The use of catalytic capital from public or philanthropic sources to increase private sector investment in developing countries to realize the Sustainable Development Goals (SDGs) of the United Nations is the core principle outlined in blended finance which broadly is a structuring approach and not an investment approach, Convergence says
By Salam Rajesh
Financing initiatives and innovations on measures to combat the triple planetary crises – global warming, climate change and extreme weather events – requires the impartial involvement of sectors that are altogether responsible for climate mitigation and adaptation measures in achieving stated goals, according to the climate blended finance watch group Convergence.
This is amplified in Convergence’s recent report, ‘State of Blended Finance 2024’, emphasizing that climate blended finance addresses the use of blended finance structures ‘to deliver private sector investment to transactions that explicitly aim to produce outcomes that combat and respond to the effects of climate change in developing countries’.
Simply put, Convergence says that the objective of blended finance is to ultimately create commercially viable markets that no longer need risk mitigation or return enhancements to attract private investment.
The use of catalytic capital from public or philanthropic sources to increase private sector investment in developing countries to realize the Sustainable Development Goals (SDGs) of the United Nations is the core principle outlined in blended finance which broadly is a structuring approach and not an investment approach, Convergence says.
Elaborating on this, the report noted that blended finance allows organizations with different objectives to invest alongside each other while achieving their own objectives, and creates investable opportunities in developing countries as a means to deliver more development impact.
One of the emerging conversations on climate financing is the carbon market. On this very aspect, the dialogue is on the functionality of carbon credits. A carbon credit represents a volume of greenhouse gas (GHG) emission reduction, typically about one metric ton, created by a specific project or activity such as reforestation and the in-situ protection and preservation of original growth forests.
Carbon credits are certified by specialist agencies such as the Gold Standard. Credits are sold by credit generating projects on a “carbon market” to buyers who are seeking to “offset” their own GHG emission production with the carbon reduction represented by the credit. The exchange facilitates carbon neutrality. Part of the credit verification process ensures a threshold where the GHG emission reduction would otherwise have not occurred if the project was not implemented, the report noted.
This deliberation further brings to focus the necessity of meeting the Nationally Determined Contributions (NDCs) of each nation to achieve carbon neutrality. The NDCs are the country-specific commitments to cut GHG emissions and adapt to the effects of climate change required by all parties to the Paris Agreement and the collective commitment to limit global warming to 1.5 degrees Celsius by the target years 2030 and 2050.
The NDCs must define how targets will be met, outline how progress towards the goals will be monitored and verified, and be updated by the respective country on a five-year cycle, the report noted.
Climate mitigation and adaptation measures also suggest the adoption of Nature-based Solutions (NbS) with concentrated focus on motivating nature-oriented initiatives to achieve carbon neutrality.
Nature-based solutions are rooted in the concept that healthy natural capital assets are both critical to functioning natural ecosystems and sustainable economic development by yielding shared benefits to modified or human-built systems, the report noted.
The emerging trend of capitalizing on extensive mangrove plantations on seashores to meet climate targets and achieve sustainable livelihoods for the local communities is hailed as one of the best NbS strategies both in terms of low investment and nature-friendly initiative. Mangrove plantation or reforestation is widely acclaimed along the coastlines of Indonesia and other coastal countries in achieving strategies to tackle extreme weather events and improve the economies of Indigenous peoples and local communities (IPLCs) especially in the developing countries.
The participation of local governments and domestic capital mobilization is essential for creating a sustainable and inclusive blended finance ecosystem, Convergence emphasizes while noting that local governments are crucial in creating an enabling environment for blended finance transactions by developing supportive policies and regulations, providing project pipelines, and facilitating stakeholder engagement.
The objectivity of blended finance is two-fold as Convergence showcases it: First, in the immediate sense, blended finance creates investable assets that meet investor risk-adjusted return appetites, thereby increasing international and domestic exposure to new markets and new asset classes. Second, blended finance is an entry point for risk determination, price discovery, and asset valuation.
Further, blended finance deals help determine spot prices of new asset classes or assets in underdeveloped markets where there is limited transaction history. They can also assist in determining the fair value of individual assets and, by supplying benchmarks on risk, support the development of valuation models, engendering market transparency and enabling investors to make more informed decisions, the report noted.
Convergence, however, noted that its cumulative data indicated that most blended finance transactions occurred in countries with non-investment grade sovereign credit ratings, where the leading rating agencies rate 76% of developing countries at grade “B”, or lower.
It further noted that most private investors have investment policies tied to more favorable investment-grade jurisdictions. This mismatch prevents capital inflows towards the regions in which they are most needed, the report stressed.
On top of this, regulatory barriers and bottlenecks pose significant challenges to the participation of institutional capital pools in blended finance transactions, the report emphasized hinting at that things usually do not sail as smoothly as it should be to achieve the desired goals.
Other these factors, the report noted that many local governments in emerging markets and developing economies lack the capacity and expertise to effectively engage in blended finance transactions. To address this challenge, Convergence opines that the blended finance community must prioritize programs that strengthen the ability of local governments to identify, develop, and implement bankable blended finance projects.
The State of Blended Finance 2024 is Convergence’s annual report on blended finance trends, opportunities, and challenges, produced in two editions for the general market and the climate finance market. The Convergence is the global network for blended finance.