Fusion the Positive Choice for Climate Impact

Blended finance vehicles can help asset owners achieve impact in emerging markets and developing economies. 

Neither the world’s financial firepower nor the impact of climate change is spread evenly, which means funding the transition to net zero is much harder and more urgent for emerging markets and developing economies (EMDEs) compared to developed ones. 

However, as asset owners’ mindsets shift from only managing ESG-related risks to more proactively implementing impact investing strategies, EMDEs are clear pools of opportunity. If asset owners can feel confident that their capital will make a difference. 

Research by the BlackRock Investment Institute has estimated that around US$1 trillion a year is needed if EMDEs are to achieve net zero by 2050.  

“Climate adaptation and mitigation investment opportunities are critical,” says Jacqueline Jackson, Head of Responsible Investment at London CIV, a UK local government pension scheme (LGPS) pool which manages £48 billion on behalf of client funds. 

“Given that impact investments are made with the intention to generate positive, measurable social and environmental impact alongside financial returns, developing markets are target regions.” 

However, asset owners have a responsibility to balance their wish to address systemic risks through real-world impact with their fiduciary duty to minimise investment risks and maximise financial returns.  

An increasingly popular solution is blended finance, which refers to the use of catalytic development finance from public financial institutions to upscale sustainable projects or companies before opening them to private investment. This way, public sector institutions are absorbing much of the upfront risk, thus providing asset owners with more reassurance that their capital is safe and more likely to generate a positive impact. 

But a recent paper on blended finance by the Organisation for Economic Cooperation and Development (OECD) noted that just US$14 billion in climate finance was mobilised through blended finance solutions for EMDEs in 2019. 

The UN-convened Net Zero Asset Owner Alliance (NZAOA) has previously called on multilateral development banks, development finance institutions and private investors to collaborate more to increase the flow of capital to climate adaptation and mitigation projects in EMDEs. NZAOA members collectively control more than US$10 trillion in assets.  

Asset owners should adopt a more “holistic approach” and identify areas where “public funding is starting to flow, which potentially has a role in enabling private funding to flow behind it”, says Adam Matthews, Chief Responsible Investment Officer of the Church of England (CoE) Pensions Board. 

The CoE Pensions Board and 11 other UK pension funds are currently collaborating to upscale their support of the climate transition in EMDEs, working to better understand how they can ensure a maximum positive impact. The group plans to unveil some of its findings ahead of COP27. 

Opportunities to invest in EMDEs’ climate adaptation and mitigation efforts are already available through blended finance vehicles, and future opportunities are being developed.  

This sends a signal that the investor ethos is changing, says Florian Kemmerich, Managing Partner at impact investing platform Bamboo Capital Partners. “In the past, impact investing was between two chairs – the philanthropic investor and the for-profit investor. The future is about doing good profitably.” 

A balancing act 

Prior to investing in an EMDE blended finance vehicle, asset owners first need to take a step back, says Matthews. 

“Asset owners should first understand what path each individual country is on to get a full picture of what their whole economy transition looks like,” he notes.  

“This can mean looking at nationally determined contributions (NDCs) or even current progress being made by key sectors, like energy.” 

They should also expect traditional assumptions to be challenged. 

“Typically, the higher the risk, the higher the expected returns – but this doesn’t match up in the impact space for EMDEs,” says Bamboo Capital’s Kemmerich. Investors “often struggle” with measuring the risks, rewards and returns of impact funds focused on “missing-middle, last-mile and early-stage companies”, he adds. 

“Blended finance impact funds with catalytic non-for-profit capital in a first-loss share class are not the same as the traditional structures they are used to investing in. This sometimes results in a misperception of the adjusted returns – thanks to the catalytic capital protection – being perceived as concessionary returns which they are not necessarily.” 

To mitigate the risks of investing in small EMDE projects and companies, Ivo Mulder, Head of the Climate Finance Unit (CFU) for the United Nations Environment Programme (UNEP), says investors are looking for opportunities with “some form of grant or concessional finance attached”.  

“It’s almost a necessity for them, particularly in cases where business models don’t have a track record or there are risks that they are uncomfortable taking on.” 

Last year, the Investor Leadership Network (ILN), representing 14 global institutional investors with over US$9 trillion in AUM, called for the creation of a rolling pool of funds that offer first or second loss guarantees to blended finance vehicles funding EMDE-based projects, thus absorbing the potential impact of any realised risks.  

Such conditions are typically sought to overcome the internal and external barriers faced by asset owners which may have to take many regulations and stakeholders into consideration.  

Further, the size of blended finance impact vehicles can serve as a barrier to securing investment from asset owners, due to concerns around overexposure if their investment makes up a large percentage of a small fund. This can lead to a preference for larger funds that aggregate investment in a wide range of projects. However, some asset owners may be attracted to smaller vehicles, as their investment will allow them more ownership and oversight. 

Financial risk mitigation is not the only part of their due diligence process.  

The governance of funds or initiatives needs to be carefully considered, according to Jackson from London CIV, as this will give the asset owner further confidence that a company or fund is well-run and poised to deliver strong returns.  

“We would undertake a similar (if not enhanced) level of scrutiny when undertaking due diligence as part of the manager selection stage,” she tells ESG Investor. “We would want to understand what the targeted returns are – not only from a financial perspective, but from an environmental and socioeconomic perspective. We would assess the metrics and themes targeted by the fund and collect information on the responsible investment strategy, policies and outcomes developed and reported upon by the investment manager.” 

Once invested, asset owners will look for quantitative metrics on the positive social and environmental impacts which have been achieved, Jackson says, adding that these could be categorised according to the UN Sustainable Development Goals (SDGs) or “may be monetised to describe the net environmental and socioeconomic return”.  

“Some funds would be happy to accept slightly below market returns in exchange for greater environmental or social return, as it could be a case of considering the trade-offs. Ultimately, for every £1 invested, an impact fund should be seeking to target the greatest financial, environmental and social ROI possible.” 

Steady momentum 

New opportunities for climate- and nature-positive impact investments are emerging, rapidly.  

In 2016, UNEP, the World Agroforestry Centre, ADM Capital and BNP Paribas launched the Tropical Landscapes Finance Facility (TLFF), which provides long-term sustainability bonds and grant financing to sustainable agricultural projects in Indonesia. ADM Capital manages the TLFF lending platform, whereas BNP Paribas arranges long-term commercially priced debt for individual projects. 

Loans made by the facility are securitised and turned into a medium-term note programme, which is run by BNP Paribas, with these bonds then sold to investors. 

In August, TLFF successfully discharged its inaugural transaction – a US$95 million loan with the bond repaid in full – which supported the upscaling of sustainable natural rubber plantation.  

The PT Royal Lestari Utama (RLU) project was originally a joint venture between integrated energy company PT Barito Pacific and tyre manufacturer Michelin Group to produce rubber more sustainably, with Michelin Group becoming the sole owner of the project in 2018. Through the agreement with TLFF, the companies committed to regularly reporting against environmental and social KPIs. 

To date, the RLU project has planted 23,000 hectares of rubber trees in a previously deforested area in Indonesia, with an additional 54,000 hectares remaining untouched in the name of conservation. 

“TLFF is now putting together a grant fund to give other promising projects the extra push they need to be of interest to investors,” Mulder says. 

The &Green Fund was set up in 2017 by UNEP in partnership with IDH Sustainable Trade Initiative and the Norwegian International Climate and Forests Initiative to delink commodity supply chains from deforestation, focusing on projects promoting sustainability in commodities such as beef, palm oil and soy. Boutique investment firm Sail Ventures serves as the fund’s specialist investment advisor.  

For a project or company to be viable for investment by &Green, it must make three public commitments: a no deforestation, no development on peatlands and no exploitation (NDPE) policy; an environmental and social action plan; and a landscape protection plan. 

In May, &Green partnered with agricultural company FS to establish a deforestation-free corn and biomass supply chain in Mato Grosso in Brazil. Utilising &Green’s US$30 million loan, the company aims to drive the sustainable transformation of land use practices of both corn and soy producers in the region. 

“UNEP wants to make sure that every partner we work with is using as many of the same KPIs around the same impact areas, such as climate mitigation, as possible, so that there’s some kind of commonality between different types of investment instruments,” says Mulder, pointing to the Land Use Finance Impact Hub it co-launched in April.  

All UNEP-backed blended finance projects, such as &Green and TLFF, must report on their progress in line with its Positive Impact Indicators Directory. 

“This is the kind of transparency and feedback that investors seek from us because, despite UNEP [and other public entities] helping to open doors with public finance, measuring the impact of these vehicles is something they remain most uncertain about,” Mulder adds.  

There are more opportunities in the pipeline. 

Although not yet open to institutional investors, the Off Grid Electricity Fund (OGEF) has been set up by the Haitian government, with support from the World Bank, and is co-managed by Bamboo Capital Partners and the Haiti’s Fonds de Développement Industriel (FDI). It aims to provide electricity to 200,000 households in Haiti within the next ten years by upscaling renewable off-grid supply. 

It’s really about supporting the establishment of a sector which is practically non-existent so far in Haiti,” says Kemmerich. “The long-term ambition is to have upscaled profitable companies to then attract private investors.” 

One of the loans OGEF has provided is to Solengy Haiti, a solar solutions provider, which is introducing the local community to more affordable solar energy systems through its lease-to-own programme. Further, OGEF provided debt financing and catalytic grants to Haiti-based project developer Alina Enèji, which aims to provide reliable, clean and affordable energy to rural households. 

“It’s in all of our interest to see EMDEs transition,” says Matthews. “And it’s in asset owners’ interests to ensure that the way we invest delivers maximum positive impact.” 

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

Copyright © 2023 ESG Investor Ltd. Company No. 12893343. ESG Investor Ltd, Fox Court, 14 Grays Inn Road, London, WC1X 8HN

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