From De-Risking Transactions to Co-Building Markets

When and How the Private Sector Can Co-Invest in Water Sector System Strengthening

The prevailing model and its limits

Development finance in the water sector has largely followed a familiar sequence: governments and development partners invest in system strengthening (regulatory reform, utility governance, technical assistance, and policy development) and private capital is expected to follow once risks have been reduced. Where private finance does appear, it is often confined to highly structured, heavily de-risked transactions. While this approach has delivered incremental progress, it also embeds a structural assumption: that systemic market failures are a public responsibility, and that the private sector’s role begins only after those failures have been addressed. Experience from other sectors suggests this division of labour is not inevitable. When long-term value is sufficiently large and persistent, firms have often chosen to invest upstream, in the very systems that make markets investable.

When markets were not investable, firms in other sectors helped build them

A useful way to understand private co-investment in market development is to look at cases where firms faced environments that were initially unbankable, not because of project-level weaknesses, but because core market functions were missing. The launch of M-PESA in Kenya illustrates this clearly. When Safaricom introduced mobile money, there was no established regulatory framework for e-money, no trusted distribution network, and limited consumer confidence in digital financial services. Rather than waiting for public actors to resolve these constraints, Safaricom invested directly in building the ecosystem. It financed and trained thousands of agents, absorbed the costs of customer education, and engaged intensively with regulators to co-develop supervisory approaches. These were high-risk, upfront investments made in advance of clear profitability. The logic was straightforward: without trust, rules, and operational infrastructure, the market would not exist. Safaricom’s willingness to invest reflected its ability to appropriate long-term returns through network effects and platform control. Market development was not separate from the business case; it was the business case.

A similar logic appears in pharmaceuticals, where firms have faced weak regulatory capacity and uncertain demand in emerging markets. Manufacturers invested heavily in quality systems, regulatory compliance, and workforce training before procurement volumes were fully secured. These investments reduced systemic risk and made scale possible, even though near-term returns were uncertain. As in fintech, firms acted because the absence of credible institutions was a binding constraint on growth.

Renewable energy markets provide a further step in the same progression. Developers and OEMs entering new markets often confronted unstable grids, underdeveloped supply chains, and limited technical capacity. Rather than treat these as exogenous risks, firms invested in grid integration planning, supplier development, skills training, and sustained policy engagement. These system-level investments were aimed at reducing curtailment risk and stabilising project pipelines over time. Again, the motivation was not altruism, but the recognition that without functioning system infrastructure, capital-intensive assets would remain stranded.

Extractive industries extend this logic into the realm of governance and political economy. Mining and oil and gas firms operate with long asset lives in politically sensitive environments. Weak transparency and institutional legitimacy increase the risk of conflict, contract renegotiation, or expropriation. This is why many companies support initiatives such as the Extractive Industries Transparency Initiative. Investment in governance and transparency serves as a form of long-term risk management, protecting asset value over decades.

Across these sectors, the pattern is consistent: when systemic weaknesses prevent profitable scale, and when firms can capture enough of the resulting value, they invest in fixing those weaknesses themselves.

What these cases tell us about private investment in market development

Taken together, these examples highlight that private upstream investment is not random. Firms tend to invest in specific types of market functions that directly affect cash-flow stability and risk over long time horizons. They invest in revenue-enabling capabilities, such as billing systems, data infrastructure, quality assurance, and performance monitoring, because these reduce uncertainty and improve predictability. They invest in standards and measurement, because credible information lowers financing costs and supports scaling. They invest in institutions and rules that stabilise contracts and pricing, because long-lived assets require predictable revenue regimes. And in politically sensitive sectors, they invest in legitimacy and transparency to reduce the risk of social or political disruption. These are precisely the areas where water sector reforms are most often needed and where development partners already invest heavily.

Why water has seen less private co-investment

Despite these parallels, private firms have rarely co-invested at scale in water sector system strengthening. This is not because water lacks long-term value, but because the incentives for private co-investment are typically weak. In many water contexts, the returns to system improvement are not clearly appropriable by private actors. Benefits are diffuse and non-excludable, encouraging free riding. Contracts are often short-term or politically fragile, undermining incentives to invest upfront. Coordination among firms is limited, and government commitments are frequently uncertain. Under these conditions, rational firms wait for public actors to absorb system-level risk.

Conditions that make private co-investment in water more likely

Evidence from fintech, pharma, renewables, and extractives suggest that private co-investment becomes more likely when several conditions align. Firms must be able to capture a meaningful share of the upside created by system strengthening, for example through long-term service arrangements or performance-linked remuneration. Investments must address constraints that directly limit firms’ own growth or profitability, not just general sector performance. Opportunities to stage investment through pilots or phased reforms reduce downside risk. Finally, credible government commitment, through stable policy, enforceable contracts, and predictable regulation, is essential. Where these conditions are absent, free riding is the rational outcome.

Implications for development finance in the water sector

For development finance institutions, the implication is not to reduce support for system strengthening, but to restructure it. Instead of treating institutional reform as a purely public good, programmes can be designed to explicitly invite private co-investment in areas where firms stand to benefit from improved system performance. This may involve structuring reforms around long-term service models, creating shared but excludable sector platforms, supporting consortia that reduce coordination problems, and using concessional finance to crowd in private capital upstream, not only at the project level. The strategic shift is from asking how public actors can make water projects safe for private capital, to asking how public and private actors can jointly invest in building water markets that are worth investing in.

Conclusion

Other sectors demonstrate that private firms will invest in market development when systemic weaknesses constrain growth and when long-term returns are visible and protectable. Water exhibits many of the same characteristics: long asset lives, politically salient services, and strong dependence on institutional performance.

If water is to move beyond episodic, heavily de-risked transactions, development finance will need to focus less on insulating the private sector from system risk, and more on structuring incentives so that private firms have a rational stake in reducing that risk themselves. That shift does not eliminate the role of public finance. It redefines it, from sole market builder to co-investor and coordinator in a shared process of market formation.