Examination of Witnesses (Questions 66 - 79)
TUESDAY 7 JULY 1998
RT HON
EARL CAIRNS,
CBE and DR
ROY REYNOLDS
Chairman
66. May I welcome you, Lord Cairns and Dr
Roy Reynolds, to this Committee and thank you very much indeed
for coming this morning. We are looking forward very much to exploring
this new animal, the private-public partnership and how it might
work in the future with you. I understand, Lord Cairns, that you
would like to make a short opening statement and then we will
continue with questions and answers as before?
(Earl Cairns) Mr Chairman, thank you very much.
Firstly, I would like to say we too very much welcome the opportunity
of being able to appear before you and share some of our thoughts
with you. We have discussed both with this and with the previous
Government the question of whether there was some way in which
we could extract ourselves from the straitjacket of public sector
controls. We believe that the CDC, against the targets that it
has been set, has a proud record of achieving those and achieving
important development at the same time. We think we have a set
of skills and a background of experience which offers something
which is not available anywhere else and is of critical importance
in a number of developing countries. We have always seen that
CDC gains part of its special advantage by its very close relationship
with Government and in all our discussions from the CDC side we
have never seen a purely privatised CDC as being the correct answer,
and that is not our intention today. At the same time, as we move
towards a PPP structure, which will allow the private sector to
come in and support CDC, we are going to have to make some changes.
The Secretary of State talked about our willingness or our intention
of increasing the equity content of our portfolio to increase
the returns to provide the attraction to get the private sector
flows coming in alongside us. That is involving us in quite a
degree of change from the previous regime and one point I would
like to make very clearly is that we would like to be able to
do that against a high degree of certainty that legislation will
come about as soon as possible, because we need to make those
changes against the certainty that various things are going to
happen. Beyond that, Mr Chairman, I have nothing further to add
to this statement, but I would be very happy to answer any questions
which you may have.
Chairman: Thank you
very much indeed, Lord Cairns. I am going to ask Mr Canavan to
start us off on the public-private partnership.
Mr Canavan
67. Lord Cairns, there appear to be three
options. Option A, the retention of full, 100 per cent, public
ownership. Option B, 100 per cent privatisation. Option C, public-private
partnership. Could you briefly explain to us please the advantages
and disadvantages of each of these three options?
(Earl Cairns) I would be delighted to do so. The
option of remaining entirely within Government control is an option
with which we would be entirely happy if the purse strings of
the Treasury could be loosened sufficiently and CDC was able to
achieve very many more of the targets that it believes it is able
to do but for the lack of funds. The least cost rule, which you
talked about earlier, is a constraint. We have borrowed small
sums of money from the EIB and concessionary funding but those
areas of opportunity are very small. We have seen the opportunity
of CDC growing at 12 to 15 per cent, that is what we think we
can do in creating outstanding development, but under the current
structure and under the current constraints of finance, we are
slowing down our rate of growth to about 8 per cent at the moment
and that is likely to continue to fall thereafter because of the
structures we have. The second option is to look at a fully privatised
CDC. CDC gains a huge amount from its relationship with Government.
It comes from a background of being a development institution
first and foremost. It is not just another private sector venture
capital fund for less developed countries. The whole ethos and
the way in which CDC has operated is of a different order. We
therefore prefer, and it is complicated and it is a mixture of
trying to get the best mixture of the two motives, to bring together
the best we have of the relationship we have with Government and
at the same time to bring in the additional side of the involvement
of the private sector.
Ms King
68. Talking of the close relationship that
the CDC has with Government, obviously you have access to highly
concessionary loans, and that will presumably end following transformation
into a public-private partnership, so you will have to seek funds
from private sources. What would you say the implications for
that public-private partnership will be for CDC's ability to take
our concessionary government loans both in terms of its profitability
but also in terms of its development role and focus? Finally,
how will CDC compensate for the higher rates of interest you will
be having to pay?
(Earl Cairns) I am sure you would expect us, given
that we believe in our cause passionately, to be arguing for the
retention of the highest proportion of those concessionary funds
as we possibly can, and 100 per cent would suit us very well.
At the same time, I suspect that at least a proportion of that
will be transferred into equity and as equity it may be part of
the equity which is sold on to other people. To the extent that
we then, in addition to that, wish to raise further funds through
private fixed interest markets, we will have to pay the going
rate for a concern like ours, and clearly the existing target
that we have of making an 8 per cent return and maximising the
development content above that, does not leave us a margin that
is likely to commend itself either to the lenders or to the outside
shareholders who are going to come in. That is one of the reasons
why we are going to have to increase the returns by taking higher
risks, and we think we can take higher risks by the portfolio
effect of spreading those risks very widely, but we shall need
to increase the returns if we are to be able to borrow substantial
sums of money.
69. Will you therefore be seeking to bank
offshore, so that you can reduce your tax burden?
(Earl Cairns) It obviously depends.
70. It makes commercial sense, I suppose.
(Earl Cairns) It depends what our tax status is
here. If we are paying tax here and not overseas it may well pay
us to borrow here and lend it overseas so we can offset that against
our tax. If we are not paying tax here we would wish to borrow
from whatever source provides us with the best funds with the
best rates we can gets irrespective of where in the world it is
from.
71. You may have heard the Secretary of
State's comments this morning. Would you yourself think it is
desirable to move offshore?
(Earl Cairns) No, our only objective is to create
a level playing field with other people who are likely to be competing
for funds in the areas in which we are operating. We have said
to Government that if we are put at a disadvantage to other vehicles
who are able avoid paying tax other than when they return it to
their shareholders a fundamental plank allowing us to gain access
to the private markets is lost and therefore it is very important
to us that that happens.
Chairman
72. There are several issues that arise
in this. If you are going to be forced into basically achieving
a higher return on your investment by moving into equity investments,
does this not drive you into two things, first of all, the kind
of equity investment which is much more short term because you
will be investing in order to get the equity return necessary
in order to make the capital gain which will give you a greater
return on your equity investment, so it is driving you into shorter
term, and that factor also seems to drive you away from your developmental
focus which the Secretary of State, as you heard, is very anxious
to retain. And a third issue is of course whilst you could be
operating at a disadvantage in relation to other private sector
operators in the same field by not being able to use a tax haven
for your operations, equally you are using public money and subsidised
money in your new organisation which will enable you to compete
on unfair terms with your private sector rivals?
(Earl Cairns) I think the business about short
and long term, Mr Chairman, is not an issue that I am worried
about. I believe that the CDC in its role will tend to take some
of the high-risk early stage development on which the returns,
properly, on a risk adjusted basis should be higher. One of the
most important things we can do in due course is to return to
the indigenous people those companies, those organisations which
we have set up and helped to set up so that they become self sustaining
without any involvement of CDC. I suspect as at present the length
of time that we will normally hold an investment, and this would
be true of a venture capitalist in the United Kingdom or anywhere
else, is a five- to seven-year period. It happens to be about
the same length of period as the majority of loans that were made
on an historic basis.
73. Really.
(Earl Cairns) So I think there is very little
problem. I do not think short-termism comes into it. We are not
going to become traders and dealers and short-term speculators
in the market. We do not have the competence for that. It is not
an area of our expertise. We are in the development world. As
far as whether we will have an advantage from a tax point of view,
clearly if we are able to achieve any advantage in terms of the
financing that we undertake, that presumably will be reflected
in the price of shares when they are offered to whomsoever they
are offered and it should also give us the opportunity to employ
for the benefit of all the shareholders and for the development
of the businesses really so that everyone will benefit therefrom.
I do not see those as being major problems. I do not see us being
driven into less developmental undertakings as I believe very
strongly that the best returns come from the most prospective
investments which are also the best development so that there
is not a conflict between maximising the development returns and
maximising the commercial returns. We wish to add value and we
wish to add value both for the recipient countries and for the
investors that are investing in them.
74. I am intrigued, Lord Cairns, what you
get Roy Reynolds to say to his regional representatives, if that
is what you call them, or executives overseas. What kind of investment
are they going to be looking for? It seems to me they must be
being asked to look for investments that will record a 25 per
cent before tax return.
(Earl Cairns) Perhaps since it is what Dr Reynolds
may be saying I should ask him what he is going to say!
(Dr Reynolds) First of all, let me add to some
of the comments my Chairman has been saying. We are in the long-term
investment business. That is what we were set up to do and we
think that is our strength. We will be looking to make investments
as equity in businesses that will thrive in the long-term. We
do believe they are in countries in which we are operating. We
believe some of them might need some managerial assistance and
that is why we are in a position to give that managerial assistance.
We do believe that there are some very viable businesses out there
but we will be making investments for the longer term. As a result
of that we do recognise that there is going to be a transition
period for the CDC because we are moving from debt to equity.
We cannot realise any of our equity investments, as we were saying,
for seven years. It will take that time to get them to a state
where we can realise them so there is a transition period but
we do believe that we are in the long-term investment business.
I should also add that in the countries we are in there are no
large financial markets such that you can go in and out and have
quick returns. What we would like to do is try and build those
up so that we can attract investors but we do not see ourselves
looking to make short-term gains because there are not the financial
institutions there such that we can do that.
75. What rate of return are you asking your
regional executives to look for when looking for business?
(Dr Reynolds) We would expect a return on our
equity of 20 per cent plus. When we are looking at that we look
at the risk:reward ratio so in some investments we will be looking
for higher returns and others around 20 per cent depending on
what sort of risk we believe that investment has.
76. Are you looking at this on an annual
basis or on a basis over a period of years or how are you doing
it?
(Dr Reynolds) We would look at it over a ten-year
time-frame.
77. So a 20 per cent per annum return looked
at over a ten-year period, right?
(Dr Reynolds) Yes.
78. Surely this drives you into certain
types of business in these kinds of countries, does it not, and
away from the more risky and more difficult kinds of investment
in developing countries?
(Dr Reynolds) In the countries we are operating
in we believe we know them pretty well and we will look to get
a balance of our investments whether it be in infrastructure,
agriculture, mining or manufacturing depending on the country
in which we are making an investment. For example, in India we
do not make many agriculture investments because it is actually
quite difficult but when we come to Africa we find we have a number
of agricultural investments which are the better types of investments.
I do not think it would drive us particularly in any direction.
79. How do you defend yourself from the
accusation that you are operating in the private sector in a privileged
position? For example, in Guyana (a country I know well as a result
of my service with the CDC) I notice that you were in competition
with five or six others who had applied to take over the nationalised
electricity corporation there. I note that you were not one of
the preferred bidders but nonetheless you are in competition with
other private sector investors possibly in a privileged position.
(Dr Reynolds) We do not see ourselves in a privileged
position in those particular cases. We will only look to bid,
to involve ourselves in that sort of project, when we think we
can add more value than other people that might be bidding. We
bring technical knowledge and we believe we can bring in additional
development capital. This is one area where we talk about these
sort of privatisations, where we find that we will come in and
take over that facility and then we will look to develop it, and
it is only on that basis that we can make that investment, whereas
others will come in and just take over that investment and not
add capital. So here we would get involved where we think we can
add value by bringing in additional capital and additional management.
We also think we bring in ethical management, where in some cases
we do not think it is probably going to have, let's say, the priority
that it might have. Having said all that, I do think here is a
very grey area which we have been very conscious of in our current
status. When we move to the public-private partnership with private
sector investors in CDC we believe we are not going to have that
dilemma in the same way, because we have private sector investors
then that we will have to give returns to like any other private
sector organisation.
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