11 June 2023
By Katja Hemmerich
KPMG's preliminary assessment of the UNICEF-IBRD financing instrument is positive, but also highlights a serious legal & political obstacle for scaling.
There has been much discussion of innovation of strategic financing solutions in recent years. This week, the UNICEF Executive Board will review KPMG’s preliminary assessment of the new UNICEF-IBRD Forward Flow Agreement (also referred to as the World Bank Instrument, agenda item no. 13). This innovative financing instrument is a bond issuance by the International Bank of Reconstruction and Development (IBRD) for investment in Private Sector Fundraising by UNICEF Country Offices.
Our spotlight this week is on how this arrangement works, what organizational factors contributed to KPMG’s positive assessment, and what needs to be done if this financing instrument is to be replicated - which will need General Assembly agreement.
What is ‘the UNICEF Instrument’?
The Instrument is a bond issued by the IBRD, the lending arm of the World Bank, from which UNICEF received half the proceeds as a loan in 2021. This loan consisted of US$50 million dollars, which UNICEF is required to pay back in full by 2026, and upon which it pays interest every six months. The loan is specifically to be used by UNICEF to invest in private sector fundraising in 24 select middle and high-income countries agreed by UNICEF and the IBRD. The idea is that investment in such fundraising will allow UNICEF not only to repay the loan and cover the interest costs, but increase its voluntary funding from private sector sources beyond that.
The Instrument therefore provides an innovative solution for UNICEF to overcome the shortfall in its core funding, which would normally be used to pay for fundraising activities. While core funding represented 30% of total voluntary contributions in 2012, in 2021, it represented only 18%. For IBRD, it is an innovative way to tap into growing interest in impact investing opportunities demonstrated, for instance by pension funds and some of the 'ultra-rich', by enhancing its competitive advantage with the UNICEF brand.
KPMG’s preliminary assessment
At the request of UNICEF, KPMG undertook the preliminary assessment of how the Instrument has functioned in the first two years to determine its usefulness and how UNICEF has managed its obligations and the risks arising from the loan. Their key findings, which are very positive, are:
Although it is too early for definitive conclusions, there is strong evidence that the Instrument has increased the number of donors or donor income in different countries, thereby allowing UNICEF to maintain or grow its fundraising outcomes in the target countries. All Country Offices using the Instrument agreed that it provided key financing that has been vital to their fundraising operations.
UNICEF has had no problems in fulfilling its interest repayment obligations or its reporting obligations to date, nor are there signs that this could become a problem in future. The assessment also did not find that the repayment obligations placed any additional strain on UNICEF’s wider resources.
UNICEF generally appears to be well-placed to manage risks related to the Instrument, although there have been some minor (but not unexpected) challenges with respect to foreign exchange volatility and execution of the Instrument.
What risks did the Instrument create for UNICEF?
The KPMG assessment provides a detailed review of the risks associated with the Instrument and UNICEF's efforts to manage those risks. This provides insights both for the continued management of the Instrument by UNICEF, but it also highlights a number of key issues that other organizations and UN member states need to be aware of, if this type of instrument is to be replicated.
An important structural feature of the bond issued by the IBRD is that it is a ‘capital-at-risk’ note, meaning if UNICEF is unable to fundraise enough to repay the $50 million, there is no obligation to repay the loan. This is because the risk of repayment is borne by the investor that purchased the Instrument. It is their capital that is “at risk”. This provides an inherent safety net for UNICEF throughout this process.
Nevertheless, this does not mean that defaulting on the loan comes without risk. Nor does it mean that this is a safety net that will be naturally offered to other international organizations seeking to use a similar financing instrument. As KPMG highlights repeatedly in their report:
"Third party stakeholders noted the issuance was possible because of UNICEF’s strong fundraising track record and brand." – KPMG
The implication is that other organizations without such a track record are unlikely to be able to take advantage of this type of financing instrument.
Although it is technically possible for UNICEF to default on the loan, this would have significant reputational repercussions both for UNICEF and IBRD. Accordingly, the Instrument is structured to allow for some flexibility in deferring payments or adjusting the schedule to allow Country Offices to plan their repayment schedule based on the results of their investments. This again has been highlighted by KPMG as an important feature.
For many Country Offices, fear of not being able to repay their portion of the loan was a concern and led to decisions to use the funds for proven private sector fundraising channels and pursue “safe bets” rather than to fundraising innovations. This highlights how seriously these Offices took the accountability elements, but it is also an issue to be managed in future if the aim is primarily to create new fundraising channels. KPMG also considered the two processes put in place by UNICEF HQ to mitigate the risk of default as positive, and suggested that more communication about how these worked could help Country Offices in reducing their risk aversion.
UNICEF HQ manages default risks both at the allocation and repayment stages. Country Offices in the selected countries were required to apply for Instrument funding and the proposals underwent a rigorous review by the Private Fundraising and Partnerships section to ensure sound business planning and a realistic cash flow analysis. Funds for repayment are managed on a ‘pool basis’, combining the revenues of all Country Offices for repayment to the IBRD. This means that Country Offices fundraising in less mature markets who may have less predictable cash flows have their default risk mitigated by Country Offices with more established and predictable cash flows. The pooling also mitigates the risks related to potential currency fluctuations, since funds are raised in local currency but the debt must be repaid in US$.
The flexible and strong management of the Instrument, which KPMG highlights, is also key to mitigating what it calls execution risks. Execution risks are related to potential problems with all the processes supporting the instrument, including misalignment of timing, lack of agility, or other process characteristics that may negatively impact effective execution. The only weakness KPMG identified - somewhat surprisingly for international organizations - was not in the processes themselves or their timeliness, but rather the Country Offices’ understanding of application criteria, decisions for funding and the repayment issues. Thus, one of their few recommendations is to further strengthen communication and transparency on these points going forward.
KPMG also found that UNICEF had done a good job to mitigate potential risks emanating from investors and donors. For impact investors, especially those less familiar with UNICEF, it was important that UNICEF reporting could demonstrate the impact of their investment. Cognizant of this, the UNICEF Controller adapted some of their traditional reporting tools and KPMG received no indication of third party concerns or investor complaints about the first impact report. Similarly, there were also concerns that donors contributing to UNICEF as a result of the Instrument would be critical if they found out those donations were being used to repay a loan or cover interest costs. While it’s early days in the communication efforts, KPMG felt that this was well explained in the first impact report and could find no such complaints.
The KPMG report therefore demonstrates quite well that innovative financing comes with a broad spectrum of risks. But these can be managed effectively by international organizations. Consequently, for organizations with the capacity and autonomy to manage those risks and processes, and a proven track record in fundraising, the Instrument shows enormous potential to grow voluntary funding.
Can this success be replicated?
Organizational capacity aside - there is a significant hurdle that needs to be overcome if this Instrument is to be replicated, even by UNICEF. KPMG repeatedly highlights - and agrees with - the UN Office of Legal Affairs' opinion that any subsequent debt issuances require the authorization of the United Nations General Assembly, i.e. the Fifth Committee.
Obviously, agreement of the UNICEF Executive Board and management is a prerequisite for even engaging with the Fifth Committee on the issue of further debt issuances. But as UNHCR found out the hard way when they wanted to establish their own Financial Rules last year, Executive Board and senior management agreement is certainly not sufficient to gain approval of the Fifth Committee. A well justified argument needs to convince the Advisory Committee on Administrative and Budgetary Questions (ACABQ), and an expertly coordinated strategy is needed to identify and address concerns of member states, as has been well-documented, for instance by Dr. Hannah Davies in reviewing other reform proposals.
As many such analyses have pointed out, governance and political issues are likely to overshadow the substantive and technical issues. While we recently highlighted some of the governance issues at play in the core funding crisis using cutting edge research, on financing issues, we go back in time to the 1960s - the only time when the General Assembly authorized a debt issuance.
Somewhat analogous to the current financial challenges, the early 1960s saw many member states seriously in arrears with their funding commitments, and there were significant funding gaps across assessed and voluntary funding for major programme areas (most acutely peacekeeping, but also development) across the UN system. A wide variety of solutions were debated in and outside of the UN, including increased funding from the private sector and allowing the UN to create its own revenue streams, neither of which received significant support. The political and governance issues were well summarized by the Brookings Institution at the time, highlighting concerns that donors outside of governments might want a say in how their money was used and how the organization functioned. More broadly, the question of allowing the UN to generate its own revenue streams outside of assessed and voluntary funding met with the following argument:
"It has yet to be demonstrated, all things considered, that it would be desirable to confer unrestricted powers upon the UN or any other world body to raise independent revenues. The power of an independent purse could become the prelude to the seizing and exercising of independent power." – Normal Padelford, Financial Crisis and The Future of the United Nations, World Politics, Jul., 1963: pg. 566
The long-term solution of the 1960s was for the General Assembly to agree on a specialized scale of assessments to fund peacekeeping operations, and there was some acceptance of greater private sources of funding. The bond issuance remained a one-off temporary measure to address arrears in payments (and the SG needed permission from the GA to sell those bonds to civil society or private buyers). These debates were not easy, and took considerable time and effort to find a constructive resolution - something that needs to be considered, if further debt issuances are to be pursued as a solution to addressing the SDG funding gap between now and 2030.
Points for Discussion
Thus, we suggest the following discussion points to consider if UNICEF’s Executive Board and management decide to expand on their success and undertake another debt issuance with the IBRD:
What measures need to be put in place to further mitigate the risks specific to the Instrument?
What strategy is needed to convince the Fifth Committee? Does the strategy consider technical, financial, governance and political issues?
Who will design the strategy and which member states will lead on engagements with key member states and groupings in the Fifth Committee?
How will coordination across member states and with UNICEF senior management be managed in implementing the strategy?