The EMDE funding agreement between the European Commission, EIB has been welcomed, but global goals need global reform.
Public sector-led funding initiatives, such as the EU’s latest commitment to invest in sustainability-focused projects across select emerging markets and developing economies (EMDEs), will not meaningfully reduce the private sector investment gap in the blended finance market, said experts calling for systemic reform.
Last month, the European Investment Bank (EIB) and European Commission signed guarantee agreements to mobilise up to €3.5 billion in lending under the European Fund for Sustainable Development Plus (EFSD+) and €500 million to the ACP Trust Fund to support sustainable development-focused businesses across African, Caribbean and Pacific (ACP) countries until 2027.
The transaction included specific measures to attract private investment alongside the public funds, but new approaches are said to be needed to prompt step change in climate- and nature-positive capital flows to EMDEs.
“The announcement is important, but far from sufficient, with responsibility for mobilising the scale of investment needed not sitting with any single entity,” Thomas Tayler, Senior Manager of the Sustainable Finance Centre for Excellence at Aviva Investors, told ESG Investor.
“Systemic reform, rather than individual announcements, is needed if we are to collectively mobilise the scale of investment needed for a just transition to a low-carbon economy.”
The new €4 billion commitment adds to the €26.7 billion agreement for public lending that the EU and EIB signed in May last year.
“These are big numbers, so this will definitely move the needle, even if much more like this is needed,” countered Harald Walkate, Founding Partner of blended finance advisory firm Route17.
“This does suggest to me that momentum around blended finance is building.”
The funding provided under the EFSD+ will allow the EIB to provide loans on “favourable terms” to generate sustainable jobs and opportunities across ACP countries, the announcement said, whereas the ACP Trust Fund, which is managed by the EIB, will enable “high impact operations”, such as supporting small renewable energy power plants in areas with no grid connection.
EFSD+ has €40 billion in guarantee capacity, with the EU providing up to €13 billion of guarantee cover until 2027, which the announcement said will better enable the EFSD+, EIB and European development finance institutions (DFIs) to de-risk activities and leverage private investment, supporting investors looking to access more challenging markets.
“Backing the private sector is key to foster a green and inclusive growth in ACP countries and globally,” said Werner Hoyer, EIB’s President.
“As public institutions, we need to go the extra mile to make our value proposition attractive for private investors and drive investment in climate, energy, health, food security, digital solutions that will create impact and ultimately boost prosperity.”
Getting the right blend
Despite its de-risking intentions, this kind of blended finance initiative isn’t effective enough to mobilise action from private investors, according to Chris Clubb, Managing Director, Europe, at global blended finance network Convergence.
“One type of blended finance is when you have concessional money coming from the public sector, such as the European Commission, and then non-concessional money from the public sector in the form of debt and equity investments from the EIB, EFSD+ and development finance institutes (DFIs),” he said.
“The blending of concessional and non-concessional finance has little to do with mobilising cross-border private investment.”
On average, blended finance funds leverage US$4 of commercial capital for every dollar of concessional capital, with just US$1.10 coming from private sector investors, according to a 2018 Convergence study that benchmarked leverage ratios for a sample of 72 blended finance funds.
In February 2023, Convergence assessed 340 transactions, expanding beyond concessional debt and equity transactions to other blending archetypes, like guarantees and technical assistance. The updated study noted that the average leverage ratio remains at 4:1, with just under half of the commercial financing mobilised by each dollar of concessional finance coming from private sector sources, with the rest supplied by MDBs, DFIs and philanthropic investors.
More involvement from private investors is desperately needed, Clubb said. The Sharm el Sheikh Implementation Plan – the final agreed statement at the end of COP27 – noted that financing the global transition will require annual investments of between US$4-6 trillion. On top of that, developing countries currently face a US$4 trillion annual investment gap for the UN Sustainable Development Goals (SDGs).
Catalytic capital from public and/or philanthropic sources should attract private sector investment in sustainable projects by de-risking investment opportunities.
However, Convergence noted in a report last year that climate-oriented blended finance transactions are in decline, from US$36.5 billion between 2016-18, decreasing by 60% to US$14 billion between 2019-21, with 25% of these commitments coming from institutional investors.
EFSD+ would be more effective if funding was opened up to a greater variety of sources, Clubb said.
“The EU and its members should be funding the best ideas and have an open competition, whether those ideas come from developing or developed countries, whether they come from the public or private sector,” he said.
“Organisations using concessional money should be allocating this funding to the best ideas globally to achieve the objectives they are trying to solve.”
Private investors are unveiling plans to upscale blended finance vehicles.
Last year, Allianz Global Investors announced its plans to launch the US$1 billion Allianz Climate Solutions Emerging Markets (ACSEM) strategy with Allianz Group and a regional DFI, adding to Allianz GI’s US$2.5 billion in commitments across five blended finance vehicles since 2017.
Reorientating the whole financial system to prioritise raising capital to contribute to long-term sustainable solutions is pivotal, experts agreed.
Issues like climate change are systemic and need a systemic response, said Tayler from Aviva Investors.
“A plan to mobilise all sources of funding is required for that – including overseas development aid and grants, projects funded through MDBs and international financial institutions and those that see concessional finance and guarantees crowd in private capital, use of sovereign debt and sovereign green bonds, projects that can be funded solely from private sources, foreign direct investment by corporates, utilisation of domestic capital and national development banks and capital pools,” he said.
In November, Convergence and the United States Agency for International Development (USAID) published an action plan for how public and philanthropic financial resources can act as a “systemwide catalyst”, working strategically with MDBs, DFIs and private investors to drive positive systemic change. The plan was developed in consultation with 100 public, philanthropic and private stakeholders.
One of the recommendations outlined in the plan is to establish a Catalytic Funding Network and an Investment Mobilisation Hub to coordinate stronger de-risking integration among public and private investors.
A number of MDBs also made a joint statement at COP27, pledging they would expand their support for countries’ climate transition efforts through a number of measures, including upscaling blended finance vehicles.
“Despite all the talk about ESG and impact investment, it’s not the primary role of pension funds and insurance companies to come up with interventions to address the SDGs – that is the role of governments, development banks, and perhaps NGOs,” said Route17’s Walkate.
“However, if the public sector takes action and designs investment vehicles that meet institutional investors’ criteria – e.g., through this exact type of intervention – they should be happy to jump on the train.”