Balancing Risk and Impact: infrastructure investment in emerging markets

GuarantCo was established in 2005 to help close the infrastructure funding gap and alleviate poverty in lower income countries across Africa and Asia. Our local currency credit solutions transform capital markets by mobilising private sector capital to finance essential infrastructure projects.

As part of the Private Infrastructure Development Group (PIDG), we operate in coordination with our sister companies over the lifecycle of such projects. Through de-risking critical infrastructure initiatives, we increase the appetite of private investors to support such initiatives in alignment with the Group’s 2030 Strategy.

Collectively, we work in spaces that typically receive little or no capital market attention – a large proportion of our activities take place beyond the comfort zone of most infrastructure investors in Least Developed Countries and often Fragile Conflict-Afflicted States. At the same time, safety for all involved in our work, gender equality and climate considerations are at the very core of what we do.

Due to the nature of our business, we face a critical question: How can we de-risk and mobilise capital while ensuring projects drive measurable, long-term development impact? This article explores the relationship between risk-adjusted return and impact, and our innovative strategies to reconcile these distinct yet complementary factors, demonstrating that risk, return and impact need not compete. By embracing innovative guarantee structures and collaborative frameworks, we can minimise risk for greater returns, while continuing to drive impact. Finally, we argue that a portfolio-based approach to balancing risk return and impact is more appropriate than trying to achieve a perfect balance on each transaction.

The relationship between risk and impact

There are scenarios where risk and impact appear to be in conflict. For instance, as a guarantor, requesting a stronger security package from sponsors (to minimise risk) may elevate project costs, which could reduce returns for investors and, ultimately, be passed on to the end-customers or the buyer of the goods and services offered by the project (thus reducing impact). Conversely, compromising on the security package increases the risk in the transaction possibly pushing it beyond our risk appetite and that of investors.

While this is a question in the short term, in the long run we believe risk management and impact go together. A balanced approach towards mobilisation for the project can improve financial sustainability, making the project more resilient to potential risks, stimulating economic growth, improving local markets, and attracting more investments, thereby reducing overall risk over a period and improving returns. The challenge for us is, in the short term, is how to mitigate risk while driving the delivery of sustainable impact.

The answer is two-fold:

1. Develop strong quantitative measurement tools for assessing the risk and impact – this helps in drawing clear boundaries and ensuring consistency in measuring different transactions.
2. Innovate and actively manage risks. We have developed unique credit enhancement solutions to achieve balanced risk and impact metrics.

Innovative solutions and active risk management

Our strategic focus is ensuring proactive risk management enables sustainability impact, and vice versa, creating a virtuous cycle for emerging market infrastructure.

1. Liquidity Extension Guarantee (LEG)
   Infrastructure financing often requires long-term funding for a project to be financially sustainable. Unfortunately, local commercial banks in developing countries are often unable to provide long-term finance due to the internal as well as regulatory limitations. Our LEG product directly addresses this tenor constraint. Unlike a credit guarantee, our credit risk on the LEG product is expected to be low in the initial years when the project is exposed to relatively higher risk (construction phase). Through various rights embedded in the agreement, we can ensure that the credit risk assumed at the expiry of the trigger period is acceptable to us, while ensuring that the necessary capital is mobilised thus driving the development impact.
2. Portfolio Guarantees
   Local lenders tend to have a deeper understanding of contextual risks and can be excellent partners in delivering on regional impact opportunities. Collaborating with local lenders helps refine our risk management and ensures projects meet community needs. For this guarantee, a specific portfolio limit is set up to mitigate concentration risk, a thorough financial and Health, Safety, Environmental and Social (HSES) due diligence is carried out to understand both the client’s risk management system and portfolio performance. Moreover, we design a suitable approach to map the client’s credit risk rating parameters to our internal rating scale, helping us leverage our partner’s local expertise and assess the risk of the guaranteed portfolio appropriately in our internal rating system. This product is typically structured as a second loss to GuarantCo, which ensures that our guarantee can only be called upon after the qualifying portfolio has experienced cumulative losses to the total of the first loss percentage, which significantly reduces the credit risk for GuarantCo. The guarantee is a “win-win” for both parties, as it provides significant capital relief to our partner banks.
3. Credit Risk Syndication
   At times, we enter into large ticket transactions which are necessary to mobilise a high amount of capital to drive impact. While the size of transactions at financial close is high, we employ an active strategy of syndicating a portion of the guaranteed amount to manage single obligor concentration risk. This approach allows us to transfer a portion of credit risk to a third party, thereby effectively reducing our risk exposure and enhancing our ability to participate in future large-scale infrastructure projects.
4. Monitor dynamically, adapt proactively, build capacity
   We believe dynamic monitoring and proactive engagement are key to managing both risk and impact effectively. By building strong, long-term relationships with our clients, we gain a deeper understanding of their financial performance and operational challenges. This close monitoring allows us to anticipate potential issues or incidents before they arise, enabling us to take timely action. We also prioritise client education throughout the project lifecycle. For instance, we deliver capacity building events – PIDG Institute in-person workshops – cover the highest risk topics. We deliver tailored training to clients to address their specific needs, and we also onboard clients to reinforce our requirements and expectations, anticipating and addressing issues and risks before they eventuate.

Criticality of robust risk and impact models

Building on the importance of innovative solutions to align risk and impact, it’s essential to recognise that robust risk-adjusted returns and impact models form the foundation of successful strategies. While innovation drives alignment, it is the strength and accuracy of the underlying models that ensure decisions are data-driven, consistent, and resilient against volatility.

Credit risk measurement

One of the primary challenges to independently build a robust model to measure credit risk is the data gap. Accurate risk measurement relies on comprehensive, timely, and reliable data. However, in the markets we operate such data can often be incomplete or even unavailable in a standardised format.

To address the data gap challenge, we place a strong emphasis on active data collection from trusted third parties. We are an active member of the Global Emerging Market Database (GeMs), a comprehensive platform that provides valuable emerging market data and insights. We engage with GeMs regularly to obtain the best quality of relevant data available, ensuring that we have access to up-to-date and accurate information for our risk measurement and decision making. We also have access to the leading rating agencies’ default datasets, which form an important foundation of our internal rating scale.

Furthermore, we perform in-depth review of our risk models on a regular basis, closely track the sovereign rating changes and collaborate actively with external consultants to assess our credit risk modelling methodology, ensuring optimal performance of our credit risk estimations.

Sustainable Development Impact (SDI) Scorecard

SDI is a core part of our decision-making process. We use the PIDG quantitative impact scorecard to screen and arrive at an impact score, which covers contributions to SDGs and key aspects of the PIDG 2030 Strategy such as people, planet, gender equality, wider economy and market transformation. This quantitative scorecard enables a consistent approach to measuring impact across various PIDG projects. The impact score enables appropriate monitoring of the risk and impact balance at a portfolio level.

High quality risk and impact measurement models are the foundation of constructing a robust portfolio that achieves an optimal balance between risk and impact, ensuring effective decision-making and strategic allocation of resources.

Conclusion: risk-adjusted return and impact – two sides of the same coin (a portfolio approach)

While we strive to balance risk-adjusted return and impact at the individual project level, we acknowledge that this balance is not always achievable in isolation. Some projects may inherently carry higher risk due to their transformative nature, therefore, we place more emphasis on achieving a risk-impact balance at the portfolio level. By diversifying across sectors, geographies and risk profiles, we ensure that the overall portfolio remains financially sustainable while delivering meaningful impact.

In practice, we use a Risk Adjusted Return on Equity (ROE) vs Sustainable Development Impact Score graph to closely monitor the balance between risk and impact dimensions at an overall portfolio level, as illustrated below. This graph allows us to visualise how well our portfolio balances risk and impact, helping to quickly identify areas of improvement or potential shifts in strategy.

PIDG Impact Frontier

Overall, the relationship between risk and sustainability impact is not a zero-sum game, and the question is not whether to prioritise risk-adjusted returns or sustainability impact, but how to harness their interdependence.

In emerging markets, the greatest opportunities lie where risks and impacts intersect. As guarantors, our role is to bridge this divide – proving that doing good and doing them well are not just compatible, but inseparable.