It’s been a decade since the last conference in Addis Ababa, when the “billions to trillions” vision was launched to accelerate capital flows for sustainable development. Yet the trillions haven’t materialised. This time around, participants acknowledged that more must be done to achieve the UN’s Sustainable Development Goals (SDGs) and more of the same is not an option with only five years to go until the SDGs’ 2030 goal. Various insightful events and engaging discussions outlined the nuanced issues and focused on implementation - in other words, how to raise the estimated annual USD 4 trillion in additional finance that developing economies need to make the SDGs achievable.
AFII came away from FFD4 with a reinforced belief in the power of fixed income markets to direct capital towards sustainable development at the scale needed.
Here are our key takeaways:
1. Making use of the existing bond toolkit: Green, social, and sustainability (GSS) bonds, sustainability-linked bonds (SLB), outcome bonds, and debt conversions (e.g. debt-for-nature and similar swaps) already offer a wide range of opportunities for issuers to show commitment to the SDGs and attract capital according to their specific circumstances. Standardised, replicable structures will be key to leveraging the strengths of the capital markets, as shown by the rise of labelled bonds in recent years. In the sovereign space, there are encouraging signs of momentum. Cameroon’s sustainable financing framework, Côte d'Ivoire’s sustainability-linked financing framework, and Kenya’s ongoing work on an SLB all demonstrate the potential of the market-led approach to climate and nature finance.
However, it’s also important to acknowledge that several vulnerable countries face high debt levels and constrained fiscal space as their financing needs grow. Accordingly, debt sustainability considerations and the cost of capital are critical for issuers. While there is no one-size-fits-all solution, there are promising approaches to bolster sustainable finance which could ultimately strengthen the countries’ credit profiles.
2. Risk sharing through credit enhancements: While dedicated emerging markets debt investors are usually comfortable with the risks linked to EMDEs, huge pools of capital remain unengaged on the sidelines. This is because they are not able and/or willing to invest in these markets due to limited risk-taking capacity. At FFD4, risk perception and mitigation in relation to these countries were recurring topics.
Credit enhancements could help here - in particular, guarantees are a powerful and underutilised tool that can broaden the universe of investors. Debt-for-nature swaps represent one implementation of this approach and can create additional fiscal space through the conversion of existing debt to boot. Another example in action concerns Côte d'Ivoire’s aforementioned sustainability-linked financing framework, which could result in a loan with credit enhancement from the World Bank. What’s important here is to develop blueprints that can be easily replicated as opposed to bespoke one-off transactions.
We see more innovation in this space and believe there is significant potential to scale up guarantees, particularly for middle-income countries. Alongside MDBs and DFIs, philanthropy is increasingly recognised as an important source of concessional capital for such transactions, particularly in the current environment of shrinking official aid budgets. However, it’s important to keep in mind that projects that used to be financed through official development assistance (ODA), particularly in low-income countries, often face significant challenges attracting private capital. While broadening the use of guarantees can help, they are not a panacea for all financing challenges. With the multilateral system under pressure, governments must not forget the relevance of ODA for the most vulnerable countries.
3. Empowering public development banks: This was a prominent topic at FFD4 thanks to the Finance in Common initiative. Public development banks are uniquely positioned to scale up sustainable finance and drive transformative investments. For example, national development banks can play a key role in financing SDG projects by leveraging their market expertise and ability to provide local-currency financing. Their ability to finance countercyclically is crucial too, as evidenced by past crises.
However, development banks need access to affordable, long-term funding to maximise their potential. In this context, we recently assessed the suitability of performance-linked debt structures as a source of funding for sustainable development. Combining such bonds with credit enhancements, like guarantees, has the potential to reduce the cost of capital and crowd in investors - ultimately helping issuers to achieve their sustainability goals. For further details, please refer to our report in collaboration with Agence Française de Développement.
Many other pressing issues were debated at FFD4, including debt pause clauses, currency risk management, domestic capital market development, mobilisation of local resources and MDB balance sheet optimisation. Significantly, lots of these discussions came back to the challenge of creating an enabling environment for in-need countries.
With the Sevilla Commitment and the Sevilla Platform for Action, countries have set out an ambitious roadmap. The steps in place for a paradigm shift to accelerate development finance and improve the world we live in. Let’s make it happen.
