Blended finance: aligning commercial outcomes with policy goals
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Last month Westminster launched the National Wealth Fund to mobilise capital in critical industries with an emphasis on using blended finance models. Blended finance is also a key part of the Association of British Insurers’ 10-point action plan to boost infrastructure and green investments. Given this shift towards public-private financing, institutional investors will need to better understand these models and their benefits.
Unlocking funding for critical policy initiatives
The government defines ‘blended finance’ as a funding model comprising “financial products or structures that combine different public and private funding sources, with the aim to lower the risk profile of specific companies or projects and ultimately attract private capital.”
This process starts with public/philanthropic sources providing catalytical capital in a project or company. Because catalytic capital is typically more patient and flexible than private capital, they are better suited to absorbing ‘first-mover’ risks. This in turn makes projects more attractive to investors like insurers and pension schemes. This model also enriches governance and project delivery by incorporating expertise from public and private stakeholders. Author's design using Canva/designesto Using blended finance is especially useful for local projects which “are often not directly or fully fundable by the financial sector”, as noted by Jamie Broderick, Deputy Director of the Impact Investing Institute. According to Jamie, these projects often struggle to get off the ground because:
Investors might find them too risky, believe the return potential is too low or that the proposition might not be well-enough developed. This is where blending capital from different sources can help. Instead of funding the entire project, government grants can help develop the project into a maturer proposition, mitigate risks or provide anchor capital, so that market investors consider it investable.
Scaling up an already impressive track record
The newly formed National Wealth Fund will align missions with the UK Infrastructure Bank (UKIB), which was established three years ago to finance the climate transition and regional growth. One key factor driving the Bank's success so far is its use of capital rather than grants to finance projects. Expanding on this, Sheer Khan, Chief Economist and Chief Impact Officer at UKIB, comments that:
A billion pounds of investment capital goes much further than a billion-pound grant. UKIB operates in a fiscally challenging economic environment, so it is important that policymakers deploy capital in a way that crowds-in and catalyses the necessary private finance to drive growth across the UK. We can be the catalyst to get other investors on board by fixing financing problems and giving confidence to the market. This is especially effective with nascent technologies where UKIB’s investment can provide confidence to potential investors and remove risk.
The British Business Bank will also align with the National Wealth Fund and since its inception has unlocked over £17bn in funding for UK businesses. The Bank primarily supports smaller businesses through loan schemes, thought leadership and regional networks. Notably, last year alone it deployed £3.5bn in public funding and attracted another £2.5bn in private capital.
Another key UK development bank is the Scottish National Investment Bank. It was launched in 2020 with a remit to provide catalytic funding that fosters innovation and investment in critical infrastructure. The Bank has 35 companies in its portfolio and has committed £640m in patient capital which ‘crowded-in’ over £1bn additional capital from third-party investors. Author's design using Infogram
Navigating the challenges in public-private ventures
Even with blended finance investors should be mindful about the level of risks they are taking on – especially with projects that involve new businesses or technologies. In fact, the British Business Bank recently reported an investment loss of £122m for their long-term investments.
Another problem is that many early stage projects are unlisted, which makes it difficult for DC pension funds to co-invest. To fix this, the British Business Bank is establishing a Long-term Investment for Technology and Science initiative and growth fund to make it easier for pension schemes to invest in venture and growth equity projects. It also set up a £425m co-investment programme which is delivered by its commercial subsidiary British Patient Capital.
The lack of public sector experience with catalytic capital may also impede progress. This is because local authorities are typically more familiar with grant-based finance than working with external investors. Fortunately, organisations like the Impact Investing Institute and Green Finance Institute are helping address this by providing forums and thought leadership for private and public sector stakeholders.
Achieving economic growth without disrupting the climate transition
The interest in blended finance signals public-private funding's increasing role in economic development and the net-zero transition. Launching the National Wealth Fund is a positive step, but policymakers must avoid disrupting the success of existing development banks with upcoming reforms. Moving forward, public and private policy organisations should coordinate their expertise to develop best practices and address challenges.
What are your thoughts about the growing use of blended finance in the UK? Please tell us in the comments below.
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