Would your project be eligible for Blended Finance?
To get a sense on the criteria that make a project eligible for Blended Finance, let’s take a look at this 2024 paper by Caroline Flammer, Thomas Giroux and Geoffrey Heal on the degree of concessionality of Blended Finance. Given my experience in Development Finance Institution, managing projects with blended finance structures, I consider their findings on-point, which is why I chose to put a spotlight on their paper here.
I’ll first refresh the basics on blended-finance, providing a high level definition and its 5 key principles. Then, I’ll summarize the decision-making criteria highlighted in their paper.
What is blended finance?
Blended Finance is a structuring strategy that blends traditional capital (that expects market return) with more patient capital that is more risk tolerant and more flexible in terms of return expectations. This more patient capital typically comes from donors or other philanthropic sources and are often channeled through funds managed by Development Finance Institutions ("DFIs").
Typically, the financial instruments from the blended finance toolkit are characterized by their level of concessionality. In this paper, the authors define "concessionality" as the subsidy offered from the blended financing.
The 5 principles
The Development Finance Institutions (DFI) have joined forced to define the Enhanced Blended Concessional Finance Principles for DFI Private Sector Operations. Known as the DFI Enhanced Principles approved in October 2017, they provide guidance for the allocation of concessional financing to mobilize private capital in their operations.
DFI Enhanced Principles
1. Additionality: only use Blended Finance, if the project would not get commercial financing otherwise. Prioritize projects with high developmental impact.
2. Crowding-In: Use it to mobilize the private sector and to address gaps in the financing structure
3.Commercial Sustainability: the support should lift the project towards sustainable commercial viability so that the subsidies will no longer be needed in the long run.
4. Reinforcing Markets (i.e. Address market failure, do not distort markets)
5.Promoting High Standards (in Corporate Governance, Social Inclusion, Environment Impact, Transparency, Integrity, Disclosure).
The decision-making criteria
In their paper, the authors review the portfolio of Development Finance Institutions ("DFIs") and conceptualize the decision-making criteria used for structuring Blended Finance solutions. The authors anticipate that:
- the degree of concessionality will be higher for projects with a higher sustainability impact.
- the degree of concessionality will be higher for projects presenting higher risk.
In a nutshell, the decision-making process addresses the following questions:
Should I blend or not?
In practice, this decision requires testing the 5 principles for Blended Finance (see above). Interestingly, the theoretical model developed by the authors relies on two key factors:
- is the project's developmental impact high enough? It implies defining some sort of "societal hurdle rate" for the DFI.
- would the project's private return be below the economic hurdle rates of private investors? If not, it means that investors would not invest in the project, and the project would not find financing.
If I blend, how much should I blend?
It's about defining the level of concessionality and the type of solution. It's a question of choosing whether the structuring will offer subsidized pricing (offering below-market interest rates), risk management provisions (offering first loss guarantees, cross-currency swaps, etc.), performance-based incentives, or a mix of the aforementioned elements.
Which projects should I prioritize?
To answer that question, trade-offs must be made because DFIs deal with several constraints and challenges in mind:
- They have limited capital available for deployment, hence, they have to wisely distill the concessionality.
- They must prioritize projects with higher developmental impact.
- Donor-imposed restrictions may influence the selection of projects
- Measuring the degree of concessionality is not straightforward for projects that mix different types of solutions (subsidies in interest rates, risk management, performance-based incentives), which may complicate the comparability of projects for prioritization purpose.
- Decisions are based on ex-ante projections of expected sustainability impacts, not on actual impacts measured.
In conclusion, the eligibility decision does not only depend on the intrinsic value of your project, it also depends on what other projects are competing for attention in the markets. To get ahead, your capacity to measure your net positive impact and to demonstrate it will be key to get ahead of the game.
