DFIs are reinventing themselves to become major impact investors

As more capital becomes available from investors willing to take greater risks in emerging markets, the space historically occupied by development finance institutions (DFIs) as capital providers is getting crowded. With deepening knowledge of the climate crisis and growing social inequalities, national governments expect their DFIs to go beyond solely being capital providers, bringing DFIs to an inflection point in their evolution.

There is increasing space for private sector development, which requires expertise, capital and strong relationships with market actors. This space sits between the traditional grants or loans for development and market-rate investments. At this inflection point, how will DFIs continue to be relevant in the capital markets? One opportunity is to increase their value-add as investors, building expertise in private sector development, both directly through their portfolios and at a market level. What have DFI’s learned so far to inform this next transition?

In 2018, the CDC Group, the UK’s development finance institution, formally launched a new vehicle, CDC Plus, to scale up its role as a value-adding investor. CDC Plus has committed over $50 million to more than 250 projects. It aims to make a lasting difference to the lives of under-served groups by increasing economic opportunity, improving standards of living and creating a more sustainable environment.

The following four lessons – derived from facilitated workshops within CDC Plus – crystallise its strategic thinking on delivering best-in-class technical assistance (TA). What emerges from these lessons is a deeper consideration not only of what we fund, but also of how we fund and with whom.

 

  FOUR LESSONS ON PROGRAMMING TECHNICAL ASSISTANCE   1) Prioritise your impact goal over specific activities and outputs

It is critical from the onset to clearly and succinctly articulate the overall impact goal of a project and ensure that all parties agree to it. This goal may be articulated by the TA recipient or co-created with partners, including end-users in the project. Based on this goal, the TA recipient should articulate a logical understanding of the project’s intended outputs, outcomes and impact.

An impact measurement approach should be built for the project, including tools such as the theory of change or impact metrics. These build on the goal to provide clear signposts whereby, as a project is implemented, there is progress towards the impact goal.

When projects are “impact-led”, they can be designed flexibly to allow adaptation over time. This flexibility can be achieved by structuring the project in multiple “phases”, allocating an overall funding envelope, rather than an activity-based budget, or taking an adaptive management approach.

The design should allow for flexibility in activities and outputs on route towards the impact goal. These approaches make it possible to test the assumptions that underpin interventions. However, they may not always be appropriate, and for those who are new to TA, flexibility can be challenging to manage effectively.

  2) Beware of "cookie-cutter" solutions – ta initiatives should be problem-, rather than solution-driven

On a fundamental level, many TA projects focus on providing support for behavioural change for a company's leadership, employees or customers. However, at the onset of a project, the barriers to behavioural change are often under-researched or poorly understood.

Grant funders are frequently approached with pre-packaged solutions that service providers seek to test in the market, touting that these will lead to the desired behavioural changes.

CDC Plus has observed that “solution-based” interventions (rather than self-identification by companies of problems they need to address) are less effective and less sustainable. For example, staff training is often proposed as “the solution”, without understanding the root causes of why staff members are not able to change their behaviour. When the root causes are not understood, the nuance of hyper-local context is missing.

CDC Plus has tested two approaches that are effective in guiding projects to a “problem-driven” approach. - Using “design phases”: A project is structured in phases, the first of which entails diagnosis of the company's problem. This includes collecting data from key stakeholders and deskbased research (e.g. interviews, surveys, and an evidence review).

The project is then designed based on this real-time data. A design phase may reveal that a full project is neither needed nor appropriate, which is an acceptable outcome (e.g., with feasibility studies). - Using ‘trusted advisors’: Industry experts and CDC’s Country Coverage are integrated into the project or consulted to bring deep-sector and geographic expertise.

For example, during CDC Plus’ COVID-19 emergency response, a private sector healthcare expert specialised in African healthcare supply chains participated in project screening. To save time, there can be pressure to skip stakeholder consultations; however, observation confirms that consultations almost always inform changes to project design.

  3) DFIs can play a strong partnership role in market-shaping activities, bringing together the public and private sectors, as well as the third sector around common goals

As DFIs invest with a poverty alleviation focus, the importance of identifying ways to direct capital to companies in fragile states and nascent, inclusive sectors1 is critical. Given that the investment mandates of DFIs are expanding to include markets that are more challenging for commercial investment, they are seeking to collaborate and engage other market actors. TA can be used for convenings, partnerships and risk mitigation in these more challenging contexts.

‘Market-shaping’ initiatives aim to influence business and investment markets in ways that enable local private sector actors to perform more effectively, while lowering investors' risk perception. Market-shaping can address systemic failings such as absent supporting industries, gaps in local talent, and ineffective regulatory environments.

Addressing these systemic failings offers a wider potential for impact and often poses a cost or risk that is too great for individual companies and investors to bear directly. CDC Plus has piloted various market-shaping initiatives, including in South Asia, Nepal Invests and the Myanmar Private Equity and Venture Capital Association, and in Africa, the Global Off-Grid Lighting Association, an Africa-focused industry body for the off-grid solar sector.

Through these initiatives, CDC and other DFIs have leveraged their convening power to bring together local and international governments, local private sectors, philanthropists, and international investors. Bringing these groups together around a common dialogue or structured partnerships is enabling CDC and others to pilot solutions to investment bottlenecks.

CDC Plus has observed that market shaping activities require flexible, longer-term funding, as a collaboration-based approach is inevitably slower and more complex. Budgets should also be allocated for partnerships with others, as well as for learning and research.

  4) New ventures must test customers' willingness to pay early on and have a plan to reach commercial sustainability, to reduce subsidy dependence over time

CDC Plus has funded a variety of new ventures, ranging from entirely new social enterprises (such as the Boardroom Africa) to products offered that address a market gap (such as Atlas, an independent microfinance data platform).

The new ventures were typically nascent, offering an unproven product or service and relatively high risk; hence the need for subsidy. There were challenges faced both by CDC Plus and those launching these ventures of matching a grant funding model with an early business model. These included:

- Permitting the enterprise sufficient flexibility to change its business model, often in material ways,

- The need for an adaptive monitoring approach by CDC Plus, rather than a KPIbased approach,

- Enterprises waiting too long to identify the target customer set and to test their willingness to pay for the products or services.

Whilst the majority of new ventures were successful in identifying an appropriate business or funding model, standard project management processes did not enable sufficient flexibility in this process. For DFIs to provide core operational funding to new ventures requires changing project management structures and being realistic about a longer timeframe for results.

Additionally, it should not be assumed that all grant-funded ventures will find a commercial model – some social and environmental problems remain beyond the scope of investment and may require subsidy or a hybrid concessional model for years to come. In the future, DFIs must explore how other financing tools, such as concessional finance or repayable grants, may be more appropriate for funding new ventures.

 

 CONCLUSION

CDC Plus is one of the youngest TA units within a DFI (only three years old), but to date, fortunately, it has been well-funded and given a broad mandate. Deploying grant funding is not easy. Yet CDC Plus seeks to minimise the use of subsidies and the risk of misusing funds, whilst striving for maximum value for money and impact. It is tempting to look for predictable solutions, such as “cookie-cutter” TA products, prescriptive budgets and KPIs, and onerous grant funding processes.

These lessons suggest that providing TA entails a nuanced approach to what is needed and how it is structured and paid for. This is time-consuming (e.g., resource-intensive), but it pays off. In return for the privilege of access to these resources, there is an imperative to ensure ongoing learning, adapting ways of working and sharing discoveries.

Integrating a culture of learning into how CDC Plus operates has required hard work, which will continue. Others are encouraged to do the same, so that DFIs and impact investors can continue to innovate and continue to add value in the capital markets.