Development banks must shoulder more risks to mobilise climate transition in emerging markets, say asset owners

Development banks should “take on much higher risks” to make climate-aligned investments in emerging markets more attractive to big investors, the UN-convened Net Zero Asset Owner Alliance (AOA) has said today.

The group, whose members include major pension funds like La Caisse de dépôt et placement du Québec, CalPERS and Alecta, has released a paper identifying blended finance as a key measure to mobilising the $1trn it estimates will be needed annually to build Net Zero emerging economies.

Blended finance refers to the strategic use of public funds, usually via multilateral development banks and development finance institutions, to mitigate investment risk and boost returns for investments that would otherwise be unable to proceed on strictly commercial terms. Currently, the volume of private capital mobilised through blended finance averages $4 for every $1 of public or philanthropic funding.

The report comes after developed nations failed once again to meet an annual pledge to provide climate funding worth $100bn to emerging markets in 2021. The financial commitment, which comprises primarily of public funding, has been missed every year since 2013.

While hundreds of institutional investors have pledged to support the climate transition globally, the AOA said they faced hurdles when it comes to emerging markets because of regulatory and fiduciary requirements to invest in investment grade debt and equity, restricted market access and lack of data. Recent fund data from the Institute of International Finance showed that emerging markets strategies received less than 5% ($4.8bn) of global inflows into ESG-labelled funds in Q3 2021.

“The current economic risk-return profiles for some climate solutions and cleantech investments in emerging markets are not fit for purpose for private institutional investors,” said Günther Thallinger, Allianz SE Board Member and AOA Chair. “In this context, scaling up the use of blended finance vehicles is a priority.”

Blended finance can be used to offer debt with investment-grade characteristics and equity with “a profile commensurate with similar investments in OECD markets”, argued the report.

Development banks also have extensive local networks and preferred creditor status which can facilitate greater market access, as well as financial data which would allow investors “to assign appropriate risk ratings to transactions”, according to the report.

In addition to using development financing to make investing in emerging markets financially viable, donor funds from private foundations and OECD countries should remove requirements for funding to have a national focus – such as supporting local exporters and companies – and be pooled together to achieve the necessary scale required by institutional investors, it said.

The AOA report follows a call to action made by the body to asset managers earlier this year to collaborate in the development of blended finance vehicles.