Using Innovative finance for new economic models in a new world


8th Nov 2019

Using Innovative finance for new economic models in a new world

Using Innovative finance for new economic models in a new world

“We are at the beginning of a mass extinction and all you can talk about is money and fairy tales of eternal economic growth. How dare you!” thundered climate activist Greta Thunberg at the 2019 UN General Assembly.

The Swedish teenagers stinging words couldn’t be more accurate. To achieve the Sustainable Development Goals (SDG) and address the climate crisis requires a complete overhaul of how the global economy is structured. The current economic system is not just failing the planet but the people who call it home and around the world there are calls to reboot the economic system to align with more inclusive ideas around value and social justice.

These calls coincide with the growing recognition of the need for additional investments to fund the Sustainable Development Goals. The UN estimates that $11.5 trillion is needed to achieve the SDGs and in Africa alone there is a need for $1 trillion per year to achieve the ambitious goals set out in the SDGs. There is widespread concern that without innovative approaches we will run out of money and will not be able to meet the SDGS by 2030.

When the SDGs were first unveiled there was consensus that capital from various sources would need to be mobilised to achieve the ambitious targets set by the United Nations and that innovative finance was a viable way to achieve that.

This has resulted in the emergence of a new capital spectrum that incorporates different types of investors and different capital structures that takes into account specific investment objectives as well as varying degrees of return on investment.

Historically philanthropy, grant making and commercial investment were treated as separate disciplines that championed either social change or financial gain. This is no longer the case.

New, innovative and blended financial models may offer a blueprint for how to restructure the global economy to serve more people, more effectively while also creating financial benefits.

In addition to the need for more finance there are four key issues that create the imperative for innovative finance:

  1. Impact measurement is seen as a nice to have rather than a core component of the organisation’s strategy
  2. A mismatch between funds that meet the needs of both investors and entrepreneurs
  3. The distribution of impact capital is creating the need for skilled intermediaries
  4. Lifecycle support that adapts as the business grows and develops to avoid dependency on funding.

Innovative finance includes a wide spectrum of models including blended finance, impact investment and performance based finance as well as social impact insurance, innovation lifecycle grants and event quasi NGO equity.

As the Berthe Centre for Social Innovation and Entrepreneurship’s report Innovative Finance in Africa says: “These instruments are designed not to treat impact as a side effect but as a core component of capital allocation by changing the cost of capital and return, screening out potential participants, enabling outcomes to trigger payments and putting monetary value to outcomes that were previously not valued.”

One of the future insights brought to light in Next Generation’s 2020 Research Report is the growth of the impact economy.

Fundamentally the impact economy is distinctly practical.  It aims to create a positive impact for the economy, society and the environment.  In addition it is premised on the notion of shared and blended value creation. This impact economy lies at the intersection of innovation finance, technology and human development.

The impact economy is driven by a number of innovative financial models aimed at unlocking additional capital to drive the global development agenda.

The Donor Committee for Enterprise Development’s (DCED) recent report Donor engagement in Innovative Finance: Opportunities and Obstacles provides an overview of three innovative financial models that are fundamentally changing the economic system.

1. Blended finance

Blended finance is an approach to raising or leveraging funds to attract more funding into the development sector.

So what is blended finance?

  • Blending refers to the combination of private and public sources of funding
  • It can also refer to the blending of different types of finance and the blending different financial instruments
  • The objective of blending various sources of capital in a number of ways allows for mobilisation of funds to support development outcomes.

Blended finance aims to:

  1. Attract additional funding: Extending the reach of limited development finance and philanthropic funds by leveraging larger amounts of private capital
  2. Enhance impact: The combination of development and commercial finance, coupled with the skills knowledge and resources of public and private investors can increase the scope, depth, range, impact and effectiveness of development interventions.
  3. Delivering risk-adjusted returns: Using a combination of private and public financial instruments can provide better risk mitigation for all parties, in particular serve as a guarantee to also realise return on investment in line with market expectations.

2. Impact investment

Impact investment aims to deliver both impact as well as financial return on investment. Impact investments is seen as an important tool in the development toolbox to mobilise additional capital to achieve the SDGs

Impact investing differs from other forms of capital in terms of:

  • Intentionality: Impact investors aim to address an economic, social and/or environmental challenge and impact investors invest in businesses that not only solve these challenges, but also provide a commercial opportunity which will deliver a return on investment
  • Impact measurement: Impact investors commit to measuring and reporting against specific economic, social and environmental objectives.

Impact investing has many benefits including:

  • Impact investment makes more capital available that can be blended with other financial instruments.

3. Performance based finance

Performance based finance is a term used for investments that are linked to specific impact and result objectives.  On achievement of these impact goals, funding is released.

Falling within the spectrum of results-based finance are impact bonds. According to Oxford University - Social Impact Bonds are partnerships that aim to improve the social outcomes for a specific group of beneficiaries by paying investors in social service providers for results achieved.

Delivering blended value:

One of the best ways that social and impact investors, donors and grantmakers can support the impact economy is through new innovative and blended investment models.

In addition to these highly innovative financial models there are also other ways that traditional finance is being adapted to serve social impact needs. These changes are smaller and less disruptive but are offering new sources of funding in particular for social enterprises as well as innovative solutions to scaling humanitarian aid.

  1. Debt: restructuring loan periods, interest rates, providing microfinance or even bringing guarantees onboard can help organisations access loans more easily. While venture debt - an extension of venture capital – a form of debt financing that is provided by venture-equity backed companies that can’t assess traditional debt.
  2. Equity: traditionally businesses have raised funding by trading ownership for other capital or assets. The rise of quasi-equity, where the investors receives a share of the revenue but no ownership is growing in Africa. While patient capital or long-term capital asks investors to forgo short-term profits for long-term profits allowing investees the time needed to grow to scale.
  3. Grants: within the grant space innovative models are evolving including venture philanthropy which aims to achieve high social return and enable NPOs and social enterprises to become sustainable. While innovation lifecycle grants fund the journey of social ventures from proof of concept to scale.
  4. Social fundraising and crowdsourcing are engaging individuals by raising funding from large numbers of people typically through online platforms for causes they care about personally.
  5. Peer-to-peer lending and diaspora funding platforms are alternative financial services that involves lending money directly to peers without the intermediary assistance. Peer-to-peer loans are often unsecured providing better access and better terms. While the diaspora funding platforms aim to help the diaspora invest impactfully in their home countries.

Despite the emergence of these new models, there is very limited research of how widely these models are being used. This reveals the need for organisations to commission research to get a better understanding of innovative finance, engage in forums to share knowledge and learning, promote transparency by developing tools and standards on effective practice, build the local markets of investable projects, mobilise investors and act as co-investors and take the lead in setting-up new vehicles for innovative finance.

Within this context of great innovation and rapid development there is a need to address the knowledge gaps this can be achieved by:
  • Developing an analysis of how innovative finance fits into the overall development finance toolbox
  • Deepening knowledge on specific financial instruments and investment vehicles used
  • Review mitigation strategies for specific innovative finance approaches and instruments
  • Facilitate engagement between the private sector and DFI networks
  • Commission a needs assessment on skills, capacity, systems and procedures required by donor agencies to engage effectively in innovative finance.
  • Commissioning reviews of the effectiveness of different approaches and instruments for leveraging private finance
  • Commissioning a needs assessment on capacity and procedural requirements in blending facilities and impact investors to engage in effective results measurement.

To learn more about the range of innovative finance models and how your organisation can use these to invest or grow your enterprise download the 2020 Research Report – Impact with Disruption,  here.