Making Blended Finance Work for Water and Sanitation

Annex A. Primer on blended finance

A primer on blended finance for water and sanitation

Blended finance in the development co-operation landscape

In order to respond to the global development challenges, the 2015 Addis Ababa Action Agenda (AAAA) put emphasis on the need to work closer with and increase investments of the private sector. Blended finance offers a promising approach to crowd-in additional commercial finance that is not currently invested for development outcomes, whereby blended finance is defined as the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries (OECD, 2018[1]). Development finance can thereby be concessional finance or non-concessional finance coming from public or private sources, e.g. philanthropic actors. Additional finance focuses on commercial finance, which refers to finance invested at commercial rates from private sources or public investors such as sovereign wealth funds.

The OECD Development Assistance Committee (DAC) Blended Finance Principles for Unlocking Commercial Finance for the Sustainable Development Goals are a regulatory framework that work towards sustainability of blended finance as a one approach to mobilise private finance in donors’ toolboxes (Figure A A.1). The OECD is currently developing guidance complementing the principles to provide further evidence to DAC members. Moreover, the OECD conducts a series of deep-dives into blended finance in specific contexts, including by sectors (water and sanitation with this publication; agriculture forthcoming in 2020), income group (OECD/UNCDF, 2019[2]) and a contribution to UNCDF (2018[3]), as well as geographical contexts as fragile contexts (Basile and Neunuebel, n.d.[4]).

At the same time, blended finance is a multi-stakeholder concept, strongly dependent on concerted efforts by development actors, commercial players and civil society. The Tri Hita Karana (THK) Roadmap was launched to establish a shared value system among international partners including governments such as Indonesia, Canada or Sweden, Multilateral Development Banks (MDBs) and Development Finance Institutions (DFIs), the private sector as well as civil society organisations (CSOs) and think tanks. Under the THK Roadmap, these actors engage in co-ordinated action to ensure that blended finance is contributing to sustainable development, including on developing good practice. This publication adds to the ambitions of the THK Roadmap by shedding light on blended finance in the water and sanitation sector.

Figure A A.1.  OECD DAC Blended Finance Principles

Source: (OECD, 2017[5]).

Blended finance instruments and mechanisms

Blended finance approaches can be categorised according to mechanisms and instruments. Blended instruments include equity, debt or mezzanine investments directly invested in typically companies or projects (OECD, 2018[1]). By deploying development finance in either of these forms, commercial investors can be mobilised by improving the viability of a transaction or enhancing its credit profile. Blended finance transactions can involve direct monetary contributions without expectation of repayment and non-monetary provisions in the form of advice or assistance, i.e. grants and technical assistance respectively that further strengthen project capacity to help mobilise commercial investment.

Instruments also include credit enhancement in the form of insurance and guarantees, which can cover for example credit risk (typically partially) or political risk. Guarantees back commercial financier’s confidence by transferring the risk of for instance debt service shortfall to the guarantor against a fee.

Figure A A.2.  Blended finance instruments and mechanisms

Note: PPP = Public-Private Partnerships

Source: (OECD, 2017[5]).

Investment funds or collective investment vehicles (CIVs) constitute mechanisms to address issues related to high risk, small investment volumes and limited sectoral or regional financial knowledge. In doing so, investment vehicles provide access to a portfolio of projects specific sectors or regions using different type of instruments, including equity, debt or guarantees. Thereby, larger volumes of commercial investment can be channelled towards sustainable development projects. Commercial investors benefit from risk diversification as well as often first loss coverage provided by development actors in the case of structured funds.

Syndicated loans are an efficient way to reduce transaction costs, while harnessing the due diligence capacity of the lead arranger, typically MDBs in blended structures. Commercial lenders disburse additional credit volumes as part of the syndicated loan. PPPs can be financed in blended forms, for example when development actors are mitigate credit or political risk for commercial actors.