EDFI Association                            3 February 2023

The role of European Development Finance Institutions (EDFIs)

 

 

I. European Development Finance Institutions: profile description

 

 

a)      Business model and related investment strategy overview:

European Development Finance Institutions (DFIs) are mandated by their governments to contribute to the UN Sustainable Development Goals (SDGs) and to align with Paris Climate Agreement by supporting the creation of decent jobs, boosting sustainable economic growth, and contributing to fighting climate change in low- and middle-income countries (LMICs). DFIs are an essential part of the development cooperation system in many European countries, as they contribute to building investment partnerships and long-term sustainable economic growth for LMICs.

EDFIs support the development of responsible private sector enterprises, financial intermediaries, and projects in LMICs, with the aim of having a positive impact on societies, economies and the environment. EDFIs invest in private sector operations: Whilst one of their aims is to provide a minimum financial return on investments, they also pursue a long-term investor view, seeking to create positive development impacts and positive externalities through their investments. The key principles of intervention of EDFIs are (i) their additionality to existing private finance in LMICs, including the catalytic effect that they can provide for private sector investments in target countries, (ii) the ability to maintain sustainable financial returns of investments and (iii) the development impact of their investments..

 

b)      Investment barriers, challenges in LMICs and the role of EDFIs:

European DFIs’ mission is to improve people’s lives in LMICs through the engine of private sector growth and entrepreneurship. As such, EDFIs enter markets where few others dare to tread, and where they provide long term financing at market-oriented rates. Investments in contexts that most require development support face a number of economic and financial obstacles, operational and ecosystem barriers. These challenges include, but are not limited to:

      Macroeconomic and (geo)political risk: The lack of stable economic and political environment (e.g., risks of coups d’état or increasing of protectionist measures …) in many of the developing markets negatively affects investors’ exposures and financial and non-financial risks. Geopolitical risks also represent an important obstacle when it comes to investing in LMICs, as investors may not want to be associated with specific countries for a variety of different reasons.

      Credit risk: Investors can be scared away from default risks in LMICs: this barrier plays a crucial role in preventing to tap more in international institutional assets.

      Currency/convertibility & transferability risks: In LMICs, foreign exchange (FX) volatility can be a significant drag on returns for investors. To protect themselves against this FX risk, investors can enter into hedging transactions which are costly. Related risks are convertibility (i.e. the ability to easily convert and exchange currencies), and transferability (i.e. the ability to exchange and transfer funds in local currency) which can are obstacles to investors: in LMICs, FX markets can be subject to unpredictable action by local governments (e.g. sudden controls or bans on currencies, ban of international transfers).

      Investability: Minimum investment ticket sizes required from institutional investors are often too large to be achieved by local investors in LMICs. In addition, investors often face obstacles related to the scalability of initial projects/investments, investment horizon, etc.

      Access to financial and sustainable data: In LMICs, there is a structural lack of track record data, especially for core credit risk data with details on default and recovery rates, which complicates appropriate risk pricing and represents a major obstacle when it comes to rating investment opportunities. This also applies to environmental, social and governance (ESG) data.

      Legal environment: In LMICs, investors can face several legal barriers such as: lack of appropriate regulatory and investment frameworks; licensing requirements; tax implications; currency controls (e.g., convertibility risk/limits, …); untested regulations, and unforeseen restrictions on repatriation of profits (incl. taxes, bans, …); insolvency issues (incl. low levels of predictability and legal certainty, low recovery rates …); enforceability of dispute resolution.

 

EDFIs’ business model is designed to address and/or mitigate these key risks inherent to investment operations in LMICs. Through their development mandate and public mission, DFIs have, by definition, a higher risk tolerance and a longer-term investment horizon. Thus, DFIs have the capacity to make long-term investments at reasonable rates in markets private investors usually find too risky. They are generally equipped with highly specialized and unique risk management frameworks and processes allowing them to achieve sustainable investments in LMICs.

 

Moreover, financial additionality is a central concept in development finance, related to risk appetite. The value added of DFIs is to target such markets that are underserved and whose development impact potential is high. By investing in high-risk sectors and geographies, DFIs can be financially additional. Moreover, the financial support DFIs bring to relatively high-risk projects is intended to serve as a catalyst, helping to attract and mobilise the involvement of other sources of private capital, including commercial banks, investment funds or private businesses and companies.

 

c)       Sustainability drivers

The assessment of the environmental, social and climate impacts and risks of the investments is at the core of the DFIs operations. Such assessment follows internationally recognized environmental, social and climate standards (e.g. IFC Performance Standards, International Labour Organisation Standards); According to such standards every transaction, commensurate to its risks, has to present respective assessments such as Environmental & Social Impact Assessment (ESIA), Climate Vulnerability and Risk Assessment, Strategic Environmental Assessment (SEA), gender equality assessment, etc. These respective assessments are typically subject to each participating DFIs due diligence, which includes a preliminary appraisal (screening) to determine the environmental, social and climate relevance and risks of a transaction.

Depending on the results of the screening, a decision is made regarding the extent of the in-depth assessments of possible adverse environmental, social and climate impacts as well as potential for climate protection and adaptation to climate change. If the DFIs due diligence or the climate assessment reveals adverse environmental, social and climate impacts or risks, which cannot be mitigated or modified to an acceptable level by an Environmental and Social Action Plan (ESAP) and Environmental and Social Management System (ESMS) and no adequate offset can be envisaged, the project may not be eligible for DFI funding according to its specific policies and procedures. If the project is eligible, the respective mitigation measures are typically specified in the investment agreement between the DFI and counterparty, which includes monitoring and reporting of the implementation.

In this context, the European DFIs have taken a number of steps to codify their commitment towards sustainable investments. In particular:

-        Environmental and Social Category Definitions

-        Requirements for Environmental and Social Due Diligence for co-financed projects

-        MDB IDFC Common Principles for Climate Mitigation Finance Tracking

-        EDFI Exclusion List (applicable to mutual financing activities)

-        EDFI Fossil Fuel Exclusion List (applicable to all financing)

-        Principles for impact management and impact measurement

In addition to the above, EDFI members regularly communicate publicly regarding their commitment to sustainability and good environmental, social and governance practices, including as below:

Thanks to the focus on strengthening positive climate outcomes of their investments, the 15 EDFI members realized the following impact:

 

d)      Distribution of European DFIs (EDFIs) portfolio[1] and development impact:

EDFIs work predominantly in LMICs and provide sustainable long-term financing on terms that are based on trade-offs between return, risk and development impact. In doing so, DFIs aim to crowd in private investors, supporting the alignment of private investment flows with the UN SDGs and the Paris Climate Agreement.

The aggregated portfolio of the 15 member institutions of the EDFI Association at the end of 2021 was composed of approximately 6,113 investments with a total value of EUR 48bn, which represent an increase of EUR 4.1 bn (+9%) compared to 2020 and of EUR 22 bn (+85%) since 2012. In terms of co-financing activities, a total of 542 co-financed clients received investments from two or more EDFIs at the end of 2021. Key development impact performance indicators of EDFIs are outlined in Annex 1.

Figure 1: EDFI’s aggregated investment portfolio at a glance (Source: EDFI, November 2022).

 

 

II. BII’s contribution to EDFI in an international context

 

a)      BII’s investment activity under EDFI portfolio

 

The UK’s Development Finance Institution, British International Investment (BII, formerly CDC) was established in 1948 and has been a founding member of EDFI in 1992. It is the world’s oldest DFI, as such a reference institution in development finance. BII is a Public Limited Company, wholly owned by the UK government. Its mission is to support the growth of businesses and jobs creation across Africa and South Asia.

 

BII is an important member of the EDFI network and an outlier in various sectors and impact themes as illustrated by the figures below:

 

      Largest DFI portfolio, with EUR 9.9 bn (out of EDFI total portfolio of EUR 48 bn at end of 2021)

      Largest DFI portfolio for equity and quasi-equity with EUR 6.53 bn (out of a total EDFI portfolio for equity and quasi-equity of EUR 21.95 bn)

      Largest amount of new commitments in 2021 with EUR 2.2 bn (out of the EUR 8.5 bn total new investments)

      Largest envelope of new commitments in Sub-Saharan Africa in 2021 with EUR 1.14 bn (out of a total EDFI commitment in the region of EUR 2.62 bn)

      Largest amount of investments in climate finance in 2021 with EUR 565 mln (out of a total EDFI commitment of EUR 2.3 bn)

      In the top 5 EDFIs for SME Finance in 2021 with EUR 166 mln (out of a total EDFI commitment of EUR 2.4 bn for this impact theme)


 

b)      BII's contribution in the EDFI Harmonization Initiative

 

As the largest member of the EDFI network, BII has played an instrumental role in the concretisation of the EDFI Harmonisation Initiative on Impact Measurement and Responsible Financing (i.e. the Harmonisation Initiative), which aims to deepen members’ cooperation on responsible financing requirements and impact measurement.

 

Since its launch in March 2019, the Harmonization Initiative has made significant progress in its alignment efforts. The Initiative set out to focus on five key impacts to which private sector enterprises contribute, including Gender Equality (SDG 5), Decent Work and Economic Growth (SDG 8), Reduced Inequality (SDG 10), and Climate Action (SDG 13), and to facilitate consolidated EDFI reporting of these impacts, including the open publication of many metrics. Dedicated working groups, under the supervision of a task force including senior representatives of several EDFI members, have produced technical harmonisation approaches in the below areas:

 

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Figure 2. Achievements of EDFI’s Harmonisation Initiative to date (Source: EDFI, April 2022).

 

 

c)       EDFI’s role in the EU and in the international context:

 

As their core mandate is to contribute to private sector investments in developing countries, EDFI members are committed to contribute to the following policy initiatives:

 

      the implementation of the EU’s Global Gateway strategy[2] to mobilise up to EUR 300 bn of investments in its LMICs, and the implementation of the related Team Europe Initiatives and the blended finance programme European Fund for Sustainable Development Plus (EFSD+); and

      as bilateral institutions, to the implementation of the G7 Partnership for Global Infrastructure Investment (PGII[3]), together with US, Canadian and Japanese partners, aiming at mobilising USD 600 bn of public and private investments in LMICs.

 

As a result, strengthening the partnership with the EU is one of the key priorities of EDFI, alongside the build-up of the DFI Alliance with US International Development Finance Corporation (US DFC) and FinDev Canada. The EU and the US, as well as G7 members, work together on the delivery of Global Gateway and PGII. BII, as the British DFI, is central to these efforts at international level.

 

Previous examples of international coalitions of DFIs led by EDFI, with a crucial role and contribution from BII, are presented in Annex 2.

 

III. EDFI and Blended Finance

 

In 2016, EDFI Association established EDFI MC (Management Company) as a common platform to expand partnerships with EU institutions and manage joint financing facilities. The company plays a central role in managing facilities complementary to DFIs, developed under EU-funded programmes. More specifically, it manages two EU-funded market development facilities EDFI AgriFI – The Agriculture Financing Initiative and EDFI ElectriFI – The Electrification Financing Initiative, in partnership with FMO.

 

EDFI MC also administrates two co-financing facilities among European DFIs, the European Investment Bank (EIB) and Agence Française de Développement (AFD): the European Financing Partners (EFP) and the Interact Climate Change Facility (ICCF), where BII is a partner. In addition, EDFI MC administers risk-sharing facilities, such as the T&C guarantee to tackle transferability and convertibility issues (in partnership with Proparco).

 

Moreover, as an innovative instrument under the EU’s Global Gateway strategy, the EFSD+ (European Fund for Sustainable Development Plus) is set to allow EU-based DFIs to go further and contribute more greatly and efficiently to the EU development agenda. The first call for proposals of EFSD+ has now been allocated to the EU’s implementing partners, and EDFI members and the EDFI Management Company are looking forward to contracting a total of more than EUR 3 bn allocated as budgetary guarantees across various proposals supporting investments in carbon sinks, transformation of sustainable value chains, venture capital, renewable energy and MSME access to finance. In this context, EDFI would welcome initiatives of non-EU shareholders to support their national DFIs with adequate resources to partner effectively with EU-based DFIs in the delivery of these blended finance schemes.

 

 

 

 

 

 

 

 

For more information, please contact Laure Blanchard-Brunac, Director of Policy & Partnerships, EDFI (laure.blanchard-brunac@edfi.eu) and Aklesso Tchedou, Policy Analyst, EDFI (aklesso.tchedou@edfi.eu).


 

Annex 1- Key 2021 figures on EDFI investment portfolio and development impact

 

Financial Contribution

Climate Finance: EDFI consolidated portfolio in climate finance at the end of 2021 was EUR 13.1 bn, amounting to 27% of the portfolio (2020: 20%). Direct investments in renewable energy account for nearly half of the climate portfolio, followed by investments into the financial sector/intermediaries with nearly one third. EDFIs invested EUR 2.3 bn in climate finance in 2021.

SME support: At the end of 2021, EUR 11 bn of the EDFI consolidated portfolio (representing 23%) directly supported SME financing.

Fragile states: The portfolio in fragile states at the end of 2021 amounted to EUR 3.4 bn (2020: EUR 2.8 bn).

Gender equality: 22% of 2021 new investments are gender smart (2020: 17%).

Digitalisation: Digital-related investments have been collected for the first time in 2021, they amounted to 4% of new investments.

Access to health: Health-related investments have been collected for the first time in 2021, they amounted to 6% of new commitments.

Private co-finance mobilisation: EDFI members reported a total amount of EUR 4.4 bn of total private co-finance mobilisation in new investments for 2021. EUR 2.8 bn of private DIRECT mobilisation and EUR 1.7 bn of private INDIRECT mobilisation (EUR 3 bn in 2020).

 

                   Realised Impact

Employment: 2.9 mln people are currently employed in EDFI financed enterprises and financial institutions (2.6 mln in 2020), and indirect employment effects are estimated at 47.2 mln people (8.6 mln in 2020). The indirect employment comprises jobs at enterprises receiving EDFI financing through financial institutions and investment funds, as well as employment in the relevant supply chains or enabled through better access to power and finance.

Energy production: Companies and projects currently financed by EDFI generated over 176 TWh of electricity in the last financial year for which data is available (100TWh in 2020).

GHG-emission reductions from climate mitigation projects: EDFI 2021 investments in renewable energy or energy efficiency projects reduced 7.8m tonnes of CO2 equivalent emissions per year (2020: 3.8 mln tonnes).

Gender equality: The number of gender impact focussed projects increased by 17% to 132 (2020: 113). Among EDFI investees (new 2021 investments) that report on gender indicators, 34% of employees are on average women.

Domestic resource mobilisation: In 2021, at least EUR 14.2 bn was paid by EDFI-backed business (direct investments, financial institutions and fund investees) to their respective governments in the form of taxes and fees (EUR 15 bn in 2020).

 

 


 

Annex 2: Examples of international coalition led by European DFIs, with instrumental input from BII:

 

1)      Coalition for sustainable and inclusive recovery of the private sector, 2020-2021:

 

At the first Finance in Common Summit (FICS) in November 2020, the EDFI Association, on behalf of its 15 members, together with the African Development Bank (AfDB), FinDev Canada, Islamic Corporation for the Development (ICD), U.S. International Development Finance Corporation (US DFC), and West African Development Bank (BOAD) launched a coalition for a sustainable and inclusive recovery of the private sector, later joined by the Trade and Development Bank (TDB).

Under this coalition, the DFIs all committed to dedicate at least USD 4 bn of financing to MSMEs in Africa, between mid-2020 and end of 2021. This initial target has been exceeded, whereby DFIs jointly committed over USD 5.55 bn (with a 40% increase) of financing of MSMEs in Africa over the period. In this effort, BII’s contribution has been crucial, representing 7% of the total with USD 377 mln committed over the period.

In addition to this challenge, the signatories to the coalition, including BII, committed to (i) deepen cooperation among their institutions, (ii) focus on inclusive financial solutions for the private sector and (iii) support clients with technical assistance and advisory services when needed.

 

2)      2X challenge, 2018-2022:

 

At the 2018 G7 Summit, BII joined DFIs from the other G7 countries – FinDev Canada, the United States (Overseas Private Investment Corporation – OPIC, now US DFC), Italy (Cassa Depositi e Presiti – CDP), France (Proparco) and Japan (JBIC and JICA), with support from Germany (DEG) – to launch the “2X Challenge” as a bold commitment to collectively mobilize USD 3 bn in private sector investments that provide women in developing country markets with improved access to leadership opportunities, quality employment, finance, enterprise support and products and services that enhance economic participation and access.

 

The 2X Challenge membership has ever since grown to include more institutions and investors, and has allowed the 2X Global (formerly 2X Collaborative) to emerge, with 66 members from the public and private sectors. In fact, the original target was 3x overachieved, with DFIs investing USD 6.9 bn and with co-investments taking the total to USD 11.4 bn.

 

At the G7 Summit 2021, 20 global DFIs committed to a new target of USD 15 bn for the period 2021-2022. BII and other EDFIs have maintained their commitment to the initiative and actively look for investment opportunities to address gender inequalities and empower women.

 

 

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[1] Portfolio for the purposes of this document includes undisbursed commitments and excludes non-commercial off-balance accounts. These commitments include own account commitments and commitments from off-balance accounts that are not reported as blended concessional finance and direct mobilisation.

[2] Global Gateway is the EU’s initiative for supporting infrastructure and investment in its partner countries. It is the new European strategy to boost smart, clean and secure links in digital, energy and transport sectors and to strengthen health, education and research systems across the world.  Between 2021 and 2027, Team Europe, meaning the EU institutions and EU Member States jointly, will mobilise up to EUR 300 billion of investments in these key sectors.

[3] PGII is a similar initiative launched by the G7, with a similar ambition to support large infrastructure investment globally, with a larger target of up to USD 600 billion. It is the follow-on plan to Build Back Better World (B3W) announced by US President Biden at the 46th G7 summit.