Essential ESG: Episode 21 – The rise of blended finance

Patrick Magee, Lawyer, Banking and Finance, Corrs Chambers Westgarth

Jo Dodd, Partner, Banking and Finance, Corrs Chambers Westgarth

Chloe Delahunt-Devlin, Senior Associate, Banking and Finance, Corrs Chambers Westgarth

Emmanuel Georgouras, Senior Associate, Banking and Finance, Corrs Chambers Westgarth

Patrick: Welcome to another instalment of Corrs’ Essential ESG podcast, brought to you from the Lands of the Gadigal People of the Eora Nation. We pay our respects to their Elders past, present and emerging. I am Pat Magee, a lawyer in the Banking and Finance team, and a member of the Sustainable Finance Working Group. Today I’m speaking with my Sustainable Finance Working Group colleagues - Jo Dodd, a Partner, and Chloe Delahunt-Devlin, a Senior Associate, each Debt Capital Market specialists in our Banking and Finance team, along with Emmanuel Georgouras, a Senior Associate in our Banking & Finance team and a regular voice on these podcasts. To kick us off, Emmanuel, could you please explain what blended finance is?

Emmanuel: Sure, and thanks, Pat. A pleasure to be here. Blended finance is an investment structure that aims to increase the attractiveness of investments that would otherwise be classified as risky (actual or perceived) through ‘blending’ of different investments. So, whilst there is no set definition of ‘blended finance’, most leading bodies agree that blended finance structures have the following characteristics. Firstly, the transaction contributes towards achieving Sustainable Development Goals. However, not every participant in a blended finance transaction needs to have that development objective. Private investors in a blended finance structure may simply be seeking a market-rate financial return. Secondly, overall, the transaction intends on yielding a positive financial return. Each participant in a blended finance structure will likely have different return expectations, ranging from concessional to market-rate. Thirdly, public and/or philanthropic parties to the transaction who provide ‘catalytic’ funding or capital. The idea is that the participation from these parties improves the risk/return profile of the transaction which attracts participation from the private sector.

Jo: That’s right, Emmanuel, and while there has been significant progress in funding and capital solutions to the world’s social and environmental problems (in particular in recent years), the challenge remains at times, deploying such funding and capital to where it is needed most. Blended finance allows for the public, private and non-profit sectors to collaborate on projects that might otherwise be difficult to get off the ground.

Chloe: It sounds a lot like ‘impact investing’, which has become an increasingly popular investment approach aimed at addressing social and environmental concerns. Jo, can you provide a bit more insight on how ‘blended finance’ differs from ‘impact investing’?

Jo: Yes, good point, Chloe. Impact investing certainly springs to mind here, and there are certainly similarities between the two. Impact investing involves deploying funding or capital with the primary goal of generating positive social and environmental outcomes alongside financial returns. On the other hand, blended finance is a structuring approach which involves the strategic use of public and private funds to mobilise additional capital for sustainable development projects, often in regions where traditional financing alone may fall short. The two approaches are similar in that they are both committed to creating positive social and environmental impact through strategic investments.

Emmanuel: I agree, Jo, and it’s actually important to note that impact investors are often participants in blended finance structures. So, for example, the Department of Foreign Affairs and Trade (DFAT) they’ve recently created a ‘Blended Finance and Investor Engagement Unit’. So, this targets the involvement of impact investors in DFAT’s blended finance initiatives. This forms part of the Government's broader blended finance agenda, including its decision to increase DFAT’s existing blended finance portfolio, which has already effectively demonstrated how blended finance can assist with driving Australia's climate and development objectives, and with a particular focus on the Indo-Pacific region.

Chloe: That’s right, Emmanuel. In response to the recommendations of the Australian Development Finance Review, the Australian Government has also established Australian Development Investments (or ADI), which reflects a significant increase in Australia’s development investment capacity, and the central role ADI will play in expanding the Government’s blended finance capability. ADI builds on the successful Emerging Market Impact Investment Fund pilot with an expanded A$250 million investment cap and focus on climate and gender impact in the Indo-Pacific region. This is intended to play a more significant role in achieving the Australian development program’s objectives.

Emmanuel: That’s right, Chloe, but while DFAT has a long history of providing concessional funding to international development projects, we haven’t actually seen many examples of it creating opportunities for private sector entities in Australia in blended finance structures. So, until recently, there has been a creation of a Blended Finance and Investor Engagement Unit, which will engage with philanthropic organisations and impact investors to attract their leadership and investment to support international development. Hopefully, this will open the door for Australian investors to help support international development projects going forward.

Jo: I agree, Emmanuel, and on the topic of international development, it’s important to flag where the bulk of blended finance has been directed to date. So, in 2019, the Overseas Development Institute reported that blended finance had been predominantly directed towards middle-income countries, where it mobilised more private finance compared to low-income countries. However, in recent years, blended finance is increasingly being used to target lower-income countries due to its resilience and growth potential, particularly in infrastructure projects. This shift is driven by the sector’s ability to withstand economic cycles better than other asset classes, as evidenced by high concessional to commercial leverage ratios and strong private sector mobilisation. Established private sector investors, already active in upper- and middle-income countries, are now more willing to explore opportunities in lower-income regions where infrastructure needs are pressing, especially due to climate change and rapid population growth. Despite low-income countries representing a small portion of overall infrastructure financing, there is a growing investor appetite for blended finance in these areas. Convergence data shows that low-income countries have consistently attracted significant infrastructure blended finance transactions, with half of these deals in 2023 occurring in these regions. Notably, Sub-Saharan Africa has seen steady capital flows, indicating commercial investors’ willingness to engage with higher perceived risks in deals led by established sponsors.

Emmanuel: Alright, so we’ve outlined what blended finance is, how it differs from impact investing and where most of blended finance activity to date has been directed, but how does it actually work in practice? What forms do the catalytic capital or concessional funds take, and who provides it, Jo?

Jo: To your first point, an organisation called ‘Convergence’, which publishes extensively on blended finance, refers to four categories of concessional funding. And when I talk about concessional finding I mean support measures which are provided, or priced at, below market rates. So, the four categories are: concessional debt or equity in the capital stack, credit-enhancement through guarantees or insurance, transaction design or preparation which is grant-funded, or the transaction is associated with a technical assistance facility (or TA facility). So, Chloe and Emmanuel, could you explain the types of entities who provide the concessional funding or capital for blended finance transactions?

Chloe: Yes. Thanks, Jo. Emmanuel, I’ll go first. We can broadly classify them as governmental (or quasi-governmental) (typically international development programs) and non-governmental (usually large philanthropic bodies). For example, the Australian Climate Finance Partnership is a A$140m concessional finance facility funded by DFAT and managed by the Asian Development Bank, which supports climate adaptation and mitigation projects in the Pacific and Southeast Asia region through a mix of “debt (USD and local currency), equity, quasi-equity and mezzanine financing, guarantees / risk sharing, and technical assistance”, including directly to financial institutions and fund managers to derisk these investments . Another example is the Private Infrastructure Development Group which is a fund supported by the governments of the United Kingdom, Canada, Netherlands, Switzerland, Sweden, Australia, and Germany.

Emmanuel: Chloe, I might just jump in here on the philanthropic side. So, some examples we’ve seen are the MacArthur Foundation (so this is supported by the Rockefeller Foundation and Omidyar Network). So this established the Catalytic Capital Consortium (or C3) to provide US$120m of catalytic funding across 10 investments to showcase the impact of blended finance. We’ve also seen the UBS Optimus Foundation, which is a philanthropic wing of UBS which in addition to running an ‘impact venture incubator’, it often provides impact investing that acts as the concessional support underpinning blended finance transactions.

Jo: And in addition to providing support, industry bodies play a vital role in bringing together the players in blended finance. One of the better-known examples is Convergence as I previously mentioned, which is a body that promotes blended finance to its 165 members by providing a deal platform of market participants who are dedicated to providing funding or capital through blended finance structures. Those members include public investors, foundations, private investors and deal sponsors.

Chloe: Jo, it’s interesting you mention Convergence because in addition to their deal platform, I’m familiar with them through their annual reports on global blended finance activity, which I’ve found really useful in tracking trends in the sector. An example is their report “The State of Blended Finance 2024 Report” found that climate blended finance transactions account for about half of the blended finance market by deal count and 57% of aggregate financing.

Emmanuel: Chloe, that trend actually aligns with the increasing importance of climate and energy transition investment activity, and in part, may be explained by the policy objectives of the governments which provide much of the catalytic funding – including Australia’s ACFP, as I mentioned earlier. The governments who provide catalytic funding through blended finance transactions will of course direct those funds to their priority issues – whether they’re geopolitical, social or environmental.

Chloe: That’s a good point, Emmanuel. Previously, a large part of international development aid was directed towards Africa, but the concentration is beginning to shift, with an increasing trend to regionalism seeing providers of catalytic capital increasingly supporting projects in their local region. For instance, the Asian Development Bank has been increasing activity in Asia and we’re also seeing similar increases in activity in Latin America and the Caribbean, too.

Jo: I completely agree, and am reminded that UBS recently predicted that there will be a surge in blended finance deals in Asia in the coming years. Australia, the US, and other nations are increasingly focusing on the Indo-Pacific region due to its pivotal role in global economic growth, stability, and resilience. Addressing the region’s development challenges, aligned with the SDGs and the Paris Agreement, can’t be achieved solely with public or philanthropic funding. Private sector investment alone is also inadequate, as investors are cautious about the high risks involved in developing economies. So, the strategic use of catalytic funds through blended finance is essential to attract private sector investment toward these goals. Australia’s 2023 Development Finance Review underscores this approach, highlighting the need for clear investment pathways and collaboration. This strategy is particularly relevant for countries like Indonesia, Vietnam, and Papua New Guinea, where blended investments and grants are being directed to address urgent development priorities. Additionally, the US is targeting countries such as the Philippines to support sustainable development, enhance supply chain resilience, and strengthen economies within the Indo-Pacific region.

Emmanuel: So, we’ve already mentioned some of Australia’s more established blended finance initiatives, but we’re also seeing increased opportunities for Australian entities emerge. So in March, the Australian and Indonesian governments launched ‘KINETIK’ - the Australia-Indonesia Climate and Infrastructure Partnership, which will (in part) coordinate and incentivise financing in climate-focused investments in Indonesia – from small-to-medium sized enterprises to large scale infrastructure projects. To kickstart this process, Australia has made a A$1 million investment in the South-East Asia Clean Energy Fund II to be directed to Indonesian projects. While that may be seem small, it’s still early days, and combined with the benefit of the 2019 Australia-Indonesia free trade agreement, we hope to see an uptick in investment in Indonesian climate projects.

Jo: Yes we also saw the Prime Minister pledge A$2 billion to establish a green energy finance fund focused on South-East Asia. We don’t have many details yet, as the pledge was made during this year’s ASEAN Summit, but it’s reported the fund will be named the South-East Asia Investment Financing Facility and be managed by Export Finance Australia. We’ve seen export finance used in blended finance structures before – an example being the joint funding of the Lotus Wind Power Project, which increased the amount of wind-generated power in Vietnam by 30%. Export Finance Australia, the Asian Development Bank and Japan’s International Cooperation Agency provided $32 million Aussie dollars of financing to make that project possible. If $32 million split between 3 providers can drive that change, it’s inspiring to think what would be possible with a $2 billion fund!

Chloe: Absolutely, Jo! It’s clear governments are driving blended finance in the region, and I’m hopeful we’ll see private capital come through to maximise the opportunities this creates. Emmanuel mentioned the South-East Asia Clean Energy Fund II and it’s worth noting that this is the first specialised private blended finance fund in the region, managed by Clime Capital, and backed by heavy hitters, including the European Climate Foundation and Microsoft.

Jo: It’s clear there’s significant potential for blended finance in Asia, particularly in climate-related and renewable energy projects. Are we seeing any other major trends in this space?

Emmanuel: We are, Jo, and frequent listeners to the podcast would now that another significant trend is the development of sustainable finance taxonomies, and their potential impact on blended finance. So, in the 14th episode of Essential ESG (24 October 2023), my colleague and I discussed the movement towards standardised taxonomies in sustainable finance. In short, these taxonomies create increased transparency and accountability, by providing a set of measurable reporting standards to assess if an economic activity (and by extension, an investment or loan) is green or not. It’s often commented that key barriers to private capital investing in blended finance structures are, firstly, difficulties aligning cross-border reporting standards, and, secondly, concerns of transparency when obtaining reports from less developed states. These concerns can ultimately drive caution, particularly in light of the recent focus on greenwashing, and in turn, increase barriers to investment. But, if sustainable finance taxonomies continue to be developed, and be internationally aligned, we should see increased transparency and certainty, and in turn, lower barriers to investment.

Jo: I completely agree, Emmanuel. Your comments remind me of another comment which UBS made. In addition to predicting a surge in blended finance in Southeast Asia, UBS identified that “transparency and accountability are crucial to engage catalytic capital” and are required to scale blended finance over the next decade. Transparency and accountability foster trust and confidence among investors, which is crucial for scaling blended finance to achieve the sustainable development goals. Private investors, often new to blended finance transactions, need assurance that funds are being used effectively and generating the intended impact. A culture of transparency promotes knowledge sharing and the adoption of best practice, which further builds investor confidence. As the field of blended finance evolves, greater standardisation in impact management and measurement is expected, making it easier to attract more investors. This standardisation will support the scale needed for transformational impact, ensuring that investments are both effective and sustainable.

Patrick: So, to bring it all together for our listeners, today we’ve explored how the innovative approach of blended finance is making a significant global impact and how Australia’s involvement in this space showcases the potential for blended finance to mobilise resources, mitigate risks, and create scalable solutions for global challenges. By leveraging both public and private sectors, more inclusive and sustainable growth can be achieved. If you have any questions or need assistance navigating this niche investment space, please don’t hesitate to reach out to us. We are here to help! Thank you for joining us and to our contributors Jo, Chloe and Emmanuel and stay tuned for the next instalment in Corrs’ Essential ESG podcast series.