PARIS - The COVID-19 pandemic exacerbated the financing gap for the implementation of the 2030 Agenda in developing countries, estimated at $3.7 trillion in 2020, corresponding to a 50% increase, rev eat a report published today by the OECD.
Shifting only 3.7% of the institutional assets – over $100 trillion in 2019 – towards sustainable activities in those countries would be enough to fill that gap.
Analysing the volumes and composition of selected institutional investors’ portfolios, this report finds that the share of investments allocated to developing countries is still limited. It also looks at the main investment drivers and considerations of these actors when operating in developing countries.
The report explores solutions to channel more of their institutional assets towards developing economies, especially through blended finance. Whilst evidence shows that risk mitigation instruments such as guarantees can contribute to lowering the perception of risks, more efforts are required to attract institutional investors in significant blended finance operations.
Executive summary
Main findingsInstitutional investors – such as pension funds and insurance companies – are key participants in financial markets, holding more than USD 100 trillion of assets at end-2019 (see Chapter 1. ). Most of these assets are invested in bonds and equities. The investments of institutional investors are usually regulated through quantitative investment limits – relatively common for pension funds – or a more principle-based approach, such as for insurance companies in many countries.While the pre-COVID-19 annual financing gap for the SDGs was estimated to amount to USD 2.5 trillion (UNCTAD, 2020[1]) for developing countries, it increased by 50% in 2020 and reached USD 3.7 trillion. Reducing the financing gap for the SDGs requires shifting financial resources towards sustainable development, including from the private sector, as well as greater alignment of all the investment chain with the SDGs.Institutional investors can help: shifting only 3.7% of their assets towards sustainable activities in developing countries would be sufficient to fill the USD 3.7 trillion gap (OECD, 2020[2]). However, a survey conducted by the OECD on selected institutional investors confirmed their propensity to mainly allocate assets in stable and low-risk contexts (Chapter 2. ). Only a small share of the global assets of institutional investors is allocated to developing countries, mostly to middle-income economies with well-developed investment climate and in the form of asset classes with a relatively low-risk profileand predictable returns.
•During 2017-18, only 8% of total assets of the 36 pension funds included in the survey sample were allocated to developing countries, mainly in Asia (68%) and in particular middle-income countries such as People’s Republic of China, India and Southeast Asian countries. Such assets were mostly held in the form of listed equity (57%) and fixed-income instruments (25%). Moreover, 85% of all assets allocated to developing countries were managed by merely fourpension funds based in three countries, showing high concentration among a limited number of institutions.
•As regards insurance companies, the survey sample of 30 insurers suggests an even more cautious allocation decision making. Only 2% of the assets of insurance companies in 2017-18 were allocated in developing countries, 90% of which in Asia. Approximately two-thirds of these assets were held in the form of fixed-income instruments while the remainder was diversified mainly across listed equity, loans and cash deposits. Investment currency is also a central driver as regards the investment decisions of insurance companies.
Investment decisions by pension funds and insurance companies are largely influenced by risks associated with local corruption levels and political or macroeconomic instabilities. The availability of skilled workforce plays an important role too for all these actors, while investment opportunities constitute the main investment driver for pension funds (Chapter 3. ).
Interest rate levels also constitute an important driver. The current low interest rate environment in the OECD countries is a challenge for investors who need to reorient their investment strategies towards more profitable asset classes and markets: there may lie an opportunity for emerging economies. Mainstreaming sustainability considerations in the internal policies of institutional investors does not necessarily imply aligning their investment with the SDGs.
Most surveyed pension funds and insurance companies showed a rather limited focus on development impact and environmental, social and governance (ESG) standards in their portfolio allocation decisions. Moreover, only half of institutional investors indicated to have aligned their internal policies to some extent with the 2030 Agenda and the SDGs.
Still, mainstreaming the objectives of the Paris Agreement in their internal strategy, at least to some extent, was indicated by approximately two-thirds of the surveyed investors.Collaboration between institutional investors and the public sector – be it governments of provider or partner countries, or multilateral organisations – remains sporadic. No more than a fifth of the surveyed institutional investors collaborate with provider countries’ development co-operation agencies, development finance institutions (DFIs) or multilateral development agencies and collaboration with governments of the developing countries is even rarer. Still, when collaboration occurs, it concentrates on risk mitigation, co-financing, access to knowledge and advice or due diligence services.
In contrast, development outcomes are not prioritised under such multi-stakeholder partnerships. Blended finance is one option in the development co-operation tool box to mobilise institutional investors’ assets toward developing countries. The use of risk mitigation instruments such as guarantees can contribute to lowering the perception of risks by institutional investors. However, development finance providers need to put more efforts to further mobilise institutional investors at scale in blended finance operations given their limited involvement so far. Finally, the mobilisation of local pension funds and insurance companies also plays an essential role in developing local capital markets and in providing local currency financing.
Main policy recommendations
•Countries hosting large pension funds and insurance companies have a role to play in introducing greater flexibility in investment regulations and removing the micro and macro-economic barriers – including the lack of transparency and information asymmetry on private investment – to unlock institutional assets at the global level and towards developing countries more specifically.
•While it is necessary to encourage the scaling-up of institutional asset allocation towards developing countries, ensuring their sustainability through impact investment policies is equally important for the achievement of the SDGs.
Aligning the financial system – banking, capital markets and insurance – with sustainable development pathways requires the involvement of all actors, including international financial institutions, banks, institutional investors, market-makers such as rating agencies and stock exchanges, as well as central banks and financial regulatory authorities.
•Blended finance can de-risk deals and enhance returns to crowd in capital from local or international institutional investors, but incentives from development finance providers are also needed to mobilise these actors at scale.
This includes efforts for aggregating multiple projects – e.g. through portfolio investment mechanism – to help achieve the needed investment ticket sizes, as well as to contribute to portfolio diversification for institutional investors.Finally, increased transparency of institutional investors’ asset distribution is critical for building trust in the markets and, thus, unlocking financing towards developing countries.
Transparency does not only build trust in the international development system, but it is also an important source of learning opportunities and inputs needed for evidence-based policies and informed partnerships for the SDGs.
To download the report, visit: https://www.oecd.org/dac/financing-sustainable-development/Mobilising-institutional-investors-for-financing-sustainable-development-final.pdf
