Multilateral Development Banks Bring Finance into Emerging Markets
Leveraging funds from both the public sector and the private sector is essential to address climate change. Multilateral Development Banks (MDBs) and Development Finance Institutions (DFIs) play a catalytic role in bringing private investment into developing regions.
To attract private investors to emerging markets, investment risks need to be addressed. These risks include regulatory hurdles, economic instability such as currency devaluation, and government unreliability – which may include war, conflict and corruption.
MDBs and DFIs recognize these challenges and have increased climate funding in the last few years. Their goals are to help the private sector gain confidence and to lower capital costs via co-investment in climate projects in emerging markets.
The MDBs covered in this article include the African Development Bank (AfDB), the Asian Development Bank (ADB), the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB), the Inter-American Development Bank (IDB), the International Finance Corporation (IFC), and the World Bank (WB).
“IFC’s role is to demonstrate the viability of commercial investments in emerging economies that also have strong development impact in terms of increasing shared prosperity and reducing poverty,” said Marcene Broadwater, global head of climate strategy and business development at the International Finance Corporation (IFC), World Bank Group. “One way IFC does that is by working with the private sector to help it invest in climate-smart projects and thus address climate-change mitigation and adaptation in client countries.”
MDBs and DFIs have adopted several strategies, including:
- Making projects available and known to private developers
- Demonstrating successful models in new areas and high-risk projects through co-investing
- Providing guarantees and risk insurance to the private sector in case of political instability, government insecurity, or other issues
- Creating new instruments that allow the aggregation of smaller climate projects in order to attract large institutional investors
- Acting as financial intermediaries to help commercial banks increase lending through concessional finance structure, risk sharing, credit enhancement, and due diligence
“We can’t force investment where the private sector doesn’t want to go, but we can serve to make sure the development impacts of these investments are best realized through OPIC financing tools,” said Charles Stadtlander, media relations spokesperson at Overseas Private Investment Corporation (OPIC).
Where will the money come from?
The financing will stem from the following sources:
Annual climate finance commitment ($100 billion by 2020)
According to OECD 2013-2014 report on climate finance, developed countries mobilized $62 billion in 2014 and $52 billion in 2013 to support climate actions in developing countries. However, funding will still fall short of meeting developed countries’ commitment of $100 billion per year by 2020 under the Copenhagen Accord and the Cancun Agreements.
MDB’s climate finance efforts ($26.5 billion, with variations)
According to the 2014 joint report published by MDBs, MDBs have mobilized over $100 billion since 2011 to support climate actions in developing and emerging economies. The annual average is $26.5 billion.
MDB’s support for Millenium Development Goals (MDGs) ($127 billion in 2014)
The “From Billions to Trillions: MDB Contributions to Financing for Development” report published by World Bank in 2015 said MDB support for MDGs “has grown from $50 billion to $127 billion annually in grants, concessional and non-concessional loans, risk-sharing instruments, guarantees and equity investment” over the past 15 years. The report also indicates that from 2016 to 2018, MDBs plan to provide additional financial support of over $400 billion.
During COP21, United States global banking and investing companies pledged hundreds of billions of dollars over the next decade to clean energy and low carbon businesses. For instance, Goldman Sachs pledged $150 billion, Bank of America pledged $125 billion, and Citi pledged $100 billion.
“Many banks in emerging economies have expressed interest in having IFC help them unlock commercial investment by addressing investment risks in developing countries,” Broadwater said.
Since IFC has already built infrastructure and credibility in many emerging markets, commercial banks can use IFC’s existing infrastructure and credit process by co-investing in these projects.
Small climate projects, such as rooftop solar and energy efficiency retrofits, are often not attractive to large institutional investors. In responding to these demands, IFC has created tools that allow the aggregation of these smaller projects.
“In cases when a climate-smart project is relatively small in size and volume, it can have difficulty attracting larger institutional investors,” Broadwater said. “To attract that new class of investor, at IFC we recognize the need to develop new instruments that can aggregate smaller climate projects and reduce the overall risk.” What goals are currently on the table?
In October 2015, World Bank announced a commitment to increase its climate-related investments by 28 percent. This number is about twice as much as the IFC's current climate investments planned for the next five years.
“We have a number of financing tools that are unique to these challenging and risky investing environments,” Stadtlander said. These financing tools will support projects in the most influential sectors. “We provide direct loans, investment guarantees, political risk insurance, and financing to investment funds that the private sector isn’t able to offer.”
The report “From Billions to Trillions: MDB Contributions to Financing for Development” said that on average, “for every dollar directly invested by MDB in the private sector operations, some $2-$5 are mobilized in additional private investment.” But this is just a rough estimate.
So far, there is no standardized methodology to calculate or estimate investment from the private sector. MDBs and DFIs are trying to work out a common approach to track and quantify private finance used for climate mitigation and adaptation projects. How do MDBs support mitigation?
In 2014, MDB reported a total commitment of $28 billion for climate finance, with $23.3 billion budgeted for mitigation and $5.1 billion set aside for adaptation actions.
Global climate-mitigation figures show that 91 percent of these funds came from MDBs. The rest came from external resources, such as bilateral or multilateral donors. About 60 percent of the funds were delivered to public recipients while the remaining 40 percent was sent to private recipients.
Private players show significant interest in renewable energy and energy efficiency projects; they dedicated 82 percent of the $9176 million received to renewable energy and energy efficiency activities. Private recipients spent $3764 million on renewable energy and $1982 million on energy efficiency. An additional $1775 million was labeled “energy efficiency, renewable energy, and other financing through financial intermediaries or similar by the private sector."
Renewables accounted for 35 percent of total mitigation finance in 2014. These numbers illustrate high investment priority from both public sector and the private sector.
Infrastructure investors are starting to consider climate change in their decision making processes. “If a road or power plant is going to be built along the coast where the place is vulnerable to extreme weather or erosion, business owners will be likely to plan for the potential risks caused by climate change and integrate these considerations into their business plans, “ Stadtlander said.
What challenges exist with adaptation financing?
Of the $5.1 billion allocated to adaptation finance globally, 89 percent comes from MDBs’ resources. In contrast to the distribution of climate mitigation finance, adaptation figures show a notable imbalance between public recipients and private recipients. For instance, the public sector received 97 percent of the funds and the private sector received only 3 percent.
Most early adaptation projects were designed to increase disaster response and were solely owned and operated by the local governments. These projects included roads, dams and public buildings, which increase cities’ resiliency to disasters.
Many barriers are preventing the private sector from integrating climate change adaptation in planning and operations. These include lack of information about climate risks, lack of policy support, unfavorable and insufficient insurance structure.
“The private sector is catching up to the public sector in gaining further insight and recognition of risks posed by climate change. As such, there continues to be a lack of information about risks and available cost-effective measures to address these challenges,” Broadwater said.
From the report we can see that private recipients invest the $141 million in a few sectors, including crop and food production ($56 million); industry ($25 million); and energy, transport and infrastructure ($29 million). Multi-sector investments were also included ($31 million).
Private business owners and entrepreneurs are more aware of climate change’s impacts and challenges now than they ever were before.
“There is a new group of leaders focused on the resiliency of global supply chains,” Broadwater said. “More and more people are realizing that there is a connection between a drought in one country and the food prices in international markets.”
To successfully address private sector adaptation, IFC identified five areas that need to be considered, including data and information; institutional arrangements; policies; economic incentives; and communication, technology and knowledge.
Globalization has a great impact on supply chain management. Nowadays, a great portion of the global supply chain is located in climate vulnerable areas in developing countries. “I believe there will be an increase in demand for adaptation finance from private investors in the near future. They are starting to look at things from a new perspective,” Broadwater said.
How much effort has OPIC made in emerging markets?
Founded in 1971, Overseas Private Investment Corporation (OPIC) functions as the United States government’s development finance institution and provides financial support to American businesses expanding into emerging markets.
OPIC has an active portfolio of $20 billion, which supports around 500 projects in over 100 countries. Over the past five years, OPIC made $4 billion in commitments every year to support development in places where private investors would not otherwise go. Every year, around $2 billion of OPIC’s investments are dedicated to power and infrastructure projects, of which half was used to support renewable-energy development. OPIC invested around $100 million in renewable energy in 2008.
“OPIC exists in part to give businesses the risk mitigation and confidence they need and the financing tools necessary to go into developing economies,” Stadtlander said.
OPIC’s renewable energy projects vary from hundreds of megawatts of wind solar projects in Kenya and South Africa, respectively, to small rooftop solar projects in India. They also provide funds to help startup businesses overcome the initial costs of renewables projects.
“OPIC works across a variety of development impact sectors like clean water, agriculture, healthcare, education and new energy access, to name a few,“ said Stadtlander. “The over 160 countries where we can work range from developing economies that are on the upper end to post-conflict recovery zones across the world.”
What are the strategies that OPIC and MDB use to motivate private investors?
Two challenges need to be addressed in order to attract private investment to climate mitigation and adaptation projects in developing countries: security and profitability.
Investors face a difficult environment, especially when it comes to large energy and infrastructure projects in developing countries where they did not previous exist.
“Emerging markets can be difficult places in which to invest and there is not always a blueprint for businesses to follow,” Stadtlander said. “We need to give confidence to the private sector that there is a welcoming investment environment in developing markets.”
In the long run, MDBs and DFIs will play a crucial role as major providers for climate adaptation and mitigation financing. We also recognize challenges in attracting private funding to these risky areas and long-term supports from MDBs and DFIs will be needed to mobilize global private investment.
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