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Blended Finance - Session 11 Managing Project Preparation for Climate Change Adaptation

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This session will cover principles of blended finance, which will enable participants to understand a variety of financing options for their project concepts. This session will also focus on how blended finance projects are typically structured. Participants will be able to identify different financing instruments that could potentially be mobilized to fund a project to ensure efficiency and sustainability.
o OBJECTIVE 1: Participants will understand the type and characteristics of different funding instruments and their benefit-cost requirements
o OBJECTIVE 2: Participants will demonstrate how each instrument can be utilized to address specific risks of a particular project.

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Blended Finance - Session 11 Managing Project Preparation for Climate Change Adaptation

  1. 1. Blended Finance
  2. 2. Outline • Understanding characteristics of different funding instruments and their sources as well as the accompanying requirements of each • Understand how different funding instrument can be used to addressed a certain risk • How to mobilize and structure different funding instruments to achieve sustainable outcome • Exercise: Financing options for a sample project
  3. 3. Blended Finance Defined Blended Finance refers to flows combining – market (or concessional) loans and other financial instruments with – accompanying grant (or grant equivalent) components • The scope is to leverage additional non- concessional public and/or private resources with different financial terms and characteristics. Source: Adopted from Evidence on Demand, 2014, TOPIC GUIDE: Blended Finance for Infrastructure and Low-Carbon Development, Oversea Development Institut http://www.evidenceondemand.info/topic-guide-blended-finance-for-infrastructure-and-low-carbon-development-full-report
  4. 4. Basic Characteristics of Financial Instruments Debt Instruments (Loan and bond) • Repayment is required in fixed schedule with different cost according to the risk profile of the borrower • Usually a guarantee is required to minimize default risk of borrower • Debt is normally less than total project cost to ensure ownership of the borrower and increase incentive to complete the project • Debt size is up to the repayment ability of the borrower and capital of the lender • Debt maturity period should match with the project life and cash-flow for repayment Grant • Grant normally does not require repayment however, it could be made based on certain criteria (output-based-aid) • Guarantee is not required • Counterpart funding (in-kind and in-cash) is usually required to ensure ownership of the project proponent • Grant size is usually small as no repayment is needed • Grant financed project is usually short-term as the size of fund is small Partial Risk Guarantee* • Partial Risk Guarantees cover private lenders, or investors through shareholder loans, against the risk of a government (or government-owned entity) failing to perform its contractual obligations with respect to a private project. *World Bank Guarantee Products: IBRD Partial Risk Guarantee (PRG) http://siteresources.worldbank.org/INTGUARANTEES/Resources/IBRD_PRG.pdf Equity • Funds provided by a private firm’s owners (investors and stockholders/shareholders) that are repaid subject to the firm’s performance • The investors normally have only expectation to be repaid. Reference: Gitman, Lawrence J. and Chad J. Zutter, 2015, Principles of Managerial Finance, 14th Eds., Pearson
  5. 5. Example of Blended Finance Global Environment Facility (GEF) Multilateral Fund (MLF) Made Grant Available through MDB MDB Local FI Made concessional fund (0% interest) Available to Local FI Facility Owner Made loan available only to purchase a qualified chiller but charged only management fee Upgrade chiller Used loan proceeds to upgrade chiller and auxiliary system Chiller Supplier Supplier guaranteed energy efficiency level Loan repayment calculated from energy savings i.e., lower electricity bill Local FI repaid concession fund within 3 years Global Benefits Reduced GHG Reduced ODS Source: Implementation Completion Report, 2006, Thailand Building Chiller Replacement Project, the World Bank http://documents.worldbank.org/curated/en/101781468132276470/Thailand-Building-Chiller-Replacement-Project Local Benefits • Leverage private capital • Create market for replacing old chillers • Enhanced competitiveness of facility owners
  6. 6. • Facility owner is reluctant to change their old inefficient chiller because – High upfront cost – High cost of borrowing – The new chiller may not provide sufficient savings (i.e., returns on investment may not be justifiable) • Grant was used to – structure the business model, project management, monitoring and evaluation and – buy down the cost of borrowing • Loan was used reduce high upfront investment cost • Equity was required as the loan only cover the purchase of the chiller. The facility owner had to finance other required auxiliary equipment and related services. • Guarantee was provided as a part of the package from qualified suppliers to ensure sufficient fund for loan repayment How different risk can be addressed by different financial instrument
  7. 7. Project Cash Flow and Risk Profile of a Typical Project (8,000,000) (6,000,000) (4,000,000) (2,000,000) - 2,000,000 4,000,000 6,000,000 8,000,000 0 1 2 3 4 5 6 7 8 9 10 11 12 13 USD Year Pre-FS Detail Design and Development Financial and Legal Arrangement Construc on Commissioning Opera on and Maintenance Major Overhual Revenue from tariff Risk Profile along the project cycle LevelofRisk
  8. 8. Exercise: How can we use blended finance to improve the outcome of a typical irrigation project? • Project: Deliver water for irrigation to increase resilient of smallholder farmer to cope with prolonged drought due to climate change • Traditional Solution: The government invests in building a reservoir and water distribution system. • Typical Challenges: – The government lacks adequate operation and maintenance expenses to maintain the asset as there is no revenue. – Since, the water is free, it is likely that its usage would not be optimized. – The system fails to deliver sufficient water to farmers. – The farmers lack new skills, know-how, financial and market access to maximize the benefit of water during the dry-spell within the rainy season and dry season. • Typical Outcome: Famers’ income and livelihood increase for a short period of time and then fall back to the level before the project when the irrigation system fails to deliver the water.
  9. 9. Example of Risk Allocation in PPP Arrangement Source: Cities Development Initiative for Asia (CDIA), 2010, CDIA PPP Guides for Municipalities http://cdia.asia/wp-content/uploads/2014/09/PPP-guide-for-municipalities.pdf
  10. 10. Basic Distinction between Public and Private Goods Divisibility of Benefits Yes No Rivalry of Consumption Yes Private Goods Common-pool Resources No Club Goods Public Goods Mobile Phone Car Clothing Food Fish Stock Timber Grass Land Satellite TV Cinema Private Park National Defense Public Area Cleansing
  11. 11. Basic Decision Tool to Identify PPP Potential Source: Cities Development Initiative for Asia (CDIA), 2010, CDIA PPP Guides for Municipalities http://cdia.asia/wp-content/uploads/2014/09/PPP-guide-for-municipalities.pdf What If, the investment can save public expenditures? What if, the investment can be done cheaper by the private party?
  12. 12. Guiding Questions for the Excercise • What risk should be managed by which party? – Government – Private Party – Financial Intermediary (National and International) – Development Partner (National and International) • What financing sources are available? – Government Budget – Grant (e.g., GEF, GCF, Adaptation Fund, Philanthropic Entity, bilateral and multilateral organization, …) – Debt (National and International FI) – Equity ((National and International Firm) • How and when each financing source should be used during the project cycle?

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