Examination of Witnesses (Questions 140
- 156)
TUESDAY 21 MARCH 2006
MR RICHARD
LAING
Q140 Mr Davies: The cost of correcting
this market failure, Mr Laing, is—my colleague has made
this calculation and he has actually deducted six or seven from
17 or 18 and brilliantly come up with a figure of about 10%—the
cost to the taxpayer of delivering the service that you deliver,
which is correcting market failures, as you describe it, around
the world is 10% on your capital. Your capital is £1.5 billion.
It is roughly £150 million a year which is the cost to the
taxpayer of achieving the purposes which you have decided you
wish to achieve.
Mr Laing: On that particular fund
there is a cost because otherwise this will not be done like this.
Q141 Mr Davies: It is a useful exercise,
is it not?
Mr Laing: It is a bit of arithmetic.
We have to weigh up this dual balance we have of getting return
on our portfolio and addressing the market failure; that there
is a price to pay for going in there.
Q142 Mr Davies: The question really
is we want to evaluate the worthwhileness in your activities—I
am very open-minded about that—we want to decide whether
or not the meeting market failures which you have achieved in
the course of a year are worth to the British taxpayer more than
£150 million a year or, put the other way, could we spent
£150 million more effectively elsewhere in the world than
addressing market failures than by subsidising the rate of return
on the CDC between the 5% plus something and the 17 or 18%. That
is the basic equation on which you have to be judged, is it not?
Mr Laing: You can certainly look
at it that way. There is a cost to addressing market failure,
yes.
Q143 Mr Davies: That is right and
it would come roughly to decide what the cost is.
Mr Laing: Yes.
Q144 Chairman: There is presumably
a benefit also, is there?
Mr Laing: There is a huge benefit
otherwise we would not exist and the people that we have just
been talking about here would not have access to capital.
Q145 Chairman: How do you and Actis
interact with DFID? You heard the evidence we heard before. The
officials were frank enough to acknowledge that DFID is feeling
its way to some extent in this private sector development. You
have expertise and information in what you do which is beyond
where DFID is active. Do you feed that back into the Department?
There are things you will not do. You have said yourself that
they are too risky for you, like Malawi where the aid community
would do it. Do you feed back into DFID ideas, suggestions or
information on which they can determine their priorities? Clearly
you have information at the commercial end which they do not,
which they need.
Mr Laing: Yes. We meet regularly
with DFID. We have formal meetings every quarter, we have informal
contacts probably every week and during that we will cover a wide
range of areas, including what it is like to be doing business
in these emerging markets.
Q146 Chairman: Do you actually pass
the ball to them? Do you say here is a project or here is a market
area where we will not go but we think you could or should?
Mr Laing: We would not pass them
a project, no, but we would certainly discuss with them areas
where, particularly on the investment climate and the background,
we feel there is need and an interaction.
Q147 Chairman: That is helpful because
it seems to me that DFID needs to be given that kind of input.
Is there any formal mechanism? You say that you meet. Do you publish
anything?
Mr Laing: We publish our annual
report which comes out next month, so that is the formal document.
We have a website.
Q148 Chairman: That obviously slightly
addresses Mr Davies' questions of how you have performed against
your objectives. Within your report do you address what you have
learnt that could be relevant or useful to help stimulate private
sector development at a level below which you would engage and,
if not, is it something you would consider?
Mr Laing: We do not formally write
a report to DFID on that but there is no reason why we should
not.
Q149 Chairman: We would ask you if
you could think about that whether it would be useful.
Mr Laing: Yes, I think it is a
useful idea.
Q150 Hugh Bayley: Quentin Davies,
with his 10% deficit on return paradigm, suggests that the value
of the development gains you buy ought to be £150 million,
10% of your capital per year. That is the paradigm he was putting
forward. I have been wondering whether that is right. The model
he has created is an interesting model which you should look at,
but since the Government is not in the business of sending out
venture capital funds which achieve 15% returns perhaps it is
not a 10% deficit, but it might be worth looking at the Government's
overall borrowing rate for the bonds, which I do not know what
that is.
Mr Davies: The gilt rate is about 4%.
Q151 Hugh Bayley: In which case you
could argue that for a government it is a nil cost. Could you
comment on my paradigm which perhaps is equally extreme?
Mr Laing: I do not like the £150
million number because we were talking about a particular sector
of business we are doing, which was microfinance, and our whole
balance sheet is not applied to microfinance. As I have said,
our cost of addressing this market failure will vary fund by fund.
We are talking about one which was at a very low rate of return
where the highest single figure is 10% which was the number we
were using. There are other funds where we will be very close,
over the long term, to being able to make market rates. The reason
we are is because people are not investing in it because they
have actually missed the opportunity. They have not realised that
in fact they can invest in these countries and make good returns
and that is why we are there, so in that sense there is no cost
to our presence there. In some areas there is no cost at all,
but in some areas there will be a cost.
Q152 Hugh Bayley: I and my colleagues
were implicitly criticising you for investing in shopping centres
in Nigeria or in aluminium smelters in Mozambique. Is there an
approach to your business within the company which says we need
to make some high return and safer investments to generate the
sort of returns the Treasury wants in order for us to take greater
risk with some low return, less safe investments?
Mr Laing: As guardians of this
£1.5 billion we have to invest responsibly and we are constantly
looking at the portfolio to make sure that we have got appropriate
risk. That means that we will invest in some firms which are less
risky than others. For example, in India we will go into general
private equity funds where we think we will get a better return
that the microfinance fund in Africa.
Q153 Mr Davies: Mr Laing, I continue
to think that my approach makes sense because you are looking
at the target, and you have acknowledged it earlier on, that the
target return on your portfolio of a minimum of 5% as against
what would be the average market return required on an investment
portfolio of equivalent risk and you have given us an estimate
of that. Can I assume that both the 5% and the 17 or 18% are net
of what you pay your fund managers? How would their remuneration
normally be formulated? Is it a fixed amount of 5% per annum?
Do they have some incentives where they get more if the rates
achieved are higher? What would be a typical arrangement? This
might explain what struck me at first as something as a mystery
which is when you said that the market rate of return on your
portfolio would be in the order of 15 to 20%. That seems to me
quite low, given the risky nature of some of these investments
in some of these countries. Maybe it is because much of the return
is absorbed by the fund managers and you were talking quite rightly
about the net return to you. Could you say a word about the remuneration
of these new fund managers to whom you are passing on your capital
to invest?
Mr Laing: For clarification, to
your first question, yes, those are net numbers. The typical structure
would be that if we put US$100 into a fund we would pay an annual
fee to the fund manager and that would range, depending on the
type of fund, the skills required, the size of the fund, from
1.5 up to 3% and it will vary fund by fund. In addition to that
basic fee there is an incentive arrangement whereby if the return
is above what in our industry is called a hurdle, if they go beyond
that hurdle then they share and participate in the profits. Again,
that sharing varies from 5% to 20%, depending on the type of fund
and the operation.
Q154 Mr Davies: They would probably
get on average across your portfolio, given in certain cases they
will meet those hurdles, sometimes they will not, but the fund
managers will be getting at least 5% return for your portfolio
as a whole, maybe slightly more than that in good times if the
performance is good. That would be a reasonable ballpark estimate,
would it?
Mr Laing: Yes. I would be very
worried if they were not getting that because otherwise they would
not be making decent returns.
Q155 Mr Davies: Of course and that
has to be compared with the cost of the 300 people who did the
job before and with the returns achieved by the 300 people who
did the job before directly and the fund managers to whom you
have now subcontracted the task. This is the way you should be
evaluated logically, is it not?
Mr Laing: Yes.
Q156 Chairman: I suppose the satisfaction
is that you have invested in projects that do make a return to
which the market would not invest in.
Mr Laing: Yes, that is the crucial
point, yes.
Chairman: Thank you very much indeed.
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