After another year of record-breaking temperatures and extreme weather disasters, what’s clear is that building a nature-positive world will require an immense mobilization of resources.
One way to scale up finance to meet the 2030 global climate goals is for publicly funded and private sector banks and institutions to join forces to provide “blended” finance to projects.
That is not very interesting, except when such blending becomes catalytic. That is, blending becomes interesting when capital is programmed in such a way as to catalyze private investors to invest their capital in something they otherwise wouldn’t do and spur private sector investment in nature-positive projects.
According to the World Economic Forum, blended finance is a key to bridging the $700 billion per year biodiversity financing gap.
This market is already worth about $50 billion globally, but experts say this sum could double within three to four years.
Blended finance is pivotal in advancing climate-smart and sustainable projects in the Middle East.
For example, IFC has used blended finance to create viable markets for renewable energy in the West Bank and Gaza region, where the PRICO solar plant is expected to provide 80% of the needed electricity, keeping 32 factories running. The Massader project will provide up to 500 schools with uninterrupted clean energy.
“Blended finance is also helping extend wholesale climate financing through financial institutions. IFC supported the first green bond issuance in Jordan,” says Khawaja Aftab Ahmed, IFC’s Regional Director for the Middle East, Pakistan, and Afghanistan. “However, there is much more potential in the market, and blended finance will be critical in unlocking that growth.”
Although, over the past few years, blended finance has helped unlock and crowd philanthropic, developmental, and commercial capital towards sustainable development causes, the gap between capital flows and the funding needed to achieve SDGs remains significantly high, estimated at $2.5 trillion.
Additionally, geopolitical instability, high inflation and interest rates, growing energy crises, and extreme climate conditions have impacted the pace and progress of SDGs globally.
AN OPPORTUNITY TO DE-RISK INVESTMENTS
The implications of these challenges are most severe in low-income countries with lower credit ratings and difficulty raising capital for a sustainable development agenda.
“There is an urgent need to massively scale public and private sector capital towards underserved beneficiary segments, such as micro-enterprises, home-based businesses, women entrepreneurs, and underdeveloped infrastructure and economic sectors in such fragile markets, where access to sustainable finance is often the biggest challenge,” says Naman Sharma, partner at Kearney Middle East & Africa, Financial Services Practice.
“Blended finance creates an opportunity to de-risk investments and improve the overall risk-return profile of investments in frontier markets, thereby making them attractive for the private sector,” he adds.
In the Middle East, there is fragmentation across the market, which calls for public and private investors to pool their resources to create giant funds to facilitate bigger projects than are currently possible.
“If it can be deployed quickly, blended finance can be a very useful tool in assisting investors in low-income countries in the region, thus supporting SDGs in the most difficult environment,” says Ahmed.
Gaining more private capital would be essential to achieving the SDGs. Experts say low-income countries should prioritize investment in infrastructure that would increase resilience to climate change and provide environmentally sound economic development.
“It can potentially facilitate private sector investments in sustainable infrastructure; the transition to renewable energy sources; food security; access to quality healthcare and education services; and affordable housing and urban services,” says Ahmed.
Case in point: financing packages combined with blended finance are helping reduce food shortages in Yemen, including the supply of staple foods to towns and villages.
“The support from blended finance was critical to balance the risk of investing in Yemen, thereby making it possible for IFC to syndicate and maximize finance for development,” adds Ahmed.
GROWTH OF MSMEs
Historically, corporations and project developers have been the largest recipients of climate-blended finance transactions. This is largely due to the greater universe of bankable projects in the renewable energy space, which are often served by large corporations or through project development constructs.
“However, over the last few years, there has been an increasing diversification of beneficiary base, including MSMEs across various sectors and microfinance institutions,” says Sharma.
Blended finance can support the growth of MSMEs by providing access to capital, technical assistance, and capacity-building in countries like Jordan, Iraq, Lebanon, and West Bank and Gaza, adds Ahmed.
Based on analysis from Convergence, startups and MSMEs account for 25% of the climate blended finance transactions. In parallel, women entrepreneurs have seen a marginal increase in blended finance transactions, accounting for 13% of the deals over the last few years.
Meanwhile, the shift towards energy transition is complicated for the region, driven by over-dependence on hydrocarbons and ongoing economic diversification and growth agenda. At the same time, the region is amongst the most climate-vulnerable regions affected by rising sea levels, extremely high temperatures, and worsening drought conditions.
“In this context, climate change and energy transition are a priority and an increasing focus of the blended finance market,” says Sharma.
According to Convergence, a global network for blended finance, two-thirds of blended finance commitments over the past three years targeted climate-related investments.
“With several countries announcing hard commitments towards the net zero transition, capital mobilization towards climate finance is increasingly essential. There is also a growing appetite from private sector players and principal investors, such as SWFs, to support the national ESG and climate agenda,” adds Sharma.
Between 2019 and 2021, 6% of global climate blended finance deals were focused on the Middle East and North Africa, attracting about $1 billion in public and private sector capital. However, most of the funding today is targeted towards climate mitigation, which accounts for 60% of the transactions in the region.
ENABLING CONDITIONS TO SCALE UP
Reaching net-zero emissions by 2030 through natural climate solutions that protect existing ecosystems, sustainably manage working lands, and restore degraded forests and wetlands will require seismic changes in global finance. Therefore, it is important to put the enabling conditions for blended finance to scale up quickly.
There is a window of opportunity for institutional investors to increase their exposure to emerging markets infrastructure by taking advantage of the risk mitigation offered by blended finance. Momentum is growing – it is possible that the blended finance market could grow if enabling conditions – policy, regulations, institutions, and stakeholder engagement — are prioritized.
“Critical factors for success include policy reforms from government partners to create openings for private sector participation and private sector collaborators displaying a readiness to engage in challenging markets,” says Ahmed.
While blended finance has been a recognized investment approach for over a decade across government agencies, multilateral development banks (MDBs), and commercial investors, several challenges must be overcome to scale up and mobilize required capital towards SDGs in emerging and low-income countries.
According to Sharma, there needs to be a coordinated and deliberate public sector strategy and action plan towards blended finance focused on increasing total capital and private sector mobilization towards least-developed countries.
Also, investors often complain about the lack of bankable projects, particularly in least-developed countries, where the sovereign rating is B- and below. To mitigate these investor concerns, sufficient mass of catalytic capital is needed to improve the risk-return profile of SDG investments and increase the universe of bankable projects,” adds Sharma
“For this MDBs, development finance institutions (DFIs) and public sector stakeholders must play a more deliberate role enabled by ambitious and clear targets and KPIs. MDBs and DFIs must play a central role with government bodies to further de-risk investment opportunities in emerging countries and expand the investor pool.”
Moreover, speed and simplicity of deployment are essential. According to experts, to scale up quickly, development finance institutions should develop programmatic approaches to streamline the approval processes for blended finance.
“Blended finance programs should be inclusive and promote gender equality. Finally, sharing best practices, lessons learned, and knowledge across stakeholders can accelerate the adoption of effective blended finance models,” adds Ahmed.
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