Koenig, A., Jackson, E. 2016. Mobilising private capital for sustainable development. GREAT Insights Magazine - Volume 5, Issue 5. October/November 2016.
For there to be any possibility of achieving the ambitious SDGs by 2030, as much as US$2.5 trillion in private financing for related physical and social infrastructure alone is required per annum in emerging countries. How can development agencies and philanthropic funders effectively mobilise private capital for both financial returns and development impact?
Public and philanthropic donors increasingly engage with private investors in order to make their own limited financial resources go further and to increase the pool of funding available for development. But there are other reasons for growing interest by donors in working more closely with the private sector: they recognise the importance of private sector activity and finance as key drivers of growth and knowledge transfer in emerging countries. Compared to traditional grant funding, some donors also expect the private sector’s involvement to have a positive effect on the financial discipline of jointly funded projects, as donors hope to recycle their money and earn a financial return that can be reinvested in other development projects.
On the other hand, private investors are interested in investing in emerging countries, attracted by high potential returns, portfolio diversification and exploration of new markets. However, they need help in overcoming a number of barriers. First, private investors are reluctant to invest in high impact funds, projects, and ventures in emerging markets because of perceived and actual high risk and low returns. Investment opportunities with the highest impact are also often small and segmented, increasing transaction costs and reducing attractiveness for large institutional investors, especially. Further, most developing and emerging countries lack the market infrastructure and regulatory framework that are needed to attract and direct private investment for development. In addition, each investor has their specific risk-return profile, asset allocation and investment strategy, and exit requirements, all of which determine how and where their capital is ultimately deployed.
There is no “one-size-fits-all” approach to mobilising and deploying private capital for sustainable development. In development finance, market-priced co-financing, matching facilities, and seed funding for pooled investment vehicles have been applied for some time in order to aggregate investment opportunities and to improve private sector financing in emerging markets.
Development finance institutions (DFIs), both bilateral and multilateral, and, more recently, pioneering philanthropic organisations, increasingly employ blended finance strategies that strategically use concessional finance or guarantees to mitigate risk, enhance potential returns and thus unlock private investment for development. A study by OECD and the World Economic Forum identified more than 70 blended finance funds and vehicles accounting for US$25.4 billion in assets.
Important tools in blended finance are structured funds, which typically divide the overall risk into different tranches, including a first-loss tranche, to make a fund investment opportunity viable. Furthermore, most structured funds mitigate capacity and sector risks using technical assistance facilities, financed by grant funding and user contributions for capacity building, project preparation, research or impact assessments. In that way, structured funds have the ability to meet the risk-return profiles of a variety of investors, such as development finance institutions, foundations, pension funds or banks.
Figure 1 shows an example of such a structured fund: the Green for Growth Fund South East Europe, initiated and supported by the German government and the German Development Bank KfW. Other structured funds using a similar blended approach include the European Fund for South East Europe also led by German development institutions (€1 billion), the Essential Capital Consortium Fund managed by Deutsche Bank and supported with a credit enhancement by the Swedish development agency Sida (US$50 million), the African Agricultural Capital Fund with subordinated finance from various American foundations (US$25 million), and the Global Climate Partnership Fund, enhanced by Danida and the German Ministry of Environment via KfW (US$300 million).
Figure 1. Typical structured fund (Green for Growth Fund)
Source: Koenig, A. and E.T Jackson, 2016.
Result-based financing mechanisms offer other means of mobilising private capital for development impact, by linking investors’ financial returns to agreed-upon and measurable impact. Examples here include development impact bonds (DIBs), and their most recent variations, Social Impact Incentives piloted by Roots of Impact with the support of the Inter-American Development Bank and the Swiss Development Agency, or the Social Success Notes developed by Yunus Social Business and supported by the Rockefeller Foundation. These and similar results-based instruments stimulate innovation and encourage providers of private capital to invest in impact-delivery organisations or provision of goods and services that would otherwise not be attractive to private investors that seek at least a minimum return. However, while a variety of pilot projects are now being implemented, these mechanisms are labour-intensive to design and implement, and have yet to reach scale in an emerging country context. Other financial tools that DFIs and governments worldwide have used are diaspora, infrastructure, and green bonds as a means to raise funds for developmental investments.
Public and philanthropic donors can also use a number of supporting instruments to mitigate risk, enhance revenue potential and prepare the ground for developmental private investment. In the past, for example, they provided support to the acceleration and investment readiness of early stage entrepreneurs, provided capacity building to local financing institutions, strengthened the standardisation of impact measurement, helped build the capacity of new fund managers, commissioned research and data collection, and supported project preparation facilities. Public-sector donors, in particular, can leverage their roles as neutral brokers and trusted public entities by facilitating policy dialogue with host governments and providing technical assistance on policy reforms. Individual donors can also capitalise on their DFI’s investment experience in emerging countries. In one notable example, the Danish DFI IFU, working with the aid agency Danida, raised €175 million from four Danish pension funds for deployment in climate related investments in emerging countries without needing to resort to any concessional finance.
A review of past experiences and close observation of the development of the impact investing field point to several trends and lessons:
While these and other trends and lessons are promising, the over-arching question facing practitioners and policymakers in this space is how rapidly such funds and mechanisms can now be scaled up to meet the implementation requirements of the 17 ambitious Sustainable Development Goals (SDGs). In particular, is there the political will for Northern donors and DFIs to exponentially scale structured, blended financing mechanisms? Or, if such political will is not there, what kind of a coalition will it take to build it? Much more is known now about how to mobilise and deploy private capital for sustainable development and that is an important advance. The imperative going forward is to ensure that the quantum of such capital is proportionate to the challenges we all face, that it is translated into SDG-compatible investments and that these investments make a meaningful difference to our common future.
This article draws on research for a recent study: Koenig, A. and E.T. Jackson, Private Capital for Sustainable Development: Concepts, Issues and Options for Engagement in Impact Investing and Innovative Finance, Danida Evaluation Department, Denmark’s Ministry of Foreign Affairs, Copenhagen, 2016 http://um.dk/en/danida-en/results/eval/Eval_reports/publicationdisplaypage/?publicationID=E15693B2-6449-4AB1-A33A-BC8BE0067D42.
Benn, J., C. Sangaré and S. Steensen, 2016, Measuring private finance mobilized for sustainable development, in OECD Development Co-operation Report 2016: The Sustainable Development Goals as Business Opportunities, OECD Publishing, Paris, 2016. http://dx.doi.org/10.1787/dcr-2016-11-en
Koenig, A., 2016, Impact investing 2.0 – global drivers and trends, Berenberg Aspects, August 2016. http://www.socialimpactmarkets.org/#insights
OECD and WEF, 2015, Blended Finance Vol. 1: A Primer for Development Finance and Philanthropic Funders. An overview of the strategic use of development finance and philanthropic funds to mobilize private capital for development. July 2015. https://www.weforum.org/projects/redesigning-development-finance
OECD and WEF, 2016, Insights from Blended Finance Investment Vehicles and Facilities, January 2016. http://www3.weforum.org/docs/WEF_Blended_Finance_
Wharton, 2016, Innovative Finance: Mobilizing Capital for Maximum Impact, August 2016. http://knowledge.wharton.upenn.edu
Wilson, K. E., 2016, Investing for social impact in developing countries, in OECD Development Cooperation Report 2016: The Sustainable Development Goals as Business Opportunities, OECD Publishing, Paris. DOI: http://dx.doi.org/10.1787/dcr-2016-11-en
About the authors
Anja Koenig (left) is Founder and Director of Social Impact Markets and Lead, Finance for Change at the Impact Hub Berlin. Edward Jackson (right) is President of E.T. Jackson and Associates Ltd. and Senior Research Fellow, Carleton University.
Photo: Catalysing private capital for investment in infrastructure: Investment in Grameenphone in Bangladesh is helping farmers price products, improving access to banking services, and keeping families in touch. Courtesy: Asian Development Bank, Flickr.com.
This article was published in GREAT Insights Volume 5, Issue 5 (October/November 2016).