Mobilizing private capital through high-volume blended finance transactions is one of the main ambitions of development finance, especially for climate finance projects, as developed countries lag behind to their Nationally Determined Contributions (NDCs) of $100 billion a year. Among development banks, blended finance has been a buzzword since 2015, but the lack of significant market transactions shows that commercial banks and asset managers are not yet completely on board with the model. “Blended finance is a solution that should work,” says Anne Marie Thurber, managing director and group leader of the Structured Export Finance team, SMBC Americas Division. “But the trick is to bring all the stakeholders together.”
From the point of view of development banks, many factors hinder blended finance: transparency of information, inadequate project pipeline, lack of measures to assess impact and find the right balance of concessionality so as not to distort the market. But for commercial banks, the bankability of a project is a primary consideration. Bankable transactions typically involve credit enhancements by Export Credit Agencies (ECAs) or Multilateral Development Banks (MDBs) in emerging markets. “I would look for a blended finance component in deals that have the potential to be bankable, but there are one or two factors in there that don’t meet the criteria for a deal that could pass a credit committee,” says Thurber.
Assessing the bankability of a transaction involves a fundamental question: will the loan be repaid according to the structure of the transaction? Bankability factors include the market risk of a transaction, the involvement of proven but not commercialized technology, among others. “For example, it could be a deal where the market only allows for commodity supply deals or five-year off-take deals instead of the typical 10-12 years you need to the underlying project finance loan, so that’s where I see blended finance coming in, which is getting the deals close to bankable and funding them,” says Thurber.
Financing social impact
Despite the surge in private capital to support social impact-focused projects with initiatives such as the UN-convened Net-Zero Banking Alliance, traditionally private investors in emerging markets have not necessarily prioritized deals with the greatest development impact. According to Uxolo Development Finance Report: Mapping the public & private capital landscape 2021, a primary concern for private capital providers is the ability to generate market-rate returns, and investors are generally much more confident in returns when the projects have an integrated structure. into a set of users who are willing to pay. The vast majority of private equity respondents (86%) to the Uxolo survey expect a return at the market rate versus the concessional rate. Just under half of all private capital respondents indicated that the risk-return profile of development bank mandates was too extreme.
While DFIs and MDBs should have a greater risk appetite for projects in emerging markets, there is also a growing appetite for “sustainability deals” among commercial banks, driven by shareholder values and compliance. ESG. “The advantage of working with DFIs is that they have a different perspective,” says Thurber. “Financial institutions are very sustainability-focused, and they are increasingly looking at how they are deploying their capital and what the impact of that investment is.” Beyond the impact, the advantage of using DFIs and MDBs is the longer duration they are willing to accept. “Getting preferred creditor status from the development banks is a nice improvement,” adds Thurber. Development banks are uniquely well-equipped and well-positioned to leverage their high-quality loan portfolios with strong underwriting capabilities, long track records and low default rates.
Commercial banks are attracted to blended finance deals that involve infrastructure projects such as power plants, airports, and ports, which generate fairly reliable returns. Blended finance operations in emerging markets therefore focus on natural resource extraction, finance, utilities, real estate, construction and telecommunications. Even under the umbrella of climate finance, climate change resilience and mitigation projects involving infrastructure such as housing and clean energy power plants are attracting private capital. But social impact projects addressing other Sustainable Development Goals such as education, health, gender equality, migration, etc. are more difficult to fund.
According to the Uxolo report, private investors who partnered with a development bank primarily invested in infrastructure and renewable energy (65%), followed by agriculture/commodities (47%) and transport (47%). %). Despite the potential return in these sectors, only 6% was invested in Chemicals/Petrochemicals, Metals & Mining, and Oil & Gas alongside Development Banks, reflecting the ubiquity of lending. environmental, social and governance (ESG) issues in current private finance programs and also the general lack of support from interest development banks for these ‘dirty’ industries.
In contrast, less than a third of private capital providers report investing alongside development banks in health projects. This figure drops to 18% for education-related projects. Indeed, development banks often struggle to identify private capital providers that match their high-impact goals.
Money from donors and philanthropists plays an important role in blended finance deals associated with social impact, says asset manager, as they are willing to absorb substantial losses and inherently have a high appetite for risk .
Lack of pipeline
A common obstacle that development banks and commercial banks face is the limited number of transactions to choose from. “The lack of project pipeline and transparency are ongoing issues, which we are unable to completely address,” says Thurber. “But there have been efforts to address this, such as the World Bank-led Global Infrastructure Facility (GIF), where SMBC and other commercial banks are advisory partners. They continue to address challenges related to the project pipeline, information transparency and risk reduction measures. »
The GIF was established in 2014 as a G20 initiative to address the shortage of high-quality, bankable infrastructure projects by providing end-to-end transaction advisory services and support to governments and multilateral development banks. development. “This allows commercial banks, advisers, other capital providers and public sector institutions to come together at least once a year in a collaborative way to discuss innovative offerings, best practices, innovative structures, etc. “, says Thurber. “Of course, the subjects stay away from elements of a confidential or competitive nature. And, although this is a collaborative forum, outside of the forum we all compete for limited offerings and resources. And the other factor is that many deals may not be fully structured, so they can’t go public until they’re fully ready.
Similarly, to broaden the project pipeline in Asia, HSBC last year launched its partnership with Singaporean public investment firm Temasek to establish a dedicated debt financing platform for sustainable infrastructure projects in South Asia. South East. The facility is also supported by the Asian Development Bank (AfDB), which “will provide technical assistance and project development expertise in an emerging market context,” says Christian Deseglise, Group Head of Sustainable Infrastructure and Innovation, HSBC. A substantial portion of the platform’s loan portfolio will target unbankable sustainable infrastructure projects, providing project development expertise, technical assistance and blended finance solutions where needed. “Marginally bankable projects are those that commercial banks would not accept today as far as possible, but with technical assistance from the AfDB, we will try to make them more bankable,” adds Deseglise.
The goal is to catalyze large flows of capital into the sustainable infrastructure space, deploying large-scale blended finance over time to unlock more marginally bankable projects and create a tradable asset class, attracting private and institutional investors. “This platform aims to overcome two challenges around blended finance: finding the right risk-return balance and expanding the pipeline of projects,” says Deseglise.
HSBC and Temasek will invest up to $150 million in equity to fund loans, working with the platform’s strategic partners in the early stage. Longer term, the ambition is to build a pipeline of large-scale projects, with the platform granting more than $1 billion in loans within five years. “We have seen some very good examples of collaboration between the private and public sectors in the area of climate finance. But they can do more. They can take on more risk and mobilize private capital through instruments such as guarantee mechanisms, risk reduction enhancements and continue to work in collaboration with the private sector,” says Deseglise.
A central principle of blended finance is to build trust between different stakeholders, with different interests and values. According to the Uxolo report, private capital providers indicated that working with development banks posed a moderate challenge and that the time required to close a deal was presented as the biggest barrier, with 83% of the sample highlighting it as a main challenge. Development banks with too many criteria or requirements (61%) and extreme risk-return profiles (44%) are also among the top challenges from a private capital perspective.
According to a Dutch asset manager, the public sector is skeptical of the profit motive that drives the private sector. While on the one hand, commercial banks focus on assessing the risk-return profile of a transaction and are willing to delegate authority and discretion to the trader; on the other hand, DFIs and MDBs are preoccupied with impact and image management, and therefore are more embedded in a project and lack confidence that a project can be developed without their management. They are criticized for being bloated, slow and too conservative. Despite the bureaucratic challenges, almost all respondents (94%) in the Uxolo survey said they intended to work with development banks in the future, indicating that there is certainly an appetite among private investors for blended finance, driven by growing influence from ESG executives and shareholder advocacy.