Making the case for blended finance

Traditionally, when we talk about philanthropy, we think of donations. Philanthropic capital has been traditionally deployed independently from the investment world, because the expected return is the social and environmental impact rather than financial.

However, over the past few years, investors, philanthropists and governments have come to realise that only through collaboration can they truly hope to address the greatest challenges facing humanity. This is particularly relevant to the rising generation of wealth owners, whose thinking about environmental issues and social challenges is innate in a way that it perhaps was not, to the same degree, for generations.

Through a greater drive from wealthy families for mission-aligning their investments, alongside more appetite from all parties for cross-sectoral partnerships, it feels that finally we are mobilising all our resources to achieve the impact we want to see in the world.

The Monetary Authority of Singapore (MAS) recently announced policy measures specifically encouraging families to deploy concessional capital and grants to blended finance models through tax incentives. During the G20 Summit last year, Indonesia as the host country launched the Global Blended Finance Alliance and introduced G20 Principles to Scale Up Blended Finance.

What is blended finance, why do we need it, and how can we benefit from it?

Essence of blended finance

Blended finance is an approach that combines non-concessional (ie. commercial investments) with concessional capital. Concessional capital, by definition, is the type of capital that is willing to absorb more risks or take a lower return, and it can come from governments, international organisations, or philanthropic institutions. The aim of blended finance is to leverage different sources of capital to achieve social and environmental objectives.

The concept of blended finance was initially introduced by multilateral development banks, such as the World Bank and Asian Development Bank, as they sought to mobilise commercial capital to support economic and social development.

As many governments and development finance institutions (DFIs) are learning from this model, the concept of Public-Private Partnership has become popular. With the role of philanthropic capital now better recognised, it has become the fourth “P” in the Public-Private-Philanthropic Partnerships.

Critical role of blended finance

In 2015, the world came together to agree on 17 sustainable development goals which include combating climate change, eradicating infectious diseases, and ending hunger. The Organisation for Economic Co-operation and Development puts the cost of achieving the UN’s Sustainable Development Goals at US$6.9 trillion a year to 2030, and there is a global development spending shortfall of at least US$2.5 trillion per year.

Meanwhile, although we are witnessing a sustained growth of philanthropic capital, it does not allow for the annual spending at the scale needed. In addition, after years of belt tightening, the pull of recovery spending post-Covid is diverting government funding away from overarching, longer-term issues.

The concept of blended finance recognises that while public sector funding and philanthropic capital play crucial roles in addressing development needs, they are often insufficient to meet the scale and complexity of global challenges. Blended finance aims to attract additional private sector investment into projects that have a positive social or environmental impact.

Blending the sources of finance also recognises the unique advantages offered by each type of capital. Commercial investment is inherently scalable but is not suited for projects with low risk-adjusted return, which is usually the case with development and climate initiatives. Government funding, which is also sizeable, is less flexible than philanthropic capital due to the involvement of additional stakeholders and taxpayers, and is also at the mercy of political cycles.

Philanthropic capital can therefore play a complementary role, as it is flexible, patient, and entirely impact-focused. Called by some the ultimate risk capital, philanthropic capital can take smart risks as long as it has a decent chance to work or can help generate useful learning. However, its size alone will not be sufficient.

By combining these types of capital, blended finance can leverage philanthropic capital to cover first losses or compensate returns so that more commercial investment and government funding can be unlocked. By reducing the risks and enhancing the financial viability of those transactions, it can allow for the financing of projects that might otherwise be considered too risky or financially unattractive by commercial investors alone.

One of the major blended finance success stories over the past decade has been its use in providing Brazil with a sustainable energy network, with hydro-electric renewables contributing 80 per cent of the energy supply in 2019. The shift has been driven by finance from the Brazilian Development Bank paired with philanthropic and private funding, along with a national push for electrification.

Brazil is now a leading low-carbon power generator, in no small degree thanks to the power of strategically applied blended finance.

Blended finance has also seen success in promoting health, education, and other social goals. The United Nations High Commissioner for Refugees has launched multiple financial structures that leverage philanthropic funding to raise resources to support millions of forcibly displaced populations.

The Bill & Melinda Gates Foundation committed US$150 million of grants and up to US$2.5 billion from its Strategic Investment Funds, including equity investments, loans, and volume guarantees, to support the research, development and deployment of vaccines, diagnostics and therapeutics for Covid-19. Thus, we can safely say that blended finance models played an important role in tackling one of the greatest global crises in recent history.

Popularise blended finance

It sounds like a magic recipe, but it is not easy, and there are challenges. In Asia, this is especially so, because overall awareness is still low, the policy environment is not conducive, and the financial sector has not done enough to support it. How can we improve the ecosystem?

First, it is about awareness. We cannot scale it when many are still unfamiliar with the concept. Asian philanthropists have traditionally been more reluctant to take risks or explore new ways to deploy capital, but that is changing as a younger cohort of impact-seeking funders take over the reins of the world’s wealth.

Second, governments should continue to adopt policies to enable and encourage it. After injecting grant capital to support Asia’s climate-related projects last year, MAS recently took another significant step by providing incentives for family offices to deploy blended finance. However, in many countries, it is still unclear whether philanthropic organisations can make financial investments other than grants.

Third, financial institutions can play a significant role. Traditionally, DFIs – with specific mandates to promote development – play a leading role in structuring blended finance transactions. While they will continue to play a major role, commercial financial institutions should also step in, especially as many of their clients, institutional investors or families are seeking a more responsible way to invest. Blended finance will not reach its full potential without their support.

As the ecosystem continues to mature, we are confident that more and more philanthropists in Asia will take advantage of the blended finance model to drive greater social and environmental impact.