Governments: Blended Finance is Like Music
You can start with a drumbeat, but if you want to have real music, you also need horns, woodwinds, violins, and so on, to create a symphony. It’s no different in blended finance. We see that there’s a steady drumbeat – people saying “we need more of it, we need more of it” – but not enough musicians are stepping up and joining in.
Sometimes this is because they’re happy playing by themselves. Sometimes because they feel they haven’t mastered their instrument, or because they don’t yet realize that the world needs more symphonies. Sometimes because there’s no producer to make sure all the musicians are booked and show up, and have the same sheet music in front of them.
Well, we’d like to call more musicians on stage. Starting with you, Governments, because you have a lot of power to further develop the blended finance marketplace. Here are three ways you can use it.
1. Use DFIs and MDBs differently
Development finance institutions (DFIs) and multilateral development banks (MDBs) were set up to finance international development and SDG solutions, and their mandates usually say they should also mobilize private capital for this. To achieve these things, they need your blessing to fail. At scale. Achieving the SDGs is challenging. It requires innovation, trial & error, experimentation, portfolios of projects and investments – the kind of stuff that Silicon Valley was built on. It might not look good at first, some of your projects will crash, but the end result is likely to be much more beneficial than what you have today: “international investment banks” doing “safe” projects.
Allow DFIs to break some eggs and to use their balance sheets more effectively in taking risk off the table for the other actors in blended finance to be lured in. We all know that we have to get more private parties (pension funds, insurance companies) involved to have a chance to reach the SDGs. DFIs can make this happen, with tools like first-loss positions. They need your consent to go all out.
You should be the host of the blended finance party: create hubs and platforms for relationship-building, collaboration, and co-investing. Invite the different actors. Ensure that projects and companies seeking capital show up, as well as DFIs, and the pension funds, insurance companies, asset managers and bankers. Everyone who is needed in the blended finance symphony needs to be there.
They will not come up with the idea of throwing the party themselves. You have to do it. But make nice invitations and get good catering, and they will come.
3. Rethink regulation of sustainable finance
You’ve been churning out laws, guidelines, regulations, taxonomies and Green Deals and you say the objective is to ‘reorient private capital flows’ but the mechanisms you use are unlikely to achieve this.
SFDR (Sustainable Finance Disclosure Regulation) is case in point: it is meant to stimulate ‘impact investment’, but having actual ‘impact’ is not even a requirement for a fund to be classified as article 9. It’s not going to reorient capital flows.
“ESG” and “impact investment” have a nice ring to it and suggest there’s a new way of financing the things you care about, but you’ve got to realize most of the old rules still apply: institutional investors assess deals primarily based on economics: risk and return. Don’t count on altruism and intentionality, or labeling and disclosures; instead use the financial tools at your disposal (taxes, subsidies, guarantees, first-loss) to ensure projects meet private investors’ risk & return requirements. People respond to incentives – laws & money – and you have the power to create them. Do it judiciously.
Are these three things going to solve the blended finance problem? No. Other actors will have to step up too. We’ll talk about this as well. But Governments are the first among equals in the blended finance symphony.
When you deliver on these three points, the other musicians will show up and you can strike up the band.
[Why Blended Finance is Critical
Most projects and activities that are needed to achieve the SDGs are not profitable, or not profitable enough, or not yet profitable. Also, most are small scale. And most are in emerging markets. At the same time, we need trillions annually (estimates vary) to flow to these activities, much, much more than governments, NGOs and charities have. So, we need institutional investors like pension funds and insurance companies because that’s where the money is. However, they do not invest in small-scale, emerging markets projects that are not profitable. Also, it’s unlikely we can persuade pension fund boards to make impact-first investments at scale – their primary aim is to invest on behalf of pensioners which comes with strict investment criteria. Also, none of the existing ESG activities (labels, ESG funds, green bonds, ESG integration, SFDR, PRI, TCFD, Taxonomy, Net Zero) are achieving any of this. So, if we want to scale this up fast in order to meet the 2030 deadline, we need to start tailoring the needed projects so that they do meet institutional investors’ requirements, and this is what blended finance does: government (or DFI or philanthropic) interventions such as guarantees, first-loss positions, grants, technical assistance, subordinated debt or junior equity, can change the risk/return profile of impactful projects enabling institutional investors to allocate capital to them.]
This article is part of a series on blended finance. It is based on the metaphor of an orchestra and the many different players and instruments required to play in harmony to produce a beautiful symphony. Stay tuned and follow illuminem for the rest of the series and read the articles addressing the other "musicians" here:
Asset Owners: Blended Finance is Like Music
Foundations: Blended Finance is Like Music
Illuminem Voices is a democratic space presenting the thoughts and opinions of leading Sustainability & Energy writers, their opinions do not necessarily represent those of illuminem.
About the authors
Harald Walkate is the founding partner of Route17, an independent blended finance advisory. He is also founder of Finding Ways Ahead, an ESG and sustainable finance advisory, and a Senior Fellow at the University of Zurich Center for Sustainable Finance and Private Wealth (CSP). Previously he was the Head of ESG and member of the Executive Committee of Natixis Investment Managers, and the Global Head of Responsible Investment at Aegon Asset Management.
Robert W. van Zwieten is the founding partner of Route17, an independent blended finance advisory firm. Amongst other engagements, he is also affiliated as an Adjunct Professor in Finance with the Asian Institute of Management. He formerly worked in senior positions at EMPEA, Asian Development Bank, Singapore Exchange, General Electric and ABN AMRO Bank.
Simon Gupta is the Founder & Managing Director of Broadpeak, a Swiss-based Advisory Company specializing in Impact Finance. He has 20 years of experience in development finance in Latin America, Africa and Asia. He is also a Partner at investment firm Investment Associate AG, where he leads social and environmental impact investing. Simon has been involved in the set-up of multiple blended finance structures on the LP side as well as the GP side. Before founding Broadpeak, he worked for financial institutions DEG, KfW, and ResponsAbility Investments AG.