“Combining concessional finance from donors or third parties alongside MDBs’ normal account finance and/or commercial finance from other investors, to develop private sector markets, address the SDGs, and mobilize private resources.”
In October 2017, the Development Finance Institutions (DFIs) Private Sector Roundtable and the Multilateral Development Bank (MDB) Heads agreed on the above definition of blended finance. Key to this definition is the use of concessional capital to unlock market-rate finance. We believe that the DFIs that master blended finance will become major conduits for other development partners, namely philanthropic foundations, to achieve their development objectives, while allowing the private sector to achieve financial return. It should be noted that to the definition of blended finance is broader among other organizations, whereas this definition adopted by the MDBs/DFIs limits blended finance to the use of concessional finance, from governments or philanthropic organizations, in combination with commercial finance from either DFIs or the private sector, for use in private sector projects.
Given challenging business environments in many low-income countries, the risk-adjusted returns of projects are not always sufficient to incentivize the private sector and commercial investors to undertake catalytic projects. This challenging business environment combined with the public good nature of some goods and services lead to market failures or sub-optimal allocation of resources. Concessional finance can be used to mitigate the market failures, reduce actual and perceived risks and improve the profile of risk-adjusted returns. This has the potential to unlock private sector financing and make projects commercially viable, particularly in new geographies and/or sectors.
From the perspective of philanthropic actors, blended finance offers the opportunity to diversify from pure grant making to using philanthropic funding to attract additional commercial and private capital and thereby increase development impact. Philanthropic actors can also facilitate the piloting of innovative blended finance structures to prove their concept before scaling up. Blended finance offers philanthropy a unique possibility to create significant leverage of their philanthropic capital from MDBs/DFIs and the private sector.
Yet, blended finance has remained somewhat fragmented to date. The number of blended finance facilities launched has tripled between 2009-2016 compared to the prior 8 years.1 However, while blended finance moved significantly into Africa during this time, it did not reach those most in need. Only 7% of the private finance mobilized through blended finance went to least developed countries (LDCs).
Therefore, the African Development Bank hopes to see blended finance significantly scaled up in a coordinated manner as it will be an important theme over the remainder of the SDG era. Given declining ODA, there are limited pools of concessional resources that can be used for blended finance transactions. Philanthropic funds can help
to fill the gap and further contribute to the scaling up of blended finance facilities and success stories. In this vein, we are establishing our own Blended Finance Framework to guide our engagement with providers of concessional finance such as foundations going forward, and look to formalizing and accelerating blended finance, as an optimal funding option to ensure maximum leverage of available development assistance across the continent.
Blended finance improving the efficiency of existing funding
One of the recent innovations the African Development Bank has successfully piloted is a balance sheet optimization initiative, which aims to unlock further capital and create additional lending headroom. In 2018, AfDB launched the Room2Run initiative (R2R), which is expected to expand the Bank’s lending capacity by allowing capital redeployment and availability of new funding resources for development projects across Africa. R2R is a collaboration between the African Development Bank, European Commission, Mariner Investment Group, Africa50, and Mizuho International which allows for a USD 1 billion synthetic securitization corresponding to a portfolio of existing pan-African credit risk. R2R is the first-ever synthetic portfolio securitization between a MDB and private sector investors, pioneering the use of securitization and credit risk transfer mechanics to a new and previously unexplored segment of the financial markets.
The R2R initiative directly responds to calls by the G20 that MDBs use their existing resources to full capacity, as articulated in the 2015 G20 MDB Action Plan to Optimize Balance Sheets, as well as calls for greater MDB efforts to crowd-in private investment. The G20 has called on MDBs to share risk in their non-sovereign operations with private investors, including through structured finance, mezzanine financing, credit guarantee programs, and hedging structures. Foundations as providers of concessional finance are critical to the success of such structures. This is shown by the role of the European Commission’s European Fund for Sustainable Development in the form of a senior mezzanine guarantee. R2R has already attracted major support from partners like the European Commission who will provide an additional USD 100 million guarantee to the project for renewable energy projects in Africa. The transaction will also attract institutional investors (pension funds) to invest in the highest-risk components of African private sector loans. In total, the freed up headroom for the African Development Bank will amount to around USD 700 million, which can be re-allocated to new projects. The underlying investor base of the anchor private sector investor (Mariner) ranges from public employee and corporate pension funds, university endowments, to charitable foundations around the world, bringing many of these private investors into African infrastructure projects for the first time. As a first of its kind credit risk transfer on a portfolio of loans between an MDB and private investors, it is our hope that R2R will garner the attention of the philanthropic community to see if it can be a model for others to follow to increase MDB lending globally.