Finance Champions: December 2023 Summaries and Takeaways

The December 7, 2023 Finance Champions meeting featured four finance-focused presentations on:

1. legal and regulatory considerations pertaining to innovative finance;
2. the Engines of Growth activity in the Western Balkans; 
3. “EduFinance”, which looks at finance for non-state schools; and
4. the Call to Action from the World Economic Forum for the financing of refugee and humanitarian populations.

USAID General Counsel’s Office – Carl Vernetti, the General Counsel (GC) backstop for the Private Sector Engagement (PSE) Hub, opened with a presentation about legal and regulatory challenges/restrictions associated with ‘innovative finance’, and the importance of working with the General Counsel and Resident Legal Officer (RLO) when designing such instruments.

The Miscellaneous Receipts Act is intended to ensure that Congress maintains the power of the purse, stipulating that any federal agency or official is not allowed to take in and retain money from outside sources, except as specifically allowed by Congress via statute. This, of course, restricts USAID’s ability to expect any sort of financial return from our funds, but has also been construed by courts to mean that USAID cannot control and provide direction over outside funds—i.e., monies which do not directly hit USAID’s bank account (for example, a limited partner contribution to a USAID supported investment fund). As such, when talking to the GC or RLO, terms such as ‘recoverable grants’ are likely to cause additional scrutiny. As a result, depending on the degree of USAID control and direction over an outside fund or foundation, USAID may be prohibited from directing their financial decisions. For example, if USAID puts funds into a foundation or fund, USAID needs to be careful about providing direction on how those funds can be deployed without constructively taking possession of the funds.

A note of hope is that USAID can receive funds through the Gift Acceptance Authority—potentially a way for funds to come back to USAID from, for example, an endowment. Moreover, the ‘additive method’ of using program income under grants (income is added to the funds originally and used to further eligible project activities or objectives) may accomplish some of the objectives of recoverable or recyclable grants (without raising concerns about compliance with the Miscellaneous Receipts Act).

Another concern is the Government Corporations Control Act, which prohibits USAID from holding an ownership interest or in exercising legal control over an independent entity. This comes into play when, for example, USAID considers providing funding for a fund, which will use those funds (possibly in conjunction with other funds) to make equity investments. While USAID can be ‘one voice in the room’, it does not want to be in a position where it is directing investment decisions.

The presenter noted that it is best practice to discuss proposed first loss approaches early on with GC as this is a topic under consideration. In general, there may be other ways to support funds which are more indirect (and thus more acceptable). Finally he noted that USAID has accumulated a vast amount of intellectual property over the past 60 years (whenever we fund something, we own the intellectual property). This experience may be very useful to our partners who are considering ‘innovative finance’ instruments and structures, and we should be mindful of it.

Takeaways:

• Engage with GC early on, and be clear about what your goal is—not just development, but what are you trying to accomplish in terms of flow of funding.
• Be open to different transaction structures (perhaps not what you were originally envisioning but which may get you there).
• Provide context about the specific outcome you are seeking—for example, our ability to put in $3 million of blended finance grant funds will unlock $50 million of commercial funds.
• Consider how USAID funds are going to be safeguarded by the recipient—what controls do we have that guarantee the funds will be used for the intended purposes. 

Engines of Growth – Lee Williams (USAID/LAC) and Ana Luisa Pinto (USAID/E&E) presented on the Engines of Growth (EoG) activity and how it sought to address the challenges of financing to meet the needs of small and medium enterprises (SMEs) with growth potential in the Western Balkans. Given that the Western Balkans is a small market, the activity decided to seek the potential economies of scale offered by working across the region rather than bilaterally. The activity was funded through a $4 million tranche of Financing Self-Reliance (FSR) funding, $1 million in regional economic growth funding, and then subsequently topped with an additional $4.3 million of Women’s Global Development and Prosperity (WGDP) funding targeted to demand and supply approaches to women’s economic empowerment.

The challenge is a common one across USAID priority countries—SMEs are only able to obtain financing through standard commercial loan products, at high rates, with short tenors, and with collateral requirements as high as 300 percent. So the EoG activity was focused on access to and utilization of finance to SMEs on terms which met their needs.  

An underlying assumption was that there were potential sophisticated partners in the region that might be able to solve this challenge, so EoG sought to allow those partners to take the lead in developing market-based solutions. There were two main windows:

• Transaction origination and support, by engaging a network of transaction advisors to support SMEs—especially W-SMEs—in accessing appropriate finance or restructuring from existing financial institutions, investors, or other opportunities.
• An opportunity window to co-create new solutions to access to finance challenges for SMEs and promote women's economic empowerment.

The award was issued through the Palladium CATALYZE activity. With a diversified portfolio of interventions, results for the activity have already been impressive. There were 778 SMEs supported to date of which 461 are women SMEs (W-SMEs), with $99 million in loans disbursed and an expected goal of a total of $150 million in additional financing for SMEs. This was largely accomplished through the transaction advisors or business advisory service providers (BASPs) who were paid as financing was committed.

Apart from the mobilized transactions, this activity will also have a sustainable impact–in large measure due to the ‘new solutions’ solicitation window. This includes a highly successful fintech platform for SMEs, an e-factoring platform, as well as a new mezzanine fund currently under development.

Takeaways:

• Getting the bulk of funding early on was helpful, because it allowed for the sub-awards to be delivered early in the project.
• Quick results allowed for additional funding into the activity–success delivers.
• Risks were taken, but bets were hedged through a broad portfolio of access to finance intervention spends.
• Pay-for-results arrangements are not one-size fits all and hence have to be crafted for each individual country.

CATALYZE EduFinance South Africa – Nirav Khambhati from Kaizenvest and Joe DiSilvio from Palladium who addressed CATALYZE EduFinance—financing for non-state education providers including Early Childhood Development (ECD) centers.

Nirav addressed the significant magnitude of the challenge in South Africa, and the theory of change of the CATALYZE EduFinance activity— that mobilizing affordable capital to ECD entrepreneurs and properly incentivizing them will lead to better ECD outcomes. However, the project soon realized that ECD is a challenging area for the mobilization of finance in South Africa. It was difficult to find financial intermediaries who would participate, and private investors had little interest in these smaller, riskier transactions.  As such, the team modified its initial approach and has developed three different channels across the blended finance continuum (attached presentation).

1. Pooled debt fund - despite challenges, the consortium managed to fundraise from multiple socially-minded investors including Nedbank Brimstone, Save the Children Global Ventures, and others. This affordable financing will be distributed through local financial intermediary Rhiza Babuyile to ECD owners in their network.
2. Soft Loans - TA from CATALYZE EduFinance has unlocked $1 million USD in grant funding from a private foundation to support GROW ECD’s enterprise accelerator program for female-led small ECD enterprises. This provides intensive training and support, below market rate loans, and connections to a whole host of other resources to help these ECD providers improve access and quality. 
3. Grants - in partnership with the Anglican Church, IMBE, and Smart Start, this model locates un(der)utilized spaces within existing Anglican churches and providing these at highly subsidized rates to ECD centers currently operating in substandard conditions, while also offering infrastructure financing via IMBE (if needed) and high quality ECD curriculum via Smart Start.

In short, this is a really good example of testing an approach, and then modifying that approach as needed. This activity is well on track to meet its initial targets and it is impacting the ECD sector positively in South Africa. It demonstrates that private funds can be generated - through the use of blended finance - for difficult development challenges such as ECD.

Takeaways: 

• The market for EduFinance in South Africa, particularly in the ECD space, is highly fragmented and informal with a challenging regulatory environment.  This means investors and Finance Providers lack quality data to make investment decisions and increases risk.
• While EduFinance is demonstrating that there is a viable market for education finance, building quality partnerships to do this market-building and prove the investment case takes time, and requires a tailored approach. 
• Improving education quality is a long-term prospect, both in terms of improving quality outcomes, and in getting private capital to move into the sector. As such, donors and investors need to accept longer time horizons to financial return and impact during these initial stages of market building in the education finance sector in particular.

World Economic Forum: Call to Action – Diego Hakspiel from the World Economic Forum reported on an ambitious initiative launched in 2019 together with the World Bank and the International Committee of the Red Cross. This call to action is designed to mobilize $10 billion in impact and commercial capital, by 2030, for investment to scale 1,000 enterprises in humanitarian and fragile areas in frontier markets.

This activity is working with about 80 public and private organizations, as well as with the U.S. International Development Finance Corporation (DFC) and the USAID/Kenya Mission–in conjunction with its first area of focus in Northern Kenya with its significant refugee population.

A key challenge and opportunity is in pipeline development (sourcing potential investee enterprises), which is a key element in investment mobilization platform activities.