Breaking Barriers: how Blended Finance accelerates sustainability across emerging economies – Oxford/24 Report

This paper is part of the Fide Foundation’s GET-2 ESG Think-Tank final report from the 2024 Oxford Congress, titled “Driving Change: Exploring Opportunities and Challenges in Accelerating Sustainable Finance.”

Key Findings  

• Blended finance is a powerful tool to accelerate the sustainable development of Emerging Markets and Developing Economies (EMDEs), helping to close the climate financing gap. 

• The blended finance ecosystem comprises a wide range of stakeholders with varying mandates, operating in different regulatory environments and motivated by diverse goals and challenges. 

• The current state of blended finance shows significant complexity in structuring operations, with a limited scalability and a lack of optimisation of the scarce existing concessional capital, leading to relatively low mobilisation and leverage ratios.  

• Institutional private investors remain hesitant to engage in blended finance, deterred by the traditional risk profiles of the destination markets and their own lack of familiarity with these regions.  

• For blended finance to play a truly transformational role in addressing EMDEs’ climate and sustainable financing needs: 

• Regulatory reforms and incentives are essential to increase the mobilisation of private capital flows into blended finance structures. 

• A global framework for public blended finance participants should be established, enhancing the flexibility and availability of concessional capital to boost mobilisation ratios and improve the efficiency of concessional funding. 

• Long-term institutional investors should expand their allocations towards blended finance solutions, gaining a better understanding of the risk-reward profiles and the diversification benefits they offer 

• There must be improved transparency and data availability, particularly with regards to the track record of Development Finance Institutions (DFIs) in these regions. 

• Blended finance should be implemented on a programmatic basis, accompanied by structural reforms in host countries. 

Abstract 

Emerging Markets and Developing Economies (EMDEs) face a significant challenge in financing their climate action and development goals, particularly in relation to infrastructure assets such as energy transition, water, transport, and social infrastructure. Funding from the public sector, donors, and international development institutions falls short given the vast scale of the required capital. The real or perceived risks associated with these projects are often too high to attract private domestic or global investment. 

Blended finance seeks to address this by combining public, philanthropic, and private capital to create sustainable, accessible, and attractive investment opportunities in these markets. Typically, the involvement of donors and public capital is aimed at reducing perceived investment risks through various mechanisms, including the provision of concessional capital, local expertise and experience in these regions as well as the absorption of potential first losses. 

As such, blended finance emerges as a powerful and transformative tool to help EMDEs achieve their sustainability goals while offering attractive investment opportunities for private investors. However, its potential is hampered by the complexity of coordinating numerous stakeholders with often misaligned goals, mandates, and interests. Additionally, the lack of global regulation and supportive public policies remains a significant barrier to the mainstreaming and scaling of blended finance. 

Drawing on the expertise of panellists with extensive experience in blended finance from both the DFI and private investment sectors, the panel at the Oxford Congress 2024 aimed to deepen the understanding of the investor community regarding the nature and potential of blended finance, using concrete examples and real-world case studies. The discussion also explored the numerous challenges encountered in structuring blended finance operations and offered practical suggestions for scaling up and enhancing its efficiency. Finally, the panellists underscored the significant benefits that blended finance solutions can provide to long-term institutional investors, while delivering meaningful and sustainable impact on the global economy and society. 

Key Words  

BLENDED FINANCE- A technique used in “Development finance” that combines public, concessional, and/or philanthropic funds with private sector capital to support projects in emerging markets or developing economies. The goal is to mitigate risk and enhance the attractiveness of investments that deliver social, environmental and economic benefits, particularly in areas like climate action, infrastructure, and sustainable development.  

CONCESSIONAL CAPITAL – funding (loans, grants or investments) provided on more favourable terms than those available in the open market, often to make a project financially viable or reduce risk for private investors.  

CATALYTIC CAPITAL – Investment capital (debt, equity, guarantees, etc) deployed to unlock or «catalyse» additional investments, particularly from private investors, by taking on risk or offering flexible capital to projects that are underfunded but have significant social or environmental impact potential. 

DFIs– Development Finance Institutions 

DONORS– Philanthropies, various concessional facilities  

EMDEs – Emerging Markets and Developing Economies  

LEVERAGE RATE – The ratio of concessional capital (below market-price) to all commercial capital (market priced) in a financial transaction. Commercial capital includes capital from private, public, and philanthropic sources.  

MOBILIZATION RATE– The ratio of concessional capital (below-market-price) to commercial capital from only private sector sources 

MDBs– Multilateral Development Banks  

ODA – Official Development Assistance  

Content 

The current allocation of capital to emerging economies highlights the imperfections in financial markets. Countries classified as «lower-income» and «least developed» have the greatest need for capital to support their transition to more sustainable economies, particularly in adapting to climate change. However, their capital markets are often either non-existent or too underdeveloped, leading to the majority of investments being channelled towards upper-middle-income markets. 

This situation limits investors’ access to lower-income markets, and when coupled with the perception of high risk, it results in a severe shortfall of funding for the countries most in need of capital. While current estimates suggest that climate investment needs in emerging markets and developing economies (EMDEs) amount to trillions, a closer look at the portfolio composition of institutional investors reveals that 97% of European insurance companies’ portfolios are invested in OECD markets, with only 3% allocated to developing countries ^{1 .} 

Blended finance aims to address this imbalance by combining public, philanthropic, and private capital to create investment strategies and solutions that provide institutional investors with access to sustainable investments in emerging markets in a de-risked and attractive way.  

There are numerous official and unofficial definitions of blended finance, often described as a «tool, instrument, mechanism, structure, or even an investment style or an asset class.»  As with Sustainable and Impact investing, blended finance is a discipline in constant evolution, with a growing number of new initiatives, stakeholders and participants, many of them newer entrants to the sector.  To avoid becoming entangled in the definition of blended finance and the many facets of a field being shaped by a wide range of participants, the panel understands blended finance mainly as a strategic approach to development financing that combines public, concessional or philanthropic funds with private sector capital to support projects in emerging markets or developing economies. 

The goal is to mitigate risk and enhance the attractiveness of investments that deliver social, environmental, or economic benefits in EMDEs, particularly in areas like climate action, infrastructure, and sustainable development. By leveraging public or concessional funding, blended finance aims to mobilise larger amounts of private capital, close financing gaps, and facilitate projects that may not otherwise receive sufficient investment due to perceived risks or market inefficiencies. 

Once the definition of blended finance has been established, it is worthwhile to take a brief look at its evolution. According to the Convergence Report “State of Blended Finance 2024” – referenced in this document- over the last decade, the blended finance market has comprised an average of 85 deals per year, with a median annual financing total of $15 billion. Convergence data illustrates a significant uptick in the cadence of blended finance in recent years; 122 annual transactions on average in 2021-2023, with bigger ticket sizes in 2023 (over $100M).  

Despite a somewhat positive recent trajectory, blended finance practices have faced growing criticism for various reasons, which the panel explored as some of the key barriers² faced when structuring blended finance solutions. These include: 

• Relatively observed low mobilisation and leverage ratios, with calls for more effective and efficient ways to attract private capital. 

• The need to optimise the scarce concessional capital, given increasingly constrained public funding sources. 

• Public capital seeking commercial returns on par with private capital, which can lead to the crowding-out of private investment. 

• This, combined with the limited number of investable opportunities and/or bankable projects, might reinforce the perception of crowding- out. 

• Growing fatigue due to the time and effort-intensive nature of blended finance, requiring more complex management by investors in their governance and investment processes, as well as by regulators. 

All the barriers outlined above could ultimately be traced back to the so-called “knowledge gap” that permeates the blended finance ecosystem, where public and private sector entities often fail to fully understand each other’s institutional mandates, regulatory frameworks, motivations, and challenges. This frequently leads to extended timeframes and significant efforts in aligning interests, and in some cases, direct competition. 

Misunderstandings about what is achievable for various blended finance stakeholders often stem from the knowledge gap, leading to mismatched expectations across the ecosystem. For instance, pursuing high leverage ratios while also targeting investment in high-risk locations, which would necessitate increased levels of concessional finance to make such investments attractive (or less risky) to private capital. Similarly, the drive for standardised approaches to improve liquidity and scalability can conflict with the need for bespoke solutions tailored to specific sectors and contexts. 

The panel acknowledges and explores the complexities inherent in a rapidly evolving, multi-stakeholder discipline like blended finance, emphasising that fostering greater understanding within the ecosystem is crucial, as this could help overcome many of the existing barriers.  

The panel also highlights several key prerequisites necessary for blended finance structures to maximise not only their financial leverage, but their development impact as well. Depending on the country context, one or more of the following elements would need to accompany any blended finance initiative: 

• A government-led programmatic approach that delivers a critical mass of bankable projects across one or more sectors. 

• Structural reforms within the target sector that, over time, reduce risk and improve affordability  

• A focus on attracting both domestic investors in local currency to mitigate foreign exchange risk, and international investors to achieve scale. 

• The adoption of hybrid financial structures that engage banks for their flexibility and expertise, alongside institutional investors for their ability to offer longer tenors. 

• Reforms in the domestic financial sector that support sustainable financing in local currency. 

¹ European Insurance and Occupational Pensions Authority (EOPA) 2020 Data 

² Barriers identified in the Report  “Scaling Up Blended Finance for Climate Mitigation and Adaptation in EMDEs”. NGFS, December 2023 

Conclusion and proposals  

The panel acknowledges that Blended finance has the potential to play a transformative role in aligning the interests of public and private capital, and despite the complexity of a nascent discipline, there are many advantages for investors and policymakers. 

For policymakers, blended finance offers a powerful tool to mobilise private capital for public objectives, helping bridge the funding gap for sustainable development in emerging markets and developing economies. It allows governments to leverage limited public resources more effectively by attracting private sector investment into high-impact sectors such as infrastructure, healthcare, and renewable energy. Additionally, blended finance can help accelerate policy goals like poverty reduction, job creation, and climate action by aligning private sector incentives with national development priorities. 

Through blended finance structures private investors have the opportunity to invest in emerging markets and developing economies with reduced risk by leveraging concessional capital from public and/or philanthropic sources. This enables them to achieve both financial returns and measurable social or environmental impact, aligning with the existing growing interest in sustainable investing and impact measurement. Additionally, it offers the potential for portfolio diversification, as investments in EMDEs are less correlated with traditional markets. 

Accordingly, and with an understanding that one of the key barriers is the diverse and complex ecosystem involved in blended finance, the panel echoes broader calls for: 

1. The creation of a global platform to foster dialogue among key stakeholders (donors, private investors, regulators), breaking down silos and facilitating the alignment of interests.  
    

2. Establishing a formal framework for policymakers and regulators to assess and develop approaches to blended finance. 
    

3. Enhancing education through greater data transparency, providing regulators and institutional investors with a clearer understanding of the actual risks involved in investing in EMDEs (emerging markets and developing economies). 
    

Participants 

Links to recommended readings or specific bibliography on the content of the panel 
 

• Convergence – “State of Blended Finance 2024” 
  https://www.convergence.finance/resource/state-of-blended-finance-2024/view 
   

• Network for Greening the Financial System- Scaling Up Blended Finance for Climate Mitigation and Adaptation in EMDEs, December 2023 
   

• Case study Allianz Global Investors– The SDG Loan Fund, a partnership between Allianz Global Investors, FMO and MacArthur Foundation  
  https://www.convergence.finance/resource/SDG-Loan-Fund/view 

• Reference study– Institutional Investors and Sustainable Infrastructure: A Global Review of Case Studies 
  https://bit.ly/3XGn5vU 

• National Bureau of Economic Research. Working paper “Blended Finance”, March 2024.  
  https://www.nber.org/papers/w32287 

Oxford/24 Final Report:

This paper is part of the Fide Foundation’s GET-2 ESG Think-Tank final report from the 2024 Oxford Congress, titled “Driving Change: Exploring Opportunities and Challenges in Accelerating Sustainable Finance.” Held at Jesus College, Oxford on September 18th, 19th, and 20th, 2024, the Congress brought together world leaders in finance, regulation, and sustainability. This comprehensive report consolidates key insights from the event, offering strategic recommendations to financial institutions and regulators on transitioning to a low-carbon economy and reaching net-zero greenhouse gas emissions by 2050. 

The full report can be found at: https://bit.ly/oxf24-report