5. Blended finance in least developed countries in practice: guest contributions

By Saber Hossain Chowdhury

Bangladesh performed commendably in achieving the Millennium Development Goals and as an “early starter” country to implement the 2030 Agenda for Sustainable Development. Bangladesh prioritised the Sustainable Development Goals (SDGs) and integrated them into its seventh Five Year National Development Plan (2016–2020). Accordingly, this plan was aligned and harmonised with 14 SDGs and partially with three of them.

The SDGs have been embraced and mainstreamed in Bangladesh through an inter-ministerial committee to co-ordinate and facilitate the overall implementation and monitoring of the SDGs under the leadership of the Prime Minister’s Office. Based on a comprehensive mapping of the SDGs, each ministry has been assigned targets that are being regularly monitored.

As the focus of the government’s efforts is now firmly on SDG implementation, blended finance offers Bangladesh a strategic opportunity to mobilise additional resources by bridging the considerable SDG funding gap at a time when the availability of concessional financing for development is under threat. The SDG Financing Strategy formulated by the Government of Bangladesh stipulates that about 42% of total finance for attaining the SDGs will have to come from the private sector, and another 6% will need to be covered by public-private partnerships (Government of Bangladesh, 2017[1]).1 Accordingly, the government attaches great importance to inclusive partnerships with the private sector as well as with development partners.

To ensure the sustainability of blended finance in Bangladesh, the terms of such finance should be calibrated and considered in a manner that minimises debt management challenges and debt servicing obligations, while at the same time ensuring that local financial markets are not undermined and market distortions are avoided (GPEDC, 2018[2]). A series of effectiveness considerations around private sector engagement, in particular blended finance, have been noted over the course of the past few years, and also informed the Kampala Principles of the Global Partnership for Effective Development Co-operation (see Figure 5.1).

Blended finance is applied globally, but there is no one size that fits all. Each investment has to take into account the local context and be tailored accordingly. However, to operationalise concept notes into successful ventures, there needs to be a clear understanding of the benefits of such investments and, just as importantly, the capacity to implement them.

Despite the identification of national priorities and the existence of an ambitious strategy, the Bangladesh experience demonstrates that there is greater scope for government participation.2 Bangladesh could also improve its own capacity to implement the national strategy by increasing the array and combination of enabling policies and frameworks to ensure better co-ordination and delivery.

Enterprises that ensure optimum national welfare, including the creation of decent jobs alongside sustainable business practices, should be prioritised, as they are severely constrained in terms of access to finance. Micro, small and medium-sized enterprises (MSMEs) account for 25% of Bangladesh’s GDP, employing over 80% of the workforce (Bangladesh Bureau of Statistics, 2017[4]). Such MSMEs also have a catalytic role in setting up larger enterprises in the medium-term.

Accordingly, MSMEs are important beneficiaries of development co-operation and receive support in the form of access to finance, capacity development, value chain development and efforts to improve environmental, social and governance standards (GPEDC, 2018[2]). They do, however, require additional support to engage in business associations and take up opportunities for public-private dialogue.

Development partners should consider different approaches to support the engagement of MSMEs in blended finance, not only as beneficiaries, but also as partners in the design of projects. The use of local currency and investment in capacity-building with local financial institutions can help to unlock some much-needed finance for MSMEs. Moreover, projects in which MSMEs are the final beneficiaries should be developed in close consultation with the organisations or associations representing them.

It is noticeable that despite the opportunities and scope for investment in social infrastructure, blended finance projects in Bangladesh have been largely occurring in economic sectors. Blended finance can be leveraged to attract investment in areas and sectors critical for the attainment of SDGs.

Given the impact of COVID-19, there is the added imperative of engaging, incentivising and mobilising the private sector at a larger scale. In accordance with the “test, test, test” advice of the World Health Organization, and following the successful strategies of test, trace and treat from countries that have effectively responded to the global pandemic (such as the Republic of Korea), Bangladesh set up a multipurpose testing and triage booth (the first of its kind) for COVID-19 at the Mugda Hospital and Medical College, Dhaka. This novel initiative, as an immediate response to the global pandemic, was implemented by Digital Healthcare Solutions, a private healthcare provider, in collaboration with the Institute for Developing Science and Health Initiatives, a private foundation. The project was co-funded by UK Aid and implemented under the stewardship of the Ministry of Health and Family Welfare. Digital Healthcare Solutions and the ministry have contributed to the initiative both financially and in kind, including by providing the physical space, supervising and co-ordinating day-to-day activities and mobilising the local community. After successfully conducting over 8,000 tests and proving the concept, the venture has been handed over to the government. This collaboration has been an excellent and defining instance of all aspects of the Kampala Principles in action: country ownership, inclusive partnership, targeted impact, transparency and accountability, with an overall focus on benefiting the most vulnerable and those furthest behind.

This project, and the experience in Bangladesh, has shown that a harder look at the effectiveness of implementing blended finance projects (through the Kampala Principles) and mobilising additional private finance (through the Blended Finance Principles of the OECD DAC) will be critical to ensure blended finance can deliver better on the SDGs and for those furthest behind first.

By Luigi Lannutti and Kruskaia Sierra-Escalante

The IFC, a member of the World Bank Group, has committed to significantly growing its annual investments in the world’s poorest and most fragile countries. In 2017, the IDA created the IDA Private Sector Window, a blended concessional finance3 facility to help the World Bank Group to deliver more sustainable private sector investment in the world’s poorest countries (OECD/UNCDF, 2019[5]).

The introduction of IFC’s new commitments – the IDA Private Sector Window and other blended finance facilities that focus on low-income countries, LDCs and fragile and conflict-affected situations (e.g. the Finland-IFC Blended Finance for Climate Facility, the Canada-IFC Renewable Energy for Africa Program) – has influenced the trajectory of the IFC’s blended finance activities. As shown in Figure 5.2, the growth of the blended finance portfolio in the past four years has been faster in the most challenging markets, including low-income countries, LDCs and fragile and conflict-affected situations.4 For example, the IFC’s cumulative blended concessional finance co-investment commitments in LDCs stood at around USD 540 million at the end of the 2020 fiscal year (excluding regional programmes), 60% of which has materialised in the past three years, since the inception of the IDA Private Sector Window in 2017, with the remaining 40% having materialised in fiscal years of 2010–2017.

The IFC’s strategic focus and the availability of resources to support clients in the poorest countries have marked a more general shift in culture, which in turn is allowing the IFC to build new pipelines in the most challenging markets. Through these changes, the IFC is taking a more systematic approach to assessing the risks in low-income countries (LICs) and LDCs and designing targeted blended finance solutions.

A review of the IFC’s blended finance investments reveals that some solutions are most effective at overcoming specific challenges and risks, especially in LICs and LDCs. While for projects in middle-income countries, limited concessionality may be enough, through either pricing or subordination, to make an innovative project happen and mobilise other financiers, in LICs and LDCs there is a need for more pronounced blending (higher concessionality,5 multiple instruments, local currency solutions, etc.) to tackle overlapping layers of risk (weak or inexperienced sponsors, higher costs, lack of security, depth and breadth of capital markets). Solutions for investing in LICs and LDCs include the following.

  • Guarantees de-risk an investment by improving its credit profile. For example, when operating through financial intermediaries, first-loss guarantees help to improve the credit profile of the financial intermediaries’ underlying portfolios; the de-risked underlying portfolios can thus be expanded to underserved populations perceived to present a higher risk.

  • Subordinated financing can help to bridge a financing gap for a project where there is not enough certainty of cash flows for senior lenders during the initial revenue ramp-up period, or in the case of limited available assets to offer as collateral.

  • Concessional local currency solutions allow the extension of long-term local currency loans to offset asset-liability mismatches at terms that are viable for the project to proceed and/or for the end users to actually use the products or services (e.g., loans at tenors and terms that are viable for SMEs).

  • Investments in LICs and LDCs can require instruments that present higher concessionality levels. For example, the IFC has observed that guarantees and local currency solutions often embed a grant element that is higher than that of other products.6

  • Multilayer approaches should be designed when several risks need to be tackled at the same time. For example, the risk due to unavailability of collateral is a participation constraint that in an LDC often coexists with a lack of affordable long-term local currency.

  • Less leverage of blended finance instruments is expected in LICs and LDCs, because it is harder to mobilise commercial investors. The overall leverage of the IFC’s blended finance facilities of USD 1 of concessional funds to USD 8 of total project cost drops to a 1-in-4 ratio for projects in LICs and LDCs.

  • The use of blended finance in tandem with public reforms and capacity-building is a must in new and/or underdeveloped markets. For example, it is important to accompany local currency loans with solutions that support the development of the local capital markets, to sustain the commercial viability of future investments; in this context, the IFC strives to use local currency loans in combination with local currency bonds as part of a holistic capital market transformation process. Technical assistance programmes are equally important.

Regardless of where and how blending is implemented, it is imperative to have rigorous governance,7 clear principles8 and disclosure practices9 for an efficient, effective and transparent use of blended concessional finance.

The use of blended finance requires a strong development rationale. The IFC’s Anticipated Impact Measurement and Monitoring (AIMM) system enables the IFC to estimate the expected development impact of its investments. The AIMM system also allows the IFC to examine a project’s systemic effects on the overall market. This is particularly important when using blended finance in LICs and LDCs, where the objective is to create a new market by using concessional finance only temporarily to help to introduce fully commercial finance over time.

The scores on the AIMM system for projects supported by blended finance are on average higher than for projects that do not use blended finance, and this is even clearer when looking at projects supported by blended finance in the most challenging markets eligible for IDA Private Sector Window resources. First movers’ transactions in LIC and LDC markets have a stronger potential for market creation (often through demonstration effects), although their probability of success may be lower due to the local market challenges.

Market failures and risks in LICs and LDCs may be exacerbated by the COVID-19 crisis. Risk perception is heightened in these countries where governments may have lower capacity to respond. Blended finance is a critical instrument for the IFC’s response. Up to USD 400 million of IDA Private Sector Window resources are supporting the expansion of the IFC’s global trade finance programme (GTFP) in IDA Private Sector Window countries10 to fill a trade-financing gap that is now widening because of COVID-19. An additional USD 80 million of IDA Private Sector Window resources have been made available to provide de-risking solutions to the IFC’s real sector crisis response, which works with IFC’s clients in industries vulnerable to the pandemic, including infrastructure, manufacturing, agriculture and services. Up to an additional USD 216.1 million of IDA Private Sector Window resources support the IFC’s Working Capital Solutions facility to expand working capital loans in IDA Private Sector Window countries by de-risking these loans through a first loss guarantee. Other blended finance solutions11 have been designed along with the IDA Private Sector Window to support on-lending from Working Capital Solutions to women-owned and women-led enterprises. In recent years, blended finance has been used to help open new markets and extend development impact; in this period of extreme uncertainty, blended finance can help the IFC to support its clients’ continued economic activity, ensuring that the progress to date is not erased and that these businesses will emerge in good standing on the other side of the crisis.

By Aakif Merchant

As we enter the decade of action to realise the SDGs, the United Nations Secretary-General António Guterres declared that LDCs will face the gravest battle to achieve sustainable development, in large part due to the annual SDG funding gap across LDCs, which is USD 400 billion, according to the United Nations Sustainable Development Solutions Network (SDSN, 2019[6]).

This staggering figure shrinks in significance in the global context; it amounts to 0.5% of global GDP, 2% of global annual savings and 0.2% of global capital markets. The only way to unlock more existing finance to advance the SDGs in LDCs is to mobilise private finance in greater volume.

The adoption of the Addis Abba Action Agenda in 2015 encouraged the global development community to explore additional ways to draw expertise and resources from the private sector to increase investment in projects targeting SDGs, to supplement official development assistance (ODA). In doing so, numerous barriers were identified that are preventing capital flows into frontier and emerging markets, including high perceived and real risks, and poor returns that are not commensurate the risks.

An efficient and scalable approach to overcome some of these challenges exists, and that is blended finance. Blended finance, a structuring approach, can bring risk-adjusted returns in line with private investors’ requirements, by shifting risks and/or managing returns. As referenced in this report, and confirmed by data from Convergence’s historical deals database, only a small percentage of blended finance flows reaches LDCs. As blended finance enters the mainstream, we need to ask ourselves how this approach can be further leveraged to mobilise much-needed resources for the LDCs.

Private investors face several challenges when investing in LDCs, but one is particularly acute – individual investment opportunities that are often too small for the private sector.

Blended finance can support transactions at one of two levels: the project/company level or the portfolio level (e.g. pooled fund or facility). To get around the barrier cited above, within LDCs, portfolio approaches can be more effective in mobilising private investment at large scale, for the following reasons.

  • They increase the ticket/deal size. Private investors often look for large investment sizes (e.g. USD 10–15 million) but few projects or companies in LDCs have sufficient stand-alone scale to warrant a sizeable investment. Aggregating multiple projects (e.g. through a portfolio or syndication approach) can therefore achieve the required critical mass.

  • They merit the long approval cycles and high appraisal costs. ODA providers such as development agencies have long project approval cycles, regardless of project size. Additionally, investors often find one-off deals to be too costly to appraise. Investors thus believe it is worth undergoing the long approval cycle and high appraisal costs for large deals, which, for SDG-targeted development projects in LDCs, can be achieved only on a portfolio basis.

  • They create diversification to reduce risk-return variance. Diversification across projects reduces risk-return variance for investors. The big three ratings agencies follow a methodology that allows for a two-notch upgrade for diversification across multiple borrowers in non-investment grade countries. Convergence’s analysis shows that countries rated in the LDC cohort have a median long-term sovereign rating of “B”, so a portfolio of B-rated projects can be enhanced to BB simply through a portfolio diversification approach. In LDCs, which have a high level of real and perceived risk, diversification across multiple companies/projects or sectors can be highly beneficial. Diversification across LDC countries also needs to be considered. Though Convergence’s data show a concentration of blended transactions across Rwanda, Tanzania and Uganda, we have observed in recent years blended finance activity expanding to new LDCs such as Cambodia, Madagascar and Mali.

Given these reasons, it is indeed no surprise that a plurality (41%) of LDC-focused blended finance transactions in Convergence database represent portfolio approaches to blending, although this number has decreased over time. Development funders should prioritise a portfolio approach along with asymmetrical risk-return profiles to mobilise private investors. The problems facing LDCs are formidable, and solving them will require significantly more financial resources to flow into projects and transactions in these countries. The approach articulated here will help to draw in additional sources of finance and bring us closer to closing the SDG funding gap in countries with the most challenging environments.

By Pooja Yadav and Nathan Kelly

CrossBoundary manages two blended finance vehicles that invest in renewable energy in sub-Saharan Africa – one investing in single off-taker, commercial and industrial solar systems, and the other investing in rural solar-powered mini-grids. Both these vehicles use donor capital to unlock private investment into high-risk sectors and geographies. While the literature on blended finance often emphasises the ability to create leverage with limited donor capital, the economic implications of COVID-19 reinforce the importance of also providing additionality to create resilient ecosystems, particularly for more vulnerable population segments. Examining both vehicles as case studies provides a useful framework for donors to consider how to use their limited capital to create both private sector leverage and additionality.

Demand for donor capital in blended finance vehicles has never been higher. But when it comes to blended finance vehicles, comparing the impact of donor capital in one vehicle versus another is not always straightforward. Some vehicles will boast very high leverage on donor capital (i.e. the amount of private capital attracted for every dollar of donor capital), while others will pursue higher-risk, lower-return opportunities where donor capital may be more additional (i.e. creating positive externalities that could not otherwise be addressed through commercial capital) but will attract less commercial capital. Understanding and comparing the amount of leverage and additionality each vehicle brings can help donors to compare the impact of blended finance opportunities more precisely, ultimately allowing them to make better decisions with their limited capital.

Challenge: Throughout sub-Saharan Africa, businesses face high electricity costs and low reliability. This critical – yet systematically underfinanced – development gap challenges the growth potential for many of the continent’s enterprises. It can also have significant environmental implications. Despite emerging solar technology, which offers cheaper, cleaner and more reliable power, many businesses continue to rely on backup diesel generation due to high upfront costs for solar installations and limited access to finance.

Opportunity: In response to this challenge, CrossBoundary launched CrossBoundary Energy (CBE), the first investment vehicle focused on commercial and industrial solar in Africa. CBE aggregates a portfolio of long-term power purchase agreements with enterprises in Africa. This structure allows investors to access a new commercial asset class with the potential for significant environmental and economic impact.

Donor role: The pilot fund launched in 2015 with an innovative two-tier equity capital structure, anchored on USD 1.3 million of first-of-its-kind first-loss capital from the United States Agency for International Development (USAID). By taking a subordinate position to other investors’ initial investments, this donor commitment provided more risk-averse investors with greater protection and increased their incentive to invest. First-loss capital can provide a critical de-risking mechanism for private investors who may recognise potential for commercial and developmental returns but are discouraged by the risk of a new sector or asset class. The blended finance structure allowed the fund to raise an additional USD 30 million from public and private institutions; it is ultimately expected to mobilise well over USD 100 million. Today, CBE is Africa’s largest utility for enterprise solar, supplying the continent’s leading brands with reliable and affordable electricity.

Challenge: Mini-grids are the most economical solution for providing access to energy to 100 million of the 600 million people without electricity in Africa (Tilleard, Davies and Shaw, 2018[7]). Still, rural mini-grids have struggled to scale up due to a lack of necessary co-ordination between investors, developers and development actors to solve the three core barriers to investment:

  • mini-grid companies develop, construct and own mini-grids, but very few investors are able to fund all three activities

  • mini-grids are small, with ticket sizes well below typical investor thresholds

  • mini-grids target rural customers in developing economies who are typically costly to connect and have low spending power. As such, the initial profitability is low, and the ultimate profitability is unknown.

Opportunity: CrossBoundary Energy Access is a blended project finance facility, the first of its kind dedicated to financing mini-grid projects in Africa, currently with investments in Tanzania. The fund aggregates mini-grid assets into special purpose vehicles – sizeable enough to attract institutional investment – and uses concessional capital to bridge the profitability gap. The fund also tests models to reduce risk (such as pay-as-you-go models) and to increase profitability (such as appliance financing schemes).

Donor role: Thanks to concessional capital from the Rockefeller Foundation, the USD 18 million pilot fund successfully raised equity from private investors and debt from development finance institutions (DFIs), allowing investors to finance just the mini-grid assets (insulating them from the development, construction and customer acquisition risk that they would face by investing directly into the developer) and subsequently receive inflation-linked returns over a 10- to 20-year period.

In this example, where the underlying assets require a subsidy to achieve commercial returns, blended finance can be used to unlock additional capital to achieve even greater impact outcomes. If the fund proves successful, it has the potential to unlock access to a trillion-dollar infrastructure capital market and bring electricity to millions of people across Africa.

For blended finance vehicles that address unproven markets but are forecasted to be commercially viable, donor capital can unlock a sector through simple risk mitigation, ultimately attracting large volumes of commercial capital for every dollar of donor capital.

For blended finance vehicles that address an asset class that is not forecasted to be commercially viable initially, donor capital will attract less commercial capital for every dollar of donor capital spent. However, these investments tend to achieve greater additionality (Figure 5.3). For donors in LDCs, understanding the commercial viability of the underlying investment will help to weigh one opportunity fairly against another in a way that relying on leverage or additionality alone will not do.

By Feisal Hussain

Blended finance perfectly captures the zeitgeist of the millennial generation, bringing together in harmony seemingly contrasting characteristics of conscious capitalism and pragmatic idealism. However, the COVID-19 pandemic has exposed the fault lines that were already evident before the pandemic, while also revealing new ones. Blended finance providers need to make a case for why, in the context of extreme fiscal pressures and bare markets, blended finance offers stronger long-term prospects to help build the economy back better. However, in doing so, they need to avoid merely rehashing the traditional business case for blended finance, and show how they will change blended finance’s priorities and approaches as a consequence of COVID-19.

The success of blended finance should be measured not simply in terms of the scale of investment triggered and the amount of private finance mobilised. More emphasis should be placed on how well blended finance has contributed to market systems that are more inclusive, sustainable and resilient, and how well it has enabled large-scale and sustainable growth in private investment.

As the world recovers from COVID-19, the blended finance community will need to ensure that every investment contributes to creating systems resilience. This means prioritising blended finance investments in, for example, health systems, research and development, and natural ecosystems that can help to regenerate local economies, while also requiring every investment, irrespective of sector, to integrate digital systems to enhance transparency and reduce risk and transaction costs. This will also improve the predictive and response capability of the systems as a whole.

The application of blended finance must be promoted responsibly and with caution, ensuring that it does not deliberately compete for public and non-commercial resources in areas that carry no private returns but generate very high socio-economic returns. Moreover, a push for blended finance should not eclipse the need for grants or divert public subsidy away from interventions that boost local investment environments.

There is reason to approach this cautiously because the unintended consequences of pushing blended finance may be to create perverse outcomes. It is important to recognise that distributional inequities in blended finance are symptoms of deeper binding constraints on commercial investment decisions. Typically, these are where the investment climate is challenging (e.g. complex regulatory requirements or corruption), markets are not functioning and the risk-adjusted rate of return is uncompetitive. For example, the Overseas Development Institute (ODI) estimates that more than 96% of private finance mobilised through blended finance goes to countries with a credit rating, which most LDCs do not have or fare badly in (ODI, 2019[8]). Under such circumstances, concessional finance may tip the balance, but will not work or sustain its effects if the economic fundamentals are not in place.

The blended finance community must break free of its dominant public sector character and must include the diverse range of providers that make up the blended finance ecosystem. The blended finance universe has found itself confined to a gated community of members drawn from the traditional world of bilateral DFIs and multilateral development banks (MDBs). Today, this traditional club of providers is complemented by the growth of other forms of financing, including from the non-DAC countries, impact investors and philanthropists, as well as private individuals who are taking advantage of digital platforms to invest directly into enterprises and projects that would have been unthinkable and prohibitively expensive a decade or two ago. Taken together, these new financiers deliver more capital to developing countries and leverage more commercial capital than traditional purveyors of blended finance. Consider the following facts.

  • According to the DFI Working Group on Blended Concessional Finance for Private Sector Projects, DFIs and MDBs mobilised USD 1.7 billion from the private sector in 2018 by blending USD 1.1 billion in concessional funds with USD 2.4 billion of DFI own-account investments (DFI Working Group, 2019[9]).

  • According to Giving USA, American philanthropic foundations managed about USD 950 billion in their endowments, and invested roughly USD 75 billion in 2019 (Giving USA, 2019[10]).

  • According to Global Impact Investing Network, its impact investor members collectively manage over USD 400 billion in assets, and in 2019 invested USD 47 billion with a compound annual growth rate of 17% (GIIN, 2019[11]).

  • According to Statista, alternative lending platforms in emerging and developing economies, including crowd lending (i.e. digital lending to SMEs) and peer-to-peer lending (i.e. digital lending to individuals), channelled USD 225 billion in 2019 with a compound annual growth rate of over 50%. Excluding China and India, the alternative lending market channelled more than USD 2.4 billion to businesses and individuals in developing and emerging markets, leveraging capital from the private sector at roughly the same level as traditional blended finance providers (Statista, 2020[12]).

The gates of the blended finance community, therefore, need to be opened to these new players, to new approaches and platforms, and to new forms of collaboration based on comparative advantage.

The artificial distinction between grant and non-grant instruments must change post-COVID-19. Blended finance as implemented by DFIs and MDBs has become synonymous with the use of non-grant instruments. Yet if financial leverage is the metric by which blended finance is judged, there is a distinction without a difference between grant and non-grant instruments vis-à-vis their blended finance capabilities. According to the ODI, MDBs and DFIs contributed just under 60% of the cost of blended finance investments overall and as much as 73% in LDCs. On the other hand, bilateral grant providers mobilise more private finance in LDCs than MDBs, relative to their contribution.

Besides value for money and leverage, the differences in approach between grant-giving institutions and non-grant-giving DFIs and MDBs are narrowing. Grant providers have been gradually honing approaches and tools that increase private sector investment. This is especially true in LDCs, where risk levels are high and private investors require a greater degree of risk mitigation. Grant providers have tested and scaled up approaches that create conditions for greater private sector investment (e.g. investment climate assessments, financial sector development, assistance for capital market development, etc.). They have also tested and scaled up tools that work directly with the private sector to trigger investment using both non-financial instruments (e.g. market systems approaches to private sector development, start-up incubators, etc.) and financial tools (e.g. challenge funds).

Notwithstanding greater convergence, non-grant and grant providers have distinctive incentives and philosophies. Non-grant agencies are instinctively risk-averse, given the pressures to retain the value of their capital or AAA rating. Consequently, they are unlikely to significantly increase their exposure in LDCs any time soon. On the other hand, grant providers have none of the commercial pressures faced by DFIs and MDBs and thus can take greater risks, especially in LDCs.

Post-COVID-19 blended finance arrangements will, therefore, need more joint approaches between grant providers and non-grant providers, leveraging each other’s comparative advantages, tools and instruments to maximise both financial leverage and larger impact. As the world convulses in response to COVID-19, so too does blended finance. While this poses some immediate risks, the pandemic also presents opportunities to improve and reform blended finance, allowing the system to build forward better.

By Roland V Pearson Junior

Blended finance continues to grow apace. Data from Convergence and the OECD/UNCDF show average annual growth rates of around 20% over the past five to ten years in both the amount of capital mobilised and the number of deals done across all sectors and country types.12 We continue to see innovations introduced among transactions at the enterprise, institution and fund levels. New structures and approaches have begun to address a more robust set of risks.

Nonetheless, several impediments continue to stymie the potential growth and impact of blended finance, such as asymmetric information, country risk, volatile foreign exchange risk, poor governance, and enterprise-level risks. In particular, frontier markets (or LDCs) and social sectors such as health and education continue to attract the tiniest proportions of global capital mobilised. Market friction presents another major barrier to the growth and sustainability of blended finance – as evidenced by the expense, complexity and over-reliance on experts from the global North. The preponderance of debt among blended finance transactions reflects market demand and supply-side limitations. However, in the absence of equity and other non-debt and longer-term instruments, enterprises face the risk of over-leverage, which will limit their ability to grow and to contribute to increases in national and household incomes, as well as job creation. To scale up and achieve more systemic impact, blended finance will need to incorporate more equity and other sophisticated instruments.

The COVID-19 crisis has shed glaring light on the insufficiency of the ecosystems of key actors and enabling policies, structures and capabilities, which mutes the potential of blended finance. The lack of local capital market integration, the poor capacity of intermediaries to connect enterprises with emergency sources of funding, and an absence of blended finance vehicles that work in the aggregate (e.g. standby facilities that would trigger guaranteed government bond issues in a crisis) are only a few of the shortcomings in current markets. Concurrently, COVID-19 does offer an opportunity to broaden the frame to look at blended finance through a risk/resilience lens. For blended finance to have sustained relevance, especially in LDCs, it must be able to respond in a systemic way to systemic crises. Blended finance must yield scope and scale that go beyond individual actors, and over periods of time that extend well beyond “normal” transactional time frames, not just in response to COVID-19, but also climate change, recurring natural disasters and persistent threats of unrest.

Beyond building the facilities for blended finance to operate well at systemic levels, a market development approach also addresses specific LDC issues. Many LDCs tend to be smaller economies where transaction costs can be inordinately high. LDCs also often lack a sufficient mass of players and prospects, while at the same time suffering from underdeveloped financial and capital markets.

In recognition of these market deficiencies, Palladium has designed a blended finance market development approach that focuses on building a key component of that ecosystem, namely, a transaction advisory and business development advisers. Our approach generates blended finance transactions, by using donor grants to fund paid-for results incentives for the advisers to close deals between financial institutions and designated demand-side clients (agro-processors, educational institutions, health services providers, women-owned enterprises, etc.). Meanwhile, we also provide training, mentorship, technical assistance and other forms of capacity building support to those advisers. We also look to embed long-term market viability and capacity support by connecting advisers to local and regional training and other institutions, facilitating connections among advisers and other key market actors.

Under the USAID-funded, eight-year CATALYZE programme, which began in October 2019, Palladium has a mandate to work globally in any sector, with a keen focus on frontier markets and social sectors. Under CATALYZE, we will apply our market development model in places like the Democratic Republic of the Congo, Ethiopia, the Sahel and Zambia, while also achieving improved development outcomes across issues as diverse as early childhood development, primary education, women’s labour force participation, and youth entrepreneurship in multiple agricultural value chains.

Although we have yet to see enough activity in our start-up phase to offer performance data, we do see potential to catalyse blended capital and foment market development through our interventions. For example, by leveraging the attention brought by COVID-19 and applying a risk and resilience lens to many investment theses, we have begun to see investor interest in post-harvest loss interventions (e.g. storage, refrigeration, etc.) for agriculture, or the building of manufacturing capabilities to meet local demand with local supply. Meanwhile, additional players are being introduced to the education field, by positioning investments as opportunities to leverage digital technologies for myriad development objectives, including to facilitate remote learning.

Across geographies and sectors, Palladium will create and promote a community of action, composed of investors, enterprises and innovators, as well as a coterie of intermediaries, thought leaders and other market actors. Facilitating transactions will result in the achievement of our USD 2 billion capital mobilisation target. More importantly, that activity will serve as both an impetus for, and a demonstration of, market development.

By Henri Dommel

The COVID-19 crisis has further increased the massive financing gap LDCs are facing to achieve the SDGs by 2030. A major disrupter and potential accelerator in attracting private capital is the digital finance revolution, which is transforming how private finance can be sourced, mobilised, deployed and monitored in ways that can reach the last mile and that were unthinkable just a decade ago.

Over the past ten years, the digital revolution has not only transformed how people access and use financial services, but has also enabled the growing integration of finance with the “real economy” in such areas as clean energy, agriculture, entrepreneurship, and health and education (UN, 2020[13]). This disruption has created rapid growth for a wide range of SMEs, and business models that can leverage blended finance solutions to reach large scale. For example, energy service companies that use digital pay-go solutions have become a new and rapidly growing asset class for blended finance investors. In LDCs, energy service companies have become some of the major recipients of on-balance-sheet concessional lending, enabling follow-on investment by domestic financial institutions or international impact investors.

Digital technologies have also profoundly transformed options to mobilise finance and align its deployment with the SDGs, as highlighted in the report of the United Nations Task Force on Digital Financing of the SDGs (UN, 2020[13]). Innovations in agent banking and alternative delivery channels have made it possible to mobilise and channel informal savings at large scale into the formal financial system. Digital technology can facilitate the reinvestment of those savings into long-term investments in priority socio-economic infrastructure (roads, schools, health centres, etc.) and localise those investments in districts where individual savers will directly benefit from improved services and from receiving financial dividends. The digital finance revolution is also disrupting and expanding how blended finance solutions can be deployed to contribute to the financing of the SDGs. It is doing so by transforming the potential for domestic resource mobilisation and for citizens to have a voice in how their savings are invested, or by expanding blended finance solutions to SMEs on a scale that was unthinkable before. This emerging generation of blended finance solutions rests on an innovative use of data that enables new models of resource mobilisation (even from very small individual savings) and their aggregation to finance a wide range of economic priorities, from socio-economic infrastructure to women-led MSMEs, supported by de-risking instruments and donor-funded technical assistance.

The feasibility of using digital savings for reinvestments by local and national governments in key socio-economic infrastructures is being tested by a2i13 in partnership with UNCDF as one of the pathfinder projects of the United Nations Task Force on Digital Financing of the SDGs. Pre-COVID-19, it was forecasted that, in 2020, savings by Bangladeshi citizens totalling USD 118.4 billion could be tapped to finance the SDGs (including USD 61 billion formal savings, USD 41 billion informal savings, USD 14 billion from remittances flows, and USD 2.4 billion zakat funds) (LightCastle Partners, forthcoming[14]); (McKinsey Global Institute, 2016[15]).14 Digital finance offers the potential to transform Bangladeshi citizens from micro-savers to micro-investors, enabling the aggregation of those savings at very low cost, with the requisite guarantee and liquidity mechanisms built into investment instruments that could fund the socio-economic infrastructure that would directly improve their lives. The infrastructure budget in Bangladesh for the fiscal year 2019–2020 stood at USD 24 billion, 48% of which was financed through external sources (LightCastle Partners, forthcoming[14]);15 this is expected to grow substantially by 2030 due to funding requirements to meet the SDGs. Harnessing domestic savings could help both to lower the dependence on external debt and to strengthen Bangladeshi citizens’ stakes in and ownership of those investments. More generally, connecting national SDG priorities and digital financing opportunities offers a tremendous scope for growth and is an area currently being advanced by UNCDF. The deployment of this type of solution calls for blended finance models that include sovereign guarantees to protect the integrity of those citizens’ savings or de-risk those infrastructure investments.

Digital finance is also accelerating the formalisation of remittance flows, which can directly benefit migrants and their families, not only through lower fees, but also by creating a financial transaction history that can facilitate access to other financial services, especially loans. Blended finance models can be deployed to further support the reinvestment of remittances in priority sectors, with a government or third-party guarantee. In Nepal, UNCDF supported a partnership between Al Fardan Exchange in the United Arab Emirates and Laxmi Bank to test a new use case to securitise remittance flows to extend un-collateralised credit based on the remittance transaction history and other alternative data sources, using a blockchain lending platform.

Digital innovations are also transforming blended finance models for MSME access to capital markets. In the context of the United Nations Task Force on Digital Financing of the SDGs, EcoCash and Financial Securities Exchange (FINSEC), with support from the Investors Exchange (IEX), the Food and Agriculture Organization of the United Nations and UNCDF, have set up an MSME investment platform (GEM Portal) in Zimbabwe linked to FINSEC that leverages alternative data generated from the major mobile money operator in the country and banks, to create investment profiles and bridge the long-term financing gap between high-potential MSME and investors.16 This platform will offer a new venue for investors, banks and venture capitalists to invest in MSMEs in Zimbabwe in a totally new way. With non-traditional and digital mechanisms of enterprise assessment implemented through this platform, the role of DFIs in this initiative to catalyse and unlock private capital to be invested becomes important, by deploying guarantee instruments and concessional capital.

In addition to improving risk pricing, the exponential growth in data gathering and processing that is enabled by the digital revolution has helped to increase both the alignment with the SDGs and the impact monitoring of blended finance investment decisions. Digital platforms such as the Future of Sustainable Data Alliance are advancing data-driven approaches to the effective integration of environmental, social and governance factors into decision making processes, and greater incorporation of SDG-related risks and impacts in financing decisions. In that respect, the digital revolution also holds the potential to help further align blended finance deployments to the SDGs.

By David Jackson and Nan Zhang

On the 75th anniversary of the United Nations it is useful to reflect on the changed demographics of the world and the financial arrangements and institutions that are now required. At the birth of the United Nations, less than a third of people lived in urban areas. By 2010, we reached a 50/50 share. Today, around two thirds of us live in towns and cities (UNCDF, 2020[16]). This change is happening at an accelerating rate (see Figure 5.4). It took Paris over 100 years to grow from half a million to a million inhabitants. Asian cities in the mid-20th century required 50 years. Lagos needed only ten years, from 1955 to 1965. Currently, African cities are making this transition at even more rapid rates.17

The world is also a much richer place than it was 75 years ago – and a more unequal one. In sub-Saharan Africa, the urban population increased from 22% in 1980 to over 40% in 2018, and total GDP surged from USD 271 billion to USD 1.7 trillion (World Bank, 2019[18]). Globally, urbanisation and GDP growth have risen hand in hand (Figure 5.5) and there seems to be a correlation between urbanisation and increases in productivity (EIB, 2020[19]).

This correlation, however, is not automatic. A closer look at the global data on GDP over time reveals that gross fixed capital formation (GFCF) has remained at about 25% of GDP since 1980. In the meantime, import and export of goods and services has grown from 13% to 26%.18 Remittances have also grown. The data show a positive relationship between trade and growth, while investment remains constant, but the devil is in the detail. While GFCF is stable at the aggregate level, in individual countries it reaches up to 45% for sustained periods during the critical accelerating phases of urbanisation.19 On this basis, the data suggest that urbanisation needs to be accompanied by investment for it to drive increases in productivity.

These are meta-trends, but economic history confirms that they map the trajectory of economic development in North and South America, the Middle East, North Africa and parts of Asia (Collier, 2017[21]). What lessons do they have for the current rapid urbanisation in Africa and other parts of Asia?

In sub-Saharan Africa, GFCF fell from nearly half of GDP in 1980, to less than one fifth in 2018 (see Figure 5.6). In contrast, total services as a share of GDP increased from 45% to 52%, and remittances received expanded from 0.6% to 2.8%. Total government expenditure remained constant at one quarter of GDP on aggregate (World Bank, 2019[18]).

In terms of economic history, urbanisation and capital investment (public and private, often subsidised) kick-started higher value-added trade in goods and services. This is a well-trodden and well-documented path.

It is also clear from the data that parts of Africa and parts of Asia are not following this route, but experiencing urbanisation without investment and services, and remittance growth without higher value jobs and wages.20 Have they found an alternative road? Can they consume their way to prosperity through an army of informal and/or small businesses? Or, more worryingly, are they not moving towards sustainable structural transformation?

The answer partly lies in productivity. Either services and remittances without investment will increase productivity, or new cities will become unproductive and environmentally unsustainable urban sprawls. Household incomes are a key barometer of what is happening. So far, the signs are not good. On aggregate, they are not increasing at a scale that indicates sufficient productivity growth.21

Despite prolonged low interest rates, capital investment in the LDCs has remained subdued. On the face of it, this is a paradox. A growing city represents a growing market, increasing land values, a larger tax base and a more diverse and skilled workforce. There ought to be interest in the potential for returns on investment. But unfortunately, the global financial architecture does not encourage capital investment. First, the domestic capital markets in the urbanising LDCs are not broad enough (in policy and the variety of investment vehicles) or deep enough (in liquidity and volume). Second, borrowing on the international market at the scale required is discouraged due to current Bretton Woods policies on national debt; domestic subnational and non-sovereign infrastructure finance would mitigate against the sovereign debt issue, although not fully, as there are issues of contingent liability that need to be addressed.22 Yet global private infrastructure funds, while strongly capitalised, including by pension funds, focus almost exclusively on already urbanised countries. So where will the money come from?

In recent times the international community has committed to subsidise investment at the volume required, for example through the financing of expansion by the European Union or the Belt and Road investments supported by China. However, these schemes do not address urbanisation in sub-Saharan Africa and parts of Asia.

Another example is green finance. The volume of concessional investment finance is significant, and appropriate investment vehicles, such as green bonds, are multiplying.23 Furthermore, the geographical coverage is more friendly to sub-Saharan Africa and the rapidly urbanising parts of Asia, and the tenor and structure of much of this finance is appropriate.

Most green finance is blended, but not all blended finance is green.24 Blended green finance is not the magic solution to the problem outlined here, but it could go some of the way towards addressing it. So far, rapidly expanding cities have not been able to tap into this second stream of financing because they have not been able to green their growth in verifiable ways. There are positive signs that this may be about to change, however.

A growing number of city networks and development finance institutions have coalesced around this agenda. For example, the Malaga Global Coalition for Municipal Finance established by UNCDF and the World Organization of United Cities and Local Governments (UCLG) promotes a financial ecosystem that works for local governments and municipalities to unlock finance for cities in the developing world to achieve sustainable, green and resilient growth. The challenge is to design blended investment packages that are appropriate to the cities’ development needs, qualify for green finance and can attract enough private capital to mitigate pressure on sovereign balance sheet liabilities. Sub-sovereign and non-sovereign intermediaries can also relieve this pressure (Smoke, forthcoming[22]).

This is not easy. There has been an oversimplification that a paucity of bankable projects is the problem. It is not as straightforward as that. Projects that are eminently profitable often do not respect green criteria. Projects that are appropriate to the cities’ needs are often green but not bankable. Projects that are green and bankable are not always urban in nature. Green finance can be attracted to projects with measurable greenhouse gas impact or measurable adaptation or resilience. Examples include transport, carbon sinks and adaptive or resilient land use (a large category from drainage to green roofs), energy, waste management, green built environment (e.g. heating or cooling), and the manufacture of green products. COVID-19 has caused a fiscal crisis, particularly for subnational governments.25 This further exacerbates the situation and we are already seeing evidence that cities are moving to rebuild their fiscal space through bankable projects that increase revenue but not productivity (e.g. shopping malls).26 On the other hand, there is evidence that the impact of the pandemic will bring value chains closer to home, and governments are now promoting local productive industry, which can be further accelerated if green.27

UNCDF has sponsored the Malaga Global Coalition for Municipal Finance with the UCLG to advocate for a financial ecosystem that works for local governments and municipalities. The Malaga Coalition promotes the global policy goals needed to unlock finance for cities in the developing world to achieve sustainable, green and resilient growth. One example is its financial instrument – the International Municipal Investment Fund – that will be managed by Meridiam and will invest in demonstration examples of blended green finance brought forward by UNCDF and its city partners.

Connecting urban investments with green blended finance through the Paris Agreement targets and other global goals is a route to increasing productive capacity in the rapidly urbanising parts of the world, in line with the sweep of economic history and the recommendations of the United Nations Committee for Development Policy towards the next LDC programme of action (UN, 2020[23]).

By Lasitha Perera

As a company founded to help mobilise local currency financing into domestic infrastructure in developing countries across Africa and Asia, GuarantCo promotes the development of local capital markets to support the alleviation of poverty.

Unfortunately, in reality, creating affordable infrastructure financed by local capital markets in LDCs can be very challenging. The high-double-digit interest rates, short tenors (typically three years), limited understanding of project financing, uncommercial collateral/security requirements and risk-averse financial market regulators are all common barriers that developers of infrastructure encounter. Nevertheless, as pension and insurance markets in LDCs develop, and the pools of capital requiring long-term investment opportunities consequently grow, local capital markets will have an increasingly important role to play in addressing the infrastructure financing gap.

Typically, investors in LDCs are restricted to investing in government securities or short-term deposits with the largest banks, thus creating significant concentration risks, which are neither desirable nor wise. This raises the question of why they are reluctant to be diversifying and investing in infrastructure projects, which in developed economies are viewed as a safe asset class. The answer lies in the local capital markets’ capacity to assess the credit (repayment) risk of an infrastructure project and therefore how to price the credit risk of infrastructure projects appropriately.

GuarantCo uses blended finance in three ways to help address this capacity gap and to mobilise local capital markets to provide long-term local currency financing into infrastructure projects.

GuarantCo was designed to be a blended finance vehicle, receiving first loss (equity) capital from public sector donors (shareholders) against which it is able to write guarantees of up to three times the value of its shareholder equity. These guarantees in turn can, on average, mobilise up to a further four times private sector investment into infrastructure projects. Consequently, through GuarantCo, every USD 1 of public sector donor capital can mobilise up to USD 12 of private sector investment into an infrastructure project in the markets on which PIDG focuses, including LDCs.

GuarantCo has high international credit ratings from Fitch Ratings (AA-) and Moody’s (A1) underpinned by the equity commitments of its government shareholders and its 15-year track record of providing guarantees without incurring any significant loss. These credit ratings make GuarantCo’s credit risk equivalent to that of sovereign credit risk in LDCs. In other words, GuarantCo risk is as good as government risk as far as the local capital market is concerned. Thus, by GuarantCo providing a guarantee, the local capital market is able to price the risk of the infrastructure project against established government benchmarks.

GuarantCo is also able to use its guarantees to extend the tenor of a financing beyond established local capital market norms, while financing to match the long-term lifecycle of infrastructure is critical. In 2019, GuarantCo provided a guarantee to a bank in Bangladesh to provide a 13-year local currency loan to the first utility-scale solar project in the country. GuarantCo was able to mobilise the bank to provide the financing with an initial 50% guarantee. Although the bank already had experience in financing the established power sector in Bangladesh, it needed to mitigate the first-mover risk attached to the solar project (despite the technology being proven and well established elsewhere) and to extend a tenor significantly longer than the market norm of five years. To help the bank overcome these challenges, GuarantCo’s guarantee steps up from covering 50% of the loan after the first five years to gradually covering 100% in the later years.

In addition to providing guarantees, GuarantCo also regularly complements its transactions with PIDG technical assistance, the grant-providing arm of PIDG that is also donor-funded, to finance free-to-attend capacity building workshops in local markets. These are designed to help train and educate investors about how to assess the credit risk of infrastructure projects.

For example, in 2014, GuarantCo organised a one-week training workshop, funded by a grant from PIDG technical assistance, for a group of Nepalese banks to learn about project financing, which resulted in these banks providing a 16-year local currency financing with a 90% guarantee after originally seeking a 100% guarantee from GuarantCo. The 10% residual risk taken by the Nepalese banks was equivalent to 14 times the value of the grant provided by PIDG technical assistance to finance the training workshop, thereby demonstrating another way that blended finance can help to develop local capital markets.

In 2017, PIDG partnered (through GuarantCo and PIDG technical assistance) with the Nigerian Sovereign Investment Authority to set up and operationalise InfraCredit, a local currency guarantor dedicated to mobilising long-term local currency financing into infrastructure in Nigeria. Through its guarantees, rated AAA locally, InfraCredit has enabled Nigerian pension funds to invest in long-dated infrastructure transactions for the first time, thereby opening up a pool of local currency liquidity equivalent to USD 2 billion, which previously had been unavailable to the infrastructure sector.

As can be seen from Figure 5.7, GuarantCo provides contingent capital (a form of guarantee) to InfraCredit that is leveraged through InfraCredit to enable every USD 1 of public sector donor capital in GuarantCo to mobilise USD 81 of private sector investment in Nigeria. GuarantCo is funded by public sector donor capital. Each USD 1 of public sector donor capital invested can be leveraged and deployed three times in GuarantCo investments to attract private capital. The contingent capital, a form of guarantee, that GuarantCo provided to InfraCredit can in turn be leveraged up to 7.5 times. As a result, public sector capital invested in GuarantCo can be leveraged up to 22.5 times through this structure. On this scale, guarantees can be truly transformational for local capital markets, as InfraCredit is proving. PIDG is actively working to build further versions of InfraCredit in other emerging markets to act as market champions.

In summary, specialised blending facilities, such as GuarantCo, support the reduction of local currency risks for infrastructure projects, help to crowd in private sector investors and develop local capital markets that ultimately create a significant developmental impact on people’s lives in lower-income countries throughout Africa and Asia. Since GuarantCo was established in 2005, the company has closed 55 transactions in 22 countries, provided 43 million people with improved access to infrastructure, created 235 000 jobs and enabled USD 5.6 billion of investments (PIDG, 2019[24]).28

By Anders Berlin and Abdul-Rahman Lediju

The COVID-19 crisis, which has prompted national lockdowns, social distancing guidelines and disrupted regional and global value chains, has forced many businesses to endure a significant slowdown or stoppage of economic activities. In higher-income economies, businesses can apply for stimulus support to manage these unprecedented circumstances. In more vulnerable markets, such as the LDCs, limited fiscal capacity makes such options difficult, thereby risking the suspension and extinction of many businesses, especially SMEs. This can have negative knock-on effects on unemployment levels, social unrest, conflict and forced migration.

Achieving the SDGs, recovering from the COVID-19 crisis and rebuilding inclusive and resilient economies will be virtually impossible for any LDC without SMEs. SMEs play a major role in formal employment (responsible for seven out of every ten new jobs created in emerging markets), economic growth (contributing up to 40% of emerging-market GDP), and innovation, creating more resilient and competitive economies (World Bank Group, 2017[25]). They deliver essential goods and services that allow communities to further grow and thrive. With population trends predicting that over 600 million new jobs will be needed to absorb a growing labour force, SMEs will be the engine for the jobs of the future.

These enterprises often do not receive the right type of financial solutions to grow. They are usually too large to receive financing from microfinance institutions, but simultaneously below the radar for classic local commercial banks, DFIs and impact investors. This is what is commonly referred to as the “missing middle” challenge.

There are three drivers that contribute to the unfortunate persistence of the missing middle: transaction costs, risk perception and investment readiness.

  • Transaction costs. The costs to appraise and monitor investments for an SME are often the same as for larger transactions. Since the returns generated from any transaction are directly connected to transaction size, it follows that it is usually more expensive to handle SME deals, especially in contrast to larger enterprises.

  • Risk perception. SMEs generally lack the attributes that conservative financiers like to see. These features include collateral options to offer as security, key founders having enough “skin in the game”, profitability trends, business life, and investor or bank investment experience in the sector or region in question. The lack of these qualities may be compounded by the financier’s lack of investment experience, or lack of data, in the sector or region in question, which leads to further uncertainty in evaluating risk. Moreover, commercial financiers lack the risk appetite to design tailored investment solutions at large scale to overcome these traditional constraints. Many SMEs therefore rely heavily on friends and family, as well as community-based informal lenders who exploit the absence of formal solutions by providing tougher terms and pricing (Runde, Yayboke and Ramanujam, 2019[26]).

  • Investment readiness. SMEs sometimes lack the fluency to engage with local commercial banks and investors in a way that can yield positive results. For example, sustained engagement with a prudent investor or bank requires the ability to build (and maintain) robust financial models, and to design strategic business plans that include a clear revenue model description, market and competition analysis, customer segmentation details, detailed strategies to finance growth, and a logical sales strategy to acquire and maintain customers.

Solving a problem as complex as the missing middle financing gap, especially during a pandemic, requires collective action. It is well understood that public stakeholders alone, acting through ODA and domestic national fiscal plans, cannot generate enough resource flows to meet this development challenge (Runde, Yayboke and Ramanujam, 2019[26]).

One solution would be to establish investment platforms or facilities that take “on higher risk” and invest in “smaller projects with growth potential and longer investment horizons”. Such a platform or facility should take into account that SMEs need different financial solutions at various stages of their lives – start-up, growth (early and mid) and expansion (Runde, Yayboke and Ramanujam, 2019[26]). UNCDF, for example, through its LDC Investment Platform, manages a portfolio of loans and guarantees on its balance sheet, focused on nurturing early-stage missing middle enterprises and projects in LDCs. By providing catalytic capital and technical assistance, we help to de-risk these businesses and enable them to access additional blended and commercial capital.

UNCDF’s finance capabilities include offering solutions that can respond in terms of pricing (concessionary terms), grace periods (up to 36 months), ranking (UNCDF can invest in any position in the investment target’s debt capital structure), risk coverage (subordinated and pari passu guarantees) and tenors (12 months to 15 years). Moreover, UNCDF invests with systemic goals in mind – either to demonstrate and build market viability, to unlock the ability of other financiers to join in, or both. The LDC Investment Platform is 100% backed by grant donations and the revolving use of the funds means that a relatively small amount of capital has the potential to support numerous businesses and amplify development impacts over time and where the support is needed most.

Another complementary solution to tackling the missing middle financing gap is to pool public and private funding in structured blended finance vehicles that offer flexible, risk-tolerant capital solutions to SMEs that are otherwise generally not available from existing funds or financiers (Johnston, 2019[27]). In UNCDF’s experience of working alongside Bamboo Capital Partners on the missing-middle-focused BUILD Fund, key considerations include mobilising the right proportion of public versus private capital, and implementing the right workflows to significantly support the missing middle in a cost-efficient (and therefore scalable) way (UNCDF, 2020[28]).

Paradoxically, the higher the proportion of public capital, the more risk-tolerant and flexible the blended finance vehicle can be. Striking the right balance is key in this regard, especially given ODA resource scarcity. In the case of the BUILD Fund, several layers (or “tranches”) of capital will be used to invest in the same future portfolio of SMEs, but with different risk and return features for the ultimate investors dependent on the tranche.

If there is a loss, the first-loss (or “catalytic”) tranche will be the first to bear it, thereby protecting the other layers of investors. The first-loss layer appeals to public actors who can use their dollars beyond grant-making to support their development objectives. If the BUILD Fund measures risk properly, the initial dollar invested can grow, be recycled for future investments, and further amplify development gains. The upper investment layers are designed to appeal to private actors. These potential investors would receive an annual, reasonable return, and would also be protected by a significant first loss layer (20% protection) in the event of losses in the underlying investment portfolio, including foreign exchange losses. In other words, the portfolio would have to effectively lose one-fifth of its value before a private investor’s initial capital is affected. This represents a significant cushion to support the crowding in and blending of different sources of capital to address the missing middle challenge.

Regarding workflows, UNCDF will leverage its in-house footprint, development expertise, technical assistance resources, and increased investment origination and due diligence capacity to develop a pipeline of investable businesses for BUILD. This will drive down some of the costs that would otherwise be fully borne by Bamboo Capital Partners and the vehicle itself.

The pandemic has reminded us that our social, public health and economic systems are intimately interconnected. SMEs, which navigate the missing middle challenge daily, are not likely to be rescued by government stimulus packages to remain resilient through the crisis. It is imperative to look to risk-tolerant facilities and blended finance to support these businesses, their customers, suppliers and their workers in the poorest and most vulnerable communities around the world.

By Samantha Attridge

National development banks (NDBs) are driving change in their countries by providing crucial funding and mobilising private investment in support of the SDGs and the Paris Agreement. Just under two thirds of LDCs have an NDB. To date, NDBs have been largely overlooked, especially in international policy discussions, but change is afoot. There is growing recognition that these institutions have made important achievements and have further huge untapped potential to support the implementation of these two key agendas.

Take, for example, the urgent need to lock in climate-smart growth and the need for countries to invest in climate-smart infrastructure. This is not an easy task for any country, not least for many LDCs, whose capital markets are not that well developed and whose public finances are stretched. Climate-smart investment often requires large upfront investment with long payback periods, requiring long-term financing, which is not widely available. When it is, it is extremely costly.

Other challenges include the risk-to-profit ratio associated with potentially risky new climate-smart technologies, and uncertainty surrounding the security of revenue generation stemming from possible changes to government policy. All these challenges are compounded by the fact that significant externalities, such as decreasing carbon emissions, are not yet reflected in market prices. For these reasons, private finance has not – and does not – naturally flow to climate-smart investments, especially in LDCs.

Cue NDBs, which are uniquely placed to overcome these challenges. Thanks to their development mandate and financing models, they can provide longer-term, more affordable financing than what is available in the market. And with their unrivalled knowledge of local markets and long-standing relationships with local private and public sectors, they possess important comparative advantages over the multilateral and bilateral banking system. Deeply rooted into the local context, NDBs are well placed to effectively and efficiently mobilise, intermediate and channel climate-smart finance and investment.

In many countries, including LDCs, the role of NDBs is changing. Traditionally, NDBs acted as public financiers of infrastructure investment. But many now play multiple roles, including focusing on the mobilisation of private investment through the blending of public development capital with their own account resource, the development of bankable pipelines, and the shaping of policy frameworks to incentivise and support climate-smart infrastructure investment (ODI, 2020[29]). To fully capitalise on the unique position of NDBs to drive investment in climate-smart infrastructure, three interlinked and mutually reinforcing preconditions need to be in place.

Good governance underpins the willingness of governments to invest in NDBs, and the willingness of private investors, MDBs, DFIs and international climate funds to partner with them. It also affects their ability to develop and access capital markets. Well-governed and well-run NDBs with clear and stable green mandates are more likely to be integrated into policy frameworks and to have a seat at the policy table, as they are better able to deliver government objectives. This leads to a virtuous circle of good governance.

NDBs need enough resources to enable them to operate at the scale required to support the transition to climate-smart growth in a meaningful way. Apart from a few large NDBs such as those in Brazil, China and Germany, most are constrained in their ability to finance and mobilise private investment at large scale. Access to developed local capital markets can help NDBs to grow and overcome scale challenges, given the real and perceived fiscal constraints in many LDCs. Where these markets are less developed, NDBs can work closely with the government, regulators and the international community to develop them. This is an area that is often overlooked, but is crucial to optimise NDB resource and mobilise private domestic savings into climate-smart investment.

Some international public actors are working closely with NDBs and are fully engaged, while others have yet to take the leap, especially in many LDCs. In our research, we found good examples of this collaboration yielding positive results, including NDB governance reform and, in some cases, even protecting NDBs from political interference. Access to international concessional climate finance and the associated capacity building has also played an important role in helping NDBs to develop their climate-smart investment portfolios, especially building pipelines of investable opportunities and bolstering the capacity of NDBs to undertake climate-smart investment. The problem is that NDBs – which are uniquely placed to leverage this capital to maximum effect – do not have access to it, especially in LDCs.

All this suggests a very clear action agenda. At the country level, NDBs need to strengthen their governance in order to improve their performance and shift their business models to allow them to fully support the mobilisation agenda. For their part, governments need to give NDBs clear and stable mandates, ensure they are adequately resourced, that supportive policy and regulatory frameworks are in place to incentivise investment, and that NDBs are integrated within these.

At the international level, MDBs, regional development banks (RDBs), DFIs and international climate funds need to step up their engagement with NDBs and support the development of their capacity. This engagement should be based on their respective comparative advantages. Smaller NDBs in LDCs can utilise their non-financial strengths to identify, develop and originate investment opportunities helped by direct access to concessional climate finance, as is the case, for example, for the Uganda Development Bank and the Development Bank of Rwanda; and MDBs, RDBs and DFIs can bring their financial might to help to catalyse private investment in these opportunities.

As we enter the decade of action we need to move away from business as usual and seek to build new partnerships and ways of working. Seizing the opportunity to embrace the potential of NDBs will help bring fresh impetus to this agenda and help to accelerate our efforts to achieve the SDGs and meet the targets of the Paris Agreement.

By David Hughes

As blended finance continues to evolve as an important component of the development finance toolkit, a growing number of development practitioners, including Global Affairs Canada, are looking at how to improve the effectiveness of blended financing mechanisms to achieve shared sustainable development objectives.

To make blended finance a scalable tool, capable of having a significant impact on SDG achievement, we need to know more about what works and where we can improve the effectiveness of blended finance mechanisms when it comes to both financial performance and development impact. Donors have an important role to play and are well placed to support the development of this evidence by creating benchmarks, monitoring trends, promoting transparency, identifying and diffusing best practices, and advocating the use of blended financing mechanisms in developing countries and frontier markets.

Yet challenges persist for all stakeholders. The international community needs access to more reliable and robust disaggregated and gender-sensitive data about blended finance projects. Access to better data will allow more accurate risk/return calculations to ensure investments are financially sustainable and to strengthen accountability to shareholders and taxpayers. Reliable data on financial performance can also help to build a public record of accomplishment for blended finance and potentially unlock greater volumes of commercial investment. This is particularly important for blended finance in the LDCs, where the perception of risk is heightened and evidence to the contrary could mobilise new forms of financing.

By increasing transparency in our blended finance transactions, we can:

  • improve access to disclosure data and information, particularly for emerging market stakeholders

  • better understand the direct impact/benefits of blended finance on poverty alleviation and/or on other relevant SDGs

  • ensure reliable, disaggregated data collection and impact measurement

  • promote a fair, open and inclusive process for participation in blended finance projects

  • encourage proper contract enforcement and respect for property rights

  • gain a better understanding of the amounts of private finance mobilised

  • demonstrate the catalytic nature of investments and encourage the continued participation of stakeholders in blended finance

  • strengthen trust and public accountability in terms of the financial and development performance and outcomes of blended finance transactions (e.g. volumes of ODA spent, concessionality provided, and social and environmental outcomes and impact) (OECD and DANIDA, 2018[30]).

A recent effort to mainstream principles and perspectives on blended finance is the Tri Hita Karana (THK) Roadmap for Blended Finance, which sets out shared values and key action areas for effectively scaling up blended finance operations (OECD, 2018[31]). Canada, together with the OECD and the IFC, co-chaired a multi-stakeholder working group on transparency in blended finance within the THK framework, which has been looking at proposals to improve blended finance transparency. The research and discussions among working group members have highlighted a need for greater transparency, particularly for impact data, in blended finance. At the same time, the members recognise that there are challenges, such as undermining competition, that need to be addressed, as well as legal limitations and/or market practices that make transparency at the project and activity level challenging.

The working group concluded that building a common understanding of the context, challenges and opportunities is critical to maintaining a conducive environment for the effective scale-up of transparency in blended finance. The working group’s recommendations include:

  • maintaining multi-stakeholder dialogue and collaboration for transparency in blended finance

  • establishing clear roles and responsibilities across all stakeholder groups

  • agreeing on minimum reporting requirements for different stakeholders

  • considering the feasibility of establishing common reporting principles

  • enhancing access to information on existing blended finance facilities and investments.

These recommendations recognise that increased transparency around operationalising blended finance is not only an end in itself; it also enables all actors to improve co-ordination, learning, trust, accountability and effectiveness with a view to strengthening sustainable development impact and the achievement of the SDGs.

As the international community responds to the effects of the COVID-19 pandemic, particularly in the LDCs, we need to ensure that our investments support sustainable outcomes. To safeguard development gains, the international community will need creativity in how it deploys international assistance tools, and a clear vision for how blending public and private finance can make a real difference by helping to stabilise economies and spur recovery. Canada looks forward to exploring the opportunities with our partners and to contributing to the thought leadership around blended and innovative financing for sustainable development.


[4] Bangladesh Bureau of Statistics (2017), Quarterly Labour Force Survey 2015-16., http://bbs.portal.gov.bd/sites/default/files/files/bbs.portal.gov.bd/page/96220c5a_5763_4628_9494_950862accd8c/QLFS_2015.pdf.

[21] Collier, P. (2017), African urbanization: an analytic policy guide, Oxford Review of Economic Policy, https://academic.oup.com/oxrep/article/33/3/405/3926157.

[32] Convergence (2020), Market Size, https://www.convergence.finance/blended-finance#market-size.

[9] DFI Working Group (2019), DFI Working Group on Blended Concessional Finance for Private Sector Projects Joint Report, October 2019 Update, https://www.ifc.org/wps/wcm/connect/73a2918d-5c46-42ef-af31-5199adea17c0/DFI+Blended+Concessional+Finance+Working+Group+Joint+Report+%28October+2019%29+v1.3+Report+.pdf?MOD=AJPERES&CVID=mUEEcSN.

[19] EIB (2020), BANKING IN AFRICA financing transformation amid uncertainty, https://www.eib.org/attachments/efs/economic_report_banking_africa_2020_en.pdf.

[11] GIIN (2019), 2019 Annual Impact Investor Survey, https://thegiin.org/research/publication/impinv-survey-2019.

[10] Giving USA (2019), Giving USA 2019 : Americans gave $427.71 billion to charity in 2018 amid complex year for charitable giving, https://givingusa.org/giving-usa-2019-americans-gave-427-71-billion-to-charity-in-2018-amid-complex-year-for-charitable-giving/.

[1] Government of Bangladesh (2017), SDGs Financing Strategy: Bangladesh Perspective, http://pksf-bd.org/web/wp-content/uploads/2018/11/2.-SDGs-Financing-Strategy-Bangladesh-Perspective.pdf (accessed on 3 July 2020).

[3] GPEDC (2019), Kampala Principles on Effective Private Sector Engagement in Development Co-operation, https://www.effectivecooperation.org/system/files/2019-07/Kampala%20Principles%20-%20final.pdf (accessed on 6 December 2019).

[2] GPEDC (2018), Private Sector Engagement through Development Co-operation in Bangladesh, Global Partnership for Effective Development Co-operation (GPEDC), https://www.effectivecooperation.org/system/files/2019-04/Bangladesh_Country_Report.pdf.

[27] Johnston, J. (2019), As blended finance deals get bigger, don’t forget the little guys, Convergence, https://www.convergence.finance/news-and-events/news/4l2G2RAIuknXQ2PFIh0cTb/view.

[14] LightCastle Partners (forthcoming), Mobilizing Savings by Bangladeshi Citizens for SDG Financing.

[15] McKinsey Global Institute (2016), DIGITAL FINANCE FOR ALL: POWERING INCLUSIVE GROWTH IN EMERGING ECONOMIES, https://www.mckinsey.com/~/media/mckinsey/featured%20insights/employment%20and%20growth/how%20digital%20finance%20could%20boost%20growth%20in%20emerging%20economies/mg-digital-finance-for-all-full-report-september-2016.ashx.

[29] ODI (2020), Securing climate finance through national development banks, https://www.odi.org/publications/16552-securing-climate-finance-through-national-development-banks.

[8] ODI (2019), Blended finance in the poorest countries, https://www.odi.org/sites/odi.org.uk/files/resource-documents/12666.pdf.

[31] OECD (2018), TRI HITA KARANA ROADMAP FOR BLENDED FINANCE, https://www.oecd.org/dac/financing-sustainable-development/development-finance-topics/_THK%20Roadmap%20booklet%20A5.pdf (accessed on 17 April 2020).

[30] OECD and DANIDA (2018), The next step in blended finance: addressing the evidence gap in development performance and results, https://www.oecd.org/dac/financing-sustainable-development/development-finance-topics/OECD-Blended%20Finance-Evidence-Gap-report.pdf.

[5] OECD/UNCDF (2019), Blended Finance in the Least Developed Countries 2019, OECD Publishing, Paris, https://dx.doi.org/10.1787/1c142aae-en.

[20] Our World in Data (2016), Urban population vs. GDP per capita, 2016, https://ourworldindata.org/grapher/urbanization-vs-gdp.

[24] PIDG (2019), 2019 Annual Review, https://www.pidg.org/2020/05/2019-annual-review/.

[26] Runde, D., E. Yayboke and S. Ramanujam (2019), The New Missing Middle in Development Finance, https://csis-website-prod.s3.amazonaws.com/s3fs-public/publication/191107_MissingMiddleinDevelopment.pdf.

[6] SDSN (2019), SDG COSTING & FINANCING FOR LOW-INCOME DEVELOPING COUNTRIES, https://sdgfinancing.unsdsn.org/static/files/sdg-costing-and-finance-for-LIDCS.pdf.

[22] Smoke, P. (forthcoming), The Role of Special Financial Intermediaries in Subnational Development Finance.

[12] Statista (2020), Alternative Lending report 2020, https://www.statista.com/study/50625/fintech-report-alternative-lending/.

[7] Tilleard, M., G. Davies and L. Shaw (2018), Minigrids Are the Cheapest Way to Bring Electricity to 100 Million Africans Today, https://www.greentechmedia.com/articles/read/minigrids-are-the-cheapest-way-to-electrify-100-million-africans-today.

[23] UN (2020), Committee for Development Policy Report on the twenty-second session, https://undocs.org/en/E/2020/33.

[13] UN (2020), People’s Money: Harnessing Digitalization to Finance a Sustainable Future, https://unsdg.un.org/resources/peoples-money-harnessing-digitalization-finance-sustainable-future.

[17] UN (2018), World Urbanization Prospects: The 2018 Revision, United Nations Department of Economic and Social Affairs, Population Division, https://population.un.org/wup/DataQuery/.

[16] UNCDF (2020), Local Government Finance is Development Finance #1, https://local-government-finance-is-development-finance.blog/2020/07/01/local-government-finance-is-development-finance-1/.

[28] UNCDF (2020), The BUILD Fund: A UNCDF and Bamboo Capital Partners partnership, https://www.uncdf.org/article/5305/the-build-fund.

[18] World Bank (2019), World Development Indicators, https://databank.worldbank.org/source/world-development-indicators.

[25] World Bank Group (2017), What’s Happening in the Missing Middle?, https://openknowledge.worldbank.org/bitstream/handle/10986/26324/113906-WhatsHappeningintheMissingMiddleLessonsinSMEFinancing-29-3-2017-14-20-24.pdf?sequence=1&isAllowed=y.


← 1. In this scenario, the strategy stipulates that the public sector would account for around 34% of the financing for the SDGs while external sources, including foreign direct investments, would account for 15%, with the remaining gap being filled by non-state organisations.

← 2. A mapping of 240 development co-operation projects in Bangladesh with the active participation of the private sector, carried out by the GPEDC, found that government institutions were listed as partners for only 9% of projects, while 8% involved civil society organisations and less than 1% involved domestic business associations (GPEDC, 2018[2]).

← 3. Blended concessional finance is the combination of concessional finance from donors or third parties alongside the IFC’s own normal account finance and/or commercial finance from other investors, to develop private sector markets, address the SDGs and mobilise private resources.

← 4. There is a significant overlap across the categories of LDCs, other low-income countries, and fragile and conflict-affected situations. Since most fragile and conflict-affected situations are classified as either low-income countries and/or LDCs, the rest of this guest contribution will focus on low-income countries and LDCs.

← 5. More information on how concessionality is calculated and levels can be found at: https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/bf.

← 6. Concessionality levels by product and themes in the IFC’s blended finance portfolio can be found at: https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/bf.

← 7. More information on the IFC’s governance system for blended concessional finance can be found at https://www.ifc.org/wps/wcm/connect/industry_ext_content/ifc_external_corporate_site/financial+institutions/resources/blended+concessional+finance+governance+matters+for+impact.

← 8. More information can be found at: https://www.ifc.org/wps/wcm/connect/topics_ext_content/ifc_external_corporate_site/bf/bf-details/bf-dfi.

← 9. When using blended finance, the IFC publishes information on concessionality at the transaction level (see the data portal at https://disclosures.ifc.org).

← 10. The IDA Private Sector Window contribution includes a pooled first loss guarantee as well as a limit expansion facility to help GTFP leverage at least USD 1 billion in trade finance in countries eligible for the IDA Private Sector Window.

← 11. These include performance-based incentives offered through the Global SME Finance Facility (GSMEF), the Women Entrepreneurs Opportunity Facility (WEOF) and/or the Women Entrepreneurs Finance Initiative (We-Fi).

← 12. See Can Blended Finance Work to Leave No One Behind?, 2020 Blended Finance LDC Consultation; and (Convergence, 2020[32]).

← 13. a2i – a whole-of-government programme of the information and communications technology division, supported by the cabinet division and the United Nations Development Programme, that catalyzes citizen-friendly public service innovations simplifying government and bringing it closer to people. It supports the government to be at the forefront of integrating new, whole-of-society approaches to achieve the SDGs.

← 14. The annual zakat estimation is based on expert opinion.

← 15. Budget data from the Ministry of Finance, Government of Bangladesh (2015–2016, 2016–2017, 2017–2018, 2018–2019, 2019–2020) courtesy of the Economic Relations Department.

← 16. UNCDF and International Labour Organization feasibility study on the MSME financing digital platform linked to the alternative stock exchange, Zimbabwe.

← 17. In many big cities in Africa, their populations have increased by more than 1 million between 2010 and 2020, such as Addis Ababa, Ethiopia (from 3.1 million to 4.8 million), Dar es Salaam, Tanzania (from 3.9 million to 6.7 million), Luanda, Angola (from 5.3 million to 8.3 million), and Kinshasa, Democratic Republic of the Congo (from 9.4 million to 14.3 million). Data source: https://population.un.org/wup/DataQuery.

← 18. The contribution of GFCF to GDP has remained at about the same level with slight fluctuations from 25.6% in 1970 to 23.6% in 2018. Exports of goods and services as a share of GDP grew from 13.6% to 30.1%, and imports of goods and services from 13.7% to 29.3%. Data source: (World Bank, 2019[18]).

← 19. For example, in Korea, GFCF averaged 35% of GDP from 1970 to 1990 while urbanisation was rapidly increasing. Korea also shows that, once urbanisation reaches 80% it levels off and can even decline – a phenomenon seen in many countries.

← 20. Countries that are not following the usual path are primarily the LDCs in Africa and Asia. Poor regions in middle-income countries in Africa and Asia are also experiencing urbanisation without investment.

← 21. Some African countries are urbanising rapidly with real GDP growth lagging, such as Angola, Malawi and Mozambique. Also see: UNCDF (2020). Capital Locast – Episode 9. Podcast interview with Jean Pierre Elong Mbassi, April 2020. https://capital-locast.captivate.fm/episode/capital-locast-episode-9.

← 22. A contingent liability arises for central governments when they are held accountable directly or indirectly for debts that are on the balance sheet of local governments. Often it is assumed that, as a last resort, central government would underwrite these debts, therefore local government borrowing can impact the national credit rating. See South Africa Local Government: Municipal Finance Management Act (2003). https://www.westerncape.gov.za/Text/2004/8/mfma.pdf.

← 23. According to the Global Landscape of Climate Finance 2019, by the Climate Policy Initiative, total global climate finance flows had been increasing rapidly from USD 350 billion in 2013 to USD 550 billion in 2018. According to the Climate Bonds Initiative, global green bonds reached USD 257.7 billion in 2019, driven by European, Asia-Pacific and North American markets. See https://www.climatebonds.net/resources/reports/2019-green-bond-market-summary.

← 24. Blended green finance investors include the Green Climate Fund, the European Investment Bank, other development finance institutions, asset managers, and other private investors.

← 25. 2021 will be a very challenging year for local governments, with increased demands for their services and reduced fiscal space. In this context, UNCDF has started a new initiative on Rebuilding Local Fiscal Space to understand the loss of local fiscal space due to the COVID 19 pandemic and to unlock access to public and private capital for local fiscal and economic recovery.

← 26. For instance, due to the significant loss of local government revenue, the city of Kumasi is focusing municipal investment more on projects that can generate revenues quickly but not contribute to productivity growth, such as car parks and shopping malls. This is also happening in other developing cities. UNCDF, through its International Municipal Investment Fund Technical Assistance Facility, is supporting cities to rebuild local fiscal space in a more sustainable way (see footnote 24).

← 27. For example, Burkina Faso is starting to make pharmaceutical equipment that was previously imported.

← 28. For more information, visit https://guarantco.com/blendedknowledge/.

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