Joan Larrea is the CEO of Convergence, a global network for blended finance. Justice Johnston is a senior associate at Convergence.
What’s the price tag for a world that is economically prosperous, environmentally secure and socially fair? The United Nations estimates it’s around US$4-trillion a year.
The UN Sustainable Development Goals (SDGs) provide a road map to such a world. However, to achieve the SDGs in developing countries by 2030, almost US$4-trillion per annum is needed – much more than the current aggregate SDG-focused funding of US$1.5-trillion annually from domestic and international sources, including official development assistance from governments and philanthropic donations. The financing gap is particularly acute in the least developed countries (LDCs), which exhibit the lowest indicators of socio-economic development.
To close this funding gap, the global development community has been exploring ways to leverage the expertise and resources of the private sector. The private sector has long played an integral role in economic development and poverty reduction. It is responsible for creating almost 90 per cent of jobs in the developing world, as well as facilitating important technological innovation and the distribution of goods and services. Global capital markets hold more than $200-trillion in assets, and an allocation of just 1 per cent of these assets toward the SDGs would go a long way.
However, private investors face a number of barriers in developing countries, including high perceived and real risks and poor returns for those risks.
Blended finance offers a way forward. It is the strategic use of catalytic capital from public or philanthropic sources to mobilize commercial capital from the private sector for developing countries. A transaction designed with catalytic “first loss capital” – money from public or charitable sources – mobilizes “senior” capital from the private sector. In case of any losses, the first loss layer shields the senior investors, thereby reducing risk and, in some cases, increasing returns.
The Canadian government has been a leader and innovator in the blended finance space. In 2016, Canada, in partnership with the World Economic Forum and others, launched Convergence to accelerate the scaling up of blended finance. Based in Toronto, Convergence is the global network for blended finance, generating blended finance data, intelligence and deal flow to increase private-sector investment in developing countries. Most recently, Ottawa launched a $300-million Equality Fund to mobilize greater investment in women in developing countries (e.g., female entrepreneurs, women’s rights organizations).
Blended finance has gained significant momentum in recent years, according to Convergence data. More than US$131-billion has already been mobilized by blended finance, with organizations across the public, philanthropic and private sectors getting on board. There’s no doubt we need the private sector to bridge the SDG funding gap, and one way to do this is through blended finance. But as it gains momentum, can we make it work for the LDCs where the financing gap is greatest?
A recent report by the United Nations Capital Development Fund (UNCDF) and the Organization for Economic Co-operation and Development (OECD) asks just this question. They observe that, of all the private financing mobilized by official development finance interventions between 2012 and 2017, only US$9.3-billion, or 6 per cent, went to LDCs, whereas more than 70 per cent went to middle-income countries. The UNCDF warns that current trends could entrench inequalities between and within countries, rather than help overcome them. At the same time, we know that innovative solutions are needed to overcome key challenges facing society, from extreme poverty to climate change.
Admittedly, blended finance is more challenging in the context of LDCs, where private investors face significant real and perceived risks to doing business. Yet we should be able to leverage the extensive track record of blended finance in middle-income countries to identify solutions that could work in LDCs. With the surge in interest in blended finance, trailblazers such as the Government of Canada need to start thinking about when and how the tool can be used most efficiently and effectively to mobilize additional financing for the highest-impact sectors and countries.
In this vein, it is important to recognize that blended finance alone will not achieve the SDGs or eradicate poverty; rather, it complements more traditional development assistance approaches such as grant-based development assistance and humanitarian relief to draw in significantly more financial resources for developing countries. Blended finance can support LDCs indirectly, relieving scarce public resources so they can be concentrated on interventions that address the poorest and most vulnerable.
The challenges facing our world are daunting, and solving them will require additional sources of finance and innovative ways to make capital work for global development. While the increased focus on blended finance from the development community is promising, it needs to focus not just on the quantity of resources for development but also on quality and how and where those resources are allocated and the impact they have on the SDGs. In particular, they must be willing to experiment more and take more risks in challenging environments such as LDCs.