The United Nations’ 2030 Agenda for Sustainable Development encompasses 17 sustainable development goals intended to positively impact the planet and its people over the next decade. The Paris Agreement aims for climate neutrality by 2100.
Achieving these ambitious goals will take investments worth trillions of dollars. The specialized field of blended finance may serve a key role in meeting this vast capital need, providing mission-critical cash where public funding, philanthropic interests, impact-minded investors, and traditional investors fall short.
Blended finance involves injecting a mix of funds into the cash-poor phases of a project to support it until traditional sources step in, according to the World Bank Group’s International Finance Corporation (IFC).
The discipline relies substantially upon catalytic capital, defined by consulting firm Tideline as investments that “accept disproportionate risk and/or concessionary returns relative to a conventional investment in order to generate positive impact and enable third-party investment that otherwise would not be possible.”
While this alternative to traditional risk-reward models only appeals to certain impact investors, the UK-based Blended Finance Taskforce reports that financial guarantees, insurance, currency hedging, technical assistance grants, and first-loss capital prove invaluable to beneficiaries, especially in emerging and frontier markets.
Specifics vary by opportunity, evident in the way blended finance has been used to stimulate development in a range of areas, from affordable housing and energy infrastructure to social entrepreneurship.
Jumpstarting Affordable Housing Initiatives
Home ownership provides families with a sense of protection and stability, as well as the ownership of a valuable asset.
Yet the Harvard Joint Center for Housing notes that shortfalls in supply are driving prices higher in the US, as are increasing land prices and regulatory measures. As a result, homebuilders generally focus on the higher end of the market, and median home prices are climbing even further out of the affordability range for millions. To address conditions in the US, Calvert Impact Capital directs blended finance funds to affordable housing developers, who must make significant investments in land, planning, and other predevelopment requirements before traditional financing kicks in.
Similarly, in West Africa, demand for decent housing far exceeds supply, yet banks have limited capital to lend. As a result, the World Bank found that mortgages were only available to a fraction of those seeking their own home. The IFC launched a program in West Africa that enhanced the capital landscape there by buying 12-year local currency bonds, which provided lenders with the funds they needed. The maneuver also allowed for longer mortgages than the traditional three-year term, which proved too expensive for many.
In both regions, blended finance reduced significant barriers to the development and accessibility of affordable homes.
Mitigating Energy Infrastructure Risk
The Paris Agreement charged signatories with limiting the rise in average global temperature to less than 2 degrees Celsius by 2050. The Brookings Institution says achieving that goal will require $85 trillion worth of investment in low-carbon, climate-resilient infrastructure by 2030.
Brookings adds, however, that current investment in the space represents barely a trickle of the capital needed, as institutional and private investors tend to shy away from infrastructure investments, especially energy-related opportunities that use relatively unproven technology or rely on government subsidies. The conditions are even more dire for low-carbon, climate-resilient projects in emerging economies, where political uncertainty, limited investment success, and currency volatility all exacerbate risk factors.
Enter the blended finance approach known as multilateral climate funds. These pools of capital extend loans with submarket rates—and occasionally negative rates of return—to complement public funding early on and therefore reduce a project’s risk for later-stage investors.
Furthering Social Entrepreneurs’ Reach
Social entrepreneurship leverages the innovation often present in startup spaces to tackle pressing social matters. Social entrepreneurs apply a business mindset to societal issues to develop market-tested solutions that are beneficial and self-sustaining.
According to global nonprofit Ashoka, though, a chasm frequently forms between startup funding provided by philanthropic interests or public funds and traditional equity or debt investments made by those who seek market-rate returns from effectively scaled businesses.
To keep early-stage companies afloat while they evolve into sustainable enterprises, blended finance bridges the divide that could otherwise doom a young enterprise.
For example, to help improve the well-being of smallholder farmers in Nigeria, the Global Innovation Fund developed a $2.5 million debt investment to back the development of an agricultural franchise model. The funding allowed the social enterprise, Babban Gona, to pay farmers a higher income than they had been earning and strengthen the agricultural network across northern Nigeria. Plus, as a subordinate offering, the bond ranks on the organization’s lowest rung with regard to payback, aiding future fundraising efforts.
Blended finance is fueled by catalytic capital and serves as a lifeline to cash-starved entities who navigate some of the most challenging funding terrain. As such, blended finance has the capacity to play an important role in the impact investment universe.