Opinion and Analysis: Using public-private partnerships to scale up grassroots climate finance in Asia
It is often said that realizing a 1.5-degree global warming scenario will require a tectonic increase in private sector capital flowing toward low-carbon development. One strategy to facilitate private capital flows is to use public funding in public-private partnerships to “crowd in” private capital that otherwise would not have been mobilized – what is increasingly known as “blended finance.”
We can look at the amount of private sector capital going to public-private partnerships to roughly gauge the extent to which “crowding in” is happening. Data show that between 2017 and 2018, only 3% of privately sourced climate finance funds went to public-private partnerships.1 This implies that public actors may not be doing enough to mobilize private sector capital in climate finance, or that sources of private capital have low confidence in such public-private partnerships, perhaps due to public entity’s lack of track record or limited technical capacity. Resolving these challenges will be important to stimulate global scale up of climate finance.
A model for local climate finance public-private partnerships
This thought piece explores a model unfolding in Mongolia that could potentially be replicated to increase the crowding-in of private climate finance in public-private partnerships in emerging markets: the Mongolian Green Finance Corporation (MGFC).
The MGFC aims to be a first-of-its-kind national financing vehicle in the region with a mandate to mobilize local and international capital toward climate change mitigation and adaptation in Mongolia. On November 13, 2020, the MGFC secured approximately $27 million USD in seed funding from the Green Climate Fund (GCF). The GCF award marks a key milestone in the establishment of MGFC. The funding will be used for a wide-ranging public-private partnership including equity investments from the Mongolian Ministry of Finance and Mongolia’s commercial banks, and debt financing through the Mongolian Ministry of Environment and Tourism.2
The GCF was established in 2015 under the United Nations Framework Convention on Climate Change to channel funds from developed nations toward climate change mitigation and adaptation in developing nations.3 Over the years, the GCF has become a key player driving climate finance activity in emerging markets. Its ambitious objectives, multilateral backing, and historically time- and resource-intensive accreditation and project development processes make any GCF Board Approval a milestone of note. Furthermore, its greenlighting of MGFC is a signal of confidence to local partners in the public-private partnership and to future entities interested in supporting MGFC’s eventual scale-up.
The MGFC is a unique example of a public-private partnership with a crowding-in effect because of its wholesale lending structure and grassroots origins.
MGFC’s wholesale lending model4
A distinctive trait of the MGFC is its wholesale lending model. XacBank, a Mongolian commercial bank, has demonstrated local market feasibility of programs providing concessional retail and corporate loans with emissions reduction criteria directly to end users (households, small businesses, and corporations).5 In contrast to the retail and corporate loan model, the MGFC will disburse funds to participating financial institutions (PFIs) (i.e., commercial banks) on a wholesale loan basis for them to disburse through retail and corporate loans to clients in accordance with each bank’s internal policies and procedures as well as a participation agreement between the MGFC and the PFIs. See Figure 1 for a flow of funds diagram.
This model enables Mongolia’s entire banking sector to have access to concessional climate finance from the GCF while circumventing the need for each bank to go through a several-year GCF accreditation process. It effectively layers a climate finance funnel on top of Mongolia’s already-established commercial banking infrastructure, lessening the new entity’s administrative and regulatory burdens.
Figure 1 – MGFC project flow of funds diagram6
Phase 1 of the MGFC’s implementation (enabled by this initial capitalization) will focus on thermal insulation for housing, energy efficiency for large energy users, and mortgages for affordable green housing. These three focus areas were deliberately chosen because of alignment with priority market needs, the relative technical simplicity of calculating their emissions impacts, their respective sector’s high contribution to local emissions, and the fact that they build on prior local project successes.
In addition to doing wholesale lending to PFIs, the MGFC will use grant funds during Phase 1 to address technical gaps through capacity building and platform development. This will enable PFIs to better assess, track, and report on green lending activities. XacBank will be responsible for capacity building implementation, due to its decade-plus experience pioneering green lending programs and, in recent years, executing GCF-funded projects in Mongolia.
After demonstrating successes in the wholesale lending model and in the improved sector-wide capacity, the MGFC’s mid-to-long-term vision is to attract other sources of investment-grade private capital for Phase 2 and Phase 3 of implementation. During later phases, the MGFC can evolve to resemble a Fund of Funds model, with an expanded project pipeline utilizing more varied financial mechanisms (e.g., equity, guarantees, or mezzanine debt), enabling greater opportunities for risk mitigation and portfolio diversification. This will come with broadened sector focus, potentially targeting organic waste recycling, sanitation, green textiles, large-scale renewable energy projects or related transmission infrastructure, apartment building retrofits, or agricultural projects.
The MGFC’s revolving structure offers climate impact performance advantages. Each dollar of initial debt financing will be repaid and relent multiple times over the institution’s indefinite lifetime. This results in higher greenhouse gas emissions reduction per dollar of initial financing than is typical of a one-off project. The revolving nature of the fund, as well as a requirement that 30% of each retail sub-loan is co-financed by the PFI and 30% covered in a down-payment by the end-user, means each dollar of the GCF’s financing investment mobilizes more than a dollar of private, non-concessional capital.7
The MGFC will be established as a non-banking financial institution (NBFI), as no other legal structure currently exists under Mongolian law that is better suited for the MGFC’s model. However, the current local laws governing NBFIs generally restrict single borrower exposure and single related party (i.e., shareholder) exposure to 30% and 10% of the NBFI’s total capital, respectively.8 Since these restrictions could limit the MGFC’s activities in the long term, the MGFC plans to work with the government to amend the relevant laws or even to legally establish the MGFC under a new Parliamentary statute. There is global precedent for this, as seen by the U.K.’s Green Investment Bank and, more locally, the Development Bank of Mongolia.9
An example of grassroots sustainable finance
Mongolia’s continental climate and traditionally rangeland-dependent livelihoods make it particularly vulnerable to the effects of rising global temperatures. The country has already experienced warming more quickly than the global average, with an increase of over 2 degrees Celsius since the 1940s.10 Warming temperatures and rangeland desertification put pressure on traditional rural livelihoods, driving rural-urban migration and a host of related socioeconomic and infrastructure challenges in the capital city, Ulaanbaatar. These conditions have made climate and sustainability priority action areas for the government and private sector, evidenced by a proliferation of climate-related policies and targets (such as a recent increase to Mongolia’s emission reduction target under the Paris Agreement).11
This top-down focus on climate has created fertile ground for the MGFC. In particular, the MGFC is the culmination of a years-long, locally led sustainable finance movement spearheaded by the Mongolian Sustainable Finance Association (MSFA, locally known as “ToC”). The MSFA catalyzed adoption of sustainable banking principles across all of Mongolia’s commercial banks in 2015 and since then has done trainings for thousands of Mongolian banking professionals in a persistent climate finance capacity building effort.12
In addition to its private sector work, the MSFA has supported local government in strengthening the relevant policy framework. Notably, it helped develop a green taxonomy for Mongolia’s banking sector. The Government of Mongolia approved the green taxonomy in December 2019, obligating all commercial banks to report on lending activity across eight categories encompassing 58 green activities.13 This shared taxonomy allows for tracking of private sector green project activity, which in turns allows for better-informed regulations and capacity building.
Learnings from the MSFA’s years-long effort at the nexus of the private and public sector have fed directly into the MGFC’s design, particularly its capacity building elements, the inclusion of commercial banks as equity investors, and the use of wholesale lending to improve sector-wide access.
From approvals to implementation
The MGFC’s task will not be easy. Only about 2% of the Mongolian banking sector’s portfolio is classified as “green” under the current taxonomy.14 Increasing that percentage will need to go hand in hand with improved technical capacities for monitoring and evaluating emissions impacts beyond renewable energy and energy efficiency projects.
That said, the public-private partnership allows the MGFC to occupy a unique space in the market. Involvement of an institution such as the Green Climate Fund signals confidence to both the Government of Mongolia as well as future potential investors. Occupying a middle ground between the public sector and private sector PFIs means the MGFC can facilitate cross-sectoral policy dialogue. Finally, utilizing a wholesale lending model with commercial banks enables high market penetration without the administrative and regulatory burdens associated with retail and corporate lending.
Other developing countries seeking to crowd in private climate finance should take note of this grassroots collaborations-driven, wholesale lending-based public-private partnership poised to accelerate Mongolia’s climate finance trajectory.
1 Source: Climate Policy Initiative Global Landscape of Climate Finance 2019, pg. 26
2 Source: Green Climate Fund MGGC Project
3 Source: Green Climate Fund Brief
4 Note: This section’s discussion of the MGFC model is primarily based on my own work on the project from 2018-2020 as well as more recent discussions with the project officers. Where possible, I provided links to sources that are publicly available at the time of writing this piece. Other details can be explored further once the public version of the MGFC Funding Proposal is published on relevant project pageon the GCF’s website.
5 Source: Green Climate Fund MSME Business Loan Program for GHG Emission Reduction
6 Source: MSFA, December 2020
7 Choi and Seiger (2020) discuss the flaws of relying on leverage ratios in evaluating blended finance projects. That a range of factors can influence the calculation of leverage ratios renders them less useful as a standard metric for evaluating the effectiveness of any given blended finance effort and draws attention away from important qualitative considerations. Nonetheless, mobilizing more than one dollar of additional capital is a directionally encouraging signal."
8 Source: Legal Info (in Mongolian), The Law on non-Bank Financial Institutions (pdf, in English)
9 Source: Commons Library Research Briefings
10 Source: Climate Change in Mongolia: Outputs from Global Climate Model, p.5
11 Source: Mongolia and Thailand Update NDCs, Pledge to Up Targets with Technological and Financial Support
12 Source: Author correspondence with MSFA officials, December 2020
13 Source: Trends in Taxonomy Development and Lessons from Emerging Markets p.16
14 Source: Banks Green Credit Report
