IDB Invest is the private sector arm of the IDB group. Their mandate is to support private sector companies in Latin America and the Caribbean.
An early player in blended finance, IDB Invest has been active in the space since 2009. Since then, they’ve closed 50 investments with total concessional resources of $375 million, which has leveraged $950 million of their own capital and $2.2 billion from traditional investors. As of February 2020, the blended finance team within IDB Invest is managing $820 million of concessional capital, which is divided across 17 different funds or programs. Unsurprisingly, they’re the largest purveyor of concessional capital in the region.
Convergence spoke to Gema Sacristan, Chief Investment Officer of IDB Invest and Matthieu Pegon, Head of Blended Finance, on the unique challenges and opportunities for blended finance in Latin America and the Caribbean, how IDB Invest measures impact, and how they expect IDB Invest to evolve its blended finance activities in the future.
As the largest provider of blended finance in the region, what are some unique challenges and opportunities in Latin America and the Caribbean?
Gema Sacristan (GS): IDB Invest’s mission is to drive investments that advance sustainable development in Latin America and the Caribbean, not only to economies at or above investment grade, but also to those below that range. To achieve this, we need to mobilize significant resources, for which blended finance has proven to be a powerful tool. We use it to pilot, replicate, and scale innovative business models and new technologies to bridge the financing gap for the Sustainable Development Goals (SDGs).
From a blended finance perspective, we analyze opportunities where our concessional resources can yield a higher risk appetite from investors and explore new frontiers, for example, on projects that may not be readily bankable but that could prove to be the new normal in the future (e.g. climate-change related, focused on gender equality, financing to small and medium-size companies). We’re also committed to not crowding-out available sources of funding for commercially viable projects, so we feel very proud to continue accompanying these markets in their transition to a cleaner energy matrix. For example, we’re seeing an opportunity for the manufacturing and agribusiness sectors to incorporate cleaner technologies, while they invest in improving their productivity and efficiency.
Finally, the private sector in the region is increasingly aware of their role in contributing to achieve the SDGs and the Paris Agreement—priority agendas for the IDB Group—and we’re pleased to be their partner of choice in this transition.
As the private sector arm of the IDB Group, what are some unexpected challenges you’ve had to navigate in blended finance?
Matthieu Pegon (MP): One of the inherent challenges is operating in the short-term subsidy space. We are constantly balancing between supporting nearly commercially viable business models, taking risks, and avoiding market distortions. And we are going the extra mile in terms of development impact and mobilization. We do all this in a market continuum that is neither static nor linear.
In fact, I would say one of the biggest challenges is knowing when to start and when to stop. In other words, when to realize your capital is additional and when it is no longer needed. Take renewable energy for example. In some markets, such as Chile, blended finance was instrumental to support the development of small scale and utility scale renewable generation. Now we are looking for the next areas where blended finance can add value, whether that is energy storage, grid optimization, or decarbonization. For instance, we recently partnered with Engie Energía Chile and the Clean Technology Fund to support the phasing out of existing coal-based plants, which could be used as template for other countries in the region. In that sense, it’s quite exciting when a sector, a technology, or a financing structure becomes commercial, as it generally leads to new challenges. We’re constantly pushing boundaries.
Can you give me an example of a specific blended finance deal that IDB Invest has been involved in? And in what capacity?
MP: I’ll tell you about the Ejido Verde project, which closed in 2019. It’s a reforestation project in the state of Michoacán, Mexico, with total financing of $2 million that includes a $1.5 million blended finance tranche from the Global Environment Facility. What’s interesting about this transaction is that it constructs a viable business model that combines sustainable land use and reforestation with supporting indigenous populations.
For this transaction we’re working with one of the leading companies in the pine resin industry in Mexico. The pine resin is obtained from pine trees that grow on indigenous land. This project addresses an often overlooked challenge faced by indigenous communities in the region: access to long-term financing. It takes eight years for a pine tree to mature and produce pine resin. Thus, if the indigenous communities cannot secure long-term funding, they turn to using those lands for grazing as a source of income, which leads to land degradation, reduces their income, and affects the supply for the company.
As a solution, Ejido was structured to match the growth cycle of the pine tree. This allows for new tree plantations and a revenue stream for the indigenous populations that take care of them in their growing stage. The lenders get repaid once the trees start yielding a return. The market failures we’re trying to address here are market inertia and information failure by proof-testing a new financing template through blended finance. The expectation is that similar investments can be gradually financed on a commercial basis.
How do you see IDB Invest evolving in the future?
GS: Since 2016, when IDB Invest consolidated all private sector and non-sovereign guaranteed transactions of the IDB Group, we have been working to become the partner of choice for investing with impact in Latin America and the Caribbean. To achieve this we have diversified sectors, for example, strengthening our involvement in technology, media, and telecom, as well as our funding – we can now provide financial products in several local currencies. We are also closer to our clients, with 42% of our field personnel based in 25 countries across the region.
But we’re not stopping there. Our new business plan for 2020-2022 reflects a renewed recognition of our role as a driver for impact far beyond financing. For example, we have signed up to support the Task Force on Climate-related Financial Disclosure (TCFD) and have placed the SDGs at the center of our actions. Personally, I see no other way to continue making investments in the future, not only in the region but anywhere in the world, without considering climate action and an inclusive sustainable development approach.
How do you measure impact in your deals? How important is impact to your investment decisions?
MP: All our transactions, whether they are blended or not, have a development impact rating on a scale from 1-10. The scale involves an extensive assessment that takes into account multiple dimensions, such as climate mitigation and adaptation, supporting SMEs/vulnerable populations, ability to crowd-in private capital, etc. If that score is not satisfactory, we do not do the transaction. Impact is, therefore, at the core of our investment decisions. For all transactions, we also measure the SDGs that the transaction is expected to contribute to.
In the case of blended finance, we have an additional layer, which is driven by the DFI Principles for Blended Finance. We ask ourselves what are the market failures preventing the transaction from being financed on a commercial basis and to what extent are blended finance interventions contributing to solving those market failures? Is this a commercially viable business model in the long run? What is the minimum concessionality required to close the deal? In this context, relying on a strong governance for the use of concessional finance is paramount. With more players entering the space of blended finance, I encourage them to subscribe to the principles.
GS: Just as Matthieu expressed, generating impact is the very purpose that drives our everyday work. Since we go hand in hand with the private sector, when we talk about impact, we mean achieving this through our clients and partners. Here is where blended finance has a key role. Since we started our blended finance activities in 2009, they have generated 50 investments for a total of US$375 million in concessional resources, which has leveraged US$950 million of our resources and US$2.2 billion from external investors. Looking at climate only, we have channeled a quarter of all climate-related international resources in the region.
Based on our data, most blended finance transactions target middle-income countries. At IDB Invest, is there any effort being made to target LDCs in your transactions?
MP: You need to look at the idiosyncrasies of the region we’re serving. For instance, Latin America and the Caribbean is the most unequal region in the world. If you look at CEPAL figures, 20% of the wealthiest people make up 45% of total household income, while the lowest quintile only accounts for 6%. That’s what drives our work. It’s not only income and wealth inequality, it’s ethnic, gender, or spatial inequality, including climate vulnerability. We are looking to address the developmental priorities of our region, whether it’s financing rural SMEs in Brazil through our Canadian Climate Fund, building access to energy in Haiti, or supporting climate resiliency in all our Caribbean countries.
Can you tell us about your professional background and what attracted you to the blended finance space?
MP: I’ve been leading the IDB Invest’s blended finance team for the last three years. I’m an investment banker by trade and I was first introduced to blended finance through climate finance.
Three things attracted me to the blended finance space: 1) The mission – doing something for a purpose; 2) How concrete it is – at the end of the day you’re financing projects in the real economy that are affecting real people; 3) It’s creative – You really can be creative in the ways you structure a transaction. That in and of itself is very rewarding.