2025 Public Sector Perspectives

How regulations need to change Regulatory reform that emerged in response to the Financial Crisis had many unintended consequences. Governments in the developed world used taxpayer money to create MDB/DFIs to reduce the risk of investments in EMDEs with the objective of generating economic growth and job creation onshore. At the same time, these governments tightened regulations limiting the usefulness of these MDB/DFIs and their instruments to mobilize private capital. This is the quagmire in which we find ourselves. In common with many commercial banks, Citi’s ability to lend and participate in MDB/DFI transactions is constrained by the regulatory treatment of MDB/DFI products and emerging market infrastructure. To attract the scope and scale of capital needed to meaningfully deliver the SDGs and other development objectives, changes to regulatory capital rules for investment in emerging markets, and sustainable infrastructure more broadly, are necessary. The goal should be to ensure consistent treatment of MDB/DFI-enabled transactions across jurisdictions, as well as a recognition of the risk mitigating features of blended finance, particularly the risk defeasance tools of the MDB/DFIs and the bespoke nature of these financing products. Basel III resulted in greater differentiation of capital treatment for various investment risks, including those inherent in EMDEs and infrastructure. The changes blurred key risk differentials between corporate and project finance, making it difficult for commercial investors to finance long-dated infrastructure assets – especially in non-investment grade countries, for unrated corporates, and in jurisdictions that do not permit external ratings. Infrastructure investments by their nature are extremely long dated, and typically bear that highest risk upfront (during construction); this is the opposite of a corporate facility risk profile. Furthermore, Basel III failed to capture the implicit “halo effect” of instruments such as A/B loans and MIGA guarantees as these products were not deemed to provide unconditional access to foreign currency and guarantees. Differing national regulations further complicate the issue. For example, more stringent interpretation in the U.S. has served to limit risk appetite fromGSIBs. Moreover, in the post-financial crisis period, banks have expanded compliance functions to meet new Basel and national regulations; many are cautious in their interpretation and application with regards to risk weighted assets. An opportunity exists for the G20 to push for a standardization of rules and a revision to capital requirements to reflect the risk mitigation characteristics of MDB/DFI tools more accurately. If regulators, risk officers, and the market can correctly value risk defeasance and assign an appropriate capital treatment, large commercial banks will be able to finance more transition and SDG-related projects. To attract the scope and scale of capital needed to meaningfully deliver the SDGs and other development objectives, changes to regulatory capital rules for investment in emerging markets, and sustainable infrastructure more broadly, are necessary. 12 Creating a NewCatalytic Asset Class