This story is part of our series on sustainable WASH finance. Alex Money shares why more catalytic innovation is needed to have a transformative impact. This story was originally published on IRC’s blog. To view the original story, click here.
By Alex Money
What is blended finance?
Blended finance is a somewhat amorphous concept. A simple definition is: a combination of different sources of finance that enable the building and maintenance of water infrastructure. The rationale of blending is that different types of funders are willing to bear different levels of risk for a given return. For example, there may be plenty of money available from long-term, cautious investors in the private sector and pension funds, for projects that are considered low risk. However, water infrastructure in developing countries often carries political, economic and technical risks that can make the projects unattractive to cautious investors. Equally, there may be money available from development finance institutions and foundations that are prepared to finance higher-risk projects, but are constrained by having limited access to capital. Infrastructure often requires lots of finance. The construction of, for example, water treatment plants means that most of the cash is needed upfront, while the income to repay that investment (in the form of water and sewerage rates, for example) is achieved over the whole lifetime of the plant, which may be twenty years or even longer.
In short, water infrastructure in the developing world needs access to significant upfront capital, from providers that can tolerate elevated political, market and technical risks. The current imbalance between supply and demand is reflected in the ‘infrastructure gap’ – that is, the difference between what is currently spent on infrastructure per year, and the amount needed in order to meet current and future demand – estimated at around US$ 1 trillion per year.
Blended finance, it is proposed, makes it possible to close the infrastructure gap by unlocking more capital through managing the risk and return attributes of projects. Blending small amounts of risk-tolerant capital (that will bear the ‘first loss’ on projects that run into difficulties) with larger amounts of long-term capital (that will supply upfront funding with an extended payback period), broadens the range of projects that can be funded:
Fig. 1. Blended finance. Source: author
Why the hype?
Following the announcement of the Sustainable Development Goals, there has been more attention on the strategic use of development finance to mobilise additional commercial finance towards achieving the SDGs. In 2016, a High-Level Meeting of the OECD announced that it would develop an “inclusive, targeted, results-oriented work programme” on blended finance. The programme’s mandate is to collate evidence and lessons learned; develop best practices for deployment; and to deliver policy guidance and principles. The OECD’s Blended Finance Principles are to be published as a key research output in 2017.
Is there hope?
It is undoubtedly the case that investments in water infrastructure could be better optimised across financial actors in the public, private and third sector. This optimisation would accelerate progress towards the SDGs, with the potential to improve the quality of life for millions of people. Inasmuch as the Blended Finance Principles and similar initiatives will help to identify suitable projects, the prospects are hopeful.
However, I believe that further catalytic innovation is necessary before blended finance can have a transformative impact on water infrastructure financing. To that end, a research group that I lead is currently working on the design of a digital intermediation platform to connect infrastructure projects to multiple sources of finance (development bank, institutional investor, private wealth etc.), using a validation layer. This layer would pre-qualify projects using on-the-ground personnel and assets, increasing their risk-adjusted return. The platform embeds a typology of investors (recognising differences in risk appetite) along with a typology of water infrastructure (recognising differences in return characteristics), and links to our broader work with the World Water Council and others. It’s an early-stage research project, but we’re pleased with the traction that we’ve already been available to gain. If you’re interested in learning more, just drop me an email and we will add you to our distribution list.
Contact: Alex Money | firstname.lastname@example.org