www.ifc.org/thoughtleadership NOTE 72 • SEP 2019 Blended Concessional Finance: The Rise of Returnable Capital Contributions By Arthur Karlin and Kruskaia Sierra-Escalante In new and challenging markets, blended concessional finance—the combining of concessional funds with other types of finance, on commercial terms—is increasingly used to mobilize capital and accelerate high- impact private sector investments. However, a relatively new approach for the provision of concessional capital for use by development finance institutions is emerging—the “returnable capital” model. With this new model, principal, interest, and other amounts are repaid to the original provider of funds (usually a government) on a regular basis. Because this can reduce the impact on donor government budgets, more government funds could become available for collaboration with the private sector. This note explores the effects of this new model on incentives, accounting, resource management, and reporting. The Rise of Returnable Capital Contributions Creation of a growing, inclusive, and sustainable private sector is essential if all countries are to meet the United Until recently, the concessional funds used by development Nations’ Sustainable Development Goals (SDGs). The finance institutions (DFIs) in blended concessional finance private sector provides most of the employment, goods, and projects came mostly from government grants or long- services needed to achieve such critical SDGs as providing term contributions to dedicated facilities. These facilities good jobs and growth and ending poverty. Blended then invested the funds in private sector projects on concessional finance1 has become increasingly important concessional terms, alongside DFI and other commercial in this regard. As the world’s remaining areas of poverty finance. This “grant/long-term contribution model” was and instability are becoming concentrated in high risk the financing modality generally used by the International environments where the private sector faces additional Finance Corporation (IFC) for donors’ contributions to obstacles, some temporary use of concessional finance is the climate facilities before fiscal year 2010, as well as for often needed to support pioneering private sector projects newer facilities that finance small and medium-enterprises and help create markets. Governments have recognized (SMEs) and agribusinesses (see Figure 1).3 Starting in FY10, this and, as a result, the allocation of donor and other with climate funds from Canada, and continuing in FY18, development money for blended concessional finance with new funds from Canada, as well as from Finland, and is growing. For example, in 2017 development finance the IDA-IFC Private Sector Window (PSW), more funding institutions (DFIs) utilized over $1.1 billion in concessional became available to IFC based on a different model—the funds to support more than $8.7 billion of private sector “returnable capital” model. With this model, there is an projects in developing countries. 2 explicit up-front agreement that reflows (interest, fees, About the Authors Arthur Karlin (akarlin@ifc.org), Consultant, Blended Finance—New Business and Portfolio, Blended Finance, Economics, and Private Sector Development, IFC. Kruskaia Sierra-Escalante (ksierraescalante@ifc.org), Senior Manager, Blended Finance—New Business and Portfolio, Blended Finance, Economics, and Private Sector Development, IFC. 1 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. dividends, and repayment of principal) are regularly choosing between the two models, the rest of this note returned to the original providers of the concessional addresses the differences between the two approaches. funds. While IFC used a similar approach with some earlier multilateral donor facilities, the desire of funders to receive Blended Concessional Finance Instruments: periodic reflows has become explicit, and has grown in The Client Perspective recent years. IFC expects that this returnable-capital model for funding blended concessional finance will become even The choice between the grant/long-term contribution more important in the future. model and the returnable capital model primarily concerns the providers of concessional funds to DFIs, rather than The “returnable capital” model can appeal to the private sector firms that ultimately receive the funds. governments because they regularly receive the reflows, However, the decision can affect the instruments as well and can redeploy the funds for other programs or as the level of concessionality and risk appetite available priorities. However, choosing between a “grant/long- for use in private sector projects. Thus, these impacts can term contribution” model and a “returnable capital” be important considerations in deciding how to structure model involves some important considerations related blended concessional finance facilities. to incentives, accounting, resource management, and reporting. Thus, to help DFIs and other providers of In 2017, the DFI Working Group on Blended Concessional blended concessional finance make the best decision when Finance surveyed DFIs to gather information on the $4000 $3500 $3000 IDA PSW $2500 WE-FI $2000 Finland Canada 2.0 Canada RE $1500 WEOF GSMEF $1000 GAFSP CTF $500 Canada 1.0 IFC EF $0 EBFP FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FIGURE 1 FY2010–FY2018 IFC Blending Concessional Funds Under Management, $ millions Source: IFC. Note: IFC EF= IFC-GEF Earth Fund Program; EBFP= IFC-GEF Environmental Business Finance Program; CTF=Clean Technology Fund (Climate Investment Funds); GAFSP=Global Agriculture and Food Security Program; GSMEF=Global SME Finance Facility; WEOF=Women Entrepreneurs Opportunity Facility; WE-FI=Women Entrepreneurs Finance Initiative; IDA PSW=IDA Private Sector Window; Finland=Finland-IFC Blended Finance for Climate Program; Canada 1.0/2.0= Canada-IFC Blended Climate Finance Program [phase 1, phase 2 respectively]; Canada RE= Canada IFC Renewable Energy Program for Africa. A description of, and links to, further information on the various funds can be found on the IFC website under Blended Finance: https://www.ifc.org/wps/wcm/connect/CORP_EXT_Content/IFC_External_Corporate_Site/Solutions/Products+and+Services/Blended-Finance. 2 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. Performance grants (or parallel funding pockets) that are used for blended $53M/5% concessional finance. Senior debt Grants $513M/44% Of the two models for providing concessional finance $9M/1% from donors, the grant/long-term contribution approach Risk sharing is the most flexible. Once funds are provided to a facility, facilities or depending upon the agreement with donors, the funds guarantees can be used for various types of debt, equity, guarantees, $131M/11% and grants, and in many cases, also for advice and/or capacity building. Returnable capital models, however, Sub debt require a regular reflow of funds, which generally means Equity $72M/6% that providing grants and performance-based incentives $380M/33% to clients and funding advisory services is not feasible, as such instruments “consume” the original capital, with no potential for reflows. FIGURE 2 DFI 2017 Blended Concessional Finance: Concessional Commitment Volume by Instrument Blended Concessional Finance Instruments: Source: DFI Working Group on Blended Concessional Finance for Private The Donors’ Perspective Sector Projects, Joint Report, October 2018 Update, p. 13. From the perspective of the providers of concessional resources (usually governments), the grant/long-term different instruments they use to provide concessional contribution and returnable capital models vary with funds to private sector clients. Figure 2 shows the results, regard to cash flows, budgets, credits for overseas which indicate that DFIs use a wide range of instruments development assistance (ODA), and the instruments for concessional finance, including various types of debt, available to the ultimate private sector clients (see Figure 3). equity, guarantees, and grants. Although the reasons for using the different instruments reflect many project Reflows variables regarding risk, costs, timing, and investor As discussed, the most obvious difference between the characteristics, the 2017 review identified some common two models is the difference in reflows. With the grant/ themes:4 long-term contribution model, principal, interest, fees, and • Senior debt, when concessional, can address cost issues, dividends from clients regularly flow back to the facility, e.g. the high start-up costs for pioneering technologies, or the high costs of providing loans to SMEs. Grants/Long-term • Sub debt and equity mitigates senior debt risk by Contributions to Private improving coverage ratios (e.g. the expected cash flows Sector Facilities Returnable Capital compared to the required senior debt interest payments). No reflows except, in some Regular reflows • Grants can address high initial capital or start-up costs cases, at the facility’s close that occur with new technologies or markets. On budget May be off budget • Performance grants can provide incentives to encourage project sponsors to meet development goals. Counts as ODA ODA count but different timing/amount (“net”) • Guarantees and risk-sharing facilities, especially when on-lending through financial intermediaries to riskier Allows for grants to private No grants to private clients segments such as smallholder farmers’ cooperatives or clients SMEs, can address underlying portfolio risks. Typically, Uses existing facility May require new partners and these are used when liquidity is either not a problem, or governance and management vehicles to indirectly address the cost of local currency funding. In addition to finance, advisory services (technical assistance) are often provided by the DFIs to help develop FIGURE 3 Blended Concessional Finance Instruments: projects, create markets, and address supply chain issues. The Donors’ Perspective In many cases, the funding comes from the same facilities Source: IFC. 3 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. not the donor. Depending on the facility’s agreement, these discourage governments from using the returnable capital reflows may be used for advisory services or additional model for concessional finance, as it could lead to a private sector investment. In some cases, there may be reduction in ODA credits due to the reflows (i.e., if the provisions for eventually returning any remaining capital to funds come out of the ODA budget and are not reinvested the original donor. in other ODA uses). An alternative method being piloted by the OECD for calculating ODA for private projects (the In the returnable capital model, principal, interest, “instrument-specific approach”) would likely not have this dividends, fees, and other reflows are paid back on a issue. In this case, the ODA calculations would be based on regular basis to the original contributor of the concessional net flows (outflows minus reflows) between the facility and finance. The original contributor can then reinvest the private sector client (rather than from the government the funds in various ways—e.g., back into the same to the facility), and, thus, under the returnable capital concessional finance facility, into alternative investments, model, ODA would not change. or used for domestic finance. Impacts on Private Sector Clients Budget As discussed above, investment grants, performance grants, Depending on the rules in the country providing the and advisory services to support the private sector can be concessional finance, the two concessional finance models important parts of DFI programs. However, these instrument can have significantly different impacts on government options would generally not be available with a returnable budgets. Grants or long-term contributions to facilities capital model. Therefore, the providers of concessional may be viewed as on-budget expenses. Contributions for finance will need to consider the importance of these different returnable capital may be viewed as investments, and instruments in the context of their development goals. thus, for the most part, off budget in terms of government expenditures.5 This can be a strong incentive to provide For example, advisory services are an essential complement funds to facilities as returnable capital rather than as in high risk countries to create markets, while performance grants or long-term contributions. Returnable capital can grants can be important in aligning incentives among be viewed as an addition to regular ODA, beyond the various stakeholders and in achieving the development current budget resources. Also, it can provide new ways of outcomes that otherwise would not be obtained. increasing development outcomes through the private sector One alternative could be to use returnable capital for via investments and leveraging private capital. investments, and use separate facility grant agreements for investment grants, performance incentives, and/or The returnable capital model seems consistent with the advisory services. Another alternative would be to structure Billions to Trillions6 concept of leveraging targeted support the facility as partially returnable capital—allowing for a from governments to increase private sector engagement in percentage to be “consumed” through some of these grant- achieving the SDGs. The overall result of the difference in based instruments. impact on government budgets could be that substantially more resources become available to the private sector An additional impact of the returnable capital model on under the returnable capital model. Also, if shifting private private sector clients could be changes in the allowable sector programs from grants to returnable capital takes risk profile for investments, pricing flexibility, and the private finance off budget, more ODA grant resources corresponding levels of concessionality. With returnable could become available for purposes that are not generally capital, the provider of concessional finance is directly suitable for returnable capital financing—for example, most affected by the performance of the private sector human capital investments. investments and the price charged for taking such risks. For donors looking for a basic level of return, this might Overseas Development Assistance lead them to put greater restrictions on the risk levels of The rules used by the Organisation for Economic Co- the projects being undertaken, the pricing, or the level operation and Development (OECD) Development of concessionality. For highly risky segments such as Assistance Committee (DAC) for counting private sector smallholder agribusiness, it may be important to be more support in ODA are currently under review.7 One of the flexible regarding the minimum return requirements. methods being piloted (the “institutional approach”) The returnable capital model is also limited due to its potential includes, as ODA, government contributions to a private inability to provide support to important development projects sector investment facility, net of any reflows of principal that may not have a clear investment return—for example, from the facility back to the government. This could social programs or disaster recovery programs. 4 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. Investment Management Returnable capital approaches for providing concessional funds to the private sector could have important benefits In many cases, the establishment of returnable capital for the providers of concessional funds, particularly models for providing concessional finance to the private through the availability of reflows, and less impact on the sector will require new partnerships between the providers budget. This could mean that far more resources might of concessional finance and the institutions that have the become available to the private sector. Other impacts may capacity and experience to effectively deploy the finance to also be important, though, as the reported ODA could private sector projects via non-grant instruments. Providers potentially become more uneven, and the instruments of concessional finance will have to consider how much available to clients, such as grants and advisory services, management can be undertaken in-house versus delegating could become more limited. The specific circumstances investment decisions to a partner. Investment partners for providers of concessional funds with regard to their should have deep experience in assessing and structuring development goals, country accounting rules, ODA rules, investments in developing countries, especially with and details of the agreements for funding facilities, will all projects in higher risk environments that are more likely affect the attractiveness of the two different options. to require blending. Investment partners should also have strong governance, fiduciary, and reporting capabilities; ACKNOWLEDGEMENTS high environmental and social standards; an understanding and commitment to development; and the ability to The authors would like to thank the following colleagues for measure different types of investment impact. In addition, their review and suggestions: Martin Spicer, Director, Blended alignment of the interests and perspectives on development Finance, Economics, and Private Sector Development, IFC; of both the providers of capital, and the implementing Niraj Shah, Principal Investment Officer, Blended Finance– partners, is essential. New Business and Portfolio, Blended Finance, Economics and Private Sector Development, IFC; Morten Lykke Lauridsen, Outlook and Recommendations Principal Multilateral Engagement Officer, Development Partnerships and Multilateral Engagements, Partnerships, Based on feedback from the providers of concessional Communication & Outreach, IFC; Max von Bonsdorff, Director, funds, use of the returnable capital model is likely to grow. Unit for Development Finance and Private Sector Cooperation, Providers of concessional funds who are considering the Ministry of Foreign Affairs, Helsinki, Finland; François Primeau, returnable capital model should carefully examine four Senior Analyst, Global Affairs Canada, Ottawa, Canada; and major issues: Thomas Rehermann, Senior Economist, Thought Leadership, 1. The importance of regular reflows for the overall Economics and Private Sector Development, IFC. management of development programs Please see the following additional reports and EM 2. The specific impacts on budgets and ODA Compass Notes about blended concessional finance: Blended Concessional Finance: Governance Matters for Impact (Note 3. The impacts on the types of funding instruments 66); Blended Concessional Finance: Scaling Up Private Investment in available to the private sector, and assessment of the Lower-Income Countries (Note 60); Blended Finance—A Stepping possible trade-offs between development impact and Stone to Creating Markets (Note 51); Blending Public and Private the required return on investments Finance—What Lessons Can be Learned from IFC’s Experience? (Note 4. Management of the funds and the selection of partners. 3). For more information please see: ifc.org/BlendedFinance 1 The DFI Blended Concessional Finance Working Group defines blended concessional finance as “Combining concessional finance from donors or third parties alongside DFIs’ normal own account finance and/or commercial finance from other investors, to develop private sector markets, address the Sustainable Development Goals (SDGs), and mobilize private resources.” 2 See “DFI Working Group on Blended Concessional Finance for Private Sector Projects, Joint Report, October 2018 Update,” p. 13. 3 This discussion reflects general trends and does not apply to all donors, e.g. one of the donors to the Global Agriculture Food Security Program has always taken back reflows. 4 See “DFI Working Group on Blended Concessional Finance for Private Sector Projects, Report on Phase 2 Activities, October 2017,” pp. 13-14. 5 The exact impact on budgets depends on the details of the donor contract, and on the rules of the different governments. For example, if interest rates are fixed, but below government funding costs, a “grant element” may be on budget, but the rest of the contribution counts as an investment. 6 World Bank and International Monetary Fund. 2015. “From Billions to Trillions: Transforming Development Finance Post-2015 – Financing for Development: Multilateral Development Finance,” April 2, 2015. 7 See OECD. 2018. “Reporting Methods for Private Sector Instruments,” December 12, 2018. http://www.oecd.org/officialdocuments/ publicdisplaydocumentpdf/?cote=DCD/DAC(2018)47/FINAL&docLanguage=En 5 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. Additional EM Compass Notes Previously Published by IFC Thought Leadership SEPTEMBER 2019 OCTOBER 2018 Note 71: Artificial Intelligence: Investment Trends and Note 59: How a Know-Your-Customer Utility Could Increase Selected Industry Uses Access to Financial Services in Emerging Markets Note 58: Competition Works: Driving Microfinance AUGUST 2019 Institutions to Reach Lower-Income People and the Note 70: How Insurtech Can Close the Protection Gap in Unbanked in Peru Emerging Markets SEPTEMBER 2018 JULY 2019 Note 57: Blockchain Governance and Regulation as an Note 69: The Role of Artificial Intelligence in Supporting Enabler for Market Creation in Emerging Markets Development in Emerging Markets JULY 2018 JUNE 2019 Note 56: A Practical Tool to Create Economic Opportunity Note 68: Basic Business Models for Banks Providing Digital for Low-Income Communities Financial Services in Africa JUNE 2018 APRIL 2019 Note 55: Peru’s Works for Taxes Scheme: An Innovative Note 67: The Case for Responsible Investing in Digital Solution to Accelerate Private Provision of Infrastructure Financial Services Investment MARCH 2019 MAY 2018 Note 66: Blended Concessional Finance: Governance Matters Note 54: Modelo Peru: A Mobile Money Platform Offering for Impact Interoperability Towards Financial Inclusion Note 65: Natural Gas and the Clean Energy Transition APRIL 2018 FEBRUARY 2019 Note 53: Crowding-In Capital Attracts Institutional Investors Note 64: Institutional Investing: A New Investor Forum to Emerging Market Infrastructure Through Co-Lending and Growing Interest in Sustainable Emerging Markets Platforms Investments Note 52: Crowding-In Capital: How Insurance Companies Can Expand Access to Finance JANUARY 2019 Note 51: Blended Finance - A Stepping Stone to Creating Note 63: Blockchain and Associated Legal Issues for Markets Emerging Markets Note 62: Service Performance Guarantees for Public Utilities JANUARY 2018 and Beyond—An Innovation with Potential to Attract Note 48: Increased Regulation and De-risking are Impeding Investors to Emerging Markets Cross-Border Financing in Emerging Markets NOVEMBER 2018 OCTOBER 2017 Note 61: Using Blockchain to Enable Cleaner, Modern Energy Note 47: From Farm to Fork: Private Enterprise Can Reduce Systems in Emerging Markets Food Loss Through Climate-Smart Agriculture Note 60: Blended Concessional Finance: Scaling Up Private Note 46: Precision Farming Enables Climate-Smart Investment in Lower-Income Countries Agribusiness 6 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. SEPTEMBER 2017 Note 29: Toward a Framework for Assessing Private vs. Note 45: Beyond Fintech: Leveraging Blockchain for More Public Investment in Infrastructure Sustainable and Inclusive Supply Chains Note 28: The Importance of Local Capital Markets for Note 44: Blockchain in Financial Services in Emerging Financing Development Markets – Part II: Selected Regional Developments Note 43: Blockchain in Financial Services in Emerging DECEMBER 2016 Markets – Part I: Current Trends Note 27: How Banks Can Seize Opportunities in Climate and Green Investment AUGUST 2017 Note 42: Digital Financial Services: Challenges and NOVEMBER 2016 Opportunities for Emerging Market Banks Note 24: De-Risking by Banks in Emerging Markets – Effects and Responses for Trade JULY 2017 Note 23: Energy Storage – Business Solutions for Emerging Note 41: Blockchain in Development – Part II: How It Can Markets Impact Emerging Markets Note 22: Mitigating the Effects of De-Risking in Emerging Note 40: Blockchain in Development – Part I: A New Markets to Preserve Remittance Flows Mechanism of ‘Trust’? 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