Blended finance trends, activities, and actors – An interview with Convergence
07 Nov 2017 by Dean Segell, Manager at Convergence
UNDP: Could you tell us about the origins of the report (why now and why this topic?) and what is the most striking element that you uncovered while doing the research?
Dean Segell (DS): Convergence is one of the leading institutions advocating for blended finance. Over the last 2 years, we have collected a wealth of institutional knowledge about who is doing what in the space, including compiling the most comprehensive database of closed blended finance transactions. While blended finance is gaining momentum, with activities being undertaken by a diverse set of actors across sectors and regions, no institution has codified and synthesized that activity in a way that could be easily absorbed and used by key stakeholders in the market. The purpose of ‘The State of Blended Finance’ report was to landscape current blended finance activities and identify key trends and lessons learned. The Blended Finance Taskforce (BFT), convened by the Business and Sustainable Development Commission, will leverage the report to inform a final set of recommendations.
One of the key findings from the report is that the private sector is unfairly and inaccurately characterized as a homogenous group, but there is a real need to better understand the unique motivations, perspectives, and investment preferences of the various segments of the private sector (i.e., insurance, pension funds, commercial banks). This is a critical next step for mobilizing private sector capital. Public and philanthropic funders need to understand what type of investment opportunities can attract private sector investors. We are currently working with the BFT on a report that will look explicitly at the role of the private sector in blended finance, which will be released next year at the World Economic Forum in Davos.
UNDP: Who do you see as the industry leaders in blended finance, in terms of size of executed deals?
DS: The European Commission is an industry leader in blended finance, providing concessional finance to the Development Finance Institutions (DFIs) to invest in higher risk projects and countries. It should be noted that we advocate for blended finance solutions that incentivize DFIs to invest in higher risk projects and countries and catalyze more private sector investment. In this vein, the Swedish International Cooperation Agency (Sida) is one of the most innovative aid agencies, doing fantastic work deploying guarantee instruments to catalyze private sector investment. The United States Agency for International Development (USAID) Development Credit Authority (DCA) also plays an industry leader role, providing guarantees to incentivize local banks to lend to underserved markets.
Beyond the public sector, Rockefeller Foundation is an industry leader in the philanthropic sector. Rockefeller is using grant money to catalyze the development of bold and innovative businesses and structures that have a significant impact (e.g., the African Risk Capacity).
UNDP: Your report highlights a continued lack of scale as a striking element of the sector—aren’t we correct to assume that by the very nature of blended finance, deal sizes will be limited because they are proprietary, expensive to execute, and focused on a very specific impact?
DS: On the contrary, we think that blended finance has great potential to scale. As stakeholders overcome the initial learning curve, the transaction costs will be reduced. One of the main barriers to scale is ensuring blended finance transactions are structured in a way that attracts private sector capital. Blended finance leverages common investment tools—such as private equity funds and debt issuances—that are easily understood and executed by the private sector. But many public institutions that traditionally deploy grant capital require capacity building to understand how to participate in, and even design, these structures. One of our primary recommendations is for DFIs – who have origination and execution capacity and hold many assets – to do more syndications and securitizations to enable private investor participation, while freeing up DFI capital to invest in more projects.
UNDP: How can we incentivize organizations to play a de-risking role—perhaps the most critical in bringing blended finance to the table? For example, what are the benefits to being the provider of a loan guarantee, or assuming a first loss tranche?
DS: The institutions that are best positioned to play this role – DFIs – already have these tools at their disposal. To encourage DFIs to play an even greater role in this space, there needs to be buy-in at the highest level—their shareholders. Many DFIs, like the International Finance Corporation (IFC) and Netherlands Development Finance Company (FMO), are on this path, but this needs to be balanced with the structural limitations to maintain AAA credit ratings. Therefore, we also think there is value in incentivizing aid agencies to play a more significant role. We highlighted the best practice activities of Sida and USAID above. We hope others follow their example by securing authorities to do more than grants, and building internal capacity to participate in blended finance structures.
UNDP: Only 12% of blended finance deals leverage a guarantee or insurance mechanism—as the protection gap grows for vulnerable communities vis a vis natural disasters, how do we increase this number?
DS: First, it should be noted that there is still a need to understand the type of de-risking mechanisms that are most effective from a private sector investor perspective. The Financial Times recently authored a fantastic article on leveraging insurance companies and their products to protect against natural disasters. The insurance industry has assembled a host of executives, alongside the United Nations and the World Bank, into a group called the Insurance Development Forum, which aims to extend the use of insurance and risk management techniques to “build greater resilience and protection” in the developing world. This is incredibly exciting.
UNDP: What will be the recipe to attract more private investors while maximizing impact?
DS: This is exactly what Convergence seeks to answer! A key characteristic of blended finance is that impact does not need to be a driving factor for every investor in the transaction. This is what separates blended finance from impact investing. The public and philanthropic investors prioritize social returns (i.e., impact), but the private investors prioritize financial returns. The investors—public, philanthropic, and private—play complementary roles: one designing and measuring the intervention and impact and the other providing the required financing. Therefore, the recipe is really around identifying those high-impact development interventions that can achieve market-rate financial returns. Microfinance, agribusiness, and access to energy are great examples. Howeer, it is important to acknowledge is that private investment won’t support all the SDGs. We need to clearly identify high-impact development interventions that can attract investment capital and then design blended finance structures that the unique capabilities of each stakeholder.
To read the full report click here.