Summary
Introduction
Blended finance structures are key to deploying catalytic capital coming from public, philanthropic, and private sector sources. The combination of the three allow for investors to pool essential capital meeting sustainable or development financing needs (e.g., SDGs, NDCs) in Emerging Markets and Developing Economies (EMDEs).
Blended finance is a structuring approach, and while seen as an effective means to deliver on both sustainable impact and risk-adjusted return objectives, questions on scalability and the complex nature of these structures remain.
Within the ecosystem of development finance, scaling up the use of these structures to mobilize larger flows of capital into EMDE starts with understanding what kind of blended finance structures exists, and what investors should be considering when entering these types of investments. Investors need to get familiar with the risks and opportunities of this structuring approach and the techniques available in the market, to understand how to mitigate perceived risks.
This paper provides clarity for investors on key characteristics of credit enhancements in blended finance structures. We address perceived investment risks in EMDE, and demonstrate which credit enhancement characteristics at the portfolio and transaction level can mitigate those perceived risks.
If blending techniques can be replicated by private and public investors and added to their investment toolbox, blended finance structures would have the conditions for market development and future scale, thereby having the potential to close the development financing gap. Our findings complement materials on standardization of blended finance structures or archetypes that exist in the blended finance space. We explore how credit enhancements at the portfolio level can be supercharged with the use of a guarantee or risk transfer mechanism within the structure, and at how different type of credit enhancements can help transactions (such as bonds or loans) become more attractive for investors.
By bringing awareness and assessing the strengths and limitations of different credit enhancement characteristics available in the market, our aim is to enable investors to make informed decisions when assessing blended finance opportunities in alignment with their investment preferences. Under these circumstances, investors contribute more broadly to the standardization of different credit enhancement approaches.
Key findings
- Blended finance is essential but underutilized for closing the sustainable development financing gap in EMDEs.
- Private sector capital mobilization is critical for scaling blended finance, but investors face significant perceived risks and barriers.
- Credit enhancement mechanisms provided by public sector (MDBs, DFIs) are vital to de-risk investments and improve credit profiles in EMDEs. Conversely, private investors view these mechanisms as being highly effective in blended finance structures.
- Layered fund structures with credit enhancements and currency risk mitigation offer a promising approach to mobilize private capital while managing risk.
- Effective credit enhancements not only reduce risk but also improve investment terms, unlock new investor bases, and increase the scale and impact of blended finance.
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