Risks more a factor of in-country context than technologies, says OECD report.
Blended finance solutions must account for “project, sector and country specific risks” to attract more commercial investment to clean energy initiatives in emerging and developing economies, according to the Organisation for Economic Cooperation and Development (OECD).
In new guidance, the OECD said blended finance interventions should be “designed on a case-by-case basis” to have maximum impact. This is because the factors underlying the financing needs are more likely to be determined by local circumstances than the characteristics of specific clean energy technologies.
“The nature of risks, market failures, and wider barriers to investment will vary markedly across projects and different country contexts,” the report said, noting also the need for blended finance to be deployed as part of a “wider suite” of enabling measures.
The OECD defines blended finance as the strategic use of development finance for the mobilisation of additional finance towards sustainable development in emerging and developing countries. Blended finance often involves public sector institutions assuming first losses, helping to de-risk investments and support effective public-private cooperation on the ground.
Last year, the UN-convened Net Zero Asset Owner Alliance published a report that said public and private investors needed to collaborate more effectively to increase the flow of private capital to climate adaptation and mitigation projects in emerging markets via blended finance solutions.
Current private capital flows are insufficient to support the implementation of clean energy technologies in emerging and developing economies at the pace and scale necessary to meet the goals of the Paris Agreement, said the OECD, making the development of new blended finance solutions a priority.
“The financing needs in emerging and developing economies – where energy needs are projected to grow rapidly – are particularly acute and pressing,” it said.
The report cited estimates made by the International Energy Agency that investment in clean energy projects in emerging and developing economies will need to reach US$1 trillion a year by the end of the decade, representing a seven-fold increase on 2020 levels.
Although clean energy accounts for most of the commercial finance mobilised by development finance, the OECD estimates that overall mobilisation figures are still “relatively low”, with just under US$6 billion of commercial capital mobilised towards renewable energy in 2019 and a total of US$14 billion mobilised by all climate finance.
The scale of demand is such that all sources of finance need to be “mobilised rapidly”, according to the OECD.
“The huge stocks of global commercial capital need to be tapped more effectively, to match investor demand for sustainable investments with projects on the ground.”
Barriers to investment
The OECD report cited a number of constraints on clean energy investment, including the distorting effects of fossil fuel subsidies, a lack of in-country transition capacity, high upfront capital costs and the long life-cycles of existing energy assets.
“The rapid pace of change in the sector, including the emergence of new technologies, makes the investment dynamic particularly complex, requiring careful consideration of where best to deploy scarce domestic and development finance,” it added.
With barriers to commercial investment being particularly high in emerging and developed markets, the OECD said providers of development finance – typically multilateral development banks and development finance institutions – needed to increase their focus on the potentially catalytic impact of blended finance.
The report highlighted a number of ways in which tailored blended finance can overcome barriers to investment in specific types of clean energy project. These included the use of blended finance to aggregate multiple off-grid clean energy projects – which implement small solar photovoltaic units and mini-grids – into investable and tradeable assets of sufficient size to attract larger investors.
“Given their outsized development impact and their importance in countries with the highest barriers to commercial investment, there is a strong case for blended finance on relatively more concessional terms with longer durations,” said the OECD report.
While the report is largely targeted at MDBs and DFIs, it also recommended that other partners to blended finance projects take steps to increase their expertise.
Project developers and commercial financial institutions must also develop “a better understanding of the facilities, structures, and instruments on offer, as well as a streamlining of the ecosystem to make the process of seeking blended finance more efficient”.
The OECD has established a set of five principles to guide use of blended finance. These specify that blended finance should be anchored to a development rationale, designed to increase mobilisation of commercial finance, tailored to local context, focused on effective partnering and monitored for transparency and results.
The policy paper – OECD Blended Finance Guidance for Clean Energy – was produced by the OECD’s Environment Policy Committee (EPOC) and its Working Party on Climate, Investment and Development (WPCID).