What Is Blended Finance, & Why Does it Matter?
The elevator pitch for blended finance seems like common sense. Combine several sources of financing with different specialties to promote higher returns and mitigate risk. Unfortunately, the reality is a bit more complicated. The combining of several sources of capital, leveraging the expertise and finance of development banks, private commercial banks, non-profit organizations, and governments requires high specialization. Luckily, several countries in Southeast Asia are leveraging these separate sources of capital to make projects that have not been possible in the past more realistic for investors.
The reason that blended finance is so critical, particularly in Southeast Asia, is that private financing may not be available for the clean energy projects needed to decrease coal, oil, and natural gas consumption. Only 60% of clean energy investment in the Philippines, Vietnam, and Indonesia comes from private capital, whereas in advanced economies this number is 90%. This is at least partially the result of the high cost of capital for PV and wind projects compared to developed economies. Blended finance is able to address many of the uncertainties which currently delay the growth of private investment through reducing risk and improving investment expertise.
Each separate sector of the blended finance market plays its own distinct role. The first of these players are the Development Finance Institutions (DFIs), such as the World Bank and International Finance Corporation. They are critical in the process of risk-adjustment, financial technical assistance, and capacity-building initiatives. Investors are encouraged by the presence of DFIs as they offer expertise and reliability.
National development banks are used in providing solutions to local markets. Rather than the broad reach of DFIs, national banks are able to use their expertise in their own country to formulate successful financial approaches to clean energy projects. The advantage of national development banks stems from their knowledge on financial structures within a country, local market dynamics, and the regulatory frameworks. Whether through loans, equity, or other financial instruments, these banks can co-finance projects and thus reduce risk and encourage private investment. The final major sector of financing comes from commercial banks, which provide the primary financial backing for energy projects. This includes providing lines of credit and loans as well as due diligence, and risk management.
Catalytic funds, the most commonly used form of blended finance across Vietnam, Philippines, and Singapore, accounts for 85% of recent blended financing. This combination of public or philanthropic funds allows for the reduction in the cost of capital or mitigation of risk. Other forms of blended finance, including grants, guarantees and insurances, and technical assistance all help to develop the renewable sector. In conversation with Peter du Pont, the co-founder and co-CEO of Asia Clean Energy Partners, the emphasis that the region must put on blended finance was clear. However, one of the major causes of concern among potential investors is the complexity of blended finance. Therefore, the role of industry experts such as Asia Clean Energy Partners and others as a means of connecting potential partners and simplifying projects is critical.
Project developers seeking advice on the convoluted process of blended finance need only look at past projects to understand what has worked previously. Between 2018 and 2020, there were almost 100 blended finance projects with a value of approximately $20 billion. This includes the Energy Transition Mechanism that was launched at Cop26 and has thus far landed over half a billion dollars in concessional funding to replace coal and fossil fuels with renewable energy in Southeast Asia.
It is important to account for the barriers to blended finance, which are covered in a study provided by Asia Clean Energy Partners. These include risk perception such as regulatory changes and market volatility. Additionally, the complexity of blended finance means that traditional investors may be dissuaded by the complicated deals. Other barriers include high transaction cost, changing regulation and policies, and the lack of data availability. Despite these barriers, blended finance continues to grow and will serve a pivotal role in the global push for renewables.
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