“Long-term impact matters, also on a business level!”
At a conference held by Swiss Sustainable Finance in Zurich on 16 January, 240 participants from 12 countries exchanged their views about innovative partnerships for development investments. One of the panelists was Claudia Arce, Director of South Asia at German development bank KfW who talked about her experiences with public-private partnerships.
You talked about public private partnerships at a panel today: What were your three main messages?
One: You need a translator between public and private investors because, many times, they speak a different language. Development Finance Institutions can help to bridge this communication gap.
Two: You need to balance risks. Both sides have very different notions of risks. It is crucial to balance this in a good way, to keep both sides on board of your instruments.
Three: You need to have both sides’ commitment to long-term partnerships. This is a bit more challenging with the private sector which tends to look for liquidity and return of investments rather than long-term impact.
«You need a translator between public and private investors because, many times, they speak a different language.»
Claudia Arce, Director of South Asia, KfW
How do you convince private investors that they can benefit from impactful investments?
You need to demonstrate that the long-term impact matters for their business models and that their businesses can, in fact, benefit. Often, they don’t understand the markets and, given complex regulatory frameworks, they are not even allowed to invest into risky topics. Public investors such as development finance institutions (DFIs) could play an important role in explaining and helping assess risks for investments in emerging and infant markets.
You talk about educating the private sector – have you seen some progress in the field?
Absolutely. The mindset has clearly developed over the last years. Five to ten years ago, if big private investors were investing in this type of impact investment, it was usually for marketing campaigns and brochures or to fulfill their CSR targets. This is changing. Take climate change, for instance. Many companies understand that climate change matters for their own business model, so investing in such instruments helps them to better understand the risks, which might affect them in their core businesses. We are currently witnessing a paradigm shift. These days, you hear a lot of private investors talk about impact investing, not for marketing purposes, but from the business model side. This change in mindset enables long-term partnerships with private investors.
«The mindset within the private sector has clearly developed over the last years.»
You are chairing a major climate fund set up as a public-private partnership. How is risk shared between public and private investors cooperate in this case?
In this specific model the total risk lies with the (public) C-class shares, but we have seen one investor, ASN Bank, who is changing its whole internal set-up towards climate change and climate risk. As a result, this investments fits very much in their profile. They were also willing to slightly lower their return expectations, because they feel it’s a good and long-term investment. At the same time, we still get investors who purely look at financial indicators.
What time frame do you need to allow before a public-private partnership becomes commercially sustainable, potentially making public involvement unnecessary?
My experience is that it takes longer than one tends to think for the market to obtain enough confidence and credit history to attract private investments. I would say that, depending on the market, geography and type of investments, you need to allow between 5 to 8 years before you will get enough market confidence to attract private capital.
«My experience is that it takes long for the market to obtain enough confidence to attract private capital.»
So it’s really about building a market among investors for this type of investment. Is KfW planning to expand this approach in the future?
Our role is to invest where the private sector is not working. It’s always difficult to find timing to say the market is now senior enough for us to exit. One thing we have learned, however, is that we should plan exits from the very beginning. And we should also keep the subsidy element of first-loss shares at a level where we can use it flexibly, so it isn’t fixed for the whole period. This will allow us to adapt subsidies depending on how markets develop.
The climate fund you chair is about to achieve a net asset value of USD 500 m. Why is this a milestone?
USD 500 m is an amount investors take seriously. You need volumes if you want to give investors confidence and set standards. The fund has now become a trademark in the market. For KfW, our main priority in future is to have large funds growing, even opening them up for different investments, rather than starting too many tiny funds.
What are the future plans for the climate fund?
It’s easy, really: the ultimate target is to avoid greenhouse gas generation. Therefore, the objective is to continue to grow, to improve quality and flexibility and to balance investments and financing activities. In order to achieve this, we are starting to bring in new types of investments to increase the outreach of the fund. For instance, we are increasing the share of direct investments in the portfolio.
«It’s easy, really: the ultimate target is to avoid greenhouse gas generation. Therefore, the fund needs to grow further.»