Insight Summary
- Blended Finance is a structuring approach aimed to strategically mobilize private capital alongside development funding (i.e. public and philanthropic funding) to finance sustainable development in emerging and frontier markets.
- The approach reduces the riskiness of an investment for private investors, thus leveraging the developing funding provided to accomplish certain United Nations Sustainable Development Goals (UN SDGs).
- Despite the growing market for blended finance, the $144 billion mobilized to date remains well below the annual $2.5 trillion needed to achieve the UN SDGs by 2030.
- Encouragingly, a recent shift towards less complex structures indicates a positive step towards more streamlined deployment.
What is Blended Finance?
Blended finance is the strategic mobilization of private capital alongside development funding (i.e. public and philanthropic funding) to finance sustainable development in emerging and frontier markets. The ultimate goal is to attract private capital to support progress towards the United Nations Sustainable Development Goals (UN SDGs). This is because public and philanthropic financing has historically fallen short. The OECD estimates that the annual financing needed to achieve the SDGs by 2030 is nearly $2.5 trillion (source).
The concept was first recognized as a solution to the funding gap in the Third International Conference on Financing for Development in July 2015 (source). It allows organizations with different objectives to invest alongside each other while achieving their own objectives (whether financial return, social impact, or a blend of both).
It’s important to note that blended finance is not an investment approach, instrument, or end solution. It is a structuring approach that reduces the riskiness of an investment for private investors, thus leveraging the developing funding provided to accomplish certain SDG goals. For example, some typical deal structures include:
- Grants – a public/philanthropic partner provides capital to support a project that has no expectation of being repaid. These funds can be used to support non-income generating activities or early stage preparations.
- Guarantees – a public/philanthropic partner offers protection (often in the form of insurance) from capital loss.
- Technical Assistance – a public/philanthropic partner supplements the capacity of investees, typically through a technical assistance facility or an incubator.
- Concessional Capital – a public/philanthropic partner provides funds on terms below market within the capital structure (sometimes referred to as first-loss capital).
Blended Finance Example
To understand how a blended finance transaction can work, let’s take a look at the Green Climate Fund (GCF), the largest fund dedicated to help fight climate change. One of its most recent projects aims to help Chile move away from its dependence on fossil fuels by investing in solar and hydroelectricity power.
This project, co-financed with Japan’s MUFG Bank, addresses the inherent challenge with renewable energy of intermittent power supply. By investing up to USD 60 million in early stage concessional equity, GCF de-risks the project and catalyses much larger private sector financing. Looking ahead, this should help attract additional private sector debt and equity investors to finance the remaining USD 1 billion.
Co-Investment Opportunities
To further catalyze capital and increase private sector investments, public capital will oftentimes require that co-investments be extended to the fund investors without any additional fees or carried interest. This is a nice incentive for the Fund’s investors to find and invest in opportunities in developing economies that align with their objectives and can lead to even more development impact.
The State of Blended Finance
The OECD created a system called ‘Convergence’ to track trends in the blended finance market. The system looks at nearly 4,300 financial commitments and nearly 600 transactions, representing nearly $144 billion in aggregate financing (as of September 2020). According to Convergence, annual financing for blended finance has remained fairly consistent, with an average of 40-50 annual transactions amounting to ~$11 billion per year since 2015 (source).
In terms of investment vehicles, Funds (e.g., equity funds, debt funds, and funds-of-funds) play a primary role, representing 43% of all transactions in the database. Projects and Companies are the next most common deal type, representing 23% and 17% of all transactions. The most common Projects are infrastructure projects, whereas a majority of Companies are social enterprises or small-to-medium sized enterprises (SMEs). Another trend to note is the recent increase in blended finance Bonds and Notes. The segment accounts for nearly 16% of all transactions between 2017-2019, in comparison to just 6% of all transactions in the database.
Despite the growing market for blended finance, the $144 billion mobilized to date remains far below the annual $2.5 trillion needed to achieve the UN SDGs by 2030. In order to achieve scale, the structuring approach needs to address some common challenges, including: lack of bankable projects due to smaller transaction sizes, complex and unfamiliar structures, and silos between the donor community and the private sector.
Encouragingly, The State of Blended Finance 2020 noted a shift towards less complex blended finance transactions. Between 2017-2019, transactions were less likely to employ multiple blending approaches in a single structure (e.g., concessional debt or equity and technical assistance grants), indicating a positive step towards more streamlined vehicles (source).
Blended Finance Leaders
According to Convergence, over 1370 unique investors have participated in the market. Over 50% of these investors have been private, with public and philanthropic investors evenly split at around 25% each (source).
Within the private sector, the most active investors have been Ceniarth LLC (33 transactions), Standard Chartered Bank (29 transactions), and Calvert Impact Capital (28 transactions). Many of these private investors have explicit impact-mandates with a relevant focus (i.e. sustainable finance).
Public investors (i.e. governments) have committed various types of financial resources to blended finance, both directly and indirectly. According to Convergence, the top donor governments, by number of direct commitments, have been the United States (72 commitments), the United Kingdom (40 commitments), and the Netherlands (39 commitments).
Within the philanthropic space, the most active investors have been the Shell Foundation (33 transactions), the Bill & Melinda Gates Foundation (31 transactions), and the Omidyar Network (28 transactions).
