By grouping catalytic capital from public and philanthropic sources with private sector financing in new investment vehicles, blended finance platforms can bring to market pivotal infrastructure projects that otherwise are unlikely to reach financial close.

Unlocking these additional projects could significantly drive private participation in infrastructure projects, reversing a 10-year trend of decreasing private infrastructure investment in primary markets. However, the ­blended finance ecosystem needs to broaden from its current underdeveloped state to achieve this.

“The transition has sparked a surge of interest from the private sector, which can and should be leveraged”

The past two years have seen increasingly urgent calls for infrastructure investment to back and accelerate the climate transition. In May 2021, the International Energy Agency issued a roadmap for the energy sector to reach net zero by 2050, calling for a “historic surge in clean energy investment”. In April 2022, the Intergovernmental Panel on Climate Change released a report it called a “code red for humanity” that listed global and regional mitigation measures.

Reaching the Paris Agreement objectives by 2030 will require about $90 trillion in climate-driven infrastructure investment, according to World Bank 2019 data. The UN Environment Program (UNEP) Adaptation Gap 2021 Report further shows adaptation costs are five to 10 times greater than all international public adaptation finance flows combined. G20 governments demonstrated a strong commitment to infrastructure with $3.2 trillion in covid-19 recovery packages directed to infrastructure projects, largely climate-driven, but even these significant investments will not fill the gap.

Private sector capital – willing and cautious

With the current stress on public finance, it is clear the public sector alone cannot fund climate transition infrastructure. Yet, the transition has sparked a surge of interest from the private sector, which can and should be leveraged.

At COP26, the Glasgow Financial Alliance for Net Zero (GFANZ) announced $130 trillion in private capital available for future investments aligned with the Paris Agreement. To explain how to put these funds to work, GFANZ chair Mark Carney produced a Country Platforms Action Plan that advocates for collaborative country platforms and scaling up blended finance through development finance institutions. The country platform effort is also supported by G20 activities.

DFIs and donors certainly have a critical role to play in breaking barriers that stand between private sector investment and infrastructure projects. Greenfield infrastructure investments particularly are often held back by perceived weaknesses in the applicable legal/regulatory frameworks, by country ratings and by capital markets – or simply by the credit risk associated with construction and ramp-up phases of a project. Such deterrents are especially problematic in emerging markets.

DFIs and donors in blended finance transactions break these barriers by providing risk mitigation instruments like grants, guarantees, political risk and non-payment insurance, and soft loans. Projects then attract more private capital and – as the projects are de-risked – private capital comes at a lower price. This ‘halo effect’ can significantly reduce the gap between the relative costs of public and private capital, ultimately benefitting the host country. The GI Hub found in 2021 that 75 percent of private investment transactions in middle- and low-income countries need co-financing from non-private institutions, most commonly development banks.

The accomplishments of DFIs in capacity building, project development and creation of blended finance programmes have been remarkable, but with regard to the latter, efforts are still too timid. Convergence’s State of Blended Finance 2021 report found blended finance capital flow averaged just $9 billion a year between 2015 and 2020, funding only about 55 transactions per year. For every dollar of DFI commitments, about 50 cents were mobilised in private finance. This is a long way from the expected targets.

“Reaching the Paris Agreement objectives by 2030 will require about $90 trillion in climate-driven infrastructure investment”

Several structural problems constrain DFI use of blended finance. These include risk-adverse business models, the lack of harmonised risk mitigation instruments, and overall how DFIs manage their transition to a more asset-light strategy while maintaining their high ratings. Several experts have made recommendations to address these issues, and the Glasgow Climate Pact further urged DFIs to scale up investments from all sources globally, including through grants and other concessional forms of finance.

DFIs and their shareholders should take this opportunity to collectively address their structural limitations and enhance their impact by increasing their contributions to blended finance platforms and maximising the DFI halo effect.

New initiatives in blended finance

Recently, some private-sector-led initiatives have offered promising approaches to make catalytic capital available at the project level or in fully blended funds.

The Climate Fund Managers’ investment strategy matches the risk appetite of a concessional fund provider with the risk level encountered during the project lifecycle. The Climate Finance Partnership, sponsored by BlackRock, is set to move large amounts of private capital in middle-income countries globally with a consortium of 22 private institutional investors and public development entities from France, Germany and Japan. The Urban Resilience Fund of Meridiam, The Rockefeller Foundation and the UNCDF focus on city projects in Europe and Africa. The Sustainable Infrastructure Investment Platform, a pilot project initiated by the Global Investors for Sustainable Development Alliance and the Global Infrastructure Facility, provides emerging markets with selected DFI partner loans and bonds while donor partners extend first loss protections. The UN-Convened Net-Zero Asset Owner Alliance, which currently has a platform in the making, regroups several GFANZ institutional investors together with the UNEP FI and the UNPRI to promote ambitious climate solutions in projects, technologies and business models globally.

These initiatives are meant to grow. GI Hub is interested to see the rate of capital deployment tracked and to see the impact of these platforms measured. This will enable further optimisation of blended finance strategies and the scaling-up of capital flows separately from mere market forces.

Key next actions

Alongside the optimisation of blended finance components, other critical pieces in the blended finance ecosystem must also align for private capital to flow to infrastructure projects at ground level. Three actions are particularly important.

1 Track sustainable dealflow

Private investors increasingly integrate the UN SDGs in their investment decisions. Reporting in accordance with the framework issued by the Task Force on Climate-Related Financial Disclosure is encouraged and expected to become more widespread with the recent creation of the International Sustainability Standards Board. Institutional investors have shown clear interest in the choice of asset, technology, financing and circular economy principles – and they seek more visibility of comprehensive pipelines of sustainable projects.

Infrastructure projects should include decarbonisation measures that meet these investor expectations. The wide adoption by the industry of a framework such as the FAST-Infra sustainable infrastructure label (SI Label) would meet the requirements for most sectors and through the project lifecycle, which could predictably shorten due diligence and accelerate the flow of private capital.

2 Adopt a regulatory framework suited to infrastructure performance

The erosion of long-term debt in project finance is largely due to the 2008 global financial crisis and its aftermath, when Basel III and other regulatory frameworks required banks and insurance companies to set aside infrastructure investment reserves judged by the industry to be 60 to 70 percent ­higher than warranted by historic performance of infrastructure debt. For over a decade, this situation has curtailed the ability of several commercial banks to intermediate and place long-term debt.

GI Hub research shows sufficient data has been assembled to demonstrate the unsuitability of the existing regulatory framework applicable to infrastructure. GI Hub is working with central banks and finance and insurance regulators to remove these barriers to private capital flow.

3 Select project delivery models that mobilise private capital

Current project delivery models fall short of attracting private capital. The public-private partnership model (a prime driver in delivery models), favours highly leveraged financing structures and leaves little room for equity investments. Long-term debt financing is also largely absent from PPP contracts for the reasons mentioned. Further, because the public-private partnership model relies on competitive and rigid lump-sum turnkey contracts, it has caused problems in cases of complex projects and unforeseen events. Several international design-build contractors, often acting as strategic investors, walked away from the PPP market in recent years, depriving it of lead private equity and associated debt financing.

The collaborative delivery models recently put forward as a remedy are in most cases funded by the public sector. Better solutions lie with hybrid models that can offer collaborative benefits while re-balancing risks and mobilising private capital. For example, the progressive design-build-finance (PDBF) model offers collaborative features during development and options to firm-up prices on pre-determined packages for the construction phase. The reasonably high degree of certainty on cost and schedule can allow for equity, short-term and long-term debt to be structured. In addition to the PDBF model, the Regulated Asset Based model, the Energy PPP/Concession model and the Post-Construction Lifecycle Transfer model may also be examined.

Collaboration and leadership

Many measures must come together to scale up private investment for the climate transition. A holistic vision is needed, and time is short. The goal is to: accelerate and maximise the movement of private capital flows by up to several trillion dollars a year; in the appropriate debt, equity and grant format; at project level, while giving priority to emerging markets.

We have called for:

• managers of blended finance platforms to coordinate their action to maximise impact.

• DFIs to harmonise and integrate their risk mitigation instruments and their shareholders to increase risk-taking.

• adoption of a standardised tool to measure project sustainability and provide visibility on climate-driven dealflows.

• finance and insurance regulators to eliminate unsuited charges.

• procurement agencies to select project delivery models that draw private capital.

Several actors are in play. Without true collaboration and some form of unified leadership, we may fail to complete these actions in time. Prospective leaders from both the private and public sectors should communicate with each other and spring into action. GI Hub is prepared to assist, and we encourage you to reach out to us as a hub of collaboration.