Instrument Overview
Blended finance approaches make use of public and development finance sources, such as development assistance from donor governments and funds provided by philanthropic foundations, to mobilise additional finance, primarily from private and commercial sources. Their purpose is often tied to the achievement of political goals, such as to address the SDGs and promote climate action in countries (Paul Horrocks, 2017). Blending involves the strategic use of a limited amount of grant resources to catalyse additional financing for development projects. Grants are often combined with loans, equity, beneficiary resources or other forms of financing, with the aim of de-risking projects and making them bankable. Blending allows partners to get the most out of their grant resources and enhance their overall development impact (EIB, 2022).
Why it matters for cities
- Blended finance provides financial support to high-impact projects that would otherwise not attract funding on fully commercial terms
- Blended finance can help re-balance the risk-reward profiles of sustainable investments by using a range of financial tools, including concessional loans, equity, grants, technical assistance, and guarantees
- Blended finance is a highly effective catalyst to mitigate early-entrant costs and project risks by demonstrating viability of innovative projects
Key features
- The transaction contributes towards achieving the SDGs. However, not every participant needs to have that development objective. Private investors in a blended finance structure may simply be seeking a market-rate financial return.
- Overall, the transaction expects to yield a positive financial return. Different investors in a blended finance structure will have different return expectations, ranging from concessional to market rate.
- The public and/or philanthropic parties are catalytic. Participation from these parties improves the risk/return profile of the transaction to attract involvement from the private sector.
How It Works
The essential idea behind blending is that a grant or grant-like contribution can be used to remove barriers to public or private investments. The use of different types of financial instruments in blending projects results from two different factors linked to the nature of the underlying projects. First, different financial instruments help to tackle a wide range of investment barriers, even if they all ultimately seek to affect the risk/return profile. Second, there is often a relationship between the choice of the financial instrument, on the one hand, and the maturity of the company and the market where the investment is taking place, on the other.
Benefits & Challenges for Cities
Benefits
- Blending finance is a proven approach for optimised risk management and can help to make otherwise high-risk investments viable for private sector investors.
- Public finance will only cover a fraction of investment needs to meet low-carbon and adaptation requirements. Blended finance allows much greater private sector investment.
Challenges
- The maturity of policies and practices guiding blending operations is still very uneven among donor governments. OECD has shown that only a few Development Assistance Committee (DAC) members have dedicated strategies or guidance in place and to resolve this, the OECD is preparing ‘Blended Finance Principles'.
- A blending approach is less accessible to smaller projects - it is more easily attracted to large projects, where it is typically brought in on the back of large public sector investments
- Monitoring and evaluation (M&E) for blended finance is particularly challenging because it must cater to the needs of diverse stakeholders. However, this is a critical step to build the evidence around the credibility and effectiveness of blended finance approaches.
Use Cases
Solid Waste Management (SWM) for Cleaner Cities in Nepal
Post-consumer waste is estimated to account for 5 percent of global GHG emissions. In addition, methane from landfills represent 12–15 percent of total global methane emissions, which has a global warming potential 21 times greater than CO2. In Nepal, municipalities generate about 700,000 tons of waste per year, but less than 50 percent of the waste gets collected and almost all of the collected waste is dumped in a haphazard manner. As municipal spending on SWM only provides services to less than 50 percent of citizens, cost recovery is also low due to inefficiencies in the service provision and citizen’s resulting “unwillingness-to-pay.”
Subsidy model and revenue economics:
- Provide $4.28 million in grant-based subsidies to five Nepalese municipalities—no repayment required, but municipalities assume the performance risk
- The grant payments are contingent upon verified improvements in the service provision and collection of service fees, and are complemented with technical assistance
- Subsidies to municipalities are paid based on agreed multiples of verified collection of fees from customers; as the municipalities‘ revenue increases, the OBA subsidies will gradually (over 4 years) be lowered and finally phased out entirely
- By the end of the project, the municipalities will be able to sustain the SWM service with the tariff and same level of government subsidy
When to Use It
Blended finance is most effective when projects are at planning or construction stages requiring significant capital and risk sharing, and can leverage private-sector efficiency during operation.
References
[1] Paul Horrocks et al., (2017), “Blended finance – Mobilising resources for sustainable development and climate action in developing countries”, OECD Publishing, https://www.oecd.org/cgfi/forum/Blended-finance-Policy-Perspectives.pdf
[2] EIB (2022), "EU Blending Facilities"
[4] Blended-finance_LSFI-Masterclass_FINAL.pdf
[5] Blended Finance: What it is, how it works and how it is use
[6] https://citiesclimatefinance.org/financial-instruments/instruments/blended_finance_vehicles
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