Blended Finance: mobilising private capital to scale sustainable impact in emerging markets

With development financing needs outpacing available resources, attracting private capital into social and environmental projects in risky markets (e.g., emerging markets) is vital. We believe that Blended Finance (BF) offers a strategic solution. Specifically, this investment approach involves the public sector leveraging private money to finance projects focused on achieving sustainable development goals (SDGs) and addressing climate change. Institutional investors are enticed to participate in these projects, which may initially appear too risky for them. BF is widely employed by public sector sponsors, such as development finance institutions (DFIs) and multilateral development banks (MDBs), whose mandates are to serve public interests (e.g., reducing poverty). 

However, there are challenges in designing effective BF solutions. These solutions need to offer private investors market-based, risk-adjusted returns while, at the same time, move beyond being bespoke solutions to scalable ones. This is necessary if BF is to no longer remain a niche within the broader field of sustainable finance. 

At the Amundi Investment Institute, we have recently focused our research on the modelling of structured BF vehicles, with particular emphasis on credit risk analysis, tranche calibration, portfolio diversification, cash flow structuring and risk premium evaluation. In particular, we look at how to reconcile diverse investors’ objectives and achieve optimal structures in junior-senior tranche vehicles¹.  This involves maximising the leverage ratio (i.e., the amount of private sector capital relative to public sector capital) for the sponsor (e.g., junior investor, DFI), managing the concessionality premium and ensuring the safety of the senior tranches². 

Several key insights emerged from our analysis. Firstly, the risk premium required (i.e., the price of ensuring an investment is attractive to private investors) by a structured BF fund may be lower than that required by a direct investment. This is due to the risk-sharing process embedded in the structure of the fund³. Secondly, to avoid allocating excessive risk to senior investors, it is critical to use scenario analysis and robust benchmarking in modelling. Finally, to create risk-return profiles that align with investors’ objectives, it is important to have a well-diversified portfolio.

Looking ahead, there is a notable financing gap between the BF market size ($230 billion) and the estimated energy transition costs ($275 trillion between 2021 and 2050)⁴. To close this gap, products’ risk sharing and scalability need to be improved, while collaboration across public and private sectors becomes increasingly important. Only then can BF reach its full potential.