Better Blending: Making the Case for Transparency and Accountability in Blended Finance
Researchers: Alyssa Bryan, Sebastien Feron, Jovan Johnson and Khai Leang Yeap.
The Sustainable Development Goals (SDGs) are the most ambitious development initiative ever launched and aim to end poverty, protect the planet and ensure that all people enjoy peace and prosperity by 2030. Achieving these goals will require an extraordinary and unprecedented amount of investment: an estimated five to seven trillion dollars per year.
As available public resources for official development assistance come under strain, an annual “funding gap” of around US$2.5 trillion is emerging between current funding commitments and the target levels of investment needed. To respond to this need, governments and international organisations are increasingly calling for greater involvement of the private sector.
Alongside other private sector channels such as conventional foreign direct investment, social impact investment and green investment, so-called “blended finance” is being hailed as a key means of funding development in low- and middle income countries.
Blended finance is the strategic use of development finance to mobilise additional commercial finance needed to achieve the SDGs. Advocates of blending contend that relatively small amounts of public resources can mobilise untapped sources of private capital by using innovative financial instruments that reduce the perceived investment risk for the private sector.
Blending differs from traditional forms of development finance in that the projects it finances are at least partially commercial in nature. Private sector entities can be involved in blending as financiers investing in revenue-generating development projects, and by acting as service providers can also be direct beneficiaries of investments channelled through blended finance initiatives. In both cases, the private sector investor or recipient expects to make a profit as a result of their involvement.
Transparency International’s new working paper Better Blending: Making the Case for Transparency and Accountability in Blended Finance finds that amid the fervour for increased blending, to date little consideration has been given to corruption risks in these mechanisms. This is concerning for two reasons. First, the participation of unfamiliar, profit-driven actors such as pension funds, commercial banks and sovereign wealth funds in development work entails potentially novel integrity risks, such as conflicts of interest, the abuse of secrecy jurisdictions and inadequate due diligence procedures. Second, the complex financing arrangements and multi-layered governance structures involved in blended finance projects make managing and monitoring transactions and results difficult.
As blended finance becomes an increasingly common instrument in development assistance, a richer understanding of the cause and impact of corrupt practices in this form of aid is essential.
The paper therefore explores potential integrity issues that might arise at various stages of the blended finance project cycle, from project financing and mediation to design and implementation. It identifies a number of areas where increased transparency and accountability could reduce potential losses due to corruption and improve development outcomes.
The focus of the paper is on multilateral development banks and bilateral development finance institutions. These so-called “intermediaries” play a pivotal role in bringing together financiers, structuring transactions and shaping the project pipeline, and as such exert influence over integrity risk mitigation at every stage of the project cycle.
These intermediaries can take a number of measures to ensure blending is appropriately deployed to promote sustainable development and reduce the risk of it being exploited by dishonest brokers to the detriment of investors, taxpayers and intended beneficiaries.
Greater transparency around procurement processes and project information
Intermediaries should ensure that procurement processes are conducted in a fair and transparent manner, adhering to the Open Contracting Global Principles to the extent possible. In line with the principle of national ownership of development, development finance institutions should scrap institutional preferences for firms from their own countries, and conduct thorough consultations with recipient country governments and communities to ensure alignment with local development strategies.
In addition, intermediaries should improve the transparency of their project-level reporting, including environmental and social impact assessments, financial transactions and effectiveness evaluations, as well as their management of incidences of corruption that may arise. Not only will this facilitate fulfilment of investors’ fiduciary duties, but also enable oversight by civil society, competitors and intended beneficiaries to reduce the risk of fraud, bribery and embezzlement.
Due diligence standards and information sharing
Second, intermediaries’ due diligence processes should be brought in line with international best practice, meaning that they should conduct robust reviews of business partners’ activities, ownership structures and, where appropriate, anti-money laundering frameworks and use of offshore financial centres.
To date, while multilaterals engage in both formal and informal information sharing activities, bilateral development finance institutions appear to have less contact with their counterparts, resulting in fewer opportunities to harmonise standards and learn from one another. When different intermediaries use different standards, unscrupulous companies may take advantage of this discrepancy to disclose less information than they might otherwise.
One way to ease this friction is to create spaces for greater information exchange between intermediaries, particularly with regards to integrity management systems, due diligence and policies on beneficial ownership and the use of secrecy jurisdictions.
Grievance mechanisms
Independent grievance mechanisms are an important channel for civil society, participating companies and affected communities to express concerns and report wrongdoing. Grievance mechanisms are also valuable for intermediaries, as they provide a channel to alert responsible bodies to behaviour that can threaten the integrity or success of a project.
Despite this, a recent study of nine European bilateral development finance institutions found that only three had established independent complaint mechanisms. Intermediaries should therefore establish grievance mechanisms open to all relevant stakeholders in line with the principles of ownership, transparency and accountability espoused in the Busan Partnership for Effective Development Cooperation.
Conflicting incentives and accountability structures
The dual purpose of blended finance projects is to generate a return on investment while simultaneously contributing towards development outcomes. Nonetheless, the different mandates of various players involved may not always be perfectly aligned, and conflicting incentive structures can constitute an underlying tension in blended finance projects. To date, minimal attention has been given to the integrity risks that arise when commercial return profiles come into conflict with development goals.
Rather than evaluating project performance in terms of funds mobilised and return on investment, intermediaries should therefore consider how to align their internal evaluation metrics at project level with the achievement of predetermined development outcomes in line with specific SDGs. Such outcomes should be verified by on-site monitoring that includes external evaluations and feedback from communities affected by the project. This will ensure that blended projects are not only accountable to their shareholders but also to affected communities.
Conclusion
Ultimately, blended finance provides an innovative and potentially catalytic set of tools that could crowd-in billions of dollars from the private sector to help achieve the SDGs. However, the issues outlined in this paper bring into sharp relief some of the tensions between the development mandate of donors and the commercial interests of private investors they are seeking to incentivise.
The participation of new private sector players in blending and the greater number of layers of intermediation involved requires robust oversight. This working paper offers a starting point by providing tangible recommendations to development finance institutions as the central convening actors in blended finance initiatives.
Establishing transparent and accountable integrity management systems to deal with these challenges can encourage more, and better, private investment in low- and middle-income countries and instil greater confidence in donors, beneficiaries and private investors.
Read Transparency International’s new working paper Better Blending: Making the Case for Transparency and Accountability in Blended Finance.
The working paper is based on research conducted by Alyssa Bryan, Sebastien Feron, Jovan Johnson and Khai Leang Yeap.
