BLENDED FINANCE

ARCHETYPES &
UNDERLYING RATIONALE
CATALYZING PRIVATE CAPITAL FOR THE
SDGs – A WORKSHOP ON BLENDED FINANCE

JAKARTA, MARCH 3RD 2020

KEY CHARACTERISTICS
OF A BLENDED FINANCE
TRANSACTION
KEY CHARACTERISTICS OF A BLENDED FINANCE TRANSACTION

Three signature markings that Convergence believes

are important to a blended finance transaction

1. Leverage - Commercial capital mobilized by Leverage

concessional capital

2. Impact - Underlying activity contributes to the Blended

Finance
SDGs in a developing country; however not all Transaction
parties need to have development intent Impact Return

3. Return - Transaction expected to achieve a

positive financial return; returns range from
concessional to market rate and depend on the
type of private sector investor in the deal

CONVERGENCE 3
UNDERLYING RATIONALE
FOR BLENDED FINANCE
NUMEROUS BARRIERS IMPEDE CAPITAL FLOWS INTO FRONTIER AND
EMERGING MARKETS
Developing countries constitute 49% of global GDP, however only a small fraction of the USD 220
trillion in global capital markets flows to these countries; primarily because of the following challenges
1 2 3 4
Liquidity is often Local financial Private investors Challenging local
weak or non markets often do have knowledge investment
existent not function and capability climate
efficiently gaps

5 6 7
Private investors Individual High volatility
have limited investment impedes stable
mandates and opportunities are investment
incentives often too small returns

The most significant barrier to private capital flow in emerging markets is that returns
are often not commensurate with the high level of risk (real or perceived)

CONVERGENCE 5
RELATIVELY LOW NON-PERFORMING LOAN (NPL) RATIOS SHOW
THAT PERCEIVED RISK MIGHT BE HIGHER THAN REAL RISK
• According to the IMF, the region has witnessed a marked Non Performing Loan Ratio (Median)

Regions/Groupings
reduction in NPL’s because High Income 3.66%
1. There have been improvements in asset quality across ODA Countries Only
Sub Saharan Africa 4.32%
the board Europe & Central Asia 10.81%

2. Progress has been made in reducing the role of state- Latin America & Caribbean
Middle East & North Africa
2.31%
8.50%
owned banks in lending South Asia 7.78%
East Asia & Pacific 2.16%
3. There has been enhanced supervision from regulators
Note: According to the IFC, there is a
strong correlation between NPL’s and loan
• Despite an improvement in the overall health of the dollarization across certain regions

banking system, recently increases in nonperforming loans

have been observed in Cambodia, Malaysia and Papua
New Guinea

CONVERGENCE 6
VARIABLES AFFECTING RISK-ADJUSTED RETURNS

Returns
Emerging markets returns are
realized based on certain
Risks variables:
Emerging markets face a • Seniority
number of unique risks:
• Tenor
• Macroeconomic
• Exit
• Political
• Credit Spread
• Regulatory
• Growth Rates
• Business
• Leverage
• Hard & Local Currency If risk adjusted returns
• Liquidity are less attractive
• Tax Conditions relative to other markets,
investors will not allocate
capital to emerging and
frontier markets
CONVERGENCE 7
BLENDED FINANCE IS A STRUCTURING APPROACH TO SHIFTING
RISKS & MANAGING RETURNS
Public and donor capital can be used to shifting risk or manage returns bringing risk adjusted
returns in line with donor requirements

Shifting Risks Managing Returns

Public investors & donors can Public investors & donors can
mitigate risks by enhance returns by
• Improving credit worthiness • Providing incentives for successful
• Limiting downside loss exposure performance outcomes

• Insuring against unforeseen events • “Topping up” returns

• Providing TA and advisory services • Providing interest rates subsidies

• Eliminating funding shortfalls • Amongst others…..

• Amongst others…..

CONVERGENCE 8
BLENDED FINANCE ENTAILS STRUCTURING TO CREATE MARKET
RISK-RETURN ACCEPTABLE TO PRIVATE SECTOR INVESTORS
Deploying Blended Finance To Achieve Commercially
• The blue line depicted is the risk-return frontier; Acceptable Risk – Return Profile
which is a range of risk & return combinations A
available to investors Expected
Return Blended Deal Market Line
with Return (Risk-Return
• For the public sector and donors to induce private Enhancement C Profile for Private
Investors)
investment, they must increase increase returns or
reduce risk of projects that fall below the blue line B B A C
Project Before Blending
Blended Deal
• Transactions below and to the right of the blue line Risk
Free with De-Risking
(Unacceptable to Private
Investors)
are less attractive to commercial investors because Return

they have a fiduciary duty to maximize risk-

adjusted returns Expected Risk

Goal of Blended Finance is to create acceptable risk-

• Significant portion of transactions recorded by
return profiles to mobilize private sector investment
Convergence seek to reduce risk rather than to SDG projects in developing countries
enhance returns
CONVERGENCE 9
BLENDED FINANCE HELPS OVERCOME CHALLENGES OF PRIVATE
SECTOR INVESTMENT IN DEVELOPING COUNTRIES
Challenge/impediment to private investment Role blended finance can play
• High risk / low returns – Risk in developing countries is • Blended finance allows subordination of concessional
high - median sovereign ratings “B+” with private sector funding to allow risk/return of investments to become
worse (expected loss 8+ times higher than Investment acceptable to investors. First phase creates demonstration
Grade). Required returns well above possible from market. effect for subsequent phases.
• Local currency volatility - Developing country
• Concessional funds absorb currency risk that can lead to
currency volatility is high – impedes both debt investors
loss on a loan or equity. Can decrease cost of FX hedges.
(increased credit risk) and equity investors (reduced IRR).
• Weak business environment and high corruption – • Portfolio blended finance solutions combined with first
Some SE Asian countries have a low score on World Bank loss capital can achieve strong diversification across many
Doing Business Report and poor Transparent International countries and projects. As well, TA attached to structure
Corruption Perceptions Index rankings. can use the projects to help achieve reforms.

• Lack of scale / small deal size - Deal sizes which can be

• Blended finance can create portfolio solutions where a
small makes portfolio debt and equity investment
series of small transactions can be funded.
inefficient and costly
COMMON BLENDED
FINANCE ARCHETYPES
BLENDED FINANCE INVOLVES DEPLOYING DEVELOPMENT FUNDS
TOWARDS SDG ALIGNED PROJECTS
Development Objectives Primary Archetype(s)
Mobilize additional financing by creating market risk-return acceptable to Funded Risk Participation &
private investors Unfunded Risk Participation
Viability Gap Funding &
Reduce up-front or ongoing costs to make an SDG project affordable
Smart Subsidies
Smart Subsidies &
Pay for “social” outcome the project or market can not afford (or will not pay)
Performance Payments
Support success of SDG project by covering part of the costs or achieve Technical Assistance
systemic impact beyond individual project
Viability Gap Funding, Project
Increase number of SDG related projects
Preparation & Design Funding
Incentivize innovation and investment into SDGs by committing to pay for Results Based Financing, Outcome
results/outcomes (advanced market commitments) Funding & Pay for Success

CONVERGENCE 12
MAIN ARCHETYPES AND INSTRUMENTS
Archetype Typical Development and Financial
Instruments
Investment or Grant: Debt (Loans and Bonds),
1. Funded Risk Participation Mezzanine Capital or Equity

Investment or Grant: Guarantee

2. Unfunded Risk Participation (Contingent)
Investment or Grant: Insurance
3. Technical Assistance Support Grant: Technical Assistance

4. Viability Gap Funding, Smart Subsidies and Performance Grant: Capital Investment and
Payments Incentive/Affordability

5. Project Preparation & Design Funding Grant: Project Preparation or Design Funding
6. Results-Based Financing Outcome Funding Grant

CONVERGENCE 13
1. CONCESSIONAL DEBT OR EQUITY

• Concessional debt or equity provide favorable terms of

rates relative to market pricing; developmental capital Capital Structure
Capital Structure
bears non-market risk-return
Senior Debt
• Subordinated (debt) or junior (equity) protects senior
investors by taking first losses on the value of the Subordinated Debt
security
Mezzanine Capital
• The use of direct investment instruments on
concessional terms helps shift the risk-return ratio for Equity
private investors to an acceptable level
Junior Equity
• Concessional finance can help bring down the weighted
average cost of capital for a project

CONVERGENCE 14
CONCESSIONAL DEBT OR EQUITY - ILLUSTRATION OF APPLICATION
Opportunities to apply this concept exist where the composition of the structuring components make
economic sense but do not deliver the necessary commercial returns. By introducing new
components or enhancing existing ones, the risk adjusted returns in the tranches are
reconfigured and the deal becomes bankable.
Basic Capital Structure Blended Capital Structure

Concessional Equity 5% rE = 5%

rE = 20% Grant Equity 5% rE = 10% Blended Equity

Equity rE = 13.75%
25%
Private Investment 10% rE = 20%

DFI Subscribed
rD = 4%
Debt 20%

rD = 7.5% Blended Debt

Debt rD = 6.625%
75%
û PV(Cashflow)
at WACC Commercial Debt rD = 7.5%
10.625% < 0 ü PV(Cashflow) at 60%
WACC 8.3% > 0

CONVERGENCE
LEVERAGE RATIO DISTRIBUTION FROM CONVERGENCE DATABASE
LEVERAGE RATIOS OF SELECT DEALS
• The historical average leverage ratio has been 4.05
for blended finance funds that are recorded in
Convergence’s deals database Median: 2.74
Average: 4.05

• Measures commercial capital mobilized by

concessional capital; commercial capital includes
capital mobilized by private investors &
MDB’s/DFI’s at market rates 0x 2x 4x 6x 8x 10x 12x 14x 16x 18x 20x 22x 24x

• Leverage ratios are sometimes lower due to the

need for demonstration effect and high perceived Leverage ratios vary significantly across
risk, however should increase over time as sectors and geographies according to
investors comfort level goes up perceived and real risks – e.g., average
leverage has been greater for Latin America
compared to Sub-Saharan Africa.

CONVERGENCE
EXAMPLE OF CONSESSIONAL DEBT/EQUITY - CLIMATE INVESTOR
ONE
• Invest in renewable energy projects that serve 7 million
individuals in emerging countries and avoid GHG emissions
of 1.2 million tons of CO2 equivalent Tier 3 Institutional Capital 160 m
Tier 2 Commercial Capital 320 m
Tier 1 Donor Capital 320 m
• Offers life-cycle support through three funds that are
designed to address barriers specific to each stage USD 30 M
Development Construction Refinancing
USD 30 M
Fund Equity Fund Fund
• Mobilizes private sector financing through catalytic public USD 50 M USD 800 M USD 800 M
sector funding; investors and donors can participate in a
fund and a tranche according to their risk-return profile

• Development Fund comprised of non-repayable donor

contributions while Construction Fund has first-loss
tranche (Tier1) that is capitalized by donor contributions
Development Equity Senior Debt
Loans & TA
• Recently announced financial close at USD 850 million
CONVERGENCE 17
EXAMPLE OF CONSESSIONAL DEBT/EQUITY - WATER FINANCING
FACILITY
• Goal is to leverage blended finance to issue locally rated
investment grade bonds to domestic institutional investors
World Water
Financing
• Facilities will be set up at national level to provide long- Facility (WWFF)
term lower-cost local currency loans to water utilities Equity First Loss
Reserve

• The blended structure is designed such that National Water

Financing
1. WWFF is funded by donors and DFI’s Facility (NWFF)
2. Credit risk of loan pool is enhanced due to first loss
Debt Reserve
subordinate invest in NWFF from WWFF Grants, Fund
3. Debt reserve fund created and supported by local govt. Technical
Assistance
Domestic
Loan Pool Institutional
4. IFI’s may provide partial credit guarantees to domestic Local Currency
Investors
Bonds (partially
institutional investors Loan guaranteed)

5. Grants and TA provided by NWFF to local utilities

Local Water
Utilities
• Aim is to mobilize $1.23 billion p.a. of pvt. finance by 2030
CONVERGENCE 18
EXAMPLE OF CONSESSIONAL DEBT/EQUITY - JAPAN ASEAN WOMEN’S
EMPOWERMENT FUND
• Blended finance structure that provides loans to microfinance SENIOR
PRIVATE SHARES
institutions that serve female entrepreneurs INVESTORS
~ $120M
• Three tiered fund that uses first-loss & mezzanine tranche to
mobilize institutional investors into the senior tranche
PUBLIC
• Has reached over 240,000 women entrepreneurs to date INVESTORS

SENIOR
• Successful fundraising and capital deployment of the fund proves MEZZANINE
SHARES
1. Experienced fund manager (Blue Orchard) can be a powerful ~ $120M

partner for concessional capital providers who are trying to

be catalytic
JUNIOR
2. Concessional capital providers do not need to take a first MEZZANINE
loss-position to attract the private sector DEAL SPONSOR
SHARES

3. Commercially oriented blended finance vehicles can mobilize FIRST-LOSS SHARES ~ $1M
institutional investors
CONVERGENCE 19
2. CONTINGENT (UNFUNDED) RISK PARTICIPATION
• Risk reduction tools that protect investors against capital losses
- Guarantee provides protection to investors if guaranteed event occurs
(eg: payment default of borrower); Insurance provides protection by
promising compensation for specific loss in return for for a premium
Capital Structure

• Provides investors secondary level of comfort that investment

Debt

Guarantee or
will be repaid if obligor is not able to fulfill its contractual

Insurance
obligations (payments)
• Lowers cost of financing for obligors as guarantor typically has Equity
better credit rating than obligor
• Helps narrow gap between real and perceived risk & typically
requires no immediate outlay of cash/capital AfDB, MIGA, USAID & Sida
• Primarily backstops debt (e.g. loans and bonds) and secondarily are active users of guarantees
for development
other instruments like equity and provide credit enhancements
CONVERGENCE 20
CHALLENGES THAT PREVENT WIDE USE OF GUARANTEES

1 There are limitations to guarantees qualifying as ODA as per OECD guidelines

2 Guarantees do not qualify towards the 5% payout rule for US foundations

3 Ratings agencies have conservative policies on partial guarantees

MDBs and DFIs face impediments linked to their capital structure and financial &
4
operational policies

CONVERGENCE 21
EXAMPLE OF CONTINGENT (UNFUNDED) RISK PARTICIPATION: IIX
WOMEN’S LIVELIHOOD BOND (WLB)
Donor Funded
• Innovative instrument that mobilizes private sector capital by Design Grant
pooling loans to social enterprises into a public debt security Grant

Portfolio
• $8m four-year bond to be listed on Singapore Stock Exchange; Manager (IIX)
Subscription
proceeds to be lent to social enterprises that focus on of bonds Bond
Holders
empowering women through sustainable livelihoods in SE Asia Issuer WLB
Asset Pvt. Ltd. Coupon
payment
• The WLB leverages three blended finance mechanisms First Loss First Loss
Provider (IIX)
1) Early stage grant funding to support design process (funded Capital $500K
Interest Provision
by Rockefeller Foundation and Japan Research Institute) payment of loans
2) Partial guarantee on the underlying loans (provided by Guarantor
USAID-DCA and subsidized by Australian DFAT) Pari- passu (USAID)
guarantee of 50%
3) Small first-loss capital tranche contributed by IIX
Social
Grantor
Enterprises &
• Looking to target 385K female beneficiaries; Social Return on Microfinance
(Australia
DFAT)
Institutions
investment (SROI) will be unique impact metric measured
CONVERGENCE
3. TECHNICAL ASSISTANCE SUPPORT
• Development funds deployed into Technical Assistance
for many reasons.Typically:
- Increase quality of project implementation Capital Structure
- Demonstrate feasibility of projects that could be
Debt
commercially viable
- Technical studies
- Training, capacity building and advisory services Equity
- Achieve systemic results beyond project (e.g., sector
reforms)

• Cover costs, which if paid for by project or private Technical Assistance

investors, would drive expected return below
acceptable level Grants

• Useful to prove business models, especially in less

mature sectors and riskier geographies
CONVERGENCE 23
EXAMPLE OF TECHNICAL ASSISTANCE SUPPORT: PACE (PARTNERING TO
ACCELERATE ENTREPRENEURSHIP) INVESTMENT READINESS PROGRAM
• PACE IRP was a <$800,000 jointly funded program between OVERVIEW OF PACE IRP
Open Capital Advisors, USAID and five impact investors to PROGRAM
identify, develop and and invest in enterprises in East Africa

• Open Capital Advisors (a financial advisory firm) identified,

screened and and provided capacity building and financial
services to early stage enterprises

• USAID provided grant capital to subsidize the program (1/2 the

capacity building costs and pipeline development) thereby
catalyzing private sector participation

• Unique aspect of the program was upfront commitment

required from investors who shared the cost of pre-investment
support in return for right of first refusal to invest upon
completion of technical assistance/capacity building
CONVERGENCE
4. VIABILITY GAP FUNDING & SMART SUBSIDIES
• Grant payments used to (1) reduce total up-front
investment required or (2) support ongoing
economics/financing of SDG project Capital
Structure
• Viability gap funding typically required to reduce cost
of implementation to affordable level for developing Debt

Grants
country

• Smart subsidies typically required due to lack of

Equity
financial viability at market terms – e.g., inability to
increase user charges to sufficient levels to pay full
cost of capital at market rates (e.g., renewable, clean
energy projects)

CONVERGENCE 25
EXAMPLE OF VIABILITY GAP FUNDING/SMART SUBSIDY: KIGALI BULK
WATER SUPPLY PROJECT
Junior Debt Facility Senior Debt Facility
• Kigali Water Limited (KWL), arranged by the Emerging
Africa Infrastructure Fund (EAIF), is building Sub-Saharan EAIF EAIF AfDB

Africa’s first water supply project using a PPP model in

order to attract private sector investment
TAF
Viability Gap
• KWL, a subsidiary of Metito received a 27yr BOT license; Funding
KWL will sell potable water to the public utility - Water &
Sanitation Corp. of Rwanda DEVCO
Feasibility
KIGALI WATER

Grant
• EAIF led financing of $40.6M of the $60.8M project; EAIF WASC Project
provided $2.6M in junior debt and $19M in senior debt PPP Agreement
Equity

with a matching amount from AfDB with an 18yr tenor

METITO

• PIDG company, DevCo provided a grant for legal, financial,

technical, environmental and feasibility while TAF provided
$6.5M in viability gap funding to reduce upfront costs
CONVERGENCE 26
5. PROJECT PREPARATION & DESIGN FUNDING

• Grants that support costs and activities that lead to

bankable/investible SDG projects
Capital
• Typically provided by those who seek to catalyze Structure
SDG projects that are currently not happening
Debt

Grants
• Typical examples include feasibility studies, proofs of
concept and technical studies to prepare projects that
are technically sound, sustainable and
Equity
bankable/investible

CONVERGENCE 27
EXAMPLE OF DESIGN/PREPARATION FUNDING: CONVERGENCE
DESIGN FUNDING PROGRAM (1/2)

CONVERGENCE DESIGN FUNDING supported by

provide
funding Convergence Transaction ready
Board of Directors platform for fundraising or
reaches financial
appoint & funding close
nominate one oversee recommendation
Funders member
Funding Committee
developed by
Convergence
assess & shortlist Publish briefs /
team
proposals case study on
design learnings
Management

apply through
funding windows

Practitioners

CONVERGENCE 28
EXAMPLE OF DESIGN/PREPARATION FUNDING: CONVERGENCE
DESIGN FUNDING PROGRAM (2/2)
SOLUTIONS SUPPORTED FUNDING AWARDED VEHICLE

18 $6.2M 11%
11%
33%
Fund
Bond/Note
Company
CAPITAL CATALYZED LEVERAGE 11% Impact Bond
Facility

$550M 88x 11%

22% Project

SECTOR REGION
Agriculture 33% Sub-Saharan Africa 33%
Health 22% Global 28%
Energy 39% East Asia and Pacific 11%
Financial Services 28% South Asia 11%
Education 11% Latin America & The Caribbean 17%
Infra (Non-Energy) 28% Middle East and North Africa 6%

CONVERGENCE 29
6. RESULTS-BASED FINANCING

• Donor pays for results instead of paying for

Outcome Funding Mechanics
inputs
Investor: Provides
• Payment for service delivery tied to achieving funding upfront
measurable outcomes
3 1

• Typically, payor for outcomes (e.g., government

or foundation) commits to provide funding if and
when the service delivered achieves contracted
results

• Examples include Development Impact Bonds Outcomes Payor: 2

Service Provider:
Pays investor based on Undertakes programing
(DIBs), Social Impact Bonds (SIBs), Advanced
agreed upon metrics that
Market Commitments are delivered by service
provider
CONVERGENCE 30
EXAMPLE OF RESULTS BASED FINANCING: THE UTKRISHT IMPACT
BOND
Mechanics of Utkrisht Impact Bond
• 9M three-year impact bond to fund maternal and Investor: UBS
newborn interventions in Rajasthan Optimus (3.5M) &
Co-investment from
• Investors will fund service providers who will support service providers
private healthcare facilities to improve their systems
3 1
and attain a quality certification

• Investors will be paid by outcome funders upon

verification that a facility(s) is ready for accreditation
under the new quality standard
Outcomes Payor: 2
Service Provider:
• 7.1% expected IRR for UBS Optimus (capped at 8%) Merck for Mothers Hindustan Latex Family
(4.5M) & USAID (4.5M) Planning Promotion Trust
• Projected to impact up to 600,000 pregnant women (HLFPPT) & Population
and save up 10,000 lives over a five-year period Services International
(PSI)
CONVERGENCE 31
KEY
CONSIDERATIONS
IMPACT IS THE KEY DUE DILIGENCE CONSIDERATION FOR
THE DONOR & PHILANTHROPIC COMMUNITY
The various parameters along which to think about the impact of a blended finance
solution are as follows

1 Intended ex-ante impact. How does this align with business model?

2 How applicant proposes to measure impact? Is that feasible?

3 Leverage

4 Additionality

5 Comparison with donor “business as usual”

CONVERGENCE 33
IT IS IMPORTANT TO EVALUATE THE APPROPRIATENESS OF
THE BLENDED FINANCE SOLUTION WHEN EXAMINING A
PROPOSAL

Vs. traditional grant programming: Is there is a sustainable business model?

1
- Offramp to independent viability or
- Needs long-term subsidy for well-considered reasons

Vs. fully commercial funding: is the concessional money really needed?

2
- Correcting for market failure that keeps market-based financing out of reach (e.g.,
advanced market commitments for vaccines and carbon credits for climate
externalities)
- Demonstrating that perceived risk > real risk profile of the venture

CONVERGENCE 34