Although several Millennium Development Goals (MDGs) have been reached, there is still a huge financing gap (approximately US$ 2,500bn per year), which is needed to meet the new Sustainable Development Goals (SDGs) for post-2015 development. There is, therefore, more interest in cooperation between the public and private sector to fill this gap, both sides. At the same time, the attention to efficiency and effectiveness of donor funds is increasing. Blending and innovative financing can help to achieve these goals.
Blending is the strategic use of donor funds to mobilize financing from official development banks and the private sector. It combines grants (which can be used for e.g. technical assistance, investment grants, interest rate and insurance premium subsidies, guarantees and risk capital, such as equity) with financing (such as loans, equity and guarantees) from official development banks and private finance for development projects.
Innovative financing for development
There are two ways to look at innovative development financing: first, as a new way to mobilise funds from new sources, in addition to public funds, NGOs and foundations. Second, as a new way to use funds in a manner which makes projects viable, for example through distribution of risks. Through innovation, new products can be developed, new markets entered and new participants attracted for development projects. Innovation will add value by mobilizing additional resources, creating an efficient financial intermediary system, and focusing on results. Until now the innovative financing market mainly consisted of thematic (e.g. green or impact) bonds, micro-finance and result-based financing.
Increased use of established instruments by new participants, the development of new instruments and their application in new and existing markets, are expected to increase this market substantially in the coming years.
There are, however, a number of barriers, which limit the growth of innovative finance. Basically, a structured market for supply and demand of innovative development finance does not exist, yet.
On the supply side, there are potentially relevant and interested, but different, groups of private funders for blending, each of them characterised by specific objectives, risk/return profiles, location and operating conditions. Examples are domestic and international banks and companies, financial investors (such as pension funds, asset managers and private equity), insurers, and social investors, such as NGOs, impact investors, foundations and philanthropists. Many of them are not familiar with development finance and have institutional constraints, e.g. limited staff resources and very strict regulatory requirements for such investments, which are mostly seen as too risky.
On the demand side, not enough funds are earmarked to design new instruments and test them in new markets. Developing them can be costly and takes time; an example is microfinance, which took decades to get off the ground. And there is not much of an intermediate structure: lack of data, standards, metrics and liquidity limit transparency and the development of a market. As for the existing innovative finance mechanisms, they often do not take into account the business environment and the investment constraints of the private sector, and low-risk products such as bonds and public sector guarantees, are most frequent.
Way forward – and the role of blending
In order to stimulate innovative financing, the public and private sector will have to work together. Exchange of information and coordination of actions will be required to build up the innovative financing market. Institutions that can mediate between public and private donors, private funders and beneficiary governments can play a useful role.
The private sector (e.g. banks, impact and institutional investors) will have to be willing to invest in existing and promising new ventures (which have been designed by financial intermediaries) that produce development and financial returns.
From its side, the public sector will have to ensure that the institutional, legal and regulatory environment allow for innovative financing and search for opportunities to deploy innovative financing mechanisms, e.g. for the ‘Bottom of the Pyramid’, the informal sector, in rural and urban areas, and in fragile states. Such actions can be financed out of technical assistance components of blending projects.
At project level, risk cushions provided by grants, e.g. in the form of guarantees or an equity contribution to a project company, can reduce the risks for public and private sector funders to an acceptable level and attract sizeable amounts of additional resources. Often projects can only start with donor support through risk capital, and other funders, both public and private, will only provide senior debt and enter with risk capital in a next stage, when the project has matured and become less risky. This applies to all kinds of projects, from micro finance to big infrastructure.
In conclusion, the combination of private sector approaches and development goals will allow for increased opportunities to alleviate poverty, fight climate change, and deal with other sustainable development challenges. Blending can be a useful tool in unlocking additional (private and public) project funds and increase innovative development financing.
Sander Winckel is an independent expert on blending and innovative finance.
The views expressed here are those of the author and not necessarily those of ECDPM.
Photo courtesy of jbdodane.
Mr Sogge is right that there are various ways to look at blending, and the mentioned reports indeed deal with relevant issues, which need to be addressed. In the past years, donors, in cooperation with development finance institutions, have been working hard on them, e.g. harmonizing the administrative paperwork, developing result indicators, analyzing the risks of involving the private sector, and establishing criteria for supporting private sector actors (1). There still is a lot to be done, such as fine tuning the available instruments and setting up of an impact measurement system, but as available resources are limited, any technical support - including from NGOs- in refining the blending system would be welcomed. Meanwhile, these reports do not prove that involving the private sector in development does not deliver effective results, simply because there hardly are any such projects completed, to date. The ECA report correctly criticizes organizational issues, but eventually is not able to address the main subject of its own report, (effectiveness of blending, (2)), since there are no impact criteria yet nor project results, as most EU blending projects haven’t even started yet. The EP report is right in criticizing the limited private sector involvement in development, up to now, but, inter alia, disregards the influence of private sector investments on public services and does not deliver a solution for the widening gap between SDG needs and diminishing ODA budgets. The very thorough Dutch report, rightly points at the lack of impact indicators and the scattered development instruments, but only looks at PSD projects, not at private cofinancing of projects in other sectors, or private finance as a source of funds, which is the main point of this blog. Innovative development finance tries to find solutions for the widening gap between SDG needs and ODA budgets, by creating links between the vast sums of available funds in the private sector and the SDG funding requirements, e.g. by using public funds to reduce the (perceived) risks of investing in development projects and creating an enabling environment for (both private and public) funders. The experiences of development finance institutions, key players in development finance, and the growing private sector interest in sustainability and corporate responsibility, indicate that this can be a way forward, provided the abovementioned safeguards and conditions are met. (1)A Stronger Role of the Private Sector in Achieving Inclusive and Sustainable Growth in Developing Countries, COM(2014) 263 final; (2) The effectiveness of blending regional investment facility grants with financial institution loans to support EU external policies, ECA, 2014
There may be other ways of looking at blending and related public-private financing schemes. Indeed three recent expert studies have looked at in various ways, and by and large they aren’t impressed with what they see. A report by the European Court of Auditors (1) provides reasons to doubt the added value of ‘blending’; this implies doubt about the adequacy of safeguards against rent-seeking by private businesses. A study for the European Parliament (2) and a critical assessment of the Dutch experience by the evaluation unit of the Ministry of Foreign Affairs (3) also question whether these schemes really add value, and further express doubt that they help fight poverty. Can blending contribute to equitable development after 2015? On the basis of these authoritative studies, I doubt it very much. 1) 'EU auditors warn the incoming Commission on the use of blending', October 2014 http://bit.ly/18Zf3mF 2) European Parliament 2014, A study for the Directorate-General for External Policies of the Union, 2014, Financing for Development Post-2015: Improving the Contribution of Private Finance, http://bit.ly/1APQoqa 3) IOB 2014, Op zoek naar focus en effectiviteit. Beleidsdoorlichting van de Nederlandse inzet voor private sector ontwikkeling 2005-2012, Policy and Operations Evaluation Department (IOB) of the Ministry of Foreign Affairs, http://bit.ly/1CKJmtN