As we move into the third year of the “Decade of Action”, the need to mobilize private sector capital has never been more urgent: the SDG funding gap is growing, climate action stalls, and COVID 19 continues to ravage populations and devastate economies worldwide. At the same time, current blended finance flows are not on track to achieve the billions to trillions agenda.
What does this mean as we head into 2022? Below we highlight five blended finance trends to watch in 2022, including a number of positive initiatives on the horizon:
1. Institutional investors are coming to the table – and concessional capital providers must rise to the occasion
As noted in our State of Blended Finance 2021 report, the blended finance market is yet to realize the full potential of the private sector in closing the SDG financing gap, with institutional investors continuing to represent a smaller segment of blended finance flows (13% of private sector commitments between 2018-2020). However, we are seeing more coordinated action from institutional investors, particularly in climate finance. Most recently, COP26 saw the pioneering Glasgow Financial Alliance for Net Zero (GFANZ), a global coalition of leading financial institutions, including banks and asset managers, who have committed over $130 trillion of capital to achieving net zero emissions by 2050. The Alliance will include existing initiatives such as the UN-convened Net Zero Asset Alliance, which represents 67 institutional investors including Allianz, Swiss Re, and Caisse des Depots.
To realize the full potential of this capital towards climate finance in developing countries, blended finance will serve as an important catalyst. As noted by BlackRock CEO Larry Fink, mobilizing $1 trillion in private climate finance will require at least $100 billion in grants and subsidies. Convergence will be collaborating with the Net Zero Asset Owner Alliance in 2022 to: i) increase the Alliance members’ access to development finance and blended finance transactions seeking private investment, (ii) increase direct collaboration between the Alliance members and the official development finance community, and (iii) realize the intersecting recommendations of the Scaling Blended Finance discussion paper and the Climate Finance Delivery Plan.
2. Climate finance will continue to represent a significant market for blended finance, including adaptation activities
According to the Climate Policy Initiative, global adaptation finance increased to $46 billion in 2019-20 from $30 billion in 2017-18, but is still nowhere near meeting the estimated needs of $180 billion per year through to 2030. In contrast, financing for climate change mitigation reached $571 billion in 2019-20. Similarly, most climate blended finance deals have targeted climate mitigation; specifically, renewable energy (43% of climate transactions) and energy efficiency (20%). Meanwhile, climate adaptation has not been highly targeted by blended transactions, with sub-sectors like sustainable agriculture being targeted by only 8% of climate transactions.
However, there are promising signs that blended finance is having more success in mobilizing capital towards adaptation. Convergence has observed uptake in several adaptation finance sub-sectors since 2018, such as in climate-smart agriculture and land and marine resource management. For example, one of the earliest blended solutions supported by Convergence’s Design Funding program, the $364 million Blue Bond for Ocean Conservation, recently reached a financial close, making it the world’s largest marine-focused debt conversion to date. Backed by the Nature Conservancy, Credit Suisse, the Government of Belize, and the U.S. International Development Finance Corporation (DFC), the bond will allocate capital towards debt sustainability and marine conservation for Belize.
3. As the COVID-19 pandemic enters its third year, pressure will grow on MDBs and DFIs to play a more active role in mobilizing private capital at scale
The OECD estimates that the annual SDG financing gap has risen from $2.5 trillion to $4.2 trillion, due to pandemic-related financing needs and a drop in external private resources. With concessional commitments from MDBs and DFIs to blended transactions remaining constant over the past 5 years, pressure will grow on MDBs and DFIs to leverage and mobilise greater volumes of private sector resources in 2022, consistent with their development additionality and financial additionality mandates.
4. In response to the ongoing effects of the pandemic, health transactions will continue to gain momentum in 2022
While blended finance has been less deployed in health for various reasons, we’re likely to see a continued upturn in blended transactions targeting health in 2022 in response to the pandemic. Recent examples include the Indonesian Resilience Fund (IRF), launched to support Indonesia’s healthcare sector in response to the pandemic and supported by investors like USAID, DFC, and Australian DFAT; and BlueOrchard’s COVID-19 Emerging and Frontier Markets MSME Support Fund, which achieved a second close of over $200 million in 2021, backed by investors like IDB Invest, CDC, DFC, and the Japan International Cooperation Agency. Similarly, the prioritization among both donors and private investors to keep small businesses afloat in the context of the COVID-19 pandemic suggests that micro-, small-, and medium-sized businesses (MSMEs) and small and growing businesses (SGBs) will continue to absorb the lion’s share of blended capital, with nearly 50% of all transactions between 2018-20 directly targeting one or both groups.
5. Rising global interest rates will make the de-risking blended finance provides more compelling, attracting local institutional investors seeking diversification and adjusted market conditions
Despite their superior understanding of local investment landscapes and their ability to invest in local currency, numerous factors have hindered the mobilization of local institutional investors into blended finance at scale, such as regulatory limits and their unfamiliarity with alternative asset classes. However, rising global interest rates will increase the attractiveness of the de-risking that blended finance can provide, attracting local institutional investors seeking diversification and adjusted market conditions.
Recent examples of local institutional investors coordinating within the space include the Kenya Pension Funds Investment Consortium (KEPFIC), a consortium of Kenyan retirement funds launched in 2020 and supported by the US government through USAID’s Kenya Investment Mechanism, Power Africa, the World Bank Group, and MiDA Advisors (in partnership with USAID INVEST). The consortium looks to collaborate on making sustainable long-term infrastructure and alternative asset investments in the region, building the infrastructure investment capacity of member funds and the institutional investment ecosystem in Kenya as a whole.