If this isn’t best practice, then what is?

Today is the official launch of the Blended Finance Principles Guidance, at the first day of the 2021 Blended Finance & Impact Week. This is the end of a process that started several years ago, the last year of which OECD really made an effort to be inclusive in the consultative process. The COVID-19 pandemic actually facilitated participation for many, including myself, since all consultations in 2020 were made via zoom. Act Church of Sweden is also one of those who provided written input.

Now we can assess the final guidelines and see the extent to which inputs from us and other CSOs influenced the document. I will highlight a few aspects here, while offering three simple guidelines to complement the OECD Guidance.

When is blended finance appropriate?

In March 2020, Act Church of Sweden published the discussion paper Blended Finance: Finding its Place. The main message was that blended finance can be an important and very useful tool, but that it is not appropriate for investments that for one reason or another should rather be made with public resources. This simple argument is self-evident in principle, even though the question of whether a particular investment should be public or private is often contested. (Most would, however, agree that basic social services must be public, as access to basic services is an agreed international human right standard.)

The point here is that the question on whether private investment is appropriate or not has to be explicitly addressed. Otherwise, the general enthusiasm for private finance in general, and blended finance in particular, may create a situation where private investments in development will replace rather than complement public investments. In fact, many would argue that in fact this is happening today.

In the paper we also argue that the assessment of whether an investment should be private or not should be guided by an examination of whether private financing could undermine human rights or the commitments to leave no one behind. One of the implications of this principle is that basic social services, including health, education and social protection should be mainly public.

Based on the discussion paper, in the input to the OECD consultation, Act Church of Sweden called for stronger recognition of the need to assess the appropriateness of blended finance as a tool. In the final version, there is indeed some language pointing in this direction in relation to Principle 1 (Anchoring blended finance to a development rationale), although not always very straight forward:

Blended finance is one approach in a toolkit of development co-operation approaches. As such, it should be deployed when its comparative advantage and value-added relative to other tools is clear, based on ex ante assessments taking into account alternative financing approaches. (Para 38)

The decision to partner with the private sector should be rooted in a theory of change that establishes whether and how the private sector is best placed to help realise specific development results and contribute to leaving no one behind. (Para 43)

Although para 43 is very much welcome in principle, it should also be recognised that the choice between private and public is political, and not a technical question of “theory of change”. Needless to say, the choice should be made at national level with the participation of local communities, and not influenced by donors. It is, therefore, extremely important that providers of development finance do not push for privatization or blended finance, and that blended finance is driven by demand rather than supply.

Specifically, many CSO cautions against using blended finance in the health sector. In the current Covid-19 contexts we see health systems with a high degree of fragmentation performing badly – this is often the case in health systems with strong involvement of the private sector, as documented by NGOs. This caution has not made it to the Guidance, but is to some degree reflected in the Detailed Guidance Note to Principle 1:

However, blended finance investments in health should carefully consider existing issues in health systems of developing countries, such as fragmentation and inequalities. The financing mechanisms chosen to deliver healthcare services should be chosen based on their ability to ensure that they benefit citizens and address inequalities. (Para 23).

Guideline no1. Use blended finance when it is not controversial to reach the development objective through private rather than public investments.

Crowd in or crowd out

The overall purpose of blended finance is to unlock commercial finance in order to increase total financing for development (crowd in private finance). Ideally, blended finance will generate new resources, and free up more ODA funds that can be used for public investments in social sectors, as productive investments are supported through loans or guarantees rather than grants. Whether this happens in practice or not depends to a large degree on:

• How much ODA funds are allocated to blending, and what the development impact and leverage of those ODA funds is.
• Whether increased private investments are used as a pretext by governments who want to decrease ODA budgets. (Recognize this risk, anyone?)

At stake is the risk that more ODA funds are not freed up for public investments, but rather, that ODA to social sectors is crowded out when more attention and resources are directed at blending. In other words, just as important as it is not to crowd out private investments, ODA allocated for blended finance must not crowd out ODA for public investments in e.g. health, education or social protection. 

Additionality and leverage

As noted above, leverage, or the ratio between the amount of commercial finance mobilised and the amount of development finance that has been injected, is key in assessing the extent to which blending is in fact increasing total financing for development.

There are sometimes claims that leverage ratios can be very high – seven is recently mentioned as an illustrative example. In practice, however, the ratio tends to be more modest, especially in more difficult contexts. It is not easy to measure leverage, but an ODI study published in 2019 found that the leverage ratios tend to be lower than 1. Thus, ”billions to billions is more plausible than billions to trillions”, it is argued.

Low leverage ratios increase the risk that blended finance cost a lot of ODA money, and thus that it will crowd out scarce ODA for other purposes. It should be noted, though, that low leverage ratios may not necessarily be a bad thing – high leverage ratios may in fact indicate low hanging fruits and unnecessary subsidies. As noted in the Guidance:

…there may be trade-offs between financial and development additionality in any given blended finance transaction. For example, if the primary objective (…) is to achieve a high mobilisation ratio of commercial finance, this may result in a focus of the intervention on more established markets and sectors. (Para 60)

If Sida’s guarantee instrument isn’t best practice – then what is?

There are different kinds of blended finance instruments but guarantees for loans is by far the most important. Most institutions which provide guarantees put money aside in a fund, to be used when there is default. The money that is put aside is in most cases ODA funds.

The guarantees offered by the Swedish development agency Sida are different, as these are backed by the Swedish government. An external risk assessment of the political and commercial risks is made by the National Debt Office, and based on the expected loss, Sida charges a guarantee fee to the bank or organisation receiving the guarantee. When necessary, a part of the guarantee fee can be subsidized by Sida grants. No other Sida resources for grants are used for the repayment of defaults.

As these subsidised fees is the only cost for Sida (apart from working hours, which I Imagine could be many!) the amount of private capital that is mobilised is very large compared to invested ODA money. According to the latest portfolio report, by the end of 2019 Sida had in its current portfolio mobilised 16,7 billion SEK (accumulated resources made available for lending) at a cost of 260 million SEK in subsidised fees. This gives a leverage of more than 60. According to Sida staff, guarantees decided in 2020 will potentially mobilise 7,5 billion SEK at a cost of 77 million SEK – which may end up in leverage ratio of 97 for 2020.

I don’t know how ODI calculated the mobilisation ratio, but to my understanding, this means that Sida’s guarantees are many times more effective in leveraging private money than others are. It also means that guarantees offered by Sida do not run the risk of crowding out grant aid.

Now, what does this have to do with the Guidance document that is launched today? The problem is that the answer is – not very much! Apart from the quote above, leverage/mobilisation ratio is not extensively discussed in the Guidance, even though Principle 2 is Design blended finance to increase the mobilisation of commercial finance. There are several examples of ’best practices’ throughout the document. But nowhere can I find a reference to the particular model of providing guarantees that Sida offers (please correct me if I’m wrong!).

Unfortunately, it seems that Sida is pretty unique in having the government backing the guarantees (again, I would be happy if I’m wrong). The Blended Finance Principles Guidance should have been a space where this model was promoted. If other countries adopted the same model, we could see blending as an instrument that is truly crowding in private finance – at the expense of very small ODA funds. As a consequence, the debate on blended finance could be a lot less contentious.

Guideline 2. Explore ways to mobilise private finance without straining scarce ODA resources. Become inspired by Sida’s model of guarantees.

Transparency, national ownership and the role of CSOs

The Guidance includes strong and very much needed emphasis on transparency and national ownership. There is a strong case for the many benefits that would come with improved monitoring, evaluation and reporting of development outcomes. In principle 5, para 21, it is for example suggested that a dedicated budget is ring-fenced for monitoring and evaluation, when making a blended finance operation.

The final version also has much stronger references to the Global Partnership for Effective Development Co-operation (GPEDC) and its Principles for Development Effectiveness, including its Kampala Principles on Effective Private Sector Engagement. Explicit reference to the need for exit strategies (para 73) is an important aspect that get more attention in the final version.

We also welcome the stronger language on the important role of CSOs (principle 3). Unfortunately, the reference to the increasingly shrinking space for CSOs and can only be found in the more Detailed Guidance Note:

Moreover, around the world restrictions on civil society are intensifying, as various governments are using laws, policies and practices to restrict the space in which civil society operates. (…) In that context it is even more important to make dialogue and consultation with CSOs more systematic throughout blended finance interventions. (Para 27)

Accountable to whom?

Act Church of Sweden, along with many other development organisations, work with a human rights-based approach (HRBA). For us, the rights, voices, and participation of the people who live in poverty, and whom we want to assist through the development cooperation (“rights holders” in the HRBA terminology), is the fundamental starting point. Human rights-based work is designed to enable people (rights holders) to increase their empowerment individually and with others, and in so doing, to shift the power over the processes of change to themselves.

The concept of ‘rights holders’ is absent in the debate on blended finance. ‘Local communities’ would be a corresponding concept, but OECD uses the term “end beneficiaries”. On a narrow interpretation however, ’end beneficiaries’ could mean just those who were targeted by blended finance projects, rather than the entire communities who might be impacted. Implementing a human rights-based approach in this context would mean that a lot of emphasis is put on participation, accountability, and reporting of development results. In particular, it would mean that it is important to question who makes assessments, and whose voices will be listened to – and whose voices are ignored.

A small sign that this kind of perspective is given at least some attention is given in Principle 5:

For instance, too little development performance data is collected ex post or taking into account the voice of end beneficiaries. (Para 18)

Further, in the Detailed Guidance Note relating to principle 5, but unfortunately not in the Guidance document itself, it is recognized that accountability should be understood towards the end beneficiaries and not only towards investors, partner countries and taxpayers:

In blended finance operations, accountability should be understood both upstream towards donors and finance providers, as well as downstream, towards local actors and end beneficiaries.

Guideline 3. Make sure there is transparency, country ownership, and that the voices and perspectives of the local communities (more than “end beneficiaries”) are included throughout the project cycle.

The wider ‘mobilising’ narrative

I will not try to make an overall assessment of the Guidance but have noted strengths as well as weaknesses. The absence of reference to Sida’s guarantees is a serious shortcoming, while the inclusion of at least some of the important suggestions from CSOs is hopefully contributing to creating a clear message that blended finance is one tool among many, that there are many contexts where it is not appropriate, and that it should be used with great care.

I believe, however, that many of my CSO colleagues will remain worried that the wider ’mobilising’ narrative will drown out the more cautious sections of the Guidance. In the midst of the COVID-19 pandemic a top priority use of limited ODA resources is to invest in universal access to health services. The risk that blending may crowd out ODA from health and other key social sectors should be taken seriously.