Christopher Clubb is Managing Director at Convergence Finance. He has over 25 years’ experience of financing development proj-ects in more than 50 emerging and frontier markets. Prior to joining Convergence, he led the European Bank for Reconstruction and Development’s (EBRD) financing/investment activities in early transition countries, during which time EBRD increased its annual invest-ments five-fold to become the largest investor in these low-income countries. While at EBRD and in partnership with more than 20 donors, Christopher Clubb innovated and implemented many of EBRD’s blended finance programmes, including the leading local currency programme for small- and medium-enterprise finance and development. Prior to EBRD, he worked at the European Investment Bank, focusing on long-term financing to strategic European infra-structure projects and provided cross-border financing to international buyers while at Export Development Canada.
Increasing sustainable investment in low- and middle-income countries (namely developing countries) to fund successful implementation of the Sustainable Development Goals (SDGs) and climate projects is paramount, and should be the North Star of development and climate finance.
The United Nations, the Organisation for Economic Co-operation and Development (OECD) and the Climate Policy Initiative estimate the annual SDG and climate investment needs in developing countries at US$ 4.5 trillion and US$ 1.5 trillion respectively. Actual investment is at only 20–25% and development finance is providing and mobilising less than 6% of the rate required:
- annual cross-border net private investment from high-income countries to developing countries (excluding China) stands at around US$ 404 billion (9% of SDG investment needs);
- public sector development finance commitments fund around US$ 240 billion of investments annually (5% of SDG investment needs); and
- seven years after the launch of the SDGs and the Paris Agreement prioritising the mobilisation of private investment and expertise, public sector development finance and climate finance mobilise US$ 48 billion of private investment annually (1% of investment needs).
Private investor groups have published numerous reports identifying their strong interest to invest in the SDGs and climate in developing countries, conditional on: 1) the investment risk lying within their regulatory/fiduciary risk limits; and 2) the investment having a market-equivalent risk-adjusted return.
The first criterion is a significant challenge: the Big Three rating agencies rate 76% of developing countries ‘B’ or lower; the underlying investment risk is beyond most investors’ fiduciary and regulatory investment obligations.1 Thus, the only way private investors can invest significantly is for the development community to ‘de-risk’ developing country investment risk to within investor limits (eg trans-forming a debt investment risk from ‘CCC’ to ‘BB’).
Unfortunately, less than 3% of public sector development finance and climate finance is deployed to de-risk developing country investment risk. The status quo has not worked and will not work. As such, official development assistance (ODA), climate finance, development finance, multilateral development banks (MDBs) and development finance institutions (DFIs) must be governed for a meaningful percent of their commitments to mobilise private investment - thereby increasing total development and climate impact.
This article describes how a small portion of concessional public sector development finance in the form of official development assistance (ODA and climate finance), together with a material percentage of non-concessional public sector development finance (MDBs and DFIs), can be strategically deployed to mobilise private investment at scale by creating investment assets that meet investors’ fiduciary and regulatory obligations, with minimal concessionality.
Optimising the use of non-concessional funds to maximise private investment is critical since the large majority of development and climate needs in developing countries require scarce Official Development Assistance and subsidised public sector loans.
Without a systemic approach, described in the Action Plan for SDG and Climate Investment Mobilization collaborated by development, blended finance and private investment experts – total investment will remain low, and the SDGs and Paris Agreement will not be achieved.2 The Action Plan identifies how to scale up investment in the near-term with existing funding, architecture and institutions. Any long-term reforms to the international development finance architecture can be pursued concurrently. The Action Plan has been written to align with, and meet the objectives of, the Addis Ababa Action Agenda3, the SDGs4, the UN Secretary-General’s SDG Stimulus5, the Bridgetown Initiative6, the Paris Agreement7, the Climate Finance Delivery Plan8 and the G20 MDB Capital Adequacy Review.9
SDG and climate investment: Needs and sources
The United Nations Conference on the Trade and Develop- ment (UNCTAD) and the Organisation for Economic Co- operation and Development (OECD) estimate the annual Sustain-able Development Goal (SDG) investment gap in developing countries at US$ 3–3.5 trillion.10 Although this gap is large relative to public sector development funds (US$ 200 billion Official Development Assistance and US$ 120 billion Multilateral Development Banks (MDB) develop-ment financing commitments annually), it is not large relative to the US$ 479 trillion of global financial assets (inclu-ding US$ 400 plus trillion controlled by the private sector).11
The main problem is the distribution of the private sector financial assets: the Financial Stability Board estimates only 5% are located in low-income countries (LICs) and middle-income countries (MICs) (excluding China). The World Bank International Debt Report12 identifies annual net private sector investment flows to these countries at only US$ 404 billion (ie net foreign direct investment at US$ 308 billion, net private debt at US$ 115 billion, and net portfolio equity investment at negative US$ 19 billion).13 The only way to achieve the SDGs and the Paris Agreement objectives is to bring more financial assets towards LICs and MICs.
Fortunately, private investment is undergoing a revolution, with investors increasingly seeking ‘purpose’ investments under the banners of environment, social and governance (ESG) investments, green finance, net-zero investments, sustainable investments and impact investments. To date, investors have met these themes by investing mostly in high-income countries, where investment risk is conducive to their mandates. Conscious of this divide, many investor groups have issued reports in 2021–2022 as guides to the development community on how to mobilise at scale: the Global Investors for Sustainable Development Alliance14, the Net-Zero Asset Owners Alliance15, the Sustainable Markets Initiative16 and the Investors Leadership Network17 have each issued a report and collaborated on the Acton Plan.18
Investors want to invest if the investment passes two important criteria to meet their fiduciary and regulatory obligations: 1) acceptable risk (for most debt investors, the equivalent of ‘BB’ and investment grade) and 2) market-equivalent risk-adjusted returns. The former is the bigger impediment in developing countries.19
In principle, blended finance should be re-named ‘blended sustainable investment’, since its objective is to mobilise medium- and long-term investments monies into the SDGs and the Paris Agreement in developing countries.
The most important private investment source are pension funds that seek long-term investments which produce returns sufficient to meet pension-holder liabilities. It has much fewer regulatory restrictions compared to banks and insurance companies. Pension companies usually require intermediaries (eg fund managers and financial arrangers) who can act as intermediaries between their investment funds and the actual debt and equity investments required in developing countries – ranging from a US$ 50 loan from a microfinance institution to a microenterprise, to a US$ 1 million loan from a bank to a small or medium enterprise (SME), to a US$ 10 million equity investment from a private equity fund to a large company, or a US$ 400 million loan from an MDB to a renewable energy project.
High country risk and currency risk assessments impede investment at scale
Cross-border private investment from high-income countries to developing counties (excluding China) is very low, primarily due to high country risk assessments from the Big Three rating agencies, beyond most investors’ fiduciary and regulatory investment obligations. For example, the Big Three rating agencies median sovereign risk rating for the 142 developing countries is ‘B’ (defined by Moody’s as ‘speculative and subject to high credit risk)’.
The large majority of debt investment opportunities in developing countries have implied ratings of ‘B’ and ‘CCC’, defined by the rating agencies as ‘speculative’ and ‘highly speculative’. Given this high risk, private financial sector cross-border net flows have averaged only around US$ 96 billion from 2018 to 2021 – equal to a miniscule 0.02% of global financial assets controlled by the private sector.20
All major development finance and climate finance initiatives and reports since 2015 (eg the SDGs, Paris Agreement, the Bridgetown Initiative, G7 and G20 communiques and the Climate Finance Delivery Plan) have identified the import-ance of mobilising private sector investment and expertise. But private investment mobilisation amounts remain very low.
The development community’s first choice should be to mobilise without subsidy and de-risking, where possible. This has been the MDBs and DFIs’ modus operandi for more than 75 years, with anaemic US$ 21 billion private investment mobilised per annum (0.5% of SDG investment needs) - around 15 cents for every dollar of their own commitments.21
In practice, the MDBs and DFIs are to deploy their capital in good development impact and climate impact projects, with private investment mobilisation a tertiary activity. The US$ 1 billion ILX Fund is an excellent recent example of mobilising without de-risking: the private investment fund co-invests in A–B loans arranged by MDBs.22
Currently, the amount of development and climate finance deployed to de-risk developing country investment risk and mobilise private investment remains low and few MDBs, DFIs, OECD-DAC members and multi-donor climate funds have meaningful mobilisation targets. Reasonable estimates of public sector funds employed to formally de-risk developing country investment risk include:
- 2% of the US$ 140 billion annual financial commitments from MDBs (eg US$ 3 billion from the Multilateral Investment Guarantee Agency (MIGA));
- almost none of the US$ 15–20 billions of financial commitments from national DFIs;
- less than 2% of the US$ 200 billions of Official Development Assistance - the Swedish International Development Cooperation Agency’s (Sida) Guarantee Program is one of the few donor programmes that mobilise private investment through de-risking);23 and
- less than 5% of the US$ 70 billion of the climate finance.
As a result, private investment mobilisation amounts remain very low eight years into the SDGs and Paris Agreement: the OECD Mobilised Private Finance for Sustainable Develop ment Report estimates all public sector develop-ment finance has mobilised $48 billion on average in 2018– 2020 (only 1% of SDG investment needs).
The OECD Climate Finance for developing countries report estimates all public sector climate finance mobilises US$ 13 billion (only 1% of climate investment needs).24
Beneficially, the past 15 years have demonstrated how to mobilise private investment at scale and achieve minimum concessionality. New innovations are not required – all that is required is to implement the best proven solutions broadly and deeply.25
How to Mobilize Private Investment at Scale in Blended Finance26 presents a summary of effective approaches to mobilise private investment, with the International Finance Corporation (IFC) – Sida Managed Co-lending Portfolio Program (MCPP) Infrastructure Program27 an excellent MDB-led example and the Blackrock Climate Finance Partnership an outstanding private sector-led example.28 The Convergence Historical Deals Database captures 1000+ blended finance transactions that have deployed concessional funds to mobilise US$ 200 billion.29 This evidence has been used to design the Action Plan which aligns with the UN’s 2023 Financing for Sustainable Development Report statement that the objective of blended finance is ‘to make SDG investments that the private sector might not have done on its own, competitive with other investment opportunities – and to do this with minimum concessionality or subsidy (ieq, just enough to make a project attractive to commercial investors)’.30
Action Plan for Climate and SDG Investment Mobilization
Experts recently collaborated to agree and publish The Action Plan for Climate and SDG Investment Mobilization that identifies simple, implementable actions to increase private investment using existing development and climate finance resources and existing institutions.31
The Action plan identifies how to mobilise US$ 280 plus billions of private investments in the short term – a six-fold increase over existing amounts and it fully adheres to the five OECD Blended Finance Principles.32 Further to it describes how to deploy non-concessional development finance (e.g. MDB and DFI financing commitments) optimally, minimising the need for concessional funds (eg ODA). To date, too much blended finance has drawn on scarce concessional funds (ODA) when non-concessional funds (MDBs) should have been deployed.
Experts agree that the optimal deployment of public sector concessional funds should happen at three levels:
- Develop viable projects in the project development phase.
Fund output-driven project development in partner- ship with private investors to transform projects from theoretical feasibility to practical viability. Most concess ional funding has been deployed at input-driven preparation that too frequently has not led to implementation.
- Transform viable projects into commercially investable projects by de-risking at project level.
Even if a project is developed to viability, it will likely not to attract debt or equity investment due to: 1) limited domestic resources; 2) unacceptable project investment risk; and 3) high country/currency risk. De-risking at the project level is often required to attract a bank to make a loan or an investor to make an equity investment. MIGA is the only MDB that de-risks projects directly to mobilise private investment.
- Increase the supply of investment at portfolio level flowing to commercially investable projects.
Most investors are prepared to invest in developing countries only through portfolio investments (funds) where an intermediary (eg fund manager) invests directly in projects (loans and equity investments). Diversification helps overcome the perceived high risk of individual projects (eg the Big Three rating agencies’ risk methodologies can yield a two-notch uplift from diversification), while aggregation overcomes the contrast between small investment needs for an individual project and investor requirements for a sizeable investment (US$ 50 plus million). In addition, financial structuring at the portfolio vehicle level (eg fund) can help mobilise private investment, ideally with three-tiers of capital: private investors in a senior position; MDBs and DFIs in the mezzanine position; and concessional donors in a junior position. This well-established approach has been demonstrated to be highly effective to mitigate project risk, country risk and credit risk in one vehicle.
The Action Plan – five pillars and two complementary activities:
- Pillar 1: Increase the supply and collaboration of con-cessional catalytic funding. The Action Plan identifies how US$ 13–15 billion concessional funds could mobilise US$ 280 billion private investments (ie 20 times leverage), thereby allowing all other concessional ODA and climate finance to be allocated without consideration for mobilisation.
- Pillar 2: Make MDBs and DFIs catalysts of mobilisation. Shareholders should assign MDBs and DFIs with key performance indicators total SDG and climate investments and 2) private investment mobilisation. Good practice governance includes balance sheet capital in development assets and investment mobilisation activities are maximised. Such investment mobilisation requires: 1) more project-level risk mitigation; 2) some MDB and DFI inancial commitments in mezzanine positions; and 3) mobilising for both private sector and public sector projects.
- Pillar 3: Maximise investable pipelines and impacts through more integrated development finance and climate finance systems. Concessional ODA and climate finance funds to the best investment mobilisation proposals globally.
- Pillar 4: Provide private investors access to the best developing country investment information, risk analytics and investment opportunities. 1) Most private investors are not used to investing in developing countries; 2) the Big Three rating agencies’ high-risk country ratings and 3) the perceived risk is higher than the actual risk observed over the past 40 years. The MDBs and DFIs’ Global Emerging Markets Risk Database demonstrates this lower-than-expected risk and should be available to private investors.33
- Pillar 5: Empower local capital markets and financial intermediaries in LICs and MICs.
- Two complementary activities: Link the supply of global capital to priority projects (projects aligned to integrated national financing frameworks, nationally determined contributions and country platforms) and improve investment climate.
United Nations initiatives
The United Nations is leading several initiatives aligned with increasing the supply of private investment:
- The Principles for Responsible Investment are important to accelerate global investors’ prioritisation of ‘purpose’ investments like climate investment and impact investment.
- United Nations Development Programme-led Integrated National Financing Frameworks should include how developing countries will mobilise private investment, including financing commitments to de-risk at the project level for priority projects such as Just Energy Transition Partnerships (JETPs), country platforms and nationally determined contributions (NDCs).
- UNDP and the United Nations Department of Economic and Social Affairs (UNDESA) global convening of both developed countries and developing countries’ input into MDB and DFI governance for mobilisation, including key performance indicator (KPI) commonality.
- The UN system spends US$ 60–65 billion donor funds per year, 150% of MDB and DFI financing commitments with the private sector in LICs and MICs. Some of these funds, especially UNDP and the United Nations Capital Develop-ment Fund (UNCDF) spending, could be deployed as concessional funding to mobilise private investment.
It is imperative to increase SDG and climate investment in developing countries. The Action Plan identifies how to combine concessional and non-concessional development and climate finance to maximise private investment mobilisation subject to minimum concessionality.
A combination of US$ 15 billion of concessional funds and governing MDBs and DFIs to allocate more of their non- concessional financing commitments to private invest ment mobilisation can mobilise US$ 280 billion in private investments. It is critical to minimise the amount of concessional funds deployed to mobilise private investment, and to allow ODA grants and concessional development and climate finance to be allocated to public sector projects with no mobilisation considerations.
No major innovations are required and no new institutions are required – the existing development finance architecture can be fit-for-purpose if governed towards the overall SDG and climate investment objective – allowing scaled invest-ment to be achieved in the short term, while any deeper or broader reforms can be pursued in the medium term.
Convergence, USAID, Prosper Africa, ‘The Action Plan for Climate & SDG Investment Mobilization For Emerging Markets & Developing Economies’, November 2022, www.convergence.finance/resource/the-action-plan-for-climate-and-sdg-in….
Capital Adequacy Frameworks Panel, ‘Boosting MDBs’ Investing Capacity: An Independent Review of Multilateral Development Banks’ Capital Adequacy Frameworks’, 2022, https://cdn.gihub.org/umbraco/media/5094/caf-review-report.pdf.
Global Investment for Sustainable Development Alliance, ‘Increasing Private Finance Mobilization: Recommendations for Development Banks and the Global Development Community’, 2021, www.gisdalliance.org/sites/default/files/2021-10/GISD%20Position%20Pape….
Christopher Clubb, ‘A blueprint for closing the SDG financing gap: How to raise $290 billion in 12 months to tackle the world’s biggest problems’, NextBillion, 19 April 2023, https://nextbillion.net/blueprint-closing-sdg-financing-gap-developing-….
MDB Task Force on Mobilization, ‘Mobilization of Private Finance by Multilateral Development Banks and Development Finance Institutions’, 2021, www.ifc.org/en/types/insights-reports/2021/mobilization-of-private-fina….
Christopher Clubb, ‘OP-ED: BlackRock’s Climate Finance Partnership, a turning point for the SDGs and Climate investment?’, Convergence blog, 15 November 21, www.convergence.finance/news-and-events/news/3s7v2XsCRrzfeHTxqf7Lzn/view.