The ‘private turn’ in development finance

Recent years have witnessed a paradigm shift in the policy and practice of international development finance. The new approach promotes the more active involvement of private actors into the development process, and has resulted in the proliferation of new instruments to catalyse private investments in the pursuit of the Sustainable Development Goals (SDGs) and other global public goods.

The growing popularity of public-private partnerships (PPPs) and blended finance illustrates this private turn in development policy. Broadly speaking, PPPs involve governments partnering up with businesses to provide goods and services, for example in agriculture, energy, health, education, and water and sanitation. Blended finance involves the use of official development finance– including subsidised loans and guarantees, grants for technical assistance, and equity investments in private ventures – to ‘crowd in’ commercial finance, including to support PPPs. In this way, blended finance seeks to incentivise commercial capital by improving the so-called ‘risk return profile’ of investments in projects and sectors traditionally shunned by private businesses.

Regulating new development partnerships

This ‘private turn’ brings into sharp focus the relationship between the ‘public goods’ mandate of donors and international financial institutions (IFIs), and the commercial interests of the private investors they seek to incentivise. It also brings development finance into closer contact with global economic governance frameworks typically associated with commercial activities, creating new challenges for the interface between development policy and the law governing foreign investment.

Policy debates and operational practice have often focused on mitigating risks to private businesses in order to encourage investment. But it is also important to discuss ways to address the risks that such investments can create for host states and local communities. These risks include social or environmental harm associated with the construction of development projects; issues of affordability and sustained quality of privatised services; and interrupted essential services, including medical care and education, should investments fail.

High-profile collapses of PPP companies in high-income countries, such as Carillion in the UK, have highlighted the precarity of reliance on private investors to deliver infrastructure development and essential services. The risks also include the legal and financial risks that States could be exposed to in complex PPP and blended finance arrangements.

The latter risks have been discussed in a number of arenas, including by us in an earlier blog, and in blogs and analysis published on UNCTAD’s investment policy hub. Where blended finance involves partnerships with foreign commercial actors, State conduct in connection with public contracts could expose authorities to costly arbitration claims under international investment agreements (IIAs).

The complex structure of PPPs and blended finance instruments can increase the number of private actors potentially eligible to claim under IIAs should investments run into difficulties, thereby expanding the potential pool of claimants against States. Contracts and IIAs have also enabled some publicly funded bilateral development finance institutions (DFIs) to bring claims against host States where such PPPs have turned sour.

Careful drafting of PPP contracts and of IIAs can mitigate some of these concerns, and the involvement of a development financier in a PPP project could avert disputes before they arise or escalate. However, these measures will not resolve all the legal, financial and, importantly, social and environmental risks associated with the shift from public to public-private or wholly private financing.

Therefore, regulation of PPPs and private financing of development projects also calls for policy and legal reforms that are complex and wide-ranging – a difficult task for many capacity-stretched governments seeking to harness the potential of PPPs. The default position for many States has been to draw on standardised model laws and contracts drafted by transnational law firms or IFIs, without independent advice or adaptation to local contexts. Regulatory oversight of PPPs remain challenging in countries where corporate governance regimes and public administrative structures are weak and under-resourced.

Governing for responsible investments: what role for IIAs?

Debates about regulatory reform have tended to focus on national law, but international instruments are also relevant. This includes so-called ‘soft-law instruments’ such as the Guiding Principles on Business and Human Rights, the OECD Guidelines for Multinational Enterprises and the Equator Principles. The OECD Development Assistance Committee (DAC) recently released Blended Finance Principles to guide donor governments’ deployment of blended finance instruments for development.

Any PPPs and blended finance structures should be aligned with such international instruments. This would require thinking through both the substantive standards and the institutional arrangements for redress – for example, clarifying how safeguard policies traditionally set and enforced through institutional accountability mechanisms, such as the International Finance Corporation (IFC)’s Compliance Advisor Ombudsman (CAO), can be upheld throughout the chain of financing.

There is also a case for integrating parameters of responsible investment into IIAs. Traditionally focusing on protecting investments, most IIAs say little or nothing about standards of responsible business conduct. But some recent treaties do seek to promote responsible business conduct in areas such as labour, the environment, corruption and human rights – featuring clauses that mandate States to set and enforce standards, or that directly encourage or require businesses to act.

The jury is still out on the effectiveness of these provisions – both because they remain rare and often under-developed relative to other treaty clauses, and because there is limited arbitral jurisprudence on their interpretation and application. In principle, however, embedding responsible investment clauses in IIAscould facilitate consideration of the investor’s conduct in the settlement of investment disputes: depending on formulations and circumstances, for example, it could require investor-State arbitral tribunals to consider investor non-compliance when deciding on the investor’s claims, and enable States to bring counterclaims against investors.

Towards more joined-up policy making

There is a need to coordinate multiple regulatory safeguards. As the OECD DAC has observed, PPPs and blended finance have increased layers of intermediation, which in turn affects the oversight of development financing. The rise of these new public-private instruments creates new administrative and regulatory challenges for both donor and recipient governments, calling for more joined-up policymaking that holistically considers the social, environmental, economic, financial and commercial issues at stake.

PPPs and blended finance instruments are not silver bullets and – depending on how they are set up – they could undermine rather than advance the SDGs. The complex legal issues associated with them justify a pause for thought. Warwick Law School’s GLOBE Centre and IIED are setting out to explore this agenda through a new initiative – Regulating Aid Investments in Development (RAID). If the theme resonates, we would be delighted to hear from you.

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Dr Celine Tan (celine.tan@warwick.ac.uk) is Associate Professor at Warwick Law School and the Director of the Law School’s Centre for Law, Regulation and Governance of the Global Economy (GLOBE Centre).

Dr Lorenzo Cotula (lorenzo.cotula@iied.org) is Principal Researcher (Law and Sustainable Development) at the International Institute for Environment and Development (IIED); Visiting Professor at Strathclyde Law School; and Visiting Research Fellow at Warwick Law School’s GLOBE Centre.

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