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03 May 22

Five things that could happen if blended finance scaled

Five things that could happen if blended finance scaled

This op-ed was originally published on Devex.

Last month, finance ministers, central bankers, and philanthropic sector leaders converged in Washington, D.C., for the World Bank Spring Meetings to discuss how to strengthen inclusive economic growth and alleviate poverty. In a time with many reasons to despair, these meetings offered an opportunity to reassess our progress when it comes to sustainable development, take note of obstacles, and chart a way forward.

In light of that, and on an aspirational note, I want to propose a thought experiment to those who participated in the meetings and anyone else engaged in development finance: What would the world look like if blended finance, the use of public and philanthropic funds to mobilize private capital, were to scale? What if blended finance were to realize its promise of mobilizing private sector funds to sustainable development in volumes never before seen — “billions to trillions”?

It’s something that I and my team at Convergence, the global network for blended finance, think about often. Especially following our last State of Blended Finance report, which found that like the rest of the global financial system, the blended finance market suffered a major setback during the COVID-19 pandemic. In 2020, blended finance flows dropped 50% to $4.5 billion.

Here are some of my thoughts on what it would look like if blended finance scaled:

1. Investors seeking to invest commercially in risky but fast-growing markets will be penalized for not considering the SDGs. In other words, if you’re an asset manager and your money needs accompaniment by concessional funds, the providers of that catalytic money will be asking hard questions about impact.

You’ll need to address their questions about why they should be shoring up your proposed investment or risk not having any donor interest in your deal. I expect we’ll see a cost-of-capital advantage for impact-promising transactions, similar to how green bonds currently command a premium to regular bonds.

2. There will be more transparency around foreign aid. We often hear that donors don’t want to work with the private sector because that’s where the corruption and the subdealing is, but in fact, the private sector has many more reporting responsibilities to shareholders, auditors, and regulators than donors often do.

So one, perhaps, unexpected outcome of blended finance scaling is that some aid flows will become more transparent, because the transactions they support will start showing up in companies’ financials. And that could lead to a feedback loop of greater transparency in decision making by donors, at least in their blended transactions.

3. Competition for catalytic money will build. If blended finance becomes business as usual and it is routine to go talk to a donor, then we may get into a situation where investors are pitching to donors, saying, “I know how to use your money better than the next person. This is how working with me will help you deliver on your mission faster, better, over a longer period.” The hope is that we end up having better and more efficient use of aid money because there is competition for it.

4. There will be a path for low-income countries into international capital markets. Maybe all the low- and middle-income countries in the world will end up with ratings, or at least shadow ratings. For instance, we’ll know that it takes 2 dollars of donor capital per dollar raised in one place and only 1 dollar in another place to achieve a credit rating on a bond.

5. Blended finance could permeate the retail investor market. As blended finance transactions become ubiquitous, donors will consider it reasonable and normal to sign onto deals whose primary purpose is to draw retail investors into markets that need developing.

Their development role will acquire another dimension, which is to create a globally connected world in which individual investors get to know faraway places, because money managers can put together risk-appropriate securities for them to buy, and with familiarity, perceived risk drops and so does the cost of capital for businesses in these countries.

These ruminations are not a pipe dream. Institutional investors currently allocate over $2 trillion — just over 1% of their total assets — to alternative assets in low- and middle-income countries relevant to blended finance. If this amount of private financing could be directed toward the SDGs through blended transactions, it would go a long way to realizing them.

Ultimately, what all of this means is that if blended finance scaled, we would see significantly more capital flow into emerging markets and toward achieving the SDGs, which would alleviate poverty, bolster climate action, and put us all on a more sustainable and resilient path.

The world of finance can feel amorphous and abstract, but the cumulative impacts of these deals are concrete. More capital flowing into a country that needs it means better infrastructure, healthier markets, and more opportunities for employment and entrepreneurship, which will improve the lives of everyone. So, after this look to the horizon, let us forge ahead and hope that some of the musings above can cross into reality.

About the Author
Joan M. Larrea

Joan M. Larrea is an expert in catalyzing investment in places that need it most and brings with her close to 30 years of experience in emerging markets investing. Joan has led Convergence since its inception, establishing it as the leading independent authority on blended finance. She serves on the Global Environment Facility Advisory Group for Non-Grant Instruments, the Advisory Council for FinDev Canada, and the Advisory Council for the U.S. Millennium Challenge Corporation. Prior to joining Convergence, she led the U.S. Overseas Private Investment Corporation's (OPIC) efforts to partner with philanthropic and private investors to increase capital flows to OPIC's target markets. While there, she also directed a pilot program to finance smaller, high impact, and innovative funds, many of which drew on blended finance structures. Previously, Joan served as a managing director on the emerging markets team at Global Environment Fund, an asset manager dedicated to the energy, environmental, and natural resource sectors. She began her career as an investment officer at International Finance Corporation, the private sector arm of the World Bank Group, where she concluded pioneering transactions in a variety of infrastructure and manufacturing sectors across Asia.