Sustainable urban development project financing in the recent times has a strong environmental component with multiple economic and social benefits to residents.

The transition to a low-carbon economy is a complex issue for municipalities and governments, partly addressed through project finance and public-private partnerships.

In recent decades, European and international discussions have given rise to new concepts of sustainable urban development that require significant sources of long-term financial resources, such as investment loans.

These tools are being actively developed by the joint efforts of representatives of the public, private and municipal sectors.

These capital-intensive investment projects focus on the construction of sustainable urban infrastructure that will improve the quality of the living environment and address the complex set of economic, social, environmental, demographic and other challenges.

Their feature is a long payback period, which requires professional planning and the use of innovative financial models with reliable support from the authorities.

Planning for the sustainable development of cities and the construction of a sustainable urban environment currently requires an increase in the share of capital investments of municipalities and diversification of funding sources.

Given the decline in government funding for public projects, an important trend in project finance in this context is to focus on innovative financial models, attract private capital, enhance cooperation with international financial institutions and enter into external capital markets to attract additional investment.

Urban development project financing

Green bonds financing of sustainable urban development projects

One of the most common forms of investment project financing by municipalities is direct financing from the capital market through the issuance of debt instruments such as bonds.

Since the 2000s, green bonds have been an important innovation in the development of municipal debt instruments, introduced in Europe with the first issuances by public institutions such as the EIB and the World Bank, followed by some municipalities to finance sustainable urban development projects.

According to the United Nations Development Program (UNDP), green bonds are innovative financial instruments for mobilizing resources from local and international capital markets for projects that bring environmental benefits to society.

The main difference between bonds is that they are guaranteed by the cash flows of projects that bring environmental benefits.

According to current sustainability requirements, environmental projects are classified into several categories related to climate change, depletion of natural resources, pollution of water, air and soil, etc. In most cases, these urban projects are aimed at promoting renewable energy, energy efficiency, control pollution and green buildings. According to analysts, in recent years the green bond market has grown exponentially from $13 billion in 2013 to $500 billion in 2021.

The growing interest in innovative bonds from issuers, investors and intermediaries requires the application of standards for assessing the environmental friendliness of bonds. The main tool that allows investors and intermediaries to assess the environmental friendliness of bonds is the Climate Bond Standard and Certification Scheme (currently Standard 3.0).

Certification confirms that a specific investment project brings significant environmental benefits in accordance with the eligibility criteria.

Some of the current requirements are listed below:

• Clear criteria for how financial flows are used and monitored within a particular project.
• Eligibility criteria for projects with low CO2 emissions and minimal environmental impact.
• Guarantee system with independent verifiers and strict procedures.
• Certification by an independent commission.

In all cases, local laws and regulations remain a priority in the preparation and issuance of bonds. The existing recommendations, principles and standards for issuing green bonds that promote sustainable development are voluntary recommendations and practices for wide use by various market participants.

Capital raised through bonds is used to finance low-carbon and sustainable infrastructure in areas such as transport, energy generation and transmission, building retrofits, industrial energy efficiency, water resources, pollution and waste control, agriculture and forestry.

Further development of the bond market based on the distribution of capital is associated with alternative financial instruments.

These are Social Bonds and Sustainable Bonds, which refer to bonds where project profits will be used solely to finance social projects or a combination of environmental and social projects, respectively.

The Green Bond Principles (GBP), the Social Bond Principles (SBP) and the Sustainability Bond Guidelines (SBG) proposed by the International Capital Markets Association (ICMA) contain the following requirements.

Innovative tools for financing sustainable urban projects

International practice shows that public-private partnership is the leading tool for financing investments in the construction of public infrastructure facilities and the provision of related services in the absence of the necessary resources in the state and municipal budgets.

Environmental protection as an integral part of public policy at the local, national and international level requires close cooperation between the public and private sectors to create sustainable assets in cities and municipalities.

Investments in sustainable urban environments usually include financial engineering tools, which are most often implemented in the form of project finance and public-private partnerships.

Sustainable urban development project financing covers projects such as green energy, transport infrastructure, waste management, and more.

The budget for such projects varies, ranging from tens of thousands of euros for the construction of a bike rack to hundreds of millions of euros for solar power plants. Accordingly, the financial needs of municipalities and the role of project finance schemes in such initiatives also varies.

Project finance: Project finance is a method of financing sustainable urban projects, public infrastructure and public service projects in which the source of debt repayment and return on equity involved in the project is the cash flows generated by this project.

A specific feature of project finance is a very high share of loans in the financial structure (up to 90% of the project cost). This requires the establishment of an independent company, referred to as a special purpose vehicle (SPV) or special purpose company (SPC).

SPV/SPC acts as a borrower and is fully responsible for the debts of the project.

Structures involved in sustainable urban development project financing are listed below:

• General contractor. Project finance schemes usually include a single general contractor who, alone or in cooperation with subcontractors, is responsible for launching the project (such projects may be carried out on the basis of an EPC contract).

• Municipal authorities. The local government takes responsibility for creating the proper legal conditions for the proper implementation of investments

• Operator. The project should be managed and maintained by a specialized company with relevant experience, which, after the completion of the project.

• Sponsors. In essence, these are the initiators of the project (private companies, organizations, municipal enterprises or local government) who promote the investment project and receive support from the authorities and the local community or other key organizations.

• Lenders. During urban development project financing, the lenders are most often local banking institutions that provide financial support directly to the Special Purpose Vehicle.

During the implementation of an urban project using PF schemes, other entities may also participate, which depends on the specifics of the investment.

This include manufacturers and suppliers of certain goods or equipment, large municipal customers who enter into long-term contracts in this area, as well as insurance companies (insurance policies are usually required to minimize the risk of investment failure).

Properly organized project finance makes it possible to create a modern municipal infrastructure using long-term funds and the experience of the private sector. In this way, the quality of services provided and the overall efficiency of projects such as power grids, water supply facilities, wastewater treatment plants and even residential buildings can be improved.

At the same time, each PF participant specializes in a certain area, such as attracting resources, risk assessment, construction and engineering, infrastructure management, and more.

Public-private partnership: Public-private partnership (PPP) mechanisms tend to be used in the most capital-intensive projects, which would otherwise be a heavy burden on the municipal budget.

When it comes to large urban projects, experts identify the following main advantages and potential benefits of PPP:

• Effective way to attract private capital to the public sector for the implementation of projects of public importance.

• Additional opportunity to accelerate social, economic, infrastructural and environmental transformations in local communities.

• Important tool for improving the infrastructure and quality of local public services (transport, security, healthcare, etc.)

• Basis for better planning and evaluation of investment projects, which is explained by the strict control of the private sector over the spending of funds.

• Participation of a private partner at all stages of the project leads to a simplification of the engineering stage, construction, financing, maintenance and operation of the facility.

• Improving the efficiency of investment projects.

• Better management of facilities and provision of better services of public interest.

• Transfer of experience and knowledge from the private sector.

• Rational distribution of risks.

• Growth of innovation.

A promising basis for achieving a balance of interests between the public and private sectors and the implementation of successful public-private projects is project finance.

The global market for green, social and sustainability bonds is growing at a rapid pace, given the growing demand for funds to create assets that bring environmental, social and other benefits.

This famous means of Urban development project financing has a very wide range of applications, and further growth in debt instruments in financing projects that meet the criteria for sustainable development is expected.

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