2023 was a big year for blended finance, with both highs (including the launch of several larger-scale blended finance initiatives like the SDG Loan Fund) and lows (Convergence’s State of Blended Finance 2023 found preliminary estimates for blended finance flows in 2023 are still not back to pre-pandemic levels). With multilateral development banks (MDBs) and development finance institutions (DFIs) continuing to evolve, official development assistance (ODA) being diverted to meet the mounting humanitarian needs (and therefore less ODA going towards private sector instruments), and the 2030 Agenda fast approaching, we predict 2024 will bear significant impact on whether the blended finance market achieves scale to meet the SDG financing needs in emerging and developing economies (EDMEs).
The following trends will shape how the blended finance market behaves:
1. Philanthropic capital: an increasingly important source of catalytic capital in blended finance
Convergence’s State of Blended Finance 2023 found that between 2017-2022, philanthropic organizations provided 10% of all concessional capital commitments to climate blended finance, indicating there is a large but unrealized opportunity to expand the participation of philanthropic capital in blended finance.
Indeed, Convergence finds that if deployed strategically, catalytic capital could mobilize $286 billion in private capital, seven times current levels of mobilization by the entire development and climate finance systems in a typical year, and 14 times the average private direct mobilization reported annually by the MDBs & DFIs.
Coalitions like the Global Energy Alliance for People and Planet (GEAPP), Catalytic Capital Consortium (C3), and Allied Capital Partners represent initiatives that utilize the power of philanthropy to scale private investment flows. Moreover, MacArthur’s participation in the SDG Loan Fund demonstrates how philanthropies can enable mobilization at scale; here a $25 million guarantee provided by MacArthur unlocked $111 million of first-loss capital from FMO and mobilized $1 billion from private institutional investors.
We also see regulatory changes to enable a larger role of philanthropy in blended finance. For example, the Monetary Authority of Singapore (MAS) is promoting an incentive-laden tax scheme to encourage single-family offices to use Singapore as a base to conduct philanthropic activity. The number of family offices in Singapore increased five-fold from 2017 to 2019 and doubled again in 2020 to reach approximately 700.
We expect to see more activity and interest from the philanthropic community to take a larger role in the blended finance market.
2. New Private Sector Instrument rules for ODA could mean more effective use of aid money in blended finance
The 32 OECD Development Assistance Committee (DAC) members (High-Income Countries) commit $210 billion of ODA (i.e., aid) annually to the 150 Low and Middle-Income Countries. Around two-thirds of this funding flows bilaterally and one-third through channels such as the Green Climate Fund, the World Bank, and the United Nations. Almost all the bilateral funding is committed as grants or subsidized loans to the public sector. To encourage private sector development and private investment mobilization, the DAC members agreed in 2019 to trial the introduction of Private Sector Instruments (PSI) as an eligible tool of ODA: (i) the institutional approach (e.g., capitalizing DFIs that finance the private sector) and (ii) the instrument approach (e.g., providing a loan to a private sector entity). After a long review, in 2023 the DAC members agreed to complete the trial and formalize the PSI rules for new instruments (e.g., guarantees).
Convergence expects the new rules will lead to an increase in issuance of PSIs for private sector development. Convergence intends to work with ODA donors to demonstrate how PSIs can be deployed strategically, effectively, and efficiently to mobilize private investment towards impact investments in developing countries – through a good practice report and workshops. Now that new rules have been agreed, it is important to identify good practices to maximize the impact of the limited ODA that will be deployed through PSIs.
3. Growth of sustainability-linked bonds will bode well for blended finance bonds
While the market for blended bonds has remained relatively nascent, Convergence data shows that in climate-related transactions, blended finance bonds were deployed in 2023 more than in previous years. As a proportion of annual climate financing volume, blended bonds have grown from 2% of total climate blended finance in 2017 to 9% in 2022.
With the increasing use of sustainable debt globally, opportunities for using blended bonds will increase as well. S&P predicts that green, social, sustainable, and sustainability-linked (GSSS) bonds will account for 14%-16% of total bond issuance in 2023, an increase of 5%-17%. Particularly in the Association of Southeast Asian Nations (ASEAN) region, the sustainable debt market has seen tremendous growth, hitting a record peak for the issuance of GSSS bonds in 2021, totalling $24 billion.
Still, there are challenges facing the growing use of blended bonds. For example, the World Bank Global Economic Prospects Report found that one in four emerging market sovereigns has effectively been cut off from the international bond market due to high debt accumulation, high interest rates, and reduced access to credit. According to the Amundi Research Centre, however, GSSS bonds, particularly green bonds, are more resilient than the overall fixed-income market and Amundi expects emerging market issuance to rebound in 2024.
Using blended finance in GSSS bonds can help emerging markets regain access to the international bond market through the provision of risk-reducing catalytic concessional capital.
4. Blended finance will continue contributing to the international climate finance architecture, including through energy transition mechanisms
In the State of Blended Finance 2023, Convergence explored some of the changes to the international climate finance architecture proposed to meet the increasing urgency of scaling climate financing and enable developing markets to achieve their net zero commitments. Meanwhile, partnerships among governments, international financial institutions, philanthropic entities, and private sector players have taken shape to chart a path forward together. For example, following Asian Development Bank (ADB)’s launch in 2021 of its Energy Transition Mechanism (ETM), which looks to use concessional and commercial capital to accelerate the retirement or repurposing of fossil fuel power plants, ADB, GEAPP, and MAS signed a memorandum of agreement at COP28 to establish a blended finance partnership to accelerate the energy transition at scale in Asia. It will mobilize concessional capital from the philanthropic and public sectors, de-risk projects, and crowd-in private capital from around the globe to finance energy transition projects in Asia.
Looking ahead, Convergence expects to see continued experimentation with additions and improvements to the international climate finance architecture, to address continued shortfalls in climate financing.