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No small change
"YOU have a lot of money stuck in some places that could be going to a better place," was Mathilde Poiraudeau's short answer to why innovative financing for development is crucial to close financing gaps.
Ms Poiraudeau is senior associate in health financing at the Asia Pacific Leaders Malaria Alliance (APLMA), an affiliation of Asian and Pacific heads of government formed to fight malaria in the region. Indeed, health and social problems in remote places in Asia often require the most critical investment capital, yet money doesn't reach them because of their risky climate. But things are changing in this part of the world, with the exponential growth of innovative financing and impact investing for development in recent years.
Innovative development financing refers to a burgeoning pool of capital that comes from sources outside government budgets and donor-country development aid. These financing mechanisms are often also the best hope for governments and communities that require finance but have fallen through the cracks of sweeping aid criteria, or simply cannot obtain enough support through traditional means to meet their needs.
In Asia, private capital is a small but steadily growing source of innovative development financing, thanks to an awakening investor conscience that investments should yield more than just financial returns.
As En Lee, partner and head of Asia-Pacific at LGT Impact, puts it: "Asia is at a very unique intersection where it has got the greatest wealth accumulation in the same place where there is the greatest need. That's never happened before."
LGT Impact focuses on private equity investments in developing and emerging countries - mostly in the healthcare, education, agriculture, energy, and inclusive finance sectors. It is the impact investing arm of private banking and asset management group LGT.
In the last 18 months, many traditional private equity managers have also set up their own impact investment funds. Most notably, TPG Growth's Rise Fund last year became the largest impact investing pool ever with a record US$2 billion collected to invest in sectors such as agriculture and food, education, energy, financial services, healthcare, technology and infrastructure.
Earlier this year, KKR & Co set up a business to invest in budding companies which have societal or environmental benefits. Other institutional investors, including pension and endowment funds, insurance, and large asset managers too, have joined the growing band of investors.
Aside from managed funds, bond financing has also emerged as a channel for those in need. In July last year, IIX's Impact Exchange, with the support of DBS Bank, created the Women's Livelihood Bond (WLB). The US$8 million debt security aims to help women in Cambodia, Vietnam, and the Philippines through better access to credit, market linkages, and affordable goods and services that will build their resilience to socio-economic shocks and stresses. The bond was listed on the Singapore Exchange.
In another variant, the social impact bond, payment to investors is linked to the social outcomes achieved. Governments or philanthropists enter into a contract with an agency providing social services, and performance targets for the services are agreed on before the institution issues the bonds. An example is the Malaysian government's Social Outcome Fund launched last year for projects that assist marginalised communities.
While wealth in Asia is still relatively young compared with its Western counterparts, Mr Lee says many families and high net worth individuals are already starting to think more deeply about their own identity and the legacy they leave behind. "Many of these families, companies and individuals have made their money in Asia, so they would have seen these problems, too - from immense poverty to environmental degradation. This is their way to try to give back.
"It's very clear now, and there is evidence and empirical data that you can do good and do well at the same time. I think that's very clear across asset classes."
Going beyond good intentions
Impact investing - investing into companies and funds to generate beneficial social or environmental impact alongside a financial return - first emerged more than a decade ago in 2007, and is only now picking up pace in Asia.
According to the Global Sustainable Investment Alliance, there is around US$70 trillion of capital circulating in capital markets, of which US$23 trillion is deployed to sustainable investments. Yet, data from the Global Impact Investing Network shows that less than one per cent of this - about US$228 billion - is invested in 'impact' assets, which are largely alternative investments into private companies and impact funds, although Mr Lee testifies that this segment has been growing "with a vengeance" in recent years.
While ESG (environmental, social and governance) investments focus on a "do-no-harm" approach, abstaining from sin industries and companies with poor governance, impact investors go beyond that to invest proactively in the solution and aim to create a positive and measurable impact, Mr Lee says.
They tend to be active investors with a clear value-creation plan throughout the life span of the investment, a long-term plan that factors in improvements in strategy, operations and financials. Often, impact investors will assume a role on the companies' boards to ensure proper corporate governance, process enhancements, and accurate reporting of financial performance as well as social and environmental outcomes.
Mr Lee cites LGT's investments in Kennemer Foods International (KFI), an agri-business in the Philippines. Agriculture in the Philippines has fragmented value chains, so smallholder farmers with small plots of land often encounter low yields and productivity, with limited access to credit, input, training and markets.
With increasing consumption of chocolate in Asia and chocolate companies hard-pressed to find high-quality and sustainable cacao, however, places like the Philippines and Indonesia can actually become prime locations for growing cacao, according to Mr Lee. "But in the past, many of these smallholder farmers didn't have the technical knowledge to grow that. They were growing very low-yielding cash crops like cassava, tapioca and corn whereas cacao is a high-yielding crop."
KFI steered smallholder farmers towards cacao instead, by providing them with high-quality planting materials, crop-appropriate financing, technical assistance, and access to global markets on fair terms. LGT's efforts since 2014 have been focused on helping KFI scale up, in the process improving the livelihoods of over 20,000 smallholder farmers in rural Philippines. These farmers have in turn planted more than 17 million trees, and increased yields up to 300 per cent.
Because of the long-term nature of the investment plan, impact investment is "patient capital", says Mr Lee. If traditional private equity capital has to wait seven to 10 years before enjoying its exit gains, what more an investment in a high-risk emerging or frontier market without much infrastructure, and bearing high risks?
And while deal sourcing is still relationship-driven as it is in private equity, "it is differentiated because you're dealing with very, very remote and hard-to-find places. The only way that you can source for strong proprietary deals is if you have strong local networks and a physical presence in the country".
With a successful investment comes the prospect that solutions can be extended, with referrals by word-of-mouth. "There are many similar problems faced in developing and emerging markets, so what we've done for cacao would be applicable for bananas and pomegranates and so forth. We really like to think deeply about finding a sustainable and effective solution that can be scaled and replicated," adds Mr Lee.
Consumers versus disease
Another form innovative financing can take is by engaging consumers and corporations, often by shaving small amounts off targeted financial transactions to fund a social cause. Effectively, it is like a tax targeted for health, education, nutrition and other development needs.
Perhaps the best-known example is Product (Red), a licensed brand owned by (Red) that partners the world's biggest brands - the likes of Nike, American Express, Apple, Coca-Cola and Starbucks - to create products where up to half the profits gained by each partner is donated to The Global Fund to support HIV/AIDS programmes.
In another example, Unitaid, a global health organisation, levies a solidarity tax on airline tickets for flights departing from about 10 participating countries. Proceeds go towards providing access to drugs for HIV/AIDS, malaria and tuberculosis.
Such an amalgamation of humanitarian aid with for-profit businesses is also coming to Asia, and what's notable is these now involve Asian money funding an Asian cause.
A couple of months ago, e-commerce platform Shopee and Singapore-listed Burmese conglomerate Yoma Strategic announced a partnership with M2030, a brand created by APLMA.
While details remain scant, Ms Poiraudeau says the collaboration will likely involve donating a percentage of proceeds from M2030 products and services to The Global Fund, that will go towards its mission to end malaria in the Greater Mekong sub-region and in Indonesia by 2030.
The task has become ever more urgent as drug-resistant forms of malaria have begun to emerge in South-east Asia, especially in the Mekong region. The disease has carry-on impacts on a region's development, tourism, agriculture and industry, and as long as it is not eliminated, intense efforts and high costs will continue to plague the country.
Innovative financing is crucial to fill the funding gap in fighting malaria. From 2018 to 2020, about US$9 billion is needed to achieve and sustain malaria elimination, but only US$1.4 billion is available from current levels of donor and government financing. The financial gap for the Asia-Pacific is about 80 per cent of the total need.
APLMA is working towards avoiding out-of-pocket costs altogether for those infected, because despite the low cost of diagnostic tests and treatment, not everyone in rural populations can afford it or will go for it because of the inconvenience of accessing a health facility.
The role of development banks
APLMA has also facilitated a partnership between The Global Fund and the Asian Development Bank (ADB). Last December, both sides signed a memorandum of understanding to support the financing, design, and implementation of country-led programmes to fight HIV, tuberculosis and malaria, and build resilient health systems in ADB member countries eligible for Global Fund financing. The two organisations are now exploring initiatives to expand health financing in the region, using both grants and loans.
One of the ways ADB facilitates innovative financing is by providing information in what it calls its knowledge products. While these are less exciting than multibillion-dollar deals, they are crucial for advocating change in the global regulatory landscape to clear the way for financial institutions to provide development financing.
For instance, the bank launched a trade register in 2010 which today is updated annually by the International Chamber of Commerce and its partners. This register contains comprehensive data of credit risks and defaults related to trade and export finance, which go a long way in helping financial institutions calibrate capital costs to supporting trade.
For its maiden report, ADB pulled data on the trade finance transactions of major banks over a five-year period and came out with the first-ever statistics on global trade finance - showing the risk profile to be extremely low, with default rates between 0.02 per cent and 0.05 per cent on about 60 per cent of global trade finance transactions.
That raised questions on why banks were not supporting more trade finance transactions in emerging countries if the risks were so low. It also suggested that the capital requirements for trade finance transactions under the Basel II framework did not reflect the low risk-profile of the activity.
"This innovative product that we created has had a positive regulatory effect and has unleashed billions of dollars to support trade finance and helped to close gaps," says Steven Beck, head of trade and supply chain finance at the ADB. "We have also been able to draw in more private sectors into our developing member countries to support more trade as a result."
Another knowledge product it is working on is a regulatory scorecard, to be launched in September, to score national regulators' compliance with anti-money laundering and terrorism financing regulations against international guidelines.
While seemingly simple an idea, it actually overcomes one of the greatest impediments to trade finance: the costly process of conducting due diligence on SMEs and banks in emerging markets, and the varying know-your-customer requirements in different jurisdictions.
Learning in progress
Can most social problems can be solved with innovative development financing? Belinda Chng, director of policy and programmes for Asia at think tank Milken Institute, says: Only partly, as many of these social problems also have to do with behavioural habits and other impediments that need to be addressed through other means.
Milken is currently working on a pilot project with Indonesia's health ministry to test an innovative financing solution to improve the affordability of new vaccines, ahead of the government's 2020 timeline for the unveiling of its five-year healthcare budget. It had found that while vaccinations are a huge life-saver in the global fight to reduce mortality from infectious disease, strains on public health budgets, depreciating currencies, and budget austerities often limit coverage, even for children and adults who otherwise have access to health care.
But cost is only one reason why more people don't get vaccinated. There are also religious concerns, particularly for Muslims unsure whether a vaccine may be haram (forbidden) or not halal (permissible for ingestion). Others worry about a day's loss of income if they take their children to the clinic for a vaccination.
Ms Chng believes that for every success story that makes a headline, there are many that fail that people don't talk about. Reasons for failure run from miscalculations in the design of a bond to over-estimation of the outcome that a programme might generate, for instance.
But at this stage, a failure is probably not taken as too hard a hit, especially as the development financing asset class is still starting up in Asia and going through trial and error.
Ultimately, such investments are fuelled by a mix of both reward and altruism, Ms Chng reckons. "For people like philanthropists, they can accept a 1-2 per cent return. People who are used to traditional giving would be happy just to get some of that returns back and reallocate the rest, so that their giving can be more sustained."
Most other impact investors expect risk-adjusted market returns which are commensurate with private equity deals, varying with the country, investment stage, and sector, and to some extent, also the business model.
As management consulting firm McKinsey puts it: "Taking a chance with new finance mechanisms may lead to some failures, but one big success can be a global game-changer. Each step along the way can help enrich the global development community by pulling in new resources and helping existing stakeholders work better together."