This blog is Part 2 of a three part series. See here for Part 1: Private Sector Engagement and Part 3: Accreditation.
The Green Climate Fund (GCF) Strategic Plan for 2020-2023 is up for consideration by the Board at its upcoming meeting in Geneva, Switzerland. Why are we paying attention? The Strategic Plan sets the vision, goals, and framework that will guide the programming of the Fund’s first replenishment for the next four years. The priorities outlined in the Plan send important signals to developing countries represented by National Designated Authorities (NDAs) as beneficiaries of the Fund, to GCF fiduciaries (accredited entities), and to stakeholders overall. The Board will consider the draft document and decide on its approval (or not) next week during its twenty-fifth meeting.
We have analyzed the document and chose to highlight three key elements that are essential in the GCF agenda-setting process. This post focuses on how the Fund expects to use the financial instruments at its disposal. The aim is to assess what the Plan is prioritizing, and also (deliberately or inadvertently) failing to clarify about GCF priorities for the next four years.
Use of its Financial Instruments
What is the key issue? Thus far, the Fund’s portfolio has been skewed to hard-currency loans. Equity and guarantees have been underused by accredited entities. The current portfolio is comprised of 45 percent grants, 42 percent loans, 1 percent guarantees and 8 percent equity, according to the latest Risk Dashboard Q4 2019. Hard currency loans are likewise widely provided by development finance institutions (DFIs) and multilateral development banks (MDBs), which have far less risk appetite than the GCF. This situation leaves borrower countries bearing foreign exchange risk, which often prevents the concessionality of the resources from reaching end beneficiaries.
What is the angle in the Strategic Plan 2020-2023? There are not many references to the strategic use of financial instruments across the Strategic Plan. Most references are general and allude to the flexibility of available instruments. There is a key reference, however, to how the GCF can foster a paradigm shifting portfolio by showing how its risk appetite differs from other climate funds and DFIs. The Plan notes that the GCF can take calculated risks (such as first-loss positions or participation in higher risk tranches) to demonstrate the viability of innovative approaches and deliver scale. Older versions of the Strategic Plan provided more clarity on how the Fund expected to use its high-risk appetite and shift from a mostly hard currency loans model to a more strategic, risk mitigation approach.
What is the subtext? There are no clear indications in terms of strategic priorities for the Fund on the use of financial instruments to effect a paradigm shift and operationalize the Fund’s high-risk appetite. Key strategic guidance from the Board and its vision would be necessary to foster the use of guarantees and equity. For instance, in supporting the use of guarantees, the Board needs to send specific signals in terms of direction around providing guarantees, taking into account the trade-offs that encouraging their use entails. For example, due to the absence of a credit rating, the Fund currently needs to provision guarantees 100 percent, which means those funds cannot be used for any other purposes. There GCF can obtain a credit rating or decide to structure guarantees without one. How to move forward and realizing the Fund’s high risk appetite and paradigm shift mandate requires a vision from the Board. Furthermore, ambitious deployment of equity requires additional highly-trained staff, budget, and business model adjustments. Perhaps most importantly, there is an urgent need for bold mandates to support local currency deployment and bearing FX risk in a way that avoids currency risk being passed to end users. The Strategic Plan should send clearer signals to the Secretariat and accredited entities.