· 7 min read
The need to scale blended finance
As climate change accelerates, leading to unprecedented warming, drying, and devastating wildfires, an urgent necessity emerges for innovative finance to amplify clean energy, energy efficiency, climate resilience, and sustainability initiatives worldwide. This need is especially acute in the least developed countries, where limited economic growth and political capacities hinder effective adaptation and mitigation efforts compared to their developed counterparts.
Blended finance is a key vehicle to facilitate these responses: financing that combines public and private resources to support sustainable development projects in developing countries. Blended finance and catalytic capital have gained popularity in recent years as a way to leverage private investment investment for sustainable development goals. Despite this progress, however, there remains an urgent need to scale blended finance in the world's least developed countries for three key reasons.
First, we have a moral obligation to confront a growing global injustice in which countries contributing negligible amounts to the world’s carbon emissions are experiencing the most harrowing impacts of climate change. Developing countries such as Pakistan, Ethiopia, Haiti, Somalia, and small island nations such as Fiji—despite accounting for less than 1% of global carbon emissions—lose the most when sea levels rise and the earth warms. Blended finance is a key tool to help right this imbalance.
Second, these countries often face significant financing gaps in their development efforts. They typically have limited access to the international capital market, and traditional sources of financing – such as foreign aid and government borrowing – are frequently insufficient. Blended finance can help bridge this gap by bringing private capital to complement public resources.
Third, blended finance can help address the unique challenges faced by these countries in achieving sustainable development. For example, the world’s least developed nations often lack the infrastructure, technology, or expertise to implement sustainable development projects. Private finance partners can provide these resources, while public actors can help ensure that projects meet development objectives in the most inclusive and equitable manner possible.
Despite the potential benefits of blended finance and—some would say—its unique position to help remedy the generational carbon injustice noted above, there are several challenges to scaling blended finance in the world's least developed countries. For example, local financial institutions typically have limited capacity to manage blended finance projects. These institutions often lack the expertise and resources to assess and manage complex investment structures involving multiple stakeholders.
There is also a perceived risk held by some officials in these nations that blended finance could displace traditional development finance, such as foreign aid. They worry that – if blended finance is used as a substitute for aid – it could reduce resources available for development efforts, particularly in the poorest countries.
The missing ingredient: investment-ready bankable projects
However the main challenge to blended finance's rapid uptake and scalable development impact is the lack of suitable investment-ready opportunities. Many of these countries do not have a robust pipeline of even preliminarily designed bankable projects attractive to private sector investment. The problem is compounding: steadily growing amounts of climate-related blended capital are pooling up on the supply side while the demand for such capital is increasing at a much more modest rate or is outright stagnating in the least developed markets. No wonder the number and volume of blended deals in climate finance have fallen in recent years.
We observed this first-hand in Afghanistan, a member of the Vulnerable Twenty (V20) group of 68 countries that are particularly vulnerable to global warming while evaluating and structuring sustainable infrastructure investments on the ground there between 2012 and 2020. As we considered potential renewable energy opportunities in wind power and transitional natural gas-fired generation capacity, our due diligence and project design were challenged by counterparties who – while well-intentioned and supportive of climate-responsible development – had little knowledge of, or expertise in, structuring these types of projects or establishing the requisite legal/regulatory frameworks needed to support the sectors.
In short, the most vulnerable countries at risk of climate crises need more than funding; they urgently need access to knowledge and technical advice from trusted sources that aren’t selling or financing products. Unfortunately, the traditional providers of such access – donors, multilateral development banks, and/or consultants paid for by aid agencies – simply are not making them available in the quantity needed in least-developed countries such as Afghanistan and many others, or they have moved on to different operating objectives entirely.
Without such expertise, neither government officials nor leaders inside the planned transaction counterparties/off-takers are well positioned to evaluate technology choices effectively, understand complex financial models, and ultimately coalesce around deal terms to feel comfortable enough to “risk” signing their names to the long-term agreements that many sustainable finance projects require. Twenty-year PPAs are complex documents for any off-taker. However, when such document tenors outstrip the ‘stability track record’ of many of the world’s least developed countries, the time horizons can seem impossibly huge and daunting for those called upon to sign them.
Some observers have called this the climate capital “demand” quandary. Joe Evans—portfolio director and a social investment officer at The Kresge Foundation—went one step further in a 2023 domestically focused commentary boldly entitled ‘Environmental justice investors: It’s the demand-side, stupid!’ Extrapolating his thesis on the global scale, he states that there is more climate-engaged available private capital and external interests than latent demand for it in least-developed countries like Afghanistan and many others.
In sum, we don’t have an awareness-building challenge to climate impact these days or a financing issue. Instead, we have a significant constraint and need to create, a funnel of financeable projects demanding capital, particularly projects of scale and magnitude that can absorb larger financing. Transactions in the most fragile and young markets worldwide have always been complex and challenging: deals don’t easily “pencil out,” in-country equity can be hard to source; and there are often multiple levels of political, currency, and even security risk. But we believe we can change this dynamic, remove the two most common barriers to project readiness, and create real “demand” if we aspire to do the following.
First, we must encourage project design that aims for a better balance between most investors’ desire for scale (i.e., to generate returns of sufficient magnitude) with the reality that implementation is the biggest challenge in most developing countries, and certainly in the least-developed ones. Managing execution risk is far more important than designing the most theoretically elegant large-scale project when – as was often the case in Afghanistan – fundamental things like spare parts, a steady supply of diesel fuel, or even reliable security to get people to/from work sites were in short supply. In sum, having the most effective “penciled out” project didn’t matter: we needed 50% of the ‘right’ answer with 100% of the ability to execute, versus 100% of the ‘right’ answer that simply was not implementable.
In Afghanistan, as in many other frontier markets, the solution to this problem was a smart design approach that we coined our ‘crawl/walk/run’ strategy. In short, we designed projects that could be proven and implemented in smaller phases with relatively short implementation timeframes and clear success metrics. This approach allowed us to determine what could/would go wrong at a more modest scale, giving us a real opportunity to de-risk and structure the overall multi-phase project for success and provide all parties – investors, developers, counterparties, and host governments alike – a chance to get some quick wins on the table with solid proofs of concept, before moving onto bigger initiatives involving larger sums of capital at risk.
Second, the way to improve the funnel of “ready” projects – what Evans terms ‘financeable demand’ – would be to use blended finance interventions (grants, technical assistance) to improve access to information and professional advice from entities that aren’t selling or financing the products, and also enable local partners to provide equity into projects. These elements are typically available to people and organizations in more affluent countries worldwide, where greater financial resources circulate and networks of educated professionals naturally proliferate. Still, they are in scarce supply in the least developed nations.
In closing, we all want to see blended finance principles activate and help scale clean energy, energy efficiency, climate resiliency, and sustainability in emerging markets and lesser developed countries worldwide. But, absent a commitment to invest as much in project readiness as in direct financing and an effort to encourage a greater tendency to reframe projects along smaller scale, “step up” designs that allow developers to de-risk and structure projects for commercial viability, we worry that we may be risking disappointment, sub-optimal development impact or, perhaps worse, capital that pools almost uniquely around projects where the lowest risk meets the highest return, rather than around investments that support the most vulnerable places. We cannot leave those most at risk of climate change impact ‘high and dry.’ Instead, let’s use blended finance to activate evidence of investment-ready project demand so that the rising investment tide will lift all boats.
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.
