Select Committee on International Development Minutes of Evidence


Examination of Witnesses (Questions 80 - 99)

TUESDAY 7 JULY 1998

RT HON EARL CAIRNS, CBE and DR ROY REYNOLDS  

Mr Rowe

  80.  It is often said that CDC sets the salary standards which means that not only NGOs but also, more importantly perhaps, entirely indigenous companies find them extremely difficult to match, so in a sense while you are giving with one hand you are taking with another because you are stripping out some of the best people because you are paying above the otherwise going rate. Is that a fair criticism?
  (Dr Reynolds)  I hope not. Coming from the private sector myself, I would hate to see us paying above the going rate for the talent we need to do the job. I hope we are not doing that and, if we are, we should look to put it right. The other point here is if we are paying salaries which are too high, if we start to look at whether the business makes money, we will be struggling there too. So we cannot afford to pay very high salaries if we want to have a business that is profitable.

  81.  Both you and the Government acknowledge that with your current profitability levels you would find it hard to attract private investment. You plan to increase the proportion of your investments in equity rather than loans, which in general attract a rather higher rate of return but are also subject to higher risk. I just wonder how much you need to raise your profitability to meet the needs of the private investor?
  (Earl Cairns)  When we have looked in the past at the CDC, the Government has set us targets to make an 8 per cent return and maximising development content thereafter. Against that background there has been a high loan content in the overall portfolio mix. I actually think that part of our development contribution, or indeed development subsidy, in that period has been that we have been taking equity risks and only been receiving a loan type reward for them, ie if all goes well you get your money back, and if it does not go well you do not get your money back, whereas as we move on to a greater emphasis on equity we can share in the up-side as well as the down-side of the fortunes of the enterprises which we develop. Our sense is that in order to attract the private sector, the risk profile that we have would indicate rates of return—and this is overall return, part may be capital, part may be income—of around 15 per cent. We are told, and this is at an early stage, those are the sort of returns we need to aim for in order to attract the interest of the private sector. I think that is quite a conservative estimate.
  (Dr Reynolds)  I do think we recognise as we move more into equities that this will mean looking at each individual investment and having to scrutinise it with perhaps greater rigour than we have in the past, because when you are taking that equity share you need to see that that business is going to be profitable and it is sustainable long-term. That means looking at it in a rather different way from when you are looking to see if they can pay back, do you have the right security on a loan. This is where it comes to the greater developmental role we think we are going to be playing. It does mean our staff will have to look at these investments in a different way and a lot more vigilant way.

  82.  Is it not going to put enormous pressure on you to move to middle income countries from the lower income countries?
  (Earl Cairns)  If I had—"disagreement" with the Secretary of State would be the wrong way to put it—a difference of view, and luckily we both came to the same conclusion for slightly different reasons, it is that I believe the comparative strength of the CDC as much in the private sector as in the public sector is our knowledge and involvement in the poorer countries. If we move into the middle bracket countries where there are more alternative people with skills and experience, we lose our comparative advantage. Our competitive advantage is (a) the knowledge and the understanding and the relationships we have within those countries and (b) it is because we have such a spread of investments that we can afford to take on each one of them a relatively high risk for, we hope, a full return in a way which nobody else can. If we move too far away from that, we lose our advantage and we become just another set of investors. So I think in commercial terms we will want to do exactly what the Secretary of State wants us to do because she does not so explicitly believe the commercial pressures are sufficient to keep us on what she would call the straight and narrow.
  (Dr Reynolds)  I would like to re-emphasise that. I think that is where our competitive strength lies, that is what has been built up over 50 years, that is what we can offer which no one else has. What we are looking to do is ask the private sector to join us in doing that. It would be foolish to move away from where our competitive strengths are. We have these 27 offices all around the world, we are very well-known. It was asked earlier why Commonwealth Development Corporation. We are so well-known as CDC in, for example, Zambia or most of Africa, that that is our strength and we have built up a critical mass of investments which gives us a competitive advantage that we would be silly to give away.

  83.  Do you have a general CDC view about how long you stay in a particular enterprise before you try and sell it on? Or is that absolutely dependent on other factors?
  (Earl Cairns)  We wish to look on the basis that within seven to ten years we are likely to be out of the business. There are plenty of investments we have held for 30 or 40 years—we have been in Chilanga on and off since 1949———

Chairman:  You have recently gone back in there.

Mr Rowe

  84.  Is that because you cannot get out or is it because it is profitable for you to stay?
  (Earl Cairns)  It is because we continue to see our presence as providing (a) reasonable returns but (b) extra development value. There are other things we can do from Chilanga, like our involvement in the Malawi Cement Business, which are complementary and we try to make those two work together for the benefit of the whole of that region. At some stage it will be right for us to come out but it will be when the extra dimension that CDC can put into that is no longer necessary, it does not give us a special objective, a special right.

Chairman

  85.  Do you think on this basis that you can attract the private sector investment in CDC which you are looking for? Who is going to invest in CDC as proposed?
  (Earl Cairns)  The Secretary of State indicated that maybe the amount of change that is going on in the CDC might cause her to look at whether there were some halfway houses before a full public offering. Clearly CDC can be sold to the public at a price. We have got £1.5 billion of assets and somebody is going to pay more than sixpence for them. Sorry, sixpence is no longer——

  86.  Six pence is alright!
  (Earl Cairns)  That may not be as we go through the initial process the most attractive way. Frankly, it is too early for us to say. We certainly believe that we have—I hate the word unique—but we have some unique characteristics which should be attractive to some elements of the investment community at a price and one of the issues is how to structure that so that that price is one which is satisfactory to the United Kingdom taxpayers and to DFID in its recycling of any part of the sale proceeds. It is also very important from the CDC's point of view that it should be seen to be an attractive and successful organisation because that is the way we are going to attract other funders to come in along side and other people to support our investments. We are in a period when equity investment in the third world for whatever reason is under more of a cloud than it has been for some time. By the time CDC is ready to offer shares, what the state of the markets is going to be I am no more able guess and probably less able to guess than you are, Chairman. I think those are decisions that have to be taken further down the line but, yes, there is a price at which people must be interested in owning shares in CDC.

Mr Robathan

  87.  Just before going on to investment policy, can I just ask you one final question on this and that is the amount of money invested in so-called ethical funds in the City is pretty minute, as I understand it. Do you think that your ethical investment is likely to be different and do you think it is likely to be attractive to the City and why? Do not go through every reason because we have heard many already.
  (Earl Cairns)  I do not think that people are going to buy shares in CDC just because we are ethical. I think that some funds that are willing to support people who are explicitly ethical. Both in our behaviour and in the developmental aspirations that we have they will be attracted. I do not think that particular block will be sufficient to acquire the 60 per cent of CDC which might at some stage be for sale. Nonetheless, I think that they can be an important part, if you like, of the shareholders' supporters club of CDC going forward which we very much hope to develop. We will be under the slide rules of the general market as well which sets some pretty severe standards and we are going to have to satisfy them that we are worth some of their money.
  (Dr Reynolds)  Our problem of course is we do not have that track record because we previously have been operating in a rather different regime so our returns of eight per cent are not going to be the ones as such commercial investors are going to find attractive. We are changing to invest in equity. We have now got to show that track record and that is why we believe there is a certain transition period. Those who know us well can understand the potential. Those who do not know us well will say, "Where is your track record?" and I think this is the issue that we now have to manage that transition period.

  88.  Can I move on to investment policy which is still about ethics, I suppose. Your criteria are set out in your Annual Report for development investment. First, do you adhere to these criteria in every investment that you make?
  (Earl Cairns)  I think what we have done here and what we are continuing to do (and we are still working on this) is making explicit quite a lot of what was implicit in the way in which CDC operated from long before I was involved. We now have a monitoring policy which we refer to.

  89.  The EDIs?
  (Earl Cairns)  Yes, which checks on a random basis a high proportion of past investments to see whether we fulfil the criteria that were laid down.

Chairman

  90.  Can I interject here. Who does this actual work?
  (Dr Reynolds)  We have one very small section which co-ordinates this activity and also goes out to audit the country managers, doing it under the auspices of a small group who sets the terms on how it has to be done and then audits on that basis and then co-ordinates the total activity.

  91.  It is internal?
  (Dr Reynolds)  It is internal.

  92.  The other question on your report is do you report it to the Department?
  (Dr Reynolds)  Yes it gets reported to the Department and we actually share with the Department how we are going to do it. We also share with the Department how we were putting this whole process together and we share with the Department our results as we do with the Development Committee of the Board.
  (Earl Cairns)  We are in the risk business and we are looking at longish term investments. We will, and probably should, make some mistakes. Not every investment is going to be successful.

  93.  You will be a superman if you do not.
  (Earl Cairns)  What we are trying to do in this process is to learn as much as we possibly can from every mistake we make, so we do not do it again. If we can cry over enough spilt milk, we will become a much better organisation.

Mr Robathan

  94.  Do you intend to continue with this method of EDIs when and if you become a public-private partnership?
  (Dr Reynolds)  Yes. Not only yes, we are looking, as Lord Cairns was saying, to actually build on this whole process because we do believe it is a learning process. So, yes, is the answer.
  (Earl Cairns)  Following on from that question and the questions you were asking earlier, we shall have to think about how in our annual report—and it is not a difficult thing to do—we can have a section which deals with the various constraints that Government intends to put upon us. One section of our annual report I think will be a sort of check list against whether we have done that which we were supposed to in terms of fulfilling what will be the constitutional objectives, so that we will have a financial report and we will have a constitutional report.

  95.  So would you describe that as a formal way of ensuring your investments correspond to the Department's country strategies?
  (Earl Cairns)  No. I would see that as conforming to the objectives which are laid down in the memorandum and articles which will be there in the prospectus which will form the constraints on our activities. As far as country strategies are concerned, to the extent it is a question of do we meet the 70 per cent criteria that you talked about earlier or the 50 per cent criteria, yes, those will be in. On an individual country basis I would see it as being subject only to those two constraints. It may be we will see fit, and probably will, to talk to a large and knowledgeable shareholder about their views of Country X or Country Y, but the decision on whether we follow the advice of the Department or Government I think at that stage, as a company answerable to its shareholders, has to be the decision of the board.

  96.  Do you see this as leading to any conflict with the Department which will be, as you say, a valued shareholder and a large shareholder?
  (Earl Cairns)  I very much doubt it. I think we find ourselves sharing objectives and there is no reason why we should not continue to share those objectives. We value the advice we get from DFID and from the FCO and to the extent that we can go on benefiting from that advice and the very public association that exists through the large shareholding, we have got to be daft if we do not do it.

  97.  There was one other question which relates to this which is we have seen your criteria for investment, but do you intend to have a new code of practice? Do you intend to consult with NGOs as to whether you should change your code of practice because they have made representations to us?
  (Earl Cairns)  We are still working on this. Roy, I know you have got the latest draft. I am sure at some stage you will want to share it with certain of the NGOs and with other organisations.
  (Dr Reynolds)  I think, as I said before, it builds on what we set out in that Annual Report. We now have to fill in all of the detail and help our country managers and investment managers make the right sorts of decisions and that is what we are doing. We are going back to first principles in a way in consulting with staff on what the core values of the CDC are so that they are part of the organisation and they are not something that comes down from on high. Out of that we are building up our business principles and out of that we get our ethical behaviour and our social policies and at the same time we are working on the detail of our social policies. Currently we are in that process. We hope by the end of this year that we shall have finalised that document and again we will share with it with DFID as we go through as we will be sharing it with NGOs as we will be sharing it with other organisations, both potential future investors as well as other governments, etcetera, etcetera to see that everybody is comfortable in the values which we are going forward with.

Mr Canavan

  98.  What do you do to ensure that CDC investment is ethical investment in terms of respect for human rights, health and safety at work, reasonable wage rates, etcetera?
  (Earl Cairns)  Every investment that comes to the board will have a section which deals very precisely with each of those headings. They will be evaluated in full before they come to the board. I suspect nothing will come before the board which is not likely to satisfy the board because the people arranging those investments will know the importance we attach to each of the subjects.

  99.  Some years ago before your time I initiated an adjournment debate. The complaint was about a plantation in the Philippines which was financed by the CDC and the allegation was that the plantation was in effect run by a crowd of homicidal gangsters. Do you ever get similar complaints now or was that a fairly unique case?
  (Earl Cairns)  We do not and we have not had complaints of that sort. We do look and the board would expect to see on each investment an assessment of the individuals who are behind each of those investments and we would want to be very careful that they were people of the standards that both you and I would approve of, Mr Canavan.


 
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