Achieving the Sustainable Development Goals will cost $5 trillion-$7 trillion every year. Current development spending falls far short of what is needed, with estimates of the annual SDG funding gap pegged at some $2.5 trillion. Blended finance has been hailed as a promising way to unlock new sources of funding to eliminate poverty and protect the planet. The approach has grown rapidly over recent years, with Convergence estimating $81 billion in blended finance mobilized between 2012-2015.
Blended finance is the strategic use of development finance to enable private capital flows to projects that address the SDGs. But blended finance is not just about mixing public and private resources into a structured financial instrument. Rather, it involves a range of actors working together at distinct stages of a project or enterprise’s lifecycle.
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Bringing a blended finance investment to fruition can be complex, fraught with coordination challenges and transaction costs. And simply executing a deal is not enough to ensure impact: Without careful planning, public facilitation of private investment can distort local capital markets. It also risks supporting projects that are unsustainable in the long run, turning investments into ongoing public subsidies or projects set up to fail.
If blended finance stands a chance of meeting the trillion-dollar investment gap, development funders must develop a clear-eyed understanding of when it is an effective approach, and what role they can play to best support the investment.
Development funders can maximize the potential of blended finance by becoming increasingly specialized across three archetypes: Builders, which support the development of public infrastructure with strategic investments alongside government, and help improve the enabling environment for business and investment; catalysts, which support the preparation of investment projects and formation of new funds and facilities in “risky” markets, and often provide early-stage risk or growth capital to plug viability gaps; and dealmakers, which help to bring transactions to fruition in close collaboration with private sector project sponsors, and tend to provide greater levels of capital to enable proven business models to scale.
Many funders are already specialized within one of these blended finance archetypes. For example, private foundations generally act as catalysts, playing a supporting role by placing comparatively small, catalytic amounts of capital into impact deals and blended funds. Development finance institutions often act as dealmakers, providing strategic subsidies or risk mitigation to crowd-in private investment.
If an institution houses different impact mandates and sources of financing, they can encompass different aspects of the three archetypes. For example, KfW — the national development bank of Germany which is responsible for the country’s development finance activities in emerging markets — plays a variety of blended finance roles. One side of KfW supports loans to governments and financial intermediaries to increase financial sector development; another makes debt and equity investments to commercial private sector partners helping to drive impact; and they can also act as a conduit for deploying grants from Germany’s Federal Ministry of Economic Cooperation and Development to shape policy and the enabling environment. Managing such a multitiered structure and set of blended finance functions requires a high degree of organizational effectiveness. It also requires deliberate communications with partners to ensure they understand the different approaches the organization may deploy to achieve its varied objectives.
The Millennium Challenge Corporation is a good example of an institution that both makes direct investments and works to make the overall investment environment more attractive to private investors in sectors that drive long-term development impact: It is both a Builder and a Catalyst. MCC is an innovative and independent United States foreign aid agency with a mandate to promote economic growth, reduce poverty, and strengthen institutions in its partner countries—while focused on country ownership and results. This provides MCC with the flexibility to identify which sets of investments would help achieve its goals and its partner countries’ aspirations, then use its resources to direct blended finance to where it is needed most. Typically, this takes the form of concentrated sector-specific investment programs, and partnership with local governments to formulate supportive policies.
In El Salvador, for example, MCC has committed $100 million in new investment for education, another $100 million for logistical infrastructure, and $40 million as a technical assistance fund to support investment climate reforms. MCC supports the El Salvador Investment Challenge, a $75 million blended finance facility designed to catalyze private investment into sectors producing internationally-traded goods and services. ESIC also supports programs that benefit private enterprise, such as infrastructure and workforce training. The Salvadoran government and MCC provide grants to private investment projects, matching new private capital commitments up to a 1:1 ratio. In this way, ESIC catalyzes new investments and creates the infrastructure necessary to promote private investment.
MCC also helps governments attract private investment into large-scale infrastructure projects. As part of a larger investment into Jordan’s water and wastewater systems, MCC committed $93 million to catalyze an additional $110 million in private sector investment to expand the country’s main wastewater treatment plant. Now operational, it produces 10 percent of the nation’s annual water supply. Coupled with MCC’s investment into the nation’s wastewater network, the project has directly benefited over 2 million people and created over $600 million in additional value.
For blended finance to mobilize capital at the scale required to address the SDGs, development funders need to think carefully about their role in the blended finance ecosystem. Some organizations will be able to operate across the blended finance archetypes; many more will be best served by specializing in one domain while seeking out partners active in other parts of the ecosystem. This choice of “where to play” for development funders will be increasingly important as more and more companies and financial institutions dip their toe into the blended finance world and seek to make sense of the varied objectives and capabilities of development funders. The growth of blended finance will depend on it.