The future of CDC - International Development Committee Contents

5  Reforming CDC

65.  This chapter outlines our views on the form that CDC should adopt in the future, building on the points that we have discussed so far. It sets out the investment tools we believe CDC should use and the criteria on which CDC should base its investments.

New investment model for CDC

66.  As we have said, it is clear that the 'fund of funds' model has had considerable successes and is an efficient way of utilising limited capital. The private equity model allows CDC to target different funds with different objectives and enables a wider scale of investment and impact. The ability of the 'fund of funds' model to leverage additional finance is invaluable considering the comparatively small amount of capital at CDC's disposal. By using this capital to demonstrate that investments in developing countries and frontier markets[156] can be successful, CDC can pull in extra investment and have a significantly more substantial impact than if it uses its capital in isolation. We recommend that the 'fund of funds' model continue to be the predominant part of CDC's operations. We believe that the continued use of this model should be contingent on improvements in transparency, accountability and targeting. CDC is renowned for its expertise in being a 'fund of funds' and should remain pre-eminent in this area. The UK's DFI should remain distinct from and complementary to the range of other bilateral and multilateral DFIs.

67.  Between 2004-2008, CDC's average annual returns on investment were 18% per annum.[157] Currently CDC invests in a range of different funds and most of its portfolio has been chosen to achieve returns which would attract more commercial investors to developing countries. As the new mandate for CDC is being designed, its future risk and return strategy must be considered. Lord Cairns, the former chair of CDC then Actis, argued that CDC should maintain its "real value capital."[158] If CDC takes on too much risk it might lose money which will reduce the capital available for investment in future, be harmful to CDC's catalytic effect and harm CDC's reputation with investors. Unsustainable investment also has negative consequences for those directly involved, for example jobs will be lost and children will have to stop going to school.[159]

68.  Richard Laing, CDC's CEO, said that one of the advantages of being state-owned is that CDC can be less risk-averse than private companies[160] and accept lower returns. Alistair Boyd, Former CDC Deputy CEO, and Bowen Wells, Chair of the International Development Select Committee between 1997-2001, argued that CDC should establish sector-specific funds with different funding bases.[161] Helios told us

We propose that CDC set up a number of 'not for loss' development type funds with lower return criteria, these could focus on specific sectors such as an agribusiness fund or lower income country-specific funds.[162]

A possible way forward would be to divide CDC into two parts with separate objectives and different rates of return. One part could maintain the use of the 'fund of funds' model and the other could target its investments specifically to have an increased development impact.

69.  All of CDC's investments must aim to be profitable in the long term. Nonetheless, CDC can allow for lower returns on parts of its portfolio. Therefore, we propose that CDC be divided into two parts. Alongside the existing 'fund of funds' model, which henceforth will be called CDC Funds, we recommend that CDC reinvest a significant proportion of the profits resulting from equity investments into a separate body which will be referred to from now on as CDC Frontier.

CDC Funds should:

  • use the 'fund of funds' model and co-investment as its primary investment methods
  • focus on ensuring that its investments are additional
  • make a higher proportion of investments in SMEs.

CDC Frontier should:

  • have an explicit mandate to reduce poverty
  • accept lower rates of return on its portfolio
  • fund sectors most in need of support
  • use a mix of financial instruments, including grants and loans.

70.  We do not specify the precise means by which CDC Frontier is created or how it achieves its goals. Our priority is that the fund meets its objective of achieving pro-poor development.

71.  By making targeted investments CDC Frontier would improve its development impact. Although CDC should allow for lower rates of return from CDC Frontier it should not sacrifice the quality of investment. By default the types of investment that CDC Frontier will be mandated to make will have a higher inherent risk, but the separation of CDC Funds and CDC Frontier will enable this risk to be managed effectively.

72.   The 'fund of funds' part of the business in CDC Funds should be ring-fenced so as not to damage CDC's reputation with private investors and to ensure it does not lose money. The anticipated profits from the 'fund of funds' part of the business could fund or subsidise CDC Frontier.

Investment methods

73.  The Secretary of State is keen to give CDC access to a wider range of instruments to achieve a greater development impact. As he put it, at the moment CDC is only using one golf club; it should be able to use all the clubs in the golf bag.[163] The Secretary of State wants CDC to "regain its power to make investments directly in target markets."[164] Making direct investments would give CDC more flexibility to target investments that will maximise development impact. However, as seen in Table One, direct investment is costly, resource-intensive and would be likely to reduce CDC's investment footprint. Local expertise is also essential for direct investment so CDC would require a presence on the ground. Direct investment would also take a long time to implement responsibly if chosen as an appropriate investment method.

74.  The Secretary of State envisages that initially CDC could co-invest with private equity investors, local investors, the International Finance Corporation or other development agencies.  Co-investment would involve viable investments being identified by other investors and CDC providing extra capital. DFID believes that co-investment "will allow CDC to use others' on-the-ground knowledge and expertise to deploy capital in challenging places, having an impact on poverty whilst building its own capacity to invest directly over a period of time."[165] Fund managers often identify viable transactions that they do not want to invest in alone for a variety of reasons.[166] CDC's current fund managers are potential co-investors, alongside whom co-investment could begin relatively quickly.

75.  Currently DFID provides grants and repayable grants for funds such as the Africa Enterprise Challenge Fund.[167]  If CDC Frontier were to be involved, it could, where appropriate, take a stake in businesses in return for grants, especially those with a clear link to poverty alleviation, and potentially provide a better return to the taxpayer to be invested in other pro-poor projects.

76.  We recommend that, in order to increase CDC's development impact, CDC should start to use co-investment alongside the 'fund of funds' model. The 'fund of funds' approach and co-investment should remain the primary investment methods for CDC Funds. Co-investment would enable CDC to target its investments without incurring the high costs that direct investment would involve.

77.  Making direct equity investments would be a radical change to CDC's current operations and should only be undertaken if CDC can identify investments responsibly. The potential development benefits should be balanced carefully against the cost of conducting thorough assessments of investments which would involve CDC having locally based staff. Moreover, direct investment could not take place immediately but would have to wait until CDC had the appropriate staff or partners in place. DFID offices should be targeted to work with CDC Frontier.

Table 2: Investment tools
Investment Method Explanation
EquityProvision of equity directly or indirectly in companies or financial institutions.
Debt / LoanA variety of loan instruments can be provided directly or indirectly through an intermediated model.
GuaranteesGuarantees indemnify companies against any commercial, non-commercial and economics risks.
Mezzanine Financing A blend of traditional debt financing and equity financing. Mezzanine financing is essentially debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full.
Technical Assistance Technical assistance can improve the performance of the fund/investee company or help to meet costs such as advisory, restructuring, training, due diligence and compliance.

78.  The Secretary of State wants CDC to utilise a wider range of financial instruments, including debt instruments and guarantees, as he believes that "greater flexibility will enable it to build a more diversified portfolio in terms of risk, maturity and liquidity."[168] The ability to use different investment tools, such as those described in Table Two, will be beneficial as the optimal investment method will vary according to country and sector. Helios, one of CDC's fund managers, welcomed the proposal for CDC to invest in debt instruments and provide guarantees.[169] CDC has started to use debt recently as a new investment method.[170]

79.  However, we received warnings about the problems that could arise from using certain investment methods or too many investment methods. Stephen Dawson, who has worked in venture capital and private equity for thirty years, advised that CDC should not try to compete with other DFIs in their areas of specialisation.[171] EMPEA informed us that CDC has an "excellent reputation as a thorough, thoughtful and sophisticated provider of capital," but this reputation could be damaged if CDC takes on too many financial instruments.[172] The Corner House and Jubilee Debt Campaign "strongly recommend against the generalised use of intermediated loans[173] and against the use of sovereign guarantees by a reformed CDC."[174] Helios told us that CDC's business principles are safeguarded for longer with equity instruments than with debt. This is because once debt has been repaid the obligation to adhere to business principles will cease whereas with equity they are a condition of the shareholders' agreement.[175]

80.  We welcome the opportunity for CDC to be allowed the flexibility to use a wider range of investment instruments when the correct opportunities arise. However we remain cautious about how many new investment tools CDC should take on. We note that CDC is regarded as an expert in private equity and although we are keen for CDC to best serve the needs of the poorest people it must protect its reputation. There is a danger that CDC could lose its expert status if it tries to take on too many new roles too quickly.

81.  We therefore recommend that CDC diversify the investment tools it uses slowly and only when it has access to sufficient expertise. Other financial instruments are available through other DFIs; CDC should not aim to do everything and should concentrate on what it is best at and what is needed. It should work alongside the other DFIs to provide the range of tools needed by developing countries.

Sectoral mandate

Table 3: European development finance institutions portfolio investments by sector 2009

Source: 2009 Comparative analysis of EDFI members, EDFI

82.  Certain sectors of the economy provide more assistance to the poor, for example through providing employment. These prospective sectors and the advantages of increasing investment in them were outlined in Chapter Three. Table Three shows that some sectors receive less support than others by the European DFIs, in particular agribusiness. Infrastructure receives more support, but probably is underrepresented given the scale of need. The ONE Foundation argued that CDC should align its investments with the national development priorities of developing countries.[176] Sectors could be identified for each country which are most appropriate to meet their development needs. Witnesses argued for increased investment in agriculture, infrastructure and SMEs.[177] CDC should target its investments at key sectors, such as agriculture, infrastructure and SMEs, in order to improve its development impact. If the Government accept our recommendation to split CDC into two parts, we recommend that CDC Frontier prioritise these key sectors, which are underfunded. We envisage that CDC Frontier should aim to have approximately 25% of its investments in agriculture, and another 25% in infrastructure. Large-scale infrastructure is particularly lacking and will require a mix of financing. Investment in agriculture and infrastructure would directly alleviate poverty, have multiple benefits and contribute to wider development goals such as food security which is increasingly important with the growing threat of climate change. We acknowledge that CDC Frontier should decide in which sectors the other 50% of investments should be made, since it will require the flexibility to remain innovative and the most appropriate sectors for investment will vary from country to country.

83.  CDC would benefit from closer collaboration with DFID in ascertaining in which sectors and in which countries they should invest to have the most demonstrable development impact.  DFID could help identify suitable investment opportunities for CDC Frontier.  In addition, CDC should consider making investments consistent with developing countries' national development strategies. 

Geographical mandate

84.  CDC's new investment policy for 2009-2013 requires it to make more than 75% of new investments in low-income countries and more than 50% of investments in Sub-Saharan Africa. On the balance of the evidence received, the Committee are content with CDC's new geographic mandate for 2009-2013. It should apply to both CDC Funds and CDC Frontier. We appreciate that investments made in middle-income countries can be valuable, especially given that recent research shows that 75% of the world's poor live in middle-income countries. However, in future CDC should aim for a more evenly-distributed portfolio between countries and avoid overconcentration of investment in any middle-income country. CDC should also target the poorest regions or areas of middle-income countries.

85.  As DFID's new Business Plan makes clear, the Department is now committed to focusing on the poorest people in the poorest countries and dedicating 30% of ODA to support fragile and conflict-affected states. DFID has 22 priority countries.[178] One option is for CDC to focus its investments in those 22 countries. This would have the benefits of increasing the development impact in those countries and of improving the synergy between CDC and DFID. However, we do not believe that CDC should be restricted to operating only in the countries that DFID does, as DFID is increasingly focused only on the poorest countries. We believe that CDC could make a wider contribution to poverty reduction if its investment policy allows for investment in middle-income countries.

Improving CDC's development focus

86.  Currently CDC's mission statement is to "foster growth in sustainable businesses, helping to raise living standards in developing countries."[179] As we have said, it does not mention poverty alleviation explicitly and the model largely relies on the benefits of economic growth reaching the poor. Oxfam would like the Secretary of State to install a "pro-poor development strategy in CDC's mandate, including clear objectives and targets," e.g. supporting female entrepreneurs, promoting small and medium sized agribusiness.[180] The Corner House and Jubilee Debt suggested that CDC should collaborate more closely with local communities and back "a more diverse range of companies (cooperatives, for example, or community-based companies) that are Southern-based and link directly to communities."[181] The mission statements of both CDC Funds and CDC Frontier should incorporate an explicit reference to their role in poverty alleviation. Investments made by CDC Frontier should include a thorough analysis of their potential for poverty alleviation before CDC commit to making an investment. The commercial viability of investments will remain of central importance, but CDC Frontier's investment decisions should also be based on the potential for alleviating poverty. Once CDC has adopted a more directly pro-poor remit we hope it would provide an example to other DFIs to focus more on poverty alleviation.

DFID oversight of CDC

87.  DFID's arms-length oversight of CDC has been deliberate, so that CDC is seen to be independent from the Government and can more readily mobilise private sector capital. DFID only sets the broad framework for CDC's operations and CDC has an independent Board. The NAO found that DFID only allocated 1.5 people to the oversight of CDC, a lower level of resources than dedicated by Government departments to oversee other Government-owned businesses.[182] The Secretary of State considers that DFID has "sometimes in the past...been too remote a shareholder,"[183] which is an opinion many others share. Save the Children UK voiced concerns over DFID considering putting a new infusion of money into CDC for the first time since 1995 at the same time as it is, according to Save the Children UK, considering cutting some of its projects, including commitments to double support to global education and spend £6 billion on health services and systems.[184] We recommend that there be a closer relationship and collaboration between DFID, especially the new Private Sector Department, and CDC than there is at present. In particular, DFID should have closer involvement with CDC Frontier. But as DFID and CDC become closer it is important that the division of accountability between CDC and DFID is made clear. The revised business plan for CDC is likely to be more complex than previously and necessitate higher risks, and will therefore require closer oversight by DFID, its sole shareholder. DFID and CDC should review the business plan on an annual basis to ensure that it remains consistent with the shareholder's aims.

The new CDC

88.  When CDC's new mandate and objectives have been decided, CDC will need to recruit new staff with the appropriate skills to ensure that it has the capacity and expertise to operate responsibly and effectively. Depending on the revised mandate CDC may need to recruit staff with development experience and expertise in the appropriate sectors.[185] The Board and staff of CDC should both reflect the mix of development and financial expertise required in the new CDC. The transition to the new model should be dictated by the time that it takes to recruit the most appropriate people.


89.  This inquiry has carefully examined the claims that although CDC has made impressive financial returns it has not had sufficient development impact. We have come to the conclusion that the 'fund of funds' model can be effective if targeted correctly, which has not always been the case. Our recommendation for CDC to be divided into two separate parts with different objectives would enable CDC to maximise its development impact whilst maintaining a sustainable finance base.

156   Markets at an early stage of economic and financial market development. Back

157   CDC Group plc, Financial Performance, 2010 Back

158   Ev w11 Back

159   Q 41  Back

160   Q 82  Back

161   Ev w67 Back

162   Ev w30 Back

163   Q 194 Back

164   Mitchell, A. 12 October 2010. Wealth Creation Speech. Back

165   Ev 90 Back

166   Q 178  Back

167   Repayable grants are essentially interest free loans (information from DFID). Back

168   Mitchell, A. 12 October 2010. Wealth Creation Speech. Back

169   Ev w30 Back

170   Q 99  Back

171   Ev w22 Back

172   Ev w26 Back

173   Intermediated loans are loans that are issued indirectly. Back

174   Ev w14 Back

175   Ev w30 Back

176   Ev w57 Back

177   Q 60 Back

178   NAO, The work of the Department for International Development in 2009-10 and its priorities for reform, 2010, pg 11 Back

179   CDC Group plc, Development Review 2009 Back

180   Ev 57 Back

181   Ev w17 Back

182   NAO, Investing for development: the Department for International Development's oversight of CDC Group plc, 2008, p27 Back

183   Q 200  Back

184   International Development Committee, Third Report of Session 2010-11, Departmental Annual Report and Resource Accounts, HC 605, Ev w48 Back

185   Ev w17 Back

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