The role of asset owners in blended finance
Institutional investors face growing calls for stronger engagement in development, especially for infrastructure, climate and social investments. The investment needs for global sustainable development are enormous. State budgets are already tight in most emerging markets and developing countries (EMDEs), with weakened tax bases and accumulating public debt.
Stagnation of private financing in developing countries
The pandemic has exacerbated weaknesses also on the side of the private sector. External private financing tends to be very volatile in EMDEs. Foreign direct investment has slowed down sharply. Portfolio investments play an insignificant role in low-income countries, where capital markets are less developed. Even controversial Chinese bank loans have retracted.
The World Bank’s PPIAF reports stagnation in volumes of infrastructure projects with private participation in EMDEs at around $ 100 billion per year, or around 0.3% of GDP. In addition, they are mainly concentrated in a small number of middle-income countries like China, India, Brazil, Vietnam or Russia. According to the G20 Global Infrastructure Hub, low-income economies are seeing only a small part, if not shrinking.
Mobilize “blended finance”
Multilateral Development Banks (MDBs) and other Development Finance Institutions (DFIs) urged to intensify their role as active facilitators of private investment, in addition to traditional operations such as grants, loans and advisory services . The “mobilization” of private capital for development by MDBs has so far been low (around 0.2% of GDP per year). Only a few billion reach the poorest countries, of which few are spent on health, education and other social infrastructure. Loans and guarantees are the dominant instruments while fund vehicles and equity investments appear to be underutilized.
There is no shortage of opinions on what governments, DFIs and investors should do to improve the flow of money. One concept has been the subject of much discussion in recent years: “blended finance”, the use of public or philanthropic funding to increase private sector investment in development. Scope, parameters and definitions vary widely. Blended finance vehicles are often complex and difficult to scale. Importantly, the involvement of asset owners is still low.
Obstacles for institutional investors
The spotlight is now on institutional investors, often seen as reluctant to deploy at least a fraction of their $ 150 trillion in assets in critical EMDE investments. Many investors want to broaden the range of investment opportunities in growth markets. There are various obstacles and challenges, including:
- political, regulatory and micro risks (real and perceived)
- regulation, fiduciary duty, investor mandates
- investor capacity and costs
- specific constraints for less liquid investments such as transport or water / sanitation projects.
How to match long-term investment with development needs? Our full report, Financing for development: mobilization of private capital and institutional investors, provides key analysis and recommendations to both policy makers and investors. In fact, institutional investors have entered emerging markets since the 1990s, primarily by purchasing securities of large publicly traded companies (such as financials, utilities, or telecommunications) or government bonds. More and more investors are now exposed to EMDEs through private equity / debt or infrastructure funds. Some large asset owners undertake direct investments, for example in renewable energies.
In short, investors can draw on the experience gained in middle-income countries. Progress is also possible in less developed economies when the conditions are right and opportunities present themselves. The main burden falls on governments. More and better actions are possible, with the help of DFIs.
Create long-term investment opportunities
- Investment environment. Good governance in a reasonably stable legal and political environment is essential. The less developed a country is, the more public institutions – national and international – must be up to the task.
- Investable assets. Governments need to develop a portfolio of assets suitable for private sector investors. Clarity on the underlying long-term funding will make it easier to finance and invest.
- BMD: Many international investors see co-investing alongside MDBs as a good way to get into ‘more difficult’ countries and riskier and less liquid assets – for reasons of experience, risk mitigation, local knowledge and political influence.
- Co-investment vehicles
Equity co-investment vehicles for riskier countries and sectors are still underdeveloped. Both commercial and blended financing vehicles (eg with some limited credit enhancements or insurance) targeting investors with different risk appetites could be broadened.
- National investors
As their asset base grows, domestic investors in EMDEs can play a growing role not only in domestic and regional investments, but also help attract international asset owners.
- Sustainability and impact investing
The boards of directors of responsible investors wish to raise their ESG and ODD profile, thus opening a new door. This demand could be increasingly satisfied in EMDEs. Green and social bonds will also gain momentum in developing countries. We see interim steps to invest in low income countries through impact funds, for example in water, housing and other community projects.
Expectations must be realistic about the potential of institutional investors, especially in less developed countries. Policymakers, DFIs and investors should not focus only on a few flagship policy instruments. They must make better use of all investment channels: impact, mixed and above all commercial. Even small reallocations of capital can have a big impact on the ground.
Georg Inderst is an independent advisor to institutional investors and international institutions, based in London.