Can COP29 boost blended finance for climate solutions?

In its latest report on the state of the climate blended finance market, Convergence, a leading global network for blended finance, published a remarkable finding: the market grew by 120% in 2023 despite no corresponding increase in donor capital.

Blended finance only works because a philanthropic or public institution donates capital to de-risk the investment for private investors. It therefore stands to reason that blended finance markets can only grow if there is a corresponding increase in donor capital.

But 2023 showed that private investors are willing to push against this hard structural limit.

Joan Larrea, CEO at Convergence, was optimistic about the cause for the development. “After years of seeing blended finance, and climate blended finance more specifically, fall short of expectations, the findings from this report are heartening. It’s telling us the market is finally getting smarter, more efficient, and bolder with how it uses limited catalytic capital.”

The implication is that clever deal-brokers have been able to make the scarce resource of catalytic capital go further. However, without an increase in donor capital, the market won’t be able to sustain such growth.

Larrea’s optimism comes at a time when COP29 – dubbed the "finance cop" – has shone a light on the need to mobilise more private capital to fill the financing gap in the developing world.

Experts warn that the official COP28 targets of tripling renewable energy by 2030 and transitioning away from fossil fuels require a dramatic increase in green capital flows from global north to global south.

To date, even the insufficient $100bn per year from developed countries for developing countries pledge has only been met once in 2022, with the bulk of the money going to mitigation efforts.

Developing countries need an estimated $2.4 trn per year by 2030 for climate action, of which around $1trn or 40% needs to come from external flows. Current flows are a fraction of this amount.

The funding gap leaves the door open to a bigger role for private capital via blended finance deals, but actors involved in these deals also need to be careful not to heap more expensive debt on countries that are already struggling with debt or fall prey to accusations of “climate colonialism”.

An alarming report by Follow the Money showed that big climate-based funds from the global north charge extractive commissions in countries which are in dire need of resources.

Consolidation

In addition to increasing the availability of catalytic capital, blended finance markets would also benefit from other innovations.

Speaking at COP29, Erich Cripton, director of business relations at the Canadian pension giant CDPQ, recommended consolidating the “small, fragmentary” pools of catalytic capital into “larger pools”.

Small pools with “different modalities and access requirements” drive up the incubation period for transactions, he argued.

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Femi Akinrebiyo, manager of global manufacturing and trade supplier finance at IFC (International Finance Corporation), said consolidation could be as simple as putting all the “guarantee instruments” of the World Bank Group (WBG) “together in one place” to create more “efficiency in the market” – a measure that the WBG is currently working on.

The World Bank Group (WBG) provides various guarantee instruments to mobilise private sector capital. Those instruments include various forms of political, credit and public sector risk guarantees.

Centralising these guarantee instruments under a single framework or platform could address operational fragmentation and improve investor access.

Currently investors may face delays, increased transaction costs and uncertainty due to challenges faced when navigating the variety of guarantee instruments offered by different WBG entities and other providers of catalytic capital.

Standardisation, data, regulation and other enablers

Standardisation is another hot topic among blended finance proponents.

Nicola Watkinson, managing director at TheCityUK, said investors crave “predictability and certainly, especially for long term investments”, something which greater standardisation and a positive policy environment could help foster in blended finance.

With its 13 best practice case studies, CDPQ’s recent blended finance playbook contributes to the standardisation discussion.

Cripton argued that the case studies owed their success to a few “key enablers” of which a greater awareness would significantly improve the market.

For example, stakeholders need to make sure their objectives are aligned and that they themselves are credible, reputable players, especially in the market in which the capital is to be deployed.

A greater clarity around the “risk mitigation” archetypes also helps. Those archetypes could include a tripartite capital stack with junior, mezzanine, and senior tranches, and the use of guarantees. However, those who design blended finance vehicles also need to be “flexible”.

According to the playbook, traditional barriers to blended finance include unfavorable risk-return nexus, scarcity of catalytic capital, an inadequate project pipeline, challenges associated with foreign exchange risk, and data limitations.

On the data point, Cripton called for MDBs to disclose their historical data to help asset owners like CDPQ distinguish between “real and perceived” risks in emerging markets.

He also called for the reform of “global prudential regulatory environment” which often impedes pension funds and other asset owners from investing in emerging markets due to risk concerns.

“We have a large, investable pool of capital,” he said. “But even when we have the risk appetite, and a granular understanding of the risks, we often face regulatory barriers. These barriers need to be addressed in a fundamental way.”