The urgency of climate change has never been more apparent, with record-breaking temperatures and unprecedented environmental challenges. While political headlines often dominate the news, the true crisis lies in the escalating climate emergency. Addressing this requires a monumental shift in how we mobilize private capital for sustainable development, particularly in emerging economies.

Transforming the Landscape of Development Finance to Meet Climate Challenges

Arctic Anomalies Signal Alarming Climate Trends

The Arctic region, known for its harsh, icy conditions, is now experiencing an alarming anomaly. In Svalbard, located deep within Norway's Arctic Circle, temperatures have soared approximately 20 degrees above historical norms. This unexpected warmth mirrors London’s winter climate, highlighting the dramatic shifts occurring in our planet's most sensitive regions. The implications are profound, signaling an urgent need for immediate action on climate finance.Climate scientists express bewilderment at the extent of these changes, underscoring the unpredictability and severity of global warming. Despite ongoing political discussions in Washington, the climate emergency continues unabated. The Independent High-Level Expert Group on Climate Finance estimates that emerging economies (excluding China) require up to $2.5 trillion annually by 2030 to combat climate change effectively. Mobilizing such vast sums necessitates tapping into the substantial pools of capital held by pension funds, life insurers, and other institutional investors.

Revolutionizing Development Finance Models

Development Finance Institutions (DFIs) like British International Investment (BII) must evolve their traditional "buy-to-hold" approach. Historically, DFIs have invested capital independently, holding onto investments for extended periods. While this model has generated significant impact, especially in markets lacking long-term capital, it struggles to scale due to limited balance sheet sizes.To address today's immense climate and development challenges, DFIs must act as catalysts for private capital. By leveraging private investment, DFIs can amplify their impact far beyond what their own resources allow. BII's recent initiatives exemplify this shift. For instance, the £100 million boost for MOBILIST aims to unlock between £400 million and £600 million in additional investment toward achieving the UN’s Sustainable Development Goals (SDGs). Similarly, the partnership with Mercer to launch a global competition seeks to attract hundreds of millions of dollars into climate investments in emerging markets.

Risk Perceptions vs. Reality in Emerging Markets

Private investors have long hesitated to allocate large sums to emerging markets, citing perceived systemic weaknesses across risk-return-liquidity-professional management metrics. However, these perceptions may be overstated. Over the past two decades, emerging market equity markets have matched U.S. stock market growth and outperformed other developed equity markets. Moreover, emerging market sovereign bonds have surpassed the performance of U.S. Treasuries and other developed sovereign bonds over the last decade.The risk associated with private debt originated by DFIs and multilateral development banks in emerging markets is comparable to that of B-rated corporate debt portfolios. Liquid products, including corporate and sovereign bonds, thrive in some markets, while secondary market transactions are on the rise. Professional asset managers specializing in emerging markets, such as Meridiam, Helios, and AIIM, have emerged alongside major global players like BlackRock and Macquarie, expanding their focus on these regions.

Strategic Actions to Unlock Capital Flows

To unlock the flow of capital to emerging markets, DFIs must take several strategic actions. First, they should regularly distribute new investments to asset managers who excel in fundraising and fiduciary management. Second, concessional finance through structured funds or guarantees can provide essential risk protection, encouraging hesitant investors. Third, improving the availability of empirical data on emerging market asset performance will enhance transparency and confidence.Furthermore, DFIs should explore innovative funding models, leveraging access to capital markets to maximize shareholder equity while maintaining a healthy risk appetite. If DFIs systematically distribute half of their new investments, hold the retained amount for half as long, and leverage their balance sheets 1:1, they can create eight times the impact per shareholder dollar. This scaling potential offers a promising path forward for both BII and the broader DFI community.