No more free-riding: the emergence of SDG value capture financing

Bold ideas welcome

The world of sustainable finance is just nowhere near where it needs to be and the trajectory remains underwhelming – it’s mediocre in its ambition and uninspiring in terms of the solutions it is currently focusing on

Kirsten Dunlop, CEO of EIT Climate-KIC, November 2018

The search for ideas and innovations to deliver profit-with-purpose on a global scale and channel the trillions of dollars in private sector investment required to meet the challenge of climate change, all while financing the UN Social Development Goals (SDGs), is at its most effervescent – an effervescence which makes the overall ponderous progression of large-scale climate finance and private sector-led sustainable infrastructure investment all the more glaring.

Open criticism once restricted to capitalism-skeptic circles has shifted to the heart of global finance and public policy, as I highlighted in a previous post, and a hunt for bold new ideas now is underway: it is a competitive yet messy one – more Easter egg hunt than marathon: enthusiastic, but wildly uncoordinated.

The value capture conversation

The SDG financing gap is symptomatic of a business model gap. Impacts can be used as a starting point for business models and generate revenues.

Excerpt from “Rethinking Impact to Finance the SDGs”, UNEP Finance Initiative, November 2018

Amid this flurry of activity, I believe that one common concept is threading its way through various corners of the diffuse SDG and infrastructure finance conversation, albeit in manner that is, once again, fragmented and inconsistently-worded, and therefore hard to bring into focus.

I would characterise this increasingly formalised concept as the generalised application of value capture.

The term “value capture” is often narrowly applied with respect to the specific infrastructure finance pattern known as “land value capture”, a public transport infrastructure investment technique that uses (or indeed “captures”) the rise in value of real estate triggered by future access to mass public transportation to help finance construction of the infrastructure. It is a method that has most famously been applied by Hong Kong’s Mass Transit Railway.

However, in a more general sense, under a value capture-based framework of partnership and project design, instead of viewing any desirable economic, social and environmental impacts of a given business or project as mere positive “externalities” (i.e. a benefit received by a third party who has no control over how such benefit was created, to use the vernacular of economics), the ecosystem of positive impacts of a given project could be used to define the perimeter of SDG financing partnerships, as well as of sustainable infrastructure projects, a catalyst of SDG impacts.

You say “tomato”; I say…

This general concept is being raised with increasing frequency across SDG finance and sustainable infrastructure finance research and practice over the last two years.

One of the most formalised frameworks to date was laid out by the Environmental Defense Fund (sic), a leading American climate-focused non-profit organisation, which released a paper entitled “Unlocking Private Capital to Finance Sustainable Infrastructure”. In it, the Fund advocates for a funding model within which “the economic, social and environmental value produced by sustainable infrastructure should be monetised where possible”.

Another detailed framework based on the concept of value capture is the “Positive Impact Initiative” approach promoted by the UN Environment Program Finance Initiative (UNEP FI). Since November 2018, UNEP FI has released a series of papers articulating the vision and principles behind this approach around the theme of “Rethinking Impact to Finance the SDGs”: from the outset of a project, intended positive impacts and “impact value chains” linking different stakeholders should be mapped out and assessed, with equal consideration for financial outcomes.

In the same vein, you could also add to this shortlist the “People-first PPPs” currently promoted by the UN’s main Public-Private Partnership centre of excellence, which proposes an update to PPP frameworks by aligning PPP design with social goals.

What these frameworks have in common is the idea that wider partnerships start with looking beyond asset-specific cash flows and two-way matchmaking (investor and investee) and, instead, invite to first build clusters of beneficiaries of positive impacts (externalities, co-benefits, or other synonyms) to define more system-based partnership patterns: projects should start with a holistic mapping of the various impacts, defining the targeted positive impacts, and using them as the starting point for new business models and financing partnership patterns.

Value capture and impact investing

The concept of ‘externalities’ will be relegated to history, with finance theory accounting for risk, return, and impact equally well.

Roadmap for the Future of Impact Investing, Global Impact Investing Network (March 2018)

The rise of impact investing (investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return) into a multi-billion mainstream market can be credited with inspiring the value capture perspective, but the main differences between the two concepts are one of creative process and of scope.

Impact investing reverse-engineers targeted impacts into an identified, profitable business endeavour, while value capture starts with a mapping of impacts before collaboratively producing the resulting business idea or project structure.

Moreover, in terms of scope, impact investing is typically focused on a single targeted positive social outcome (e.g. school attendance and graduation rates, access to drinking water), whereas value capture is more of a “meta-framework” that tries to encompass an array of impacts, be they social, environmental or economic.

Ultimately, the two concepts can complement each other: value capture-based financing partnerships can help identify specific impact investing opportunities; conversely, impact investing activities can help prove and thereby de-risk targeted social impacts of wider, multi-impact financing partnerships.

The green shoots of green alignment?

When it comes to sustainable infrastructure and SDG finance, there is an urgent and near-universally recognised need to find new types of partnerships between the various disciplines and stakeholders. A rapidly expanding set of experimental forums is focused on such endeavours: academic city labs, district-wide urban living labs, or so-called financing workshops focused on co-creating financing solutions to real-life sustainable urban cases.

In that regard, what makes these emerging value capture finance frameworks most promising is that the ex ante holistic impact mapping upon which they are premised appears to mirror the rising clamour for similar approaches from other disciplines (urban design, urban development, development planning, etc.): more joined-up (programmatic), holistic (cross-cutting, systemic, inclusive) and increasingly co-creative (participatory), in recognition of the interconnected nature of risks, but also of positive impacts (benefits, co-benefits, externalities), especially when considering climate change and the SDGs.

In the current period of experimentation, whether any of these new value capture-based financing frameworks can evolve into “best practice” and be applied in a modular way in the Global South, where both the need for sustainable infrastructure and vulnerability to climate change are the greatest, remains to be demonstrated.

Nonetheless, it appears all but certain that the value capture principle behind these approaches will be an increasingly important theme for the new SDG and sustainable infrastructure financing partnerships that emerge in the near future. We should therefore look forward to further initiatives and research on their practical implications and how to align the initial impact mapping exercises that they are all founded on.

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