Blended Finance: transforming the way public and private investors work together

Sarah Gordon is a Visiting Professor in Practice at the London School of Economics’ Grantham Research Institute on climate and the environment. For her recent research on this topic, please click here.

AfricaGrow was set up in 2019 to promote small and medium-sized businesses and start-ups in Africa. A fund-of-funds, it is designed not only to get more investment into a thriving and dynamic sector, but also to support local venture capital and private equity managers and, thus, the development of broader and deeper capital markets across the region.

The fund is a great example of collaboration between governments and pioneering private asset managers. Managed and structured by Allianz Global Investors, half of its €200 million in assets comes from Germany’s Federal Ministry for Economic Cooperation and Development. The country’s development bank, KfW, provided a further €30 million and Allianz companies invested €70 million. Importantly, the German government is also funding a €15 million technical assistance facility, to build skills alongside investment. 

AfricaGrow is one of a growing number of successful blended finance initiatives in recent years, spanning emerging and developed markets, equity and debt and a range of investment structures. These initiatives now demonstrate a track record which means they could be replicated at scale, crowding in multiples of private investment for every $1 contributed by taxpayers.

The need to do so is unquestionable. Trillions of dollars are needed to address the twin crises of social injustice and environmental damage, capital which is currently not being invested at anything near the scale required. Governments, multilateral development banks, development finance institutions and other public investors have an opportunity to mobilise far greater amounts of private investment for public policy priorities like these than is the case now.

Blended finance combines private capital, generally in search of an investment return, with other ‘catalytic’ funding, often with a different purpose and risk profile. It offers a tried and tested pathway for investors with different outcome, risk and return expectations to work effectively together. Deployed well, it also provides a model for collaboration between different actors in society for public good, with all parties learning and changing as a result.

The term is often interpreted too narrowly as applying purely to development finance. Emerging markets have provided a testing ground for large-scale initiatives such as the IFC’s syndicated loan programme, which could be translated to more developed economies. A broader interpretation helps policymakers and others better understand the potential offered by the wide range of blended finance tools and approaches. These include providing grants or first-loss capital, co-investment to create scale in an underinvested market, guarantees and other instruments, often deployed alongside complementary policy instruments, such as tax credits.

After years of practitioners’ disappointment that blended finance hasn’t reached the scale it could, there is new momentum and energy behind a range of initiatives across the globe.

In the US, the 2022 Inflation Reduction Act (IRA) aims to direct $369 billion in federal funding to clean energy, delivered using a range of financial and policy instruments, including grants, loan guarantees and tax credits.

In the EU, the Green Deal commits over €1 trillion to transition EU countries to a sustainable economic model. A key element is the InvestEU programme, which aims to use guarantees from the EU budget to crowd in €372 billion in additional public and private investment.

In emerging markets, the testing ground for some of the most ambitious blended finance initiatives to date, blended finance transactions are now estimated by Convergence to total $200bn.

Scale in blended finance is finally being achieved. The most successful examples share some important characteristics. Best practice requires different investors, with different priorities and desired outcomes, to work together from the outset to identify an appropriate investment funding structure and to design this in a collaborative process. Collaborating effectively means acknowledging - and addressing - power and knowledge imbalances between partners, and ensuring that the right governance arrangements are in place.

Blended finance is not always the right answer to respond to a given policy challenge. But when investors’ desired outcomes can be appropriately reconciled, it brings a range of benefits in addition to the financial. It can create a market for a public good, such as clean air or renewable energy, where one does not already exist. And not only does it enable public investors to use their own resources – taxpayers’ money – to crowd in multiples of private capital, but it can change the system itself.

For policymakers, blended finance can deliver better-funded projects and improved ability to deliver on policy objectives. Done well, it demands more efficient and transparent ways of working in which more capital can be effectively and accountably dedicated to driving growth. The more government, asset owners, the financial services industry, philanthropic funders, business and communities work together to design and implement blended finance approaches, the more robust the bridges of trust between them.

A consultant in the UK’s National Health Service recently spoke powerfully about how working on a blended finance project with Social Finance, an innovation and solutions consultancy, changed their department’s ways of working:

“One of the massive benefits… has been the broader impact on our service. Yes, of course having financial investment is very powerful and opens a lot of doors, but the project has had a much deeper effect on the department. It has brought energy and excitement that we can do things, achieve things, change things…. and this is seen in other innovative ideas and approaches team members are taking.”

Blended finance is not just about getting more money to where it is needed – important as that is. Done well, it can transform the way private and public investors work together to deliver productive investment for an inclusive, profitable and sustainable future. Let us hope that more seize the potential it offers.