The Future of CDC - International Development Committee Contents

Examination of Witnesses (Question Numbers 1-51)

Tom Cairnes, Dr Sarah Bracking and Dr Michiel Timmerman

7 December 2010

Chair: Good morning and welcome. You're all here in your own individual right, but, for the record, will you just introduce yourselves and say who you represent, things like that?

Dr Timmerman: My name is Michiel Timmerman. I'm the Chairman of Equity for Africa, which is a charity that invests on a commercial basis in small businesses, focused in Tanzania. I have some other background that may be relevant to this, which is that for the last 12 years I have been running a fund of funds for RBS Coutts, and, most recently, Aberdeen Asset Management, investing in private equity and hedge funds.

Dr Bracking: My name is Dr Bracking. I'm a Senior Lecturer at the University of Manchester. I research development finance and international development.

Tom Cairnes: My name is Tom Cairnes. I've spent the last six years living in Sierra Leone, where I do a couple of things. I helped to set up an investment business called ManoCap, which is part-funded by CDC. We also run the Business Development Initiative, which is a technical assistance facility that was founded by support from DFID. I also run a charity that provides direct support to the Children's Hospital in Freetown.

Q1   Chair: Thank you. We have two sessions, with three witnesses in this panel and two in the other. I don't want you to feel that you can't say what you want to say, but at the same time, not everybody has to answer every question. If we have short questions and short answers, we'll get through a lot more information.

If I can kick off, you will be aware that the Secretary of State is reviewing the whole of the CDC operation, and certainly wants it to undertake more direct investment. Perhaps we can take CDC as it is at the moment, and say how you would assess its recent performance against the objectives, specifically in contributing to economic growth and pro­poor growth. One of the criticisms is that it has tended to take the easier options. Do you believe that that's a fair comment, or do you think it has been effective in delivering pro­poor growth in poor countries?

Tom Cairnes: Maybe I can start.

Chair: From the sharp end.

Tom Cairnes: We've had support from CDC to invest in Sierra Leone. I don't really have the expertise to talk about CDC outside Sierra Leone. I can only talk specifically about the work that they've done with us. I definitely think that the model of investing in small and medium­sized enterprises, through funds like ManoCap, is pro­poor. There's obviously a range of different ways that an organisation like DFID can engage, and there are lots of different potential ingredients to deliver pro­poor growth. My personal view is that there has definitely been a lack of focus in the development community at large on investment and private sector development. Therefore, investing in a fund like ManoCap, and the work that we do in Sierra Leone, is, in my view, the kind of thing that an organisation like CDC should be doing. In terms of the impact that we've had over the last three years, we've invested about $8 million in four businesses. I think the jury's still out on whether that's been a success or not. We have definitely not declared victory. It's very hard to make investments work in the space in which we've invested. In that short space of time, however, we've created around 800 additional jobs. There has been about $750,000 of increased tax revenue for the local government, and there is a real opportunity for this model to deliver results in very challenging environments.

Q2   Chair: What kind of businesses or projects are they?

Tom Cairnes: We've invested in an industrial fishing business, an ice manufacturing company, and a mobile payments business, a bit like M­PESA, which I'm sure you've heard of. We've also invested in a transportation and distribution business focused on the agricultural sector, linking small­scale farmers in rural areas with the main market hub in Freetown.

Q3   Chair: I'm asking about CDC's performance, but since a shift is going to take place, can you perhaps say where you think it might usefully go in terms of direct investment, unlocking other private investment and pro­poor delivery? The argument is that pro­poor is difficult. Tom Cairnes has just said it's difficult. The other argument is that CDC doesn't always go where nobody else goes. Should the test be that it goes there because private sector funding is otherwise not available, or is there a temptation simply to do what the private sector might do anyway?

Dr Bracking: Obviously there will be examples of where CDC is doing its job well, but if we go back to the total portfolio for a moment, the financial indicators used by CDC on internal rates of return have been as high as 18%. Compared with other European­like organisations, this is quite high. Relatively speaking, if you had a table, the rates of return on financial investments in other European institutions tend to be quite a lot lower, in single figures at least. If you look at the economic criteria for how well CDC is doing, it normally uses employment creation and tax paid at a local level. Those two measures are actually quite thin, and the methodology that's used to calculate them is not particularly sophisticated. EDFI, which compiles those figures, tends not to use pro rata data. It attributes to the DFIs the whole employed workforce, or the whole tax paid. What the DFIs are not generally doing is paying a lot of capital gains tax and income­based tax for the investor, because of their domicile pattern. In terms of other development criteria, such as being pro­poor, obviously SMEs are generally used as an example of that. However, to get to a SME they're using a financial chain, a fund of funds, where a lot of money is being leaked into management fees, licensing fees, offshore, before you get to those communities. I would propose a much more direct model, rather than the intermediated model, if you want to get value for money in the developmental sense for these types of investments.

Dr Timmerman: My experience of dealing directly with CDC is limited. We've had some past conversations with them about possible investments in Equity for Africa funds. My understanding, from reading around CDC, is that there is much more of a focus on larger investments, and there is, as Sarah said, quite a heavy focus on financial returns. If I compare that to other development finance institutions, such as Cordaid, who are an investor with Equity for Africa, they are interested in commercial return. However, they are looking for 10-12% returns in local currency terms, rather than 17 to 18% returns. My view is that it is a myth that there is a scarcity of capital and interest in investing in Africa. I've been to the last two FT private equity conferences on Africa, and they have been completely oversubscribed. In addition, in my fund of funds job, talking to funds in which we invest, a number of them have significant interest and some have significant exposure to Africa, in areas such as infrastructure and resources, including telecommunications. Consequently, I think there is a dearth of capital going into certain sectors of Africa, but it is very much at the smaller end of the spectrum. However, if you hamstring yourself by having high return IRR targets for your investments, you're not going to be able to access those smaller investments.

Q4   Chair: That implies that CDC, in its present form, is not adding a heck of a lot of value in that context. It's adding value in the sense that it is making a return on the investment, but not doing anything significantly different from what the private sector could or is doing?

Dr Bracking: Yes.

Dr Timmerman: I'd say, broadly speaking, that's my understanding. However, there are some exceptions, such as the ManoCap investment, or the investment in Grofin, which is another SME fund. I'd say in general the focus tends to be on the larger, more commercial investments, but CDC may be hamstrung in the sense of having been imposed, or setting itself, high IRR targets.

Chair: This obviously is the moment to review all of that.

Q5   Richard Burden: I have to go to a debate in Westminster Hall for 11, so if you're in the middle of an answer and I walk out, it's nothing you've said. Well, it might be, but I don't think it will be. Do you get the sense that there is a kind of model of DFIs that CDC would do well to emulate? You've talked about rates of return being lower with other DFIs. You have some criticisms of the way that CDC operates, but are there areas of best practice, and methodologies, they positively should be following?

Dr Bracking: I've just been working for Norad on a study of Norfund. The first thing to say is that across Europe these questions tend to be on the table, so this isn't happening in a vacuum. The Swedish and Norwegian Governments already have better restrictions on the use of tax havens or secrecy jurisdictions than we do. This was the specific area of my research. CDC has a widespread use of secrecy jurisdictions that requires regulation. Its development impact criteria, or the way that it monitors developmental impact, are also not very sophisticated compared with some of the others. I would say Norfund are better, DEG are better, FMO are better, maybe not the EIB. CDC has been following a model of synergy with the way the private sector behaves too much, so its developmental impact has been assumed by the commensurability of any type of growth with any type of development. They think, "We could basically invest anywhere and it will induce growth, and then growth means development for us." They haven't looked specifically at different types of economic growth and different types of ways that economies are growing. This, in Africa, is a problem, because if you use funds and financial intermediation, you tend to invest only at the top of chains. You are getting to the elites, not the commercial banking sector, not the domestic manufacturing and industrial sectors, and certainly not the missing middle of investors who are desperate for capital. We're supporting the big end of the economy, not further down where more pro­poor growth could be expected to occur.

Dr Timmerman: In terms of CDC's investment model, certainly there is targeting at the top end. I would question the sense of CDC making direct investments, in the sense that it is an entirely different business model. You need a much larger number of people to monitor your investments. If you look at leading private equity companies, they will raise, say, $2 billion to $3 billion for a fund, they will make 15 to 20 investments with that fund over five years, and they will have several hundred staff to do so. Although you pay away fees on the fund of funds business, at the same time it is a much leaner way of operating, and your spread is much wider than it would be if you were making direct investments. There is a compromise, which is doing co­investments, where effectively the funds you are working with do a lot of the donkey work in terms of research and monitoring of the businesses in which you invest.

Q6   Richard Burden: Are there any examples of good practice on that that you'd like to draw our attention to?

Dr Timmerman: Before answering that, I'd just like to talk about the two development institutions we work with, which are Cordaid and Norfund, who I'd say have a very different business model from CDC. I'd characterise them as a bit more of a venture capital model, in the sense that they look for good quality people. They look for people who have clear commercial objectives and experience, and have a good idea, and hopefully somewhat of a track record of having put the idea into practice. They will then give a smallish amount of money to those firms, and that gets you access to new and innovative ways of accessing particularly the missing middle and the slightly smaller investments. You are not, as Sarah was saying, taking just a conventional commercial private equity model, which I believe CDC is very much following.

Q7   Chris White: What are the benefits and limitations of the fund of funds model?

Dr Timmerman: Clearly, a limitation is that you have to pay people money, fees, to manage a fund for you. That introduces an extra layer of fees. The other disadvantage is that you have a more limited control over the investments that that fund makes than if you are making your own investments yourself. The advantages are, as I was saying earlier, that the impact of your organisation can be far greater if you're investing in funds, because you have effectively a much larger number of people who are working for you. If you weren't investing in funds, you would have to hire quite a few of those people yourself, and consequently you would be paying out the money for salaries for those individuals. Equally, if you're a very large investor such as CDC, you have very substantial negotiating power. Particularly in an area where there may be new or smaller funds seeking to be established, you can negotiate some pretty advantageous terms with the individual funds, both in terms of the fees that they charge, and the amount of influence you have over the investments that the underlying fund makes. I would say overall, if you were looking to invest globally across a wide range of sectors, and build up a diversified portfolio, the fund of funds model is an attractive one. I would just like to say I don't have an axe to grind here: Equity for Africa makes direct investments.

Q8   Chris White: Just to continue on the development benefits, do you think this model is compatible with targeting in terms of sectors or geography?

Dr Timmerman: I think the challenge at the moment for investing in funds or companies specifically targeting social benefits as well as financial returns is that there's a limited supply of funds that specifically target poverty and small businesses. Consequently, you would struggle to put £1.9 billion,[1] i.e. CDC's entire portfolio, to work in that particular sector today. However, there is a conundrum, which is that because there is a limited amount of capital investing in firms such as Growfin and ManoCap, there is limited supply, because people are struggling to raise money to launch the funds. Again, if you were to invest part of your portfolio in funds such as ManoCap or Growfin, you would be promoting the development of the funds industry, which would be of huge benefit. The chances of an organisation like CDC investing $2 million to $3 million in a dairy business in Sierra Leone, or an engineering business in Tanzania, is pretty limited, because you need a lot of people on the ground to do so.[2]

Q9   Chris White: Seeing as you're about to speak, I was going to ask you a question, just to get the feel of the scale and scope of some of the work you're doing. You mentioned, for example, an ice­making business. How many people would be employed in one of the three examples that you've put up?

Tom Cairnes: Our investments have ranged from the smallest at $1 million to the largest at $6 million. Our smallest company, which is the ice manufacturing business, employs about 50 people. We supply ice to around 400 artisanal fishermen, which doubles the amount of time they can go fishing, allows them to store fish for much longer, and provides them with the possibility to access export markets. To be able to get fish from an artisanal fisherman through the value chain to the port or the airport requires them to be able to demonstrate that they've kept that product cool over the lifetime of the cycle. Our largest business, the fishing company, employs 150 people directly and then we have probably 250 casual workers in addition to that. The business we have that employs the most people is our mobile payments business, and we have about 800 salesforce people who go out to sell that product directly to people in the marketplace.

May I just make one more comment on the fund of funds model? I think there's a challenge in that there's no "one size fits all" solution to this. In certain markets it makes a lot of sense to make direct investments, particularly where there is a lot of expertise in place. In markets that are difficult to access, like Sierra Leone, there is a benefit to having funds like us, or people like us, based on the ground in the country, being able to manage the portfolio. When I think about aid in general, DFID doesn't have a direct aid model. It gives money through NGOs, it gives money directly through Governments, and probably at much greater costs than it would do giving through funds of funds. Therefore personally I don't have a problem with not doing direct aid work, or providing money directly to beneficiaries. The challenge is to choose the right vessels through which that money should flow. Per se I don't think there is a problem with the fund of funds model. It can have a huge advantage where you have the right people on the ground to be able to go and see those investments and add value to the businesses that the money is going into on a day­to­day basis. At the same time, at the larger scale, I can see that it would be easier for an organisation like CDC to make direct investments. That was my thought on the fund of funds model itself.

Chris White: That's very helpful.

Q10   Chair: Do you accept that there is some validity in the argument that the fund of funds model has encouraged CDC to go after the easy targets? Whilst you're all saying the difficult targets are going to be much more expensive—I'm looking at Sarah Bracking here—the implication is that some of the other comparable institutions have clearly taken more risks and got a poorer return, but delivered better on development and poverty reduction. Is that fair?

Dr Bracking: Yes. The point about the fund of funds model is that CDC doesn't actually have the power to target anything. It's putting its equity with a fund manager, who then makes those decisions. This problematises risk management and due diligence, because it's a sub­contracting arrangement. The fund manager promises to meet the investment stipulations as DFID has handed them to CDC, and then they hand them on again. The act of faith here is the idea that you put a small amount of equity in a much larger fund, and that buys you influence and impact. There's not actually much empirical data to prove that assertion, because CDC is only in control of 1% of all the foreign direct investment that goes to the least developed countries. There's an argument that, because they are sitting on the Board, they can influence the way the funds behave, but they only ask that the fund produces a best practice document for, say, environmental impact or social impact. They can't mandate them to do anything, not even keep international standards on such things.

Q11   Chair: I just want to clarify this point. The slight implication of what you're saying is that if you targeted more specific funds, or put more specific objectives on those funds, even the fund of funds model could deliver a much better result on development and poverty reduction.

Dr Bracking: I'm not opposed to private equity per se. It's just that at the moment, about 86% of the private equity funds in which CDC invests are also domiciled in secrecy jurisdictions. There's no country­by­country accounting. There's no way of verifying that the geographic targets are being met, and there's no way of checking who the underlying investee companies are.

Chair: We'll come back to that specific point in a minute.

Q12   Jeremy Lefroy: Following up on that, it seems to me, from what you're all saying, that the fund of funds model isn't necessarily in itself a problem. The rate of return is a problem because, by its very nature, it restricts the areas in which investment can be made. There is no real objection, for instance, to CDC promoting the setting up of funds that target more developmental outcomes at a lower rate of return, where they wouldn't necessarily have to have large numbers of people on the ground. They could perhaps help set up—as indeed Actis was originally part of CDC—such a fund manager in which they could invest. Would that be a possibility?

Tom Cairnes: In terms of the way that our business developed, we started as a technical assistance facility, directly funded by DFID, providing business planning and business advice and support to small businesses in Sierra Leone. From that we realised that there was a lack of capital to invest in medium­sized businesses that wasn't at interest rates of 25 to 30%, which the entrepreneurs that we were working with really weren't interested in taking. If you sit down and work with business people in Sierra Leone, anyone who's had their business destroyed in the war, had it rebuilt, had it destroyed again, had it rebuilt and makes reasonable profits is a good person to back. There are not a lot of people looking to find those opportunities. Translating between good entrepreneurs, who are very rough around the edges, and private commercial capital that needs transparency and the ability to be able to monitor those investments, there is a gap there for funds of funds in our space. There are some lessons to be learned from our experience. CDC, along with DFID, have the opportunity to push the forefront of investing in places like Sierra Leone. However, I would say it's incredibly risky. I don't think investing in Sierra Leone is purely commercial. Considering the risk­adjusted returns on our fund, I would not tell my grandmother to put her pension in our fund. That is a bad investment decision. I do think, in the long term, there are real benefits to be had from providing capital to entrepreneurs and businesses who deserve that opportunity. At the same time, that doesn't mean you should reduce the investment rigour. Sometimes, mixed in with this, "We need to reduce IRR targets", is the idea that you need to reduce the quality of the investment decision­making, and the principles of investment decision­making that you apply. It's inevitable that the golden rule of investing, which is to go where the IRR is highest, needs to be relaxed in this space, but all other investment rules should hold. You should invest in good businesses, in good people, where there is transparency, where taxes are paid properly. If you relax every other investment principle along with the IRR, you have a problem. That is one of the risks. There is too much of a broad conversation about IRRs. There's no trade­off between investment principles and development returns, if what you're saying is you have to apply high­quality investment decision­making. You shouldn't feel sorry for people in poor countries, you should treat them as hard as you would do in this country; however, in doing that, you respect them and provide them with an opportunity to deliver jobs.

Chair: Thank you. That's very helpful.

Q13   Mr McCann: I have a question on financial instruments, and perhaps I can direct it in the first instance to Dr Timmerman. The Secretary of State suggested that in the future, CDC should use a wider range of financial instruments to support a more diversified portfolio. In your experience, what financial instruments are most needed by recipients in poor countries?

Dr Timmerman: The equity model is very difficult to implement in smaller companies in developing countries, because the legal structure doesn't really exist. The concept of equity doesn't exist particularly well either. Consequently, you need to look at other ways of sharing risk as well as having a stake in the business. Models such as providing debt but with revenue sharing arrangements, where you may participate in a percentage of the revenues from the business, would be an equity­like option, but you are sharing some of the risk of the business. I'd say, broadly speaking, that there shouldn't be a constraint on the instruments that CDC or other investors are willing to consider, in that it's really all about understanding what risk and return objective you have, and therefore which instruments allow you to access that risk and return. Consequently, if you don't want to take a large amount of risk, and you want fairly steady returns, you should be looking at debt­like investments. If you want to participate in more of the upside, you should be looking at equity­like investments. There is not a lot of sense in being dogmatic: "We only invest in equity," or "We only invest in debt," or "We only invest in something in between." What you should be looking at is what the financial outcome is that you are looking for. What's the risk return profile? How much risk are you prepared to take, compared with how much risk the business is taking? What type of investment does the business need in order also to have the non­financial outcomes, i.e. the employment creation or whatever it is you're trying to achieve by investing in the business?

Q14   Mr McCann: I think you've just answered this question, but I'll put it to you anyway. Would increasing the number of different instruments have an impact on overall cost?

Dr Timmerman: Cost to CDC?

Q15   Mr McCann: Yes. Investment costs.

Dr Timmerman: I wouldn't expect so. It may require some additional financial expertise to be hired by CDC. However, most of the investments you'll be making in developing countries are going to be pretty basic compared with today's financial engineering standards in developed markets. None of these instruments are going to be very complicated. There may be some extra legal costs to get the right documentation in place.

Q16   Mr McCann: Mr Cairnes mentioned, in answer to an earlier question, technical assistance. Do you think that technical assistance should be an integral part of DFIs?

Tom Cairnes: It's incredibly helpful to be able to provide businesses with technical assistance pre­investment. It definitely gets into a grey area of subsidising returns. One of the debates that people have had with us about the use of what's called the Business Development Initiative is that essentially what we are doing is preparing businesses to get investment. In some cases we manage the investment as well. In all of this debate, there is this grey zone between private returns and development returns. It requires judgment calls as you go on. I don't think there is necessarily a right answer. Technical assistance is incredibly helpful. When we look at businesses, there are lots of reasons why they aren't ready for investment. Why is bank capital so expensive? In part because it's almost impossible to get good information out of businesses in somewhere like Sierra Leone, mostly because they are, quite rightly, trying to hide how much tax they should be paying. The tax discussion is basically a negotiation with the tax collector, who walks in and says, "Well, if you give me this much, you'll pay that much tax." That's the system within which they work. When we invest, we say that there will have to be proper accounting systems, which means that the amount of tax paid will go up by 20 to 30%. So there needs to be a real benefit to the companies themselves. The technical assistance helps them see the benefit of good accounting practice in advance of capital being put in place. For an investor, it allows you to look the guy in the eye, before you do any work with him. On structures, I like equity, not necessarily because of the increased returns, but because it allows you to sit down with someone and say, "I am your partner. We are going to live this. I make money when you make money. We will be here through the trenches of the disasters that will inevitably happen in the next six years." Doing technical assistance in advance helps you build that relationship. If you spend six months working with someone, you sit down and talk to them about how they're going to handle their employment decisions or manage customers, how difficult it is working with junior minister x in the Ministry of Fisheries, you build a relationship that is essential to make investments work. If you don't have that trust, if you have to go to court, it's over. You've lost. All the money is gone. You're proving a point because you need to demonstrate that you can go to court, but that's not where you want to get to. Technical assistance is helpful because it allows you to get transparency into the business and help businesses understand what it means to get outside investment. It's a nice pilot and it builds a strong relationship. Then I like equity combined with other types of product that help to mitigate risk, because of that primary gut response you have with the guy that you're working with: "I am your partner through all of the crap that's going to happen in the next four or five years, until we get money out of this." When you talk to people, they know that it's going to be hard to make money. I think that's the reality of the work that we do.

Q17   Jeremy Lefroy: I'd just like to declare my interest, in that I'm a director, with Michiel, of Equity for Africa. I'd just like to concentrate a bit more on the question of direct investment. We've spoken a little bit about whether it would be worth CDC making direct investments in the same way as, for instance, IFC do, or other funds do. I would like to hear your views on that.

Tom Cairnes: Again, there's nothing wrong with CDC doing direct investments. The most important thing is not to have cookie­cutter solutions for making investments in different spaces. The solution to doing agricultural investment in Kenya might be to do a direct investment. The solution to doing it in Liberia might be to do it through a fund. I don't think you can make generalisations about the best impact that could be had apart from making a judgment of the people who will be involved in that investment. I think CDC should consider doing direct investments, where it can demonstrate that it has the capacity to do so. Working with funds allows it to potentially co­invest as well. One of the ways that CDC could get greater advantage out of its portfolio of investments in funds would be to co­invest alongside those funds and take greater control in those investments. In principle, I don't think there's anything wrong with direct investments.

Dr Bracking: There has been a pattern in the past of using private equity to try to avoid institutional problems in under­developed markets. If you move the unit of analysis from just the firm and the success of the firm in which you're invested to the whole soft infrastructure of the country, then the benefit of direct investments can be more fully seen. Institutions don't improve unless you use them. When a DFI makes a direct investment, you have a sense of their frustration about the transactional costs, and the bureaucracy, and the arbitrary nature of such laws. However, that's part of their developmental remit, in my opinion, and they should be doing that, however frustrating, because the multipliers for other businesses are very large. You're changing the whole market environment for a much wider group of people than just the firm that you're investing in.

Q18   Jeremy Lefroy: Thank you. That's a very important point. If I might just put that back to Mr Cairnes. Given that you've just mentioned, which I fully understand, the problem with dealing with local tax authorities, do you think the fact that CDC is one step removed from that means that they can say, "That's your responsibility. We're not going to get involved with the problems of local tax authorities?" I have to say I have had similar experiences.

Tom Cairnes: Again, I can only speak of our experiences. I don't think CDC wipes its hands of that responsibility by investing through us. We have a lot of conversation with DFID, with the British High Commission, and with CDC about the challenges of dealing with corruption, and ensuring that our businesses pay tax. We had a problem with one of our companies, where when we went in we discovered there was tax avoidance, and we had to have a conversation with the Anti­Corruption Commission, with DFID, and with CDC about how to deal with that. From that, DFID itself started having a conversation with the Government about the way the NRA, which is the tax collection unit, works. That does enable CDC, perhaps indirectly through us, but also working with DFID and the British High Commission, to have conversations with Government. It's incumbent on people who accept funds from the British Government, through institutions like CDC, to engage with the other British Government arms on the ground in a country like Sierra Leone. I don't think that that is very hard to do.

Q19   Jeremy Lefroy: Was CDC supportive when you raised the question of the tax problems?

Tom Cairnes: It was. One of the helpful things they did was to put us in contact with one of their other funds, to have a conversation about how they dealt with it. That was the most helpful network effect that we got from the fund of funds space. DFID has people on the ground in Sierra Leone whom we have spent a lot of time talking to. Just as some of the NGOs, and some of the other partners that DFID has, provide information to the British Government's effort in Sierra Leone, we feel very much part of that. I think that's important. Yes, CDC could be wiping its hands of the tax problem, but that doesn't necessarily need to be the case. At least the people we deal with are quite sophisticated on the matter.

Q20   Anas Sarwar: I've got a few questions, again, to you, Tom, with regard to the relationship of ManoCap with CDC. It would be helpful to explore just what the relationship is like, so we can get a better understanding of how CDC operates. How much oversight and influence does CDC insist upon from you when it comes to, for example, investment decisions and operations?

Tom Cairnes: I would split our relationship with CDC into two parts: the pre­investment part, before they made a commitment to us, and the post­investment part, once they'd made that commitment. Pre­investment, they spent a huge amount of time helping us improve our own internal processes, particularly around ESG and governance and reporting. It took us, I would say, just over 18 months from the beginning of our conversation with CDC to closing the investment decision. During that period, they visited us four times in­country. We made probably the same amount of trips here to talk to them. We found that incredibly helpful in improving our own standards, and our own private investors felt that as well. Pre­investment, CDC were incredibly helpful, and we had significant amounts of engagement. Post­investment, the relationship with CDC changes. The way the investment model works is that we, as limited partners, provide you with the authority to make investment decisions. Those investment decisions need to meet our ESG standards, and you need to report to us on a quarterly basis. Since the investment that they've made in us has been provided, we probably talk to them monthly. There's someone within the Africa team who sits above us and monitors our investment—their investment in us. We talk on a monthly basis. They don't engage directly in investment decisions. The investment decisions are made by ManoCap's investment committee, which is made up of three of our investors and the two partners in ManoCap. They do sit on our advisory board, who meet on a six­monthly basis and make broad decisions about where the fund should be investing and the performance of the businesses. That's how we relate to them now.

Q21   Anas Sarwar: How rigorously do they monitor their own investment code with, for example, ManoCap and other companies? Is there a rigorous monitoring process that CDC does to ensure that ManoCap, or any other business, is going along with CDC's investment code?

Tom Cairnes: We provide them with quarterly reports on the performance of the businesses. Normally, after sending a quarterly report, we have a phone conversation to discuss current results. That's the level of engagement we have with them now.

Q22   Anas Sarwar: Thirdly, how much investment does CDC have with ManoCap? Do CDC reward fund managers for being more development­friendly?

Tom Cairnes: They have $5 million invested with us, and they reward us on financial return. Our compensation is a percentage of the returns of the fund, and a management fee on the total capital that we have managed. There are no direct development aspects to my compensation.

Q23   Anas Sarwar: In terms of private sector investment in ManoCap, have you mobilised further third­party capital on the back of CDC's involvement? Has the CDC involvement helped you attract other third­party investment into the company?

Tom Cairnes: Absolutely. The evolution of our fund is that we started only with private sector investors, which was a small group of high net worth individuals, who seeded us. We then had a second round of investment where CDC came in, and I think that the stamp of approval that CDC provided allowed us to scale up the amount of capital that we had. We went from $6 million to $22.5 million. We definitely started off with a small group of private investors, and CDC came in, which allowed us to scale up. We brought in another semi­development institution, as well, the Soros Economic Development Fund, who are also one of our investors.

Q24   Pauline Latham: Can you tell us what sectors are most in need of CDC support, in order for CDC to have significant development impact? Where do you see the gap in funding? Where is it most severe?

Dr Timmerman: The biggest gap in funding is the gap in which we operate, which is called the "missing middle", between $5,000 to $100,000 investments. Equity for Africa operates right at the bottom of that. Specifically, in Tanzania, the small businesses in which we invest have no other source of capital. We screen for businesses that are unable to get bank financing. Certainly, in our area, there's a real dearth of capital. Such capital is important for two reasons. One is that small businesses that are above microfinance level are important to create a vibrant economy, and it is a benefit to the entrepreneurs, but even more importantly it creates employment among the population. In a country like Tanzania, but also other sub­Saharan countries, employment is predominantly agricultural­based, and agricultural incomes are pretty much below the poverty line. Providing people with salaried and paid employment so that they can access bank accounts, pay for school fees and health care, has a huge collateral benefit to those individuals. It also has a secondary benefit to their children and their families. I'd say at that missing middle, there is—

Pauline Latham: A real gap. Yes.

Dr Timmerman: —a real dearth of capital. The impact of every dollar you put into that missing middle is substantially greater, in terms of poverty alleviation, than if you're investing a dollar in, say, a telco in a country like Tanzania. On average we create about one job for every $1,500 we invest.

Q25   Pauline Latham: And they're permanent jobs?

Dr Timmerman: Yes. Provided we're making good investment decisions, they're permanent jobs, because the businesses will continue once they've paid us back our capital, yes.

Q26   Pauline Latham: Andrew Mitchell says that he envisages climate change initiatives should be featuring in CDC's portfolio. Do you see that there's a future role for CDC in the development of green energy and technology—particularly affordable green energy and technology—for developing countries?

Dr Bracking: Yes. If you look at the underlying investments from the fund investments in the total portfolio, CDC have got a lot of investments in power and ICT, but they tend to be traditional power infrastructure rather than renewables. Norfund have made a big effort with renewables. CDC also invest very little in water and sanitation infrastructure. To go back to your original question about developmental impact, if it's not measured by the units of employment or tax paid, which are quite thin, but developed more widely on the multiplier effects on the economy as a whole, CDC could afford to move more into those basic infrastructures. Clean water is one of the most important poverty­reducing effects for the poorest in the population at large. Otherwise, I endorse what's just been said about the missing middle.

Q27   Pauline Latham: Do you see any evidence to prove that if CDC invested heavily in agriculture, infrastructure and/or green energy this would stimulate further private sector involvement in the whole scene?

Dr Bracking: Yes. The legacy portfolio that was sold when CDC was reorganised had a quite low value that year, but it bounced quite quickly afterwards. Agricultural pricing, in Africa in particular, tends to have quite a high variance. Overall, what CDC did best, in its older incarnation in the 1970s and 1980s, even though half of those investments didn't end up being that profitable, was a very good job in agriculture. It invested in crops with a very long temporality, like woodland and forests and plantation crops and outgrower schemes. There hasn't been much concentration on that in the last decade across the EDFI portfolio, and it would be of great benefit and developmental impact if they could return to that as part of their core mandate.

Q28   Pauline Latham: Particularly if they were looking at something like crops that can survive in drought conditions. Obviously the climate is changing, and it's important that the investment is in something that's going to work in the long term, not what used to work, because it's changing.

Dr Bracking: Food crops?

Pauline Latham: Yes, in terms of food crops. Obviously the other things are still very useful.

Q29   Chair: The point you made about sanitation and water is of some interest, because when we did a report on that, we had a slightly diversionary discussion about the role of privatisation of water. What we did find was that an awful lot of the projects we did look at were commercially financed. Certainly on maintenance and operating costs, people were prepared to pay for water, and paying for running water is cheaper than paying for water being delivered in cartons or tankers and so on. Are you suggesting the reason CDC doesn't do it is to do with rates of return, or the complexity of making those types of investments?

Dr Bracking: At the moment the public sector in Africa pays about half of the cost of infrastructure investments in water and sanitation, and private capital has the minor part, mostly through these PPIs or risk­sharing arrangements. About half of those have had some procedural problem, and ended in court. That was the first generation, however, and there's been a lot of learning by doing those types of projects. The overall point is that CDC hasn't tended to engage much with the public sector at all. It prefers a fund model, which is a bit more ephemeral. If CDC were to re­engage more with the wholesale and retail banking sector within the country, the national structures and the Government, through parastatals or through budget support, and link back together with the public and private sectors institutionally, that would really assist the development of water and sanitation infrastructure.

Q30   Chair: But that would require a bit more management supervision?

Dr Bracking: Yes. The idea that CDC would have to have more core staff in London would be accepted, because they would have to have more oversight. I don't see a problem with expanding the CDC's staff.

Chair: We need to know whether the Government have any political problem with that, given the admin charges.

Tom Cairnes: I would echo the comments that Michiel made, but would add one extra thing. I think, concerning the sectors where you might want CDC to invest, there is a very compelling argument to be made about scale, but in sectors and types of economies where capital isn't around. In Sierra Leone, for example, there's a gap at $10,000, a gap at $100,000, and a gap at $1 million. If you are looking at, let's say, large­scale agricultural investments, which might be $20 million, there is definitely a gap there. Scale to the missing middle shouldn't necessarily be an over­focus. There is an opportunity to make investment in post­conflict countries, where people don't necessarily allocate capital, and CDC has real expertise in looking at scale investments as well as those types of missing middle investments. I wouldn't do it in Nigeria. I wouldn't make large investments in South Africa, or perhaps in Kenya, the more developed economies. However, I can definitely see a case for larger­scale investments in economies like Sierra Leone and Liberia, potentially even in places like Afghanistan, where there are strong political as well as developmental links. I think there's a post­conflict sectoral focus that would be important. I would urge that there is a breadth of approach, so not just small­scale investments, but a sensible approach to deciding which large­scale investments to make.

Pauline Latham: It sounds as if they've lost their way a bit.

Tom Cairnes: I can only speak of what CDC do for us, and I think the kind of investment they've made in us is the kind of investment that an organisation like CDC should be doing. We've had a very positive experience of them.

Dr Timmerman: Can I make one comment on agriculture? As I'm sure you are aware, there's a huge amount of commercial interest in investing in large­scale agriculture, which started off in Latin America and is now making its way to Africa. There are issues around large­scale commercial investment in agriculture, particularly in Africa, where there's very little attention paid to the historical ownership of the land and the development opportunities through agriculture. There is certainly an opportunity for CDC to go back to some of those roots in agriculture, and invest in responsible agricultural practices in Africa, rather than leaving the field open to large­scale hedge fund investments in agriculture that will simply seek to replicate the Latin American model of almost zero employment and large­scale investment in machinery.

Chair: That's a very important point for us to take up. Thank you.

Pauline Latham: It is.

Q31   Anas Sarwar: I'd like to get your thoughts on which parts of the world you think CDC should be focusing its work on. Do you think the geographic focus of the CDC should change going forward from what it is now? What do you think the priorities should be? Or do you think that being prescriptive on what sectors we invest in, or the geography of where the CDC invests, could have a harmful effect? Do you think it could have a positive effect in focusing the mind on where the investments should be going? I'd just like to get your thoughts on the geography of it.

Dr Timmerman: I'd say that geography is a very crude measure. The focus, under the current guidelines, sounds about right. However, there are substantial opportunities for poverty alleviation in middle­income countries, and there are equally substantial commercial opportunities in low­income countries. The investment policy should be driven by outcomes, both financial and developmental, rather than being very focused on exactly which country one should be investing in. Every country presents a range of opportunities.

Q32   Anas Sarwar: Would you both agree with that?

Tom Cairnes: I would add one thing, which is that it makes sense for CDC to look to invest where the British Government itself has the greatest political influence. Investment in development does not happen in a political vacuum. One of the criticisms I would make of development in general is that there is an assumption that it does so. A lot of problems that are faced by various actors within the development field come from the fact that the political interaction between the local government and local business community is not considered. Our experience with the British High Commission and DFID in Sierra Leone has been incredibly beneficial. CDC could look to have a greater impact by trying to focus on areas where the UK has influence and interest. However, the geographic measure is very crude. There should be a focus on development impact and returns.


Q33   Chair: Just on the point you made before, I don't think we have time now, but do you think you might be able to give us a note?[3] You talked about responsible agricultural investment, avoiding the mistakes of Latin America. If you had a slightly more detailed thought of how that might be, and the others could certainly contribute to that, it might be helpful, because I think we need to explore that in a bit more detail.

Q34   Anas Sarwar: A follow­on question: are there any circumstances where you think CDC should invest in high­income countries?

Dr Bracking: I think the geographical focus is about right. But, at the moment, you can't prove the money is going to those geographies. We've been using it as a proxy that the investments are going to the poorest people, but that isn't well proved. You can say most of it goes to Africa; they need to prove that most of it stays in Africa, or goes there in the first place, and then that it is reaching the poorest people.

Q35   Anas Sarwar: What about the point on the high­income countries? Any thoughts on that?

Tom Cairnes: Where would you put a country like India? There are obviously opportunities for investment in agriculture and infrastructure and water in a country like India in which the private sector is not investing. The country measure, because of its crudeness as an average across a billion people, makes that very difficult. I would say in somewhere like India, there probably are opportunities for CDC to invest. I wouldn't go to the United States though.

Q36   Mr McCann: A short question for each of you: is it acceptable for CDC to invest in fund managers who are domiciled in offshore financial centres?

Dr Bracking: No.

Q37   Mr McCann: Is that a collective no?

Tom Cairnes: We're domiciled in Mauritius, which makes us tax transparent in the UK. All our investment companies pay tax within Sierra Leone, so we pay a 30% corporate tax. Any capital that gets remitted outside from those investments to Mauritius attracts a 10% withholding tax. Depending on how that gets treated out, that depends how our investors themselves pay tax, which is standard practice in the investment community. There is a broader debate about tax havens and how they should be used in investment, and that's something that I'm probably not the right person to speak about. I don't think that it impacts the amount of tax we pay in Sierra Leone. We engage very heavily with the tax community. For example, if we domiciled ourselves in the UK or in Ireland, we would be paying the same amount of tax in Sierra Leone.

Dr Timmerman: It depends: there are two answers. One answer is, is the implication of your question that people who are resident in offshore centres are dishonest or bad people?

Mr McCann: No: it's more to do with the fact that they wouldn't be paying their proper dues.

Dr Timmerman: I'd say that CDC need to always engage with people of integrity, who pay the right amount of tax. As you were saying, if you pay the right amount of tax, I don't see why you should not invest with people in an offshore jurisdiction. Presumably in the case of ManoCap, none of you work in the UK and consequently it doesn't matter where your jurisdiction is.

Dr Bracking: Could I just point out that investee companies who pay tax because they're domiciled in Sierra Leone is a different point from a fund paying tax. What's happening here is that capital gains tax is being avoided. I find it a slight conflation of logic that a fund can say, or the DFIs generally say, "We pay tax," and then quote figures on it. That's the tax paid by a domestic company in which they are an investor—they have a part investment. That's not tax they're paying, because they're a fund. They should be paying capital gains tax, but because of the double taxation agreement they're avoiding it, which is part of the attraction to the international investor. The international investor, in this model, is then privileged over the domestic investor, who's still paying tax. I don't think that's a due process in paying tax, myself, because some stakeholders are benefiting and others not.

Mr McCann: Right. That's helpful. Thank you very much.

Q38   Pauline Latham: CDC claim to pay what is needed to get the best people. Do you believe this level of remuneration that they offer is the right level that they should be recruiting at?

Tom Cairnes: I don't know how much they get paid. I don't know their people.

Q39   Chair: The Chief Executive has earned nearly £1 million, and is currently earning about half that.

Dr Timmerman: Our experience, at Equity for Africa, is that we are getting a steady supply of investment bankers and professionals at leading management consultancies, who want to come and work for us at 30% of what they used to be paid. I'd say there is a significant minority of people out there who are considering their career options, who have a very high degree of skill, and who want to become, or want to be engaged in, social entrepreneurship.

Chair: Put something back.

Dr Timmerman: Put something back, exactly. They may have been working for three, four, or five years for these companies. Consequently we're not finding a problem recruiting highly skilled people who, in the commercial market, you'd have to pay £200,000 to over £300,000 for, if you include their bonuses. It may be difficult to find 100 people like that, but certainly finding tens of people like that I wouldn't expect there to be a problem.

Tom Cairnes: Again, I would echo that sentiment. In our own experience, our most recent hire was a Ghanaian from Barclays Capital, just out of Harvard Business School, who probably took a 70% cut on his last salary job. I don't know how long we will be able to retain someone of that calibre, and I don't know how many people there are who are willing to make that commitment. Because of our own size, we can't match London or New York in terms of paying people, but there are people out there who will do that. I personally don't have a problem with paying people for doing good in this space. I think you can get people, but I don't have a principled problem with paying people well.

Q40   Pauline Latham: One option for reform is for CDC to continue its operations but reinvest the profits in a more development­friendly fund, which would undertake riskier investments, accept lower rates of return, and fund sectors most in need of support. What are your opinions on this suggested model? Do you think they could do that, and that countries would be better for it?

Dr Bracking: I think that that has to happen, but there also has to be a change in the way that CDC is managed. You have people who own part of it who are also making managerial decisions, who are also calculating risk.

Q41   Pauline Latham: Sorry, did you say "who own part of it"?

Dr Bracking: If you see the companies that were spun out, the Actis fund is part­owned by its managers.

Pauline Latham: Right. Yes.

Chair: At 60%.

Dr Bracking: Yes. I work in the public sector, so my benchmark coordinates are much different, but it seems to me that there's a problem of conflict of interest there. There should at least be a better form of regulation. As in the financial crisis, if the people who are calculating risk are in the pay of the people selling the product, that seems to me to be a dysfunctional relationship.

Tom Cairnes: Specifically on the question of should CDC take more risk, and should there be a greater percentage of their portfolio allocated to riskier investments, I think the inevitable result of that is that CDC will lose money. I'm not necessarily sure that that's a policy decision that should be made as to whether CDC should be trying to maintain its capital or grow its capital over time. I think that there are ways to make riskier investments in countries like Sierra Leone, where you are taking IRR sacrifice, but not necessarily losing investment principles. There is a delicate balance to be made by the managers of CDC in whatever form it takes after this kind of review. What I'm trying to say is there's no direct relationship between risk and development returns, and the idea that if you're taking more risks you're doing better for poor people is not true. If you lose money, that's bad for everybody. You give people a job and then they're fine, but two years later they'll be bad, because what will have happened when they get a job is that their dependants will have doubled. The children will be going to school but will stop instantaneously. If these businesses shut down, you're doing more harm than you would have done. I think that's a really important principle to apply.

Dr Timmerman: As we were saying earlier, I think there is a big case to be made for sacrificing some return, but as Tom was saying absolutely no case to be made for sacrificing quality of investment. I'd say, going with the sacrificing of returns, there is a case to be made for taking on a bit more risk. However, the investments need to be made with the view of making money—maybe not 18% but a bit less than that. That needs to go hand­in­hand with very clear development objectives and very clear monitoring of the development outcomes of the investments that have been made, to a greater degree than is probably the case currently. It needs to be part of the contract with the fund manager that they will report on livelihood improvements, employment creation, whatever your measures are going to be.

Q42   Pauline Latham: So it's not taking the risks, it's looking at lower rates of return that's more important?

Dr Timmerman: Yes. But having said that, investments such as Equity for Africa or ManoCap or Growfin, as Tom said earlier, are probably riskier than investing in a telecoms company in Zambia, for example.

Q43   Pauline Latham: And do you think that has any implications for the type of staff at CDC, or the numbers that they'd need to employ?

Dr Timmerman: I think they would probably need to add people with non­financial measurement expertise in order to monitor that in a more rigorous way than they do today. But other than that, they would probably need to add to their sector specialism in those particular slightly lower return, higher risk areas of investment, although from what Tom was saying there's already good expertise at CDC in that area.

Tom Cairnes: What exists right now is a group of people who know how to run a fund of funds. If the decision is to change that mandate you would inevitably have to change the team. Once you make the policy decision to change CDC's mandate the pace of that change should be dictated by the pace with which you can bring in good people. It is better to wait to find somebody good, which may take a year or a year and a half, than just to hire the worst common denominator to be able to execute, because development isn't a two­year project. My personal commitment is that I've been in Sierra Leone for six years; I'll probably be there for another 10. At that point I may have made some small difference, and I think that the speed with which these changes need to be delivered should be considered within that timeframe. This is a generational change that is required to happen in very poor countries in the world, and so the requirements here should be driven by talent once that policy decision is made. That will be a very delicate balance for CDC to get right, because you will lose a lot of money if you hire rubbish people.

Dr Bracking: Can I make the point that in the research we've just been doing, we actually saw the company accounts from funds in the Norfund and Swedfund portfolios, and I was actually quite shocked at some of the management fees and the technical fees that were being paid, as a proportion of the overall fund to be invested. There needs to be a systematic review of the subsumed costs in the fund of funds model that should be reported to the Public Accounts Committee, because if we ask "do you think these people are too well paid or not too well paid", I have no benchmarks personally to answer the question. But there should be appropriate institutional benchmarks and at the moment it is entirely non­transparent. Given that it is public money that's voted through and counted as money we're spending on development, we might not be. We might be spending up to 30%, 40% on management fees. If that cost is brought back in house and we used not just an output measure like IRRs but looked at the cost and output measure as a whole we might find that bringing more staff in­house in CDC would be cheaper than using funds.

Q44   Mr Clappison: I am sorry that I arrived slightly late. Can I just come in on that because it's something I'm interested in? Are you saying that the money that is being spent on the management fees, which you've just described as being of a high proportion, is counted as overseas aid?

Dr Bracking: Yes, because the money is voted to the fund. The management fees are deducted by the fund managers before the fund closes. The fund closure generates the IRR that the CDC publish. But the fees and costs have already been taken out. But when they say that they have spent, say, £400 million in sub­Saharan Africa, they're adding up everything they vote to and invest in the funds.

Q45   Mr Clappison: So when you talk about management fees, can you give us some ideas of the scale of the fees, and the nature of them?

Dr Bracking: The actual numbers are subject to a non­disclosure agreement for 10 years that my university signed with Norfund and Swedfund, so I am not allowed to use any company names, but I will give you a general idea.

Q46   Mr Clappison: Who asked for the non­disclosure clause?

Dr Bracking: Norfund and Swedfund. CDC wouldn't give us data at all, and CDC's data isn't in the public domain, so Swedfund and Norfund are going a step further. But we saw management fees and start­up fees and establishment fees of up to 40% of the investable fund. But Norfund and Swedfund responded that the funds we were looking at were in their first year and an establishment year is always costly, and it approximates over five years and they go down. We couldn't do a systematic review of that because of time, but this Committee or the PAC need to do a systematic review of the cost structure of equity funds.

Tom Cairnes: Can I just make a brief comment?

Q47   Chair: Sorry, do you have any more published information on your work on Norfund?

Dr Bracking: The Committee already has the report, but the actual data, no, because I can't give it to you.

Q48   Chair: Are they worth talking to, for us?

Dr Bracking: Yes.

Tom Cairnes: Again, I can't speak for anywhere else. Our management fee is 3% of capital under management. The benchmark for fees should be something along those lines, and I think it should be compared with other development spending. So when I look at management fees, for example, for NGOs that take funds from DFID, I think we compare incredibly favourably. In fact, that is one of the reasons why I personally do what I do. The management fee on the capital that we use in the development space should be compared with that of UNDP, who historically charge an 8% management fee on an annual basis, and if you look at some of the NGOs that DFID support, that rate could be between 12% and 12.5% on an annual basis. I think that's the right benchmark for this capital.

Q49   Mr Clappison: Sorry to just come back, but you're telling us there's a much higher amount than that aren't you?

Dr Bracking: There are different types of fees. The management fee is generally 3 to 5%.

Q50   Mr Clappison: There usually are different types of fees in these things aren't there?

Dr Bracking: Yes, but then some fund managers have other lines of money as well. For instance, they also charge a technical assistance fee or a leasing fee. These are the ones that tend to go out to the secrecy jurisdiction. So they're not paying any capital gains on the fees either. So the amount of income that can be earned by having fairly fungible or multiple fee structures—

Mr Clappison: Sounds like nice work if you can get it.

Chair: We're running way over time.

Q51   Pauline Latham: Just very quickly, the Secretary of State is very keen that CDC changes and we're looking at a new business plan next March. Is there anything that you feel should be in it that you haven't mentioned so far?

Dr Bracking: There should be an official regulator. The forms of transparency and accountability of CDC aren't appropriate for a modern democracy.

Chair: I think you've made that clear.

Dr Bracking: Yes. Sorry.

Pauline Latham: No, no, that's fine. Maybe our new DFID watchdog might have a look at it.

Chair: I think we may have to look at it first. Thanks all three of you very much. It's been a useful and informative session. It's very opportune that the Government are reviewing CDC. Obviously the Committee was anxious to have some contribution to that review before it was settled. Your evidence, both what you've put in writing and what you've given to us this morning, has been very helpful. It has set up a number of lines of thought. On the one or two issues that we've asked for follow­ups, if you're able to give us a short follow­up note that would we much appreciated, and it certainly will help us produce what I hope will be a useful report. I know that the Secretary of State is quite interested in what we may have to conclude. Thank you very much indeed for your contribution.

1   Note by Witness: The figure should, in fact, be £1.4 billion, not £1.9 billion. Back

2   Note by Witness: Investing in smaller funds, focused on making smaller investments is likely to reach companies which CDC may otherwise not reach. Back

3   Ev 59 Back

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