Figure: The greatest opportunities for impact are in Sub-Saharan Africa, and South and East Asia.
Blended finance is a key tool to help nations meet the United Nations’ Sustainable Development Goals and the goals of the Paris Climate Agreement, while also addressing the risks and barriers faced by investors when pursuing the opportunities these afford. By using a combination of public and philanthropic concessional funding to leverage multiples of private investment, blended finance seeks to deliver both attractive returns to private investors and social and environmental impact to the public, bridging the gap to long-term commercial viability. But, like any tool, its deployment requires knowledge of how best to utilize it to achieve the results sought.
Fortunately, a rich foundation of experience in blended finance already exists, notably in the clean energy sector, where public, philanthropic, and private sector organizations have been innovating for many years, including through the Global Innovation Lab for Climate Finance (the Lab), for which CPI acts as Secretariat. CPI’s recently released publication for the Business & Sustainable Development Commission’s Blended Finance Taskforce, “Blended Finance in Clean Energy: Experiences and Opportunities,” synthesizes this vast knowledge base and proposes a path forward.
Here are a few notable findings from the report:
Seek the sweet spot: Aligning the impact goals of public and philanthropic sector funding with the requirements of private investors to generate returns that reflect the risks taken can be difficult to achieve, especially in developing economies or for new technologies. Blended finance needs to find the “sweet spot” – those countries that are still considered “risky” for investors, but have implemented policies conducive to private sector and clean energy investment, and that also have significant potential to achieve social and environmental impact goals. Our report identifies the top regions, countries, and energy sub-sectors that are the best fit for blended finance.
As an example of such an approach, Climate Investor One, an instrument from the 2014-15 Lab cycle, managed by Climate Fund Managers and supported by the Netherlands’ FMO, is a lifecycle financing facility for renewable energy projects. It focuses on the development, construction, and re-financing of projects in multiple countries that are sub-investment grade, thereby diversifying risk, reducing transaction costs, and deploying targeted concessional capital to countries that need it, all while delivering competitive returns to investors. The instrument has already raised more than USD 400mn from institutional investors and public finance institutions.
Blend risk, not just finance: Despite impressive reductions in the cost of clean energy, investors continue to face a wide variety of barriers that prevent investment, especially in developing economies. By analyzing 75 existing blended finance initiatives, we found a gap between the investment risks and barriers addressed by earlier blended finance initiatives – which were largely focused on reducing the cost of clean energy – and those cited today by the largest classes of investors – institutional investors and commercial banks – as most important to address going forward. Investors today are concerned with the lack of liquidity and small scale of many clean energy investments, as well as risks from volatile currencies and off-takers who lack credit-worthiness. Many are also concerned with the uncertainties present in early-stage businesses, such as start-up off-grid companies or grid-connected projects that face policy and permitting uncertainty before they even advance to construction. This means that risk mitigation instruments such as guarantees, hedging, and insurance are more important today, as are initiatives that absorb early stage risks and those that focus on aggregating and securitizing investments.
Another Lab instrument, the Long-Term FX Risk Management facility managed by TCX, has helped extend local currency financing for renewable energy by offering currency hedging solutions when commercial solutions are not available. Backed by a EUR 30mn concessional investment from the German government, the instrument mobilized another EUR 100mn in investments. Its currency hedging solutions have enabled M-KOPA, a Kenyan solar home systems provider, to connect nearly 500,000 homes in Kenya, Tanzania, and Uganda to solar power by matching the currency of the company’s loans with the currency of its cash flows.
Choose innovation and scale. Blended finance is still a relatively young market, offering opportunities for both new innovations as well as replicating, scaling, and mainstreaming ideas that are proven to work. Understanding whether to develop new solutions or to adapt existing ones requires local, market-specific knowledge and analysis, in addition to support from multi-stakeholder networks to identify strong initiatives and create connections among various national and international market players.
To give a sense as to how this could work, take Energy Savings Insurance, an energy efficiency instrument that was pioneered by the Inter-American Development Bank with the support of the Lab, as an example. After first being piloted in two countries in Latin America, this tool has mobilized at least USD 100mn in investment from public and commercial bank lenders to be replicated in 10 countries across three continents. The most recent implementations are being undertaken by the French Development Agency, another Lab member, which is replicating the early successes in countries outside the IDB’s territory.
Bring the whole toolbox. As a tool, blended finance is a means to an end, not an end in and of itself. For the results of blended finance efforts to be sustainable in the long run, the parallel deployment of other tools is required, such as continued policy and investment environment reforms and technical advisory services to build capacity on the ground. Systematic data gathering of technology and business model track records is also needed to develop a robust, quantitative case for investors, and lead to the demonstration effect that many initiatives cite as their rationale.
Many innovators are already taking these lessons to heart and building the next generation of blended finance initiatives. We’ve come a long way in understanding what it takes to succeed in blended finance, but there’s much more to be done to reach the aspirations of the global goals.
To read the full “Blended Finance in Clean Energy: Experiences and Opportunities,” report, please click here.