In a thought-provoking discussion organized for the 3’rd Annual PSDRN Conference and facilitated by Nancy Lee, a Senior Fellow at the Center for Global Development, panellists discuss their respective organizations’ efforts and ideas for tackling common issues faced by development finance institutions (DFI) as they attempt to sustainably deploy capital to enact the green recovery. The panelists are Andrew Herscowitz, Chief Development Officer of the US International Development Finance Corporation (DFC), Marisa Buchanan, Global Head of Sustainability at JP Morgan, and Hans Peter Lankes,a Visiting Professor at the London School of Economics and who was the VP of Economics and Private Sector Development at the International Finance Corporation (IFC) until 2021.
What is the role of development financial institutions (DFI) when it comes to investing in the “Green recovery”?
The Private Sector
The private sector has been very active and decisive in its efforts to quickly grow resources and capacity to tackle environmental issues. Marisa shared how the largest commercial banks have been making Paris Agreement-aligned financing commitments to encourage lending clients to reduce emissions as well as increase investments seeking to transform the fossil fuel, electric generation, and automotive industries among others into green industries. The Net-Zero Banking Alliance, an umbrella organization of banks, asset managers, asset owners, and insurance providers is seeking to pave the path to achieving net-zero emissions by 2050. Marisa also discussed that private institutions are also increasingly committing to financing targets to lend to institutions driving environmental and social progress, with JP Morgan alone committing to a 10year $2.5 trillion target. These efforts are underpinned by increasing investor demand and are facilitated by tremendous growth in internal tools and capacity at private institutions.
The Public Sector
The public sector efforts to tackle the green recovery have also grown in capacity and flexibility. Andrew highlighted how the growth in resources providing technical assistance and expertise has been fundamental. The new capabilities have also been particularly helpful in working to design a new method to measure greenhouse gas emissions more accurately, as opposed to the standard algorithms used historically. Andrew noted the tremendous increase in demand for all the different types of inancing products that are available, and thatone of the issues is that some markets are struggling to demonstrate commercial viability to make a project “bankable”. This increase in demand has not only been from the usual suspects, but from a wide variety of private and public organizations. The public sector has been experimenting with unique financing structures, such as “blue bonds” to support cash-flow generating projects to support the health and rehabilitation of marine systems. Andrew mentioned the shift in perception in the public sector and the DFC in particular, which is now prefacing all its efforts by asking “What are the real obstacles to this transition?” When those obstacles are identified, projects can be amended to solve or circumvent those issues.
What are the Constraints Affecting Climate Finance?
Hans Peter stressed how necessary it is for institutions to increase capital and resource allocation, as well as, coordinate efforts to tackle climate change. This investment needs to be frontloaded and represents a large increase in capital allocated compared to where we are right now. Hans Peter also pointed out that projects have to be supported at a country-level by setting a specific policy environment and through access to appropriate financing channels. It is also important to begin efforts at a local level, meaning that countries should not be initially looking abroad to deploy green finance, but should first focus on the myriad of opportunities within their borders. This should be done to not only mitigate the serious obstacle of currency risk but also because there is so much work to be done in developed countries, considering they are the biggest contributors greenhouse gas emissions. He shared ho prtnerships between public and private organizations have been extremely successful in dealing with these issues. For example, the World Bank, with its robust policy advantage can set the right environment in a country, while a financing institution like the IFC can bring in investors and work to de-risk investments, presenting a powerful combination of abilities. Previously, a lack of coordination between different institutions has been a significant challenge, but now we are seeing increasing coordination with efforts such as joint diagnostics and strategies. DFIs must work together to overcome these hurdles. Developing and sharing financing and technical assistance for projects is not sufficient, we also need this macro-level coordination.
There remains a cultural disconnect between DFIs and multilateral development banks (MDBs) which do the lending, and the donor agencies which gather funding to deploy; It should not be one or the other. Although there is a lot of talk about increasing blended financing lending there needs to be more focus on deploying it. A big misconception among organizations is that if a project is not commercially viable it should receive a grant, but this simply isn’t the best way to deal with the issue. One of the biggest hurdles to project viability is the local currency mismatch. For example, if an institution provides a 20-year USD-denominated loan to ]a power project in a developing country, one should expect the tariff to increase in 10-15 years, overburdening the local consumers and leading to a loss on the investment. To be concessionary in a sustainable manner, a public lending institution can provide the loan in the project country’s local currency with the expectation that some money will likely be lost over the project’s entire duration. This would ensure that a non-bankable deal is financed, but not by a costly full grant. Andrew mentioned a comment made by a presenter at COP26 who after hearing the amount of capital that different organizations were committing said, “These are great announcements, but you’re announcing them in the wrong currency.”
What is the Role of Blended and Concessional Finance?
Andrew insisted that blended finance presents the best opportunity to de-risk projects in high-risk and low-income countries seeking green development financing. He noted the “countless” unbankable projects that are at the cusp of bankability. With the right subsidies provided through blended financing facilities by public DFIs and MDBs, those projects would receive the private capital they urgently need. The projects are primarily in frontier countries, strategies, and business models where there is a hesitancy among private institutions to lend to. As increases in blended financing facilities directed at de-risking these projects in a concessionary manner, we will see an unprecedented flood investment to these countries. The focus on these blended financing initiatives is at choosing, replicating, and scaling one solution to drive volume rather than tailoring them for every setting. Andrew pointed out that progress in this space is hindered mainly by a lack of coordination and specialization by the various development institutions, rather than a lack of money. Public DFIs are increasingly becoming unshackled from mandates to achieve a certain return, and this will allow for more flexibility to increase the impact of our capital on solving our climate crisis.
How to Tackle Policy, Governance, and Technical Issues in Project Countries? Top-Down or Bottom-Up?
Hans Peter and Andrew both agreed on the necessity of encouraging different parties work together from the get-go while coordinating their efforts through the entire lengths of multiple projects. This primarily involves collaborating initially on setting the right type of policy environment to open the field up for investment in vastly different opportunities. Diagnostics are another necessary and easy way to collaborate for the benefit of all parties. Andrew added that legacy DFI institutions used to do their work by initially identifying all the reforms needed to be enacted so that the private sector could jump in afterward and fix everything. Now the focus has shifted to allow the progress of a specific transaction to uncover different issues, which are then dealt with by reform or other means for the benefit of the current and future transactions. This approach has been much faster and much more successful at dealing with the different issues facing climate finance. Overall, the outlook is very hopeful for climate finance,and the various stakeholders tackling the hurdles are incredibly well motivated.
In conclusion, we are in an advantageous position for tackling the green recovery as we have plenty of capital committed and allocated towards this effort. However, there are certain considerations needed to tackle some of the overarching issues and get the job done. These include finding a way to more closely coordinate and specialize within the DFI and MDB ecosystem. This would increase the availability of shared resources and expertise between different organizations, and would help to develop a scalable concessionary blended financing vehicle with different stakeholders to provide a sustainable solution for higher risk projects and countries. Developing these capabilities quickly will be imperative to enacting a meaningful solution for our global climate problem.
Hadi Hussaini, CFA (MBA 2023) has four years of experience in asset management working at The TCW Group and Morgan Stanley. He is now a PR & Communications officer of the London Business School Student Administration and an intern at the Wheeler Institute focused on content generation to drive workforce inclusivity and sustainable development in the Middle East and Africa.
The Private Sector Development Research Network is a community of institutions with an active research agenda on Private Sector Development. The PSD Research Network is a collaboration between the Wheeler Institute, CDC Group, Center for Global Development, European Bank for Reconstruction and Development, IBD Invest, International Finance Corporation, International Growth Centre and the Think Tank ODI which aims to promote the exchange of ideas and facilitate collaboration.