Catalytic Capital | November 16, 2017

Blending finance to crowd in private capital for climate action and the global agenda

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By Joan Larrea, CEO of Convergence, and Chiara Trabacchi, climate finance specialist at IDB Invest

There’s more than just the future of the climate at stake in the global talks underway in Bonn, Germany. All of the global goals for 2030, from the end of poverty to the regeneration of land and sea, will fail if the 2015 Paris climate agreement fails first.

Climate change and its impacts cut across nearly all the Sustainable Development Goals, from affordable and clean energy (№7) to eradication of poverty (№1) and gender equality (№5).

So let’s imagine success. Against the backdrop of the COP23 climate talks, imagine a world where private investment were indeed flowing in the trillions of dollars to keeping the planet under two-degrees Celsius of warming and meet the 2030 SDG deadlines at the same time.

What will the world look like when private investors and financiers have seized climate-smart investment opportunities estimated to be $23 trillion in just 21 economies representing about half of all global greenhouse gas emissions, not to mention those in the other half of the global economy? How can we get there, fast?

Carrots and sticks

Regulation and policy is prodding corporations, investors and financiers to respond with new restrictions, requirements and incentives for investing in needed changes. Shareholder and industry pressures have also led to divestment from fossil fuel and enhanced disclosures on climate footprints and on climate-related risks to their businesses.

What has been missing are ‘pull strategies’ that allow the private sector to bet massively on the sustainable development challenge, and to bring its capital, creativity and skills to the fore.

This is where blended finance comes in to leverage public and philanthropic concessional money. Blended finance has the potential to pull private investment into geographies and markets otherwise deemed too risky, costly or not business-relevant.

For example, energy savings performance structures pioneered in Mexico and Chile, which unlocked financing for energy efficient public lighting at the municipal level. The private sector arm of the Inter-American Investment Bank (IDB) Group, IDB Invest, which has a range of blended finance approaches for engaging private investors and financiers in climate action, deployed donors’ concessional capital to demonstrate highly scalable and replicable financing models. By mitigating early-mover risks, IDB helped institutional investors slow low-carbon assets into their traditional asset-allocation models. The Canadian Climate Fund and the Clean Technology Fund supported the deal.

That risk-return profile is the key to commercial viability. In developing and emerging markets with poor institutional, political and economic conditions, blended finance can help rebalance the risk-return profile to address investors’ concerns by acting on both sides of the equation. IDB Invest is developing aggregation and securitization platforms structuring the concessional finance tranche to meet institutional investors’ risk appetite.

Blended finance also allows for the creative structuring needed to address mispriced climate change risks, getting climate-smart investments off-the-ground that wouldn’t otherwise happen. In Colombia, loans are letting small farmers and micro-entrepreneurs make investments in agricultural production while reducing their vulnerability to climate-related impacts. With resources from the Global Environment Facility, IDB Invest is partnering with a microfinance institution to provide working capital and loans. These transactions, still underway, would demonstrate the viability of innovative business models and investments, thereby encouraging replication with lower or no subsidy.

Guiding principles

This world that we have painted, in which companies, asset owners, and banks are putting their money hard to work alongside public institutions, is not that far off.

The recently published State of Blended Finance report a set of 187 blended finance transactions alone have already mobilized US$ 51.2 billion towards sustainable development, with financial services, energy and climate sectors accounting for half of blended finance deals. It may be tough to structure investible climate change-related transactions, but it can and is being done, and blended finance is one of the ways we will get there. To date, sub-Saharan Africa has received the largest share of blended finance by number of deals (36%), followed by Asia (20%) and Latin America (17%).

The report, from Convergence, covers blended finance deals across sectors and geographies. The concessional element in these deals may show up as first loss capital, as guarantee or other risk capacity, as technical assistance or as the first money into an early concept.

Organizations such as Convergence, the IDB Group, and other Development Finance Institutions, will continue to expand the evidence-base as investors develop, pilot, and replicate innovative financial mechanisms using blended finance. To mount a successful financial response to climate change, the international community meeting in Bonn has the opportunity to reflect on the experience gained to date on blended finance, its guiding principles, and expand the range of instruments used.

For the world to meet its common goals, we need to see public, philanthropic, and private investors working together to crowd-in more investment in sustainable development.

Only then will the world envisioned by these global agreements become a reality.

Unlocking blended finance for the 2030 global goals

Joan Larrea, CEO of Convergence, the world’s first blended finance institution, and Chiara Trabacchi, Climate Finance Specialist, Advisory Services and Blended Finance Team of IDB Invest — the private sector arm of the IDB Group.