A new kind of consortium
On 23 May 2019, with little fanfare, the Dutch government announced that it had awarded the mandate to manage the newly-established Dutch Fund for Climate and Development (“DCFD”) to a consortium formed by Dutch development bank FMO, the Dutch branch of the World Wide Fund for Nature (WWF-NL), SNV Netherlands Development Organisation and Climate Fund Managers (CFM), a fund manager jointly owned by FMO and Sanlam InfraWorks, a South African infrastructure investment business.
Currently sized at EUR 160 million, the Dutch government’s ambition is for DCFD to leverage up to EUR 1 billion in private sector investment for climate-resilient projects in developing countries, with a particular emphasis on climate adaptation.
Given the welcome (though still uncoordinated) surge of activity in the global search for ways to close the trillion-dollar gap in SDG, sustainable infrastructure and climate finance, it was easy for one announcement among many to slip under the media radar. However, this groundbreaking, multidisciplinary consortium, comprising a development finance institution, a private sector investment manager, a conservation NGO and a social development NGO may very well be the prototype for future financing consortia designed around impacts.
The focus of the fund on the especially under-served area of climate change adaptation projects presents the opportunity for a more general appreciation of the challenges faced by sustainable infrastructure and SDG finance.
Climate adaptation: climate finance’s poor cousin
There is no accepted measurement framework used to price or put an asset value on the project or adaptation feature. Without an accepted methodology, it will remain difficult to attract private investment finance.“From Risk to Return: Investing in Climate Change Adaptation”, The Investor Group on Climate Change (March 2017)
In the field of climate finance which, as a whole, already suffers from vastly insufficient funding, projects focused on climate change adaptation (i.e. preparing communities for the actual and expected consequences of climate change) attract a mere fraction of the available finance: in a November 2018 report, the Climate Policy Initiative, a think tank, estimated that less than 5% of annual climate finance flows in the 2015-2016 period could be reliably traced to climate adaptation initiatives.
There is a host of reasons for this, including public resource scarcity and the difficulty in clearly identifying climate adaptation measures within larger development initiatives (e.g. developing drought-resistant crops), as well as the context-related difficulties commonly associated with mobilising private finance in developing countries (de-risking the investment environment, credible counterparties, etc).
However, from a business and financing perspective with respect to adaptation-driven projects, the two factors which are arguably most critical for explaining the scarcity of private sector mobilisation are (i) lack of accounting for climate-related financial risks and (ii) the absence of a ready-made business model.
Indeed, it is an increasingly well-known fact that climate risks and their associated costs are still insufficiently accounted for by the private sector in general, and therefore generally minimised in corporate decisions. Furthermore, as highlighted by the Investor Group for Climate Change (“IGCC”), a network of Australian and New Zealand institutional investors and advisors, it can be difficult to find a revenue stream for, say, sea walls protecting coastlines.
Typically, such investments would be met by (tax-funded) government bodies. However, the scale and dwindling timeframe of the climate challenge means that public resources, especially in developing countries, are bound to be insufficient: business models accounting for climate-related financial risks are urgently required to meet the climate adaptation infrastructure challenge.
Co-benefits and value capture: the new financing frameworks
Global efforts to remedy the lack of accounting for climate-related financial risks in business are underway, most promisingly the implementation of the Task Force on Climate-related Financial Disclosures (“TCFD”) which, while off to a timid start, could prove transformational in how private investment is assessed and create an explicit value around climate adaptation and resilience: the value of any revenue-generating activity and economic benefit associated with the infrastructure, along with, more crucially, the value of the avoided costs realised through such infrastructure investments.
To make a broader point, beyond merely climate adaptation: the financial and economic benefits of enhancing SDGs, or indeed the cost of undermining such SDGs, climate-related or otherwise, are still poorly taken into account by private sector interests.
This observation is the foundation of the growing number of recent experimental business models and financing frameworks designed around absorbing (“capturing”) the economic value of an array of targeted positive impacts mapped out from the outset: frameworks such as the UN Environment Program Finance Initiative’s “Positive Impact Finance” or the UN Economic Commission for Europe’s “People-first PPPs”, a game-shifting trend commented on in further detail in a previous post.
The partnership premium
The evolving financing landscape, including new actors and a wider range of instruments, have added complexity to the financing challenge and put a premium on strategic approaches to actively manage financing flows and other means of implementation.Excerpt from “Financing for Sustainable Development” report, Inter-agency Task Force on Financing for Development (May 2019)
Bringing this trend into focus brings us back to the pioneering consortium retained to manage the Dutch Climate Fund for Climate and Development.
By joining up industrial, financial and NGO interests under one partnership, the financial and economic benefits produced by an array of positive impacts can be evidenced and actively driven by Development Finance Institutions (DFIs) along with NGOs, with financial incentives and support from the private sector and concessional finance providers; such benefits and associated avoided costs can in turn be captured towards financing any enabling infrastructure.
For instance, in the case of DCFD, one could envision a nature-based flood prevention barrier such as a a mangrove producing multiple benefits (fisheries, biodiversity, carbon storage, tourism, etc.), such benefits facilitating the raising of finance from either mission-driven providers (e.g. concessional finance, impact investors) or non mission-driven providers, which could be applied towards realising the mangrove project. Further fundraising opportunities would be generated by the avoided costs (e.g. disaster prevention) and created opportunities (e.g. insurable land, land value capture).
Far-fetched? Such ideas are already under development thanks to forward-thinking organisations such as the Climate Policy Initiative’s Climate Finance Lab.
Regardless of whether DCFD consortium aligns itself with any of the new financing frameworks being proposed, it carries the potential to abide by their common principles of financing through SDG value capture – and perhaps even earn one of their “labels” ex post.
DCFD’s first announced deals will be revealing, as much for their hopeful success as for lessons learned, in particular with respect to how the public sector establishes ownership of any financing solution, and how the roles and responsibilities under such partnerships will be governed — the matter of governance in particular is shaping up to be the next (next) frontier in sustainable and SDG-based financing.
Urban development and partnership financing
It is worth highlighting that such multidisciplinary consortia are especially relevant in the urban context, where increasingly compact cities require multidimensional urban infrastructure that is designed and financed with right-sized consideration for its resulting social and climate impacts, as well as for their economic fallout.
In fact, such catalytic urban partnership patterns involving finance are already being undertaken, but with a focus that is often narrowed to capturing a limited range of economic “externalities”: whether it is “innovation districts” partnering real estate developers with education hubs or “transit-oriented development” (TOD) associated with land value capture as successfully implemented in Hong Kong and now championed by the World Bank and the Global Environment Facility.
But why limit the value capture to real estate and land? Whether it is TOD or other urban development models, there is an opportunity to incorporate a wider array of positive impacts and possibly their economic consequences from the very start, to finance climate adaptation and the wider SDGs.
For instance, if a piece of infrastructure built in a climate-resilient manner that results in improved climate adaptation, there is economic value in the anticipated ability for the infrastructure itself to go from being uninsurable to insurable, but also in the wider ability to insure and develop the land area that has thus been made more climate resilient. Social goals can also be incorporated into the design, such as gender equity and their known positive social and economic impacts, with the active participation and result-based financing from relevant development banks and NGOs, each contributing to the financing of the enabling infrastructure.
The new ‘origination’
In finance dealmaking slang, ‘origination‘ is the sourcing of a pipeline of new deals – the stuff dealmakers live for. It may be too soon to predict, but given the need to inlay business models within targeted networks of impacts, the future of origination seems to be shifting from a matchmaking exercise to the smart design of consortia framed by the targeted impacts of a financial or economic endeavour.
If this plays out, although Multilateral Development Banks (MDBs) appear best placed to handle the complexity of providing this kind of partnership-building “additionality”, real upscaling at a global level would be truly accelerated if the private sector could also eventually make it its mission to structure such partnerships.
Pre-established consortia such as the one managing DCFD would still have their relevance as some partnership patterns can be replicated and scaled up regionally, globally or according to comparable circumstances such as the similar issues faced by fast-growing cities in low-income countries.
Nonetheless, while climate change is a global phenomenon and the SDGs a global aspiration, their consequences are decidedly local and as varied as there are spatial and human situations. Therefore, circumstances would likely call for tailored partnerships, aligned with local and national initiatives and policy priorities.
A new way of doing business.