The dating game of development finance

By Naki B. Mendoza 24 November 2015

The Northern Ugandan Agriculture Cooperative farm is one of the first agribusinesses to receive financing from the African Agriculture Capital Fund. The fund was capitalized with $17 million from a variety of foundations plus an $8 million commercial loan from JPMorgan Chase. Photo by: Bobby Neptune / USAID / CC BY-NC

Like love and romance, much of development finance comes down to finding the right partner. That involves understanding each other’s intentions, defining complementary roles and ensuring that all parties share a common set of goals.

The analogy likely ends there, but it speaks to pragmatic advice that can lead investors from a variety of sectors to partner up on development finance initiatives.

The practice of blended finance tries to forge partnerships across different sources of capital. But as investors note, several large barriers in both mindset and understanding still persist.

“There is a construct for this ‘social mission-driven stuff’ that it is philanthropy,” Matt Arnold, head of social and sustainable finance at JPMorgan Chase & Co., said of the bank’s high-impact social investments. Arnold’s comments came at a recent forum on public-private partnerships and the Sustainable Development Goals organized by Pyxera Global in Washington, D.C.

Officially, JPMorgan Chase’s fundraising for impact investments is classified as philanthropy, based on how it is measured by the bank’s systems and score cards. Large financial institutions that are in the business of generating high returns often set a public target for their returns on equity investments that ranges in the midteens. But social investments that draw blended capital from donors, foundations and private investments banks often yield lower returns in the single digits.

“Anything less than [our public ROE] has to be treated legally as a philanthropy,” Arnold said.

Such categorizations, development finance experts say, feed a false narrative that only two types of financial commitments exist — fully commercial or fully philanthropic. Tackling some of these technical classifications and misperceptions could help create additional funding opportunities.

The benefit of a blended finance model is that contributors of all sorts can meet their expected returns while still advancing a shared impact mission.

Blended finance investments pool together capital from all ends of the investor spectrum with a variety of risk profiles. Any given transaction, for example, can mix grant-writing foundations who are used to donating their funds with commercial lenders who seek a 30 percent return on their investment. As Arnold noted, “that’s a 130 percent point range.”

But still, a prevailing sentiment among financiers is that they are uncomfortable going into that gray zone between commercial and philanthropic capital.

“They are not measured against what they can achieve in that space,” said Yasmina Zaidman of the Acumen Fund. “It’s one versus the other.”

So perhaps another necessary step is improving measurement and metrics in the space and proving out that positive returns are the norm in blended finance investments.

It also helps that deals are frequently structured to attract capital from commercial investors by cushioning the blow from potential losses. Foundations, for example, can contribute grant capital or make first loss guarantees and development finance institutions can pitch in with concessionary loans.

The U.S. Agency for International Development offers a powerful tool through its Development Credit Authority, which de-risks early-stage markets and new investments with its credit guarantees.

In 2011 a consortium of investors partnered to launch the $25 million African Agricultural Capital Fund to boost agricultural productivity in East Africa. The fund was capitalized with $17 million from a variety of foundations plus an $8 million commercial loan from JPMorgan Chase. The loan was backed with a 50 percent guarantee from USAID, which the bank cited as a major catalyst for its decision to invest in the fund.

In many ways, blended finance becomes a process of blending time tables, risks and capacities of different capital providers as much as their financial streams. The mix and match of variables can allow investors of many sorts to pursue a common agenda, which, by design, is not intended to yield the same returns for all.

Many of the world’s largest banks are involved in blended capital ventures, raising funds from their clients to channel into high impact investments. This summer for example, global giant Citibank became a founding member of the Sustainable Development Investment Partnership — a blended finance fund that aims to invest $100 billion in developing country infrastructure over the next five years.

And JPMorgan Chase has also raised $108 million for the Global Health Investment Fund, which supports late-stage health technologies in developing countries. The Bill & Melinda Gates Foundation bears the risk of first loss in that fund. But these examples are still far from the norm.

“The key is to have an intimate, nuanced sense of the investor,” said Arnold. “Who are they? What is their social purpose? What are their ranges of flexibility? And what do their programs look like?”

Often this can lead to a convenient alignment of high value capital and donor entities with a policy-driven mission to maximize returns on that capital.

The Millennium Challenge Corp. — the U.S. government’s independent foreign aid agency — for example, measures its success more from a systemic impact perspective than on a transaction by transaction basis. Among its indicators for evaluating success are whether its concession-based grants are piloting new innovations, bearing first mover costs or stimulating public-private collaboration through collective actions.

Combined, those kinds of indicators are rooted in an objective to not just shield private investment from risk, but to increase its returns through a robust enabling environment for building development ventures.

Private finance will be required to play a growing role in order to plug the nearly $2.5 trillion funding gap for developing country needs in the 2030 development agenda. Blended finance represents a huge opportunity to create innovations in development by utilizing the financial industry equivalent of public-private partnerships.

Financial institutions can mobilize significant streams of capital for development-related initiatives in partnership with mission-driven government and civil society partners with complementary risk profiles. And in doing so, dispel notions that financing for development is measured in only gains and losses.

Despite the progress, it’s going to take new ways of classifying the investments, a greater openness to collaboration, a higher tolerance of uncertainty and more foundation and development finance institution backed guarantees to make these blended finance deals a truly significant part of the financing equation. The development community has to hope that as the parties in these relationships get to know one another better, some of these challenges will work themselves out.

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About the author

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Naki B. Mendozamfbmendoza

Naki is a former reporter for Devex Impact based in Washington, D.C., where he covered the intersection of business and international development. Prior to Devex he was a Latin America reporter for Energy Intelligence covering corporate investments and political risks in the region’s energy sector. His previous assignments abroad have posted him throughout Europe, South America and Australia.


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