NB Financial Innovation
Closing the $2.5 Trillion Gap: How blended finance can help achieve the SDGs
One of the most quoted numbers in international development today is $3.9 trillion. That’s the annual funding the UN estimates will be needed to achieve the Sustainable Development Goals (SDGs). That’s a pretty tall order – especially considering that current annual levels of official development assistance funding are only $180 billion, with combined public and private investment in the SDGs at only $1.4 trillion. This results in an annual funding gap of $2.5 trillion. To help close it, the international development community has been looking to tap new sources of capital – particularly from private investors.
Blended finance represents one approach that has the potential to attract new sources of funding to the biggest global challenges. As Convergence’s CEO Joan Larrea recently wrote in ImpactAlpha, the term refers to transactions that encourage more private investment by being strategic with the money already at work from official development assistance and philanthropic sources. Notably, blended finance transactions yield a financial return while also contributing toward achieving social goals, and in these transactions the public and/or philanthropic parties at the table are catalytic – making a deal happen that would otherwise attract little or no interest from the private sector. While it has been used in many forms in recent decades, blended finance is increasingly being discussed as a promising way to close the SDG funding gap. As a testament to this growing momentum, UN member countries reached consensus in June 2015 on the importance of deploying public funds to attract private investment through blended finance.
These transactions have enormous potential to change how development efforts are funded, but bringing together public and private investors is not easy. At Convergence, a new platform dedicated to supporting blended finance investments and building the market, we’re working with partners across the sector to answer two important questions: How can we provide practitioners with the time and funding to effectively bring together public and private investors, and execute on blended finance transactions? And what can would-be blended finance practitioners learn from the successes and failures of past efforts?
Designing structures that bring together public and private investors
Blended finance has much potential, but it faces a number of challenges to achieving scale. Convergence is dedicated to tackling many of these challenges, one of the most notable being the need to develop blended finance structures that effectively bring together public and private investors.
Blended finance structures can quickly become highly complex. They have multiple stakeholders at the table, all with vastly different objectives and requirements. Public investors want to ensure that their capital is truly additional and drives social and environmental impact, and that the risk/return allocation of the structure is fair. And while private investors may also have impact-related targets, they first and foremost want structures with acceptable risk-return profiles. Further complicating matters is the fact that public and private investors speak very different languages. These challenges make the process of developing blended finance structures costly and risky. To make things even more difficult, practitioners developing blended finance structures have few best practices to build on. At this point in time, little evidence exists on which approaches work, and which don’t.
Tackling design challenges through grant funding and knowledge sharing
Convergence hopes to tackle these design challenges in multiple ways. First, it offers grant funding for practitioners to design innovative blended finance structures. The process is similar to a challenge fund – practitioners apply to Convergence with their blended finance concept, and Convergence reviews applications and awards grants to the strongest ideas once per quarter. This funding allows practitioners to invest time in coordinating public and private investors, modeling impact and financial returns, and creating structures that appeal to both public and private investors. At the end of each grant, Convergence will publish knowledge documents that outline why practitioners made specific design decisions and what they learned from their design process. These learnings will create an important foundation for other practitioners to build on when considering similar blended finance structures.
Convergence recently announced the recipients of its inaugural Design Funding grants. One will go to Palladium for the design of an impact bond to fund maternal and newborn health interventions in Rajasthan, India, and the other will go to Rainforest Alliance for the design of a financing facility to increase lending to smallholder farmers in the Ghanaian cocoa sector. Both of these awards are exciting to those who are eager to see the blended finance field flourish – they represent bold structures that, if successful, could be replicated and scaled in multiple emerging market contexts. And if they’re not successful, at least practitioners will understand why.
Beyond pulling learnings from the experiences of its own grantees, Convergence is convening workshops, delivering tailored training sessions, and writing case studies on other blended finance transactions in an attempt to further build the evidence base and advance best practices. Convergence’s first case study on the Africa Agriculture Trade and Investment Fund outlines how Deutsche Bank successfully structured a fund with multiple layers of capital to invest in the agriculture sector in Sub-Saharan Africa. Focusing on a different structure, Convergence’s second case study on Sarona Frontier Markets Fund 2 details how Sarona Asset Management created a unique fund of funds structure with first-loss capital to invest in private equity funds across emerging markets. Each of these case studies contains useful insights and lessons for others who are considering structuring blended funds.
Convergence aims to build a thriving blended finance market, but we can only do so with the expertise and support of practitioners – we look forward to seeing the bold ideas practitioners put forward that bring together public and private investors to achieve the SDGs.