“Those innovative instruments are now recognised as effective instruments to finance urban development”

Interview with Jean François Habeau

Subnational Pooled Financing Mechanisms (SPFMs) are expected to play an increasingly strategic role in financing sustainable development. Jean-François Habeau, Executive Director of the international cities network FMDV, talks about the benefits and specific challenges of Subnational Pooled Financing Mechanisms for developing countries.

Mr. Habeau, could you give us a brief explanation of what Subnational Pooled Financing Mechanisms (SPFMs) are?
The wide definition of pooled financing is the co¬operation between local and regional governments with a focus on financing local infrastructure investments through external debt sources. In more technical terms, SPFMs are specific financial institutions dedicated to providing joint access to private capital markets, bank finance and bonds, as well as public sector funding at advantageous terms for local and regional governments.

Those instruments aim at pooling together local governments that share similar missions and credit characteristics and that either want to diversify their resources or who cannot individually access credit markets due to limited financial scope and scale, expertise and credit history.

Many experts believe that Subnational Pooled Financing Mechanisms are of particular interest to local and regional governments in developing countries. How exactly might they benefit from these instruments?
The benefits of SPFMs for local governments in developing countries are widespread. For example do they allow for finance for local infrastructure and other essential public services at reduced costs. Furthermore, they act as “market-makers”, stimulating the development of domestic capital markets; furthermore they enable greater quality of projects and creditworthiness and create a new “hard credit culture” for local and regional governments. They allow the adoption of strict market standards, enabling greater results and transparency. Finally, SPFMs support the implementation of the Sustainable Development Goals (SDGs) and national development goals by reducing costs to end-users and improving operational efficiencies in the provision of local services.

Indeed, SPFMs over the last 15 years have mobilized close to US$ 3 billion in developing countries to finance a broad spectrum of essential public services, including water and sanitation, energy, transport, telecommunications, education, marketplaces, etc. In addition, SFPMs have catalysed the rise of a subnational development-oriented asset class in the domestic capital markets, matching the long-term investment needs of in-country pension funds and other institutional investors with the availability of creditworthy pools of essential infrastructure projects.

What are the significant challenges for setting up SPFMs in developing countries?
A review of the history of SPFMs we conducted in developing countries reveals many challenges and risks due to the need to develop national and local level frameworks and domestic capital markets, as well as credit enhancements, projects, and technical capacity for their set-up and operation. SPFMs have historically required extensive upfront technical assistance to develop and structure them so they can be successful in securing private finance.

From what we observed and analysed, there are some important preconditions that help to avoid these risks. Firstly, the introduction of SPFMs requires high-level and sustained political support at national and local levels. Secondly, depending on the specific circumstances of the country and the structure of the SPFMs, the project leader has to ensure that the institutional, regulatory and legal frameworks are adapted. If they are obstructive, reforms must be engaged to enable SPFMs. Thirdly, SPFMs require intensive communication, consultation, advocacy and lobbying to ensure the support of stakeholders and the buy-in from the investors. And finally, upfront structuring costs have to be secured to structure the SPFMs and to mobilise high skilled professionals. SPFMs need to be managed by credible and experienced experts to meet investor requirements.

Implementing SPFMs in a new market requires time and a significant upfront process. However, once established, SPFMs are reported as being cost-effective in terms of securing long term low cost finance, low operating costs, and having low default rates.

Could you give us some examples of SPFM implementations in developing countries?
The SPFM approaches from developed countries have been successfully adapted to circumstances in developing countries to secure both bank loans and bond finance with greatest replication in Asia, Latin America and Africa.

In Mexico for example, the Bond Bank of the State of Hidalgo, founded in 2007 with support from the USAID Global Development Alliance program, conducted three bond issues raising a total of US$ 213 million. In addition, SPFMs have successfully secured finance for more than 650 small projects in India, South Africa, Colombia, Kenya and Mexico.

However, the scaling up of SPFMs in developing countries has not occurred, due to a lack of support from the public sector and donors.

Indeed, meeting the specific preconditions – including enabling local and regional governments to achieve a stable financial status by greater authority over own sources of revenues and providing them with timely, predictable, and adequate intergovernmental financial transfers – require financial support from donors and institutional support from central Governments.

This is part of the necessary advocacy process FMDV participates in to-gether with the Global Task Force of Local and Regional Governments and some financial institutions such as the French Development Agency AFD.

At the Habitat III conference in Quito this fall, the member states of the UN will agree on a new urban strategy, the New Urban Agenda. Financing sustainable urban development will be one of the major topics. Do you think that the New Urban Agenda could pave the way to enable SPFMs in developing countries on a large scale?
FMDV actively participates in the Habitat III process with a special focus on financing sustainable urban development. In March, we co-organized with the City of Mexico the thematic conference “Financing Urban Development” with more than 700 participants. We issued the Mexico Declaration with 11 drivers for action to implement in the New Urban Agenda.

SPFMs are included in the Mexico Declaration and I am very pleased to say that those innovative instruments are now recognized as effective instruments to finance urban development and are integrated in the Draft Zero of the Urban Agenda thanks to the advocacy we developed together with the Global Task Force and the French Government.

If the final text of the New Urban Agenda retains the citation, SPFMs will become an essential mainstream financial instrument to support the achievement of the SDGs and national development goals, using a “blended finance” approach for government-owned and sponsored projects.