Perspectives 2019 2020 Public Sector

Citi Perspectives 31 Key Building Blocks for Blended Finance Alignment of mandates In order to effectively bring stakeholders of blended finance together, it is important to understand each party’s mandate and obligation, and respect these mandates. Donor governments, recipient governments and development finance institutions (DFIs) are guided by developmental mandate but the prior ones seek concessional returns while DFIs also aims for financial sustainability — i.e. commercial returns, especially in their private sector operations. Non-governmental- organizations (NGOs) and other philanthropic donors are development-oriented and can be flexible in providing capital at concessional terms or as grants to meet their objectives. Public investment funds, including pension funds and sovereign wealth funds, prioritize preserving and enhancing the value of public funds but sometimes with an additional development mandate. Other institutional investors are driven by commercial and fiduciary mandates of ensuring certain commercial returns thresholds. Public investment funds and other institutional investors tend to have long-term investment horizon and therefore seek to invest in assets of the same nature. This is different from commercial banks who are also driven by commercial motives but only able to participate in short to medium term investments given their regulatory and capital constraints. Successful blended finance structures do not change the motivation of these development or commercial actors but seek to align them by creating investment opportunities that yield both development and commercial returns. Risk Allocation The key to this alignment of interests is the allocation of risks and returns between financing parties, i.e. leveraging concessional finance to mitigate risks (e.g. guarantees or first loss absorption) and match the adjusted risk with the given returns requirement of commercial finance. Risk allocation is about deconstructing an asset or project’s risks into various categories, and determining which actors can most efficiently manage each category. A project or asset’s risks can be broadly disaggregated into the following categories: political & regulatory risks, operational & commercial risks, credit risks, market risks, and impact & development risks. Operational & commercial risks are best managed by private sector while political & regulatory risks or impact & development risks are best managed by the public sector. Credit risks and market risks could be shared among public and private stakeholders. Who manages which type of risks is driven by the expertise of each stakeholder and the available tools they have at hand to mitigate these risks. For example, political & regulatory risks could be managed by DFIs who could offer political risk insurance or partial risk guarantee. Or impact & development risks could be managed by NGOs who have the expertise and could offer technical assistance or capacity building to ensure any positive environmental, social or governance impact is maximized.