Daring to Do More Blended Finance

Blended finance has proved its effectiveness over and over in the past 10 years, for instance in developmental aid. But that’s not all. The provided funds have often advanced projects to achieve the United Nations’ sustainability goals. For instance, in 2017, under the Managed Co-Lending Portfolio Program, the Allianz Group and the International Finance Corporation set up a program that focuses entirely on implementing the goals of the 2015 Paris Agreement on climate protection.

Which leads me to the following suggestion: why don’t we also apply blended finance in the European Union? It could be a major lever in mobilizing much more capital for public-private partnerships, and thus help achieve our ambitious climate goals faster and more easily.

The United Nations has called climate change the most urgent existential threat to humanity. If we still want to avert the worst scenarios in the latest reports from the Intergovernmental Panel on Climate Change, the world has to become climate-neutral by mid-century. To achieve that goal, the Member States of the European Union (EU) and the largest national economies worldwide must reduce their greenhouse gas emissions substantially. The EU has already set itself the goal of cutting its Member States’ emissions 55% from the 1990 level by 2030. That’s an ambitious interim target, though only a first step. The European Commission now estimates that achieving even this goal will call for investments of more than EUR 1 trillion a year. For comparison, in recent years we’ve invested only around EUR 700 billion.

European governments know they can’t possibly finance such amounts on their own, and are openly appealing to private investors for support. Since investors have become increasingly aware over the past few years of the threats from advancing climate change, interest in green investments has grown vigorously. Yet we can’t rely on rising demand alone. We need to get active and combine the power of public and private financing. That’s the only way we can strengthen the funding for European projects to mitigate climate change, and accelerate those projects’ execution.

Europe already has mixed-financing instruments for investment, of course. But the problem is that we haven’t worked out yet how to scale them up fast and effectively.

Through its InvestEU fund, the European Commission is making some EUR 26 billion in credit guarantees available to encourage innovative technologies relating to environmental projection, climate resilience, or social sustainability. These guarantees are intended to cushion the credit risk for private investors, and to mobilize up to EUR 370 billion in private investment.

As a supplement to this funding, the European Commission and European Investment Bank have launched the InnovFin initiative, intended to selectively encourage innovative, significantly riskier company models that would often get no financing from private investors alone. InnovFin is furnishing up to EUR 75 million per project to attract further investment. One example of a supported project is Steelanol, an unprecedented plant in Belgium that will convert waste from steelmaking into ethanol. The plant is expected to compensate for the CO2 emissions of up to 250,000 passenger cars at a single stroke.

So blended finance funds can make a major contribution toward mitigating risk for investments in climate technologies. But they’re not yet available on a sufficient scale to cover the urgent need to decarbonize the industrial sector. So we need to concentrate on making these instruments available across the board.

The problem is that this development is impeded by numerous regulatory requirements. European Union rules on state aid are a particularly significant obstacle. These rules are actually intended to ensure a fair internal market. And they’re meant to prevent the European Union’s 27 governments from tilting the playing field in favor of domestic companies or economic sectors.

This approach has done good service for the EU up to now, but it poses almost insurmountable obstacles for the financing of projects relating to the climate. One such obstacle comes from the fact that state support is not allowed to distort competition. Proving the absence of such distortion is a complex, heavily bureaucratized undertaking – and often scarcely possible in the case of climate-related projects in particular.

Take clean hydrogen as an example. If governments hold firm to their commitments, hydrogen is going to become an important energy source. By 2050 it may account for up to 24% of the world’s energy demand. It could drive trucks, ships and aircraft – in a word, it might become the key to climate-neutral mobility. Last but not least, hydrogen might stabilize our electric grids, enabling us to store surplus renewable energy during the day and feed it back into the grid at night. That’s a courageous, encouraging vision. But getting there will be no easy task – because generating clean hydrogen will need extensive investment, for instance in catalysts and a storage infrastructure. On top of that, the existing gas infrastructure will need to be retrofitted for this new energy source. Still more, we’ll have to continue expanding the network to carry hydrogen from future production sites to Europe’s economic centers.

Another matter we’ll have to address is the regulatory and solvency treatment of blended finance vehicles. As is well known, insurance companies like the Allianz Group are covered by “Solvency II,” a European Union Directive that governs insurers’ capitalization, organization and disclosure obligations. Following the global financial crisis of 2008 and 2009, risk capital regulations were tightened substantially. Ever since, companies regulated by Solvency II must maintain significantly more risk capital for investments associated with a securitization structure than for an investment in a vehicle not classified as a securitization. The same also goes for the structures typical of a blended finance fund, and if the rule were to be applied, it would make such funds unattractive for many investors. To avert that today, very complicated, non-transparent fund structures often come into play. We urgently need to simplify that.

It might be argued that Europe is already flooded with funding for the green transformation, especially in the aftermath of the European Union’s financial injection of some EUR 800 billion in the form of NextGenerationEU. This is an ambitious program for making Europe’s economy more resilient, more innovative, more digital, and more sustainable.

However, a large share of that funding is likely to go into familiar business models – meaning business models with whose underlying technologies we have many years of good experience, like solar farms and wind farms. Yet much of what we need in order to avert a climate crisis falls in the category of little-tested models.

Investors, especially institutional investors like insurance companies and pension funds, are willing to do their share to assist the green transformation – including for a very obvious reason: our long-term pension obligations have an investment horizon that often extends far beyond 2050, and we need to safeguard our portfolios. Numerous alliances and initiatives have been founded in recent years, many of them under UN patronage, to rechannel capital flows in favor of sustainable investments. Yet as I’ve already outlined, these investments’ current risk-return profiles are often unsuitable for large-scale investment. All the same, private capital is around that is willing to invest. Here blended finance can help right now to overcome the impediments for the private sector, and thus speed up the growth of innovative climate solutions and low-carbon energy sources.

Fortunately, the dynamics for blended finance in Europe are positive. Germany itself has already gained initial experiences that can be applied in structuring blended finance vehicles. One good example is the “ Fund for the Future” set up by the Federal Ministry for Economic Affairs and Climate Action in 2021 to facilitate funding for startups in the capital-intensive growth phase. Part of the available financing is to be provided by way of a EUR 1 billion umbrella fund, the KfW Capital Growth Fund, which has two modules: an aid-free product with an asymmetric distribution of risk and return, intended to mobilize investment from institutional investors; and a parallel structure in which public funding and private investors both invest on the same terms. As part of the structuring, KfW has dealt successfully with matters like state-aid law and questions of securitization. So the expertise is on hand.

We face a gigantic task in averting the impending climate catastrophe. For that reason, I believe government and regulators must take three specific steps to ensure even greater scalability and replicability for blended finance models:

First: National and European laws on state aid must be revised to facilitate focused state support by way of blended finance structures.

Second: We need to revise the rules for how the solvency of blended finance vehicles is assessed, so as to avert complex, non-transparent fund structures.

And third: We must acquire investors, especially for concessionary capital in the economy.

I’m certain that blended finance can make an important contribution here. And I’m confident we’ll be able to do that. All we have to do is dare to make the effort – and now.