Better Blending

Less than 10 per cent of EU aid reaches the world’s poorest countries, according to a report published today, which puts the 2030 Agenda for Sustainable Development at risk. To respond to this need, governments and international organisations are increasingly calling for greater involvement of the private sector.

However, some commentators have pointed out that the much-hyped ‘blended finance’ is by no means a panacea to the problem of limited aid budgets.

Transparency International has previously highlighted how integrity risks in these public-private development partnerships can negate their potentially positive contribution to sustainable development. Here we explain in more detail where the potential problems are, and what needs to be done by international financial institutions.

Alongside other private sector channels such as conventional foreign direct investment, social impact investment and green investment, so-called “blended finance” is being hailed as a key means of funding development in low- and middle income countries.

Blended finance is the strategic use of development finance to mobilise additional commercial finance needed to achieve the SDGs. Advocates of blending contend that relatively small amounts of public resources can mobilise untapped sources of private capital by using innovative financial instruments that reduce the perceived investment risk for the private sector.

Blending differs from traditional forms of development finance in that the projects it finances are at least partially commercial in nature. Private sector entities can be involved in blending as financiers investing in revenue-generating development projects. By acting as service providers, they can also be direct beneficiaries of investments channelled through blended finance initiatives. In both cases, the private sector investor or recipient expects to make a profit as a result of their involvement.

Investors have been answering the call; 23 of the 30 Development Assistance Committee members are engaged in blending, and conservative estimates put the aggregate value of blended finance deals at well over $100 billion. The World Bank’s International Finance Corporation (IFC) is somewhat of a trailblazer when it comes to blending, and to date has committed over $2.4 billion of its own funds to leverage private investment with the stated ambition of becoming “not just a provider but a facilitator of capital.” The IFC also heads the Development Finance Institute Working Group on Blended Finance and is itself one of the largest players in terms of mobilising commercial finance through its Managed Co-lending Portfolio Platform, Private Sector Window, Global Environment Facility and other blending facilities.

Despite the much-trumpeted potential of blending to mobilise additional commercial financing that could contribute to the 2030 Agenda, even its advocates concede that “blended finance can only address a subset of SDGs that are investable … [it is] less aligned with goals such as Goal 16 (Peace, Justice, and Strong Institutions).”

Such sentiment comes at the issue from the wrong angle. The SDGs are an inherently interconnected agenda, and given what we know about the devastating impact of poor governance on development, there is a clear need to embed the spirit of SDG 16 across all of the Goals — not least SDG 17, which deals with financing the SDGs.

This means that transparency, accountability and participation must be at the heart not only of the implementation of the 2030 Agenda, but also of efforts to mobilise the necessary resources. In the area of blended finance, there are legitimate concerns that this isn’t currently the case.

Unlike the previous Multilateral Development Bank Principles to Support Sustainable Private Sector Operations from 2012, the new principles for blending developed by the IFC-led Working Group in 2017 place limited emphasis on transparency around the use of Official Development Assistance (ODA) to subsidise private investments. Whereas the 2012 Principles made a clear commitment to “ensuring that subsidies are transparent” and “avoiding the introduction of rent-seeking opportunities”, the more recent Working Group document simply states “when confidentiality and other internal DFI considerations permit, DFIs should aim to report on their concessional programs and the results of these programs.”[1]

A related problem is the lack of publicly available data. Studies have found that blended finance projects, particularly those implemented by bilateral development finance institutions, are considerably less transparent than projects funded using other forms of ODA. For instance, while the IFC does now publish data to the International Aid Transparency Initiative, it publishes much less information about its projects’ financing structures than its sister organisation at the World Bank, the International Development Association. According to some observers, the result is that the IFC’s blending facilities such as the Private Sector Window “take (comparatively) transparent aid money and turn it into (almost completely) opaque private finance.”

As the OECD notes, there is a need for much greater transparency, “both in terms of financial flows going towards blending as well as impact of blended finance.” This is a clarion call for multilateral development banks and bilateral development finance institutions to make information on blended projects publicly available. This will ensure that public money in the form of ODA is “being used fairly and efficiently, not for private gain at public expense.”

In the absence of such data, there is healthy scepticism about the relationship between blending and debt sustainability, national ownership, extreme poverty, development impact and aid effectiveness. Greater transparency therefore represents a win-win for those involved. The limited availability of data about blended projects’ commercial performance is widely seen as one of the key “bottlenecks holding back private investments in emerging markets.” At the same time, public disclosure of more information about blending’s developmental outcomes has the potential to enhance downward social accountability to affected communities.

Transparency International is not alone in calling for more accountability in blended finance; the UN Task Force on Financing for Development has repeatedly stressed the need for transparency and local ownership in blended finance deals, while the Tri Hata Karana Roadmap for Blended Finance likewise acknowledges that “financial flows and development results should be tracked, reported and communicated.”

Amid the fervour for increased blending, to date little consideration has been given to the potential integrity risks involved. This is a pressing issue for two main reasons. First, blending entails the participation of unfamiliar, profit-driven actors such as pension funds, commercial banks and sovereign wealth funds in development work, who bring with them potentially novel governance risks, such as conflicts of interest, the abuse of secrecy jurisdictions and inadequate due diligence procedures. Second, the complex financing arrangements and multi-layered governance structures involved in blended finance projects make managing and monitoring transactions and results difficult.

As so-called “intermediaries”, multilateral development banks and bilateral development finance institutions play a pivotal role in bringing together financiers and structuring transactions. As well as improving the public disclosure of project-level data, they thus have a key role to play in enforcing the highest possible standards of integrity among their private sector partners and the companies they invest in.

In addition, they can take a number of measures to ensure blending is appropriately deployed to promote sustainable development and reduce the risk of it being exploited by dishonest brokers to the detriment of investors, taxpayers and intended beneficiaries. These measures include establishing independent grievance mechanisms and improving due diligence processes to conduct robust reviews of business partners’ activities, ownership structures and, where appropriate, anti-money laundering frameworks and use of offshore financial centres.

Blended finance provides an innovative and potentially catalytic set of tools that could crowd-in billions of dollars from the private sector to help achieve the SDGs. Establishing greater transparency and accountability can encourage more, and better, private investment in low- and middle-income countries and instill greater confidence among donors, beneficiaries and private investors. Intermediaries such as the IFC should ensure that where ODA is used for blended finance, it adheres to the principles laid out in the Paris Declaration on Aid Effectiveness: ownership, alignment, harmonisation, results and mutual accountability.

Ultimately, international organisations like the World Bank have a key role to play in connecting the mechanisms of transparency, accountability and participation foreseen under SDG 16 with the efforts to mobilise development finance as part of SDG 17. The IMF has already taken some promising steps, such as launching its new Anti-Corruption Framework and committing to address corruption “systematically, effectively [and] candidly.” The World Bank should now follow suit by rigorously considering integrity risks involved in its efforts to leverage additional commercial finance. A first step would be to revisit the guidance it has historically provided states around the world on the importance of transparency in the use of government-backed subsidies for the private sector, and embed this into its portfolio of blended finance facilities.

[1] Emphasis added