House of Commons - The future of CDC - International Development Committee

The future of CDC - International Development Committee Contents

4 Remaining challenges

40. While the previous chapter examined claims that CDC has had an inadequate impact on development, this chapter assesses other concerns and criticisms made of CDC's current operations, covering a broad range of issues ranging from their use of tax havens to the levels of CDC's staff remuneration.

Implementation of CDC's Investment Code

41. As part of its commitment to Corporate Social Responsibility, CDC's Investment Code was developed in collaboration with DFID and is designed to promote responsible business practices in respect of environment, social and governance (ESG) matters. CDC requires fund managers to operate in line with the Investment Code. The fund managers are responsible for ensuring that portfolio companies adhere to responsible business practices.[96]

42. Concerns have been raised about the quality of CDC's Investment Code, its implementation and enforcement. Oxfam stated that the Investment Code "leaves considerable room for interpretation"[97] and that it needs to be strengthened to make it more rigorous.[98] CDC's business model, under which it funds others to invest rather than investing itself, limits CDC's ability to ensure portfolio companies are compliant. Although fund managers are responsible for enforcing compliance, CDC acknowledges that these managers "may not always be in a position to exercise control or influence over their portfolio companies."[99] Oxfam believes that CDC should require all portfolio companies to comply with the Investment Code, if necessary by "ensuring more than 20% ownership over all portfolio companies."[100]

43. However, others had a better opinion of the Code. Tom Cairnes, the fund manager of Manocap, told us that CDC had made a very valuable contribution before it had invested in the fund to improving Manocap's internal processes "particularly around ESG and governance and reporting."[101]

44. In practice, DFID and CDC recognise that "not all companies in the difficult markets in which CDC invests are likely to meet the business principles in full from the outset."[102]Instead of applying them as a barrier to investing, CDC asks fund managers to ensure that companies have effective action plans in place to achieve the necessary improvements in reasonable time.[103] The minimum standards required for a CDC-backed investment to be made are unclear.

45. Witnesses claimed that there had been serious failings in the implementation of the Code. We were told that Emerging Capital Partners Africa Fund II and Ethos Fund, both CDC-backed funds,[104] both invested in Intercontinental and Oceanic Banks, which were cited by Nigeria's Economic and Financial Crimes Commission for their alleged involvement in money laundering.[105] Emerging Capital Partners also invested in Anvil Mining Ltd which has been accused of involvement in serious human rights abuses in the Democratic Republic of Congo.[106]Anvil's role in the Kilwa massacre[107] was under investigation by the Australian Federal Police when CDC made their investment.[108]

46. There have been some changes to the way that CDC monitors compliance with the Investment Code. CDC used to rely wholly on assurance from fund managers that portfolio companies adhere to the investment principles.[109] This predominantly remains the case, but now some 'mid-point fund evaluations' are conducted independently.[110] Witnesses believed that CDC should adopt more rigorous monitoring and due diligence procedures to improve CDC's oversight of its investments.[111]

47. We acknowledge the difficulty some companies have in complying with CDC's Investment Code during initial stages and support the notion of encouraging improvement in Environmental, Social and Governance standards. However, CDC's Investment Code must set a clear baseline standard of compliance for investments. We are concerned by the claims that some of the funds in which CDC has invested have not met these standards. We recommend that CDC ensure that thorough due diligence and monitoring is conducted on all CDC-backed investments.

Measuring development impact

48. As we saw in the last chapter, CDC has been criticised on the grounds that its impact on development is inadequate. However, there is a consensus that "gaining a worthwhile assessment of the impact of investment on economic development and poverty reduction is inherently difficult."[112] No standard group of indicators can comprehensively measure the development impact of a diverse range of investments accurately.[113] Factors that should be considered include job creation, capacity to stimulate other private sector investment and tax revenues. In isolation, however, these measurements are crude and overly simplistic. It is especially difficult to categorise the indirect impacts of investment, for instance the impacts of increased trade from financing a road and the multiplier effects on an entire economy, and to assess both the short-term and long-term impacts. DFIs often report overall taxes paid by their portfolio companies rather than incremental changes that are attributable to their investment. This is also true of the way that some report on employment.[114]

49. CDC began quantifying its development impact in 2008 with its first annual Impact Report which set out, on the basis of a model adapted from the International Finance Corporation's Development Outcome Tracking System, its emerging evidence on the impact of its post-2004 investment activities. Funds are evaluated at the midpoint and at the end of the fund's life. In 2009, 17 of the 20 fund evaluations undertaken by CDC scored 'satisfactory' or 'successful' on development outcomes. Three were scored 'below expectations'.

50. CDC only analyses its development impact at fund level, but not beyond this i.e. the impact of individual investee companies. CDC assesses fund investments on four indicators—financial; economic; Environmental, Social and Governance (ESG) performance; and private sector development.[115] The fund investment is graded on the basis of these four indicators. The aggregate grading is problematic as it could mask extremely poor aspects of ESG performance if a fund performed well financially.[116] In 2009, seven of the 20 development impact evaluations were conducted by an independent assessor, Steward Redqueen (formerly Triple Value), a specialist in investment evaluation. In 2010, 50% of fund evaluations were conducted independently.[117] This should ensure that CDC's evaluation process is robust. It will also provide an external benchmark for comparison against CDC's internal evaluations.

51. According to Dr Sarah Bracking of Manchester University other DFIs including Norfund, DEG and FMO have superior development impact criteria to CDC.[118] According to Helios, CDC could improve its measurement of "key tangible development indicators."[119] Witnesses called for the establishment of more detailed indicators relating to development impact and poverty alleviation.[120] They argued that CDC should report its achievements against these indicators and report on its development impact.[121]

52. We welcome the increased independent evaluation of CDC's development impact. CDC should establish more comprehensive indicators relating to development impact, poverty reduction and employment generation (including whether the jobs are permanent, the wages paid, whether any jobs were lost due to restructuring before an investment was made etc.) CDC should monitor these indicators and report on them.

Transparency

53. Many have called for CDC to be more transparent in order to enhance its accountability and facilitate public oversight.[122] Richard Brooks of Private Eye told us that currently there is a "vacuum of accountability."[123] Save the Children UK claim that it is not possible for a member of the UK public or a citizen of the country of investment to see a list of companies which have had CDC-backed investment.[124] Christian Aid stated that it was imperative that CDC's structure and investment model facilitated transparency, especially with regard to its tax payments and those of investee companies, and if they did not they should be changed.[125] The Public Accounts Committee recommended that CDC should use its influence over fund managers to increase transparency around reporting on fund plans and performance.[126]

54. We were informed that, currently, CDC gave too much weight to commercial interests and too little to public disclosure.[127] According to The One Foundation, in order for CDC to successfully achieve its development mandate it "must [...] become a global champion of transparency."[128] Transparency is essential to enabling the public to hold CDC, a Government-owned company, to account. We acknowledge that commercial sensitivities exist but recommend that much more rigorous requirements are placed upon CDC to ensure that its investment decisions, development impact and the tax payments of their fund managers are as transparent as possible. In its response to this report, DFID should indicate how it plans to do this.

Use of tax havens

55. CDC invests in funds which pay a variety of taxes in the countries in which they operate. In some cases their profits are recognised in countries widely regarded as tax havens. The Organisation for Economic Co-operation and Development (OECD) recognises these countries and has divided them into three categories, a 'white list', for those that had substantially implemented internationally agreed-upon tax standards, a 'grey list' for those that had committed to the tax standards but had not yet implemented them and a 'black list' for those that had not yet committed to the standards.[129]

56. CDC's use of tax havens has been heavily criticised, especially by NGOs, for depriving developing countries of much-needed tax revenues, avoiding capital gains tax, exacerbating governance problems, facilitating corruption and reducing transparency.[130] Richard Brooks from Private Eye informed us of the case of Mineral Deposits Ltd in Senegal, in which Actis is the largest shareholder. The company only paid £20,000 in tax in 2008 and 2009 and rid itself of £6 million in tax charges by recording its profit in Mauritius.[131]

57. Using the IMF list of tax havens for 2007, Dr Bracking and colleagues classified the domicile of CDC's funds (excluding subsidiaries) in 2010. The totals revealed that 144 were domiciled in 'secrecy jurisdictions'[132]—80% of all CDC's investments by number.[133]The academics conducted research into the tax losses for developing countries due to domicile of companies in secrecy jurisdictions. They estimated that for 29 companies in which Norfund invested, the "tax losses for developing countries because of domicile in secrecy jurisdictions has been calculated for 2008 at over (gross) $14.6 million."[134] The tax loss to developing countries from the use of tax havens for the entire European DFI portfolio was estimated, by the same academics, to be over EUR430 million a year on average over the last five years.[135]

58. Nonetheless, CDC claim that investing in funds domiciled in offshore financial centres "is the most efficient way of pooling capital for investment in businesses in the developing world"[136] and is necessary in order to co-invest alongside the private sector. CDC states that it only invests through OECD's 'white list' offshore financial centres, with the exception of one fund from the mid-1990s for the Pacific Region which is domiciled in Vanuatu, currently on the OECD's 'grey list.'[137] Whilst most DFIs do not have restrictions on the use of tax havens by the funds and companies they support, since 2009 three DFIs—Norfund (the Norwegian DFI), Swedfund (the Swedish DFI) and Proparco (the French DFI)—have been operating under stricter restrictions on their use of secrecy jurisdictions.[138] The Secretary of State observed that Norfund's more stringent rules had "restricted its ability to attract third-party funding, and also in some circumstances restricted its ability to invest in Africa."[139]

59. Changes are, however, being considered. The 2009 DFID White Paper affirms that, "we all suffer from weak financial regulation, the financial impact of imbalances in trade, and the action of tax havens."[140] The Secretary of State said that the Treasury was carefully examining this issue.

60. The domicile of companies and funds in tax havens is a complex area which demands further investigation and we stress the importance of HM Treasury addressing this issue. Once established, CDC should follow standards of best practice. By doing so, CDC could raise standards across all DFIs. The tax payments made by CDC's fund managers and investee companies should be transparent. They should be published annually on a country-by-country basis.

Remuneration

61. The remuneration paid to CDC's executive directors has attracted much criticism. The remuneration framework is agreed with DFID and is benchmarked against the lowest quartile of the 'fund of funds' industry. The Chief Executive's base salary was £225,000 for 2010.[141] Like all CDC employees, the CEO is eligible for his basic salary, an annual bonus and the returns from the long-term incentive plan (LTIP). Firm-wide the average bonus paid for 2009 performance was 47.5% of salary.[142] CDC claim to pay the necessary rate to recruit experts in this field.[143] About 40% of the annual bonus is contingent on development impact.[144] The NAO underlined the advantages of linking remuneration to performance measures which had the potential to align staff behaviour with DFID's objectives.[145]

62. However, many believe that CDC salaries are unnecessarily high and too closely aligned with the financial performance of funds. Jubilee Debt Campaign referred to the high pay levels as "scandalous."[146] The Committee received evidence that there would be individuals with appropriate expertise who would be willing to work for a unique organisation like CDC for far less money,[147] and this opinion was shared by the Secretary of State.[148] On the other hand, CDC claimed that this would not prove possible in practice.[149] Remuneration should be linked to performance but we are concerned that current pay rates within CDC are above what is necessary to recruit and retain the appropriate staff. The remuneration framework needs to be redesigned to provide more incentives to CDC's staff to increase CDC's development impact, instead of focusing too heavily on financial returns. CDC should, as the Secretary of State proposed, examine the possibility of recruiting experienced staff that might be willing to work in a development organisation at lower pay rates.

Actis

63. Actis Capital LLP was split out of CDC in 2004, as a commercially-orientated fund manager. It took over CDC's overseas offices and the majority of CDC's staff, including all those in overseas locations. Actis is a limited liability partnership (LLP), owned 60% by its partners and an employee share trust, and 40% by the Secretary of State for International Development. The 60% shareholding in Actis was sold for just £373,000; by May 2010 Actis had $4.8 billion of funds under management.[150]

64. The Secretary of State told us that the taxpayer was also entitled to 80% of the profits but had not received any money from Actis, despite its significant financial success and the fact that 44% of its capital came from CDC.[151] The Secretary of State explained that no profits have been declared because Actis has set up its own charitable division.[152] He said that he was "amazed and surprised at the way the management of Actis have so enthusiastically exploited the taxpayer's position."[153] Alistair Boyd, Former CDC Deputy CEO, and Bowen Wells, Chair of the International Development Select Committee 1997-2001, believed that it was logical to sell DFID's shareholding in Actis and for the proceeds to be made available to the new CDC.[154] The Secretary of State agreed that there is no strategic reason to retain the shareholding.[155] We were astonished to discover that following the sale of Actis for just £373,000 the taxpayer had not received any return despite being entitled to 80% of the company's profits. We recommend that DFID's shareholding in Actis should be sold, but care must be taken to achieve the maximum value. The capital received from the sale could be reinvested into CDC.