Blended finance could address climate financing gap, but changes are needed, Stanford study finds

Stanford Energy

By Kate Gibson

Addressing climate change is increasingly a finance problem, as much as a science or political one. Blended finance has emerged as a promising solution to fund the world’s decarbonization, but it needs some early course corrections to have the intended impact at scale, according to a new study from Stanford University.

The world needs to invest trillions of dollars annually to limit warming to 1.5°C, and current global finance flows are vastly inadequate. Blended finance uses public and/or philanthropic capital to catalyze additional private capital that would otherwise not be available for climate investments in developing countries. The changes needed to the current implementation of blended finance, according to the analysis “Catalyzing Capital for the Transition toward Decarbonization: Blended Finance and Its Way Forward” include better governance structures, more transparency and a more systemic, holistic approach to achieving climate impact. Perhaps most important, blended finance should fund transformative ventures, not one-off projects.

Photo of Jeffrey Ball, Anne Finucane and John Kerry
Stanford’s Jeffrey Ball interviews Bank of America’s vice chairman Anne Finucane and former
U.S. secretary of state John Kerry at Stanford’s Clean Energy Finance Forum in 2017.

“Projects with incremental, short-term impact won’t help industrializing economies avoid the trap of building a fossil fuel-based economy,” said the paper’s lead author, Esther Choi, who is a research fellow at Stanford’s Sustainable Finance Initiative. “Instead of fixating on total dollar amounts leveraged, creators of blended finance vehicles should look for the quality and scalability of projects that can have systemic impact in the targeted sector or countries.”

The new study pays particular attention to investments in developing economies, where improved and expanded blended finance could benefit local and global environments the most.

“The ultimate goal of blended finance is to transform markets or – as is often the case in developing economies – create markets,” said Alicia Seiger, co-author on the paper and managing director of the Sustainable Finance Initiative. “The intervention should build confidence, capacities and a track record so that eventually public or philanthropic contributions are no longer necessary.”

Governance and transparency

Blended finance has been promoted as a tool to help deliver the goals of the Paris Agreement and UN Sustainable Development Goals by leveraging billions of dollars in public and philanthropic capital into trillions of dollars of private capital. The paper examines three blended finance vehicles active in developing economies: the Global Energy Efficiency & Renewable Energy Fund, the Climate Public Private Partnership, and Climate Investor One. The authors find common lessons learned from these funds, which have raised and invested more than $10 billion from public and private sources.

Headshot of Esther Choi
Esther Choi is a research fellow at the Sustainable Finance Initiative of Stanford’s Precourt Institute for Energy.

Blended finance brings together stakeholders with different mandates and interests. This collaboration can result in underlying tensions and potential investment trade-offs. Private investors are sometimes wary about public bureaucracy and lengthy government processes. Public investors can find it difficult to work with commercially-oriented private entities. It’s important for stakeholders to design blended finance vehicles that can weather these issues.

“Blended finance is not simply about mixing public and private resources,” said Seiger. “Everyone has to work together toward an effective approach.”

Unlike previous analyses of blended finance, which have been largely quantitative and focused on financial size, the paper’s analysis of the three case is a qualitative assessment that pays close attention to the internal configuration of and interactions within the vehicles. The authors sought to more precisely understand and explain the processes and mechanisms through which blended finance capital is used today.

“As blended finance has gained traction in the past few years, various perspectives have been offered on its principles and characteristics,” said Choi. “There is a great need to collect and connect what’s been argued in principle and implemented in practice, and identify common themes that can shed light on blended finance’s potential to realize climate impacts in developing countries.”

Another major issue in blended finance is a lack of transparency. One reason for this is the growing complexity of blended finance, which has moved from a direct grant-based approach to a more layered and complex mechanism. The climate finance landscape is crowded with diverse actors, as investors increasingly rely on intermediaries to make investment decisions and manage funds. Increased transparency and consistency in reporting would give researchers and investors alike a better understanding of the role and effectiveness of blended finance.

“The lack of publicly available impact data, especially at the project level, and absence of knowledge sharing raises questions about the effectiveness and added value of blended finance,” Choi said. “It suggests significant room for improvement.”

Headshot of Alicia Seiger
Alicia Seiger is the managing director of the
Sustainable Finance Initiative and a lecturer
at Stanford Law School.

Transformation and developing economies

Transformation is fundamental to blended finance. To transform markets and maximize climate impact, blended finance interventions need to be systemic and aligned with local needs. Instead, climate finance projects often find it difficult to scale up their efforts due to the lack of a good project pipeline and, as a result, investors often engage in one-off projects.

“The cases offer innovative approaches to solving the pipeline challenge and different interpretations of what is meant by scaling up,” said Choi.

Blended finance needs to take systemic approach and seek to alter fundamental attributes of a fossil fuel-based system. It also must actively engage developing countries and align investments with their priorities. Too many blended finance solutions are implemented without sufficient local involvement, Choi explained.

While developing countries are not responsible for historic emissions, they have a critical part to play in addressing climate change.

“If developed countries stopped all emissions by 2050 and developing countries carried on as usual, warming would still exceed 2°C by the end of the century,” Seiger explained.

Decisions by industrializing countries within the next ten years will have significant ramifications for addressing climate change. Although it is not a silver bullet, blended finance can help developing economies avoid the “carbon lock-in” problem of developed economies, the report says, and instead pursue a climate-friendly development pathway.

Choi and Seiger would like to further assess a marketplace or platform where blended finance participants can match demand and supply in climate finance. In addition to addressing the project pipeline issue, such a marketplace could address the need for greater transparency in blended finance vehicles. They also recommend more study into how blended finance can branch out from renewable energy and energy efficiency to other sectors. The application of blended finance in land use and agriculture projects, for example, can further address greenhouse gas emissions while improving biodiversity, soil quality and food security in developing countries.

The Sustainable Finance Initiative, which is part of Stanford’s Precourt Institute for Energy, is funded by Bank of America.

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