www.ifc.org/thoughtleadership NOTE 52 • APRIL 2018 Crowding-In Capital: How Insurance Companies Can Expand Access to Finance Development institutions, governments, and the investment community have been exploring ways to increase private capital flows to support critical development projects in emerging markets. A new financing mechanism applies the risk-bearing capacity and know-how of insurance companies to allow these companies to take what are, in many cases, their first insurance exposure to markets and counterparties. This innovative credit insurance solution, which we call “Credit Mobilization,” is being pioneered to provide long-term funding to developing country banks, and may offer significant potential for scale-up and replication. The Sustainable Development Goals approved by the With low yields in developed markets, many institutional members of the United Nations provide ambitious targets investors are seeking higher-yield opportunities. For for global, sustainable development. Achieving these targets example, many pension funds are allocating more of their by 2030 will require substantial know-how and resources, funds to “alternate” investments beyond the traditional potentially reaching into several trillions of dollars per developed country bond and stock markets, to include year. This is well beyond what governments can provide on high-yield products, private equity, emerging markets, their own and will require a significant contribution by the and other investments. The increased appetite among private sector and private investment to succeed.1 250 International banks have traditionally been major financiers of private-sector projects in developing 200 countries, and continue to be a major source of capital. However, since the 2008 global financial crisis, these 150 institutions have grown more cautious about cross-border exposures, especially for longer tenors. International 100 banks’ cross-border claims on emerging markets remain at under 50 percent of their peak pre-crisis levels. 2 A broader 50 base of funding is clearly needed. A major alternative to international bank finance is funding 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 from institutional investors. This investor class includes Loan—UM Loan—LM Loan—L Bond—UM Bond—LM Bond—L a wide range of entities, from sovereign wealth funds, pension funds and endowments, to hedge funds, mutual funds, and insurance companies. As a group, institutional FIGURE 1Emerging Markets International Bond and Syndicated Loan Issuance by Corporations, investors control over $70 trillion of funds in developed Excluding China (in $bn) markets. Institutional investors based in emerging markets Source: IFC and Dealogic. L=Low Income, LM=Lower Middle Income, currently hold between $4 trillion and $5 trillion in assets UM=Upper Middle Income. For maturities greater than one year. and are seeing considerable growth.3 Includes only products marketed to international investors. 1 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. institutional investors for emerging market investments IFC has developed a structure that gives insurers access to has coincided with and helped support rapid growth in high-quality, long-term credit risks in emerging markets. the issuance of bonds from emerging markets (Figure This structure “mobilizes” the critical risk-bearing capacity 1). Institutional investors have exhibited a strong desire of the insurance companies and connects it with the for debt instruments from emerging market financial project development, structuring expertise, and funding institutions in particular.4 capabilities of IFC. The Credit Mobilization solution yields Still, there remain substantial limitations for emerging a new funding mechanism that is initially being used to market companies to obtain funding from institutional support emerging market banks, with enormous potential investors through the bond market or through other means. for scale-up and replication in other sectors, notably Only the largest and most sophisticated firms have access to infrastructure. international bond markets. Also, local bond markets have IFC Builds Out a Successful Syndications developed in any significant way in only a few countries. At Platform to Expand Financing Options for the same time, direct lending by institutional investors to Emerging Market Banks private companies in emerging markets is virtually non- IFC’s Credit Mobilization initiative uses an existing existent. For smaller companies in higher-risk markets, syndications platform developed to bring investors into a the information costs render investments by institutional portfolio of IFC projects. The platform, launched in 2013, investors prohibitively expensive. is the Managed Co-Lending Portfolio Program (MCPP)5. Institutional investor interest in developing countries is While IFC has had tremendous success in channeling primarily driven by a search for higher yield. To that end, investors into single projects, bringing in over $60 billion large portions of these investors’ asset allocations are in additional funding alongside its own investments over directed to higher returning asset classes such as equities. the past six decades, the MCPP allows IFC for the first time On the debt side, notwithstanding the general search for to deploy private capital across its emerging market debt yield, many investors have a preference (often driven by investments on a portfolio basis. regulatory requirements) in their core investment strategies MCPP investors passively participate in IFC’s future senior- for investment-grade products. Since many emerging loan portfolio, and IFC also participates in each project. market investments remain below investment grade, this Project appraisal, approval, commitment, and supervision can limit the amount of funding available. are delegated to IFC. IFC’s knowledge of local clients and Thus, a key challenge for increasing the flow of debt finance market conditions, coupled with its project origination to emerging markets is to develop a range of innovative capacity and proven track record, help overcome investors’ financing vehicles that can match the structuring, risk, challenges of sourcing viable investment opportunities in and return requirements of various investors with viable developing countries. The fact that IFC maintains a share developing country projects. of each investment for its own account ensures that its decisions align with the interests of investors. Together, The Credit Mobilization Solution: Providing a Project Pipeline for Insurance Companies these aspects of the MCPP structure have contributed to its success: the program has grown from an initial investment The global insurance industry provides a solution. This of $3 billion by the People’s Bank of China to a $7 billion group of companies has a deep understanding and platform with eight global investors. appetite for various types of risk. Unlike most institutional investors, insuring risk is central to these companies’ While the original format provided an opportunity business models. Credit insurance is a growing segment for institutions with funds to invest directly in IFC within the risk portfolios of insurance companies, and it projects, the MCPP has now been further developed to can provide attractive diversification for them by providing allow participation in an IFC-originated portfolio on an risk assets that are distinct from those in their core unfunded risk-sharing basis using Credit Mobilization. businesses of weather, life, and other non-financial risks. In The first successful application of the Credit Mobilization many cases, however, insurance companies lack a pipeline initiative is the MCPP Financial Institutions facility, of financial assets to insure, aside from short-term supplier which began operations in October 2017. MCPP Financial credits in developed countries. Institutions involves a partnership with two insurance 2 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. companies, Liberty Specialty Markets and Munich Re, to to obtain more of it, more efficiently, and at lower cost. bring in $1 billion of unfunded credit risk exposure that Initially, this funding will arrive in the form of larger loans will support $2 billion of IFC senior loans to developing available from IFC, with part of the borrower’s credit country financial intermediaries (Figure 2). Mobilizing risk covered by the participating insurance company. The third-party funding for these beneficiaries from other banks credit-risk structure also presents a simplified operational has been a challenge in the past, but this solution enables relationship for borrowers. With the ability to get larger IFC to leverage a new set of partners to increase access to amounts of capital through a single transaction with one capital for the financial sector. lender, borrowers are likely to see cost reductions. Insurance companies, too, benefit from the innovative INSURER structure and access to a unique pipeline of emerging market projects. The Credit Mobilization structure allows 1. IFC signs credit insurance insurers to engage with IFC through the insurance side of policy with insurer their businesses rather than the investment side. For some companies, the insurance side may provide a better strategic IFC 3. Insurer takes match of risk appetite and expertise to support IFC activities. 2. IFC funds credit risk entire amount on agreed % of A Loan Credit Mobilization also presents insurers with exposure of A Loan at disbursement amount to a new set of risk assets (non-OECD financial risk), with potential for risk diversification, while also providing A LOAN INSURED PORTION good returns. It utilizes IFC portfolio diversification for 4. Borrower receives larger geographic pooling and exposure to a much wider set of financing package than IFC could provide on its own countries than could be obtained via direct investments. IFC has existing relationships with over 400 emerging BORROWER market commercial banks. Furthermore, the initiative utilizes IFC’s expertise and track record in selecting projects and structuring and mitigating risks, including FIGURE 2 Sample Credit Mobilization Structure extensive experience in addressing environmental, social, Source: IFC and corporate governance issues. It provides a broad platform for insurers’ participation in projects that address For the individual loans financed through MCPP Financial poverty alleviation and the Sustainable Development Goals. Institutions, IFC provides all the capital, though a pre- This fulfills important strategic goals for many companies, agreed percentage of the risk is borne by the insurance including corporate social responsibility. companies, which receive a fee for this coverage. The fee is The long-term objective for Credit Mobilization is to covered by the loan interest spread, so that the charge to the introduce new participants into emerging markets and end user remains at market rates. This reduces IFC’s total create an environment where insurers allocate ever greater capital requirements for the loans, allowing IFC to provide portions of their risk appetite to impact investments. With additional capacity to financial intermediaries to lend to the knowledge and experience gained while leveraging small and medium enterprises, women-owned businesses, IFC’s origination capacity, insurers will become more climate-change projects, and other critical market segments. comfortable with greater exposure to underserved countries Credit Mobilization will support IFC lending in all its and sectors. The hope is that, over time, this will lay the countries of operation, including some of the poorest, where groundwork for further investments in other forms. banks currently have limited access to capital. Market Opportunity: A Successful Model Offers New Initiative Benefits Borrowers and Potential for Replication and Expansion Insurers Alike The credit insurance market is expanding rapidly, with The Credit Mobilization initiative offers borrowers in growing potential for participation from companies emerging markets a significant new source of hard-to- interested in increasing their exposure to alternative source, long-term debt funding, as well as the potential risks. The global insurance industry’s capacity for private 3 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. non-payment credit insurance grew more than sevenfold through capital markets or syndicated loans. from 2003 to 2015 (Figure 3)—an indicator of increasing Credit mobilization is not a silver bullet for channeling appetite. IFC’s partners express growing interest in working capital to developing markets, but it is an important and with investment teams to underwrite an ever-expanding growing approach. Much will be learned by pioneering these pool of development projects. Insurance companies have new initiatives—in terms of finding good matches among started to hire more bankers who understand credit and different parties with respect to structures, risk profiles, and can successfully engage with emerging market risk. pricing—that can lead to successful financing solutions. USD billions 3 Conclusion: Credit Mobilization Can Be One Piece Non-payment private of the “Billions to Trillions” Puzzle Non-payment sovereign Facilitating private investment in developing countries is Investment insurance a core component of the World Bank Group’s strategy to 2 Capacity for private reduce poverty, create shared prosperity, and accomplish non-payment credit insurance the Sustainable Development Goals. The World Bank has grown by Group’s 2030 vision calls for the institution to “leverage 1 7.5 times over the 2003–2015 the full range of its capability to expand and create markets period where private capital has been less forthcoming.”6 Reaching the financing scale required to implement the Goals will 0 require moving from billions in development aid to trillions 2003 2005 2007 2009 2011 2013 2015 of financing, and leveraging the private sector will be FIGURE 3 Annual Credit Insurance Market Capacity essential to achieving this ambitious vision. for Single-Exposure Risk, 2003–2015 While great strides have already been made by the Source: Marsh community of multilateral development banks to identify new sources of capital and unlock financing that remains Within IFC, the pilot facility of the Credit Mobilization on the sidelines, large amounts of untapped risk-bearing initiative has been targeted toward portfolios of U.S. dollar capacity remain that could be applied to capital deployed in denominated senior loans to banks, but the structure is emerging markets. Successfully mobilizing this risk appetite correspondingly applicable in other economic sectors. As for development objectives calls for new structures that can an important indicator of the scale-up potential of Credit connect the holders of capital and those institutions able to Mobilization, in 2018 IFC has already launched a $500 bear risk with emerging market beneficiaries in search of million MCPP facility with Swiss Re to provide critical financing to sustain their operations and pursue growth. infrastructure finance investments for power, water, transport, and telecommunications improvements in The Credit Mobilization initiative provides a pioneering developing countries. Credit insurance has also been used model for enabling a new class of institutional investors at IFC for individual transactions and with trade insurance, to expand their exposure to emerging market risk. By indicating significant scope for different uses. Future facilitating the greater flow of capital to developing facilities will seek to leverage insurance companies’ risk countries under the risk cover of partner insurance capacity to support greater financing for emerging market companies, Credit Mobilization has significant potential for agribusiness, manufacturing, and services firms and expand replication and scale-up. into other products, institutions, and currencies. Over the long term, it offers the promise of local capital Moreover, the structure could be replicated by other market development by introducing new participants multilateral development banks, enlarging the pool of to emerging market finance and fostering new linkages eligible financing into the tens of billions of dollars. Credit between developing country firms and international Mobilization also has the potential over time, as countries financial institutions. The impact of greater finance for develop, to directly support credit to banks, funds, and emerging markets will be an increase in productivity, jobs, other companies, bypassing multilaterals entirely and wage growth and poverty reduction—and greater likelihood providing credit insurance directly to facilitate finance of realizing the Sustainable Development Goals. n 4 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group. AUTHORS Investment Officer, Financial Institutions Group – Latin Arthur Karlin, Consultant, Thought Leadership, Economics America & The Caribbean, IFC; Matthew Huggins, Principal and Private Sector Development, IFC (AKarlin@ifc.org) Counsel, IFC; Morten Lauridsen, Principal Economist, Thought Leadership, Economics and Private Sector Development, Euan Marshall, Head, Investor Engagement Unit, Syndicated IFC; and Thomas Rehermann, Senior Economist, Thought Loans and Management, IFC (EMarshall1@ifc.org) Leadership, Economics and Private Sector Development, IFC. Mahfuza Afroz, Senior Syndications Officer, Investor Engagement Unit, Syndicated Loans and Management, IFC ADDITIONAL EM COMPASS NOTES ABOUT (MAfroz@ifc.org) MOBILIZING CAPITAL Michael Kurdyla, Strategy Officer, Syndicated Loans and Please also refer to the following EM Compass Notes: Management, Treasury and Syndications, IFC (mkurdyla@ifc.org) Crowding-In Capital Attracts Institutional Investors to Emerging Market Infrastructure Through Co-Lending Platform (Note 53); ACKNOWLEDGMENTS Masala Bond Program–Nurturing a Local Currency Bond Market The authors would like to thank the following colleagues (Note 30); and Mobilizing Private Climate Finance—Green Bonds for their review and suggestions: James Smouse, Principal and Beyond (Note 25). 1 World Bank, International Monetary Fund. 2015. “From Billions to Trillions: Transforming Development Finance.” Washington, DC. 2 World Bank. 2018. “Global Financial Development Report 2017/2018: Bankers Without Borders.” Washington, DC. 3 World Bank, IMF, OECD. 2015. “Capital market instruments to mobilize institutional investors to infrastructure and SME financing in Emerging Market Economies: report for the G20.” Washington, DC. 4 Ibid. 5 See Mapila, Kopo, Morten Lauridsen and Carl Chastenay. 2017. “Mobilizing Institutional Investments into Emerging Market Infrastructure”. EM Compass Note 36, IFC. 6 World Bank. 2016. “Forward Look: A Vision for the World Bank Group in 2030.” Washington, DC. 5 This publication may be reused for noncommercial purposes if the source is cited as IFC, a member of the World Bank Group.