Select Committee on International Development Seventh Special Report



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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