- The risk perception associated with investing in emerging markets remains one of the limiting opportunities for a sustainable post-COVID economic recovery.
- Adopting a more comprehensive approach to risk mitigation is required to improve the attractiveness and business environment of a country and projects for private capital.
- Risk mitigation needs to be understood as going beyond just financial risk mitigation products, towards a broader concept of “non-financial risk mitigation measures”.
There is an ever-increasing urgency to address the barriers limiting private sector capital flowing at scale to achieve the sizeable UN Sustainable Development Goals (SDGs) in developing and emerging economies. One such barrier is the risk perception associated with investing in emerging markets, which has historically been addressed on a project-by-project basis. This remains one of the longstanding, severely limiting opportunities for a sustainable post-COVID economic recovery.
The approach to managing and mitigating risks has been focused on transaction specific solutions, typically financial risk mitigation products and measures such as guarantees. While these mitigation products are more regularly being deployed in emerging markets, these instruments impose a financial cost on a transaction, which is invariably passed onto to the end user through higher tariffs. Alternatively, the risks are perceived as either too high or too hard to assess to be acceptable for any actor, including public finance providers or impact investors.
Adopting a broader, more comprehensive approach to risk mitigation is required to improve the attractiveness and business environment of a country, sectors and ultimately projects for private capital. Risk mitigation needs to be understood as going beyond just financial risk mitigation products, towards a broader concept of “non-financial risk mitigation measures”.
Reconnecting the dots
The Global Future Council (GFC) on SDG Investments is a group of experts leading innovative thought leadership to “reconnect the dots” between countries, private and institutional investors, donors, and development finance actors to unlock capital at scale towards the SDGs. In its latest report, “Leveraging the Power of Non-financial De-risking Measures to Attract Private Sector Investment”, the GFC collectively collated a set of evidence-based principles serving as a guide to innovate and update institutional responses to risk perception.
Compared to traditional financial de-risking measures, non-financial de-risking measures encompass broader, early-stage macro or sectoral interventions to address the underlying barriers in the investment environment that impact the attractiveness of investments. Instead of focusing on specific transactions in a project-by-project manner, expanding the nature of de-risking provides a unique opportunity to crowd in more private financing for the SDGs in the places that need it most.
Further detailed in the report, non-financial de-risking measures uphold the following characteristics:
- The measures address and attempt to remove the underlying barriers that are the root causes of specific financial risks at a transaction level.
- They often have a wider focus on systemic market failures, whereas financial mitigation measures are tailored to specific transactions.
- While financial de-risking measures are effective immediately, non-financial de-risking instruments are often long term in nature. They require considerable amounts of time and effort to implement and then take effect.
- The costs incurred for such measures cannot be associated with a specific transaction and therefore cannot be ring-fenced or priced into a specific investment.
Non-financial de-risking in practice
To contextualise the impact of non-financial measures, concrete examples are showcased to demonstrate their impact. The report highlights how such measures were applied in the Colombia roads public-private partnerships (PPP) programme and South Africa’s renewable energy programme.
In the case of transport infrastructure in Colombia, access to sufficient financing faced multiple policy barriers marked by corruption and institutional capacity restrictions. To combat this, the country implemented a PPP law in 2012 that defined a clear set of guidelines for PPP and ensured a higher degree of shared risk between entities. More specifically, an infrastructure PPP came to the surface, providing a dedicated avenue for more responsible project management and enhanced credibility. The country also streamlined standards for lending contracts and closer monitoring of public resource use to address persistent transparency issues.
In the context of South Africa, where coal supplies 70% of overall energy needs, there is an increasingly urgent call to decrease reliance on fossil fuels and transition to clean energy sources. The Renewable Energy Independent Power Producers Procurement Programme (REIPPPP) was launched in 2010 to tackle the challenge and draw private capital to support the move to renewable energy sources.
As ever, there were barriers to the programme’s success that required innovative solutions to lower risk, both real and perceived, and make way for the action and impact needed. The programme’s goal – to generate 17,800 MW of electricity from renewable energy by 2030 – would only be met by rebuilding and re-establishing institutional capacity.
Since much of the country’s government agencies faced heightened scrutiny, the REIPPPP ultimately benefitted from standardised technical evaluations performed by domestic and international advisors. Additionally, a clear policy and regulatory framework, alongside revamped procurement structures and political support were other vital ‘non-financial’ measures that served to reduce the risk perception of investors. Rather, investor confidence has exponentially increased and carried South Africa closer to achieve key SDG-related objectives of its National Development Plan.
Both examples illustrate the power of combining non-financial de-risking measures to create an overall harmonious environment that is attractive to private investors and ultimately lowers the cost of financial de-risking instruments. Furthermore, the principles of non-financial de-risking encourage a shift from reactive risk management to proactive and foundational risk mitigation, providing a chance to break away from previous patterns of systemic distrust, corruption, and scepticism.
What will it take?
It is no surprise that the answer to driving solutions forward will require commitment and collaboration from all sides. The foundational and systems-driven aspect of non-financial de-risking calls for the private sector, donors, and government to align on the various attribute that will make the approach successful. The successful cases identified were the direct result of the cooperation garnered from all sides.
The good news is that there are incentives for all actors to participate, including regulations that iron out a more transparent investment landscape for all involved. The first step is to create a space for open dialogue that enables stakeholders to express core priorities, explore their capacity for operational restructuring, and identify concrete next steps.
The World Economic Forum’s Sustainable Development Investment Partnership (SDIP) is well-suited as a neutral platform to crowd-in and explore avenues for de-risking and beyond. As a joint initiative of the Organization for Economic Cooperation and Development (OECD) and the World Economic Forum, SDIP combines regional and global communities of purpose with forward-thinking thought leadership to deliver solutions and achieve impact through innovative approaches to SDG financing.