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Development Co-operation Report 2016
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branch I. The SDGs as sustainable business opportunities and five approaches to make it happen
  branch 3. Blending public and private funds for sustainable development

by

Richard Samans

Head of the Centre for the Global Agenda and Member of the Managing Board, World Economic Forum

Blended finance offers huge, largely untapped potential for public, philanthropic and private actors to work together to dramatically improve the scale of investment in developing countries. Its potential lies in its ability to remove many bottlenecks that prevent private investors from targeting the sectors and countries that urgently need additional investment. To accelerate social and economic progress towards the Sustainable Development Goals, blended finance needs to be scaled up, but in a systematic way that avoids certain risks. This chapter outlines how to underpin international development efforts using blended finance solutions that have the potential to transform economies, societies and lives, concluding with a set of key recommendations.

Challenge piece by Gavin E.R. Wilson, International Finance Corporation Asset Management Company. Opinion pieces by Jay Collins, Citigroup; LI Yong, United Nations Industrial Development Organization.

The challenge: Can blended finance increase the scale and sustainability of finance for development?

Gavin E.R. Wilson, CEO of the IFC Asset Management Company

Policy makers and experts from all sectors are discussing ways to finance the 17 Sustainable Development Goals (see Chapter 1) (Sachs, Schmidt-Traub and Shah, 2015). This dialogue is testament to an ongoing paradigm shift in the thinking about development finance: today, there is a clear focus on how to remove constraints, mitigate risks and unlock the resources needed to move from billions to the trillions required to achieve the new development agenda (see Figure 3.1) (ADB et al., 2015).

Providers of official development assistance (ODA), working in partnership with the private sector, can play a key role in underpinning commercially viable, sustainable and scalable solutions. They can use public funds strategically to provide, for instance, de-risking instruments; these instruments can incentivise private finance for investments with strong social and development benefits that would otherwise not materialise due to higher actual or perceived risk (OECD, 2014). Operating at the intersection of fully commercial and subsidised/grant-dependent projects, they can move the needle towards self-reliance, viability and scalability.

This is the concept behind what is referred to as “blended finance” . Where development challenges or perceptions of risk prevent investment on purely commercial terms, these models can enable the private sector to balance certain risks with appropriate rewards. This, in turn, can connect target groups to the market and eventually enable solutions to become financially sustainable. For multi-stakeholder partnerships to have the desired development impact, both public institutional expertise and emerging market knowledge are essential; together they permit the identification and structuring of projects that can be sustainable and replicable in the long run.

Blended finance investment solutions capitalise on partnerships among diverse actors, including international organisations, development co-operation agencies and private enterprise. An example of such a partnership is the Women Entrepreneurs Opportunity Facility, launched in March 2014 by the International Finance Corporation and Goldman Sachs' 10,000 Women. This is the first of its kind of global facility dedicated to expanding access to capital for women-owned small and medium enterprises. Through the facility, the International Finance Corporation aims to invest up to USD 600 million in financial institutions that are committed to expanding their financial services to small and medium enterprises owned by women in emerging markets. It also aims to signal the relevance of this asset class to the broader investor market. The funding for the facility includes USD 50 million of blended finance from Goldman Sachs' 10,000 Women to create performance incentives for financial institutions to boost their lending to this segment, and to support capacity building among financial institutions and women borrowers.

Nonetheless, it is important that the growing focus on blended instruments within the post-2015 development agenda does not lead partners to overlook other financial vehicles that can deliver commercially viable outcomes without a concessional element. The range of tools available to catalyse private finance for development includes instruments such as market-priced co-financing, seed capital for collective investment vehicles, partial risk guarantees, advisory services and support for sound project structuring. Some of these tools depend simply on an alignment of interests rather than the provision of an explicit subsidy. Blended finance solutions are best used when partial market failures undermine economic efficiency, including pioneering investments in high-risk environments or those that use new technologies; or when equity or distributional goals prevail, such as promoting affordable access to basic services for underserved groups.

The use of concessional subsidies could, however, encourage investors to compete against each other, leading to a race to the bottom in terms of pricing. The challenge for development partners providing blended finance instruments is to implement them strategically and selectively. This requires, to begin with, a shared understanding of exactly which forms of capital constitute a blended finance instrument. In addition, organisational capacity and vision are needed to:

  1. Identify and structure projects where blending is needed to make projects viable and ensure that the concessional element can be phased out in a reasonable time period, leading to commercially sustainable projects.
  2. Target projects that address critical gaps in development and can be scaled up and/or replicated to yield significant benefits beyond the original undertaking. This is particularly important for projects in fragile and conflict-affected states.

In essence, blended finance implies that certain policy-driven investors take on a higher level of risk, without commensurate commercial rewards. These partners are compensated by the prospect of strong development impact, of demonstrating the viability of new sectors and of attracting additional commercially-driven private finance to fund development challenges.

 

Despite the challenges of investing in emerging markets, 8 where development needs are the greatest, developing countries offer investment opportunities that are increasingly attractive to private investors and corporations, including rising financial returns, portfolio diversification, and access to young and growing markets. By helping to mitigate the perceived and real risks, and the inefficiencies that characterise these markets, new financial approaches can enable investors to realise commercial benefits while allowing developing countries to tap into significant capital resources.

Blended finance 9 – development finance and philanthropic resources used to mobilise private capital to promote development outcomes across a range of sectors and countries – is one such innovative approach (see the challenge piece by Gavin E.R. Wilson at the beginning of this chapter). By mitigating risks and enhancing returns for investors, this financing model can accelerate financial flows to emerging markets, thereby dramatically improving the scale of investment in development.

This chapter outlines how blended finance can promote public-private co-operation to underpin international development efforts, offering huge, largely untapped potential for public, philanthropic and private actors to work together towards win-win solutions. Private investors can make attractive returns on their capital. Public and philanthropic providers can make their limited dollars go further, yet ensure scale of implementation. Most importantly, people in developing countries can benefit from more funds – and knowledge – being channelled to emerging and frontier markets, 10 and being used strategically to transform economies, societies and lives – and ultimately to achieve the Sustainable Development Goals (SDGs).


Notes
8.  This chapter uses the term “emerging markets” to refer to developing country markets in general.
9.  Blended finance is the use of development finance and philanthropic resources to mobilise private capital at scale so as to deliver risk-adjusted returns and economic progress across a range of sectors and countries while ensuring significant development outcomes.
10.  For the purposes of this chapter, emerging and frontier markets refer to countries included in the OECD “DAC List of ODA Recipients (2014-16)” at: www.oecd.org/dac/stats/documentupload/DAC%20List%20of%20ODA%20 Recipients%202014%20final.pdf.
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