Investing for impact The 50 Trillion Dollar Question: Closing the emerging markets’ capital gap

The 50 Trillion Dollar Question: Closing the emerging markets’ capital gap

There is a growing need to increase the investment in sustainable projects in emerging markets. But how do we make that a reality?

Just ten per cent of global sustainable investments are made in developing economies in Middle East, Africa and South America according to our recent survey of the world’s top asset managers. And during the pandemic, the already pronounced capital gap between developed and emerging markets has widened further.

The UN estimates that less than 60 per cent of the funding required to reach the Sustainable Development Goals (SDGs) in low- and middle-income countries was being met before 2020. In Africa, it’s as little as 10 per cent.
With developing economies critical to hitting the SDGs, we are not on track to meeting the 2030 SDG deadline – and the same goes for the Paris Agreement which aims to prevent global warming.
We need a fundamental shift in where money is invested to make real progress on creating a more sustainable world. And the finance community must pull together to turn that corner.

Therefore, we need to expand our investment toolkit for emerging markets, support international investors deploy their capital in a responsible manner and help potential investee companies and countries present themselves in a more favourable light, reflecting their true potential more accurately.

Why we need to shift investment to emerging markets

Emerging markets face the biggest risk from climate change but have the greatest opportunity to leapfrog to low-carbon technologies. However, even though sustainable finance has been undergoing unprecedented growth, the funds are not flowing to the markets that are most in need.

The 50 Trillion Dollar Question, a survey we conducted among the world’s top 300 investment firms with assets under management of more than USD50 trillion, found that more than two-thirds of their investments are held in Europe and North America, with only 5 per cent in the Middle East and Africa combined. Only 13 per cent of the panel’s AUM is currently directed towards SDG-linked investments.

Despite the funding gap, 88 per cent of investors said investments in emerging markets have matched or outperformed developed markets over the past three years. So, what’s keeping asset managers from committing more funds to emerging markets?

Putting together the right ‘toolkit’ for emerging-market investments

One of the biggest obstacles remains the perceived risk associated with emerging markets, such as political volatility, creditworthiness and environmental risks. There are several ways in which these concerns can be addressed.Government policy reforms can play a critical role. As Karin Finkelston, Vice President, Partnerships, Communication, and Outreach at the International Finance Corporation (IFC) recently highlighted, this is central to helping catalyse private sector investment.

First, we need to make these projects or these companies attractive to investors. And second, they are perceived as quite risky. So how can we help reduce the risk and give incentives to investors? Blended finance is one approach which we pursue in the Climate Finance Partnership with anchor government and foundation investors who underwrite some of the risk.

Thomas Fekete
Head of Sustainable Investment Solutions for EMEA and APAC at BlackRock

Blended finance has become an increasingly popular route towards de-risking emerging markets investments, by sharing the risks with development banks or multilaterals. But, as Karin Finkelston of IFC noted, this is not a panacea.“What’s really important is that we use these blended finance tools carefully,” she explained. “We are trying to create markets that will eventually support the economies without over-reliance on subsidies.”

Making emerging markets an attractive investment proposition

Alongside managing and re-evaluating risk, there are some other key issues we need to tackle to make emerging market investments look more attractive.There is still a significant lack of information about sustainable finance among investors. For example, our survey showed that one-fifth of asset managers were completely unaware of the SDGs. This needs to change.Part of the issue is that traditionally, investing in societal and environmental needs would have been looked at separately from financial investment, according to Andrew Howard, Global Head of Sustainable Investment with Schroders. This is changing and the two are moving ever closer together with the growing importance of ESG (environment, social, governance) factors in investment decisions.Besides, the financial sector needs to demonstrate that impact and financial returns can go together.While The 50 Trillion Dollar Question shows that emerging markets projects generally deliver higher returns than those in the developed markets, at the same time, our recent Sustainable Finance Impact Report found that a single dollar invested into a solar project in India has a seven times bigger impact in terms of climate change than a similar project in France.

These considerations are only going to become more important as Thomas Fekete of BlackRock underlined:

“Whatever project they finance today, if they don’t anticipate sustainability and climate risk impacts, then the value of the assets in 10 years’ time may be vastly reduced as these risks will have become widely reflected in valuations. So, they need to embrace sustainability today.”

Creating a pipeline of investments for emerging markets

Catalysing finance is half the challenge, the other is to grow the amount of ‘bankable’ sustainable projects. Karin Finkelston of IFC described this ambition by saying:“Looking ahead, we see our biggest role in creating pipelines of bankable projects. This will enable the private sector to work alongside government in solving the challenges in these countries.”However, that means, the entire investment community and the surrounding ecosystem – policymakers, multilaterals – must align behind environmental and societal needs.And while climate change abatement is the immediate priority, we should also start looking beyond climate – to social and other sustainability issues. Our community needs to not just be green but “rainbow-coloured” so that all aspects of the SDGs are included in investment strategies.To finance change, we need to catalyse a flow of capital; standardise to make the products and information we present to investors more accessible; and democratise so that investments flow to where they are needed the most.

Comments from this article are taken from “The 50 Trillion Dollar Question: Closing the emerging markets’ capital gap” a virtual webinar hosted by The Economist and Standard Chartered

Where can ESG investments make the biggest impact on our world?

Climate change
Worker welfare
Access to healthcare
Corporate risk management