Investment gaps in emerging markets
Emerging markets need massive investment to mitigate the looming climate disaster that will affect everyone. UNEP estimates that figure to be somewhere between USD 187-359 billion per year[1]. To mobilise capital of this magnitude, the development finance industry needs to learn from some asset classes that have successfully channelled private investment into the market. Only then can it support emerging markets and developing economies’ growth while still transitioning to clean fuels.
Successful capital markets model
Nothing comes close to the capital markets as a means to deliver the scale that is needed. Capital markets thrive on homogeneity. It is standardisation and aggregation that have unlocked the multi-trillion volume we see in, for example, the bond markets. Intermediaries structure and underwrite a uniform product that can be rated, listed, traded, hedged, indexed, reported, regulated, analysed, compared and benchmarked against almost any other in the same asset class.
The green, social and sustainability (GSS) bond market, which has grown past USD 5 trillion[2] benefits from standardised impact metrics, such as the regional allocation of a fund, that can be traced and reported against. In turn, this enables asset managers to calibrate their performance against sustainability indices such as the Dow Jones Sustainability Index or FTSE4Good Index and attract further savings drawn to investing for the good of the planet.
A unique challenge
But this does not address the current funding volume question for emerging markets. The Organisation for Economic Co-operation and Development (OECD) estimates there are over 200 different types of blended finance structures on offer[3]. That would discourage any market participant from investing any time analysing or tracking this asset class, let alone commit any capital. Currently, almost every blended finance facility is bespoke – tailored either to an investor’s requirements, or to those of the provider of the risk buffer (i.e. the “first loss” provider). Together with time-consuming due diligence, this leads to a protracted fund-raise, complex and expensive documentation, and low liquidity.
Understanding why this has come to be may at least help define the problem that we need to solve if capital is going to be unlocked at the scale and pace needed. The answer is not simple, but lies in successfully addressing the various perceived risks inherent in the transaction: credit, liquidity and refinancing being the main elements, all of which have given rise to investors needing varying levels of assurance to mitigate them.
Growing risk appetite and need for standardisation
The fact that over 200 different structures have been developed in blended finance is indicative of the scale of interest. It also shows that the risk appetite exists, but that as an asset class, it is not a compellingly scalable investment proposition. We also know that the financial industry is comprised of many different stakeholders whose interests are not always aligned.
Brady bonds were an example of successfully aligning the interests of multiple stakeholders, which crucially restored access to capital markets for debtor nations, enabling the delivery of volume across several emerging markets.
Indeed, various asset classes in the capital markets have succeeded by unpicking the different stages and risks of a transaction in ways that have incentivised different interests to create volume. They flourished by creating investment propositions that are as “plain” and “vanilla” as possible and therefore lend themselves to mobilising private investment at scale, far more so than the esoteric blended finance structures that are all too often only the preserve of development finance institutions themselves. Put more simply: they currently don’t mobilise nearly enough.
The need for an intervention
We know that aggregation vehicles such as PIDG’s Emerging Africa and Asia Infrastructure Fund (EAAIF), Allianz’s EMCAF, Climate Fund Managers’ Climate Investor One and others are successful in meeting their clients’ needs. There is now an opportunity for funds such as these to harmonise certain terms when raising capital of their own, or even perhaps to tap the capital markets. Equally, more such funds could be created if common standards were to be adopted when structuring them, as is the case in export finance transactions.
This poses a two-part challenge for the industry including those who work in development finance: first, to create standard forms of risk mitigation instruments that all parties can more easily structure, analyse and compare for greater investor assurance; and second, to incorporate elements of these into real, simpler, investable and scalable opportunities that will enable private capital to flow more easily and process more expediently. Only by working together with these objectives in mind will blended finance deliver on its promise.
PIDG uses blended finance to: stimulate innovation in infrastructure development and financing to improve people’s lives and advance climate goals; de-risk infrastructure projects into commercially viable, investment-ready and sustainable operational assets that attract private capital; mobilise domestic and international investors into sustainable infrastructure and develop local capital markets for infrastructure; deploy private capital for infrastructure where it is most needed to achieve the Sustainable Development Goals and global climate goals; raise standards in infrastructure development and sustainable finance and build local capacity. Our long-term debt fund, The Emerging Africa & Asia Infrastructure Fund has been a successful blended finance instrument for transformative infrastructure projects over the past 22 years.
[1] 2024 UNEP Adaptation Gap Report https://www.unep.org/events/publication-launch/launch-adaptation-gap-report-2024
[2] World Bank https://thedocs.worldbank.org/en/doc/dacb969cc71f53abde2d2758f1cc13ed-0340012024/original/GSSS-Quarterly-Newsletter-Issue-No-8.pdf
[3] Dembele, F. et al. (2022), “Blended finance funds and facilities: 2020 survey results”, OECD Development Co-operation Working Papers, No. 107, OECD Publishing, Paris, https://doi.org/10.1787/fb282f7e-en.
