3. Funding to the multilateral development system

Abstract

Contributions to multilateral organisations continued to increase throughout 2019 and 2020. However, this increase has not benefitted all parts of the multilateral system equally, and multilateral development organisations continue to experience significant funding gaps. The current global context also calls for strategically rethinking DAC members’ support to multilateral organisations. This involves reconsidering and resetting their funding approach in light of the organisations’ evolving mandates, new demands on the system, and the strategic implications of the rise of emerging donors, such as China and the private sector. However, efforts to diversify and optimise multilateral funding sources need to be accompanied by discussions about the governance and accountability mechanisms of new funding arrangements. This is particularly important to ensure that multilateral organisations continue to anchor their operations in their development mandates and the commitment to serve the countries and sectors with the greatest needs.

3.1. The multilateral development system continues to grow in importance as an ODA channel

3.1.1. DAC members’ multilateral contributions reached an all-time high in 2020

Despite the tightening budget constraints for DAC member countries during the pandemic, their inflows to the multilateral system continued to rise in 2020. Over the past decade, the multilateral development system has channelled growing volumes of ODA. Between 2012 and 2019, annual core 1 and non-core 2 contributions to multilateral development organisations increased from USD 56.8 billion to USD 70.6 billion (+24%). The outbreak of the COVID-19 pandemic in 2020 seems to have accelerated this trend, with DAC members’ multilateral contributions reaching an all-time high of USD 76.4 billion in 2020 (Figure 3.1). This represented an 8% increase from 2019, compared to the 1% and 2% increases registered respectively between 2018-19 and 2017-18.

Figure 3.1. Multilateral inflows from DAC members reached an all-time high in 2020

The pandemic did not immediately lead to an abrupt change in the allocation of DAC members’ ODA between multilateral and bilateral channels. The 8% increase observed in ODA channelled to and through multilateral organisations in 2020 was slightly larger than the increase in direct bilateral ODA (6%). As a result, the allocation patterns between multilateral and bilateral aid remained consistent with the long-term trend of a steady but slow increase in the use of multilateral channels. Between 2019 and 2020, the share of DAC members’ ODA channelled to or through multilateral development organisations increased by around 1%, in line with the average increase observed over the four previous years (2015-2019). The fact that the exceptional circumstances faced in 2020 did not result in a larger digression from previous trends suggests the possible existence of rigidities and path-dependencies constraining the ability of DAC members to swiftly adjust and balance their multilateral and bilateral allocations.

The overall increase in multilateral contributions hides significant disparities across DAC members. Most DAC members have increased their funding to multilateral organisations in recent years. Between 2019 and 2020, for example, 22 out of 29 DAC countries increased their multilateral contributions (Figure 3.2). Germany and the United States increased their multilateral contributions by the largest amounts, by USD 2.6 billion and USD 1.1 billion, respectively. In relative terms, Sweden (32%) and Hungary (28%) registered the largest increases. On the other hand, six DAC members, including some of the largest multilateral donors such as the United Kingdom and Japan, decreased their funding to the multilateral development system over the same period.

Figure 3.2. Most DAC members have increased their multilateral development funding

3.1.2. DAC members continue to supply most of the multilateral development system’s funding

The sustained increase in DAC members’ multilateral contributions has allowed their share of donor funding to the UNDS to remain stable in recent years, while China’s share has increased. DAC members account for more than 80% of total contributions to the UNDS, and their collective share has remained stable since 2018 (Figure 3.3, Panel A). On the other hand, China’s share has increased slowly but steadily over the last three years, from 3% in 2018 to 4% in 2019 and 5% in 2020. Analysis based on the United Nations System Chief Executives Board for Coordination (CEB) Financial Statistics database reveals that the growth of China’s share of total UNDS contributions has been at the expense of the share of contributions of other non-DAC donors, which decreased from 16% in 2018 to 15% in 2019 and 14% in 2020 (UNCEB, 2022[2]). These changes in the funding patterns of the UNDS result from diverging trends in the multilateral contributions of these different donor groupings. Between 2018 and 2020, for example, DAC countries’ collective contributions to the UNDS increased by USD 1.7 billion, from USD 32.5 billion to USD 34.2 billion (+5%). Over the same period, China’s contributions to the UNDS also grew. They reached USD 1.9 billion in 2020, up by almost 50%, or USD 650 million, compared to 2018 (USD 1.3 billion). In contrast, UNDS contributions from other non-DAC donor governments decreased over these three years, from USD 6.3 billion to USD 6.1 billion (-3%, or USD 194 million).

DAC members contribute the majority of the funding for most UN entities. Figure 3.3, Panel B shows that the collective share of DAC donors in the UN Development System exceeds 50% for most UN entities. However, there are some rare cases, such as the International Maritime Organisation (IMO) and the World Tourism Organisation (UNWTO), where DAC members are minority funders, with collective shares of 36% and 30%, respectively. The figure also shows that China’s multilateral contributions represent less than 5% of most UN entities’ funding. Here again, there are some notable exceptions. For example, China provides a relatively high share of some organisations’ funding, such as the United Nations Industrial Development Organisation (UNIDO, 16%) and the UN Department of Peace Operations (UNDPO, 14%). UNDPO is primarily funded by assessed contributions,3 and therefore the funding composition better reflects the economic power of members. China’s relatively high share of funding to UNIDO, which receives almost half (47%) of its funds in the form of voluntary contributions, sheds light on the priority areas for China’s development co-operation efforts.

Figure 3.3. DAC countries account for most UN entities’ total funding from donor governments

In 2020, DAC members stepped up their contributions to the UNDS, while non-DAC countries’ funding decreased. DAC members’ contributions to UNDS entities rose by 6% in 2020, from USD 31.6 billion to USD 33.4 billion. Over the same period, non-DAC countries slightly decreased their contributions to the UNDS (from USD 9.4 billion USD to USD 8.9 billion), possibly as a consequence of tightening fiscal conditions during the crisis. Figure 3.4 shows that a majority of DAC members increased their contributions to UN entities between 2019 and 2020, albeit by incremental amounts except for Germany and the United States, which both provided steep increases.

In contrast, non-DAC donors increased their contributions to IDA replenishments – both in absolute terms and as a relative share of the total. This change in the proportion of DAC and non-DAC donors was mostly driven by two factors. First, the distribution on the left-hand side of Figure 3.4 is widest at and slightly above zero, reflecting that most DAC members only slightly increased their IDA contributions between replenishments in 2019 (IDA19) and 2021 (IDA20). The United States increased its contributions the most, while the UK significantly decreased its funding, from USD 3.9 billion to USD 2.0 billion (-49%). Second, BRICS and other non-DAC donors increased their contributions: Saudi Arabia significantly increased its contributions, from USD 300 million in IDA19 to USD 700 million in IDA20 (+75%). China and Russia both increased their contributions: China from USD 1.2 billion to USD 1.32 billion (+10%) and Russia from no contributions to USD 50 million.

Figure 3.4. Bar a few notable exceptions, most DAC members slightly increased contributions to the UNDS and IDA

3.1.3. Recent increases in multilateral contributions are not evenly distributed across the system

Despite the pandemic-induced global crisis, some multilateral organisations raised significant resources through successful replenishments. For example, the International Fund for Agricultural Development (IFAD) mobilised a record amount of USD 3.8 billion in its 12th replenishment in 2020. In the following year, IDA set another record by raising USD 93 billion 4 in its 20th replenishment. Moreover, the advancement of IDA20 by one year, which resulted in a shortening of IDA19 to two years, constitutes in and of itself an increase in donor contributions. The Global Fund to Fight AIDS, Tuberculosis and Malaria (Global Fund), which received an unprecedented amount (USD 14 billion) in donor commitments for its sixth replenishment in 2019, now aims to achieve USD 18 billion for its seventh replenishment in 2022. As of end September 2022, it has already raised USD 14.25 billion in pledges.

Overall, contributions to the UNDS and vertical funds increased sharply in 2020, while those to MDBs presented a mixed picture. Contributions to UN Funds and Programmes rose by 2.7%, from USD 12.3 billion in 2019 to USD 12.7 billion in 2020 (Figure 3.5, Panel A). In comparison, other UNDS entities saw an increase in contributions of about 4.9% over the same period. The largest increase was experienced by the vertical funds, whose contributions collectively rose by 56.9%, from USD 6 billion to USD 9.5 billion. Funding to the World Bank Group, on the other hand, decreased by 4.7%.

Figure 3.5. The UN and vertical funds gained most from the increase in multilateral inflows in 2020

The different modalities for resource mobilisation across multilateral organisations only explain part of the divergence in funding trends. The divergence can be partially explained by the nature and cycle of MDB and vertical fund replenishments, which occur over a multi-year period. Yet, even when averaging out annual contributions over multiple years, the divergence between the funding trends of various types of multilateral organisations remains visible (Figure 3.5, Panel B). The analysis shows that over the past decade, contributions to both UN Funds and Programmes and other UN agencies experienced a steep increase (+28%), while vertical funds and the World Bank Group have registered more moderate increases. Conversely, contributions to other MDBs have decreased.

This suggests that DAC providers may increasingly recognise the ability of MDBs to raise financing from capital markets and therefore prioritise funding to the UN. More than half of DAC members (17 out of 30) decreased the share of contributions to MDBs in their overall multilateral funding between the 2015-17 and 2018-20 periods. In contrast, only about one third of DAC members decreased the share of their contributions to the UN Development System or vertical funds (Figure 3.6). One additional explanation for this trend is that donors favour the UN system, with its strong track record on humanitarian assistance, for channelling resources for emergency relief, as was required during the pandemic. Until now, MDBs have been able to compensate for the downturn in some members’ multilateral contributions by mobilising additional financing using callable capital from member governments. However, as explored in detail in Section 3.2, there may be a need to review to what extent capital market financing can and should be expanded to substitute for official providers’ contributions.

Figure 3.6. Most DAC members’ funding allocation changes are incremental

3.1.4. Official providers’ continued tendency to earmark their contributions constrains the flexibility of multilateral development organisations and their ability to reform

Funds earmarked through the multilateral development system represent a growing share of DAC members’ ODA. In their efforts to scale up multilateral development finance, DAC members have been increasing both their core and non-core (earmarked) contributions. Between 2019 and 2020, DAC members’ core contributions to the multilateral development system increased by 6.5%, from USD 45 billion to USD 48 billion (Figure 3.7, Panel A). Over the same period, their non-core contributions rose by roughly the same amount (USD 3 billion, representing a 11.3% increase). In terms of proportion, however, the share of earmarked funding continued to grow, in line with the trend observed over the past decade.

DAC members’ increase in earmarked funding has come at the expense of direct bilateral spending. As pointed out in the previous edition of this report (OECD, 2020[4]), earmarked contributions have grown at the cost of purely bilateral rather than core multilateral ODA. For example, while the share of DAC members’ non-core (earmarked) contributions in their total ODA grew from 13% to 16% between 2015 and 2020, the share of their direct bilateral ODA declined from 61% to 57%, and the share of their core contributions increased only slightly, from 26% to 27% (Figure 3.7, Panel B).

Donors’ earmarking tendencies suggest a continued shift towards an “à la carte” multilateralism, as pointed out in the previous edition of this report. Earmarking can be a way for donors to shift multilateral organisations’ activities towards evolving development challenges that current allocation patterns and core priorities do not sufficiently address. An increasing tendency to earmark funds, therefore, may reflect a real or perceived failure of multilateral organisations to reflect the evolving priorities of the majority funders. In the long term, however, the rise of earmarked funding could result in a multilateral development system in which funding allocations are driven and shaped by the priorities of a narrower set of multilateral donors, rather than backed by broad-based consensus across the membership.

Figure 3.7. Earmarked funding represents a growing portion of DAC members’ ODA

If sustained, the growing share of earmarked funds could also affect the system’s ability to respond to global emergencies and slow down efforts to make it fit to tackle global challenges. A recent study from the Multilateral Organisation Performance Assessment Network (MOPAN) on the reform initiatives of the United Nations Development System found that the lack of sustainable and predictable funding poses one of the greatest risks to the success of multilateral reform (MOPAN, 2021[5]). As an increasing portion of development finance channelled through the multilateral development system is earmarked for specific objectives, core functions receive a smaller share of funding. In the long run, this could lead to a gradual erosion of the core functions of the multilateral system critical to providing strategic and long-term oversight, implementing key reforms, and adapting to the evolving and expanding nature of global development challenges.

Earmarking patterns changed slightly in 2020, as DAC members’ contributions became less tightly earmarked geographically, but more earmarked thematically. Contributions earmarked for country-specific programmes and projects made up 53% of all earmarked funds in 2020, down from 62% in 2019 (Figure 3.8, Panel A). At the same time, the share of contributions earmarked for specific projects rose from 37% and 38% in 2018 and 2019 respectively, to 47% in 2020. The increase in the share of multilateral contributions earmarked at the global or regional level (i.e. not for a specific country) reflects in part the global nature of the COVID-19 crisis, which has led to the establishment of global financing mechanisms, such as the COVID-19 Response and Recovery Trust Fund. This also explains why global or regional project-type contributions, which account for a small share of DAC countries’ earmarked funding, registered the highest increase among the different earmarking modalities (from 8% in 2019 to 13% in 2020). In fact, a 2020 policy brief on DAC countries’ earmarking highlighted that this specific earmarking modality had already been used in response to previous pandemics, for example to channel funding to the Ebola Response Fund (OECD, 2020[6]).

Figure 3.8. The pandemic response drove DAC members’ earmarking patterns in 2020

In terms of sectoral allocation, the need to cope with the public health crisis and its social consequences drove greater earmarking in the social sector (Figure 3.8, Panel B). The social sector, which comprises health and social protection measures, registered the largest increase in earmarked contributions from DAC members between 2018 and 2020 (+7%, from 17% to 24%). This increase was largely driven by a rise in contributions earmarked for health (+USD 2.1 billion) and other social infrastructure and services (+USD 455 million). The share of contributions earmarked for humanitarian purposes, on the other hand, registered the largest decrease between 2018 and 2020, from 45% to 39%, although this trend is likely to be reversed again in 2021 and 2022.

DAC members’ earmarking modalities and allocations provided them with some flexibility to respond to the COVID-19 pandemic. While DAC members did not abruptly increase their multilateral contributions in 2020 (as noted earlier in this chapter), their earmarked funding allowed them to channel resources to new priorities and objectives. This highlights a key rationale for DAC members to earmark their contributions to the multilateral development system, since it provides them with the agility to quickly react and adapt to crises and unexpected challenges in a way not possible with their core contributions. Given the prospect of more frequent global shocks, discussed in Chapter 2, this rationale implies increased upwards pressure on DAC members’ earmarked contributions in the coming years.

3.2. Multilateral organisations are under pressure to diversify and optimise their funding structures

3.2.1. The UN Development System seeks to overcome funding vulnerabilities through system-wide reforms and greater engagement of private actors

Funding vulnerabilities continue to challenge the UN Development System

The overall increase in inflows to the UN system masks a set of intensifying funding vulnerabilities. While inflows to both UN Funds and Programmes and other UN agencies have increased steadily since 2011, Figure 3.9 illustrates that this does not always translate into an increase in the volume of funding received by individual organisations. Despite the increase in total contributions to other UN entities, average contributions remain flat. For UN Funds and Programmes, steep increases in funding to the World Food Programme (WFP) and the United Nations’ Children’s Fund (UNICEF) accounted for most of the overall increase in average inflows. On the other hand, funding remained flat for the other UN Funds and Programmes, including the United Nations Development Programme (UNDP), United Nations Environment Programme (UNEP), United Nations Human Settlement Programme (UN-Habitat), and the United Nations Population Fund (UNFPA). In the case of other UN agencies, the average contributions to each organisation have remained virtually the same over the years, suggesting that the significant increase in overall inflows has not flowed proportionately across agencies.

Figure 3.9. The increase in member states’ contributions has not benefitted all UN entities equally

The UN system is particularly vulnerable due to its large reliance on voluntary, and increasingly earmarked, contributions. The share of earmarked funds in total contributions to the UNDS stood at 57% in 2019, and continued to increase to reach 59% in 2020. Between 2019 and 2020, earmarked contributions from DAC members to UN entities grew at an especially rapid pace, from USD 18 billion to USD 20 billion, which represented an 11% increase. Due to this increase, the share of earmarked contributions in DAC members’ total contributions to the UNDS entities rose from 58% to 61% between 2019 and 2020 (Figure 3.10). Recent MOPAN assessments have highlighted that the large share of non-core, earmarked funds received by some UNDS entities constrains their ability to reallocate resources in an agile way in response to crises (MOPAN, 2021[5]). In some cases, such as UNICEF and UNEP, the high reliance on earmarked contributions has also led to challenges for resource mobilisation due to the fiscal constraints experienced by member states.

Member states’ preference for earmarked funding also undermines the UN’s ability to act as a convenor. Recent research suggests that an overreliance on non-core (earmarked) contributions can compromise UN entities’ ability to co-ordinate across the UN system and with other development actors (Dag Hammarskjöld Foundation, 2021[7]). According to the same study, a key reason for member states’ reluctance to increase the share of core contributions to UN entities is the perceived lack of transparency and visibility over how core contributions to the UN Development System are being used in countries to support national development priorities. In particular, there are concerns that large proportions of overhead costs are allocated to UN entities at headquarters rather than to support activities in countries. This suggests that improved information and transparency about the use of members’ core funding could increase incentives for member states to raise the proportion of these contributions.

Figure 3.10. Earmarking to the UNDS increased further in 2020 to finance the pandemic response

Funding vulnerability varies widely across the different UN entities, largely driven by their high reliance on non-core, earmarked contributions. Generally, UN Funds and Programmes such as WFP, UNICEF, and UNDP are more reliant on non-core (earmarked) funding than other UN agencies (Figure 3.11). High reliance on earmarked contributions also seems to be a common feature for UN entities which focus on humanitarian aid, such as the UNHCR, WFP, UNICEF and IOM. It is noteworthy that the WFP and UNICEF are also two of the organisations that have registered the most rapid increase in donor contributions between 2011 and 2020, driven by a rise in earmarked funding for humanitarian purposes. This implies that rapid growth in donor contributions may come at the expense of sustainability and predictability of funding.

The funding volatility experienced by some UN entities is largely driven by their high reliance on non-core, earmarked contributions. The lack of predictable funding is a key ingredient of multilateral organisations’ funding vulnerability and can impair their capacity to deliver on their mandates. While the high funding volatility experienced by some UN entities has multiple causes, the analysis reveals that the level of earmarked contributions received by these entities is a better predictor of their funding volatility than other variables, such as their sectoral focus, governance model, or funding volume. For example, while it seems logical for entities with a focus on humanitarian assistance to experience funding volatility since their operations and funding needs are tied to specific crisis outbreaks, this does not explain why other entities, such as the WHO and UNEP, also have high levels of funding volatility. In some cases, such as UNDPO, the low share of earmarked funding is in turn explained by high reliance on assessed contributions, which may be the main reason for low funding volatility. Other variables, such as the funding volume or the type of UN entity (e.g. UN Funds and Programmes, or other UN entities), do not offer a better explanation of UN entities’ funding volatility. UNWOMEN stands out as the entity with the highest funding volatility, despite a relatively moderate share of earmarked funds. This can be explained by the fact that UNWOMEN was established in 2010 and has experienced steep increases in funding in its relatively short history.

Figure 3.11. The share of earmarked contributions received by UN entities explains much of their funding volatility

The pandemic has highlighted the funding problems of the WHO. The analysis confirms that, even among UN entities, the WHO receives a high share of non-core (earmarked) funding (Figure 3.11) and is also among the entities with the highest funding volatility. The Contingency Fund for Emergencies, which provides the WHO with the resources to respond rapidly to disease outbreaks and health emergencies, had been undercapitalised for years and depleted by the Ebola Crisis in 2018. At the outbreak of the pandemic its available funds amounted to only USD 12.9 million. In fact, the recent initiative of the World Health Assembly (WHA) to reform the WHO’s financing model, described in Box 3.1, aims to lessen its funding vulnerability by significantly reducing its dependence on members’ voluntary contributions.

Box 3.1. Member states recently agreed to reform the WHO’s financing model to enhance the organisation’s independence and flexibility

At the 75th session of the WHA, held in May 2022, member states adopted a landmark decision to improve the WHO’s financing model. The agreement called for the implementation of the recommendations of the Sustainable Financing Working Group, set up in January 2021, which included gradually increasing the WHO member states’ assessed contributions (membership dues) to 50% of its core budget by the 2030–2031 budget cycle (WHO, 2022[8]). By way of comparison, assessed contributions represented only 16% of the organisation’s approved programme budget in the 2020–2021 budget biennium.

This decision aims to reform WHO's current financing model, which has been shown to pose a risk to the integrity and independence of its work. Assessed contributions have been frozen since the 1980s, when the WHA introduced a “zero-real growth policy” for the regular budget. As a result, the organisation’s over-reliance on voluntary contributions, with a large proportion of funding earmarked for specific areas of work, affected its ability to fulfil its essential global health functions. This includes the creation of norms and standards based on the best technical knowledge and evidence, as well as the prevention, detection and response to disease outbreaks such as the COVID-19 pandemic (Gulrajani, Haug and Weinlich, 2022[9]).

During the COVID-19 crisis, the WHO used multi-pronged resource mobilisation strategies to mitigate its funding vulnerability. The WHO, jointly with the UN Foundation and Swiss Philanthropy Foundation (SPF), launched the Solidarity Response Fund (SRF) in March 2020 to mobilise direct financial contributions – from companies, organisations and individuals – to the COVID-19 response efforts of WHO and its partners. Between March 2020 and November 2021, the SRF successfully raised a total of USD 257 million. An external evaluation of the SRF noted that it had yielded significant, un-earmarked funding for the WHO and partners (IOD PARC, 2021[10]). In the second year of the pandemic, the WHO also appealed for USD 2 billion to fund the operationalisation of the COVID-19 Strategic Preparedness and Response Plan (SPRP) published in February 2020 through the so-called COVID-19 Member-State Pooled Fund. This pooled fund enabled member states to pool their contributions into a single, unearmarked and revolving fund that could be used immediately to support countries. In 2020, the COVID-19 Member-State Pooled Fund raised a total of USD 1.5 billion, and enabled the WHO to take rapid action through increased funding flexibility and reduced administrative processes. The fund played a role in mitigating vaccine and other supply shortages early in the pandemic. In the first few months of the pandemic, LICs and MICs obtained 50% of the personal protective equipment (PPE) and essential medical supplies through the Supply Chain System, for which the SRF was a key source of funds.

The UN Funding Compact shows mixed progress in the effort to secure stable and sustainable funding

UN member states adopted the Funding Compact in 2019 as a means of aligning their financial support to the UNDS with the 2030 Agenda for Sustainable Development. The Funding Compact represents a holistic system-wide framework for change and accountability, aimed at strengthening trust among the various stakeholders of the UN system. It contains a set of commitments, measured by indicators, for member states and UN entities. The commitments of UN entities are grouped into three categories: (i) accelerating results on the ground by working jointly towards common objectives; (ii) improving transparency and accountability through reporting on needs, resources, results and impact; and (iii) increasing efficiencies. At the same time, the Compact encourages member states to (i) align funding to UN entities’ requirements; (ii) provide funding stability by committing more to core UN resources as opposed to earmarked funding; and (iii) facilitate coherence and efficiency. In concrete terms, member states commit to increasing core resources to a level of at least 30% by 2023; enhancing multi-year and flexible contributions; and doubling resources channelled through development-related inter-agency pooled funds and single-agency thematic funds.

So far, the Compact has seen mixed results, with member states lagging behind UN entities in their implementation of the commitments. The overall results of the most recent Quadrennial Comprehensive Policy Review (QCPR) reporting process, which undertakes the global monitoring of the Funding Compact indicators, are summarised in Figure 3.12. While UN entities have made advances on some of their commitments, member states have largely failed to realise theirs. Of 36 indicators measuring progress against commitments by UN entities, rapid progress was reported for 14, medium progress for 12, and stalled or slow progress for 8, while results could not be measured for two indicators. Most progress was made in increasing transparency and accountability, while least progress was made in achieving results on the ground. In comparison, for 10 of the 17 indicators related to commitments made by member states, progress was either stalled or slow. Rapid progress was reported for only two indicators, and medium progress for four indicators. Whereas some progress was made towards better aligning funding with UN entities’ mandates, least progress was reported on facilitating coherence and efficiency (e.g. through harmonised reporting and visibility requirements for earmarked contributions at the country level).

Figure 3.12. The monitoring of the UN Funding Compact implementation shows mixed results

Despite the progress in some areas, implementation of the Compact remains hampered by the lack of individual commitment from member states and low awareness at the country level. While UN member states committed collectively to improve their support to the UN system as part of the Funding Compact, the monitoring exercise shows that these collective commitments have rarely translated into positive change. One of the reasons for this lack of progress lies in the lack of commitment by individual member states, which prevents proper accountability. In addition, a recent study which explored the level of implementation of the Funding Compact in partner countries through in-depth country studies, found that most UN entities interviewed had not received clear guidance on the Funding Compact, or directives on how it should be operationalised at the country level (Dag Hammarskjöld Foundation, 2021[7]). Among member states, embassies or their development co-operation sections had rarely received information on the Funding Compact from capitals, ministries of foreign affairs or development agency headquarters.

Partnerships with the private sector offer both opportunities and risks

As part of wider efforts to diversify their funding base, UN entities are increasingly seeking contributions from the private sector, notably philanthropic foundations. In 2020, private contributions to the UNDS nearly doubled as donors provided a total of just over USD 1 billion, up from USD 708 million in 2019 (+45%). This shows that partnerships with the private sector are increasingly looked upon as a way to mobilise additional resources. However, they also offer opportunities to pursue pragmatic, flexible and solution-oriented approaches to achieving the complex and interlinked development challenges that the 2030 Agenda sets out to tackle.

Although private contributions constitute only a fraction of total funding to the UNDS, some individual UN entities have a relatively high reliance on private donors. Despite the significant increase observed in 2020, private contributions still constitute a minority of overall contributions to the UN Development System. Between 2019 and 2020, for example, the collective share of private contributions to the UNDS increased from 1.5% to just 2%. Yet, the share of private contributions varies across UN entities. For example, the share of private contributions (including private sector, foundations and NGOs) is especially high for UNICEF (23%), WHO (21%), UNHCR (11%) and UNCDF (10%) (Figure 3.13, Panel B).

The Bill and Melinda Gates Foundation (BMGF) is the most prominent private donor to the UNDS. With its endowment of USD 50 billion, the BMGF is by far the largest private sector funder to the UNDS. Most of its spending is dedicated to global health and global agriculture. Between 2018 and 2020, for example, the BMGF provided more than USD 850 million in direct contributions to the WHO. In fact, the Multilateral Development Finance 2020 report highlighted that the foundation was the WHO’s second largest funder in 2018 (OECD, 2020[4]). Moreover, the BMGF also contributes indirectly to the UN through its support to various vertical funds, such as the Global Fund to fight AIDS, Tuberculosis and Malaria (Global Fund) and Gavi, the Vaccine Alliance, which channel some of their funds through the UNDS.

Figure 3.13. Private contributions to the UNDS increased sharply in 2020, but their share of total funding varies considerably across UN entities

While UN entities’ efforts to diversify their funding sources make sense for reducing their funding vulnerability, the implications need to be considered carefully. The previous edition of the Multilateral Development Finance report highlighted that changes in funding practices can have implications for the governance and effectiveness of the multilateral development system, potentially undermining the consensus-based decision-making process (OECD, 2020[4]). Over time, an overreliance on partnerships with private foundations or companies can have adverse effects that are similar to a dependence on earmarked funding from official providers. For example, the proliferation of partnerships between corporations, philanthropic foundations and the UN provides private actors with growing influence over policy priorities and strategic direction in the allocation of multilateral development resources, despite lacking a constituency that they represent and to which they are accountable. Potential risks include a shift away from policy and programme priorities defined by intergovernmental bodies, high transaction costs, reduced coherence of the system, and difficulties related to planning and co-ordination. Since many private foundations and corporations promote market-based approaches to development, with a strong emphasis on short-term results and impact, their increased involvement in strategic decisions on multilateral development finance allocations can also lead to under-investments in systemic and country-owned approaches where impact only becomes evident in the long term.

3.2.2. Multilateral development banks are increasingly capitalising on their unique ability to access global financial markets

The MDBs’ unique financial model provides flexibility in times of crisis

The MDBs’ funding model, which allows them to raise funds from international capital markets and earn resources on their lending operations, has enabled a prompt and flexible response to the COVID-19 crisis. MDBs’ access to capital markets is backed by the capital contributions from their member governments. MDBs typically have very high, often “AAA” credit ratings, which reflects two factors: (i) the MDBs’ multilateral shareholding structure and preferred creditor status;5 and (ii) their strong levels of capitalisation, which are generally much higher than for commercial lenders. The capital from member governments usually comes in two forms: “paid-in capital,” which generally requires the payment of cash to the MDB; and “callable capital,” which member governments agree to provide in the case of an imminent default on a borrowing or guarantee payment. Paid-in capital constitutes only a small portion (typically less than 5%) of MDBs’ total capital, while the bulk is in the form of callable capital. MDBs’ creditworthiness underlies the financial model and viability of their operations. Based on their high credit ratings, MDBs can raise financing at competitive rates and fund their operations from the spread between the interest rates they pay to investors and the rates client countries pay on the loans MDBs provide to them. For this reason, MDBs have set up capital adequacy frameworks that impose limits on their annual lending.

MDBs have taken steps to ramp up their counter-cyclical lending to developing countries. Since the beginning of the pandemic, many MDBs have announced the acceleration of disbursements, set up additional credit facilities and repurposed existing financing for COVID-19-related projects. The increase in outflows from MDBs, which is further highlighted in Chapter 4, stands in stark contrast to the stagnating levels of multilateral inflows provided to MDBs by their member states.

Initiatives are under way to ease the constraints on MDBs by enhancing the efficiency of their capital use. In 2021, the G20 commissioned an independent review of MDBs’ capital adequacy frameworks (CAFs). The main objective of the review was to enable shareholders to consider adaptations to the current frameworks in order to maximise MDBs' financing capacity, potentially unlocking hundreds of billions of dollars in additional lending. Recognising that MDBs’ highly conservative approaches to capital adequacy may clash with the need to provide counter-cyclical and large-scale financing, the independent review encouraged shareholders to (i) revisit their risk management approaches and align MDB risk appetites with operational priorities and strategies; (ii) recognise the benefits of callable capital; (iii) expand the use of financial innovations, (iv) enhance dialogue with credit rating agencies, and (v) promote greater transparency regarding MDB credit performance. With regard to the need for more transparency, the review especially called for an improvement of capital adequacy governance by enhancing shareholders’ information and understanding of the capital adequacy management approaches of different MDBs. If implemented, such measures could collectively help to free up capital in the range of USD 500 billion to USD 1 trillion. (G20, 2022[12]).

MDBs’ financing headroom is reduced by limited potential for new capital increases

Successive bond issuances, backed by recent capital increases, have allowed MDBs to scale up their lending in recent years. Following the financial crisis, all major MDBs received capital increases although their level varied widely across institutions (Table 3.1). In addition, several organisations were also recapitalised more recently, including the IBRD in 2018, and the AfDB and IFC in 2019. The recapitalisation of the main MDBs allowed them to provide massive support for the immediate response to the COVID-19 crisis, mainly financed through bond issuances on global capital markets. In the case of the IBRD, paid-in capital from the 2018 general capital increase strengthened its equity base, allowing it to issue bonds at record levels during fiscal years 2020 (FY2020) and 2021 (FY2021). In FY2020 and FY2021, the IBRD raised respectively USD 75 billion and USD 68 billion, up from USD 54 billion in FY2019. The Asian Development Bank (ADB) issued a record 160 bonds in 2021 (compared to 120 in 2019), representing a 33% increase. In both 2020 and 2021, the financing raised by ADB through its bond issuances amounted to USD 36 billion a year, compared to only USD 25 billion in 2019 (+40%).

Table 3.1. The main MDBs have seen large capital increases recently
MDB	Year of first capital increase after global financial crisis	Percentage change of capital increase	Year of more recent capital increase (if any)	Percentage change of capital increase
AfDB	2010	200%	2019	125%
ADB	2009	200%	-	-
EBRD	2010	50%	-	-
IBRD	2010	31%	2018	22%
IDB	2012	70%	In progress
IFC	2010	8%	2018	220%
Source: Authors’ compilation based on (Moss, Staats and Barmeier, 2011[13]), (World Bank Group, 2018[14]), (African Development Bank, 2019[15]).

However, the potential for further capital increases appears limited. Despite the massive scaling up of disbursements by MDBs and the acknowledgement of persisting financing needs in developing countries, there are hardly any calls to boost the capital base of the main MDBs further. A notable exception is the Inter-American Development Bank (IDB), whose Board of Governors mandated in March 2022 a proposal for a capital increase of IDB Invest, its private-sector arm. The strain of successive crises on member governments’ budgets may partly explain the lack of support for further MDB capital increases (even though the bulk of capital increases would be in the form of callable capital, which does not directly impact governments’ budgets). The other factor that comes into play is the tense geopolitical dynamics among shareholders; in the case of new capital increases these would likely lead to discussions around shareholder reform and the adjustment of voting rights in the main MDBs.

MDBs are under increasing pressure to do more with less and optimise their balance sheets

While the MDB model gives them financial autonomy from donors, it also exposes them to the influence of capital markets. The ability to borrow from capital markets gives MDBs financial autonomy from donors beyond that available to a standard, budget-funded multilateral organisation. It also provides them with the flexibility to respond counter-cyclically to crises, as explored in greater detail in Chapter 3. However, MDBs’ financial autonomy from official donors hinges on their ability to maintain triple A ratings, and ensure the attractiveness of their bonds vis-à-vis capital market investors (Humphrey, 2017[16]).

MDBs’ accountability to non-government stakeholders, especially credit rating agencies (CRA) and capital market investors, could clash with their development mandate. As explained in Box 3.2, there is a risk that pressures to maintain triple A ratings in light of the stringent requirements of CRAs can lead to a highly conservative approach in terms of MDBs’ capital adequacy. Ultimately, this could cause MDBs to: (i) restrict their overall capacity to make use of their balance sheet for development projects; and (ii) limit lending to some countries facing economic difficulties. Until now, MDBs have been able to successfully maintain concessionality and provide counter-cyclical financing. However, should donor contributions continue to stagnate over the long-term, MDBs could experience mounting difficulties in maintaining the balance between the need to meet capital market requirements to maintain triple A ratings, and the ability to supply low-cost financing at scale to countries most in need. This trade-off could also intensify in coming years because of the evolution of the global economic and financial context. For example, the quantitative tightening put in place by the central banks of the world’s major economies in 2022 in reaction to global inflationary pressures prompted interest rates to rise at levels not seen since before the global financial crisis. If sustained, the resulting contraction of bond markets could directly impact MDBs’ ability to raise resources.

Box 3.2. The methodologies of the main credit rating agencies lead to a conservative approach towards MDBs’ capital adequacy

The MDBs’ operational model puts them at a disadvantage in terms of credit ratings compared to other actors. This can encourage them to be highly conservative in managing credit risk and capital adequacy to preserve their triple A ratings. Credit rating agencies (CRAs) assess the creditworthiness of MDBs by evaluating the risk of default on their loan portfolios and the adequacy of their capital. In practice, MDBs are often subject to the same models and methodologies used to rate commercial banks. However, this puts them at a disadvantage due to their specific features. For example, credit rating methodologies tend to penalise MDBs for the high concentration risk in their portfolios. This is particularly the case for the regional and sub-regional MDBs, which are focused on a specific geographic area and typically have a narrow loan portfolio. By way of comparison, the non-concessional lending windows of the major regional MDBs have between 15 (AfDB) and 32 (ADB) country exposures, compared to thousands of individual exposures for most large commercial banks. In addition, the bulk of loans in this narrow portfolio go to a small number of large middle-income countries, due mainly to their absorptive capacity (Humphrey, 2017[16]). Lastly, many MDBs’ borrowers have relatively low credit ratings, which adds to the penalty for the high concentration risk.

In contrast, the features that constitute the strength of the MDB model are often given lower weight by the different credit rating methodologies. For example, MDBs enjoy preferred creditor treatment (PCT), which means that borrower governments will continue to repay MDBs even if they default on or delay repayment to other creditors. Due to the PCT, MDBs generally have lower non-performing loan (NPL) records than commercial banks. However, depending on the rating methodology, the weight given to PCT can be low relative to the concentration risk penalty. In determining the financial strength of MDBs, the extent to which callable capital is recognised is also crucial, because the bulk of MDBs’ capital base is in the form of callable capital. In the case of Standard and Poor’s (S&P) rating methodology, only callable capital from governments that are rated higher than the MDBs (i.e. higher than AAA for the main MDBs) counts towards their capital strength assessment. This effectively ignores huge sums of capital commitments, including from shareholders such as the United States, which is currently rated at AA+ by S&P (Settimo, 2019[17]).

Reliance on CRAs can lead to MDBs taking a highly conservative approach to their capital adequacy. The G20-commissioned Independent Review of Multilateral Development Banks’ Capital Adequacy Frameworks, published in July 2022, points out that uncertainty and widely divergent criteria in the methodologies of the three major rating agencies induces MDBs to apply the most stringent components of each. This ultimately leads them to build excessive buffers and to lower their risk appetite to below what one would expect for a triple A rating (G20, 2022[12]). The review recommends strengthening communication between MDBs as a collective group (supported by their shareholders) and CRAs, to encourage the latter to adapt their methodologies to better take into consideration the peculiarities of MDBs’ operational models.

Source: (Humphrey, 2017[16]), He who Pays the Piper Calls the Tune: Credit rating agencies and multilateral development banks https://ideas.repec.org/a/spr/revint/v12y2017i2d10.1007_s11558-017-9271-6.html.

Current initiatives to enhance the efficiency of MDBs’ capital use builds on a track record of innovative solutions to unleash MDB resources to scale up lending. The G20 began pushing for efficiency increases in the use of MDBs’ capital resources over the past decade, including through the MDB Action Plan on Balance Sheet Optimisation, which was approved in 2015. The action plan called on MDBs to work with their respective shareholders on measures to increase their lending through balance sheet optimisation. The Action Plan cautioned that the optimisation should not jeopardise the MDBs’ AAA credit ratings, nor adversely impact MDBs’ ability to provide counter-cyclical lending (G20, 2015[18]).

Over the past decade, some of the major MDBs have restructured their balance sheets to increase their financial capacity. As illustrated in Figure 3.14, the various approaches chosen by the major MDBs reflect in part the unique institutional set-up and portfolio characteristics of each organisation.

Figure 3.14. Institutional and economic considerations have shaped MDBs’ initiatives to optimise their balance sheets

The Asian Development Bank merged its ordinary capital resources (OCR) with the lending operations of its concessional window, the Asian Development Fund, in 2017. By combining the equity of the two windows, the merger almost tripled the equity base of the OCR from about USD 18 billion to USD 53 billion, which allowed the ADB to expand its lending room vis-à-vis both concessional and non-concessional borrowing countries. Since the merger, the Asian Development Fund (AsDF) functions as a grant-only donor fund, and requires a significantly lower volume of donor contributions through replenishments. The 12^th replenishment of the AsDF, for example, was significantly smaller in volume than in previous cycles (Figure 3.15).

Similarly, the IDB transferred the assets and liabilities of its concessional window, the Fund of Special Operations (FSO), to its ordinary capital (OC) in 2019. This led to a roughly 20% increase in the OC’s equity and the benefit of additional diversification of the sovereign-guaranteed loan portfolio. For both organisations, the merging of the concessional and non-concessional windows was further justified by the fact that many borrowing members in Asia and Latin America had already graduated from concessional assistance.

The World Bank, on the other hand, opted for a hybrid financial model for its concessional window, IDA. A merger of the World Bank’s concessional and non-concessional windows was less desirable for two reasons. First, IDA is a separate legal entity from IBRD, with its own international treaty agreement and a different ownership structure. Donor countries have a much higher ownership stake in IDA equity than at IBRD, due to their replenishment contributions over the years. A merger of IDA and IBRD would thus necessitate either increasing the voting share of donor countries relative to borrower shareholders, or asking donor countries to give up their ownership stake in IDA – which are two politically difficult options. Second, a merged IDA-IBRD loan portfolio would provide fewer financial benefits, and would have a substantially higher risk profile than for the ADB and IDB since IDA supports many large low-income countries. In fact, recent research states that the market rates at which a merged IDA–IBRD could borrow would be above the highly concessional rates of IDA loans (Morris, Lu and Fisher-Post, 2018[19]). Instead, IDA introduced a hybrid financing model in 2017 by issuing debt in commercial bond markets against its equity base, which is the largest of any supranational issuer.6 This allowed the organisation to leverage donors’ capital contributions and scale up its replenishment envelopes. IDA’s 20^th replenishment (IDA20), for example, made headlines by raising a record amount of USD 93 billion in financing, despite stagnant donor contributions (Figure 3.15). Donor contributions to IDA20 amounted to USD 23.5 billion, meaning that every dollar contributed by donors is now leveraged into almost four dollars of financial support to the poorest countries.

Figure 3.15. Donor contributions to the replenishments of MDBs’ concessional windows have remained flat in recent years

The AfDB has less room for manoeuvre in financing concessional operations apart from through donor contributions. Similar to the IDA, the African Development Fund (AfDF) is a separate legal entity to the African Development Bank (AfDB), with a distinct ownership structure, which makes it more challenging to merge the two balance sheets. Unlike the IDA, the AfDF would gain less from tapping capital markets on a standalone basis, although there are views that with suitable risk mitigation measures, AfDF could nonetheless obtain high ratings and leverage significant funds relative to its size. The higher concentration risk in the AfDF’s portfolio, in large part due to its regional focus and lower capital base, would make its bonds less attractive to investors than IDA bonds (Prizzon, 2021[20]). The AfDf therefore relies more on a continuous and stable supply of contributions from donors. Paradoxically, there is a risk that the AfDF will have to increasingly compete for donor contributions with the IDA, whose larger size and financial efficiency may be more appealing to donors (Lee, Landers and Aboneaaj, 2022[21]). The latest replenishment of the AfDF reversed a trend of declining donor contributions (Figure 3.15). In 2021, AfDB shareholders demonstrated exceptional support by introducing a temporary callable capital increase. This would come into play in the case of a credit rating downgrade of the United States, which would adversely affect AfDB’s ratings. Like the other MDBs, the AfDB is also actively pursuing a series of innovative financial techniques which would allow the organisation to transfer credit risk and free up capital.

Innovative risk transfer techniques offer an alternative to strengthening the capital adequacy of MDBs without requiring changes to the composition of their lending portfolios. For example, exposure exchange agreements (EEAs) allow MDBs to swap portions of their outstanding loan portfolio with one another, which provides them with capital relief by reducing the high concentration of their loans in some countries. This is particularly effective for regional development banks, whose lending is often restricted to a limited number of borrowing countries. In December 2015, the AfDB, IDB, and the World Bank concluded an arrangement to exchange loan exposure. This reduced the country concentration at the AfDB and the IDB, and boosted S&P’s evaluation of capital adequacy for both banks, freeing up several billion dollars in additional loan portfolio space (Humphrey, 2017[22]). More recently, the Board of Governors of the ADB approved a policy framework governing ADB’s participation in EEA agreements in 2020, allowing the bank to pilot an EEA transaction of USD 1 billion with the IDB (Asian Development Bank, 2020[23]).

Balance sheet optimisation initiatives also open up new entry points for DAC members and other official donors as investors or guarantee providers to MDBs. The Swedish International Development Cooperation Agency’s (Sida) guarantees to IDB and ADB are an example of how DAC members can help to provide capital relief. In 2016, the ADB entered into a risk transfer agreement with Sida, which provided a guarantee on the principal repayments of up to USD 155 million of the ADB’s sovereign loans to a single Asian country. The ADB estimated that the risk transfer would increase its lending capacity by about USD 50 million per year from 2016 to 2026, generating a total of USD 500 million additional financing over ten years. In 2020, Sida also issued a synthetic guarantee to backstop a concentrated portfolio exposure for the IDB. This guarantee covered up to USD 100 million on a large concentrated sovereign exposure in the IDB’s portfolio, allowing the bank to expand lending by up to three times the amount of the guarantee (USD 300 million) in other less concentrated countries (Galizia et al., 2021[24]).

Donors can also provide first-loss guarantees and other forms of credit enhancement to capital market investors in securitisations that are similarly structured. In 2018, the AfDB entered into a transaction under which it securitised USD 1 billion in existing non-sovereign loans. Referred to as the Room2Run transaction, it involved the shifting of credit risk to capital market investors. The AfDB’s counterparties in this initiative are the International Infrastructure Finance Company Fund II (IIFC), a private credit investment vehicle managed by Mariner Investment Group; Africa50, a multilateral regional investment fund; and the European Commission. The AfDB retained the most senior and the most junior tranches, IIFC and Africa50 invested in a junior mezzanine tranche, while the European Commission held a senior mezzanine tranche. The Room2Run transaction was a synthetic securitisation, meaning that the loans remained on AfDB’s balance sheet and that the MDB continued to act as servicer and lender of record. This ensured that AfDB had the incentive to engage in strong oversight and monitoring of the loans (Risk Control, 2019[25]).

While some of these initiatives have received much attention from other MDBs and their shareholders, such transactions can be challenging to replicate on a wider scale. In the Room2Run transaction, for example, the underlying portfolio consisted of loans to private sector borrowers. However, the majority of MDB loans are sovereign loans priced at a subsidised rate, which makes them less attractive to capital market investors – unless there is a facilitator willing to cover the margin of the MDB and market-based pricing by issuing a guarantee or investing in the junior tranches of a securitisation.

If transactions of this kind were to expand in the future, they could change the dynamic between donor governments, partner countries and multilateral development organisations. The G20 Independent Review of MDBs’ Capital Adequacy Frameworks encourages the implementation of innovative risk transfers, including shareholder guarantees (G20, 2015[18]), opening up room for more and similar transactions to take place in the future. Yet, this also raises questions that merit further research and discussion. For example, what kind of influence do donors have in their capacities as investors and guarantors in such transactions? How can these roles be used to reflect policy priorities of donors? And how do these new donor roles complement and fit into existing governance and accountability frameworks?

Special drawing rights rechannelling offers another option to boost MDBs’ lending capacity

In August 2021, the International Monetary Fund (IMF) issued a USD 650 billion allocation of special drawing rights (SDRs). This SDR allocation, the largest in the IMF's history, aimed to “boost global liquidity” and help all members “address the long-term global need for reserves” in the context of the COVID-19 crisis (IMF, 2022[26]). SDRs are a “reserve asset”, originally created to strengthen the foreign exchange reserves of countries vulnerable to a balance-of-payments crisis. They can be exchanged for hard currencies among the IMF member countries and their value is determined by a basket of the five freely and most traded currencies – the US dollar, Euro, Japanese yen, pound sterling and the Chinese renminbi. Since SDR allocations are made in proportion to the IMF quotas of the individual member countries, they disproportionally benefit developed countries. In fact, about two-thirds (USD 420 billion) of the recent SDR allocation were directed to developed economies whose external reserve positions were not constrained and who already had the fiscal and monetary tools to react to the economic downturn. By contrast, only about USD 275 billion went to emerging and developing countries, and low-income countries (LICs) received around USD 21 billion (Mariotti, 2022[27]).

In October 2021, the G20 agreed to re-channel USD 100 billion of SDRs to the benefit of LICs, small states and vulnerable middle-income countries (MICs). As of September 2022, this has not yet materialised. One reason for this delay is the difficulty of setting up appropriate mechanisms to serve as conduits for the re-channelling. Although various channels are being considered, one key condition for developed countries to agree to the reallocation is that SDRs are used in a way that preserves their reserve asset nature, which requires that the SDR-denominated claim has limited credit and liquidity risk.7

The first and most obvious channel for the SDR reallocation is the IMF itself. Since 2010, several countries have voluntarily lent SDRs to the Poverty Reduction and Growth Trust (PRGT), the IMF’s concessional facility for low-income countries. This option has the merit of preserving the reserve asset nature of SDR claims, thanks to the IMF’s status as a preferred creditor, and to the prudential provisions that require the PRGT to maintain a minimum level of liquidity. In addition to the PRGT, the Executive Board of the IMF approved in April 2022 the establishment of the Resilience and Sustainability Trust (RST), which will complement the existing IMF toolkit. The RST, which aims to help countries build resilience to external shocks and ensure sustainable growth, will also be used as a channel to re-allocate SDRs to low-income and vulnerable middle-income countries. The RST is specifically targeted to address systemic challenges such as climate change and pandemic preparedness through its conditionalities.

MDBs present another potential channel for reallocating SDRs to support developing countries, provided some measures are taken to preserve their reserve asset nature. Most of the main MDBs 8 are already prescribed holders of SDRs and can therefore use them as part of their financial operations. Recent analyses point out that a re-channelling of SDRs through MDBs could take two forms (Figure 3.16):

On-lending schemes: Developed countries could lend SDRs to the MDBs to increase their available loan funds. The features of the on-lending schemes would have to be designed in a way that preserves the reserve asset nature of SDRs by limiting credit and liquidity risks. MDBs and SDR lenders would need to examine whether credit risks would be adequately mitigated, particularly if the MDBs sought to lend SDRs at maturities longer than the 10-year-maximum in the IMF’s PRGT. Establishing a reserve account (similar to the one in the PRGT) that could repay creditors in the event of delayed repayments by borrowers could be part of the risk mitigation strategy (Plant, 2021[28]). It would also be important for the MDB’s preferred creditor status to extend to SDR on-lending. Lastly, if MDBs wanted to reduce rates on all, or some of, their SDR financed lending below the SDR rate, they would need to establish a subsidy account, funded with hard currency resources.
Capital injections: SDRs could also be lent or pledged 9 as capital contributions to MDBs, which would allow MDBs to raise more debt from capital markets. MDBs’ ability to leverage their equity can multiply the impact of one SDR invested by a factor of 3 or 4, which would provide an efficient SDR rerouting mechanism with a significant multiplier effect. However, leveraging SDRs to raise debt would mean taking on credit risk for the lent or pledged SDRs, thereby compromising their reserve asset status. Currently, MDBs are exploring a range of solutions to circumvent this dilemma, including investing SDRs as subordinated debt 10 instead of equity (Lazard, 2022[29]).

Figure 3.16. MDBs can be another effective channel to re-distribute special drawing rights

3.2.3. Increased funding to vertical funds helps scale up multilateral development finance but risks exacerbating pressures on the system

Donor governments seek recourse to vertical funds in the face of emerging global challenges

While donor contributions to the replenishments of MDB concessional windows have remained flat in recent years, vertical funds have experienced a clear upward trend. With the pandemic raising the profile of global health issues, the two major health funds – the Global Fund and Gavi – have benefited from steep increases in funding from donor countries. Donor contributions to the sixth replenishment of the Global Fund (covering the period 2020 to 2022) increased by 55% from the previous round. Similarly, the most recent Gavi replenishment for the 2021-25 period raised a record amount of USD 20 billion, up from USD 9.5 billion in the previous cycle (+110%). This exceptional increase was in large part due to the establishment of the COVID-19 Vaccines Global Access Advance Market Commitment (the COVAX AMC), which accounted for USD 9 billion of the total pledges.

Non-health vertical funds also registered a significant growth in their most recent replenishments, albeit to a lesser extent. The Global Partnership for Education (GPE), for example, raised USD 4 billion for the 2021-2025 period, up from USD 2.3 billion in the previous cycle (+74%), although the latter covered a three-year period (2018-2020). In the environment sector, the latest replenishment envelope for the Global Environmental Facility (GEF-8) was up by 30% on the previous cycle, and the Green Climate Fund carried out its first replenishment (GCF-1) in 2020, with cumulative pledges amounting to approximately USD 10 billion – presenting a 19% increase compared to its initial funding (Figure 3.17).

Figure 3.17. Donors have stepped up their contributions to vertical funds in recent years

The establishment of a new fund for pandemic prevention and response (PPR) confirms donors’ tendency to respond to high-visibility global crises by creating new multilateral channels. Following a recommendation from the G20 High Level Independent Panel on Financing the Global Commons for Pandemic Preparedness and Response (2021[35]), the G20 requested the World Bank to set up a new financial intermediary fund (FIF) to finance critical investments in PPR capacities at national, regional, and global levels, with a focus on low and middle-income countries. The fund will complement the financing and technical support provided by the World Bank, leverage the technical expertise of the WHO, and engage other key organisations. Of the USD 1 billion in pledges made so far, the United States accounts for USD 450 million (45%), an amount matched by the European Commission. Additional donors include Germany, Singapore, and Indonesia, as well as private philanthropies such as We llcome and the Bill and M elinda Gates Foundation. The new PPR fund will be the first new FIF set up and hosted by the World Bank since FY2018 due to the Bank’s strict policy of upstream selectivity to avoid the proliferation of FIFs and the resulting fragmentation of its trust fund and FIF portfolio (World Bank Group, 2021[36]).

The move to create new vertical funds instead of building on existing organisations reflects in part a perception that the design and capacities of existing institutions do not sufficiently address global challenges. Recent crises have highlighted the shortcomings of the current multilateral development system, and the G20’s decision to create a new FIF responds in part to an assessment that existing multilateral institutions are not adequately equipped to cope effectively with emerging global risks and challenges. It is also justified by the consideration that wholesale reform of the multilateral development system, even if desirable, is unlikely to be politically and administratively feasible, and could even be counter-productive in the near term (Butler and Ross, 2022[37]).

Vertical funds allow donors to advance policy priorities that are not, or are insufficiently, addressed by traditional multilateral organisations, while building on their country presence, delivery channels and technical expertise. For example, Akmal et al. (2021[38]) argue that a larger share of GPE funds tend to be allocated to low-income and fragile countries compared to outflows from the World Bank. These policy priorities can also stem from differences in the governance and decision-making structures between other multilateral organisations and vertical funds, which often include private sector partners and civil society organisations (CSOs) on their governing boards, and can have a larger developing country representation than other funders.

The narrower funding base characteristic of vertical funds gives them more flexibility but can also be a source of financial vulnerability and increased fragmentation of the multilateral system. One feature that allows vertical funds to act relatively quickly is the fact that their donor base is often narrower than in traditional multilateral organisations. Vertical funds can be set up on the initiative of a few champions, who provide the bulk of the funding and shape the agenda and priorities of the organisation. However, this can come at the risk of compromising broad-based multilateral consensus and accountability. The narrow funding base can also cause financial vulnerability, for example by making vertical funds overly reliant on the continuous supply of resources from a handful of donor countries. The degree of concentration in the funding of some vertical funds has intensified throughout the pandemic. For example, the five largest donors to the sixth replenishment of the Global Fund accounted for 76% of total contributions, up from 72% in the previous cycle. Similarly, in the GCF’s first replenishment, the five largest donors accounted for 77% of total contributions, up from 75% in the fund’s initial resource mobilisation. The fact that the United States only delivered USD 1 billion of a USD 3 billion pledge to the GCF made in 2014 illustrates how dependence on large single donors can make multilateral organisations vulnerable. This is especially the case for organisations with relatively specialised mandates that may not always align with the political priorities of successive governments. In the case of GCF, the fallout from the United States, which had the largest stake in the initial funding commitments to the organisation, was in large part compensated for by European donors.

Most vertical funds ultimately rely on the implementing capacity of existing multilateral organisations

Vertical funds channel the vast majority of their financing through existing multilateral organisations, notably the UN Development System and the major MDBs. Vertical funds use these multilateral organisations as a conduit to provide funding to partner governments. For example, based on data reported to the OECD’s Creditor Reporting System (CRS) for 2018-2020, 83% of Gavi and 73% of GEF disbursements pass through the UN system, while all of the CIF funds are channelled through the World Bank Group and other MDBs (Figure 3.18). Similarly, the GPE relies largely on the World Bank, which, as the largest grant implementing agent of the vertical fund, accounted for 75% of GPE’s spending between 2016 and 2018 (Akmal et al., 2021[38]).

Figure 3.18. Funding to vertical funds ultimately passes through the traditional multilateral system

Establishing new vertical funds will, in the long-term, increase – rather than diminish – the need for multilateral reform. Vertical funds can be an effective means to mobilise and scale up funds for specific purposes in the short term, delaying the need to clarify the division of roles and mandates of existing organisations and the discussions and negotiations necessary to build consensus on a reform of the multilateral architecture. However, by adding layers of delegation, the vertical fund model also adds complexity to the multilateral system and can increase transaction costs. Every time funds pass through delivery channels, for example, overhead costs are charged in the form of agency and supervision fees (Akmal et al., 2021[38]). Moreover, as long as vertical funds channel their resources through legacy multilateral development organisations such as UN entities or MDBs, their operations will remain affected by the potential inefficiencies that donors are attempting to bypass in creating new facilities.

3.3. Outlook and policy recommendations

3.3.1. The pandemic has highlighted and amplified the strengths and weaknesses of the multilateral system

The multilateral development system has demonstrated considerable resilience in the face of recent multidimensional crises. This partly owes to the fact that DAC members, despite the growing constraints on their public budgets, have stepped up their multilateral contributions. In parallel, multilateral organisations, notably MDBs, have deftly leveraged their abilities to tap into alternative sources of finance, including from capital markets, to raise exceptional amounts of finance.

However, the need to respond to the pandemic has exacerbated existing funding vulnerabilities. The crisis reversed the reform momentum and some early signs of progress, such as on the UN Funding Compact, which had been promoting greater flexibility, predictability and sustainability of donor contributions to UN entities. The share of earmarked funding to the UN Development System, for example, increased from 55% in 2018 to 59% in 2020, reversing the slight progress achieved in previous years. Although data on donor contributions are not yet available for 2021 and 2022, experience from previous crises suggests that the rise in non-core (earmarked) contributions is unlikely to recede once the emergency is over.

The exceptional crisis generated by the COVID-19 pandemic has exacerbated pre-existing trends; it has not led to a drastic overhaul of DAC members’ support to the multilateral development system. For most DAC members, contributions to multilateral organisations have continued to evolve in an incremental fashion. This suggests the existence of path-dependencies in DAC members’ multilateral funding decisions, which often seem driven by previous funding patterns rather than by a longer-term vision of the contribution to the global development agenda expected of multilateral development organisations.

Looking forward, the growing importance of private sector contributions for multilateral organisations could have long-term implications for their ability to deliver their development mandate. While MDBs have hitherto maintained a strong capital base, allowing them to extend financing at concessional terms, market pressures coupled with donors’ stagnating levels of replenishment efforts could eventually limit MDBs’ ability to continue servicing countries most in need, as well as their flexibly to immediately scale up financing in a future crisis. In a similar vein, greater private sector engagement in the UN Development System could aggravate the concerns raised by some entities’ already high reliance on non-core, earmarked funds, which include a focus on short-term results, fragmentation of the multilateral architecture, and a dilution of consensus-based governance models.

The successive and mutually reinforcing crises the world has experienced in recent years mean that the demands on and expectations of the multilateral development system are growing. The list of priorities to be tackled by the multilateral development system is ever increasing. In an attempt to bypass the need for deep and politically challenging reforms of traditional organisations, donor governments tend to be tempted to opt for quicker, ad hoc solutions, such as creating new entities with narrow mandates. However, without system-wide efforts to clarify and agree on the division of roles among multilateral organisations, there is a risk that ad hoc solutions will lead to further fragmentation and overlap of mandates, as well as intensified competition for limited resources by a growing number of multilateral entities.

3.3.2. DAC members have a shared responsibility to safeguard the effectiveness of the multilateral development system

As the majority funders and shareholders of the multilateral development system, DAC members have a shared responsibility to ensure the system is equipped to address emerging development challenges. Figure 3.19 summarises the key policy recommendations for the DAC that follow from the analysis in this chapter to help build a more fit-for-purpose, resilient and integrated multilateral development system.

Figure 3.19. How the DAC can contribute to a more fit-for-purpose, resilient and integrated system

Develop a holistic vision for the multilateral system to ensure its fitness to meet new global development challenges

Consider developing a multilateral co-operation strategy to ensure alignment of multilateral contributions with the growing requirements of the global development agenda. The design of a multilateral strategy can help clarify the objectives and modalities of each member’s support to the multilateral development organisations. By reconciling members’ expectations of, and support to, the multilateral development system, multilateral strategies can ensure that multilateral development organisations are provided with sufficient financial capacity and flexible resources to adapt to new development challenges. Close to half (13) of DAC members currently have a multilateral development strategy that clarifies the priorities of their multilateral engagement and how it fits within their broader development co-operation efforts. Recent examples include those published by Finland (Ministry for Foreign Affairs of Finland, 2021[39]), Norway (Norway's Ministry of Foreign Affairs, 2019[40]), and Germany (BMZ, 2019[41]), as well as Denmark’s guidelines on its core and earmarked support to multilateral organisations (Ministry of Foreign Affairs of Denmark, 2020[42]).
Support the design and implementation of innovative approaches to adapt MDBs’ financial capacity to new and emerging global development challenges. This includes steering MDBs towards redefining their risk appetite and adjusting their internal capital adequacy frameworks for greater alignment with the pressing development needs they have to cater to (building, for example, on the recent recommendations of the G20 Independent Review of MDBs’ Capital Adequacy Frameworks). DAC members should especially explore how their own actions as MDBs’ shareholders, funders and beyond (for example, as providers of guarantees) affect the MDBs’ operations and development impact. Lessons learned from early movers, such as Sida and the European Commission, could be shared within the DAC community through peer-learning exchanges in order to identify successful approaches and explore possibilities for replication or scaling up.
Identify gaps and redundancies in the multilateral system’s contribution to key areas of the global development agenda. This could help DAC members better target support, see where change is needed to the system’s architecture, and develop a holistic view of the strengths and weaknesses of the current system. In view of donors’ tendency to create new multilateral channels in response to new development challenges, the review could focus on specific areas where a large number of multilateral entities already coexist (such as health and climate finance), or on sectors that are foreseen to play an important role in supporting developing countries’ recovery and resilience to future shocks (such as social protection, gender equality and food security). This could inform future decisions on creating and funding new entities and facilities (or sunsetting and defunding obsolete or redundant ones). These system-wide assessments would complement other performance assessments of individual multilateral organisations, which often underpin members’ decisions to support and engage with specific organisations. These include assessments carried out by MOPAN, and through the Global Partnership for Effective Development Co-operation (GPEDC) monitoring, which looks at how multilateral organisations are performing at country level on meeting effective development co-operation commitments (Box 4.4 in Chapter 4).

Provide sustainable and predictable funding for a more resilient system

Renew DAC members’ commitment to the UN Funding Compact and make use of existing tools to monitor their individual progress. The need to dedicate development resources to pandemic relief and other crises has indirectly slowed the momentum towards institutional or system-wide reform, such as the UN Funding Compact. The UNDS embarked on far-reaching reforms in 2019, and several studies observe that some of the institutional changes undertaken as part of these reforms allowed for increased cross-organisational and cross-sectoral co-ordination during the pandemic response (Weinlich et al., 2022[43]) (MOPAN, 2022[44]). Recent monitoring of the Funding Compact shows little progress on member states’ commitment to strengthen the core financing of the UN system. It also reveals insufficient efforts to make use of soft earmarking modalities, such as multi-agency pooled funds, which can promote greater co-ordination among implementing agencies. While the QCPR Monitoring only provides an aggregate view of member states’ progress against their commitments, existing tools such as DAC Peer Reviews can be used to assess the progress made by individual DAC members to support UN member states’ Funding Compact commitments.
Conduct a comparative review of funding options available to multilateral organisations. This could help to better assess the risks and opportunities associated with different diversification strategies. The analysis in this chapter has shown large variations across multilateral development organisations in terms of funding vulnerability. It has also revealed that multilateral organisations are under increasing pressure to diversify their funding sources. A comparative review of new funding options available to multilateral organisations would help assess the benefits and costs of each modality, such as earmarked funding and private sector partnerships. It could also help assess their potential to raise additional resources, as well as their implications for the governance and ability of multilateral development organisations to deliver on their development mandate. The review could also provide recommendations on how DAC members can best support multilateral organisations’ efforts to diversify and optimise their funding.
Reinforce donor contributions to future MDB replenishments to ensure the resilience of the multilateral development system. In recent years, donor contributions to MDB replenishments have been stagnating. While MDBs have achieved successful replenishments by increasingly tapping into capital markets, this trend could be problematic in the long run, especially for regional players with a strong focus on low-income countries, such as the AfDB. Even for other MDBs with stronger capital positions, such as IDA, continued donor commitments to supply capital are necessary to effectively and continuously raise additional resources from capital markets. Renewed commitments to strengthen donor contributions to future replenishments of MDB concessional windows could ensure that MDBs can continue servicing the poorest countries and providing them with counter-cyclical support in the face of more frequent global shocks.

Improve co-ordination across the system to increase the coherence and complementarity of multilateral efforts

Design and adopt a set of broad principles for effective multilateral engagement and donorship to ensure a more coherent and co-ordinated approach across DAC members. These principles could allow the DAC to outline a common vision for multilateral development co-operation. They could also form the basis of strategic dialogue within the DAC on how their decisions vis-à-vis multilateral development organisations affect the system as a whole. For example, the UK’s recent decision to reduce its aid budget had profound implications for the funding of multilateral entities such as IDA, and other donors had to step up their efforts to fill the gap. Donor platforms such as the DAC can be used to co-ordinate joint action across donors, which could help send even stronger signals to multilateral organisations or mitigate any potential negative consequences of any one-sided donor action.
Harmonise funding procedures among donors, especially earmarked contributions, as noted by the UN Funding Compact. Donors need to streamline and harmonise their reporting and visibility requirements as part of their efforts to ensure the effectiveness of the ODA that they channel to and through the multilateral development system. This is especially important in partner countries in order to reduce transaction costs, both for the multilateral entity that channels the funds and for partner countries themselves (IISD SDG Knowledge Hub, 2019[45]).
Improve the complementarity of multilateral and bilateral approaches to ensure greater coherence among multiple initiatives contributing to the global development agenda. The fact that the multilateral development system is an increasingly complex and crowded space makes it difficult to get a clear understanding of the division of labour and complementarity of efforts deployed by multiple stakeholders. The proliferation of global values-based initiatives observed in recent years adds to this complexity. Their heavy focus on infrastructure financing – an area that has traditionally been dominated by the MDBs – could make some multilateral and bilateral aid portfolios redundant, or crowd out multilateral contributions. Further research to map the areas of complementarity between the aid portfolios of multilateral and bilateral actors could be useful to ensure greater coherence and co-ordination among these efforts.

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Notes

← 1. Core contributions to multilateral organisations are resources to which the governing boards of these organisations have the unqualified right to allocate as they see fit within the limits prescribed by the organisation’s mandate.

← 2. Non-core, or earmarked, contributions to multilateral organisations are resources channelled through multilateral organisations over which the donor retains some degree of control in decisions regarding disposal of the funds. Such flows can be earmarked for a specific country, project, region, sector or theme, and they technically qualify as bilateral ODA.

← 3. Assessed contributions are the dues countries pay in order to be a member of a UN entity. The amount each member state must pay is calculated based on the country's wealth and population. Members can also make voluntary contributions (both earmarked and unearmarked) in addition to assessed contributions.

← 4. IDA20’s USD 93 billion package consisted of USD 23.5 billion in donor contributions as well as additional financing from capital markets, repayments and IBRD transfers.

← 5. Preferred creditor status (PCS) is a widely accepted principle under which MDBs are given priority for repayment of debt in the event of a borrower experiencing financial stress.

← 6. Apart from market borrowing and donor contributions, IDA resources also come from internal reflows on loan repayments and transfers.

← 7. IMF member countries commit to relinquishing SDRs to the fund if member countries decide to cancel them. Therefore, SDRs represent an asset and a liability on the central bank’s or the Treasury fund’s books. Giving SDRs away would create a hole in their balance sheets that could necessitate direct monetary financing of the state.

← 8. This includes the African Development Bank, African Development Fund, Asian Development Bank, International Bank for Reconstruction and Development, the International Development Association, and the Islamic Development Bank.

← 9. SDRs could in principle be donated as a capital contribution, but in practice the donated SDRs would lose their reserve asset status from the perspective of the donor.

← 10. In the case of bankruptcy of the issuing organisation, subordinated debt would only be paid after the other debt obligations are paid in full, but before any payment to equity-holders.

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