change policies, energy efficient incentives, renewables and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.
Marco’s Background and Career Path
Bilal Hafeez (00:01:46):
Well, Marco, I like to start my conversations with me learning a bit more about my guests’ background. So I kind of like to really go back to your origin story. So what did you study at university? And then how did that take you to where you are today, very much at the center of climate change, sustainability and investment?
Marco Monroy (00:02:07):
I’m more originally from Colombia. I started going to law school in Colombia. I spent some time in D.C. I went back, finished law school and became a Colombia lawyer. Immediately after that, I came to the States, did a LLM, a Masters in Law, specializing in Environmental Law. And it happened to be the year after the earth summit – that was in 1992, when the Climate Change Convention, the Biodiversity Convention, all these environmental treaties were signed. I then became a lawyer in New York. The Kyoto Protocol that created the mechanisms for accounting CO2 emission reductions and trading just came in 1997, but it was actually implemented in regulations after the year 2000, 2001. So during the ’90s I worked at a Japanese consulting firm supporting the nuclear industry carrying radioactive material through the Panama Canal.
Then of course, after the Kyoto Protocol came in the late ’90s, the Japanese government hired us. And then, I was in charge of identifying opportunities to reduce greenhouse gas emissions in Latin America. So, I would write reports and tell the Japanese government and by going to the region, meeting people, establishing a climate change network in the late ’90s, I decided to create a company in the year 2000 to create projects that will feed this market. Most people in the market would go to London and they were mainly thinking about trading these carbon credits or brokering. But I realized there has to be a need to develop the assets on the ground, which meant identifying the hydro project that you could take through the United Nations process so that you could develop carbon credits out of that project. So, from 2001 to 2005, I collected so many of these contracts with commissions on carbon credits and I structured the projects.
So, we coined the term “I spare my business” as project developers. We were the first project development company. So I came very early, surrounded myself with very smart, technical people that wrote these documents, took risks as an entrepreneur, doing the work with no income and to survive I would sell advisory services in Japan. I would be advising boards of large companies in Japan on the future of markets and climate change or climate change issues. I was in my late 20s. Then we build a portfolio. We build a team. By the time Kyoto entered into effect in ’05 we already had several offices around the world.
By 2006, we had about 13 offices around the world. Our most successful office was in Beijing. We had started in Argentina – the team we created in Argentina because the 2001 crisis had just happened. And then we grew from there, we had a very nice portfolio. The first time the global industry did an analysis of the various player,s we were selected as the best developer in world cargo markets. It was very good. And then, at the end of ’06 we sold 38% of our company to Morgan Stanley, the commodities division.
So, it was very interesting to see the trading side of the business. They had very high hopes for carbon as a commodity at the time, but then ’08-’09 crisis came. It was mainly the European crisis affected the global carbon markets because the industrial output was not as it used to be. So there was less need to buy carbon credits because there was less production in Europe and Europe was driving the market. So we decided to sell together with Morgan Stanley in 2010 the whole company.
Back then, buying and selling carbon credits was called carbon finance. Then, after Kyoto, the era of climate finance started. Climate finance basically invests in equity projects that reduce greenhouse gas emissions. But the objective is triple usually. It is getting a commercial financial return as well as accounting for the environmental benefits and the social benefits. So we call it a triple bottom line investment. And then we created one of the first funds on climate finance. And we invested in projects in Latin America that reduce greenhouse gas emissions, but focus mainly on energy efficiency.
So, doing energy efficiency projects, changing air conditioning units in hotels and charging a percentage of the savings in Cancun for example, doing landfill gas to energy projects in Mexico City, co-generation projects in the steel and glass industry in Colombia, more hydros. So that’s what we’re doing now. We are investing in these projects, mainly energy efficiency in Latin America and the Caribbean that reduce greenhouse gas emissions, but also look for a commercial return. And we basically have a private equity fund and we call it a Reset Climate Finance Fund.
Climate Change Policies: Cap-and-trade, Carbon Taxes, Technology Funding
Bilal Hafeez (00:07:22):
Okay. That’s great. I mean, it sounds like you’ve had quite a varied career in the different aspects of climate and from the very early days, all the way to where it is now. So I guess before we go into some of the specific investment opportunities and just how the financing works, maybe we could step back a bit and just look at the bigger picture. When it comes to like policy proposals it seems like, at least in Europe they’re talking about going carbon neutral by around 2050, the Chinese are 2060, the U.S. I’m not a hundred percent sure, but let’s say it’s around that sort of ballpark. And so that’s like 30, 40 years away. So it’s quite far away.
The second factor is all the current proposals to deal with this. You have the cap and trade (that idea has been around for a while), carbon taxes etc. There’s also all the whole investment in green energy, green energy stocks have done really well over the last 12 months, but then recently they’ve come off. Then there’s a techie utopian group who think there’ll be a technology solution around the corner. So, I mean, how do you think about the measures countries are taking to address this?
Marco Monroy (00:08:27):
First of all, I think it’s important to address the main sources of greenhouse gas emissions. So whenever you design policy or regulations, or you want to green some sort of investments, look at where the emissions are. According to Bill Gates in his book that came out last month, he talks about 51 billion tons of greenhouse gas emissions per year. In manufacturing – mainly big industry, steel, plastic, cement – he puts at around 31%. Electricity generation, coal, diesel, natural gas, 27%. Agriculture and cattle 19%. So cattle is like the cows emissions and also a lot of nitrogen fertilizers that’s a big cost in emissions 19%. Transport, burning of fossil fuel 17% and air conditioning and heating 7%. And in this last point, we expect that from now till the year 2050 that you just mentioned, the units of air conditioning will triple because places in the North will start using air conditioning.
You see it in Germany people using air conditioning, plus people in developing countries that are coming into the middle class, they can afford air con units and you have micro-credit that support and improve the lifestyle. So we have to focus on those four. In terms of solutions, of course, I build my career on cap-and-trade. So, I’m a big supporter of cap-and-trade. I think it’s a very intelligent system. It worked fairly well in Kyoto. I think the problem was that it was managed by the UN and there was a disconnect. And then the financial crisis and the lack of political commitment post 2012 that-
Bilal Hafeez (00:10:11):
Actually, just for the benefit of our listeners can you explain what cap-and-trade is?
Marco Monroy (00:10:15):
Yes. So basically cap-and-trade, you take let’s say an economy, you can take a country, a state, a region like the European Union, and you identify four or five sectors that are the most intensive in terms of emissions, usually is the cement, power sector, steel, ceramic. And then you design a program for the next 10 years, for example, and you call it cap-and-trade. You do an inventory of how many CO2 emissions all these companies are producing currently. Once you know how much, you give them a cap that is very close to their current emissions.
So, let’s say a company is emitting 10 million tons per year, but they have a growth of 2% or 3% per year. Then you give them 10 million or a number of allowances. So they can emit that number. They’re allowed to emit up to that number. But every year you reduce that allowance, so in 2022/2023 you have a little bit of a smaller allowance. So, what that cap does is that it either forces the company to innovate to reduce their emissions or to pay for it. Companies can also trade allowances. So, if you are very efficient, you can trade allowances and then you have a new asset and you make money. And that was extremely beneficial for the German utilities in the EU Emissions Trading System (ETS). They became very efficient very quickly and they traded their carbon allowances. And then typically, you design the market to be short, so the as number of allowances decrease, the price increases. Thus, companies are incentivized to be even more efficient because they can make money out of selling their allowances.
Cap-and-trade Systems Around the World
Bilal Hafeez (00:12:09):
Okay. Yeah. Understood. Yeah. And the Europeans were the leader in this with the European Union Emissions Trading Scheme?
Marco Monroy (00:12:14):
Exactly. It was originally a U.S. idea. But then, the U.S. retracted from Kyoto and the Europeans implemented it. It went very well. And the way it works is that they allow for a percentage of offsets to come in. So, let’s say that company has the number of allowances. They can select to become more efficient. Or, if they cannot be more efficient because they are already at the state of the art of technology in whatever they’re doing, they can buy offsets from outside that geography, for example, Asia or Latin America, where producing a CO2 reduction is cheaper. So let’s say to reduce one ton of CO2 that factory is going to cost $200 because you need a special filter, but you can reduce a CO2 emission in Brazil for $5 or $10 because there are more emissions. You are able to import those offsets. There’s a compliance system the companies participate in. And then, there is a regulatory system to allow the offsets. There are transparency processes.
So, you have a cap and trade, with caps that decrease overtime. You can trade those allowances, and the systema also allows a certain number of offsets to be imported. And those offsets serve the purpose of providing more liquidity. It allows companies to comply, to stay within their caps, and also acts as a relief mechanism, so the capped allowances will not explode in prices as they become scarcer. The offsets come cheaper.
Bilal Hafeez (00:13:57):
And where’s the U.S. and China in relation to cap-and-trade? Because my understanding is I think California, some states in the U.S. like California are involved but not nationally. China, I don’t know about. So you’ll have to kind of fill me in on that.
Marco Monroy (00:14:11):
The Europeans are well advanced in cap-and-trade – they’re the most advanced in the world. In the U.S., California has had a very successful cap-and-trade with the same characteristics and they were linking it to Quebec. The former U.S. administration tried to stop it because of some technical legal issues that banned states from doing international treaties. In the end, California was successful – they linked the systems of Quebec and California. There is also a Northeast regional cap-and-trade system in the U.S. which several states are part of, and that’s also going very well.
China has a voluntary scheme from 2015 that has been very successful. They accept 200 types of projects. They’re very entrepreneurial. They learned a lot during the Kyoto time. So they designed a good system. And now they have trading systems by provinces, by regions, and large metropolises – e.g., the Shanghai, the Beijing. Each area has its own. And then they will have a national linked system. They are in the pilot phase. In one or two years, they will have a national carbon trading system. And that’s going very well.
So, the U.S. has the two (the Northeast and the California), then Europe continuous with their old cap-and-trade system under new rules. But those are probably the main ones. Australia had some. Korea has a very successful cap-and-trade system. It was quite small.
But cap-and-trade is just part of the solution. The idea is that it generates innovation. It pays for itself. It creates a profit motive for companies to become more efficient and reduce greenhouse gas emissions. And it gives a price to carbon. Once carbon or CO2 emissions reductions have a price, then that’s very important because then, you can quantify it and you can reduce it. If carbon emissions are free, then it won’t happen.
The Importance of Energy Efficiency Incentives
Marco Monroy (00:16:06):
Then you have, of course, you have carbon taxes, which we had and it went well. Colombia, my home country, has some carbon taxes and they allow for offsets and it’s going well. Of course, in some countries it’s more difficult to impose taxes because of the connotation it brings, but it could be effective to drive innovation, support technology development etc. For example, Tesla was strongly supported by the U.S. government, on both the R&D and sales sides. Consumers were given tax breaks. Every time we bought Teslas, we received tax breaks. The incentives were very generous at the beginning when electric cars were less attractive but are now being phased out. But now, Tesla is commercially viable and is the most expensive car company in the world. And Tesla is actually the product not only of innovation in California, but of a private-public-partnership. It received very strong government support. It changed the auto industry, an industry that is responsible for 17% of greenhouse gas emissions. Now many cars are following Tesla’s lead. And so that’s a great example of how private-public-partnerships could work very well in terms of technology development. Incentives for energy efficiency at homes through utilities. You become more efficient then you have incentives. Those are very good policies: cap-and-trade, taxes, and technology tax breaks are very good.
In Colombia, just to continue, when you import equipment to produce renewable energy, you don’t have a VAT, which is I think 16%. And you can imagine on a big hydro project, 16% in CapEx is a very important reduction. And it’s one incentive for these kinds of projects.
Net Zero Emissions Targets in the US – Will the Biden Administration Made a Difference?
Marco Monroy (00:17:47):
People are talking about net zero in terms of the goal that we need to achieve. We’re talking about net zero by 2050, that’s kind of the general rule. In the U.S., as you know, the federal government has been shy, but governments at the state level have been aggressive.
In 2018, Hawaii was the first state that committed to be net zero by 2045. California also committed to be net zero by 2045, and then Massachusetts net zero by 2050. Colorado, 90% below 2005 levels by 2050 – so about 90%. Pennsylvania, 80%, but it’s more or less there. And I will explain for the audience what net zero means. So, you cannot avoid completely fossil fuels even in 2050, because there are some goods, let’s say hydrogen, which is the new upcoming fuel, that’s cheaper made from fossil fuels. Still, you have green hydrogen, but we’ll have to keep some fossil fuels even in 2050.
Net zero means that you reduce as much as possible your emissions, but then whatever you cannot reduce, you compensate by doing carbon sinks like protecting forests that keep the CO2 or by implementing technologies or carbon capture and storage, so your emissions technically net to zero. You might have a positive number of emissions, but you can compensate by absorbing emissions or a storage, is storing CO2 under the earth or under the ocean. And those are kind of the dream technologies that you mentioned.
Bilal Hafeez (00:19:55):
So you’ve mentioned a range of these different initiatives. And earlier you talked about climate finance, how does kind of climate finance relate to all of these different things?
Marco Monroy (00:20:04):
Yeah. That is the regulatory and policy framework to implement the targets. The 2050 targets, which as you mentioned, are a long time away. And I was just thinking that next year, the Climate Change Convention would have been signed 30 years ago. So, 30 years onwards. Of course, you are younger than me so you may not see it, but it’s almost imminent. 2050 is good, but the problem with having targets so far away is that you don’t have the level of urgency. And that’s what all these policies and regulations are aimed at calibrating. Some of them look more aspirational, more or less the good thing to say, but no government or democratic government lasts for 30 years will to be able to fulfill their word. You have political changes. So there has to be, I think, globally, the need to have a sense of urgency. And this is more or less what Biden had come up with.
He has a czar for climate change, John Kerry, which is a person who could have been the President of the U.S. He’s sitting in the Treasury Department, which is important because it shows how they’re looking at it. It’s not under EPA because it’s not an environmental issue. It’s not necessarily an energy issue, so it’s not under the department of energy. He said the Treasury Department. So it’s very important the fact that the U.S. is putting the climate change czar at the Treasury Department.
What is Climate Finance?
Marco Monroy (00:21:34):
Before we go to climate finance, one more mechanism that that is very important to consider is barriers to trade. The European Union is going to have the Carbon Border Adjustment mechanism, and they are supposed to start in one or two years. When you are importing to the EU goods that carry a higher emission footprint, and they’ll have a tax to compensate for that. So the carbon intensity of the product that is imported, the carbon unit will have a tax or a tariff and that’s how we’re-
Bilal Hafeez (00:22:15):
Okay. So to remove the incentive to kind of go around the rules and just import carbon intensive products from elsewhere?
Marco Monroy (00:22:23):
Exactly. So that is the stick and the carrot maybe. For exporters to the European Union, they’ll have to clean up their production or neutralize their production so that they don’t have to pay the tariff and they maintain their price competitiveness. In terms of climate finance, so as I was explaining to you carbon finance is the buying and selling of carbon credits – carbon trading. It was very active until 2012, prices went up until 2009. An allowance, a carbon credit was €20, €30. Then it collapsed to €3, €4. And then, there was no market post-2012 [European Debt Crisis]. Now it’s mainly a global voluntary market or pre-compliance market at maybe, at €5, €10 a carbon credit. It’s coming back, but it’s not going to be the main solution.
So, what governments have agreed is that they would start investing in climate finance and climate finance as a term started in 2013. So now we are probably in this seventh or eighth year of climate finance, and it means investing equity or debt into projects that reduce greenhouse gas emissions, but also have a commercial return. So, it’s more a more holistic objective. It’s a good business that has a climate benefits. So it has to make financial sense. And that’s where we operate, those are our-
Bilal Hafeez (00:23:54):
And is there some subsidy you get from governments to engage in this? I mean, is there some incentive to participate in this area?
Marco Monroy (00:24:00):
We get some incentives, but no, not really. Our climate funds follow private equity rules. So we have a stringent 8% hurdle rate in U.S. dollars and we invest in emerging markets. So it’s quite high. And okay, sometimes we get some technical assistance from these governments in the form of a small budget to do studies. The government of Japan has some incentives if you use Japanese technology for climate projects – those are very helpful but are nothing big. This is a completely commercial business operation. And the fact that these governments are investors is because, in general, they have a stronger climate objective and climate policy than the private sector.
In 2013, climate finance was about $300 billion globally. Now it’s around doubled, 2020 must have had about $600 billion in investments. 44% was in the public sector – mainly in transport and some adaptation to climate change like disaster relief, and broader improvements to agriculture practices, but it’s been mainly transport. Private finance was 56% in climate finance, of which 85% went to renewable energy, mainly wind and solar. And that’s why it has grown so much, renewable energy, to the point that it’s competitive now with fossil fuels or even cheaper sometimes. Wind and solar-
Bilal Hafeez (00:25:29):
Just on that, I have a question for you, I mean, has your fund made any investments in the renewable energy sector?
Marco Monroy (00:25:35):
Yeah. Yes. So many. We have lots of solar energy in five, six countries in rooftop solar, utility scale solar. We have hybrid solar on an island in Panama where before, it had only diesel. We replaced part of the diesel with solar. We are doing solar battery in Costa Rica.
Are Renewables Overpriced?
Bilal Hafeez (00:25:55):
I mean, one of the things that seems, again, I’m not a specialist in this area, but it seems like there’s certain bubble type dynamics that are occurring in the renewable sector when you look at funds like ETFs and so on linked to renewable companies, and anecdotally you hear about lots of projects that have incredibly high projected IRRs which seem unreasonable and all sorts of assumptions about the duration of how long the solar panels or the wind farms will last, which don’t seem quite realistic. Presumably that’s not nuance, I’m kind of exaggerating all of these sorts of things, but what’s your kind of sense of the kind of the bubbly dynamics in this whole area?
Marco Monroy (00:26:37):
Yes. It happens more so in the developed world, in which, for example, Japan after the tsunami 10 years ago, Spain, even U.S. offer high tariffs to incentivize the industry, higher than what they need to justify an investment. So, that attracts a lot of investment because you have feed-in tariffs that pay very handsome prices per kilowatt hour. So that might have created a bubble in those markets to the point that Spain during the crisis had to stop the contracts because they were unrealistically priced.
And then, you had cases where people had solid contracts but were actually producing with fossil fuels because the contract was sub-board. But then, for example, in the case of Japan, the prices were reduced, as the price of technology came down. So, if you needed let’s say 15 cents per kilowatt hour number to justify your investment, then you needed 12 cents, then you needed 10 cents. Now you need maybe 5, 6 cents for people with a low cost of capital.
In emerging markets, Chile was a case where the bubble burst and lots of lawyers were enjoying the process. And then, as you know there’s a lot of money in the world and it’s sold as a great opportunity, the new thing. So a lot of money went and lots of unsuccessful stories as well. What we do as investors, we need long contracts, 15, 20 years to recover our investment in solar projects. We might shrink that if we include batteries to 10 years. And then, we have a hard time having mid-teens returns. We need leverage. So, returns in developing countries are probably single digit, high single digits, which in developing countries are not so good because as you know, foreign exchange can eat a lot of that return. And that’s the cost of debt in many of our countries.
So, it’s better probably than fixed income, but it’s not that great. Even within the investments that we have made, we focus more on energy efficiency – we lease efficient equipment for 5-to-10-year contracts. For that, we get a higher return with less risk.
However, you still have countries like Brazil, where they have very good regulations. There, you can build, let’s say, a five-megawatt plant in a state and sell to many retail customers. So, you can create condominium solar (aka community solar in the U.S.), mini-utilities and sell to small retail customers that have high tariffs. Then, we can see very good returns. While you still have the Brazil risk, you can have returns above 20% easily. So Brazil is a great market for that. But of course, you have the other side of the coin, which is the country risk.
The Role of Nuclear Energy
Bilal Hafeez (00:29:31):
I have a question on nuclear energy. There’s a lot of improvements in nuclear power plants, these smaller modular power plants that just seem to be relatively safe yet it’s kind of looked down upon, with the whole nuclear side. Yeah. Same time the energy efficiency of nuclear is amazing, just the efficiency. I mean, the renewables like solar, wind, just the energy density is very low. So the scale has to be very big to replicate what you can get from coal or gas. Where do you stand on nuclear?
Marco Monroy (00:30:00):
I think nuclear should be part of the solution because it does not have greenhouse gas emissions. As you said, it’s very efficient, very effective. It requires large investments. It’s not the for everywhere because it’s dangerous. In case of terrorism, it’s an easy target. The accidents – you see Chernobyl or Fukushima – yes, they’ve been bad and that’s what public sentiment shows. So, you see Japan had created the whole energy sector based on nuclear power and after Fukushima, changed their strategy dramatically. Now, they only have apparently 9 plants left out of 50-some that they built.
So, if these nuclear plants, if you address the residues, you can treat them properly, that should be part of the solution provided security is there. But I’m not against nuclear at all. I think it’s very good as a base technology, as you say. Solar and wind are intermittent and we need a lot of batteries to make them as reliable as fossil fuels while nuclear is as reliable as fossil fuels. So it should be part of the solution. And hopefully some of these technologies come up right and we see the results.
Are Battery Metals Sustainable?
Bilal Hafeez (00:31:15):
Yeah. And then the other question I had was when it comes to say battery and electrification in general, it does require lots of metals, whether it’s like rare earth metals or lithium, copper, cobalt, some of these types of metals are in countries that are fairly unstable or aren’t as developed as others. I mean, how do you kind of see that kind of risk?
Marco Monroy (00:31:36):
I think, yeah, batteries of course, is a good solution and the metal issue, yes, there are some risks but fossil fuels are also in very risky places like the Middle East and Russia. We have handled it somehow. So I think there’s of course a risk for supply of materials. But there’s so many other ways of doing batteries. So many alternatives that I don’t think that at least in the next 10, 20 years, that will be a limitation. There might be enough to have the technological breakthrough we need to give a stability to renewables, so by 2050, they can become indeed a main part of the grid anecdotical as they are right now.
Bilal Hafeez (00:32:22):
Okay, yeah. Okay, understood. Yeah.
The Global Landscape of Climate Finance
Marco Monroy (00:32:23):
In terms of climate finance, in terms of geographies, China and Southeast Asia is the clear winner at about $238 billion, the Americas/U.S., $93 million, Western Europe, $100 million, Africa, including Sub-Saharan and the North, $30 billion, Latin America, $20 billion. So, a lot of things are happening in mainly in East Asia and Pacific, but of course, in the U.S., renewable energy is also a very important story.
While climate finance is rewarded, it’s not that large. We’re talking about billions. If you look at the macro numbers, we need trillions to reach the goals. So, right now, we’re talking about $600 billion a year. They say that to get somewhere to what the Paris Agreement outlines or net zero by 2050, we need at least to quadruple. We need about $2.5 to $3 trillion per year of investments in climate finance to reach the net zero by 2050. And we’re only at 600 million-
Bilal Hafeez (00:33:41):
Actually, let me kind of turn around and ask you, when you’re looking for projects, are you finding it hard to find enough projects to invest in? Let’s say you’ve got double or triple the amount of money coming towards climate finance and your fund and so on. I mean, are there enough projects to go around?
Marco Monroy (00:33:57):
Yes, I think it is, but not, at least in Latin America, not on a trillion basis. Maybe I could double or triple or maybe there could be another two or three like me doing the same thing, but it’s not necessarily easy if you want commercial returns. It’s not that projects are not there – because the energy need is there and the need to improve the efficiency of the factories is there. You can also reduce the greenhouse gas emissions. The landfill is out there. You can capture that landfill and generate electricity or produce fuel.
The issue is the economic barriers. You need a 15-20% return in a project in a country that could have 20% forex volatility in a given year, where access to credit is difficult. Banks are not so familiar with this still, if you get a loan is 10% the interest rate.
Bilal Hafeez (00:34:53):
So it’s almost more the macro kind of factors are the problem rather than the micro. So the projects are there, it’s just that the infrastructure around it isn’t helping you. The FX rates is too much, the access to credit, the regulatory barriers, those sorts of things aren’t right for you. Yeah.
Marco Monroy (00:35:06):
Exactly. But the projects are there. Yeah, I think the projects are there. If you lower your interest or your return expectations to 5%, then the universe is much bigger. If you do something like the Swiss government is trying to do, which is sort of a grant program that you return with a couple of points of interest. It’s not a “grant program”, because then, it might not be taken seriously and it might not attract the level of responsibility that you need to take the return. But, if you at least return the capital with a low interest, then the universe of projects is bigger. So, at some point, if there are some investors or governments that required no returns, the universe is quite big. But we can still get handsome returns-
Landfill/carbon capture
Bilal Hafeez (00:35:54):
And just another question you mentioned landfills, and you also earlier mentioned carbon capture, some of the best investments or infrastructure that has been built for carbon capture are coming from traditional big oil companies, the dirty energy companies, yet those companies are viewed as the enemy, as kind of not helping the cause. I mean, how do you kind of square that circle?
Marco Monroy (00:36:18):
Even when we were in carbon markets, we saw so many very good people in fossil fuel companies. They have great talent. They have access to information, resources, experience working all over the world. I think when players like Shell started investing in solar and renewable, they become major players. You see Petrobras in Brazil, their oil and gas company, leading the ethanol revolution. You also see countries, e.g., Abu Dhabi and Dubai, that are fossil fuel countries that moving towards the green economy. I think they have enough intelligence to recognize that they have to shift because the economy will be driven by green in, let’s say, 20, 30 years.
I’m not certain about fossil fuels. I have sometimes given talks to the oil and gas industry. It’s just that level of returns they get when an exploration goes well, the volumes that they manage by moving oil and gas around the world, the consumption of oil on a daily basis, transport, industry, energy, is so huge that they might not get as excited because this green issue is important. But unless you do something like Tesla or some very large storage project in the south of California or something, it doesn’t command the numbers that these guys are used to seeing. They can probably create subsidiaries and move some of their bright people into their own. I did see some good aspects. And I think that they could be big part of the solution. Some of them will transition to green gladly and some of them may have to be forced by the necessity of the business to move into that direction.
And then, they have R&D capabilities. Yeah, 10, 15 years ago, I was working a lot with Statoil Norway (aka Equinor) on carbon capture and storage. There were well-advanced and deeply committed people in oil and gas companies. So I have high hopes that instead of being perceived as the enemy, they could be part of the solution in terms of financial resources, human capital, and even some of the technologies applied to the solution.
Who’s Who: Public Markets, ESG, Green Bonds, Social Bonds, and Impact Investing
Bilal Hafeez (00:38:36):
And what do you make of ESG investments? Because I’m kind of more on the public market side and ESG has become such a huge thing. Well, I can see the positive case that you want to incentivize people to do the right thing for the environment and climate. But then at the same time you hear lots of stories of greenwashing, where people are just, “It’s just a marketing story, it’s not real when you look under the hood.” So maybe it’d be useful to kind of hear your thoughts on ESG.
Marco Monroy (00:39:06):
Yes. As I was saying, in climate finance we need to quadruple on a yearly basis the deployment of capital to address the climate change issue. Doing it the way we do by putting together a few hundred million dollars and investing in projects that take 10 years to recover is the hard way. It’s a contribution, but we need public markets and large institutional investors to get involved to get to this result. Just offering that to these kind of initiatives is very important. Green bonds and the whole ESG market. And I will talk a little bit about these terms.
Now ESG, you call it ESG, you call impact investment, that they might be green, social, and sustainable bond markets. And then, in order to avoid greenwashing, just as when you create a carbon credit, you create standards and you need certifications. We’re about to consider issuing some green bonds in Panama for some Latin American projects. And we need to certify that they are indeed independent party’s green bonds so that the bonds comply. There must be some information for investors on how to know that they are really green bonds and not greenwashed bonds.
But again, here, the numbers need to increase. And I think they would increase for various reasons that I will mention. So, from 2007 until now, these ESG bonds have issued bonds on an amount of $1 trillion. In 20 years $1 trillion, and that’s only 0.86% of the total bonds in circulation. So even though we feel, oh, a trillion dollars is a lot in 20 years, it’s less than 1% of the total bond market.
Blackrock did survey with 425 large institutions investors. Right now, large institutional investors have about 18% in sustainable bonds. The survey of this 425 said that they expect to double their positions in green, social, and sustainable bonds to 37% in five years. So it will be 37% of the bond portfolio or green bonds, which is very interesting. In your public markets, you have the corporates that are public companies that raise capital through public markets. And you have also the investors that buy their stocks.
Just last week, the Securities and Exchange Commission of the U.S. said that the priority for 2021 was to ramp up its focus on climate-related investment risks. The SEC wants to focus on having investors assess the climate investment risks, to have whoever is running the business to take into account or incorporate the climate risks. The U.S. issued the Climate Risk Disclosure Act of 2019. So there’s going to be an obligation for all public companies to incorporate climate change into their Risk Disclosure Acts. That’s very important. So, the big investors are incorporating climate risk in portfolio design. They’re incorporating that and that’s very important.
As I was saying, the important thing is that both corporations that run their businesses and investors are climate aware. Climate awareness means first, what is the contribution of the company or the portfolio to climate change. Whatever company it is, you must be able to easily determine your footprint. What are the emissions if you are in transport? If you are in food service? Any company need to be able to assess its contribution to climate change. This has to be monitored. And that’s part of ESG, very important, the environmental part. They have to identify what are the climate risks – like utilities, extreme weather events that endanger insurance companies etc.
Also, what are the opportunities do climate change technology companies have? It’s very clear to see a solar company having an opportunity. But also, some technology companies, for example, logistics software can also reduce carbon footprints. Logistics software could be seen as a climate friendly company. We are investing in online supermarkets that avoid retail supermarkets with more refrigeration and air conditioning, delivering directly from the warehouse to the home. There are multiple ways in which they are avoiding both emissions and their risk. Ghost kitchens that are set next to the place where the food is delivered, it avoids some emissions.
So, corporations and investors look at the contribution to climate change. What are the risks that climate change poses? How vulnerable they are to extreme climate events? What are the opportunities? And then maybe the main point of awareness is to incorporate climate change as a variable when they do models, when they make decisions always have climate change as a horizontal variable. And that’s what the Climate Risk Disclosure Act is intending to do.
It’s a policy decision to force companies to take this into consideration. So that’s how will you provide your information. It’s extremely important that companies play a vital role in the solution of climate change while protecting against the risks and addressing some opportunities. And when they’re analyzing on a stock, investors ought to think of how climate change can pose an opportunity. For example, Amazon benefited a lot from the pandemic. They may benefit from climate change, or they might be at risk of climate change in certain areas.
Then you have the green bonds, which are basically bonds that are issued to do green projects, but as you know, the bond is only as strong as the issuer is. So, let’s say if I were to buy a green bond, I will focus more on who is the issuer of the bond is and whether that premium is consistent. Then you have the social bonds. So social bonds are bonds that are looking for a positive social outcome, for example, housing projects, supporting SMEs’ access to credit, to the base of the pyramid. Then, they have some social bond principles by which you can make sure they are not fake, but they’re real social bonds.
And then you have ESG investments. So you have ESG, you have green bonds, you have social bonds. ESG, so green bonds focus more on the environmental aspect of ESG, social bonds on the social aspect of ESG. ESG focuses on environmental, social and governance issues and like executive pay, gender equality, treatment of employees, customers. So ESG is a wider aspect. For example, an investor would like a tobacco company on ESG grounds because they have good environmental practices, good social programs, great governance, but probably a socially responsible investor would not like that because they don’t like the health impacts.
So, you can have ESG investments that are positive, but are not so positive for socially responsible investing. And then, you have the impact investors that are focused more on the intent of the investment than on the return. So you are willing to take a lower return, but to have a bigger social or environmental impact. So it’s all growing, we needed to grow more. Morgan Stanley Institute for Sustainable Investment did some studies and they analyzed sustainable funds compared to traditional funds from 2004 to 2019. And they saw that the returns of sustainable funds were very similar if not a little bit higher than traditional funds, but at least the same. So returns on ESG or sustainable funds are good. And what they also found in the very volatile years, like 2008, ’09, ’15 or ’18, that the downside risk of sustainable funds was lower than traditional funds.
What this means is that climate investment or sustainable investments are good business opportunities – not necessarily a cost. It’s an investment and you reap returns in the future financially, but also environmentally and socially. So, the notion that addressing climate change is very expensive, which is popular in the U.S., is not true. Of course, it’s an outflow of money to do something. But if you look at the big picture and you see the enormous cost that you have to avoid remediating natural catastrophes or increased climate conditions or sea level rise is way much more expensive. So it’s expensive, but it is not as expensive as not acting.
Investing in sustainable bonds and green bonds gives you the same returns as you would have in traditional investments with the additional benefits. So, it’s not an either/or. I’m going back to the pandemic – what is keeping our brains busy these days. You see what Israel did. Israel, as soon as the vaccine showed up in the summer, they paid 40% more than the rest of the world, but they ensured they would have vaccines for the whole country. And maybe an initial analysis will say, “Why? It’s too expensive? Why would you pay much more than the rest of the world?” And the payback is incredible, just in the taxes they recover from a functional economy. In a week, they might recover the extra costs. While some countries were worried about the cost is so expensive, but the income they are not having by keeping the economy under lockdown is much more expensive than paying a little bit more. So we have to see climate and sustainability as a good investment, and it doesn’t have to be financially bad, but of course-
Bilal Hafeez (00:49:59):
I mean, just to kind of wrap up our conversation because we’ve covered a lots of ground and I’m sure we could talk for longer, but what one or two projects that you’re focused on at the moment in your fund are you most excited about?
Marco Monroy (00:50:11):
I’m excited about helping high growth companies by creating a financial solution for leasing equipment. For example, supermarket chains that are growing at a rate of a hundred supermarkets per year, we lease them the refrigerators, the air conditioning units or the cold chain for the warehouses. So they only pay us a rental fee per month. And instead of devoting that capital to invest in assets that depreciate, they keep using their funds to grow, to create more employment, to have more stores, to grow value for the equity investors.
Particularly in the food tech industry, which has been very resilient during the pandemic, we’re helping these companies grow regionally. For example, in Colombia, they moved to bigger markets like Mexico and Brazil, and we keep supporting them. In some of these companies we’re taking equity positions and liens because our leasing gives them the opportunity to increase in value.
We take very small equity positions, and that’s how we are hedging against the risks of having these leasing contracts in weak currencies, because these are valued in dollars. And usually the growth of these companies is higher than the devaluation of our currencies. So we found a way by taking equity position in high-grade hydro companies to compensate the losses we might have on currency risks. So helping these companies, because I’m an entrepreneur at heart, helping them grow, and then we turn these companies carbon neutral. They change packaging processes, they improve logistically. It’s kind of doing a little bit of everything that we talked about, making the big investments and maybe executing these small changes so that consumers can also contribute to the climate solution.
Football Chatter and Marco and Bilal’s Book Picks
Bilal Hafeez (00:52:04):
Yeah. I wanted to kind of end our conversation with some personal things. I understand that you are a big football fan, soccer as the Americans would call it, but not the rest of the world. And you have actually met Diego Maradona before. So can you tell me that story?
Marco Monroy (00:52:22):
Yes. Thank you Bilal. So good story I lived in 2003. I always loved football, that’s the sport I played since childhood. When Maradona retired in 2001 or so I was living in Washington. I went for the weekend to Buenos Aires just to see his farewell game. And so, I just went for the day to Buenos Aires, it was from New York an 11-hour flight. So I always admire him, especially for what he did on the pitch. In 2003, I was invited to China to talk about climate change and landfills. And somebody in the reception told me that Maradona was staying in the same hotel. So we met him. I just wanted to take a picture with him and have one shirt signed by him.
I carried soccer shirts. When I was younger, I used to carry soccer shirts around the world. But what happened was that he was having legal troubles because he had fought with his agent and he was negotiating some contracts with the Chinese over a brand of clothing and some appearances. So he couldn’t negotiate with the Chinese because he had no skills and he didn’t know what to do. So he asked us to come. I was with my wife from Argentina and a friend of ours. We started talking. It was snowing in Beijing. China was very different than what it is now. It was very, quite isolated. We started talking about football. I told him about my story going from Washington to see his farewell. And we got along quite well.
And then he told me the problems he was having. So I said, “Okay, I’m a lawyer. I can help you with the contract.” So what happened was that I stopped all my business in China. I didn’t go back to our booth in the trade show that we were attending. And I just became his lawyer for four days and night negotiating with the Chinese on all these contracts. And it was a wonderful experience. Every time we would have a good result on a contract clause, we would stand up from the table and celebrate as if we had a scored a goal.
I would stay at night while we were waiting for the Chinese counterpart to come back with comments on the contract. We were watching on TV the many goals that he played. Then I would ask him, “Okay, whether you told me how you scored the goal with your hand?” He would stand up and I’d see how he saw the referee with the back of his head, how he jumped. And it was kind of a private showing on how he scored that goal just for me at three in the morning in China. So, we lived wonderful experiences, lots of stories.
Fortunately, I didn’t see the dark side. I didn’t see any drugs. I witnessed how fast his brain was to negotiate, how quickly he was to recognize the issues in the contracts. Even though he had no education, he was highly intelligent. And it was a wonderful experience. I helped him take out a couple of mortgages that he had gotten to support his family because he was in very difficult financial situation at the time. I had them make some money, solve some contracts. And then I continued on with my business and I have a great memory-
Bilal Hafeez (00:55:26):
I mean, now that you saw Maradona I have to ask you the tough question, is Maradona or Pelé the greatest footballer of all time?
Marco Monroy (00:55:31):
I think that in Argentina they say that Pelé is the King and Maradona is God, that’s how they call it. I have very close ties to Brazil. I saw Maradona play because I grew up in ’80s. I couldn’t see a lot of Pelé. I saw him a little bit when he played in Cosmos. Both did amazing things. Pelé scored more goals, but Maradona had to play a much tougher football. Pelé had better teams with him when he won the World Cups. He was extremely good, but he had magnificent teams. Maradona in 1986 had great players around, but it was not a solid team. It was his card that drove the teams. What he did in Napoli was amazing. So he didn’t need great teams to make things happen. So I think if you could discount ages, probably Maradona would have been the best. But of course, it’s extremely personal but it’s very difficult to-
Bilal Hafeez (00:56:32):
You’re very diplomatic, because you deal in that in the Americas. So you don’t want to cut off your Brazilian colleagues.
Marco Monroy (00:56:38):
Brazil is a big market with a growing economy. Argentina is a tough economy, not a lot of business there, but great memories and a lot of family in Argentina. So, I would choose Maradona if I had to
Bilal Hafeez (00:56:49):
And just last question now, and I always ask this, I’m a big reader of books. Is there a book that’s really influenced you in your life? Alternatively, is there a really good book that you’ve read recently that you’d like to share?
Marco Monroy (00:57:03):
I grew up reading Latin American writers like García Márquez from Colombia, Vargas Llosa, they were both Nobel Prizes. I learned a lot about culture in our region and not just in Colombia. Great novels that culturally driven. I was enjoying my literature and I got to know – I loved the region where I work and where I was born. In my 20s, an author that had a great influence it was Paulo Coelho, a Brazilian guy. People could find him superficial, but it’s kind of a self-help beautiful stories and I have-
Bilal Hafeez (00:57:40):
Is there a particular book of his that you like?
Marco Monroy (00:57:42):
Yeah. The Alchemist is a classic, but he has two or three that are very good. And then, I happened to meet him and eventually we exchanged end of the year cards during Christmas. I met him at restaurants in several places and then I got to be in touch with him. So Paulo Coelho during my 20s, when I was about to start my business. It gave me a lot of self-confidence by reading that.
Marco Monroy (00:58:07):
Then, what I read mostly, business entrepreneurship, psychology, that’s what I read the most. Michael Gladwell, Blink, Outliers, The Tipping Point, David and Goliath, Malcolm Gladwell, Daniel Coleman, Emotional Intelligence. It’s just the bread and butter of business books. One that had a big impact on me personally at a deeper level is Viktor Frankl, the Holocaust survivor, Man’s Search for Meaning when he recounted the stories about the Holocaust, talk about forgiveness and the strength of the human spirit. So Viktor Frankl, Paulo Coelho, Garcia Marquez, Vargas Llosa-
Bilal Hafeez (00:58:49):
Thank you. Some great authors there.
Marco Monroy (00:58:50):
Yeah. Some are extremely commercial and very popular, but I liked those. I read a lot of newspaper articles deeper. I read a lot, a lot, a lot about technology, about history. I’m subscribed to the New York Times, Wall Street Journal, Washington Post, El Pais. I read a lot about things that have nothing to do with my business with climate change and they all help. So, it’s a wonderful legacy that my father left, the love of football, the love of reading is very important for my life.
Bilal Hafeez (00:59:24):
And if listeners wanted to follow your work or reach out to you, what’s the best way for people to learn a bit more about what you’re doing?
Marco Monroy (00:59:32):
Okay. So we have this group of companies doing climate investments. It’s called MGM Innova Group. My email is marcogmonroy@mgminnova.com.
Bilal Hafeez (00:59:49):
Okay. Yeah. So I’ll add that as well to the show notes. So if anybody wants to reach out and learn a little bit more about what you’re doing and… We can do that.
Marco Monroy (00:59:58):
Thank you Bilal. Bilal, sorry. I know you’re the interviewer. I just have a question or two questions. What team do you follow at the Premier League?
Bilal Hafeez (01:00:05):
Oh, Premier League I follow Liverpool and this season is going horribly wrong. Obviously, Liverpool won the last season and this season it’s just falling apart. For like almost two years they were unbeaten at home. They lost five or six matches in a row at home, which is a shocking, so it’s been a horrible season, but Liverpool, I’ve been a diehard fan of Liverpool for a long, long time. And then at the national level, obviously England, but outside of England, I like any good team really.
I mean, I love watching Brazil play or Argentina play. Spain, when they were at their peak, they were really good. I love France when they had Zidane. That era when they won the World Cup, I was really impressed by them. So I do kind of admire great football at the international level. I mean, England as a football team, there’s a lot of hype around England, but they never quite make it unfortunately.
Marco Monroy (01:00:58):
Yeah, and is now the idea.
Bilal Hafeez (01:00:58):
Oh, yeah.
Marco Monroy (01:01:00):
Spain was like that until they broke through in the 2009/2010.
Bilal Hafeez (01:01:04):
Yeah. I guess Spain was a good example.
Marco Monroy (01:01:05):
And then any books you’re an avid reader, any good books you would recommend?
Bilal Hafeez (01:01:12):
Yeah, sure. I mean the book that’s had probably the biggest influence on me in recent years is this book by the physicist David Deutsch called The Beginning of Infinity. Sometimes it gets a bit technical, but it’s still well written. It’s basically a way of thinking about science and the scientific process and what the limits of science. And when you read that book, it makes you very optimistic about what possibilities that there are, essentially everything is possible as long as it doesn’t violate the laws of physics. And so that means, for example, that it is very feasible to colonize Mars. That there’s nothing in physics that tells you that you can’t. So it may not happen in next 10 years, but that book really, really influential. This is a book I reread often.
So, I definitely recommend that book. I think it’s really, really good. And then other books I like, I mean, I do like kind of the ancient classics. So, for example, I like Marcus Aurelius’ Meditations, a stoic philosopher. What I like about him was Marcus Aurelius was a Roman Emperor, but also a philosopher. So he was kind of the classic philosopher king. I like people who aren’t just in a monastery philosophizing about life, rather the people who are stuck in the real world and yet also come up with philosophy. So Marcus Aurelius is really good like that. So I always like to read that to get some inspiration. So those are probably the two that I kind of go back to, and then I’m always reading lots of random little books here and there, but those are the ones I’d recommend if you want something that will kind of be of an impact to you.
Marco Monroy (01:02:45):
Yeah. The Beginning of Infinity is very appropriate for this stuff because climate change requires technology also.
Bilal Hafeez (01:02:51):
I think he’s a very good thinker as well. In the science field, I like Richard Feynman, his books that he wrote. I think David Tong in some ways is kind of the new Richard Feynman. And I just like the way he teaches you how to think about things, that it’s important not to just rely on data to tell you what to do. You have to come up with a theory or an idea first and then use data to validate it or not. Otherwise you could end up with just spurious, random things. So I liked kind of the way it teaches you to think, I think is very good.
Marco Monroy (01:03:24):
Yeah, that’s wonderful. Thank you.
Bilal Hafeez (01:03:27):
Yeah. Okay. Well, I’ve taken so much of your time, so I think we should wrap it up there. It’s been lovely to speak to you and good luck with all your endeavors.
Marco Monroy (01:03:36):
Thank you Bilal, same and good luck also. Your businesses is going so well and I appreciate very much your emails and information from your colleagues. Thank you very much. That’s very useful.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)