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Skip to 0 minutes and 13 seconds Financing smart cities requires integrated solutions to ensure an energy-efficient urban development. Grids, energy-efficient buildings, energy supply systems, transport and the behavior of citizens should lead towards considerable energy savings and green house gas reductions, which is the final objective. The potential solutions for financing a smart city are confronted with certain barriers.

Skip to 0 minutes and 39 seconds These can be summarized as follows: Perception of high risk when investing in innovative solutions and energy efficiency measures. Uncertain energy price policies and uncertainty about fossil fuel prices. Large investments required. Long-term delays before reaching maturity and profitability. Limited capacity for public funding. High public deficits in municipalities and incapacity to raise funds from capital markets. The impossibility of monetizing the benefits of the infrastructure, such as an increase in public health, a better investment atmosphere in the region, among others. In order to attract the necessary capital investments,

Skip to 1 minute and 23 seconds smart cities innovative technological solutions should meet the following requirements: Reduce the real and perceived risks of investment. Attract long-term finance from specialized institutions, like pension funds. Develop project aggregation mechanisms to create bankable and sizeable investments with reduced transaction costs. Develop off-balance sheet investment systems with private mechanisms, development of single purpose vehicles and PPPs. However, it is important to note that not all challenges can be solved through financial engineering. Many barriers are regulatory and region specific. Every investment is subject to risk and it is not the role of the public sector to remove reasonable risk levels, as it would create perverse incentives by mutualizing risks and privatizing profits.

Skip to 2 minutes and 19 seconds By identifying the nature of the risks that limit private interest, the public sector can unblock private finance. Nature of risks.

Skip to 2 minutes and 29 seconds Technology risk: Implementing a new technology that does not perform as expected in real life deployment.

Skip to 2 minutes and 36 seconds Operational risk: Operation of the infrastructure or technical application is suboptimal due, for example, due to a lack of skilled operators.

Skip to 2 minutes and 45 seconds Construction risk: Unexpected complications or delays affecting the return on investment.

Skip to 2 minutes and 52 seconds Market risk: The market demand for the new infrastructure or service is below expectation, leading to a loss of operational profit.

Skip to 3 minutes and 1 second Legal risk: A changing regulatory framework, for example.

Skip to 3 minutes and 10 seconds The financial system operates through two alternative financing channels, known as direct and indirect financing.

Skip to 3 minutes and 18 seconds Direct financing: Firms raise money directly from savers by selling them securities for cash. A security is a certificate that specifies the conditions under which the firm has received the money.

Skip to 3 minutes and 33 seconds Indirect or intermediated financing: Very often, firms cannot access the financial markets to sell their securities directly to investors. So firms raise capital through financial intermediaries, such as commercial banks, insurance companies, pension funds and venture capital funds.

Skip to 3 minutes and 52 seconds The classic financial instruments are:

Skip to 3 minutes and 54 seconds Debt financing: The acquisition of funds through borrowing. A lender provides capital to a borrower for a defined purpose over a fixed period of time. These can be loans or bonds.

Skip to 4 minutes and 6 seconds Subordinated debt finance: Capital that sits midway between senior debt, for example long-term secure bonds, and equity in the order of repayments, for instance, level of seniority. It is considered more risky in terms of collateral rights, as senior debt holders have preferential rights over these.

Skip to 4 minutes and 27 seconds Equity financing: The acquisition of funds by issuing shares of common or preferred stock, in anticipation of income. Equity is the most junior class of investments in an asset, after all liabilities are paid.

Skip to 4 minutes and 42 seconds Public finance mechanisms: Grants, Interest subsidies, for example, soft loans or revolving funds. In order to attract private investors, governments are increasingly using financial instruments. Such instruments are combinations of grants and loans aiming to change the cost and risk-return profile of projects in order to attract investors, as well as expanding the leverage of private funding to finance projects with public objectives. The investment needed to promote SMART initiatives requires resources that are significant and often different from traditional ones. The funding models for the realization of SMART CITIES is shifting from the use of the above mentioned “traditional” tools to contractual models of Public Private Partnership (PPP), which are more able to attract private capital.

Skip to 5 minutes and 38 seconds There are many financing mechanisms that can be used for specific needs, depending on the nature of the investment, the level of maturity, and the time needed for financial recoup. Models for early demonstration and deployment of innovative solutions. Using a grant, guarantee and loan blending mechanism. Fiscal Incentives. Project financing. The financial transactions through which public administrations fund public works, and of which the financial burden is partly or wholly borne by private capital, on the basis of a financial plan able to ensure a self-financing process for the operation. Spread shareholding. It is similar to that of smart bonds, but investors do not buy bonds, but shares of ownership in the infrastructure that they are financing through their investments.

Skip to 6 minutes and 28 seconds This type of investment involves a higher level of risk for investors, but also the possibility of a greater profit. Smart bonds. Bonds that are paid off following the achievement of a specific goal, such as the construction of the infrastructure, the implementation of a service or an efficiency increase. Their return is guaranteed by the economic benefits derived by the SMART initiatives financed in the area. Crowdfunding. The collective effort of individuals who network and pool their resources to support efforts initiated by other people or organizations. The Internet usually acts as the main channel for gathering financial resources.

Skip to 7 minutes and 10 seconds Compared with other financial funding instruments, crowdfunding really distinguishes itself through the motivational factors behind the participation of the funders who, depending on the type of project, often decide to invest due to emotional, geographical and other personal preferences. Energy performance contracting for energy efficiency. An ESCO (Energy Services Company) bears the risk (technical, operational and financial), in order to achieve the agreed savings objectives, and is directly or indirectly compensated through the savings achieved. Property Assessed Clean Energy. PACE is an innovative form of on-tax financing that provides citizens long-term up-front funding for building upgrades that stay with the property, not with the individual, upon sale.

Skip to 8 minutes and 1 second PACE financing covers up to 100% of a project’s costs and is repaid as a special tax charge added to a property tax bill over a term of up to 20 years. PACE allows project investors to lend money for deep retrofits and to then get repaid through a tax bill. On-tax financing is built upon the existing relationship municipalities have with their citizens.

Business models for smart cities

Financing smart cities requires integrated solutions to ensure an energy-efficient urban development. Grids, energy-efficient buildings, energy supply systems, transport and the behavior of citizens should lead towards considerable energy savings and green house gas reductions, which is the final objective.

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Smart Grids for Smart Cities: Towards Zero Emissions

EIT InnoEnergy