APPENDIX
Memorandum from the Secretary of State for International
Development
The Government welcomes the Report of the International
Development Committee in Session 1997-98 on the Future of the
Commonwealth Development Corporation. It agrees with the Committee's
conclusion that 'the Public/Private Partnership may provide a
challenging and unique opportunity for the best characteristics
of the public and private sectors to be combined to make a significant
contribution to poverty eradication'. Detailed points raised in
the Committee's Report are dealt with below:
THE PUBLIC/PRIVATE PARTNERSHIP
Attracting Private Investors
Paragraph 16: Recommendation 2
Until the downward trend in the Commonwealth Development
Corporation's returns is significantly and sustainably improved,
it seems unlikely that the Public/Private Partnership will be
a commercially viable venture.
The Government's target for CDC's return on capital
employed has been a three year average of 8%; adverse market conditions
in 1997 (which have continued into 1998) have had an impact on
returns but, in general, CDC has achieved the target with profitability
levels above those of other Development Finance Institutions.
However, Government and CDC are aware that returns at this level
will not be sufficient to attract funds from the private capital
markets and CDC will be seeking to increase profitability. This
will come partly from continuing the shift to equity investments,
which give CDC a better balance between risk and reward in their
investments. Strong private sector skills and willingness to take
risk are required to make equity investment successful, an approach
which will be reinforced by creation of the Public/Private Partnership.
CDC's method of working, which relies on close management of equity
positions, also improves its ability to identify and pursue good
investments.
The Government is aware of the importance of CDC
building a track record before listing and will seek to ensure
that private capital is introduced at the right time for the business.
A decision on timing of sale will be taken in the light of what
is right for development.
Paragraph 19: Recommendation 3
The requirement stipulated by the Commonwealth
Development Corporation that a transition
period be allowed for the implementation of the changes necessitated
by the increase in equity investments, the need for the Commonwealth
Development Corporation to improve significantly its rates of
return, our concerns about the validity of the assumptions inherent
in the planned increase in equity investments, and issues surrounding
the design of the Partnership, all need to be resolved before
the Public/Private Partnership can be successfully established.
If the Public/Private Partnership is established before these
issues have been resolved, it could be unable to function effectively
and unable to increase its returns sufficiently to attract private
investors. We therefore recommend that the establishment of the
Public/Private Partnership be delayed until:
(a) the precise details of the Public/Private
Partnership have been decided, and further research has been undertaken
to establish private sector interest in the transformed Commonwealth
Development Corporation;
(b) the Commonwealth Development Corporation
has undertaken the necessary shift in management focus and skills-base
necessitated by the move to increased equity investments; and
(c) the Commonwealth Development Corporation's
equity portfolio has been expanded sufficiently for a track record
to have been established which demonstrates the profitability
of equity investments in developing countries.
The Government fully agrees with the need to ensure
that the attractiveness of the Public/Private Partnership to private
investors is based on a successful record in managing equity and
other investments, whilst retaining a focus on the poorer countries
where CDC's distinctive expertise lies. The Government aims to
secure the greatest overall development impact from the Public/Private
Partnership. It wants to see a successful CDC mobilising and investing
private capital in the poorer countries and demonstrating that
attractive returns can be made from such investments. In deciding
when to introduce private capital, account will be taken of market
conditions as well as CDC's performance in the interim and forecast
profitability. It is too early to say when that time will be.
However, creation of the Private/Public Partnership
itself will take time. The process has already begun, and it is
important to maintain momentum and continue to make progress towards
it. Key aspects of the partnership are currently being finalised.
CDC has begun to make the shift in management focus and skills
development and is continuing its trend towards more equity investment.
The Government has taken initial advice about private sector interest,
and that has confirmed that there is likely to be interest. Legislation
would allow the next steps (such as work on CDC's structure, and
further investigation of private sector interest) to take place.
While these preparatory steps are going on, CDC will be building
its track record.
Paragraph 21: Recommendation 4
We recommend that the Government consider significantly
increasing the net amount of its loans to the Commonwealth Development
Corporation during the period of its transition from a wholly
Government-owned statutory corporation to a Public/Private Partnership,
in order to allow it to expand its equity portfolio. This will
provide an opportunity for the feasibility of increased equity
investments to be tested before the introduction of private capital
is invited.
The Government notes the recommendation. For 1998/9
we have agreed 'nil net funding' for CDC, whereas it was earlier
planned that there should be negative net funding by Government.
We will further examine the case for additional funding for CDC
over the coming years in order to allow it to expand further its
equity portfolio.
The Tax Status of the PPP
Paragraph 22: Recommendation 5
We look forward to monitoring progress in the
establishment of a special tax category for development investment
institutions.
The Government notes the Committee's wish to follow
progress in this area, and will keep them informed of developments.
Paragraph 24: Recommendation 6
We do not accept the argument put forward by the
Government and the Commonwealth Development Corporation that successful
equity investment automatically equals good development.
Successful equity business generally involves transfer
of management know-how as well as capital, and involves sharing
of risk between the parties, both of whom therefore have an increased
stake in the company's success. It therefore helps create and
develop long-term sustainable business. Equity investors tend
to be much more active partners than debt investors, and to play
a significant role in the management of companies. CDC will be
able, for example, to use its equity position in order to promote
ethical best practice in the enterprises concerned. By developing
sustainable businesses, equity investment helps create jobs and
livelihoods in poorer countries, as well as contributing to tax
revenue. It is of course possible to have successful business
which is not appropriate to a country's circumstances: but CDC's
ethical policy and practice will help guard against such investments,
and will include sectors and activities which CDC will not invest
in. CDC will also be able to draw on its long experience, during
which it has developed knowledge of what sort of investment is
appropriate and ultimately sustainable in the countries in which
it operates.
Paragraph 25: Recommendation 7
Given the importance of the agriculture sector
in least-developed countries, we would welcome comments from the
Government on how the move to equity investments will affect the
sectoral composition of the Commonwealth Development Corporation's
portfolio.
More than a quarter of CDC's existing portfolio is
in the agriculture/ agribusiness sector, as were over 20% of new
investments in 1997. This is an area where CDC have strong experience
and a track record on which they are expected to build: agribusiness
will remain a priority sector. The Government does not intend,
however, to set sectoral targets for CDC's investments.
RETAINING CDC'S DEVELOPMENT ROLE
(Recommendations 8 - 12)
Paragraph 30: Recommendation 9
It is of the utmost importance that the requirement
from the private sector, that the Government does not interfere
in the running of the Commonwealth Development Corporation in
excessive and "unpredictable" ways, does not cause the
Commonwealth Development Corporation's developmental role to be
sidelined, nor weaken the development targets and requirements.
The Golden Share
Paragraph 35: Recommendation 10
Once the constitution of the transformed Commonwealth
Development Corporation has been agreed and implemented, it will
be difficult, and undesirable, for the Government to change it.
It is therefore crucial that the Articles and Memorandum of Association
are well-designed to ensure that the Commonwealth Development
Corporation retains its development focus. We therefore recommend
that the Articles and Memorandum of Association of the new Commonwealth
Development Corporation be made available to Parliament before the Bill establishing the Public/Private Partnership is debated.
Targets Relating to the Countries in which CDC Invests
Paragraph 26: Recommendation 8
We agree with Clare Short, who told us:
"If you just privatised [the Commonwealth
Development Corporation] and left it to commercial imperatives
it would pull itself out of the poorest countries. Commercial
imperatives do not work there, you can get a more reliable, higher
rate of return if you move off to the middle-income countries
or richer countries".
Paragraph 38: Recommendation 11
The Government proposes to retain in the Public/Private
Partnership the existing target that 70 per cent of the Commonwealth
Development Corporation's new investments be made in countries
with a per capita income of less that $1,670 (according to 1995
figures), and plans to introduce an additional target that the
Commonwealth Development Corporation make at least 50 per cent
of its new investments in Sub-Saharan Africa and South Asia. We
welcome this proposal, and recommend that the Government ensure
that these targets be included in the Memorandum and Articles
of Association of the Commonwealth Development Corporation.
The Statement of Business Principles
Paragraph 40: Recommendation 12
We welcome the progress so far made in the development
of the Commonwealth Development Corporation's Statement of Business
Principles. We recommend that the completed document be included
in the Memorandum and Articles of Association of the Commonwealth
Development Corporation, and as such serve as a guide for all
its investments and a standard against which its future performance
can be measured.
The Government intends to ensure that CDC's development
role is not sidelined, by protecting its investment and ethical
policies. The Government will therefore ensure that all the provisions
necessary to ensure that CDC will fulfil its development role
are set out clearly from the start in the partnership framework
and the company's constitution. This means that these provisions
will be part of the essential identity of the company and will
be clear to potential investors.
The approach it intends to take is as follows. CDC's
Memorandum will set out the objectives of the company as being
to invest in developing economies and to implement policies designed
(in the opinion of Directors) to maximise the creation and long-term
growth of viable businesses in developing economies, especially
the poorer economies, to achieve attractive returns for shareholders
and to implement ethical best practice. The Articles will set
out the requirement for CDC to have, implement and report on investment
and ethical policies designed to achieve CDC's objectives. The
Articles will also cover Golden Shareholder rights. It is not,
however, intended to set out the detail of the investment or ethical
policies in the Memorandum or Articles. The policies are likely
to be detailed documents, more appropriately dealt with elsewhere.
Both investment and ethical policies will be put
in place before inviting private participation and establishing
the Partnership. Any changes to the policies will require the
consent of the Golden Shareholder or be protected under the Golden
Shareholder's reserved rights; they will therefore be protected
in CDC's constitution, even though not set out in full in the
Memorandum and Articles of Association. The Government considers
that this mechanism provides the necessary protection, and that
inclusion of the details of the policies in the Articles (which
would require a 75% vote of ordinary shareholders) would not offer
any significant additional protection. The Government does not
expect to vote its ordinary shareholding, except in exceptional
circumstances.
The focus on poorer countries will be secured by
means of the investment policy. This will contain both categories
of countries in which CDC may invest, and targets for investment
in the poorer countries. Any changes to either will require the
consent of the Golden Shareholder, as well as a majority of ordinary
shareholders. This is designed to safeguard the content of the
investment policy. CDC's wide network of offices on the ground
and strong track record of investing profitably in the poorer
countries also provide a sound commercial reason for them to continue
to invest where they have a comparative advantage. It will, however,
continue to be possible for CDC to invest some of its funds in
middle income countries, to help secure a balanced portfolio with
an appropriate spread of risk.
Entrenchment of the ethical policy will protect CDC's
Statement of Business Principles and other elements of the ethics
policy, and enable this to set the guide and standard proposed
by the Committee.
The Government intends to lay the Memorandum and
Articles of Association in the Libraries of the House of Commons
and Lords at the time when the Bill is introduced. It also intends
to table the proposed investment and ethical policies.
Paragraph 41: Recommendation 13
We recommend that the Statement of Business Principles
include a strategy for improving the representation of women and
persons from different ethnic backgrounds in its senior management
structure, and for promoting equal opportunities at all levels.
The Government fully endorses the need for women
and people from ethnic minorities to be represented in CDC's senior
management. It expects to see CDC's declared commitment to equal
opportunities in its personnel and recruitment policies reflected
in the future composition of its staff at all levels. The role
of CDC's Statement of Business Principles is to provide guidance
for CDC staff in making investment decisions and conducting business
overseas. As such, it is not about senior CDC staff management
or appointments.
ACCOUNTABILITY OF CDC
Paragraph 46: Recommendation 14
We recommend that the Articles and Memorandum
of Association include requirements for the publication of an
annual report which is subject to rigorous guidelines relating
to the information to be provided. As a minimum, this must include:
(a) an analysis of new investments and the
overall portfolio by sector and income group;
(b) a detailed analysis of the development
impact of Commonwealth Development Corporation's investments based
on the monitoring procedures set out in the Statement of Business
Principles;
(c) an assessment of the Commonwealth Development
Corporation's achievement of the standards set out in the Statement
of Business Principles; and
(d) a statement of progress in the implementation
of an equal opportunity policy at all levels of the organisation.
Once a public limited company, the contents of CDC's
annual report and accounts will be largely set by the laws and
regulations applying to such companies. However, in recognition
of the Public/Private Partnership, the Memorandum and Articles
will require CDC to report on its compliance with the investment
policy and ethical code. CDC will be required to provide enough
information to allow an informed assessment to be made.
Paragraph 47: Recommendation 15
In addition, the Department for International
Development should include in its Departmental Report:
(a) an assessment of the Commonwealth Development
Corporation's adherence to its Statement of Business Principles;
(b) information on the achievement of targets
relating to investments in poor countries and countries in Sub-Saharan
Africa;
(c) an indication of whether it has been judged
necessary for the Government to use its Golden Share; and
(d) information on the stake currently held
by the Government in the Commonwealth Development Corporation.
The Government intends to report to Parliament (through
our Departmental Report) on its involvement in CDC. This would
cover key points, including those set out above.
Paragraph 48: Recommendation 16
We are glad to have been able to take this opportunity
to examine the Government's proposals for the future of the Commonwealth
Development Corporation at a pre-legislative stage. We do not,
however, intend our involvement to end here. It is our assessment
that the transformation of the Commonwealth Development Corporation
into a Public/Private Partnership may provide a challenging and
unique opportunity for the best characteristics of the public
and private sectors to be combined to make a significant contribution
to poverty eradication. It is essential that the Public/Private
Partnership is designed correctly. Some of our concerns cannot
be resolved until a later stage, once the design of the Partnership
has been established in more detail, and the Commonwealth Development
Corporation has made further progress in the transformation of
its management structures and knowledge base, enabling it to expand
significantly its equity portfolio. We therefore recommend that
the House commit the Bill establishing the Public/Private Partnership
to a Special Standing Committee, where these concerns can be examined
further and the proposed Articles and Memorandum of Association
can be evaluated.
It is not for Government to comment on this recommendation.
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