Reform in a Storm

Investors, governments argue that MDBs must be far more effective crowding in private investment targeting climate action and SDGs in EMDEs. 

United Nations Secretary-General António Guterres has never been one to mince his words, and, last month, his message to governments, investors and companies was clear.  

“I see a lack of ambition. A lack of trust. A lack of support. A lack of cooperation. And an abundance of problems around clarity and credibility. 

“The climate agenda is being undermined.”   

The Sharm El Sheikh Implementation Plan – the final agreed statement published at the end of COP27 – noted that financing the global transition to net zero will require annual investments of between US$4-6 trillion; global investment in energy transition technologies reached US$1.3 trillion in 2022.  

Developing countries alone will require an estimated US$160-US$340 billion per year by 2030 to adapt to increasing climate impacts, but less than US$50 billion is allocated to climate adaptation.  

On top of that, developing countries face a US$4 trillion annual investment gap for the UN Sustainable Development Goals (SDGs) 

“In principle, 2015 was meant to be an inflection point for development finance – the launch of both the SDGs and the Paris Agreement – which emphasises the importance of mobilising private sector expertise and investment,” says Chris Clubb, Managing Director at global blended finance network Convergence.  

“In practice, little has changed,” he adds. 

To plug climate and SDG investment gaps, Guterres has urged governments to “push multilateral development banks (MDBs) to adapt their business models, skill sets, and approaches to risk – and to leverage far more private finance at reasonable cost to developing countries to allow for a massive increase in investment in renewables”.  

“Finance for them implies making good profits from climate change and indebting even more to developing countries,” Guterres said.  

MDBs have an important role to play in providing catalytic capital across a variety of projects globally to incentivise investment from the private sector. Blended finance is seen as a vital tool to contribute the capital flows needed to meet both the goals of the Paris Agreement and the SDGs.  

In 2021, MDBs accounted for US$51 billion of climate finance to low- and middle-income countries, and the largest institutions – such as the World Bank and the International Monetary Fund (IMF) – have been able to leverage more than 30 times their paid-in capital since their creation.  

But the blended finance market is stuttering 

Katherine Stodulka, Chair of the Blended Finance Taskforce and Partner at Systemiq, says that “we have ended up with a perfect cycle of blame and finger-pointing”, where the private sector wants MDBs to de-risk investment opportunities in emerging markets, the MDBs require their shareholders to mandate such action, and the shareholders say they would shift MDB mandates but citizens find it difficult to engage or understand this agenda.

“It is often not vote-winning to scale climate finance in emerging markets, when the cost-of-living crisis is hurting so many at home,” she says. 

State and non-state actors are increasingly recognising that meeting the goals of the Paris Agreement and the SDGs requires financial system reform such that we have not seen in the post-war era – and this starts with MDBs.  

“MDBs were originally built and directed to maximise their own investments in developing countries, but now they need to see their role as acting as a catalyst to maximise total investment in developing countries,” says Marc-André Blanchard, Global Head of Sustainability at Caisse de dépôt et placement du Québec (CDPQ), a founding member of the UN-convened Net Zero Asset Owner Alliance (NZAOA). 

Moving into position 

Reform of the global financial system takes time. Experts speaking to ESG Investor say that high-level talks around MDBs have been painfully slow but are finally gathering pace.  

Last year, the Group of 20 (G20) commissioned an external review of capital adequacy frameworks (CAFs), outlining a series of recommendations to help MDBs increase lending capacity, enhance risk management, improve credit ratings, and attract more private capital. 

MDBs need to adapt their risk tolerance, the report said, noting that MDBs are currently using overly conservative measures of risk and reducing the amount they can lend by hundreds of billions of dollars.   

Also last year, Prime Minister of Barbados Mia Mottley authored the Bridgetown Agenda, calling for bolder measures to ensure that MDBs can help direct debt-distressed countries to fund climate-related developments.  

One step taken by the initiative was to call for the board of the IMF to re-channel at least US$100 billion of unused Special Drawing Rights (SDRs) to those who need it. 

Last month, France hosted the summit for New Global Financing Pact, an event aiming to coordinate and catalyse international action to address the development financing needs of the Global South through existing and new avenues.  

Valerie Laxton, Senior Associate in the World Resources Institute’s (WRI) Finance Center, was in attendance. “It was very clear that governments are starting to realise that climate finance and development finance are mutually supportive,” she says. 

“Although institutional investors weren’t very prominent, I was pleased to see the leadership from MDBs, heads of state and the Global South, which to me signals the key partnership-building needed for MDB reform.” 

Following the G20 CAF review, a roadmap was produced at the Paris summit which urged G20 partners to “give an additional push” to the review and outline short-term measures and a medium-term agenda to optimise the use of capital by MDBs and encourage them to pursue innovation measures, such as guarantee mechanisms and hybrid capital.  

Further, in line with the Bridgetown Initiative, the reallocation of US$100 billion of IMF special reserve assets to provide more liquidity support to emerging markets was announced 

The summit’s concluding ‘Paris Agenda for People and Planet’ document raised the expectation that MDBs would add US$200 billion to their lending capacity over the next ten years by optimising their balance sheets and taking more risks, with shareholders re-injecting new capital into the MDBs.  

“Each dollar of lending by MDBs should be complemented by at least one dollar of private finance,” the document added.  

The US Treasury also partnered with CDPQ, Natixis Investment Managers, Ninety One, the Rockefeller Foundation and other investors. The group plans to accelerate institutional investment in EMDEs over the next three years.  

“A few years ago, such a discussion with the US Treasury and other institutional investors would not have been possible,” CDPQ’s Blanchard tells ESG Investor. 

“This is a big step forward and I have never felt so optimistic.”  

However, governments can go further still by “explicitly requiring MDBs to account for climate and the SDGs in their activities”, urges Harald Walkate, Founding Partner of blended finance advisory firm Route17. He also sits on the ESG Advisory Committee at the UK Financial Conduct Authority (FCA).  

The World Bank and IMF – the so-called Bretton Woods institutions – were developed with a specific mandate to invest in development and poverty reduction post-World War Two; they were not formed to be climate banks.  

However, the existential threat of climate change means that climate-related concerns are rapidly becoming more intrinsically intertwined with their mandated goals, points out Thomas Tayler, Head of Climate Finance at Aviva Investors’ Sustainable Finance Centre for Excellence. 

“MDBs’ biggest shareholders in developed countries – such as the US in the World Bank – have the power to explicitly say that work on poverty alleviation and development is inextricably linked to tackling climate change and making sure development is resilient to climate change,” he says.  

At New Global Financing Pact, new World Bank President Ajay Banga announced the launch of the Private Sector Investment Lab to develop and scale solutions that address the barriers preventing private sector investment in emerging markets. The lab will be co-chaired by UN Special Envoy on Climate Action and Finance Mark Carney, who is also the Co-Chair of the Glasgow Financial Alliance for Net Zero (GFANZ). 

Margarita Pirovska, Director of Policy at the UN-convened Principles for Responsible Investment (PRI), notes that New Global Financing Pact is certainly “not the end” of discussions.  

“We ultimately need conversations between governments and MDBs – and all financial actors – to be guided by the ‘apex goal’ of aligning all financial flows with a low greenhouse gas (GHG) emission, climate-resilient development pathway.”  

Steps to reform  

Alongside mandate renewal, MDB reform must tackle three key areas, according to Blanchard from CDPQ. 

“Firstly, de-risking instruments need to be scaled and fit for institutional investors,” he says. 

Annika Brouwer, Sustainability Specialist at asset manager Ninety One, says there are currently “few sources” of risk mitigation capital available for the private sector to access that would sufficiently de-risk investments in middle-income countries. 

One such vehicle is the Global Fund for Coral Reefs, which provides growth equity to the blue economy by protecting coral reefs. The Green Climate Fund (GCF) assumes the initial loss of US$125 million to mobilise the hoped for US$500 million from private investors.  

In November, Convergence partnered with the United States Agency for International Development (USAID) to publish an action plan for how public sector finance can operate as a “systemwide catalyst” for the private sector. One of its recommendations is to establish a catalytic funding network and an investment mobilisation hub to coordinate stronger de-risking integration among public and private investors.  

“Scaling the sources and uses of risk mitigation capital is critical for private capital mobilisation,” says Brouwer.  

A report published by the Blended Finance Taskforce called for the smarter use of public capital in guarantee projects by structurally linking it to project development, which could contribute to a fivefold increase in climate finance. 

The second issue is that “project preparation needs to be put on steroids”, says Blanchard.  

“There’s a lack of bankable projects. In many cases, MDBs and institutional investors are talking in a different language and have a different approach, but the project preparation needs to be fit for purpose for investors.” 

Tayler from Aviva Investors notes that it can be harder to attract private investment in climate adaptation projects in emerging markets when “investors need to see three times the return in South Africa compared to Germany to warrant a solar project”. 

“The third step is for MDBs to share their deep experience of investment and project development in emerging markets, as this would help to lower the cost of financing in many parts of the world and would better allow institutional investors to assess the risks and opportunities,” says Blanchard. 

There is a practical first step MDBs can take, which is to make their Global Emerging Markets (GEMs) database available to private investors – a move which Stodulka from the Blended Finance Taskforce says is “a no-brainer”.  

Twenty-four MDBs globally contribute to the GEMs database, which contains data on default probabilities, as well as expected losses for loans to sovereigns and the private sector. Making that data available to the private sector would better enable investors to assess the risks of partnering with MDBs.  

Walkate from Route17 adds that the communication channels between MDBs and the private sector currently “aren’t very solid”, presenting barriers to collaboration and understanding.  

“There isn’t enough of a marketplace where development banks and pension funds can meet to evaluate potential investments and to assess which tools to use to make the investments sufficiently attractive to private investors,” he adds.  

A potential solution would be for MDBs to simply recruit people with experience operating in the private sector, Walkate says, thus giving development banks more in-house experience of how investors allocate capital, how they evaluate risks, and what kinds of opportunities they will go for. 

MDBs also need to learn how to operate as a system to drive sustainable change, as opposed to separately, adds WRI’s Laxton.  

At COP27, MDBs published a statement outlining their joint ambition to expand their support for countries’ low-carbon, climate-resilient transitions by formulating policies to spur systemic change, defining specific investment plans, mobilising financial resources, and undertaking analyses to identify priority mitigation and adaptation actions for individual countries. 

We are at a point in the discussion where everyone knows the headline recommendations about better blended finance and MDB reform,” says Stodulka from the Blended Finance Taskforce. 

Now we need to shift to implementation – which means developing more transactional solutions which are disaggregated by the types of institutions, sectors and geographies that need to be involved. We need to get more granular to develop de-risking products which are demand-driven to overcome private sector barriers to entry in emerging markets.” 

In the same boat  

While talk of MDB reform is hugely positive, it’s just one part of a system-wide reform of global finance.  

There is so much talk about the MDBs that we are forgetting other key players, such as development finance institutions (DFIs), Stodulka says. 

“As the private sector arms of the multilaterals, the DFIs should be mobilisers-in-chief,” she says. 

DFIs have also been asked to improve their transparency on what and how they fund projects to improve scale and crowd in private capital.  

Although the overall goal seems monumental, perhaps at times even insurmountable, experts speaking to ESG Investor are hopeful that the global finance system can be restructured, placing core climate and sustainability goals at its heart.  

“MDB reform is only one part of the puzzle; we also need to be thinking about the broader financial and regulatory piece,” says Tayler from Aviva Investors. 

At New Global Financing Pact, he says he witnessed many welcome conversations “of how international financial architecture needs to change”. 

Blanchard from CDPQ is similarly optimistic.  

“We [governments and the finance sector] all recognise that we are in the same boat and facing the same storms, and that we all need to be part of the solution while considering our respective fiduciary duties,” he says.  

The next opportunity for governments and non-state actors to discuss MDB and financial architecture reform will be at the 2023 SDG Summit, which is marking the halfway point to the SDG 2030 deadline and will be taking place in New York this September during the UN General Assembly. 

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