by Aniket Bhushan and Matthew Gouett
Published: December 7, 2017
“Blended finance” is a key emerging area in development finance. Our aim in this series is to compile key resources to help to make sense of it, share perspectives and raise questions for further discussion.
In this analysis, we look at measurement and reporting issues, and leverage effects in more detail with the help of examples. We argue that, to be taken seriously as a ‘leader in blended finance,’ Canada needs a clear policy framework to guide its investments and efforts in this area. The perceptible lack of a framework means there is little clarity on objectives. This, in turn, weakens transparency and accountability, and complicates measurement and reporting. As a result, it is difficult to meaningfully unpack the efficacy or impact of Canada’s very few firsthand forays into this space. This hinders the task of building further support for more ambitious efforts in an area that otherwise offers potential for unlocking greater private capital and new investors into development. With a clearer sense of objectives, Canada could make a substantive contribution in the blended finance space.
Canada as a ‘leader in blended finance’?
In the last few years, a number of steps have been taken to position Canada in the blended finance space. In the lead up to the “Financing for Development” conference in Addis Ababa (2015), Canada made a point of emphasizing this space as a key focus and proclaimed itself a ‘leader in blended finance’. This was further validated by external partners.
Interest in this space, and more generally in an expanded role for the private sector (especially private capital in development), has transcended party lines. For example, while blended finance was championed by the previous government (Conservative), it has been re-endorsed by the current (Liberal).
One of the key ways the previous government manifested its support was through the WEF-OECD “Redesigning Development Finance” initiative, where it championed the launch of a new blended finance platform. The current Prime Minister, flanked by the (then) trade minister and international development minister, announced the launch of the Convergence platform at the WEF in Davos in January 2016. The development minister reaffirmed her desire to position Canada as a ‘leader in innovative approaches to financing for development.’
While not limited to blended finance per se, another example is the decision to carry through with the launch of the new Canadian development finance institution (DFI), which is expected to commence in January 2018, though was first announced in Budget 2015.
In a bid to “boost United Nations Security Council chances,” Canada has again seized on this area. Under the auspices of Canada’s Permanent Representative to the United Nations, Marc-Andre Blanchard, Canada is playing a keen role in the “Group of Friends of SDG Financing,” an initiative that aims to scale up private capital into development.
Actual firsthand Canadian experience of doing blending—i.e. deploying concessional finance to leverage private capital at scale while pursuing developmental objectives—is much more limited. Without data or hard cases, all we have is conjecture (or worse, marketing). In the Canadian context, only two cases (with inconsistent information) come to mind.
In order to get away from making a general esoteric case for the need for a policy framework or ‘coherence,’ we focus on available data from cases to (a) raise key questions and (b) demonstrate how the absence of a policy framework makes Canada’s efforts less effective than they otherwise might be.
Transparency, tracking, reporting and learning
As we have shown elsewhere, the lack of key comparable data and methods is a major weakness of the blended finance space. In the absence of more robust data, we are left with voluntary survey-based assessments that are often inconsistently applied. A key recent source is the OECD survey of private mobilization.
The curious case of one project with multiple interpretations
In its survey of private finance mobilized by official development finance for the 2012-2015 period, the OECD includes Canada. The total amount attributed to Canada for this period is USD$47 million (approx. USD$34 million attributed to GAC/DFATD, the rest to Finance Canada).
Some of this includes a catalyst fund managed by IFC Asset Management in which Canada is an investor. We were curious about the rest and how this squares with our understanding of one Canadian-sponsored, explicitly ‘blended’ project, which has been analyzed as such by multiple blended finance surveys by Convergence, Development Initiatives (DI), the World Economic Forum (WEF), and in fact also by the OECD-DAC elsewhere.
In Global Affairs Canada’s (GAC) databases, the project is described as “A New Partnership for Sustainable Impact Investing in Frontier Markets.” However, the main partner, Mennonite Economic Development Associates (MEDA), brands it as “INFRONT.” The main component of the project is an emerging/frontier market private equity (PE) fund the “Sarona Frontier Markets Fund 2 or SFMF2”.
The project is an interesting and much discussed example of good practice “blending”: GAC/DFATD puts in $15 million first-loss capital (stretched over a long, 15 year term) and an additional $5 million in technical assistance (TA) + OPIC, the US DFI, comes in with $50 million in senior debt via guaranteed certificates of participation (COP) + an additional $85 million in LP equity is raised from private investors comprising corporations, foundations, endowments, pension funds and individuals, which gives the total fund size of $150 million. The capital raise and closure happen within the period that spans the OECD-DAC survey.
But hang on a minute, then why is this not reflected in the OECD survey? Data for GAC/DFATD place the total private capital mobilized at only $34 million, which is less than even the purely private mobilization attributed to this one project ($85 million)?
The answer may lie in multiple understandings of the project.
GAC describes the project as supporting the launch of a 15 year investment fund. It mentions all the main partners (MEDA, Sarona Asset Management and the MaRS Centre for Impact Investing) in its description, but nowhere does it specify that $15 million of its $19.95 million concessional contribution is for a “first loss” provision. It also omits that, while MEDA and MaRS handle most of the TA, the investment fund is managed by Sarona, and that it is in fact SFMF2, the “2” implying it is a follow on to SFMF1 (a pilot fund by Sarona), and that SFMF2 employs a ‘fund of funds’ model. Essentially the structure is a private equity (PE) limited partnership (LP) fund of funds (FoF) model.
Further, while the 15 year time-frame applies to the “first loss” provision, the TA component is much shorter (roughly 4.5 years), which matters because for all practical purposes, that is the duration of the project for MEDA, the main contracting partner. It is also left unclear how, why or what TA goals are expected to be achieved in such a short period, and why they are not stretched out longer.
These points, which are quite fundamental to understanding the project, are not represented systematically at all by GAC. So it is no surprise that, when the OECD-DAC surveys GAC on private mobilization, the project likely slipped through the cracks. To the funder, it is just another grant funding arrangement with MEDA, with which it has several contracts. The issue of whether it classifies as “leveraging private capital” likely does not even arise.
We were curious, so went through the trouble of checking with the OECD-DAC who were clear that their methodology is only set up to cover ‘first level’ mobilization. As far as bilateral donors are concerned, the method is aimed primarily at bilateral DFIs (which of course over the period in question did not exist in the case of Canada). A complex project with multiple and cascading intermediaries such as this likely gets missed—even though it seems to fit squarely within the remit of the survey.
From pilot to pilot, without take off?
The above experience could be dismissed as a relatively small and one-off miss given it was an early foray and a ‘pilot’ for Canada. However, in the lead up to 28th G8 summit in Kananaskis, Alberta, in June 2002—the last time Canada hosted (prior to Muskoka in 2010)—the government announced the “Canada Fund for Africa,” a $500 million commitment in support of the G8 Africa Action Plan and NEPAD. The centrepiece of the fund was the $100 million “Canada Investment Fund for Africa (CIFA).” This was an early foray into using public funds to leverage private capital for development, managed by private sector fund managers (in this case Cordiant Capital based in Montreal and Actis based in London, UK) and was billed as a ‘pilot’ initiative at the time.
CIFA began in 2005, was slated to end in December 2013, but was extended (to 2015). It operated as a “commercially viable and self-sustaining provider of risk capital for private investments in Africa under a limited partnership (LP) structure.” CIFA had 3 main goals: increase private investment in Africa, encourage FDI into development friendly sectors, and further Canadian public and private investment interest in Africa.
CIFA’s experience and learning from the same would seem to be highly relevant for future initiatives (including, for instance, the design of INFRONT/SFMF2 discussed above). But there appears little evidence of the same.
CIFA’s mid-term review (which GAC no longer makes publicly available, but thankfully we saved) points to the following relevant lessons:
- The main conclusion reached by the review was around the lack of internal capacity within the government (i.e. at CIDA/GAC). According to the review, the CIFA experience represented “a challenging marriage between the cultures and capacities for oversight of CIFA partners and development aims abroad. The successful harmonization of these various aims and expectations will require time and effort to build a dedicated unit within the Government of Canada with the necessary expertise and experience.”
- CIFA’s review explicitly pointed to the challenges and limitations associated with the LP model. “While the Limited Partnership model limits Government of Canada’s exposure to risks, including reputational risk and financial liability for eventual losses, such a model also comes with a loss of decision-making control”. In particular the review notes the “reduced ability to obtain detailed results” and associated attribution issues that are common in an LP model (and are even more challenging in a ‘fund of funds’ model).
- It also notes that the distinct legal and financial framework of a PE LP model was repeatedly confounded with the more common grant and contributions model of a development agency. And that this distinct model of promoting and investing in a private equity fund needs to be more clearly in view.
- The review concludes that, during the course of the experience, a “striking evolution in Africa’s financial development has taken place,” which includes the emergence of a “healthy private equity sector,” and hence the “case today for new donor supported initiatives in this field is less pressing.”
The mid-term review expressed frustration with the its inability to assess progress further—neither in terms of development outcomes or even financial return (IRRs, which were not available). And yet the conclusion was that the initiative was visionary and relevant.
It should also be noted, CIFA was not “ODA.” The review states this explicitly. We checked OECD micro data (2012-2015) and the project was not reported as ODA, but the project is included in GAC’s development projects explorer and the funding type is described as “aid grant.” It may well be that the project is not booked as ODA (donors do have a fair bit of discretion on this front), perhaps because reverse flows or ‘profits’ were expected (and in fact reaped). However, this raises the question of consistency, transparency, accountability and internal learning.
Unlike CIFA, the totality of the INFRONT/SFMF2 project is booked as “ODA.” Things are made more confusing by the fact that, in terms of ‘type of finance,’ both initiatives are described identically as “aid grants.” Whether reported as ODA or not, clearly both use public funds to leverage private capital.
Understanding and measuring leverage
Given blended finance is about scaling up private capital into development a key component is estimation of leverage. In this case, the ratio of public finance used to crowd-in or otherwise catalyze private capital into development is a key measure. As demonstrated below, the lack of a consistent understanding and measurement of leverage (even ex-post) is a major weakness of the blended finance space. This is important as it goes to the heart of the promise of using small amounts of public, i.e. taxpayer funded finance, to crowd-in larger amounts in private capital.
Leverage effect of guarantees
The OECD-DAC survey on private mobilization notes that guarantees were the largest leverage mechanism. Approximately 44%, or $36 billion in private finance mobilized by official development finance over 2012-2015 is attributed to guarantees.
Guarantees imply a trade-off between leverage and cost: when guarantees are provided to projects or investments that are truly very risky, they create more leverage. By changing the risk-return profile, guarantees motivate participation by investors who otherwise would not participate. But, by the same logic, because the investments are truly risky, the chances of the guarantee being ‘called’ is higher and the cost of the guarantee itself is higher. When guarantees are on less risky projects, both the chances of being called are lower and the cost of cover is lower, and the level of leverage is also correspondingly lower (i.e. those investments may have taken place anyway).
In reality, guarantees are much more complex, as there are various types, and clearly ‘call’ or other ‘trigger’ criteria matter a great deal, which is not obvious from the outside. Leaving that complexity aside, what does the relatively sparse publicly available data on guarantees in the development space show in terms of call rates?
Two key providers of (non-trade) guarantees in development are the International Bank for Reconstruction and Development/International Development Association (IBRD/IDA) and the Multilateral Investment Guarantee Agency (MIGA). Data for IBRD/IDA over 1994-2013 shows that, on a total guarantee volume of $5.5 billion, about $250 million was ‘called,’ implying a call rate of 4.5% (over nearly a decade). Data for MIGA, the main provider of multilateral guarantees, over 1990-2013 shows that, on total volume of $30 billion, a mere $16 million was ‘called,’ implying a call rate of 0.05% (spanning over two decades; for more see here).
This could either imply that the perception of risk is much higher than real risk or that these multilateral guarantees are not really covering the riskiest projects in the first place (and/or there are structural, e.g. reputational disincentives to ‘call in’ such guarantees). Where the latter is the case, guarantees likely have a lower mobilization effect than imagined.
The key question is how the mobilization effect of guarantees is calculated. While it is not clear in the most recent survey, earlier versions of the OECD-DAC’s survey counted in the total value of projects that received any sort of guarantee (even if the guarantee only covered a part of the debt or equity capital). This method certainly has the effect of exaggerating the level of private mobilization attributed to guarantees.
Leverage and SFMF2
Assessing leverage is also complicated in other cases, such as SFMF2. While not a guarantee but rather a first-loss provision, answering the seemingly straightforward question of the level of private capital leveraged by GAC’s $15 million first-loss contribution quickly becomes tricky.
Even if we limit to just the GP (Sarona) or main fund level, and ignore the fact that leverage exists at the level of the intermediary investment funds of which there can be several in a ‘fund of funds’ model, a question of attribution arises. For example, if the GAC $15 million first-loss is the most important in the capital stack, then the leverage ratio could be said to be 9:1 (given the total $150 million size, less GAC). But this implies OPIC’s $50 million senior debt contribution has no bearing on the private investment raised. This may be defensible (say, GAC was in first, all the private investment was mobilized after GAC but before OPIC, or the differences in participation are such that they make GAC and OPIC’s involvement qualitatively very different). But in reality, the involvement of OPIC likely had some impact on private investors and the total effect is a shared function of both GAC and OPIC. Even if one attributes the total private contribution of $85 million to the $15 million GAC layer, the leverage ratio falls to 5.6:1.
Using the DAC’s new guidance on blended finance, however, it is the distinction between official and commercial finance that matters more. In which case, in this example, we have $65 million of official (GAC and OPIC) and $85 million of commercial, implying a much lower leverage ratio of about 1.3:1.
Leverage and CIFA
According to publicly available information in the case of CIFA the “Government of Canada investment of $100 million has leveraged an additional $160 million for investments in fifteen individual African companies.” These companies included: “oil and gas, mining, consumer goods, financial services, agribusiness, manufacturing, and logistics sectors, as well as two regional equity funds targeting small and medium-sized enterprises (SMEs).” The source of the additional investment—whether public or private, on concessional or market terms—is not clear, but the leverage ratio this implies is 1.6:1.
As is evident, reported leverage achieved varies significantly and depends wholly on the choice of definition. Inconsistent methods and application of methods makes it nearly impossible to judge the efficacy of blending in terms of leveraging private capital into development.
When does the lack of clear frameworks start to matter?
When initiatives are framed as ‘pilots’ and aimed at driving ‘learning,’ the lack of an overarching framework is less of a concern. But, when they are elevated in scope (and referenced as evidence of Canada being a ‘leader’) or when there are multiple forays that quickly add up both in terms of taxpayer dollar outlay and the level of private capital that may be mobilized but insufficiently tracked or reported, the lack of a guiding framework becomes a bigger issue. The lack of a policy framework means there is little clarity on objectives. This, in turn, weakens transparency and accountability, and complicates measurement and reporting. As a result, it is difficult to meaningfully unpack the efficacy of efforts made and hinders the task of building support for more ambitious efforts.
Key questions and issues that demonstrate the lack of a policy framework is a gap
Our assessment of publicly available information on the cases above points to a number of key (unanswered) questions. A policy framework that clarifies what Canada hoped to achieve via blending would go a long way to address some of these issues:
- Internal capacity and learning from experience are key issues pointed out in reviews of past initiatives. What evidence is there of internal learning from ‘pilots’ and what precisely was learnt? What lessons from CIFA for instance fed into the decision point on INFRONT/SFMF2 (if any)?
- The CIFA review noted the challenges with the PE LP model. How was this reflected in the decision to again undertake a PE LP (albeit indirect) in the case of SFMF2?
- The CIFA review also noted the dramatic change in the PE landscape in Africa over the course of the fund’s duration, and even concluded that the “case for donor supported initiatives in this field is less pressing.” How did this factor into the decision on future PE focused efforts?
- In the case of CIFA the Government of Canada’s contribution was not booked as “ODA.” Why was this different in the case of SFMF2? And why then are both described identically as “aid grants” by GAC?
- Why was a fund of funds model chosen? Clearly, this has advantages (risk mitigation via diversification), but these typically come at a cost (higher and multiple layers of fees) and past experience (e.g. with CIFA) had already led to challenges for CIDA/GAC as a development funder (especially around availability of detailed results information, attribution issues etc.).
- This question is especially pertinent as other development financiers—e.g. DFIs like the UK’s CDC Group—have recently made a purposeful decision to move away from the fund-of-funds model.
- In the case of SFMF2, how was the investment level ($19.95 million overall of which $15 million in first-loss) arrived at? Was it for e.g. a function of an investment rationale made by the proponents, or, more a function of authorization limits?
- Why did GAC agree to such a junior position—essentially ‘giving away’ money with no upside participation—alongside the other official provider, OPIC, which takes a senior position and participates in upside?
- The ability to accept a return on investment has been noted as one potential issue, however this doesn’t seem to have affected CIFA, which GAC claims “generated return of capital and profits to Canada in excess of $30 million.”
- What was the intended effect of taking a ‘first-loss’ position in terms of pricing/participation of others, especially private investors? Was that effect realized? And was the ‘first-loss’ provision the make or break factor?
- What links were made between the choice of instrument and type of problem/challenge or objective? Why ‘first loss’ and not another instrument?
- Perhaps the most important question is whether GAC, as a development financier, has a framework to assess when it makes sense to ‘buy down risk’ and when it doesn’t? Or, when it makes sense to work at the other end of the spectrum and incentivize or pay a premium for results? It is hard to believe this is the case when far more sophisticated development financiers (e.g. IFC) are only getting to the question of how and when to deploy concessional funds to blend/crowd in private capital only now.
Conclusion: from billions to trillions?
Canada is a self-proclaimed ‘leader in blended finance,’ but this analysis has shown that the track record of firsthand experience in blending is very small. Furthermore, we deep dive into transparency, accountability and reporting issues, by way of two Canadian signature projects in this space. We also analyze the issue of how much ‘leverage’ is achieved by way of utilizing public finance to crowd-in private capital into development.
Our overall finding is that the lack of a clear policy framework—a clear sense of what Canada is looking to achieve by blending—is a major gap. And one that certainly makes the claim of being a ‘leader’ in this space questionable. By way of publicly available information on the handful of cases where Canada has tried blending, we are able to raise a series of key questions and issues that point to an overall lack of strategy and internal learning.
In the absence of a strategy or policy framework there is a sense of bumbling from pilot initiative to pilot initiative. As we warned (about 2 years ago) the absence of a strategy is likely to be filled by one-off innovative sounding initiatives that no one can be sure add up to what.
It is important to also underscore the state of play in this space more generally. As others have noted, for all the talk of going from “billions to trillions” in development finance the reality to date is disappointing. For e.g. the level of private funding for infrastructure mobilized by the multilateral development banks is declining not increasing. According to the World Bank’s own data infrastructure investment with private participation has decline from $210 billion in 2012 to only $76 billion in 2016 (see here and here).
Donors seem to have a long way to go in realizing the lofty ambitions of scaling up private capital to finance the SDGs. Canada for its part needs to (a) make a concerted effort to drive and consolidate learning from its limited first-hand experience in this space and (b) lay out a clear strategy on blended finance.