ONENDREW JOHNSTONE runs a fund that “goes where people haven’t gone before”. Climate Investor One was launched in 2015 and finances renewable energy projects that the market considers too risky, such as wind farms in Vietnam and hydropower plants in Uganda. It uses grants from development agencies to attract capital from pension funds. This allows more money to be raised. For every $ 1 grant, $ 12 was secured from the private sector.
The Fund is an example of mixed finance, where public or philanthropic funds reduce the risk of investments for the private sector through the use of financial instruments such as default insurance or loan guarantees. The mixed up money either finances projects directly, often infrastructure in poor countries, or goes to a fund that supports many companies. The idea was rooted in development circles at the end of the 2000s. Many still see it as a way for markets to bridge the funding gap to meet the target U.N.The sustainable development goals are estimated at a whopping $ 2.5 billion per year.
Institutional investors, so the reasoning, are exposed to emerging markets with a lower risk. Development institutions like the World Bank’s financing arm are providing more capital. Ideally, blended finance would open up new markets. For example, once the viability of water treatment plants in Kenya has been demonstrated, the private sector should self-finance similar projects.
However, blended finance is struggling to grow. According to data from Convergence, a nonprofit, the inflow of public and private capital into mixed projects and funds has remained unchanged since 2014 at around $ 20 billion per year. That is far from that of the U.N. in 2015, which aimed at spending on climate change and should be met this year. Even some proponents admit the approach is stalling.
What’s wrong For one thing, institutional investors are reluctant to get involved. The asset class is unknown. Projects are often bespoke and too small to make the effort worthwhile. The median was $ 50 million in 2018. This poses another problem, says Jay Collins of Citigroup, a bank. Creating a mixed structure requires financial support. But the wizards usually work for large financial firms with little interest in tricky deals. Getting the mix right also requires trust on both the public and private sides, says Johnstone. A culture war can forbid that. A portfolio manager describes working with the cumbersome bureaucracies as “tortuous”.
Another stumbling block lies with public institutions. On average, multilateral development banks mobilize less than $ 1 in private capital for every public dollar, says Katherine Stodulka of the Blended Finance Taskforce, a global organization. This is in part because their internal operations provide incentives for grants that go beyond blending.
Viable projects are also hard to find. In poor countries, governments find it difficult to prepare projects for investors because, for example, they lack the expertise to carry out feasibility studies. Retail investors want the most returns for a given risk. Scholars want the greatest impact. A blended finance project has to reconcile the two, and there are only a few of them, says Christoph Kuhn from the European Investment Bank (EIB).
Some development banks work with poor governments to show that projects are profitable. That costs 2-5% of the project expenses (in consulting fees etc.), but calms the investors. Mr. Kuhn recommends the use of mixed techniques that investors are familiar with. The EIB focuses on stratification of equity, where the public tranche suffers the first loss if a project goes wrong, and guaranteed against losses for banks.
More transparency could also attract investors. Data on deals is often confidential, so it’s hard to tell what returns are normal and how many projects will go broke. Development banks promise more disclosure (but investors doubt that will happen).
Such small corrections encourage growth. Merging public and private money will always be difficult, however, and early hopes may have been just too starry. A trillion dollar market seems out of reach. Even reaching the hundreds of billions a year can be a stretch. ■
This article appeared in the Finance & Economics section of the print edition under the heading “Search Scale”.