Four key ways for financing sustainable development

Over the past four years, the development finance community has made significant progress: a number of innovative financial instruments and platforms have been created to catalyse private capital for sustainable development, and many multi-stakeholder initiatives have been set up to help address key challenges. The growth of blended finance stands out as probably the most notable advancement, stimulating additional sources of private capital by “blending” commercial investments with public resources, thereby de-risking sustainable development projects in developing countries.

Nevertheless, the funding gap persists. The United Nations Conference on Trade and Development estimates that attainment of the Sustainable Development Goals (SDGs) would require $2.5 trillion annually. The Global Future Council on Development Finance, convened by the World Economic Forum and comprising 23 experts active in the field of development finance, is focusing on innovative ways to overcome the systemic challenges that limit the flow of development finance.

The Council, which includes representatives from national governments, multilateral and bilateral development finance institutions (DFIs), investors, foundations, finance and academia, believes that conventional approaches to development finance are inadequate to address the challenges that countries actually experience at the national level. A change is required: we must move from a closed-system, project-by-project ”funding” approach to an open-system strategic “financing” approach, where each country and its advisers give more prominence to the need to mobilize private capital at scale.

In their report, the Council proposes four ways for countries to address the systemic challenges in raising the development finance required to achieve the SDGs.

1. Moving from “funding” to “financing” of sustainable development

The development finance community should help countries become more strategic in how they raise capital, building their entire SDG plans around what can actually be financed with public funds used more sparingly and private capital mobilized more effectively.

Currently, most developing countries focus on a traditional “funding” approach, relying primarily on official development assistance and their own public funds when investing in sustainable development. This prevents a holistic consideration of all the sources of capital that could be mobilized towards the achievement of the SDGs: a “financing” approach that attracts a range of public, private, domestic and international sources of capital to build a high-impact pipeline of projects that advance development at a national level.

2. National level plans and “investable governance”

For countries to move effectively from a funding to a financing approach, one key element is their ability to link country-level SDG goals with national allocation processes. This can be a complicated process, and is immensely helped if the country is able to provide “investable governance”. What does this mean?

We know that investment climate is important: a healthy regulatory environment, backed up by the rule of law and functioning market systems and institutions, will help to attract capital. The Council’s notion of “investable governance” goes beyond this, including the capacity of government entities, their advisers and local institutions to develop strategic financing plans for their SDGs.

Investable governance applies also to multilateral and bilateral organizations focused on specific SDGs or on sustainable development more broadly. The better the governance at these organizations, the better they are able to engender confidence from other capital providers, including private investors and lenders. For instance Gavi, The Vaccine Alliance, has been particularly effective in bringing private and public actors together to create new markets and innovative financing approaches in its chosen field.

When “investable governance” is in place, the full range of development finance sources can be mobilized, and countries are better placed to design, finance and implement an effective pipeline of sustainable development projects to meet their SDGs.

3. Development Finance Institutions and an understanding of risk

Given the need for more strategic financing plans at the country level and for greater investable governance both in local institutions and in DFI partners, it is important that DFIs adopt a more open system. This requires working more as an intermediary linking multiple projects (not just their own projects) with multiple sources of finance (not just their own finance). This would help their partner countries develop holistic SDG plans that are based on what can actually be financed rather than on what they hope might be financed.

In areas where commercial capital can realistically be raised, this means DFIs must focus relentlessly on maximising mobilisation of such financing while minimising their own capital investment. Conversely, in areas where commercial capital cannot be raised, including early-stage project development, DFIs need to be empowered by their shareholders to take more risk onto their own books. And in between, of course, are the situations where judicious use of DFI capital and a well-structured project can raise some commercial capital through appropriate management of risk.

The common thread to all this is the need for DFIs to understand how to measure, mitigate and manage risk, and how different types of investor will tolerate different types of risk. Acquiring, enhancing and embedding this understanding of risk should be a strategic priority for DFIs.

4. Action plan for development finance stakeholders

The changes we are considering cannot be achieved by one institution or one country acting alone. Collective action is needed to overcome longstanding challenges, as well as the new challenges created by the ambition and scale of the Global Goals. By definition, an open-system approach will require more collaboration between players in the development finance community.

Nevertheless, there are certain things that each type of institution can do right now, without waiting for others to act as well. In particular, the Council’s message for governments designing national plans, for DFIs advising on and financing these plans, and for private capital providers looking to invest in them, is as follows:

Governments should align their national planning processes to the SDGs; they should translate their objectives into actionable SDG financing plans that are based on a strategic and realistic assessment of what can be financed; and they should focus on improving the investable governance of their country and of those institutions partnering with them.

Multilateral and bilateral development finance institutions should adopt consistent targets maximising the mobilization of private capital; they should act more as intermediaries connecting projects with multiple sources of capital; and they should enhance their risk-management skills for better interaction with governments and private investors.

Private capital providers should make it as clear as possible what their specific risk tolerances are so that national governments and DFIs can bring them investable projects; asset owners should measure the impact of their portfolios on the SDGs; and asset managers should design products for their clients that are aligned with one or more SDGs.

With these changes we can enhance the flow of capital needed to underwrite a new era of international progress on sustainability.