Why blended finance hasn't taken off

PARIS — Blended finance has been the hot topic in development finance circles for a number of years, but despite the excitement around it, the practice hasn’t taken off.

The Organisation for Economic Co-operation and Development defines blended finance as “the strategic use of development finance for the mobilisation of additional finance towards sustainable development.” It has amounted to about $140 billion to date, according to Convergence, a global network for blended finance. But the amount of money in blended finance deals has remained relatively flat over the past few years.

While there is more familiarity with the concept than there was a few years ago, there is still a lack of understanding about how to use concessional capital to help de-risk deals and bring in private investors, and the deals are still complicated and take time to put together.

There is a psychological or knowledge barrier to using blended finance, said Florian Kemmerich, managing partner of Bamboo Capital. While people understand grants, or for-profit companies or investments, the “space between is complex and different,” he added.

Kemmerich has seen the challenges of putting together blended finance deals firsthand. Bamboo recently launched SDG500, a $500 million platform of six funds that are “blended-finance impact-first funds” focused on a range of issues — from agriculture to women-owned businesses and health technology.

What Bamboo learned is that with these types of riskier funds that are distributing smaller amounts of funding in low-income countries, there needs to be at least a 20% protection for investors, he said.

While there is good traction for the funds, they have taken quite a lot of work, and while they are designed to be replicated or scaled, that will take time, Kemmerich said. It will take a lot of explanation and education to get institutional investors on board, he said, and products need to be developed that will appeal to them.

Institutional investors are interested in blended finance deals or funds because they present a way for them to start investing in emerging markets, an institutional investment manager who asked for anonymity in order to speak freely told Devex. In recent years, some are getting more comfortable with infrastructure and private debt than they were seven to 10 years ago, the investor said.

The investor’s company has several blended finance funds that are all de-risked in some way, but the first loss is hard to negotiate with development finance institutions, the investor said. One challenge is that DFIs are often hesitant to work with others or provide first-loss guarantees to funds in which other DFIs might be investing.

More funds need to be rolled out to show a track record and prove that the investments can succeed, the investor said. DFIs could also help in establishing the track record if they publicly shared more data — particularly about default and recovery rates. Specifically, the Global Emerging Markets Risk Database — which is housed at the European Investment Bank and pools data on credit default rates and recovery rates from partner international financial institutions — could be a key source of information, but it is private, the investor said.

“They talk about mobilization, but they don’t walk the talk,” the investor said. “Incentives have not changed at the deal-structure level.”

While there is continued talk about the importance of mobilization at DFIs and multilateral development banks, it is not a priority on the scorecards that are used to measure performance, said Chris Clubb, Convergence’s managing director for Europe.

Often, the blame is put on the institutions or their employees, but that’s misplaced — it’s the shareholders that guide policy priorities, structures, and incentives, he said.

However, if the OECD’s Development Assistance Committee members, who own the majority of those institutions, decided that they need to be “mobilizers,” then “they could change the way those institutions work,” Clubb said. While there is an “intellectual appetite” to mobilize at these institutions, it will not happen voluntarily, he added.

Some in the development community have raised concerns that the push for high mobilization rates could lead DFIs and MDBs to focus even more on middle-income countries where that would be easier to achieve.

The institutions can address this issue by developing nuanced strategies around mobilization rates that set different rules for fragile states and middle-income countries, said Gavin Wilson, co-chair of the World Economic Forum’s Global Future Council on Development Finance. With those strategies in place, DFIs should work to replicate models that have the highest mobilization rates, he said.

Creating investable products and a deal pipeline is still a barrier, and there need to be more intermediaries in the space, Wilson said. Countries can also be more strategic in how they think about their needs and how the different types of projects could be financed, he said.

Another limitation to the expansion of blended finance is perhaps obvious: There is a limited pool of concessional capital that can be used to de-risk investments, with official development-assistance dollars essentially flat. While there is pressure on private organizations to achieve more with their investments, MDBs and DFIs are “forgoing the opportunity and not operating on all cylinders,” Clubb said.

Some development organizations have questioned the benefits of blending and are calling for more data, transparency, and evidence that using public money to de-risk private finance is effective. They have also raised questions over how and where most blended finance transactions take place — specifically, over lower-income countries and social issues often getting only a small share of the investment.

OECD has heard these complaints, said Paul Horrocks, head of the Private Finance for Sustainable Development Unit at the OECD Development Co-operation Directorate. While some DFIs are doing reports, they are not consistent or common, and this question of performance needs to be addressed, he said. DAC has released blended finance principles and is looking at how it can play a role in setting minimum standards, evaluating impact, and creating a common way of looking at blended finance, Horrocks said.

Editor’s note: OECD facilitated Devex's travel for this reporting from the Private Finance for Sustainable Development Conference. Devex maintains full editorial control of the content.