Source: Convergence (2020) State of Blended Finance Report 2020
Earlier this month, Convergence concluded its second series of virtual seminars designed to build capacity in institutions eager to employ blended finance. While the first set of seminars focused on popular blended finance instruments, Convergence’s second series of 10 seminars addressed the role of blended finance in select sectors, specifically in water and sanitation, climate and the environment, agriculture, financial inclusion, and health and education. The sessions attracted over 450 attendees from across Convergence’s global network, and beyond, including development agencies, financial intermediaries, and commercial investors.
Despite the unique development challenges facing each sector, Convergence did note a few reoccurring observations and recommendations to improve blended finance activity and increase private capital flows:
Observation: Timelines of blended vehicles and expected impacts do not always match
Recommendation: Deal sponsors should prioritize stakeholder feedback and educate investors on realistic timelines for impact assessment
Even with the best output and outcome indicators, impact evaluation on the full benefits of an intervention can often only be realized after a solution has been implemented. Consider changes in cultural norms for gender and increases in the resilience towards climate-related risks, which present over generations, and some impacts of sanitation, health, and education interventions, which display decades later. However, funders demand tight timelines for evaluating the social and environmental impacts of an intervention to match the term of the blended transaction. Consequently, deal sponsors should:
1) Discuss realistic impact indicators and timelines with investors to avoid over promising and under delivering. Closed-end blended funds – often 6 to 10-year fund terms with regular reporting processes – do not have the time to assess the longer-term social and environmental impact of their solutions. In such cases, deal sponsors should be very clear about what impact reporting is achievable during the implementation of a solution, and what data and insights can only be shared ex-post to convey the longer-term benefits of an intervention.
2) When possible, create investment vehicles with longer time horizons. Permanent capital vehicles, or ‘evergreen’ funds, are well positioned to report over longer time periods and see long term impacts materialize over time. One example is Finance in Motion’s eco.business fund, which provides debt financing to local financial institutions and businesses engaged in advancing biodiversity conservation, sustainable land use and climate change mitigation. In Nicaragua and Panama, the eco.business fund has financed measures to support the uptake of sustainable practices by cattle producers.
Observation: Blended finance shows increased appetite for technology-enabled solutions
Recommendation: Identify where technology-enabled solutions may already be a part of your portfolio of investees – if not, consider integrating it.
Digitalization has helped significantly scale access to and affordability of essential goods and services. The COVID-19 pandemic further proved that technology-enabled solutions are important to uphold critical services (whether financial services, health, or education) in times when in-person services may be restricted. As a result, there has been a noticeable boom in fin-tech, ed-tech and health-tech companies during a period of general economic slow-down because technology solutions are (i) more familiar to private investors from a cost perspective, and (ii) signal an intervention will not be dependent on public funding, further incentivizing private investors to put their capital to work.
Convergence’s membership features many institutions that support technology-enabled models, such as Impact Credit Solutions, Sakhiwo Health Solutions, Aiim Partners and EarthSpark International. In Convergence’s training seminar on financial inclusion, Lendable, another Convergence member, shared its experience investing in fintech companies across frontier and emerging markets. Participants learned that the high volume of financial data being collected by each of these companies is being used to facilitate credit risk assessments and ensure additional transparency. Whether as an investor or a deal sponsor, screening your portfolio for technology-enabled solutions may be worthwhile.
Observation: Too often, the most vulnerable borrowers have to bear foreign exchange risks
Recommendation: Engage in peer-to-peer conversations on using blended finance instruments to shift the foreign exchange risk to those who can bear it
How to manage foreign exchange risk was a topic that participants raised in almost all trainings. Convergence has long been advocating for increased local currency financing in international investments. However, most foreign investment, whether from impact investors, development agencies or development banks, continues to be denominated in hard currency (e.g., US dollar or Euro), placing the burden of managing foreign exchange risk on the enterprise or project itself or, even worse, on its ultimate end users, customers and beneficiaries.
Blended finance solutions can mitigate foreign exchange risk, shifting it from the most vulnerable parties to well-capitalized organizations that can best bear and manage the risk. But it will take concerted efforts to normalize the issuance of local currency debt and scale and replicate existing models. In these most recent virtual trainings, participants learned about to two specialized entities that are dedicated to hedging foreign exchange risks: The Currency Exchange Fund (TCX) and the currency hedging facility MFX. TCX, a Convergence member, provides swaps and forward contracts to investors and clients to help them provide their borrowers with local currency financing, while shifting the currency risk to TCX. TCX’s model is based on diversification (i.e., pooling the currency risks from lending activities globally) and a strong capital base. TCX is backed by numerous multilateral and bilateral development finance institutions and microfinance investment vehicles, and the Dutch and German governments. MFX is a credit intermediary that gives development lenders access to a range of hedging markets. Because MFX is backed by guarantees from the U.S. government and the Dutch government (FMO), it can hedge with very low collateral requirements.
From a market-builder perspective, Convergence sees a need for investors and deal sponsors to exchange information and data on portfolio diversification, hedging, guarantees, and other blended finance structures that can help shift the foreign exchange risk away from the most vulnerable. There is no need to re-invent the wheel; deal sponsors should learn from approaches others have taken. Peer-to-peer conversations are one way to facilitate knowledge sharing and move the needle.
Having concluded this seminar series, we are gearing up for our next series, which will start in June. Which seminar topics should we prioritize? Let us know your thoughts via this survey.