UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 921-ii

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

INTERNATIONAL DEVELOPMENT C0MMITTEE

 

 

PRIVATE SECTOR DEVELOPMENT

 

 

Tuesday 21 March 2006

MS SHARON WHITE, MR WILLIAM KINGSMILL, MR GAVIN McGILLIVRAY and MR RICHARD BOULTER

MR RICHARD LAING

Evidence heard in Public Questions 62 - 154

 

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Oral Evidence

Taken before the International Development Committee

on Tuesday 21 March 2006

Members present

Malcolm Bruce, in the Chair

John Battle

Hugh Bayley

John Bercow

Richard Burden

Mr Quentin Davies

Mr Jeremy Hunt

Ann McKechin

Joan Ruddock

________________

 

Examination of Witnesses

 

Witnesses: Ms Sharon White, Director, Policy Division, Mr William Kingsmill, Head, Growth and Investment Group, Mr Gavin McGillivray, Head, International Financial Institutions Department, and Mr Richard Boulter, Head of Profession, Enterprise and Development, Department for International Development, gave evidence.

Q62 Chairman: Good morning. Thank you very much for coming in. I wonder if you could briefly introduce your team before we start.

Ms White: Thank you very much indeed. I am Sharon White and I am the Director of Policy at DFID. On my right is Richard Boulter who heads our enterprise development advisers within the Department. On my left is William Kingsmill who was Head of our Nigeria office and who is now heading our growth and development work in the Department. Furthest to my left is Gavin McGillivray who heads our International Financial Institutions Department which covers CDC as well as private sector infrastructure.

Q63 Chairman: Thank you very much. You will appreciate that the Committee is just now getting into a report on the role of private sector development as a means of alleviating and resolving poverty and we are approaching this in a very genuinely open-minded way. We want to know how it can do it and what is being done to make it happen and obviously we are interested in what you are doing. I know that Kofi Annan has made a comment to the effect that private sector development and the growth of the private sector in poor countries is essential to the alleviation of poverty. The OECD Development Assistance Committee's suggestion is that "Instead of regarding private sector development as just one of a number of tools, it should be regarded as a major, if not central, part of country assistance that donors provide". Given the terms of the International Development Act and the focus on poverty, do you think that these two things are compatible?

Ms White: The answer is we do. DFID has recognised fairly recently the importance of the private sector to poverty reduction and to the MDGs. I think it is fair to say that it is probably in the last five or so years that this has begun to take rising prominence. I think it has been part of the debate that we have seen in the last few years around poverty reduction strategies and the early focus on social sectors, on health and education primarily and the sort of missing heart or growth in the private sector. As we look, in the light of the 2005 commitment, at what has driven growth in Asia and at how we can replicate that in Africa, I think we are becoming more and more seized of the importance of growth and of the private sector. It is also important for us that the poor are the private sector, that nine in ten poor people in work in developing countries are privately occupied and so we cannot do development effectively without a strong focus on the private sector. That said, it is still a relatively small part of our work, but it will take on growing importance and I think you will begin to see that in the White Paper that the Secretary of State will launch this summer.

Q64 Chairman: That obviously is something that we are looking forward to. As you know, the Committee has recently returned from a trip to a number of places in Africa. If you take what we learned in Malawi - and you are quite right, the poor are the private sector - we were constantly told they were so poor they had no capacity to buy anything and therefore there was no ability to stimulate a private sector to service people who had no purchasing power, it was kind of locked into that. What do you think of the policies that you can pursue which will actually break the way out of that and start to enable poverty to be reduced by actually enabling those people to do something that generates economic activity and subsequently growth that will reduce their poverty? Have you got ideas and experience?

Ms White: I think we want to take a multi-pronged approach and for us the Gleneagles commitments from last year are a key part of this. When we look at the financial commitment from last year, I think we are clear that the extra £50 billion of ODA that we expect between now and 2010 needs to be as much focused around infrastructure, transport, the key enabling environment for growth as on education, health and basic public services. I think we are also working tremendously hard, although with less success than we would have liked, on the trade environment. Creating bigger markets for the produce of the poor is absolutely vital to this. DFID's approach on the private sector, as I am sure you are beginning to see from your country visits to Malawi, Sierra Leone and Mozambique, has been very focused on small scale microfinance, which is fantastically important, it saw lots of women coming through, but at the same time we have learnt the importance of growing rather more upstream, looking at the enabling environment for business, working with governments to cut red tape, reduce regulation, improve competition and so on both at the macro level of trying to make sure we get the aid flows through, working in the right direction on infrastructure as well as the social sectors, but also working more upstream on a policy environment with the private sector.

Mr Boulter: On Malawi, where we used to concentrate on microfinance, we now tend to promote what is called access to finance, so we are talking about things like savings and insurance and pensions to some extent. In Malawi we have a programme with what is called the Opportunity International Bank of Malawi that is savings driven. There are a lot of poor people coming to that bank to bank their savings. Then, as Sharon says, the investment climate is really important. One of the things we have learnt in the last two years is that we can put time in to what we call private-public sector dialogue and getting those two sectors together. There is something called a National Action Group in Malawi that is bringing those two sectors together and we have been talking about the importance of the investment climate.

Q65 John Bercow: Looking at the enabling environment, Sharon, as you have just described it, presumably it includes looking at countries in which property rights are not secure or indeed non-existent. It would therefore be helpful if you could give us some indication of what DFID is doing in the countries where that problem is especially acute and on what scale. I recently asked the Secretary of State about Hernando de Soto's work and I got, in fairness, a very constructive reply which obviously had involved officials thinking about the work and offering me a summary of their views on it. That was useful in terms of a one-to-one exchange and reactively I suppose it was certainly better than getting no reply, but I do not have any very strong sense personally that DFID is all that seized by the property rights agenda, it seems to be a very, very small scale feature of your work or almost a very belated afterthought and it seems to me to be rather central. Secondly, who amongst your team advising on these matters has any experience of establishing and running a successful business? Do you use anybody from the private sector who, as opposed to merely theorising about the subject or displaying some competence in the field, has actually done it?

Ms White: I think both your questions relate to the fact that this is a relatively new area for DFID and my colleagues can talk to you in more detail about how far we have been trying to get in experts who are much closer to the coal face in terms of setting up businesses and so on. As I am sure the Secretary of State mentioned, we are becoming more conscious of the importance of property rights in terms of unlocking private sector development and obviously it varies hugely by country. In Peru where 90% of businesses do not have security of tenure it is an enormous problem in contrast to Vietnam where clearly the changes that took place with the change of government and increasing security have had a tremendous impact on the private sector climate. In answer to your question as to whether we are taking a systematic approach across the board to this, I think there are clearly gaps. Richard is head of our enterprise profession. We have 25 enterprise or business advisers across the Department. That is a huge increase from where we started five or six years ago. That gives you a demonstration of the fact that this is still a relatively under-explored area for us. We are trying to make links to the private sector. Gavin used to work in the City. We have actively tried to recruit the skills that we do not have internally. Perhaps Gavin can also talk about the links we are trying to forge with people who run businesses.

Mr McGillivray: Having a few people in-house is helpful with that experience but so is using people outside of DFID. We have got a very interesting new model with CDC and Actis with the emerging African Infrastructure Fund, with InfraCo, where we have our money focused on certain objectives, so there is a framework which defines how it will be used to achieve development ends, but then we recruit through a competitive process a private entrepreneurial entity to run that money and so we get this entrepreneurial drive behind our objectives and it is really producing astonishingly good results. In our private sector infrastructure programme we have spent about £100 million over the last five years and we reckon we precipitated through that $1.5 billion of private investment into markets which it otherwise would not have gone into and more than 90% of that has gone into Africa.

John Bercow: I personally regard this as being of the essence and therefore I wonder if it is possible to have a note to members of the Committee describing in a little more detail the sorts of progress to which you have just referred. Is it simply a matter of capacity that has so far prevented DFID making a significant contribution in this field? If that is all it is and you are trying to address that within the resources available then that is very reassuring. Can you allay my anxiety that there is something else involved, that DFID is so culturally sensitive to the norms and traditions and cultural practices in many developing countries that it is frit to offer this advice for fear of being accused of neocolonialism and so on, because if that were the attitude it would be terribly disappointing? The reality of the matter is that this can make an enormous difference. We are not afraid to offer gender advice and that is absolutely right, I applaud DFID for doing that. I have never engaged in a cheapskate tax on DFID's gender advice approach, I think that makes a great deal of sense, but if DFID is prepared to do that because we are at a certain stage and we feel that we should encourage developing countries similarly to respect women and to expand opportunities and so on, surely if we know that capitalism works, the fact is it has won the arguments around the world, why not advise developing countries to have property rights, a transparent banking system and what I call the institutional legal infrastructure for competitive markets?

Q66 Chairman: On the specific point that John has made about a note on what is happening, I think that would be helpful. We appreciate that you are engaged in it but, as you have said yourself, Sharon, it is a relatively new area and I think we are keen that we should see more results. I do not know whether you want to answer that point specifically.

Mr Kingsmill: We are vitally interested in property rights. In Nigeria, for example, we were supporting the renewal of the land registry because we saw how important in Lagos state land is as a fundamental building block of the market economy and the Nigerians were keen for us to do that, but we have to be aware that formal land registry systems are hugely expensive and that many very poor people, the nine out of ten people who we were talking about, are going to depend on informed systems and crafting those is very difficult and it does have to work with the traditional systems. Governments have very strong views on land tenure. Around 20 years ago you would have found ODA and ODM doing a lot of work on establishing new systems of land tenure and we have been eased out of that business because it is highly politicised. In all of our programmes there is an awareness of property rights and not only establishing land as the most important aspect for all poor people but to establish dispute resolution mechanisms as well, which is something we were also doing in Nigeria, to make sure that the people have access. These are vitally important to us. Although these areas do not cost mega billions, they are very labour intensive and I think it is quite right to point out that DFID is constrained in terms of its labour resources. We do focus on property rights very significantly.

Q67 Hugh Bayley: Has the Department considered whether it could establish a wing within the Department that works on commercial terms, that provides advice, that is mainstream to DFID's own mission on rural livelihood development, improving governance and so on, but on a consultancy basis to middle income countries? We withdrew from Latin America because the priority was low income countries. If you look at this Committee's report, in India we suggested that perhaps in ten years' time we should not be a donor to a middle income country with a massive space programme but that if they really valued the expertise we have in rural livelihoods perhaps they should buy the services. If we were to develop that way of marketing part of a package of DFID services, do you think it would build more of a private sector culture within the Department and less of a social work one?

Ms White: It is a very interesting question because the context of the Comprehensive Spending Review that we are going through with the Treasury at the moment is that DFID's budget with a 0.7 target means that we are in the very happy position that we are about to triple our budget between now and 2015 from about £5 billion to around £15 billion with around the same staff. That means that very stark questions about where we put our resourcing and particularly how much we can afford to give a priority to middle income countries is a fantastically live debate at the moment both in terms of cash resource and in terms of technical assistance. One of the developments for us over the next year will be a sense of what DFID's business model looks like in middle income countries. I do not think we have considered precisely your proposal of whether part of the reconfiguration of our business model might be a fee-ed service with middle income countries. I know the Bank operates to some extent on that basis, but I think it is something that we will definitely take away to consider as part of the CSR.

Mr McGillivray: On middle income countries, one of the instruments we have is the international financial institutions, the World Bank, the Asian Development Bank, the InterAmerican Development Bank, which we are shareholders in and which we fund. We are keen for them to continue to operate in middle income countries and to focus on the role of poverty reduction. Although our bilateral programme is concentrating on lower income countries, we have this almost off balance sheet ability to work in middle income countries.

Q68 John Battle: We looked at the CDC a while ago in this Committee. I think there was then quite a major restructuring in 2004 of the Commonwealth Development Corporation and the setting up of Actis and Aureos and a refocusing of CDC rather than large power plants in Latin America to try and see how that tied in with a strategy to tackle poverty. CDC is now described as the emerging markets funder fund investment company. Under the Memorandum of Understanding with the Department, although it is government owned, is an idea that there should be no interference or intervention by DFID in CDC's activities. I can see that from the structural point of view. How do you see CDC fitting into DFID's overall model of development?

Mr McGillivray: Where it fits in is in terms of pioneering investment. I think you will have seen in this booklet here the emphasis on building the enabling environment, which is laws, regulations, policies, institutions and infrastructure, but in many countries it is a generational challenge to get all those things better. In the meantime we see a strong role for entities like CDC and also the IFC coming in and going where the private sector would not of itself go, bringing in private sector partners with it and showing that it can be done, that you can invest decently and profitably in these two difficult environments. That is the most powerful impetus to others to follow suit. Thus far - and fingers crossed - in our view the Actis CDC model is working extremely well. CDC remains with the great bulk of its capital focused on the poorer countries and with a far greater focus than the other development finance institutions, it is making profits and it is bringing in other money alongside it. It seems to be going very well.

Q69 John Battle: Do you see CDC as a thin wire that pulls in the larger rope of further investment when others are reluctant to go? Is that what it adds to it?

Mr McGillivray: Yes. That was the principal impetus behind the restructuring. It has always done good work. It has always invested decently and created direct employment exports, foreign exchange and set standards, which is very important, and it continues to do that, but the new model now has far greater ability to mobilise other money alongside it.

Q70 John Battle: Is it just a catalyst? Do you not see it having a role in the future? The private sector will go where it has been led by CDC. What do you see as the future for CDC in the long term?

Mr McGillivray: I think within our lifetimes there will still be a strong role because the frontier keeps on advancing. This is the difficult judgment that we have to make with CDC, the IFC and the EBRD, that these large financial institutions that invest in private companies keep on moving out to the geographical areas, the sectors and the instruments that the private sector is not going in of its own accord. There is a risk that organisations become comfortable. They like to do business in easy places just like everybody else. So constantly keeping that frontier and investing in that frontier is how we would see it going.

Q71 Mr Hunt: I set up my own business. I was interested to hear you talking about Asia. What a lot of people who have looked at the economic success of Asia say is that the focus on private sector developments in Asia has been amongst the growth of small businesses rather than big businesses and particularly agricultural businesses. A lot of people date the rise in China's success back to the moment when the communes were disbanded and farm holders were allowed to have their own small holdings. The question I have not been able to understand is how this relates to extreme poverty. How possible is it for people who are earning less than a dollar a day to set up and run their own businesses? People like Geoffrey Sacks, for example, say it just is not possible when you are so desperate at that level, that you cannot save enough to get any kind of business going, but then there are other perhaps more hardheaded US economists who say anyone can start up a business, you have just got to create the right environment and extreme poverty should not be a bar to that. I just wondered what you feel about that. Are we talking about creating an environment where effectively the middle classes in African countries can set up businesses which hopefully benefit everyone or are we talking about an environment where everyone can set up a business no matter what the poverty?

Ms White: I think our take on this is probably the latter. If we look at the pattern of business, particularly if we look at the informal economy in Africa, people on very low incomes are doing very, very small scale trading, whether it is selling bars of soap at roadsides or something else. We are not looking at a middle class-led trickle down strategy. One issue for us is how to replicate some of the agricultural productivity gains that we have seen in China, in India and with the Green revolution in Africa where some of the physical constraints are much more binding. How do we go beyond small scale trades which are enough to get by but not enough to fund school fees and the other basics of life which donor resourcing still needs to come through? We have a new agricultural strategy which is trying to get into some of these barriers. Our approach is to try from the bottom more broadly, because the numbers of poor is so fantastically concentrated at the bottom end, but believing that we can raise incomes through private sector enterprenuerism right the way through the sector.

Mr Boulter: You are absolutely right to refer to China because that is an example where it unleashed the potential of farmers once it gave them the right to sell their own produce. I think a better country to look at is Bangladesh, where for many years particularly Bangladeshi organisations have been working in the microfinance sector and they have been asking if that covers enough poor people and they defined it in terms of helping the ultra poor. We should all start from the basis that every poor person wants to be economically active and so in that sense you should never marginalise them and say they can never be economically active, but then you have to grasp what microfinance can do and cannot do and often you end up concentrating on people being economically active part time, so you try and introduce ways to make the markets much more accessible to them. In some ways DFID is very much working at the base of the pyramid to that extent.

Chairman: Africa is rich in resources. How those resources are distributed is an issue that Hugh Bayley wants to raise.

Q72 Hugh Bayley: The principle behind the Extractive Industries Transparency Initiative is a great principle. Would you agree that the value of the initiative is diluted by its voluntary nature, that there are not so many countries signed up as you would like to see? Has DFID looked at the possibility of creating a statutory scheme and if so, how could that work?

Ms White: We do not feel that it is made less effective by being voluntary. Given the phase of where we are in the stage of the initiative, I think being voluntary has been very useful in terms of trying to get the buy-in in what is a very complicated multi-stakeholder setup. Two years ago we were at the stage with the EITI of desperately hoping that one or two key countries might come on board and since then we have had a domino effect. I think Nigeria and Azerbaijan are now at the stage of having quite substantive EITI reports. Those of us who have been fairly close to it have been rather pleased that it has taken off in the way it has. Some have been calling on DFID to investigate on a more mandatory basis and we have looked into this. I think one of the concerns we would have with a listings basis is that you would lose something like 70/73% of revenues which are due to state-owned desk enterprises if you are basically only able to lock in companies who are listed in the New York or London Stock Exchange. My sense is that in two or three years' time, once we have got a broader stock of countries absolutely signed up, that may be the time to revisit this question, but for now, given it is quite a fragile process, I think being voluntary has been very useful.

Q73 Hugh Bayley: DFID has announced that at some time fairly soon it will give up its stewardship of the Secretariat. Do you think there has yet been sufficient buy-in from other donors? Is it taken seriously enough by the Americans, the Japanese, the Dutch and others? Who is likely to take over the helm? Will they be as tough and forward looking as DFID has been?

Ms White: That is a very good question. We have always hoped that we would reach the stage with the initiative where in a sense we could send the whole of the co-ordination into the international system because there are pros and cons for it being closely associated with the UK even though it is an international Secretariat. We are hoping that over the next couple of years we will be in a position where the rest of the international community has embraced the initiative to take this on board and we have been discussing this with the Bank and the IMF and others, but we will not do that until we are happy and confident that the initiative will continue to run effectively. So we are not looking to transfer responsibility because of efficiency savings or other reasons but because we believe there will be a stronger business case for this being parked elsewhere in the international community.

Q74 Chairman: So the near future is elastic?

Ms White: We hope that is sooner rather than later, but we have been having this discussion for 18 months.

Q75 Ann McKechin: In your written submission you suggest that the initiative could be extended to other sectors. Could you confirm whether that is being actively pursued and if so, which sectors do you think could benefit? How do you see the partnership that you have built up between private companies and DFID as a result of the initiative working in the future? Perhaps you could give some indication of what work you have done with private companies about labour rights and also their work in terms of sustaining economic development in the countries in which they are operating. I have noticed in our discussions this morning there has not been terribly much emphasis on the creation of employment as a priority, it seemed to be mentioned as a byproduct. I would be interested to hear about what targets or goals you have in connection with how much is invested and how many jobs you expect to come out at the other end.

Ms White: We are actively considering how we can extend the principles of the EITI to other sectors. The analysis we are doing at the moment is to look at the sectors where we see the strongest governance and corruption issues and they include procurement generally but also construction and arms. We are actively looking at this in connection with the White Paper. One of the areas the Secretary of State has flagged that we will be looking to say something more concrete on in July when the paper is announced is what the future of the EITI looks like and how that gets expanded.

Mr Kingsmill: We entirely share your view that growth is about jobs and that is how our partners see it in developing countries. They do not talk to us about growth strategies, they want to talk about an employment strategy as they want jobs for people. That is why growth matters to them and why it matters that we find new models of growth that are sustainable, because there is a desperate need for jobs. The reality is that, whilst a lot of jobs are being created in many countries, the vast majority of people are still self-employed and they are going to be for some time to come and they run very small different businesses, each household is a business and surviving in the informal sector and that is how it will be for some time. That said, we are very keen on promoting decent jobs and making sure that where investment happens the investors are aware of their obligations. We know through our partnership in the ethical trade initiative that in fact at the UK end there is a great deal of interest in investors in businesses, promoting proper adherence to labour rights and proper employment. We work with the Fairtrade Foundation also. There is a growing interest in the British commercial sector in promoting proper labour practices.

Chairman: The other issue we have seen is that even in the most successful countries in Africa they are still struggling to find enough of a range of dynamics in the economy and in services as well.

Q76 Richard Burden: Obviously FinMark is meant to be a market catalyst to try to develop the financial sector. I would like to get your sense of how you feel that has performed in practice and the scope for replication elsewhere.

Mr Boulter: I think the FinMark Trust has done extremely well. It has been in existence three or four years. We had considerable help in terms of timing in that the South African Government was putting financial access as a high priority to the majority of its population and we also benefited from the FinMark Trust hiring somebody from the banking sector who was very well aware of the potential for the banking sector, for example, to promote basic bank accounts so that many more people could get bank accounts and therefore access through remittances, not just savings and credit and so on. Perhaps the most tangible thing that has come out of FinMark is the emphasis on a methodology for finding how much poor people have access to credit, savings, a bank account and insurance. The methodology they use is now being paid for by the private sector in South Africa and it is to identify what the potential is for expanding the financing market there and their methodology is now spreading through southern Africa and further north. It has been a genuinely impressive programme and the emphasis on innovation has been really important plus the emphasis on getting the investment climate right for the financial sector.

Q77 Richard Burden: When you are talking about the developing methodology and providing the analysis are you talking about FinScope?

Mr Boulter: Yes, that is right. Basically it is a survey methodology. You may have read the stuff yourself.

Q78 Richard Burden: How is that leading on to anything else? I accept getting that information is very useful, but how is FinMark taking that going on or is that FinMark's contribution finished at that stage?

Mr Boulter: It is particularly by going to visit a range of people through the survey. It has provided more information to banks about the demands that poor people have in terms of what sort of bank account or what sort of access to insurance services they need. It is something where initially DFID's money was used in a pump-priming way, so we paid for the first year's survey and then the South African banks identified that the information coming out of the survey was useful for them and then they funded half the survey for the next year and so on. Now it is self-financing in South Africa.

Q79 Richard Burden: Do you see possibilities for this to be transferred elsewhere as a model, and is there anyone else interested in collaborating, the World Bank for example?

Mr Boulter: We have been having very active discussions with the World Bank and building on their greater expertise and household surveys to take the methodology to many more countries. We have had initial missions in Zambia, Kenya and Nigeria to see whether those governments and their central banks in particular want to adopt some version of the methodology. By the way, that will be able to give us some comparison on financial access between different countries.

Q80 Richard Burden: You seem to be suggesting that we are fairly confident that that as a project makes economic sense for DFID. Extending what you were saying before about where it goes here, how can you best make sure that any benefits for the countries, in this case South Africa and the surrounding countries but possibly elsewhere, can actually offer sustainable benefits for the people there rather than good information systems but that is it?

Mr Boulter: To some extent it is the demonstration effect, that people see how the data is used in southern Africa. To some extent now it is the involvement of the World Bank providing additional credibility and this information is important. In a sense how confident are we? We are confident enough that people who have not been directly linked to DFID or FinMark have been approaching FinMark saying "Can you bring this to India?" or "Can you bring this to Bangladesh?". People outside DFID are demonstrating that this information is really important to the financial sector. The much harder answer for you is at what stage in a smaller country like Uganda or somewhere like that will the commercial banks make the methodology sustainable. Obviously the formal banking sector is much smaller in countries like that and so that is a difficult one.

Q81 Chairman: I wonder whether the FinMark Trust has helped to deepen understanding of the case for co-operation in areas where it is operating. One of the things you have come across is that the Customs barriers, the tariffs, the internal tolls and so forth really inhibit trade. I just wonder whether financial services information across the board has helped people to understand that collecting your revenue at the border may be good for your income but in the long term it is bad for your trade and therefore your economic growth potential. Is there a role for something like FinMark in that?

Mr Boulter: I think the best comparison perhaps is the World Bank's investment climate surveys where, for example, in a large country like India what has happened is the states are looking at each other to see how they are performing on investment climate indicators. It is very much our hope that the same thing will happen with the FinMark and World Bank data on financial access and that governments will say why do, say, 25% of people in Botswana have bank accounts when the figure is only 7% for Uganda. Those are not exact figures but I will give you a range. At the moment we are in an early stage there. We do not know that that is the way it will happen. The investment climate surveys are improving the way to show a mirror up to how different states are doing and I hope the same will happen on access to finance.

Q82 Mr Davies: On the investment climate facility, in DFID you have really taken a very favourable view of this initiative. You are the major donor so far that has come forward. I think you offered $30 million the first three years. My instinct is that this is a very sensible initiative to back because I think all of us are very aware that one of the sad ironies of the developed world is that donors and indeed private individuals and charities are providing a lot of money in the hope of contributing to poverty alleviation and therefore wealth creation in the very big countries and a lot of the governments in developing countries are spending an awful lot of their time and energy through perverse and unnecessary bureaucracy, ill considered tax regimes and so forth and preventing wealth creation from taking place. If we can change the investment climate and we can remove some of these obstacles we are obviously doing a very good day's work. We have to probe on this Committee whether this money is being sensibly spent. I wonder if you can fill us in on at what stage you are at. I gather there was a board meeting yesterday and I do not know what happened at that. It does seem to me that the most crucial decision to be taken at this stage is the appointment of the right chief executive because the personality and credibility of the chief executive is going to be a determinant factor in the influence that the ICF can have in those African governments. I see in the business plan that some $6 million is provided a year for the cost of overhead administration, in other words the internal bureaucracy of Johannesburg. That $6 million should be able to buy you some reasonably good people. I would like to know where you are at in setting the thing up and whom you have so far selected for these key roles.

Ms White: The ICF came out of the Commission for Africa last year and we see as one of the key features the ownership that the African governments have on this. We are the principal donor so far. We are hoping for $550 million over seven years and we are making progress with that. We are at about $34 million at this stage.

Q83 Mr Davies: You have committed $30 million for the first three years. The $550 relates to the seven-year business plan. What is the business plan for the first three years so we can look and see what proportion of that DFID is contributing?

Ms White: At the moment we are the major funders. We have got quite good partnerships with key players within the private sector, ie Shell, Anglo American and Unilever have all committed, but we are looking for broader ownership and there is interest. What we are now looking to is the interest that has been given by the World Bank, by Ireland, by Denmark ---

Q84 Mr Davies: I do not think you heard me correctly or you misunderstood my question. What is the budget for the first three years to which our $30 million is a contribution?

Mr Boulter: It is $110 million.

Q85 Mr Davies: Can you tell us where you are at in appointing a chief executive?

Ms White: We have code shares with Encarta and Niall FitzGerald who is the Chairman of Reuters. The good thing is we now have joint chairs who are working effectively, but we are still in process with the rest of the staffing.

Mr Kingsmill: That is my understanding too. The meeting yesterday was an exploratory meeting to try to attract additional support for the funder number. There is a broad welcome for the facility from a very wide number of potential partners. We now need to see how the business rolls out following the meeting yesterday and whether we can turn the expression of very strong support into practical financial commitments. We are hopeful that that will happen.

Q86 Mr Davies: Do you not agree, Mr Kingsmill, that the personality and qualities of the chief executive are going to be very crucial for the success of this venture? Has it occurred to you that the personality and qualities of the chief executive and the fact that he or she is in place might be quite crucial for getting requisite donor commitments? Therefore, rather than pushing to the back end of the queue the issue of the chief executive and talking about something else, as Ms White has just done when I raised the issue, would you like to tell me what progress we are making, if any and, if we are not, what DFID is doing about it in terms of recruiting the right chief executive? If we are coming up with between 25 and 30% of the money required we must have some influence on this.

Ms White: Our focus at the moment has been through very active code shares. Niall FitzGerald in particular, the Chair of Reuters, has been very, very active in fundraising, in networking and in reaching out to the business.

Q87 Mr Davies: I know Niall FitzGerald. He is an impressive man. He has a very fine business record. If you are putting money into an organisation what you really want to know is who is going to be running it and who you are backing, not who the other backers are. Who is going to be spending the money? I hope Niall FitzGerald is going to be playing a major role in finding the chief executive who is going to be based in Johannesburg, although where he is based is a secondary matter. Who he or she is is very important. So far no progress has been made in identifying the individual at all. Have you appointed headhunters? Have you got a shortlist of names? If not, why not? You are spending our taxpayers' money on this so we do want some answers to these questions.

Mr Boulter: It is a sequencing issue. At what point do you appoint the chief executive? Do you do it very early in the process, in which case he or she can help with the fundraising, or do you attract a better person if you have a firmer idea about how big your budget is? It is laid out in the plan. FinMark is an independent institution. Yes, DFID is a major investor and we obviously have involvement in the processes, but we have not had a full read out of the trustees' meeting yesterday. Hopefully they will have addressed this particular issue because they are very focused on when they can launch this.

Q88 Mr Davies: Did DFID see the agenda?

Ms White: Yes, and we have attended.

Q89 Mr Davies: Was the appointment of a chief executive on the agenda?

Ms White: Not specifically. The main issue for the meeting yesterday of the trustees has been very, very focused on fundraising and getting from the position where the UK is the lead donor ---

Mr Davies: Ms White, we have a limited amount of time. Can I put it to you that I think it would be sensible to bring forward the issue of a chief executive? You want to make progress with this. You want to have a business plan with slightly more detail than you have got here. One of the important things is that you want to line up the sort of people who are going to be delivering this kind of agenda. I would suggest, if I may, that the next time you have a meeting you make sure this matter is discussed urgently. If you come back to this Committee in a few weeks' time and you are still proposing to spend $30 million over the first three years and you still have not the faintest idea who is going to be delivering the services you have in mind to finance, then I think you may get some rather more sceptical questioning from us than you have had this morning.

Q90 Chairman: Perhaps you could provide us with an answer as to what the timetable is.

Ms White: We will obviously take on board the very important points about making sure that we have got the head and the staffing of this adequately reflected, but we will also get back to the Committee with a note on just where we are in terms of the process with headhunters and so on.

Mr McGillivray: It is quite a complex area in terms of getting other donors onside. We completely share your view that having the right person leading it is essential for the success. How do you get the right person? Partly it is in terms of ensuring the marketplace of the right sort of people that there is a substantial venture but also in terms of having a remuneration package that is of interest and DFID has been quite progressive over this and generally over our private sector infrastructure facilities. We select chief executives through open and competitive processes. In terms of getting other donors on board, particularly the Nordics, the Nordics are not that keen on paying the right amount to get the right calibre of people.

Q91 Mr Davies: Mr McGillivray, you are just confirming the impression that I already have; you have not grappled with this issue. You had a meeting yesterday and this was not even on the agenda. You did not try at the meeting yesterday to get a consensus on what the remuneration package would be, or what the procedure would be for identifying and appointing someone. You have not got to first base on this. I repeat my point: can you please look at this again and next time we see you we would like to hear that there has been some concrete progress on this matter or, if not, there are better reasons than you have come up with today why progress cannot be made on appointing a chief executive. My own view is that, unless you make progress on this, you will not get this whole thing up and running.

Mr McGillivray: Yes.

Chairman: That point has been clearly made. Thank you for coming. Picking up on John Bercow's point from earlier on, it is clear to the Committee, as you yourself acknowledge, that moving into the area and putting private sector development as a major part of poverty reduction is relatively new within DFID and in that sense you have been upfront about the fact that you are learning. The Committee do believe that we need to see practical results from what is happening and we do want to see your ability to say to us what you are doing and what the practical effects are in all of these areas. We commend you for addressing the issues and for being honest in saying that they are relatively new. We hope that they are not just a fashion and that we will hear more from you. Thank you very much indeed.

 

Witness: Mr Richard Laing, CEO, CDC Group, gave evidence.

Q92 Chairman: Mr Laing, thank you very much for agreeing to give evidence to us. You obviously heard the previous evidence session. The Committee has met with you in the past. It is interesting that in the article that you had in The Guardian on 22 February, which interestingly enough for us related to Mozambique, you make the point that investing in the Maputo Corridor toll road - we were looking at roads and railways there - has reduced costs to the local community, but it does raise the question of how you identify projects that reduce poverty and the extent to which you are doing things that would not otherwise happen because would not other people have invested in the Maputo Corridor if CDC had not done so? I wonder if you could identify the extent to which your strategy is targeted at reducing poverty, whether it is by going for low income countries, or identifying poverty in other countries, and also how you relate to other investors in terms of stimulating the private sector. As you are a public corporation accountable to DFID what we really need to know is what do you do that the private sector or the aid community cannot do?

Mr Laing: Chairman, it may be worth explaining how we do what we do to get to the answer to your question. To remind the Committee, we are fully owned by government. We now have about £1.5 billion worth of assets. Earlier the split of CDC into two entities was mentioned; that is CDC remaining with the assets owned 100% by government and the creation of a fund management company called Actis, which takes our capital and other people's capital and they then manage that money and they do the individual investments. We are now putting our money with them and with other fund managers as well. We now have a total of about 17 fund managers; that is people where we allocate capital to them and they will then go and do the individual investments. The question therefore, to answer your question, is how do we allocate that capital and how do we make sure that that capital is going to places in the world where there is a shortage of capital? The answer is that we will select funds and fund managers to manage our money on our behalf in areas where we feel there is a need. The first target we have been given by our shareholder - we are 100% owned by DFID - is that 70% of our investments have to go in the very poor countries of the world.

Q93 Chairman: That is your own target.

Mr Laing: I would say it is a non-negotiable target in that we will ensure that that does happen. Our definition of poor countries is those with a GNI per head of less than US$1,750. There is a second test which is that 50% of our investments, again over a five year rolling period, must go into sub-Saharan Africa and South Asia. That way we allocate our capital to those parts of the world where it is most needed. Secondly, this new structure we have is that we are now able to choose sectors where we feel there is a particular need for capital. For example, in the last 12 months we have allocated capital to companies who manage our capital on our behalf involved in microfinance; into agribusiness - last month we finalised terms of a US$75 million sub-Saharan Africa agribusiness investments - black empowerment in South Africa - we have closed in the last year two funds involved in black empowerment - and also small and medium enterprises (SMEs) where we have a specific target to get capital to work in SMEs.

Q94 Chairman: You have explained the anti-poverty strategy but, for example, taking the Maputo Corridor, what do you do that other people will not do when you are operating? We have identified that you put into those countries the majority of the money, but what do you do?

Mr Laing: What we do is provide the capital and in a sense that is all we do. We will provide capital to teams of people on the ground. We will identify those areas which I have just outlined where we feel there is a need for capital. It will then be up to the individual manager of that capital to decide which individual projects to go into. Clearly if we said that we want this to be an agribusiness fund, then all those projects, by definition, will be in agribusiness, but we, based in London, do not get involved in the individual projects other than monitoring them.

Q95 John Battle: I have a sense of the structure now post-restructuring, but the CDC has been going a long time as well and it is not too far removed from what the original intention was back in the 1960s and that notion of trying a thin string and then a thicker string of investors will follow in. Could you give me any specific examples of countries? You mentioned the new ideas of black empowerment and agribusiness, but examples where CDC has pioneered the investment, got the structure up and running on your terms, but then other investors have followed after and you have been able to move away. Have you any examples?

Mr Laing: I will use the small and medium enterprise as one of the top examples. The entity that manages our capital is a company called Aureos, which we will have a 50% shareholding in. That has a series of teams of people around the world running SME funds in Africa and in Latin America. We have recently committed US$20 million to a fund in India and South East Asia, the Pacific Islands and so forth. Since 1 January 2003 - for the last three years - they have raised a total of US$145 million in addition to our capital of a similar amount. By starting with them ceding a fund that gives a kick-start, they can then go out to other providers of capital and say CDC is here - and let us use South Asia as an example, the India fund - they have committed US$20 million, this fund will work. We are now able to build the team up, we have recruited the team, why do you not come and join us? The ceding of that fund enables other people to say yes, this is real, and they will commit capital. Alongside our capital others will follow.

Q96 John Battle: Will follow or have followed? Has it happened yet in India?

Mr Laing: Yes. The chief executive of the Norwegian Development Finance Institution came to see me yesterday and confirmed that his institution would be committing initially US$10 million and then a further US$10 million in the future. I know there are discussions going on with local financial institutions, some of which are ready to sign up.

Q97 Joan Ruddock: I am a little confused because what you are saying is that things are going very well and that you are doing lots of things, but we have been given information saying that the number of people employed by firms managed by CDC has fallen from 34,000 in 1999 to around 17,000 today. Is that because money is going to other bodies who are then doing the management and so you have actually taken yourself out of management?

Mr Laing: That is right. CDC today consists of 28 people. CDC three years ago consisted of about 300 people and they would manage the individual projects and there would be direct investments that we would make into those projects run by those 300 people. The new model is exactly as we say; we have now created two fund managers who will manage our capital and we are investing with others and the investments are now run by those fund managers and those investments, that is where the people being employed are. The people are still being employed; it is just not directly by us and not subsidiaries of ours any more because they are investments of those separate pools of capital, the funds that we have invested in.

Q98 Joan Ruddock: Are you confident that with that new arms-length you can still deliver to the poorest people and you can still create the employment, which has to be the major aim of this exercise, does it not?

Mr Laing: I agree, it does, and in a sense I am more confident. The original model back in 1997, when the Prime Minister announced that CDC would become a PPP, was that shares in CDC would be sold and that CDC as a whole would remain and we would sell shares in that. The implication of that was that we were going to have to provide very high returns for those new shareholders. The advantage of the current structure where we are still owned by government is that we are less return-sensitive and we can direct capital to those areas where maybe we will not maximise our return, but we will see the capital go to areas where we think it is necessary. The examples I have given, such as microfinance, agribusiness, SMEs, we are now doing more of that than we would have done under the old privatisation-type structure.

Q99 Joan Ruddock: We have also been told that your involvement in agriculture has fallen from 18% of portfolio five years ago to 10% now. Is there a similar explanation as to why that is the case?

Mr Laing: It is true that our exposure to agriculture fell. One of the reasons was that returns on agribusiness were quite low. I also said that we have just this year committed US$75 million to agribusiness because we recognise that that is a very important area to be in. We are now able to reverse that pure emphasis on returns to emphasis on certainly returns are vital - we must make profits, we must do this sustainably - but also put capital to work in places where there is a lack of capital.

Q100 Joan Ruddock: You say that you must do it sustainably. When we were on our visit to southern Africa, particularly in Malawi and in Mozambique, it was absolutely clear that the majority of farmers could not progress because they could not get capital together, they could not invest in the most basic irrigation schemes which are absolutely fundamental to smallholdings with the rain patterns that they have. What you are saying is that you started investing and then, because the profits were not good enough, you stopped. How is that sustainable when, over a five year period, you have gone from saying this is good business, this is bad business, and now it is good business again?

Mr Laing: The reality is that the returns on micro business are lower than some other sectors. I would repeat that we still see this as a very interesting area and an area which we are and will continue to invest in. Are there problems with agribusiness? You have seen them yourself and, yes, there are. What we have to do is to find the appropriate models which will mean that those farmers have a sustainable business.

Q101 Joan Ruddock: Is it not the case that in these least developed countries where, as we heard earlier today, the majority of the population are privately employed and they are employed on the land?

Mr Laing: Yes.

Q102 Joan Ruddock: Do you not believe that the country as a whole cannot progress if there is not real progress on the land?

Mr Laing: I entirely agree, which is why we are investing in agribusiness.

Q103 Joan Ruddock: The agribusiness that you have just said you are putting large amounts of new money into, are those at the level of smallholdings? We saw people putting their faith in we will bring in a hundred Zimbabwean beef farmers and that will solve our problems when it clearly will not.

Mr Laing: Some of our agribusiness investments are large-scale; for example, tea in Tanzania, teak and forestry in Tanzania, arable farm in Zambia, horticulture in Kenya, so there is a wide spread.

Q104 Joan Ruddock: That is not a wide spread in my view; that is big agribusiness.

Mr Laing: Agribusinesses which employ people, which pay taxes, which have tens of thousands of out-growers of small businesses. Let me give you an example of where I think the sort of investment we do really has an effect on the ground and that is a project called Wakulima, which is a tea area near Mbeya in Tanzania. I went there last year. The original investment was in a tea-processing plant which was publicly-owned and which had declined over the years. It needed to be refurbished and our capital went into that refurbishment and also the purchase of some land of a core tea area round about. It certainly did not stop there because most of the tea comes from out-growers - which again I visited - small farmers with perhaps just one hectare, a very small amount of land. The factory is now producing about five times the amount of tea that it was producing before our investment. Where is it getting the raw leaf from? It is getting it from the small out-growers. What you call these large-scale plants, yes, they are large-scale but they have a direct impact on the local communities and involve large numbers of out-growers and small farmers. That is a demonstration that large-scale agribusiness can benefit local communities and does.

Q105 Joan Ruddock: I can see that that very example you give does. I am not convinced that that is the general pattern. I think there are many other models which are not going to deliver that to the smallest farmers. Leaving that aside, you said in your submission that approximately a third of your portfolio was in energy.

Mr Laing: Yes.

Q106 Joan Ruddock: One of the things I found rather distressing on our visits was no reference to climate change and no thought to adaptation which Africa specifically needs in respect of climate change, not that they are contributing but they are actually suffering. How do you approach that when you look at infrastructure investment, for example?

Mr Laing: Our first objective is to get power up and running and we would do that responsibly but if that means burning hydrocarbons then we will. Another good example would be - it is in Tanzania - the Songas project which is taking gas offshore, piping it for 250 km to Dar es Salaam where it is then used to generate electricity. We do that because Tanzania has a desperate need for power. As you know, you need power to run schools, hospitals, businesses, the whole community, and also interestingly their hydropower on the day we switched on the gas-powered generator the levels in the lakes were at an all time low and the hydro was generating less. I am not saying that we have a specific programme to just do sustainable energy; our primary purpose is to generate energy. Will we make sure we do that responsibly? Yes, we will, and we will use best practice in that plant to generate the electricity as efficiently as possible. We do not just invest in sustainable power.

Q107 Joan Ruddock: Do you look at adaptation?

Mr Laing: Yes. We do not just invest in sustainable power; we do invest and some of our projects are sustainable. For example, in Bolivia, which is one of the poorest countries in the world, we are investing in a project called COBEE which is a run of the river power hydro generating scheme. This morning I was looking at some photographs of expansion going on there to generate more electricity from the hydro.

Q108 Chairman: The reduction in the numbers employed because of the changing structure - I do not want you to manufacture figures - do you track employment generation in investments that you have made? Again, the information as the extent to which you have actually stimulated the creation of jobs would be helpful to your cause and interesting as long as it was legitimate. I wondered whether you followed those things through.

Mr Laing: We can follow those things through and in fact we are doing quite a lot of work at the moment not just about that indicator of what is good developmentally, but other indicators of how we should measure our development impact by what we do. We are starting with this new model that we now have when we are working on that as to how we should measure our development.

Q109 Chairman: Measured by the indicator over time of jobs that you have helped to create.

Mr Laing: Yes, jobs would be one of them. There are complications with jobs.

Q110 Chairman: I know as I have been in the presence of people who claim the same jobs over and again.

Mr Laing: Exactly.

Q111 Chairman: You closed your office in Malawi where there were only about five developers and you mentioned in your Guardian article South Korea introduced agrarian reforms to ensure the population had enough to eat before it then diversified. Leaving aside that South Korea is a bit of a special case, the reality is that Malawi's first priority is to have enough to eat before they can diversify. Why have you not got activities in Malawi?

Mr Laing: Our prime objective is to find business models which are sustainable. We cannot solve all the issues that are around in many countries, some of which you have just heard DFID talk about. We have a genuine dilemma that where there is not a sustainable business model it would not be responsible of us to use our capital to invest in that. What we need to do is seek out those business models. You have put your finger on a very important point that in the very poorest countries there is a real challenge to get businesses up and going. We will look at that, particularly through microfinance initiatives and so forth, but it is difficult in those very poor countries to find good business models which are sustainable.

Q112 Joan Ruddock: Are you honestly telling us that you closed the Malawi office because you could not find any way ---

Mr Laing: No, I did not say that.

Q113 Joan Ruddock: Why did you close the Malawi office?

Mr Laing: We only have one office in London. I presume you are referring to the old CDC office in Malawi which was closed four or five years ago now. It would be wrong of me to say here that we can find good business models in the very poorest countries in the world in a wide range of things to do. That is a challenge.

Q114 Chairman: You will not do it. That is where DFID or somebody else comes in.

Mr Laing: That is where aid comes in to kick-start that and to get some of those going. We are not an aid programme; we are an investment programme.

Q115 Mr Hunt: I would like to follow up on some of Joan Ruddock's concerns. In December 2005 the Palms Shopping Centre in Lagos was opened. That was backed largely by Actis, which is one of your funds, and on the face of it providing a glitzy shopping mall in Lagos is not going to be the best way to help the poor in Nigeria, particularly those working in the fields. I am concerned that the structure you talked about where you have moved to a much tighter decentralised structure where you have slimmed down massively but you are then in partnership with fund managers, correct me if I am wrong, but fund managers are in the private sector so they are in the business of making a profit. We are really talking about countries where it is very difficult to make a profit. It seems to me that the only rationale for what you are doing is you are saying you are going to invest in things that other private sector people would not be interested in because the margins are a lot lower. Is there not a danger if you go into partnership with the private sector that they push you towards investing in the glitzy shopping malls which bring Starbucks to the Nigerian middle classes instead of investing in the incredibly unprofitable microfinance projects in places like Bangladesh where the margins are absolutely tiny and they are very difficult to get off the ground, but those are the real things that are going to help people develop private sector businesses in poor countries?

Mr Laing: With respect, I do not think it is just doing one thing that is going to really defeat poverty through the generation of wealth which is what our thesis is all about. We are investing in Bangladesh in a microfinance bank, for example, and it is a very important investment, but you are right, we have also invested in infrastructure in Nigeria. An economy such as Nigeria needs infrastructure. You need to have good offices; you need to have shopping malls. The middle classes, which are going to be key to the growth of many, many countries, why should they not have a decent shopping mall to invest in? You need infrastructure.

Q116 Mr Hunt: Why do you need the CDC to invest in those shopping malls?

Mr Laing: Because nobody else is doing it.

Q117 Mr Hunt: Are you really saying that there are no private sector investors who are interested in building shopping malls in Nigeria with all that oil money that is feeding the middle classes?

Mr Laing: All I can tell you is the facts and that is this is the first major shopping mall in Nigeria, it has been built with our capital and it has been a great success. What I hope will happen is that others will then follow because what we will have demonstrated is that investing in this sort of infrastructure - it may be an office building, it may be commercial property, other forms of property - we will demonstrate that it can be done, you can make returns and others will follow and when they do follow then we will back off. I am very proud of that investment as an example of what can be done responsibly with our capital.

Q118 Hugh Bayley: May I run with another good investment in financial terms which, on the face of it, I am surprised needed CDC's support. You put some US$15 million into Mozal. It seemed such a sure-fire winner that I am not sure why CDC needed to invest. When we talked to the World Bank about their investment in Mozal they accepted that it produced very little in the way of jobs and a similar level of investment in other fields would produce substantially more jobs. Why did you invest in financial terms and why did you invest in development?

Mr Laing: This was an investment made some years back. I have to say at the time this was something the Mozambique Government wanted to do. It does generate jobs and it generates foreign exchange and wealth for the country. At the time it was not seen as a dead cert. When we now look back at it, clearly it has been a great success and been a good investment, but at the time raising capital for it was not straightforward.

Q119 Ann McKechin: Who was it a good investment for? This project created practically no taxable income for the Mozambique economy which, compared with, for example, the Debswana exploitation of Diamonds in Botswana, it was completely opposite where it was a public/private partnership. Why are you investing in things which, frankly speaking, the global world market is more than capable of investing in and finding profit by and which has very limited value in terms of development on any score? No local jobs, no transfer of skills and no taxable income. Frankly speaking, it seems to me anti-development in thought process.

Mr Laing: If you spoke to the literally hundreds of thousands of people who are employed by projects which are ultimately being funded by CDC they would say this is good. The reality is that many of these projects could be funded by the private sector and by various banks but they are not. Part of our role is to go into these countries, take that risk, take the view that there is a market failure, that people are not doing this sort of thing, go in there, do it and then get others to follow. As I answered the question earlier, there is now evidence that people are following. It would be fantastic if we did not have to be there and lots of other people were doing it, but they are not.

Q120 Chairman: The point was made to us by one businessman in Mozambique that he wanted to pay taxes and that tax exemption meant that the aid community pulled the strings instead of the business community; in other words, the businesses are saying we were paying taxes. If the government were more dependent on business then maybe they would be more prepared to listen to business - this was his sour grapes - but they were much more prepared to listen to the donor community than they are to the business community.

Mr Laing: I have a lot of sympathy with that businessman.

Q121 Chairman: But they might not have a deal if it shows they did pay taxes, the problem being that Mozal had a tax holiday.

Mr Laing: We are talking about one investment. The norm of our business is that once they generate profits they ought to pay tax. Indeed, part of the development thesis here is that by employing people, by generating profits on which taxes are then paid which is then income for government that is creating the wealth that will defeat poverty. The payment of taxes at an investor company level is important.

Q122 Mr Davies: Mr Laing, it is true to say, is it not, and it has emerged quite clearly from this morning's discussion so far that the CDC has had for many years, and probably still has, both in its own mind and in the public mind, a considerable crisis of identity. The public certainly have not really known whether you should be investing on purely market principles, in which case you are open to the accusation that you should not exist in the public sector, you ought to be privatised - that of course was tried and did not work - or, alternatively, that you should be investing on non-market principles in which case you are going to have trouble with the treasury and you are also not going to generate the flow of future funds of future investment that you would like to generate. It is fair to say, is it not, against that background you have now come up with what you consider a satisfactory third way? I am trying to probe whether that is a sustainable and coherent compromise or whether it is a muddled and unsustainable compromise. Can you tell me, first of all, how in this new regime, when you place money with these fund managers, how you define the return that you are going to demand from them? Presumably you say to a fund manager I will give you this money on the basis that your target threshold rate of return is the following, is that right?

Mr Laing: That is right.

Q123 Mr Davies: How do you define that?

Mr Laing: What we will do is assess a whole range of potential fund managers. In some parts of the world we have significant choice and in others there is very little choice. We will look at their proposition, we will do due diligence on that team, we will assess whether the target return that they are suggesting is (a) appropriate and (b) possible and then we will take a view as to whether we should invest.

Q124 Mr Davies: How do you define "appropriate"? If it is not the market rate of return, how are you defining "appropriate"? We understand how market rates of return are defined - they are defined by the market - and the value of investment rises or falls to achieve the market rate of return. That is how markets work. You are trying to second-guess the market. You have decided that you are not being guided by purely market principles. I want to know on what basis you compute an acceptable rate of return.

Mr Laing: The best way to answer that question would be to look at specific cases.

Q125 Mr Davies: In other words, you have no guiding principles on this at all?

Mr Laing: No, what we do is we have a case-by-case, investment-by-investment guidance.

Q126 Mr Davies: But you have no target globally or broken down by potential activity or anything like that?

Mr Laing: We have an overall target set by the Government which is that we should make at least 5% on our capital, but that is an overall target and that is, broadly speaking, in the history of CDC what CDC is looking at.

Q127 Mr Davies: If you were going to make a market rate of return, given the average risk across your asset portfolio, what would you think that would be?

Mr Laing: I know you will not like this answer because one has to disaggregate it. If you were looking at a particular market like China, you would have to look at that market and respond to that.

Q128 Mr Davies: You were saying that the treasury has given you an overall average target of 5%.

Mr Laing: That is a minimum that we must make at the least.

Q129 Mr Davies: That is a threshold of 5%. That is expressed as an overall rate of return on your total investment portfolio. That is much lower than the market rate of return, we all understand that, but what would be a market rate of return, given the profile of your asset book overall; in other words, an average. In some projects you might say, given the risk, that it should be 25%; some might be 30%, some 15%. What is the average which would be the market rate of return which would be demanded for that asset portfolio?

Mr Laing: If you looked at it overall it would be high teens.

Q130 Mr Davies: Between 15 and 20%?

Mr Laing: Yes.

Q131 Mr Davies: You have now given me the answer I wanted. Would you like to go back to what you were trying to tell me?

Mr Laing: Having said that, if we then went into a microfinance fund we would have to take a view as to whether it is actually achievable to get the high teens and because - it comes from the point being made on my right here - we feel that there is a real need for capital in that sector that we will take the view that we will accept less than the high teens because otherwise nothing would be done. In microfinance we are looking for approximately 10%.

Q132 Mr Davies: In other words, you decide yourselves what is the appropriate rate of return which, in many cases, would be below the market rate of return, or perhaps in all the cases below the market rate of return for each sector of activity - microfinance, agricultural projects, manufacturing projects, extracted projects - they will all have different rates of return depending on their sector of activity, possibly depending on their geographical location as well, is that right?

Mr Laing: Because we are pioneering in nature and we are choosing to go in at an early stage - I will continue to use microfinance as an example - we must go in and make a return. We have got to go in and demonstrate that you can make a return on your capital in that particular sector. We will take a view there is no market, we are pioneers and we are correcting the market failure. By definition there is no market there.

Q133 Mr Davies: There is no market rate of return.

Mr Laing: We have to take a view.

Q134 Mr Davies: You start off by taking a view that you want to have the following rate of return with the following activity. You then go to fund managers and say: we will come into microfinance if you can make 15%. Is that the sort of dialogue you have?

Mr Laing: That is the sort of line, yes.

Q135 Mr Davies: You do, contrary to the impression you gave a moment ago, set out guidelines for your fund managers or those who are appointing fund managers or monitoring them.

Mr Laing: Yes. I was pushing back at you on the overall. We do on a disaggregated basis fund by fund we will have a very clear idea what our return expectations will be.

Q136 Mr Davies: The board sets those targets.

Mr Laing: Yes, the board controls the company.

Q137 Mr Davies: Since we now know that the market rate of return on your particular investments would be high teens, would you say, the average?

Mr Laing: Overall.

Q138 Mr Davies: You are going to get 5% plus something, perhaps two or three if you can better the treasury. We can all calculate and it is a matter of simple arithmetic what the net value loss is going to be by the CDCs operations over a number of years.

Mr Laing: No, I do not think you can.

Q139 Mr Davies: You have a market rate of return. If you are making that you are creating value. Anything above that is additional value created; anything below that is less than value created because the risk is higher than the return. You are therefore losing to the taxpayer an amount of money which is between the rate of return you are achieving, which is just over 5% you hope, and the figure between 15 and 20% - let us say 17 or 18% - which you have acknowledged to be the market rate of return on that activity.

Mr Laing: If we are going in to correct market failure.

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.

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%.

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.

Q150 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.

Q151 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 target rates were 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.

Q152 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.

Q153 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.

Q154 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.