Governments and multilateral lending institutions (MLIs) have long supported the development of low- and lower-middle-income countries and regions through direct investment and lending. As a result, the use of blended finance transactions has grown. Market interest in blended finance has also increased, and we've seen continued innovation across a variety of structures that seek to balance the efficient use of government and MLI balance sheets, climate goals, and private investor capital.

Indeed, the Paris Agreement of 2015 brought the additional dimension of sustainability to these goals--and, as a result, a new urgency and recognition that private capital is needed to support countries in achieving the goals.

Here we address common questions we've received about blended finance and how we view the innovative structures that governments and MLIs are seeking.

Frequently Asked Questions

How are governments and MLIs looking to blended finance to support low-income and lower-middle-income countries?

The traditional means by which developed-market governments support low-income and lower-middle-income countries has been through direct investment and lending, both bilaterally and through MLIs. The sizes of the capital commitments from governments that fund the MLIs can limit this approach, since governments' balance sheets have been under pressure after the heavy fiscal spending needed since the pandemic. They are demanding that MLIs use their current resources more efficiently.

MLIs have recently started to turn to hybrid capital securities to expand their balance sheets. Hybrids are a means for private capital to access the MLI model, in addition to existing senior debt issuances. We credit hybrids as equity up to certain thresholds (see "Hybrid Capital: Methodology And Assumptions," March 2, 2022). As a result, MLIs can issue more debt while maintaining their targeted capital ratio and, thus, have a greater impact on low-income and lower-middle-income countries.

Based on inquiries we've received, some governments and MLIs have proposed partial guarantees of debt instruments in support of development funds. These guarantees can help borrowers lower their cost of capital or access a source of funding that might not be otherwise available.

From the perspective of a government or MLI providing a guarantee, partial guarantees have the benefit of being finite in their value and duration. They can use a smaller slice of the balance sheet than a full guarantee while still providing value, potentially expanding the government's or MLI's influence.

How are partial guarantees different from full guarantees, and how does S&P Global Ratings consider partial guarantees in its analysis?

Partial guarantees and full guarantees share some features but also have some important differences. We consider a full guarantee that meets the conditions outlined in our guarantee criteria (see "Guarantee Criteria," Oct. 21, 2016) to qualify for "rating substitution" as a form of credit enhancement--meaning we shift the evaluation of creditworthiness from the primary obligor to that of the guarantor.

Partial guarantees are typically structured to cover 100% of each debt service payment, but only up to a guaranteed amount. That guarantee amount can be expressed as a percentage of principal that amortizes in proportion to the bond or loan and may increase or decrease over the life of the obligation.

We do not equalize ratings on the obligor with those on the guarantor solely because a partial guarantee is in place. Our credit ratings speak to the likelihood of a full and timely payment of principal and interest, and don't typically consider post-default recovery (the exception being speculative-grade corporate issue ratings). Since partial guarantees are not structured to ensure timely payment of principal and interest in full, we do not view them in the same fashion as full guarantees.

However, that doesn't mean we never give any credit to partial guarantees in our ratings. Partial guarantees do reflect some level of ongoing support, and the possibility of potential future support, from guarantors.

If we determined that the party providing the partial guarantee were likely to provide future support that did improve the creditworthiness of the issue or issuer, we could reflect that through our group ratings analysis or government-related entity analysis, as appropriate. Similarly, we could give some value to partial guarantees if we believed they might support and enhance future cash flows and/or provide liquidity in structured finance or project finance transactions.

For example, project finance transactions Concesionaria Mexiquense S.A. de C.V. in Mexico and Planta de Reserva Fria de Generacion de Eten S.A. in Peru receive partial credit guarantees, which boost our assessments of their liquidity to strong. That enhanced liquidity translates into a one-notch rating uplift.

How does S&P Global Ratings factor sovereign risk into transactions investing in developing markets?

The sovereign rating typically represents the highest credit quality across sectors in a developed or developing market. However, an entity or issue can be rated above the sovereign foreign currency rating if, in our view, there is an appreciable likelihood that it would not default if the sovereign were to default. (See "Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And Assumptions," Nov. 19, 2013, and "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions," Jan. 30, 2019.)

Corporates, financial services, and project finance.  Across the corporate, financial services, and project finance sectors, for an entity or structure to be rated above the respective sovereign foreign currency rating, we apply a hypothetical sovereign foreign currency default stress test. This stress test is applied with respect to the country (or countries) where the entity has material concentrations of exposure and where the potential rating would exceed the foreign currency rating on the sovereign.

If it passes, we can rate the entity or structure up to four notches above the relevant sovereign. We take into account the potential for external support or structural aspects to determine whether the entity or structure passes the stress test.

Ultimately, only approximately 4% of our project finance transactions are currently rated above the relevant sovereign foreign currency rating, and most of those benefit from unconditional and irrevocable guarantees sufficient to meet our credit substitution criteria (see "Project Finance: Why Ratings Above The Sovereign Are Uncommon," July 4, 2024).

Structured finance.  Similarly, for structured finance, we cap the maximum achievable rating depending on the sensitivity of the transaction's assets and structure to a sovereign default. For multijurisdictional transactions, we give credit for diversification but apply the same sovereign default scenario as for single-jurisdiction transactions when the asset balance for a country exceeds a predetermined threshold. In structured finance, tranche ratings can be up to six notches above relevant sovereign ratings.

Transfer and convertibility risk.  We also consider transfer and convertibility (T&C) risk in our analysis (see the relevant sovereign risk criteria, linked above), which speaks to the likelihood that a sovereign will limit the ability of a nonsovereign to access the foreign exchange necessary to meet the nonsovereign's debt service obligations, which can often constrain ratings.

Project finance and structured finance transactions can include features that aim to offset T&C risk. But even if we expected a transaction to generate enough local currency under a sovereign stress scenario to buy foreign currency to service the debt, our view on the likelihood of the sovereign imposing T&C restrictions could constrain our ability to rate the project or tranche higher than the T&C assessment.

But in project finance, the contracts cannot anticipate all possible scenarios, and the scope to make changes quickly is limited.

How does S&P Global Ratings incorporate recoveries into its loss assumptions for blended finance structured transactions?

Low-income and lower-middle-income countries, where governments and MLIs have pursued blended finance, often have relatively weak credit protections, which can mean lower recovery prospects and higher loss assumptions.

In our structured finance ratings analysis, we analyze a transaction's cash flows and payment profile. We review the transaction's structural characteristics and level of enhancement, together with covenants, including those relating to the spread in the portfolio and recovery rates.

Recovery rates of the securitized assets are a function of the asset type, the priority/seniority of the asset (senior secured, senior unsecured, or subordinated) in an insolvency of the company, and its country grouping. For different asset types' recoveries, we group countries based on our analysis of their insolvency legal frameworks.

These jurisdiction ranking assessments are an indicator of the relative degree of protection that a country's insolvency laws and practices afford to creditors' interests, and of the predictability of those proceedings. Countries grouped into the 'A' category present the strongest creditor protections, while countries in group 'C' present the weakest. Low-income and lower-middle-income countries are typically ranked in our 'C' category.

MLIs do benefit from preferred creditor status when lending to governments and have lower risk exposure to the private sector than average financial institutions. However, it can be difficult to quantify the advantage MLIs have in recoveries. The Global Emerging Market Risk Database (GEMs) Consortium released default and recovery figures, but we have thus far found the data to be insufficient to allow for the type of in-depth analysis we'd require to adjust our approach to recovery (see "GEMs' Enhanced Recovery Statistics Are Yet To Provide Sufficient Transparency And Quality For Detailed Analysis," June 4, 2024).

What is S&P Global Ratings monitoring in terms of blended finance?

We continue to monitor the evolution of these investment vehicles, including their incorporation of full and partial guarantees, features that might help to mitigate sovereign-related risks, data that might support a differentiated approach to recovery, or other innovations. We do so to ensure our methodologies transparently and consistently capture the risks and features presented.