- The perception of risk associated with investing in emerging markets remains one of the limiting opportunities for a sustainable post-COVID economic recovery.
- Adopting a more holistic approach to risk mitigation is necessary to improve a country’s attractiveness and business environment and private capital projects.
- Risk mitigation should be understood as going beyond just financial risk mitigation products, to a broader concept of “non-financial risk mitigation measures”.
Overcoming the obstacles that limit large-scale private sector capital flows is increasingly urgent to achieve the United Nations Sustainable Development Goals (SDGs) in developing and emerging economies. One of these obstacles is the perception of risk associated with investing in emerging markets, which has always been dealt with on a project-by-project basis. This remains one of the long-standing and severely limiting opportunities for a lasting post-COVID economic recovery.
The risk management and mitigation approach has focused on transaction-specific solutions, typically financial risk mitigation products and measures such as guarantees. While these mitigation products are more regularly deployed in emerging markets, these instruments impose a financial cost on a transaction, which is invariably passed on to the end user through higher tariffs. Alternatively, the risks are perceived as too high or too difficult to assess to be acceptable to any actor, including public funders or impact investors.
Taking a broader and more holistic approach to risk mitigation is necessary to improve the attractiveness and business environment of a country, sectors and, ultimately, private capital projects. Risk mitigation should be understood as going beyond just financial risk mitigation products, to a broader concept of “non-financial risk mitigation measures”.
The Global Future Council (GFC) on SDG Investments is a group of experts leading innovative thought leadership to ‘reconnect the dots’ between countries, private and institutional investors, donors and stakeholders. development finance to unlock large-scale capital for the SDGs. In its latest report, “Harnessing the Power of Non-Financial Risk Reduction Measures to Attract Private Sector Investment,” the GFC has collectively assembled a set of evidence-based principles to guide innovation and update institutional responses to risk perception.
Compared to traditional financial risk reduction measures, non-financial risk reduction measures encompass broader and early-stage macro or sector interventions. to remove underlying obstacles in the investment environment that impact the attractiveness of investments. Instead of focusing on specific transactions in a project-by-project manner, broadening the nature of risk reduction offers a unique opportunity to attract more private finance for the SDGs to the places that have it most. need.
In more detail in the report, non-financial risk reduction measures have the following characteristics:
- The measures address and attempt to remove the underlying barriers that create specific financial risks at the transaction level.
- They often focus more broadly on systemic market failures, while financial mitigation measures are tailored to specific transactions.
- While financial risk reduction measures take effect immediately, non-financial risk reduction instruments are often long-term in nature. Their implementation and entry into force require considerable time and effort.
- The costs incurred for such measures cannot be associated with a specific transaction and therefore cannot be confined or measured in a specific investment.
Reducing non-financial risks in practice
To contextualize the impact of non-financial measures, concrete examples are presented to demonstrate their impact. The report highlights how these measures have been applied in Colombia’s road public-private partnership (PPP) program and South Africa’s renewable energy program.
In the case of transport infrastructure in Colombia, access to sufficient financing has faced multiple political obstacles marked by corruption and restrictions on institutional capacity. To combat this, the country implemented a PPP law in 2012 that defines a clear set of guidelines for PPPs and ensures a higher degree of risk sharing between entities. More specifically, an infrastructure PPP has emerged, offering a dedicated avenue for more responsible project management and increased credibility. The country has also streamlined standards for loan contracts and closer monitoring of the use of public resources to address persistent transparency issues.
In the context of South Africa, where coal provides 70% of global energy needs, there is an increasingly urgent call to reduce dependence on fossil fuels and shift to clean energy sources. The supply program for independent renewable energy producers (REIPPPP) was launched in 2010 to rise to the challenge and attract private capital to support the switch to renewable energy sources.
As always, there were obstacles to the success of the program that required innovative solutions to reduce risks, real and perceived, and make room for the necessary action and impact. The program’s goal – to produce 17,800 MW of electricity from renewable energies by 2030 – would only be achieved by rebuilding and re-establishing institutional capacity.
As much of the country’s government agencies came under scrutiny, the REIPPPP ultimately benefited from standardized technical assessments carried out by national and international advisers. In addition, a clear policy and regulatory framework, as well as redesigned procurement structures and political support were other vital “non-financial” measures that have served to reduce investor risk perception. On the contrary, investor confidence has grown exponentially and brought South Africa closer to meeting the key SDG-related goals of its national development plan.
Both examples illustrate the power of combining non-financial risk reduction measures to create a harmonious overall environment that is attractive to private investors and ultimately lowers the cost of financial risk reduction instruments. In addition, the principles of non-financial risk reduction encourage a shift from reactive risk management to proactive and fundamental risk mitigation, offering a chance to break with previous patterns of systemic mistrust, corruption and skepticism.
It’s no surprise that the answer to the search for solutions requires commitment and collaboration from all sides. The fundamental and systems-oriented aspect of non-financial risk reduction calls on the private sector, donors and government to align with the various attributes that will make the approach successful. The success stories identified are the direct result of cooperation gathered from all sides.
The good news is that there are incentives for all players to participate, including regulations that smooth out a more transparent investment landscape for all parties involved. The first step is to create a space for open dialogue that allows stakeholders to express their core priorities, explore their capacity for operational restructuring and identify concrete next steps.
The World Economic Forum’s Sustainable Development Investment Partnership (SDIP) is well suited as a neutral platform to attract and explore avenues for risk reduction and beyond. As a joint initiative of the Organization for Economic Co-operation and Development (OECD) and the World Economic Forum, the SDIP connects regional and global communities of interest with forward-thinking thought leadership to deliver solutions and achieve impact through innovative approaches to financing the SDGs.
This is an annual meeting showcasing the best examples of public-private cooperation and Fourth Industrial Revolution technologies used to develop the sustainable development agenda.
It runs alongside the United Nations General Assembly, which this year hosts a one-day climate summit. This is timely given growing public fears – and citizen action – about weather conditions, pollution, healthy oceans and dwindling wildlife. It also reflects the understanding of the growing business case for action.
The UN Strategic Development Goals and the Paris Agreement provide the architecture to resolve many of these challenges. But to get there, we need to change the way we produce, operate and consume.
The work of the World Economic Forum is essential, with the summit providing the opportunity to debate, discuss and engage on these issues at the global political level.
To take this work forward, the SDIP Africa Hub strives to create this space by introducing ‘Sprints’ – an initiative designed to enable cross-sectoral stakeholders to review the principles of thematic non-financial risk reduction measures. specific to the regional level. . In fall 2021, SDIP will launch the Affordable Housing and Small and Medium Enterprise (SME) Sectors Initiative in the Africa region, both highlighted in the recently launched Country Financing Roadmap for SDGs: Ghana Analysis Report.