increasingly becoming a tool of development finance, communities of practice only recently emerged surrounding it. The easiest proof is the fact that there are still varying definitions of what blended finance is. At a practical level, this means that the field has not yet truly leveraged those actors with specific capabilities in blended finance to ensure that they apply their skills and capital in a tailored, impactful way. Fortunately, more and more official donors are looking to blended finance to drive impact. As sub-sets of donors emerge with specific interests within blended finance, they need to be able to easily identify blended finance structures and transactions that fit with their specific comparative advantages — whether on the basis of instrument used; geographic area or region; an investment sector, or a development theme, such as scale, LDCs, or gender. Institutions such as the Swedish International Development Co-operation Agency, Sida, have an edge in the issuance of guarantees in complex, structured transactions such as the IFC Managed Co-Lending Portfolio Programme. Others have strong institutional connections to the host governments where they work. The Millennium Challenge Corporation, for instance, operates through compacts with host governments that allow it to push for investment environment changes that facilitate the major infrastructure projects it supports. Leveraging comparative advantage in this space will go a long way towards ensuring that the right blended finance transactions are being executed, in the right places, in the right ways. DO NOT OVERLOOK LOCAL CAPITAL International capital markets would seem to offer some solutions for those in the development finance space seeking to mobilize additional money into the SDGs. The trillions it would take to close the annual SDG financing gap for developing countries is still a fraction of the global financial assets that are traded daily. But this capital is also very difficult to access for riskier investments in developing countries and LDCs. Institutional capital of this nature is looking for scale, predictable returns, replicable vehicles, and oft-invested markets. This does not mean ignoring such markets, but it does mean not overlooking local capital markets. Many developing countries and LDCs simply do not have developed local capital markets. But where there are local capital actors, they may very well represent the appropriate sources of capital for a blended finance transaction. These sources of capital are often investing in safer bets, notably government bonds. So, a blended finance transaction with its first-loss cushion involving a local project can be quite suitable for a local bank to invest in. In addition, local capital can be deployed without incurring any foreign exchange risk. 26
One particular kind of investment where this can be impactful involves SMEs, specifically in LDCs. For SMEs in these markets to scale, their capital needs are typically between $50,000 and $1m. Of course, it doesn’t make sense to blend $50,000 at a time, which is why many blended finance structures designed to invest in SMEs typically blend different forms of capital in an intermediate vessel first (a financing facility or fund), which then makes smaller investments into SMEs. A good example is Aceli Africa, a financing facility designed to improve local lending to agricultural SMEs in Africa. Once operational, it intends to do this by offering financial institutions cash incentive payments to defray the high operating costs, and a risk-sharing mechanism to reduce lenders’ exposure. REVERSE ENGINEER Between the SDGs becoming mainstream and the increasing awareness of the impact investment market — the Global Impact Investors Network estimates the size of the market at just over $500bn — the desire for investment tools and products that provide return on investment and SDG impact is growing. But to better entice the private sector, it’s critical for donors who are engaged in blended finance to adapt their products to the needs of the private sector. They need to look first at the type of investor they need to energise, understand the constraints on that investor type, and then mould, or reverse engineer, their own offering to those commercial requirements. Donors mostly have a fixed set of products and it falls to the private sector investor to figure out how and whether to use them. UNCDF has been involved in two blended finance vehicles designed to invest in SDG-oriented projects in developing and least developed countries. One vehicle — the BUILD Fund — focuses on capitalising early stage companies and SMEs in LDCs. A separate vehicle — the International Municipal Investment Fund (IMIF), managed by the infrastructure investment and global asset manager, Meridiam; and created by UNCDF, United Cities and Local Governments and the Global Fund for Cities Development — is a bespoke fund. It is designed to focus exclusively on supporting cities and local governments; notably municipalities in developing countries, including the least-developed countries. Both funds rely on first loss tranches to catalyse commercial capital into the mezzanine and senior tranches, which will be protected from early losses. Blended finance is, by no means, a panacea to achieve the SDGs. But there is no path to sustainable development reaching the places with the greatest development needs without private capital, which will not be accessible unless an array of game changing tools is deployed. CFI.co | Capital Finance International
Blended finance can be one of those gamechanging tools, but only if it is utilised in a gamechanging fashion. With 10 years to go until the 2030 deadline of the SDGs, there is little time to waste. ABOUT THE AUTHORS Joan Larrea is CEO of Convergence Blended Finance, the global network for blended finance. It generates blended finance data, intelligence, and deal flow to increase private sector investment in developing countries. Laura Sennett is policy specialist with the United Nations Capital Development Fund, which makes public and private finance work for the poor in the 47 least developed countries. ABOUT UNCDF UNCDF offers “last mile” finance models that unlock public and private resources, especially at the domestic level, to reduce poverty and support local economic development. UNCDF pursues innovative financing solutions through: (1) financial inclusion, which expands the opportunities for individuals, households, and small and medium-sized enterprises to participate in the local economy, while also providing differentiated products for women and men so they can climb out of poverty and manage their financial lives; (2) local development finance, which shows how fiscal decentralization, innovative municipal finance, and structured project finance can drive public and private funding that underpins local economic expansion, women’s economic empowerment, climate adaptation, and sustainable development; and (3) a least developed countries investment platform that deploys a tailored set of financial instruments to a growing pipeline of impactful projects in the “missing middle.’’
Author: Joan Larrea
Author: Laura Sennett