Required Reading: Why "Blended Finance" Is Among the Most Important International Development Tools
Andrew Herscowitz
CEO of the Mission 300 Accelerator, Former ODI Executive Director and Former Power Africa Coordinator, Development Finance Executive, and Diplomat
“The objective of blended finance is to ultimately create commercially viable markets that no longer need risk mitigation or return enhancements to attract private investment.”
“Blended finance creates investable opportunities in developing countries as a means to deliver more development impact.”
One of the reasons I joined the think tank world when I left government was so that I could share my own thoughts and those of my colleagues on how to improve the development ecosystem. I learned so much on the “inside.” But we know that we can be more efficient and effective with our limited global aid and financing dollars. We all have the same goal of helping more people and countries emerge from poverty and dependence as quickly as possible. Eventually, aid and development finance agencies should put themselves out of business, once countries and the private markets are equipped to solve development problems. That will be success.
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A key to that success is “Blended Finance.” I heard that term for the first time a decade ago. It took me a minute to understand what the person was talking about. I thought, “you mean what we’ve already been doing for many years already?”
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Blended Finance is sort of a fancy way of saying “subsidized financing.” And by subsidized, that can include low or below cost financing. It can mean free technical assistance (grants) that bring down the cost of a project. It essentially means using a little bit of public or philanthropic money to remove obstacles to help deals move forward. That's what we did successfully again and again with Power Africa. Or that money could be directed to intentionally bring down the cost of a deal to increase the development impact: such as providing small businesses with access to credit for the first time at a reasonable interest rate.
If your aunt gave you a little bit of money to help you with the down payment on your house, that’s blended finance as far as I’m concerned. You got some free money to help reduce your financing costs.
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Not everybody agrees on the definition, though. As you’ll see in the Convergence “State of Blended Finance 2024” report, the OECD, the DFI Working Group on Blended Finance, and Convergence each have their own definitions. I like Convergence’s definition the most.
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I’ve written more than a dozen blogs or Op-Eds since I joined ODI Global a few months ago, which essentially have the same theme:
WE NEED MORE BLENDED FINANCE!!!
Yes, I’m a broken record. Some people push back, asking me for more evidence that blended finance is even effective.
I know it’s effective because I’ve been doing it my whole career and have seen the positive results first-hand, not to mention many USAID audit reports on its Development Credit Authority loan guarantee program, including one I worked on in Uganda, which consistently demonstrated the effectiveness of the program.
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But now, thanks to Convergence, we have 93-page, detailed, fact-laden, evidence-based report. It’s dense. It takes a very long time to get through. But it’s damn good.
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It should be required reading for anyone who works in development or development finance. Because if you don’t read it, you're missing out.
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No need to worry, though. I took notes! So, I’m sharing my favorite quotes from this voluminous report with my own commentary. I hope you find it useful:
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Background:
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“Blended finance in 2024 benefits from the trial and experimentation in the past 15 years, with Convergence’s Historical Deals Database including 1,123 transactions for a total of $213 billion investment.”
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“Convergence observed a greater frequency of deals with ticket sizes over $100 million in 2023 than the previous two years (40% of deals in 2023, 17% in 2022, 28% in 2021).”
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Convergence recommendation: “Prioritize data transparency to showcase the actual risk of investing in developing markets to regulators and institutional investors.”
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Why blended finance?
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“The objective of blended finance is to ultimately create commercially viable markets that no longer need risk mitigation or return enhancements to attract private investment.”
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“The main investment barriers for private investors addressed by blended finance are:”
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“Blended finance creates investable opportunities in developing countries as a means to deliver more development impact.”
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“In blended finance transactions, which are a form of structured finance, often a concessional??? party takes up a junior tier, but without a market rate, higher return profile. The concessional party does so to adjust the risk-return profile for the tiers above them and make the transaction investible for the commercial investors in those senior tiers.”
“[W]e must accelerate the implementation of blended finance use now. This will continue to introduce more investors to more sectors and asset classes, keep investors engaged in the market to build their familiarity of investing in blended finance structures, and crucially, lead to EMDE investing becoming more central to their core investment activities.”
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“[B]lended finance can help by bringing together MDBs and national development banks (NDBs) to provide the financing necessary to support the development of climate-smart projects, like irrigation infrastructure, that support multiple stakeholders.”
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On how much ODA was used to support Blended Finance:
“ODA supplied to the entire blended finance market totalled $1.07 billion in? 2022, of which? about 10% was directed to projects in Ukraine.”
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Good examples of Blended Finance successes:
“[T]he Blended Finance for the Energy Transition (BFET) initiative, a partnership between the United States Agency for International Development ( USAID ), the Danish Ministry of Foreign Affairs, and the Investment Fund for Developing Countries ( IFU ), which aims to mobilize $1 billion in private sector capital to accelerate just energy transition efforts in EMDEs by supporting private sector-led investment vehicles;”
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“[T]he Investment Mobilization Collaboration Agreement (IMCA), a partnership between USAID, IFU, the Swedish International Development Cooperation Agency ( Sida ), and the Danish, Swedish, and Finish Ministries of Foreign Affairs, that will provide catalytic investment support and technical expertise to build out a pipeline of bankable climate-centric investments;”
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“ CrossBoundary Group Access has shared three project finance term sheets used for over $80 million of mini-grid projects in Africa. This activity, funded by the Shell Foundation and the UK Foreign, Commonwealth and Development Office ( Foreign, Commonwealth and Development Office FCDO ) under the Open Source initiative, allows others to adopt a mini-grid project finance approach more quickly and at lower cost.”
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Challenges to Blended Finance:
“The mixing of international capital and local capital can sometimes be a significant regulatory challenge and limit the opportunity for increased investment.”
“[T]ransparency in blended finance ensures that concessional financing does not lead to market distortion (e.g., by crowding out or over-subsidizing the private sector), and helps practitioners reduce structuring time, better assess market risk, spur replication, and ultimately build? an off-ramp to fully bankable transactions on commercial terms.”
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On Latin America & the Caribbean:
“Globally, Latin America and the Caribbean accounts for a larger share of agricultural production than the European Union or the United States plus Canada in 2020, and it is the world’s leading net food-exporting region. Agriculture transactions in Latin America and the Caribbean face additional challenges to attracting private sector capital finance, including low farm productivity and high inequality and informality. Latin America and the Caribbean also has one of the slowest global GDP growth rates at 2% in 2023. However, due to the maturity of the agriculture market there are opportunities for blended finance to be deployed in? advanced areas, such as the digitization of the sector, which will help it become more productive and therefore incentivize higher levels of private investment.”
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“Mid-sized businesses and project developers were the direct beneficiaries of most blended agriculture transactions from 2021-2023 (58% of transactions), while smallholder farmers were the largest end beneficiaries (72%? of transactions).”
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“An example of how the benefits of blended finance can directly flow through a company to a smallholder farmer is Thrive Agric, a Nigeria-based agri-tech company that links farmers to capital and global markets for their commodities. USAID WATIH provided a $1.75 million grant to the company, which enabled it to raise an additional $10 million to increase the number of rice, maize, and soybean smallholder farmers with access to its agronomy advisory services, harvest logistics support, and credit and insurance products.”
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On Energy:
“In the energy access space, ‘Blended finance is well-positioned to play a key role in delivering on these goals by helping to ensure a steady pipeline of bankable transactions in EMDEs.’”
“The energy sector remains the most active segment of the blended? finance market, comprising nearly one third of deal activity and 47% ($101 billion) of total blended capital? flows. Much of this investment targets renewable energy development—over the last year 91% of blended transactions in the sector channeled financing to renewable energy, with nearly $10 billion going towards solar projects.”
“Steady project pipelines, standardized business models, a growing? supply of sector-specific concessional funding, and substantial capital needs in EMDEs have energy blended finance primed to scale. To tap into the growing appetite for renewable energy assets among institutional investors blended finance instruments must be better tailored to their specific investment limitations and risk thresholds at both the portfolio (funds) and project level (bonds).”
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“PIDG is the most active development agency in energy blended finance since 2018, providing 55 investments for a total $550 million in concessional investment.”?
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On Financial Services:
“Blended finance in the financial services sector has proven to be countercyclical,? an effective way to during macroeconomic uncertainty to stabilize access to financing in EMDEs and protect? development? gains.”
“Blended finance transactions in the financial services sector are increasingly focused on supporting financial institutions to grow their on-lending activities to micro-, small- and medium-sized enterprises (MSMEs). These types of deals have gained prominence due to the sustained financial pressures faced by banks in [Emerging Market and Developing Economies] EMDEs precipitated by the economic fallout from the COVID-19 pandemic.”???????
“[T]here has been a notable decrease in the proportion of deals targeting rural communities and smallholder farmers within the past three years, from 55% of deals in 2018-2020 to 24% in 2021-2023. This aligns with broader research, which????? suggests that farmers are finding it more???? difficult to access credit than before the COVID-19 pandemic. The drop???? in blended finance transactions aimed at low-income or base-of-the-pyramid (BoP) consumers—from 57% to 27% between the periods 2018-2020 and 2021-2023—similarly raises concerns.”
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“US DFC is the leading provider of market rate capital to the two social sectors (10 commitments). US DFC funded the Future of Work Fund, which is engaged in financing tertiary education in? Rwanda, South Africa, and Kenya. The fund supports income sharing agreements, with a specific focus on women and other traditionally excluded populations. The fund will finance students’ tuition in return for graduates committing to repay a percentage of their income exceeding a specified threshold. UBS Optimus Foundation provided a concessional equity anchor investment, which mobilized funding from US DFC and other commercial investors. US DFC also provided a TA grant to support the fund manager, Chancen, in enhancing its? capacity to efficiently manage its portfolio.”
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On Health & Education:
“30% of concessional finance in blended health and education transactions is provided through grants, and 87% of this grant funding is financed by development agencies.”
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On Low-Income Countries:
“[L]ow-income countries have consistently attracted a significant number of infrastructure blended finance transactions. In fact, in 2023, low-income countries comprised 50% of infrastructure deals. Steady capital flows towards infrastructure transactions in low-income countries, particularly in Sub-Saharan Africa, indicates a willingness from commercial investors to have some exposure to the perceived higher risk associated with these countries in deals led by established deal sponsors.”
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“[D]eals targeting these countries often financed large corporations looking??????? to expand their geographic operational footprint in both low- and middle-income countries, especially in sectors like telecommunications.”?????
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On why DFIs and MDBs should take first loss and mezzanine positions:
“By exiting senior positions? and strategically taking first loss and mezzanine positions in the capital stack, [DFIs and MDBs] can effectively derisk investments and create a more attractive risk-return? profile for private investors. This approach is essential for mobilizing large-scale private capital, as it helps to overcome the perceived high risks associated with investing in emerging markets and developing economies.”
“$13-15 billion of concessional funds could mobilize $280+ billion of private investment. As the leading allocators of concessional capital, MDBs and DFIs must become more ambitious and deliberate in aligning concessional pools with private-sector mobilization outcomes.”
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On why more aid money (ODA, IDA, etc.) should be made available to DFIs and MDBs:
“[T]he use of technical assistance?and funds [are] highly effective in achieving impact targets. For example, by providing targeted support for project preparation and capacity building, an enabling environment for increased blended finance transactions and enhanced development impact can be achieved.”
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On why it’s important to mobilize local resources in countries:
“[T]he blended finance community must prioritize programs that strengthen the ability of local governments to identify, develop, and implement bankable blended finance projects. Moreover,? the mobilization of domestic capital, particularly from institutional investors such as pension funds and insurance companies, can help to create a more sustainable and resilient blended finance ecosystem.”???
Executive | CEO | Business Development | Global Marketing | Strategy | Entrepreneur | C-Level Trusted Advisor | Result Driven | Leading Opening of an International New Market to Generate Revenue
1 个月Dear Andrew Thank you very much for sharing. My colleague would be happy to work with you. [email protected]
African Economic Development Executive, Private Sector, International Trade, and Investment Specialist, Servant Leader
8 个月Thanks for the "CliffsNotes" version Andy...will definitely share...
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9 个月I DO SUPPORT THE PROPOSED BLENDED FINANCE and HOPE this will expedite process, be inclusive of related fields together, ease monitoring and reduce complexities.
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