Catalyzing Capital for the Transition toward Decarbonization: Blended Finance and Its Way Forward

Abstract

Climate finance is at the center of discussions about how the international community can shift to low-emission, climate-resilient development pathways. The world needs to invest trillions of dollars annually in order to keep warming within 1.5°C. Current global climate finance flows, however, are vastly inadequate. The demand for additional capital is particularly acute in developing countries, where choices to be made over the next decade will play a major role in determining the future course of the global climate system. Blended finance, a structuring mechanism with potential to mobilize significant capital and investment from diverse actors, has emerged as one promising solution to help economies decarbonize and deliver the goals of the Paris Agreement. As blended finance has gained traction in the past few years, its principles and characteristics have also been extensively assessed, with its promises increasingly promoted as well as questioned. Attention on blended finance thus far has largely focused on volumetric contributions of blended finance, partly because of the quantitative financial targets set by the international community. Often missing is a qualitative assessment of blended finance that examines the processes and mechanisms through which sources of capital are mobilized and operationalized. Having a clearer picture of the internal governance configuration of blended finance vehicles and their investment strategy will greatly facilitate efforts to assess and determine additionality, scalability, and transformative impact of climate finance. Only then can public and private actors effectively determine the ways to mobilize, structure, and coordinate flows of climate finance towards sustainable and decarbonized development pathways at scale. This paper explores blended finance both in principle and in practice based on extensive literature review and case studies of blended finance vehicles. Specifically, the paper examines the role and application of blended finance for decarbonization in developing countries, organizing them around five themes: 1) changing features of climate finance, where we observe a shift from a model of direct investment to a layered mechanism with thicker and lengthened value chains; 2) governance of blended finance, focusing on how blended vehicles originate, structure, and function; 3) transparency, which has significant implications on monitoring and evaluation, scalability, and impact; 4) additionality, whose interpretation and application need to be broadened to improve the quality and effectiveness of climate finance; and 5) transformative impact, which every blended finance vehicle strives to achieve but with various interpretations and applications. The paper investigates, and draws insights from, three cases: the Global Energy Efficiency and Renewable Energy Fund (GEEREF), the Climate Public Private Partnership (CP3), and Climate Investor One (CI1). The paper concludes with a proposed research agenda that can assist in enhancing the potential for blended finance.

Keywords: Blended finance, climate finance, private finance, governance, financing structure