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.
What is “blended finance”?
There are at least 15 definitions of blended finance that have been compiled recently. They are different in subtle but nuanced ways. Given the increasing level of interest especially from donors, there was a need to consolidate concepts. An important recent contribution that aims to do just that is from the OECD-DAC. The OECD defines blended finance as:
There are two key components: (a) the use of development finance is strategic (i.e. small and hopefully catalytic); and (b) the utilization is to mobilize additional financing that is ‘commercial’ (i.e. at or near market terms).
Development Initiatives (DI) describes blended finance as the use of public-sector funds or guarantees to mobilize private capital for the financing of development projects.
The World Economic Forum (WEF) outlined it as the strategic use of development finance and philanthropic funds to mobilize private capital flows to emerging frontier markets, resulting in positive results for both investors and communities.
The World Bank’s International Finance Corporation (IFC) refers to blended finance as a financing package comprised of concessional funding (provided by development partners) and commercial funding (provided by IFC and co-investors). IFC makes the case that blended finance solutions can provide financial support to a high-impact project that would not attract funding on strictly commercial terms because the risks are considered too high and the returns are either unproven or not commensurate with the level of risk.
Three common threads run across various definitions: (a) blended finance entails some use of development finance, i.e. official or public finance that is concessional; to (b) mobilize other funds, primarily from private investors, i.e. non-concessional; for (c) some development impact or payoff in addition to financial return (or at least break-even).
What do we know about its scale?
While most reports on blended finance discuss its potential to close the funding gap to achieve the Sustainable Development Goals (SDGs), data regarding the size, scale, and amount mobilized by blended finance transactions remains highly selective.
The WEF report on blended finance provided data from 74 transactions that were valued at $25.4B. However, only 19 of the 74 deals provided information regarding the source of funds. Based on these, the WEF was able to report that $2.7B of the funds included in these 19 deals came from private investors.
Convergence reported on 187 blended finance deals, some going back to the 1980s, which they have tracked in their database. These 187 deals mobilized $51.2B towards the SDGs.
The OECD states that $81.1B was mobilized from the private sector by official development finance interventions in 2012-15; the highest number we came across in our research. Guarantees mobilized the largest share of finance over the three years ($35.9B), followed by syndicated loans ($15.9B) and credit lines ($15.2B).
Based entirely on OECD data (which, as we note below has significant drawbacks), others have projected that the total volume of private finance mobilized via blending could reach $252B by 2020.
The OECD also notes that, since 2000, in total $31B in donor facilities were committed towards blending across 189 blended finance funds.
Clearly the picture is quite confusing. It gets more so when we look deeper at the nuanced differences between concepts and methods. For example, the OECD concept of “mobilization” differs from the more standard financial concept of “leverage” in important ways. The OECD-DAC, for its part, does not explicitly equate “mobilization” with “blending.” However, others do precisely that. For example, the DI study and blended finance projections are based entirely on DAC mobilization data. As we show below, there are elements of “blending” that the DAC approach fails to capture. There are also elements of “mobilization” that greatly exaggerate the level of blending if counted at face value.
Although the numbers regarding the scale of blended finance differ among these reports, all agree that most of the blended finance transactions are concentrated in the financial services sector, energy, and industrial sectors. Geographically, leaving aside investments that are global in scope, most of the mobilization is for projects, deals or investments in Sub-Saharan Africa.
What do we know about performance?
Of the three reports providing information regarding the scale of blended finance, only the WEF survey reported on leverage, as it disaggregated which funds came from private firms in 19 deals. From these 19 data points, the WEF found that the amount of private capital leveraged on $1 of deployed development funding ranged from $0.29 to $20.40. It is important to note that the majority of the 19 deals studied leveraged less than $5 per dollar of development funding; an impressive finding nonetheless.
With a longer track-record, the EU generally provides more data and information on its blending facilities. For instance, in terms of leverage achieved, the EU explicitly notes that the EU-African Infrastructure Trust Fund (EU-AITF), launched in 2007, achieves a leverage ratio in the range of 1:14. The EU’s Asian Investment Facility (AIF), launched in 2010, boasts a leverage ratio of 1:30. However, again, there are measurement issues and it is unclear how this leverage is calculated (it seems that all forms of ‘pooling,’ whether at market, or on more generous terms, including from other DFIs, is counted as ‘leverage’).
With respect to returns, the WEF’s efforts at accurately reporting figures was impeded by number of respondents willing to disclose their financial returns. Average target returns on debt and equity were 4.9% and 11.4%, respectively, based on six respondents using debt and twelve respondents using equity. Average realized returns were 5.4% for debt and 16.3% for equity, but only had four respondents for each.
Regarding the development impacts of blended finance, only the WEF survey and the Convergence report offer insights. From the WEF data, 24 respondents, representing less than 20% of the capital analyzed by the WEF, reported reaching 177.4 million beneficiaries. Twenty-six respondents also purported to have created over 442,000 jobs.
Convergence reports on the alignment between blended finance transactions and the 17 SDGs. Convergence states that blended finance deals best align with Goal 17 (Partnerships), Goal 9 (Industry and Innovation), Goal 1 (No Poverty), and Goal 10 (Decent Work and Economic Growth).
At a case-study level, Convergence provides some insight into performance. For example, SFMF2, a USD$150 million fund that invests in frontier and emerging market private equity funds, tracks over 30 IRIS metrics covering areas like job creation, gender equality and environmental impact. In terms of financial returns, the fund has a target net internal rate of return (IRR) of 15% for limited partners (LPs), which Convergence notes compares favourably with emerging market private equity and venture capital funds of a comparable vintage. (We discuss SFMF2 in further detail below).
Who tracks it and how? This is where it gets complicated.
The blended finance landscape remains somewhat confusing from a metrics perspective. Part of the reason for this is the lack of a clear and common definition. The OECD’s recent contribution may help, but there are other issues. It is unclear who, if any central agency or multilateral forum, is best placed to track and report on blending. Unlike official development assistance (ODA) and other forms of official development finance which are tracked by the OECD-DAC, the involvement of private actors and their financial contributions complicates reporting because the DAC cannot mandate such information from private players. Furthermore, competitiveness, confidentiality and other concerns arise quite quickly, making an already complex task even more challenging.
Most reports identify this as a key weakness of the space. For example, Convergence shows that deeper and more actionable blended finance data is required. While several think-tanks have compiled reports on blended finance, Convergence notes that they primarily focus on capital mobilized and ignore a fundamental component: returns. We would argue also risk, or risk adjusted returns, both developmental and financial. Convergence concludes that “there needs to be a concerted effort to quantify returns for different levels of the capital stack in historical blended finance transactions, particularly to enable private investors to make informed investment decisions based on comparable data.” DI concludes that “neither data reporting nor qualitative information on blended finance is good enough to be able to accurately assess the comparative advantage of this type of development finance.”
In sum, we are left with voluntary survey based assessments. Surveys are fine so long as the core concepts are clear and understood in the same way by the surveyor and those being surveyed, and so long as they are internally consistent (which is not always the case).
As we show elsewhere, with the help of cases that demonstrate key measurement and reporting issues, current approaches, such as the OECD-DAC’s survey are inadequate in terms of being able to capture blended finance—they both exaggerate the effect in some cases, and miss it completely in others.
Blended finance is an important and interesting corner of development finance.
The lack of a common definition, reporting and measurement standards, and the diversity of what passes off as ‘blended’ are a challenge for this space. When so many fundamentally different deals/project types/interventions/instruments are shoe-horned into one concept it makes it hard to gauge the efficacy of the concept itself.
Given the recent interest and efforts to crystallize concepts, one might think blended finance is new. This is not the case. Some databases track blended deals back to the 1980s. Others include any and all forms of ‘innovative’ financial instruments.
Case in point are the GAVI IFFIm and AMC. Both fix specific market failures (accelerating availability finance, increasing predictability of funding, guaranteeing a market where positive social externalities are significant but the requisite financial incentives do not exist). While these are game-changers in their own right, neither qualifies as “mobilizing additional commercial finance.” Yet, they show up in blended finance surveys (e.g. the IFFIm is covered in the WEF survey. The AMC has likewise been discussed as an example of blending).
Similarly, social impact bonds (SIBs) and development impact bonds (DIBs) are often equated with blending. However, not all SIBs/DIBs aim to scale commercial finance. In fact, most do not. They rather aim to structure collective incentives and better link payoffs to outcomes. In some cases, they may crowd-in private investors who may not otherwise have an instrument, let alone incentive, to participate. But they are not blended by default, even if they include both concessional and non-concessional finance.
Our preliminary and partial assessment, given we are working on forthcoming theoretical piece, is that “blended finance” is more appropriately described as a form of bespoke financial engineering with a development motive and intention. We think intention, motivation, and origination matter a great deal.
In so far as the aim is to leverage or otherwise crowd-in “additional commercial finance,” blended finance remains nascent, and, given the issues described above, very hard to evaluate. Blended finance is probably more efficacious as a space to bring together creativity (i.e. financial engineering for development) to tackle the challenges of scaling up development finance.
Where to look for more resources to make sense of it?
OECD-DAC on Blended Finance provides analyses and infographics on blended finance as well as links to articles, blogs, and events.
Convergence Knowledge Library offers a wide-range of research on blended finance and the development impact of various financial instruments, supplemented by in-depth case studies. Registration required.
WEF Blended Finance Toolkit is a comprehensive offering of informational primers and guides on blended finance.
IFC on Blended Finance provides an outline of IFC’s blended finance activities and how IFC works with other organizations in blended finance arrangements.
EU Blending provides an overview of EU blending facilities, policy priorities and frameworks, and project/investment level data.
Trending: blending by The Economist provides an overview of blended finance, which the magazine describes as the “fad for mixing public, charitable and private money.”
Sizing Up ‘Blended Finance’: A Guide to a New Financing Approach to Fuel Sustainable Development by Joan Larrea is a deal-level analysis of the ways in which to think about blended finance from the CEO of Convergence.
Untangling Misconceptions about Blended Finance by Neil Gregory provides a sobering outlook on the potential promise of blended finance from Head of Thought Leadership for IFC.
Maximising bang for the buck: Risks, returns, and what it really means to use ODA to leverage private funds by Paddy Carter continues the important discussion on how blended finance can be viewed as subsidizing private investment and the politics associated.
Making Sense of Blending: Canada Needs a Policy Framework by Aniket Bhushan and Matthew Gouett looks 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.