their investments. The European Fund for Southeast Europe is an example of a first-loss arrangement (box 7).

# **Box 7. A Strategic Investment Fund with a First-Loss Arrangement**

The European Fund for Southeast Europe (EFSE), based in Luxembourg, is a hybrid strategic investment fund (SIF) with €756 million ($1.1 billion) in commitments from donor agencies, international financial institutions (IFIs), and private investors. The public-private partnership approach enables the EFSE to mobilize funding from private institutional investors to top up international public donor funding for development finance. In addition, it provides a platform for the coordination of donor activities in its regions. This pooling of resources multiplies the impact of public funding. The EFSE operates as a market enabler, facilitator, and risk taker as well as an innovator and incubator for new financial products. Donor or public capital constitutes the first-loss tranche— that is, the tranche to be used first in the event of losses. IFIs invest in the mezzanine tranche, private investors in the senior tranche. Because of its investment structure, the EFSE is able to provide access to long-term finance at market conditions to qualified investors. To undertake an investment, different sources of funds representing different risk-level tranches are pooled into a single source of financing for the EFSE. For the investment portfolio in each country, the proportion of the different risk tranches contributing to the total amount of pooled funds remains intact. Hence, donors and other investors hold a specific share of the pooled funds in the amount of their original nominal contribution to the EFSE.

_Sources:_ Wang et al. 2013; EFSE website, <u>http://www.efse.lu/about-the-fund/mission/.</u> An SIF could also seek to attract impact investors or commercially oriented financial institutions that identify with the policy objectives of the fund and often require a lower financial return than traditional investors (box 8). For example, AREF received financing from Sustainable Energy for Africa, a fund administered by the African Development Bank, at a rate of return capped at 4 percent.

# **Box 8. Public Finance and Impact Investment**

Emerging and frontier economies hold significant promise for private investors and corporations that seek to diversify their portfolios and enter new high-growth markets. Yet, the high level of risk (real or perceived) is often a barrier to investment. Public and philanthropic funders can use their resources to shift the risk-return profile of investee projects or companies to create favorable conditions for private sector engagement. Such blending of public, philanthropic, and private resources can in turn significantly scale up investment in areas that are critical for sustainable development, including infrastructure, climate change solutions, agriculture, health care, and financial services.

Impact investors have diverse financial return expectations. Some intentionally invest for concessional returns in order to maximize impact or to catalyze additional investment capital by accepting a riskier position in a deal. Others pursue market-competitive and market-beating returns, which are often linked to their fiduciary responsibility toward investors. According to a survey of impact investors carried out in 2015 by the Global Impact Investing Network—a nonprofit organization dedicated to increasing the scale and effectiveness of impact investing—25 percent of respondents were pursuing below-market returns at close to the market rate, and 16 percent below-market returns close to capital preservation.

_Sources:_ Authors, based on OECD (2015) and a 2015 Global Impact Investing Network survey, results of which can be <u>perused at https://thegiin.org/impact-investing/need-to-know/#s5.</u> 17