How can blended finance reach scalable impact?
In conversation with Chris Clubb, Managing Director, Europe at Convergence, we discuss the current opportunities and challenges of scaling blended finance, and what is needed to achieve the scalable impact in developing countries across Africa and Asia. We explore how a coordinated and calculated approach can unleash blended finance’s real potential to increase investment and advance the Sustainable Development Goals (SDGs) in the countries where it is most needed.
‘’Blended finance is the use of catalytic capital from public or philanthropic sources to increase private sector investment in sustainable development’’
According to the 2019 State of Blended Finance report, approximately USD 140 billion have been mobilized by blended finance, with around 50 transactions closed annually. According to the United Nations, at approximately USD 20 billion annually, the scale is far below the potential to narrow the USD 2.5 trillion SDG Investment Gap in developing countries. There are numerous challenges to bridging the financing gap, but two significant factors are the (i) high country risk – the median rating of the 145 Low and Middle-Income Countries is S&P-equivalent “B,” which is far too risky for the large majority of investors, and (ii) lack of bankable/investible investment opportunities for private investors. Blended finance create investment assets that meet market benchmarks and mobilize private investment, ensuring increased capital flows to bankable and near-bankable projects aligned to the Sustainable Development Goals. Added to this, “blended” implies there is a commitment by development-focused organizations to participate at below-market terms to mobilize more capital from the private sector to projects that have strong development impact.
To generate interest and increase the appeal for investors, blended finance solutions must be deployed at both a project and portfolio level. GuarantCo, a Private Infrastructure Development Group (PIDG) company, is a good example of facilitating blended finance at project level, where innovative credit solutions support the transition of projects from near-bankable to bankable, making projects acceptable for private investors.
In particular, cross border investors hesitate to take on individual project risk and prefer to invest in project portfolios, which allows them to diversify their risk across sectors and geographies. Portfolio diversification can lead to a credit rating upgrade from reputable rating agencies, such as Fitch and Moody’s, which support companies to reach a high investment rating thus providing confidence to investors.
It is important to acknowledge the slight mismatch between the amount of funding available through local institutional investors and what they invest in locally. Logically, almost all local institutional investors are like international institutional investors in how they require capital commitments to underwrite risks. Local market capacity building is and will continue to play a critical role in educating key stakeholders on the key principles of blended finance and the various options, including credit guarantees, available for mobilizing local market capital flows toward projects focused on improving the lives of people in developing countries.
Convergence Blended Finance continues to champion the role of blended finance in closing the funding gap in developing countries. Knowledge of blended finance is still relatively low, but Convergence and its funders and partners are committed to change this by sharing knowledge, data, and best practices, and facilitating interaction between private and institutional investors, investees, guarantors and arrangers. Convergence is working with USAID, UK FCDO and other donors on the Scale Blended Finance Working Group to unlock new avenues for blended finance to better achieve development at scale through increased private investment.
In summary, there needs to be continuous focus on creating awareness about blended finance and understanding and driving local market capacity building to increase the investment opportunities in near bankable and bankable projects. Blended finance should be focused on sectors and SDGs that have underlying projects that generate revenues to remunerate private investors. This will only be feasible if all stakeholders strengthen their understanding and collaboration efforts to advance sustainable economic development in emerging markets and developing countries.