Blended Finance and Catalytic Capital

The opportunity for innovative blended finance structures to expand the reach and scale of impact investing is encouraging. Particular objectives such as increasing access to healthcare and affordable housing, or supporting community development, can be supported more effectively by these approaches. The GIIN is committed to continue to work with the investor community to build guidance and thought leadership around these tools.

As previously referenced above, the core characteristic of blended finance approaches is that they allow two or more investors to invest alongside each other while simultaneously targeting their own objectives. One investor can pursue market rate returns, while the other can provide sub-market rate returns in exchange for social or environmental impact. Frequently these groups will be referred to as “Private Capital,” targeting market-rate or near market-rate returns, and “Public/Philanthropic Capital,” targeting concessional, or more flexible/patient, capital returns.

A unique offering of blended finance structures is their ability to expand the definition of what constitutes a feasible investment. Certain investors may deem a particular investment unsuitable based on risk-adjusted returns. Restructuring this same investment opportunity in a blended finance vehicle provides a lower-cost layer of capital, which can enable the more risk-averse investors to reassess the opportunity as a good investment. This is an example of creating a “blended pool,” so that impact-focused investors can invest alongside a more diverse group of investors.

The scenarios below are examples of how blended finance conversations are typically triggered. Catalytic capital is used to address risks (perceived or real) facing market-rate investors and preventing them from entering into an investment. These risks could be associated with the piloting of a new business model or entrance into an unfamiliar market. 

While only a portion of the blended finance relationship, catalytic capital can play an outsized role in addressing significant challenges, such as affordable housing, supply chain sustainability, microfinance opportunities and smallholder farming. A variety of investor types are actively utilizing catalytic strategies, but due to the requirements tied to this approach, certain groups and institutions are more likely to be active in this space. Organizations like the IFC and World Bank, multilateral and development banks, Development Finance Institutions (DFIs) and institutional investors are prime examples of asset owners who are exploring catalytic innovations. Another organization helping drive the growth of catalytic capital is the John D. and Catherine T. MacArthur Foundation. Partnering with a group including other foundations, impact investors and nonprofits the John D. and Catherine T. MacArthur Foundation has launched the Catalytic Capital Consortium, C3, which, “aims to demonstrate the power of this form of investment to extend and deepen the reach of the impact investing field.”

Catalytic capital can also be used in priming early stage investments. If an investment may not yet be ready to attract risk-averse, market rate investors, catalytic capital can be used to help build the financial capacity so that overtime additional investors can be brought in. This can be especially useful in enabling investments to scale up in developing or emerging markets, where the current state of the market may limit the entry of traditional private investors. In this sense we can see catalytic capital as a tool for international development.

Investors who consciously assess financial returns alongside social and environmental impact frequently have a wider definition of an acceptable investment than those who solely measure results on financial returns. This being said, some impact opportunities may struggle to gain traction, particularly in the early stage. A variety of factors can cause this, such as high upfront costs or uncertain return potential. In such instances, the strategic use of catalytic capital can be the key to unlocking this impact. By accepting disproportionate risk and/or concessionary returns, catalytic investors can bridge the gap between grants and traditional impact investments.