Creating development finance as an asset class

Two critical insights emerged from COP29 climate change conference. First, the clean energy transition must not hamper the growth and aspirations of poor countries or underserved communities in wealthy countries. Therefore, the “development” agenda must be prioritized alongside the “sustainability” agenda. Second, as governments grapple with budget constraints and competing priorities, public resources are insufficient to finance global sustainable development.

In a recent report, the United Nations estimated a $4 trillion annual financing gap to achieve the Sustainable Development Goals (SDGs) in developing countries. Comparing this to the $300 billion annual climate finance pledged by wealthy nations to support developing countries at COP29 demonstrates the magnitude of the financing challenge.

Global capital markets are a major source of raising private financing; in 2023, the total amount of debt issued in capital markets stood at $25.2 trillion. Among capital markets investors, the segment that is seeking financial, environmental and social returns (sustainable finance) was last estimated at $3.3 trillion in assets under management (AUM). While demand for sustainable investing continues to grow, the growth of this segment is constrained by the supply of investible opportunities.

Institutional investors typically identify sustainable investments through two approaches:

1. ESG-labeled securities (securities whose proceeds would be allocated to sustainable projects)

2. Securities issued by issuers receiving high ESG scores

This approach has effectively directed capital towards entities with pipelines of capital expenditure-intensive projects, such as building solar plants, or companies with low environmental and social risk in their operations, such as technology firms. However, companies issuing securities for general budgetary purposes, which may be aimed at expanding their businesses to serve the basic needs of underserved segments of society, often fall out of the scope of this approach.

The lack of transparency on the development impact of an entity’s strategic plan prohibits qualifying the general budgetary financing of such entities as sustainable investments. This, in turn, limits asset managers from creating funds that target such investments, leaving the growing demand for sustainable investing unfulfilled.

To address these challenges, over 80 of the world’s largest capital markets participants (both sell-side and buy-side financial institutions) and industry stakeholders formed the Impact Disclosure Taskforce.

The task force recently released guidance to help corporate and sovereign entities leverage existing reporting standards to produce a Sustainable Development Impact Disclosure (SDID). The SDID is characterized by being:

– Entity-level but context-specific: Assesses the entity’s overall strategy in countries of focus, measuring how the entity’s products, services, and operations are anticipated to address the most acute development gaps in each country.

– Impact-oriented: Focuses on outputs and outcomes, including plans to achieve outputs and the theory of change assumed to lead to outcomes.

– Forward-looking: Establishes targets that measure intended impact, as well as a commitment to monitoring and reporting progress against targets.

In other words, the SDID shares a company or a government’s plans to reduce poverty and inequality in their countries of operations. The SDID is global in scope, providing transparency on an entity’s impact on underserved communities in both developed and developing countries.

The task force has also called for a consortium of financial institutions to develop an Impact Data Platform, which would leverage artificial intelligence to facilitate the creation of SDIDs. The platform would also offer independent verification and analytical tools for portfolio construction, helping investors incorporate this information into their investment decisions.

In 2024, the J.P. Morgan Development Finance Institution (JPM DFI) assisted Africell Holding Limited in producing an SDID, which was included in the offering documents for the company's debut $300 million senior secured bond.

The bond was issued to refinance all existing senior facilities and to support the company’s general corporate purposes. Its SDID, however, outlined Africell's plans and an accountability framework to advance digital inclusion and connectivity across its operations in Angola, the Democratic Republic of the Congo, The Gambia and Sierra Leone. It also highlighted Africell's commitment to reporting its performance on improving education, promoting gender equality, supporting affordable and clean energy initiatives, fostering economic growth, promoting innovation and building resilient infrastructure.

The bond was marketed to sustainable investors, resulting in a high-quality order book and successful pricing. Over 20% of the investors who submitted orders for the bond informed J.P. Morgan that the SDID influenced their investment allocation decisions. The SDID not only helped Africell attract additional investor capital, but also enabled them to reach a broader range of investors, including investors with stewardship roles who can act as thought-partners in supporting the company's sustainable development agenda.

Climate finance has been established as an asset class that has positive impact on climate mitigation and adaptation. Similarly, development finance can be defined as securities that fund entities that have significant development impact. The Impact Disclosure Guidance provides an industry consensus on how development impact should be measured and disclosed, laying the groundwork for establishing development finance as a distinct asset class.

This asset class could materialize through indices focused on various development impact themes. For example, a food-security fixed-income index could be developed for bonds issued by entities whose SDID demonstrates credible and ambitious intentions to enhance food security outcomes. These entities must also commit to monitoring and reporting their impact performance. A track record for meeting targets may be one of the criteria for remaining in the index, increasing the incentive for companies to deliver on targets. Similar indices could be established for other SDGs, such as health, water and sanitation, gender equality, financial inclusion, clean transportation and affordable housing.

This approach expands the investible universe for sustainable investors beyond traditional use-of-proceeds financing to include corporate and sovereign budgetary financings that offer both commercial returns and development impact. According to our estimates, establishing the industry consortium to build the Impact Data Platform could create a $1 trillion asset class within five years.

The World Economic Forum’s Annual Meeting provides an opportunity to bring stakeholders together to make this vision a reality.