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12 December, 2017

Putting the new OECD blended finance principles in focus

Putting the new OECD blended finance principles in focus

As blended finance becomes increasingly important as a source of development finance, the necessity for shared principles to guide the use of finite public resources for blended finance is clear. At the OECD Development Assistance Committee (DAC) High Level Meeting on October 30-31, the members and participants addressed this growing need by adopting a set of blended finance principles to improve and grow financing and resources for the 2030 Agenda. These principles are the culmination of extensive research and engagement with a Senior Advisory Group that included representatives from different constituencies. The OECD will continue to convene relevant stakeholders to ensure that best practices and policy guidance can be developed in support of the principles.

This is an important milestone for blended finance: an acknowledgement at the highest level of the role that blended finance can play in closing the financing gap for the Sustainable Development Goals (SDGs). These five principles cover the basic underpinnings of blended finance, including concessionality, additionality, and transparency—and highlight the critical steps required for blended finance to achieve scale and impact.

Mobilizing commercial capital at scale

To date, private investors have not participated in blended finance at scale. To close the $2.5 trillion gap in annual funding required to meet the ambitious SDGs, blended finance transactions should be designed to increase the mobilization of commercial finance—as outlined in Principle 2. Specifically, three barriers to private investment in emerging markets must be addressed:

  1. Absolute risk for private investors must be acceptable (e.g., large majority of institutional investors require an investment grade risk profile),
  2. Risk-return profile for investors must be at market prices or at a premium to attract investors to new asset classes, and
  3. Pooling of assets across countries and sectors to allow improved diversification and scale for investors.

Blended finance can overcome these investment barriers through the strategic use of concessional capital from the public and philanthropic sectors. However, the volume of private sector capital that is attracted to each blended finance transaction (i.e., the leverage) will vary significantly based on the target sector and markets, blended structure, and target investors; therefore, it should always be based on the context and conditions of each transaction. Principle 2 rightly advocates that blended finance practitioners, “Seek leverage based on context and conditions.”

Supporting local capital market development

To be truly impactful and build sustainability, blended finance must support local development priorities and contribute to local capital market development—as outlined in Principle 3. Currently, the domestic financial sector in most developing countries cannot provide the financing required to achieve local development priorities: the financing needs are too large and financial intermediation is disproportionately denominated in foreign currencies. As a result, developers of economically important projects cannot obtain long tenor local currency financing, especially for capital-intensive projects dependent on debt, such as infrastructure and renewable energy.

Through blended finance, there is an opportunity to develop and grow local capital markets, encouraging local currency investments rather than the continued influx of foreign-denominated currency investment. Further, Principle 3 highlights the importance of using blended finance “alongside efforts to promote a sound enabling environment”, which is fundamental for building stable and flourishing markets. There are multiple current and future blended finance solutions to support capital market development in developing countries—including the ALCB Fund and GuarantCo—but there is a need to scale solutions for greater impact.

From principles to practice

Now, it is time to put these principles to use! In February 2018, Convergence and the OECD will host a Knowledge Exchange for the OECD DAC members. The goal of the event is to support the application of the OECD Blended Finance Principles and enable the DAC members to understand the potential of blended finance as a complement to Official Development Assistance (ODA) grants in achieving the SDGs.

While clearly there is great potential for blended finance, it is critical to continue to share and grow the evidence base so that blended finance can mobilize additional resources required to meet the SDGs. Beyond capacity building, Convergence connects investors to deals through an online community; educates investors by publishing original blended finance knowledge, data, and research; and supports investors by providing grants to design innovative blended finance structures.

Read the full OECD DAC blended finance principles document.

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