As host of last year’s COP28 climate gathering, the United Arab Emirates made a splash with its $30 billion Altérra climate fund. Tucked within: A carveout for catalytic investments to mitigate risk and crowd in commercial investments in climate solutions for the Global South.
The $5 billion Alterra Transformation fund is among the largest deployments of catalytic capital to date. The Transformation fund has seeded TPG Rise Climate’s Global South Initiative with $500 million, and Brookfield’s Catalytic Transition Fund with $1 billion.
Altérra “wants to challenge the status quo of how we invest in climate solutions,” Altérra CEO H.E Majid Al-Suwaid said earlier this year.
Larger blended finance funds, which leverage guarantees, first-loss reserves and other forms of catalytic capital, are creating investment-grade pathways for renewable energy, sustainable agriculture and small business lending in emerging markets.
Blended transactions hit a five-year high of $15 billion last year. While billion-dollar-plus deals remain rare, a raft of recent examples provides practical lessons for catalyzing billions for climate and development impact.
Climate Investor Two has leveraged a tranche of first-loss capital to raise more than $850 million for climate adaptation and mitigation in emerging markets. Project GAIA, led by Mitsubishi UFJ Financial Group, is targeting $1.5 billion, for a similar mandate, with at least 25% for least-developed countries and small island states. The SDG Loan Fund raised $1 billion from institutional investors with catalytic capital from FMO and MacArthur Foundation.
On this Thursday’s Agents of Impact Call, Climate Fund Managers’ Rajashree Padmanabhi will join Mitsubishi UFJ’s Ariane Pevide, MacArthur Foundation’s Debra Schwartz, and Convergence’s Nnamdi Igbokwe, to share practical lessons in “Blending Billions,” Thursday, Sept. 19, at 10am PT / 1pm ET / 6pm London. RSVP today.
High leverage
The $1 billion SDG Loan Fund took more than three years to put together (for background, see “Allianz’s SDG Loan Fund leverages a $25 million guarantee to catalyze $1.1 billion”). Like other large institutional investors, Munich-based Allianz, which manages more than $2 trillion, faced obstacles, including the need to write large checks, in allocating capital toward the Sustainable Development Goals and other impact frameworks.
The insurer sought out FMO, the Dutch development finance institution, which agreed to put up a first-loss reserve of $111 million, or 10% of the committed private capital. FMO’s rare willingness to take such a junior position provided downside protection for Allianz and other senior lenders, including the Swedish bank Skandia.
To satisfy FMO’s own risk considerations, MacArthur Foundation, with its Triple-A rating, agreed to put up an unfunded guarantee commitment of $25 million to protect FMO against downstream investment losses.
“The ratio between the dollars committed to the guarantee and the dollars ultimately unlocked from the private investors is a 40:1 ratio,” MacArthur’s Debra Schwartz told ImpactAlpha. “That’s a pretty efficient use of our impact investment, we think.”
The vehicle is “one of the best examples to date of aligned partnership among commercial institutional investors, development finance institutions and foundations,” wrote Laurie Spengler of Courageous Capital Advisors in a guest post on ImpactAlpha, and demonstrates “that mobilization at scale is possible.”
Risk mitigation
Launched out of the Global Innovation Lab for Climate Finance, Climate Investor One leveraged a tranche of first lost capital to raise and deploy more than $800 million to finance climate mitigation strategies in emerging markets, with a particular focus on renewable energy projects. Deployed through three funds, the financing facility provided early-stage development, construction financing, and post-construction refinancing for more than a dozen renewable energy projects.
Climate Fund Managers, The Hague-based fund manager that manages the blended strategy has already raised more than $850 million for Climate Investor Two with a similar structure and an expanded mandate that includes adaptation strategies such as oceans, water and sanitation infrastructure.
The blended approach has allowed the manager to “mobilize private sector financing at scale for the climate crisis,” CFM’s Rajashree Padmanabhi tells ImpactAlpha. Private institutional investors in the fund include KLP, BNG Bank, SwedFund and the Green Climate Fund.
CFM last year structured and invested from its second fund in one of the largest debt-for-climate conversions in history to protect the Galapagos Islands. The transaction exchanged $1.6 billion in Ecuadorian government bonds for a $656 million impact loan. From the $1.1 billion in savings, Ecuador will invest $323 million by 2041 to conserve the Galapagos and create an endowment fund to finance preservation efforts.
The presence of first loss capital, which exists to absorb the initial losses of the fund, helps “remove or reduce the investment risk in emerging markets, enabling private capital to participate at a risk return profile that meets their requirements,” says Padmanabhi.
Climate + gender
The climate may be changing fast, but adapting to those changes requires a long-term strategy. The $1.5 billion Project GAIA has an investment timeline of 30 years.
The blended finance vehicle from Canadian development finance institution FinDev Canada and Mitsubishi UFJ Financial Group is working to rally both public and private capital to support climate resilience and the green transition in low-income countries. The partners set up GAIA as a long-term debt facility for large projects needing $250 million in financing or more.
Unlike most mega climate funds in the market, 70% of GAIA’s capital must be invested in adaptation projects, including ecosystem preservation and restoration, food and water security, and health and wellbeing. A quarter of the capital must go to the least developed countries and small island nations, including Barbados, Benin, Togo and Jamaica.
GAIA, named for the Greek goddess personifying Earth, is also set to become one of the largest – if not the largest gender-focused climate fund. The partners have pledged 2X Criteria alignment for gender inclusion, project-level gender action plans to promote women’s empowerment, and risk screening and mitigation on serious human rights abuses, including gender-based violence and sexual harassment or exploitation.
Project GAIA aims to address a myriad of other adaptation finance obstacles in low-income countries that struggle to borrow affordably.
First, funding can be used flexibly so countries can decide which are their “most pressing mitigation and adaptation priorities.” Second, capital will be disbursed in a mix of hard currency and local currency, mitigating risk for investors while easing potential strain from currency volatility. Third, no sovereign guarantee will be required for eligibility. Finally, an adjoining vehicle will provide technical assistance and help with costs for project development, pre-construction and other project set up needs to help “realize the projects’ impact potential and advance financial sustainability.”
GAIA is being set up with multiple capital layers and de-risking mechanisms. Timeline-wise, that includes a 7.5-year ramp up period to build a pipeline of investable projects. Structurally, it includes a first-loss, junior equity tranche, a second-loss guarantee tranche of up to $300 million, and foreign exchange hedging to buffer losses on local currency loans. The Green Climate Fund has approved up to $150 million in junior equity, or 10% of the fund, depending on how much the partners raise. Axa XL has signed on for up to $50 million for the guarantee tranche. GAIA will look for grant funding for the parallel technical assistance facility.
Scale and impact
Some earlier lessons of large-scale blended finance facilities are emerging.
In an earlier report for ImpactAlpha, Dalberg’s Kusi Hornberger and Marcos Paya analyzed the 39 blended transactions of over $1 billion in Convergence’s deal database (such large deals represent less than 3% of more than 1,100 deals). Among the takeaways: Africa and climate projects attract the largest shares of billion-dollar transactions. Transactions structured with technical assistance or concessional capital are more likely to achieve their impact targets than those with guarantees. And companies, facilities and funds more often hit their impact targets than projects.
“Such scale can not only draw substantial institutional investments but also demonstrate that the deployment of concessional financing can be done with greater efficiency,” wrote Hornberger and Paya.
In a separate analysis of large, first-of-their-kind approaches to blended finance by African development finance agencies, Convergence’s Aakif Merchant highlighted the essential role of credit enhancement, investment grade pathways for private capital and diversification of funding sources
“Standardization and scale of financial products are key to mobilizing commercial capital towards Africa’s development priorities,” wrote Merchant.
