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
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
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.
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
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.
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
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.
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.
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
- make a higher proportion of
investments in SMEs.
CDC Frontier should:
- have an explicit mandate to
- accept lower rates of return
on its portfolio
- fund sectors most in need of
- 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
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.
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.
The Secretary of State wants CDC to "regain its power to
make investments directly in target markets."
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
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
Fund managers often identify viable transactions that they do
not want to invest in alone for a variety of reasons.
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.
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
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.
2: Investment tools
|Equity||Provision of equity directly or indirectly in companies or financial institutions.
|Debt / Loan||A variety of loan instruments can be provided directly or indirectly through an intermediated model.
|Guarantees||Guarantees indemnify companies against any commercial, non-commercial and economics risks.
||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 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."
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.
CDC has started to use debt recently as a new investment method.
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.
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
The Corner House and Jubilee Debt Campaign "strongly recommend
against the generalised use of intermediated loans
and against the use of sovereign guarantees by a reformed CDC."
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.
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.
3: European development finance institutions portfolio investments
by sector 2009
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.
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.
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.
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.
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
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.
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
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."
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.
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."
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.
The Secretary of State considers that DFID has "sometimes
in the past...been too remote a shareholder,"
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
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.
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.
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