July 21, 2015    6 minute read

Blended Finance: Road to Sustainable Development

   July 21, 2015    6 minute read

Blended Finance: Road to Sustainable Development

What is ‘Blended Finance’?

Blended Finance is defined by the World Economic Forum (WEF) and the Organisation for Economic Co-Operation and Development (OECD) as:

“The strategic use of development finance and philanthropic funds to mobilise private capital flows to emerging and frontier markets.”

Private capital investments can be channelled from pension funds, insurance, sovereign wealth funds and transnational corporations. Some prospective sectors include clean energy, financial services, food and agriculture, healthcare and infrastructure.

Blended Finance has 3 key characteristics, including:

  • Leverage: Development finance and philanthropic funds are used strategically to attract private capital flows
  • Impact: After being leveraged, these funds are then used to fund projects which facilitate social, environmental and economic progress
  • Returns: Financial returns are paid back to private investors. Ideally, based on real and perceived risks, risk adjusted returns should be in line with other markets in order to attract private capital allocation to emerging and frontier markets

However, it should be noted that Blended Finance and Public Private Partnerships (PPPs) are not the same. Indeed, PPPs are a sub-set of Blended Finance as Blended Finance involves not only public infrastructure and service responsibilities being provided by private sector but also public sector assisting private one in sectors not usually provided by the public sector.

Why is it needed?

Following the Millennium Development Goals, which are due to expire at the end of this year, the United Nation (UN) has proposed a new, universal set of goals, called the Sustainable Development Goals (SDGs). SDGs were launched after the Rio+20 Conference in June, 2012 and are still being discussed in details. If member states agree the draft set of 17 SDGs in the UN summit in New York this September, these goals will come into force in 2016. They are expected to create a framework for UN member states’ agendas and policies, transforming the world’s prospect by 2030.

Nonetheless, apart from the proposing, negotiating and bureaucracy difficulties, a challenge surfaced is financing, which was highlighted and discussed extensively in the UN Third Financing for Development conference, in Addis Ababa, Ethiopia, between 13-16 July. In particular, the United Nations Conference on Trade and Development (UNCTAD) estimated that:

“The total investment needs in developing countries amounts to $3.3-4.5 trillion annually, with current investment at $1.4 trillion implying an investment gap of $1.9-3.1 trillion per year.”

On the other hand, despite global capital markets being valued at $218 trillion and the fact that emerging and frontier markets contributing over 49% of global GDP, a very small fraction of this $218 trillion flows into emerging markets. In particular, in 2014, private equity investment in emerging and frontier markets totalled $33.8 billion.

This difficulty of solely public funding and lack of private investment in emerging and frontier markets is where Blended Finance comes into use as it would address the funding gap by attracting capital from the private sector. It would create a win-win situation where countries and organisations can leverage their funds and reach their SDGs whilst private investors have more investing opportunities and make returns on their money.

According to a recent survey conducted on behalf of the WEF, there were 74 pooled funds and facilities identified representing $25.4 billion in Blended Finance assets. These funds have had impacts on over 177 million lives, showing the tremendous benefits and potential of Blended Finance.

An example of Blended Finance in use is the Danish Climate Investment Fund (DCIF) which provides risk capital for climate-related projects. It is expected to create measurable savings and facilitate sustainability in developing countries as well as to create jobs through investee enterprises. Using risk sharing mechanisms, DCIF raised $94 million from the Danish government and IFU and $142 million from Danish institutional investors including PensionDanmark, PKA, Pædagogernes Pensionskasse, Dansk Vækstkapital and Aage V. Jensen Charity Foundation.

In addition to scaling existing funds, Blended Finance can have many other benefits. To name a few, it can facilitate the sharing of operational, sectoral expertise and best practice in investment, enhance investment skills and improve the terms of investment by increasing the time horizons and pushing reforms thus reduce risks associated.

Figure 1: Blended Finance Benefits by Stage (Source: Blended Finance Vol. 1: A Primer for Development Finance and Philanthropic Funders report)

Figure 1: Blended Finance Benefits by Stage
(Source: Blended Finance Vol. 1: A Primer for Development Finance and Philanthropic Funders report)

 

How can Blended Finance be employed?

According to Dalberg, a strategic advisory firm dedicated to global development, public investors can support blended finance transactions in three primary ways:

  1. Participating directly in a given investment opportunity, for instance, by providing equity or debt financing at market rates and terms
  2. Issuing products to mitigate investment risk including partial and full credit guarantees, political risk insurance, and currency swaps, for instance
  3. Supporting efforts to identify or develop investment opportunities by providing direct funding or technical assistance

What are the challenges facing Blended Finance?

According to the WEF and OECD, the main challenges to Blended Finance include:

  • Low returns given the degree of real and/or perceived risks
  • Markets are efficient and typically weak
  • Imperfect information as private investors have little knowledge about the nature and capability of the sectors, hence investment opportunities in these countries
  • Lack of incentives to invest in sectors or markets with high social and developmental returns
  • Challenges in local and global investment climates regarding legal framework, regulation and possible corruption, for instance

The greater the amount of risks tackled, the greater the returns for private sectors and thus their incentives to invest in these emerging and frontier markets. Some of the possible methods which are used to address these difficulties include technical assistance, risk underwriting, market incentives and direct funding. Once Blended Finance gains momentum, risks perceived by private investors can possibly be reduced even further.

Additionally, Michael Elliott, the President and Chief Executive Officer of ONE, the global campaigning and advocacy organisation fighting extreme poverty and preventable disease, argued for another two challenges. The first one is the transparency and accountability of Blended Finance project as private institution do not always provide disaggregate data or data on development impacts claiming commercial sensitivity. Therefore, the procurement and implementation process as well as data collection and establishment should be open and monitored to ensure the initial goals of Blended Finance are reached. The second challenge is the risky situation in the very poorest countries and thus the possible benefits for them. He suggested that deals should be carefully scrutinised and implemented to prevent poor countries from being burdened with debts, given their poor institutional framework.

The Future of Blended Finance

Blended Finance is being increasingly integrated into development projects and organisations. Some examples include the 3 new Blended Finance initiatives of the WEF and OECD introduced formally through the work of the Forum’s ReDesigning Development Finance Initiative, and plans to establish a Canadian Development Finance Initiative.

Blended Finance has a great potential for facilitating economic growth and development across many countries. It is essential for following up with the gains from the Millennium Development Goals and achieving the SDGs. As a result, Development Finance and Philanthropic Funders need to learn and integrate Blended Finance best practices into their organisations and the governments should do its best to facilitate this change in development finance landscape.

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