SPI JOURNAL H1 2025
Blended finance should evolve beyond project-level de-risking to scalable solutions
The lack of a predictable pipeline of blended finance projects complicates the ability to raise dedicated capital, writes Vivian Guo, portfolio manager and co-head of ESG, Templeton Global Macro at Franklin Templeton.
Blended finance first surfaced as a tool to close the United Nations' Sustainable Development Goals funding gap for emerging markets in 2015. However, over the last decade, Convergence, a database on such transactions, estimates that blended finance has mobilised only around $230bn for sustainable development, compared to the $4tn per year that the same countries need to meet their SDGs.
Among the key findings from the report produced by OMFIF’s Transition Finance Working Group, which surveyed global asset owners’ perspectives on barriers and solutions to transition finance, were the twin challenges of project availability and scalability. One is the lack of a predictable pipeline of blended finance projects in which investors can participate, complicating the ability to raise dedicated capital. The second is that many of these projects remain small and bespoke, which presents challenges for institutional investors that require standardised instruments to put capital to use and at scale.
Both challenges share one solution: to leverage private capital to expand the balance sheets of multilateral development banks. Existing blended finance instruments have largely focused on the project level, using guarantees and grants – among other assurances – to de-risk specific investments. While these are valuable tools, this singular focus ignores other possibilities for mobilising private capital.
How MDBs can expand capacity
MDBs serve as cornerstones of global development. They possess long-established pipelines for sourcing meaningful projects along with the expertise to evaluate the impact of those projects. Aligning with development goals and technical expertise also incentivises borrowers to work with MDBs. This access is significant and should be leveraged to mobilise private capital.
The private sector can help MDBs expand their capacity in several ways. One option is for development banks to raise additional capital through bonds, hybrid instruments or equity. On the bond side, strong credit ratings and preferred creditor status would attract investors. The labelled bond market holds promise as it accounts for only 17% of MDB debt, compared to their lending, which is strongly aligned with labelled bond requirements. At the same time, issuing these bonds in local currency would allow banks to increase their local currency lending, thereby reducing risk to borrowers.
Another avenue is through facilitating private capital to invest alongside MDBs – and co-investments or parallel loan structures have the potential, especially at a fund level. MDBs could also distribute existing loans to private investors off their balance sheets, retaining a tranche to maintain a relationship with the borrower or sell down exposure for maintenance phase loans. Additionally, synthetic risk transfers would reduce the provisions that banks must hold for their assets and open space for additional lending. These solutions differentiate themselves from project-level support in that they could have a multiplier effect on MDB balance sheets, rather than creating greater claims upon them.
Many of these options benefit from their familiarity to private investors compared to bespoke structures. Leveraging existing asset classes and established standards will, we believe, increase investor confidence to enter unfamiliar territory and increase the likelihood of compliance with prevailing sustainable investing regulatory treatment. These factors should facilitate scale, while reducing the cost of blended finance transactions.
Of course, there are challenges to this approach. Greater communication between MDBs and private investors would be necessary, as collaboration must occur across the life cycle of an investment. Questions around how rating agencies evaluate risk for MDBs must also be resolved. However, there must be a mindset change in how to operationalise blended finance. For private investors, the appeal of working with MDBs lies not only in their concessionary capital, but also in their capabilities as development institutions. Leveraging this expertise will be critical to delivering on the promises of blended finance.
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