Can Blended Finance Unlock More Investment for Climate MSMEs?

Climate change is a reality. It impacts our lives every day in so many ways. Stopping it, or its impact on people, will not be easy nor cheap. Can blended finance be used to bridge the climate financing gap in Malaysia?

November 8, 2024

Malaysia is seeing more floods than ever before. Strong heat waves are making wildfires more likely (1). Increasingly erratic weather patterns exacerbate poverty and inequality. Its impacts are most evident in rural and remote communities as they often dependent on agriculture, fishing, and informal sectors in the urban economy. Recent research conducted by IRENA, suggests the climate financing gap in Malaysia is at least USD 375 billion. This is consistent in scale with the National Energy Transition Roadmap (NETR), which also estimates that Malaysia will require RM 1.2 trillion to 1.3 trillion by 2050 (2).

To bridge this gap, UNDP together with like-minded organisations, is exploring blended finance models to crowd-in much-needed climate investment at scale. The blended finance can be defined as “the use of catalytic capital from public or philanthropic sources to mobilise additional private sector investment in sustainable development” (3) . Blended finance allows organisations with different objectives to invest alongside each other while achieving their own objectives (whether financial return, social/environmental impact, or a blend of both). Could Blended Finance help Malaysia address this challenge? What models are suited to Malaysia’s context?

UNDP Malaysia aims to assess whether blended finance approach can be used to attract investment that assists micro, small and medium-sized enterprises (MSMEs) delivering goods and services that target climate mitigation and adaptation. UNDP Malaysia, under the Climate Finance Network initiative, proudly funded by the United Kingdom Foreign, Commonwealth and Development Office (FCDO), is assessing how such blended finance could empower MSMEs. This assessment aims to assess market gaps and lays out possible blended finance strategies that could be replicabled in the Malaysian context. The work is part of a preparatory phase of introducing a viable blended financing model to Malaysia. In stating how such efforts reinforce the United Kingdom’s commitment to climate action, Carol Koh, Sustainable Development Adviser to the British High Commission in Kuala Lumpur, said, “Blended finance would lay the foundation for sustainable, long-term growth by equipping MSMEs with the resources to develop resilient solutions and strengthen their ability to innovate and adapt.”

Time to Talk: Challenges of Investing in Climate MSMEs

As part of UNDP’s assessment, the Blended Finance for Climate MSMEs Workshop was held on 11 September 2024 through a collaborative effort with Malaysia Venture Capital Management Berhad (MAVCAP), Seedstars and Malaysia Digital Economy Corporation (MDEC) aimed at addressing the financing shortfall for climate MSMEs in Malaysia. The workshop brought together financiers and climate businesses to explore how blended finance could be leveraged to de-risk such investments.

In her opening remarks, Ms. Manon Bernier, UNDP’s Deputy Resident Representative to Malaysia, Singapore and Brunei, stressed the importance of private investment, noting that public funding alone cannot meet the urgent need to bridge the climate financing gap. Acknowledging the challenges she witnessed, including the scarcity of bankable projects and the limited de-risking measures, she shared her thoughts on the potential of blended finance. Other speakers, Ms. Yin Wei Chong (Head, SDG Impact Finance and Innovation, UNDP Malaysia) and Ms. Melissa Yeoh (Head of ESG and Partnership, MAVCAP), further outlined preliminary findings from the assessment and survey.

a group of people sitting in front of a computer — Participants engage in breakout room discussions.

UNDP Malaysia

Participants from both the supply and demand sides of finance then exchanged views and outlined their concerns during the breakout sessions. The first group, with the demand side, addressed MSMEs’ specific needs and challenges in securing green finance, while the groups from the supply side identified key challenges in deploying funds in the area, especially for MSMEs.

Investors do not fully understand climate tech businesses

The ‘missing middle’ highlighted a demand for action. The majority of companies surveyed, especially small-sized ones, rely on grants, equity, and personal savings rather than loans. Participants said that before reaching the size of RM 250,000, there are limited financing options available, and financial institutions, especially banks, were reluctant to provide financing due to the high (perceived) risks of small-size firms. They also pointed out that many investors, including venture capitalists (VCs) and angel investors, have a limited understanding of green initiatives with narrowly defined climate industry and impact metrics. Their doubts about the business viability of climate solutions often result in unrealistic expectations of what kind of returns could be enjoyed, leaving one participant to state,

“Many investors often expect returns within two years, creating a substantial disparity. Because climate tech companies require a much longer time – 5 to 7 years, renewable energy can easily exceed 10 years. This gap is further exacerbated by investors' lack of understanding about the capital-intensive nature of early-stage climate tech ventures. Some investors withdraw their support prematurely, which jeopardises the growth of sustainable solutions.”

Faced with a lack of patient capital, participants said grants have been extremely helpful in facilitating early-stage development of businesses and unlocking additional funding avenues. A participant shared their experience on how the results created with the grant support played a significant role in attracting subsequent funding.

We do not see good pipelines we can invest into

The lack of pipeline was identified as a key challenge to supply. Participants found that the perception of climate/green tech as being highly technical is putting off not only financiers but also entrepreneurs. Participants felt that the lack of entrepreneurship is more evident in Malaysia than in neighbouring countries such as Singapore and Indonesia. Although the climate industry is garnering significant interest, the growth potential and risks to individual businesses are difficult to assess. MSME’s lack of good financial management practices makes evaluation even more challenging.

While noting this problem, the investors asked whether channeling catalytic finance through blended finance should come first or incubating and supporting climate-positive companies should happen in advance: Demand or Supply?

Furthermore, participants also pointed out the conservative nature of corporate venture capital (CVC) firms and philanthropic investors in Malaysia. To make the ecosystem more vibrant and foster innovation and technology development, participants suggested that they needed to explore strategies to assess risks better and work with other investors.

Acknowledging the challenges from both sides, the potential of blended finance was underscored as a viable solution for bridging the financing gap by pooling public, private, and philanthropic resources, as stated by Khalid Gibran from Esave.ai.

“Blended finance is expected to offer a powerful catalyst for MSMEs to tackle climate challenges by combining public and private capital, de-risking investments, and unlocking access to essential resources. This approach drives not only impactful change but also empowers small businesses to innovate and scale sustainable solutions, accelerating the transition to a greener economy.”

One of the characteristics of blended finance that captured participants’ attention was that it may open a way for various types of investors/funders to work hand-in-hand. To further support MSMEs, the participants called for an integrated approach where patient capital, grant support and private investment can all come into one place. Blended finance is seen as one way of structuring such partnerships.

Responding to investors’ concern over the readiness of the MSMEs, participants also strongly recommended including technical assistance for MSMEs to build their capacities when designing the blended finance structure. By combining such support, only then MSMEs would be better positioned to access financial resources and scale their climate-positive solutions.

In general, the workshop highlighted the importance of continued dialogue between the sectors not only to understand each other but also to facilitate a more concrete conversation around designing large-scale blended finance projects/funds. UNDP, along with other established institutions, were asked to pave the way for additional groups to participate in this innovative financing structure.

UNDP will continue to play an important role in convening stakeholders and facilitating partnerships to underwrite such efforts. UNDP, together with relevant organisations, is currently exploring a blended finance model in nature-positive investment and many more. Stay tuned and join us as we walk together on this journey.

This story is produced under UNDP Malaysia, authored by Nurin Haril (Communications Intern) and Heesu Jeon (SDG Impact Finance Analyst).

References

ND-GAIN. Malaysia ranked 49th out of 182 countries in the 2022 ND-GAIN index, which calculates a country’s vulnerability and readiness for climate change Available at: https://gain-new.crc.nd.edu/country/malaysia#:~:text=The%20low%20vulnerability%20score%20and,the%2053rd%20most%20ready%20country
Ministry of Economy (2023) National Energy Transition Roadmap: Energising the Nation, Powering Our Future. Available at: https://ekonomi.gov.my/sites/default/files/2023-08/National%20Energy%20Transition%20Roadmap.pdf
There are a few ways of defining the blended finance but here we are following the definition of Convergence https://www.convergence.finance/blended-finance (assessed: 7 Nov 2024)