Funding innovations – unlocking a virtuous cycle of development
By Jana van Deventer, Senior Researcher: Impact Investing, Intellidex
Globally, annual development funding to the value of USD158 billion gets disbursed each year. That large sum is not nearly enough to meet the world’s development needs. Specifically, to achieve the Sustainable Development Goals, USD2.5 trillion in annual funding is needed in the years leading up to 2030. That said, an enormous pool of private funding can be tapped to bridge the gap. Philanthropic funders already contribute USD8 billion, and they hold the key to unlocking a USD212 trillion pool of capital. They can do this through innovative financing methods such as blended finance, philanthropic platforms and outcomes-based contracting and be the spark in a new, virtuous cycle of development funding.
Consider this story. Miriam Kituma from Kipandini, Kenya, used to walk an hour each way, twice daily to get to the local market to buy fresh produce. The daily trips meant that Miriam did not have much time to spend with her children to support them with their homework. Miriam’s life has changed dramatically since her husband, Joseph, acquired a Solar Fridge from M-KOPA. She now only visits the market once a day, freeing up time to help her children with their homework.
In addition to freeing up time for Miriam, Joseph is saving 150 Kenyan shillings per day (equivalent to $1.26). He is saving to purchase a water tank and for his children’s education – his wish is that their children will become engineers, lawyers, or pilots.
This is just one story of the impact that M-KOPA is having on its customers’ lives. Their innovation in the fintech and green energy space has enhanced the health, wealth, and productivity of their customers. This is achieved by providing customers with a pathway to products such as solar-powered lighting, TVs, fridges and more. M-KOPA customers report that children’s education improves, and 55% cite increased study time at home with bright lighting. Nearly 40% note women are the primary beneficiary of solar that empowers them with access to critical, informative content through TV and/or radio.
What is the relevance of this story? Following incubation by Signal Point Partners in 2011, M-KOPA secured a combination of donor funding and impact capital worth approximately $2.5mn (the exact amount is unconfirmed). The company has since raised a total of $263.6mn from 27 investors in 16 funding rounds. It has six global offices, employs more than 1,000 people, and has provided more than $400mn in financing to more than two million customers. M-KOPA demonstrates how a small sum of donor and impact funding can be catalysts for achieving impact at scale.
Innovative financing refers to funding mechanisms that utilise a combination of financial and philanthropic tools to maximise the financing’s social, environmental, and financial impact.[1] Often, these innovative mechanisms are designed with philanthropic funding as a catalyst that crowds in private and public sector investors to achieve scale. The funding can be used to de-risk a project, programme, or investment, to demonstrate proof of concept, or to test innovations. In this article, we review three such innovative funding mechanisms and tools.
Blended finance
The OECD’s definition of blended finance (own emphasis) is “the strategic use of development finance for the mobilisation of additional finance towards sustainable development in developing countries[2].”
The Blended Finance Taskforce, meanwhile, defines blended finance as “the use of development capital to mobilise additional private finance for SDG related investments[3]”.
A blended finance model uses concessional or non-concessional public or private development funding to mobilise additional, non-concessional public or commercial private capital in a financing structure. Concessional capital is financing offered at a below-market rate to accelerate development objectives[4], whereas non-concessional financing requires market-based returns.
Various instruments can be used by development funders to blend in commercial financiers. These could include, but are not limited to, credit guarantees, where the development funder offers security in the event of non-payment by the borrower; currency hedging, which offers protection against adverse fluctuations in the foreign exchange rate; provision of insurance against risks associated with unanticipated financial loss; technical assistance funding for expert skills and resources; and the provision of first-loss capital, which acts as a credit-enhancement mechanism through the absorption of the first (if any) investment losses.
These blended finance models can be designed according to the relevant stakeholders’ requirements, which offers flexibility to philanthropic funders in terms of the level of risk they are willing to take on to achieve their strategic development objectives.
The OECD Development Assistance Committee has developed guidance on blended finance outlining best practices when applying this model. The guidance includes five principles:
- Principle 1: All development finance interventions, including blended finance activities, are based on the mandate of development finance providers to support developing countries in achieving social, economic, and environmentally sustainable development.
- Principle 2: Development finance in blended finance should facilitate the unlocking of commercial finance to optimise total financing directed towards development outcomes.
- Principle 3: Development finance should be deployed to ensure that blended finance supports local development needs, priorities and capacities in a way that is consistent with and, where possible, contributes to local financial market development.
- Principle 4: Blended finance works if both development and financial objectives can be achieved, with appropriate allocation and sharing of risk between parties, whether the parties are commercial or developmental. Development finance should leverage the complementary motivation of commercial actors, while not compromising on the prevailing standards for development finance deployment.
- Principle 5: To ensure accountability on the appropriate use and value for money of development finance, blended finance operations should be monitored on the basis of clear results frameworks, measuring, reporting on, and communicating on financial flows, commercial returns as well as development results.
Philanthropic platforms and pooled funds
A philanthropic platform is an instrument used to pool capital from various types of funders, including foundations, philanthropists, and others, to invest jointly in development projects, social enterprises and the like. It is an instrument that can unlock multi-stakeholder partnerships and leverage the expertise, innovation, and financial resources of each of these stakeholders to achieve larger scale impact. It supports the mobilisation and distribution of funds in a more coordinated and efficient way while allowing for greater portfolio (and risk) diversification. These platforms are an ideal mechanism to catalyse further investment beyond philanthropic funding as the enterprises that are invested in will typically be early-stage investments.
Funders typically find a common strategic development objective that they want to address, and parameters are determined accordingly. The fund can have a regional, thematic, or sectoral focus, and the minimum investment is determined by the fund. This model enables grant-makers to explore alternative funding mechanisms by allocating a small proportion of capital for venture philanthropy. At the same time, it helps diversify risk through a portfolio investing approach.
Outcomes-based contracting
Outcomes-based contracting is typically used as a mechanism through which public services can be procured. It uses outcomes as incentives with payments linked to results or outcomes rather than inputs and activities. This form of contracting shifts the emphasis from activity-based funding to results-based funding. These funding mechanisms tend to be technically complex and given the involvement of various stakeholders, require collaboration and innovation. Regardless of its complexities, these contracts tend to have robust governance structures due to the involvement of multiple stakeholders, which can enhance the quality of outcomes achieved.
Consider the logic model – a roadmap depicting the shared relationships between various elements of a programme or model, including resources, activities, outputs, outcomes, and impact – provided below. Traditional grant-making typically focuses on funding the activity that has been identified to solve a particular social or environmental issue, regardless of whether the activity ultimately achieves the intended outcome. A results-based contract, meanwhile, stipulates that funding will only be disbursed once the intended outcome has been achieved and verified.
There are various roles that a philanthropic funder can play in an outcomes-based contracting model. For example, philanthropists can act as first-loss investors to crowd in commercial investors (the investors provide the initial, upfront working capital required for the implementation of a programme). Alternatively, philanthropists can provide technical assistance funding for the design and development of a social impact bond, or act as an outcomes funder alongside a public sector financier, whereby funding will only be disbursed if the intended outcomes are achieved.
Innovative funding models enable a virtuous cycle of development
Philanthropists hold the key that can unlock and catalyse private and public sector capital to achieve impact at scale.
In theory, the process will start with the disbursement of philanthropic funding, often in the early stages of the funding ecosystem. This capital is used as an innovative funding mechanism, either through one of the examples outlined above or through the provision of, for example, a recoverable grant, a forgivable loan, research, and development etc. It acts as a catalyst to unlock private investment, primarily through the de-risking of the initial investment. The additional funding enables the programme, project, or investment to achieve impact at scale. The outcomes of the investment are measured and evaluated to ensure that the project has delivered on strategic objectives. Finally, the findings from the evaluation enable philanthropic funders to refine and replicate projects, programmes, and investments to continue the virtuous cycle of innovative finance.
Innovative financing offers philanthropists an opportunity to rethink how their funding gets disbursed. It can enable grant-makers to deploy capital in a way that materially increases the total capital allocated to specific projects, programmes, and investments to achieve impact at scale. Moreover, these structures have additional benefits, including:
- Enhancing the effectiveness of funding to ensure that mandates or objectives are met;
- Improving the efficiency with which limited funding resources are disbursed;
- Enhancing sustainability of projects as there are likely to be lasting benefits beyond the initial funding provided by philanthropists; and
- Ultimately unlock more opportunities to achieve impact at scale.
Venturing into the innovative financing field does not require an instant pivot and complete overhaul of existing grant-making processes and practices. Instead, funders can start small to test some outside-the-box thinking and explore alternative funding mechanisms. In the medium to long run, through the virtuous cycle of innovative financing, philanthropic funders can significantly amplify the social and/or environmental return on the funding disbursed by leveraging private sector capital.
[1] Bertha Centre. (2016). Innovative Finance in Africa Review. Cape Town, South Africa. Retrieved from https://www.gsb.uct.ac.za/Downloads/InnovativeFinanceAfrica_1.pdf
[2] OECD. (2022). Blended Finance. OECD. Paris, France. Retrieved from https://www.oecd.org/dac/financing-sustainable-development/blended-finance-principles/
[3] Blended Finance Taskforce. (2022). Investing in the Global Goals. Blended Finance Taskforce. London, UK. Retrieved from https://www.blendedfinance.earth/why-blended-finance
[4] OECD. (2003). Concessional loans. OECD. Paris, France. Retrieved from https://stats.oecd.org/glossary/detail.asp?ID=5901
Sources
Bertha Centre. (2016). Innovative Finance in Africa Review. Cape Town, South Africa. Retrieved from https://www.gsb.uct.ac.za/Downloads/InnovativeFinanceAfrica_1.pdf
Blended Finance Taskforce. (2022). Why Blending. London, UK. Retrieved from https://www.blendedfinance.earth/why-blended-finance
Gibson, M. (2022). Outcomes-based contracting. Government Outcomes Lab. Oxford, UK. Retrieved from https://golab.bsg.ox.ac.uk/the-basics/outcomes-based-contracting/
Intellidex. (2021). Social Impact Bonds in South Africa report. Intellidex. Sandton, South Africa. Retrieved from https://www.intellidex.co.za/insights/impact-investing/the-intellidex-sibs-report-series/
MacArthur Foundation. (2022). Catalytic Capital Consortium. Chicago, IL, United States. Retrieved from https://www.macfound.org/programs/catalytic-capital-consortium/
OECD. (2018). Making Blended Finance Work for the Sustainable Development Goals. OECD Publishing. Paris, France. Retrieved from https://www.oecd.org/development/making-blended-finance-work-for-the-sustainable-development-goals-9789264288768-en.htm
OECD. (2021). The OECD DAC Blended Finance Guidance. OECD Publishing. Paris, France. Retrieved from https://doi.org/10.1787/ded656b4-en.
The Global Fund. (2022). Innovative finance. The Global Fund. Retrieved from https://www.theglobalfund.org/en/innovative-finance/
The Rockefeller Foundation. (2020). Making opportunity universal and sustainable through Innovative Finance. Washington, D.C., United States. Retrieved from https://www.rockefellerfoundation.org/commitment/innovative-finance/
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