Conclusions and recommendations |
CDC's ability to leverage additional finance
1. Although it is not always easy to prove, the key benefit of the 'fund of funds' model is its ability to leverage additional finance. This 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. Diaspora communities often have an interest in poverty alleviation in their countries of origin but have difficulties in finding out how to make investments. CDC should seek to attract funds from such diaspora communities and, in addition, develop partnerships with UK businesses, provided they have a pro-poor focus in developing countries and are not tied to UK national interests.
Is CDC's funding additional to private capital?
2. It is imperative that all of CDC's funding backs investments that the private sector would not otherwise support. CDC should make assessments before investing, including an appraisal of whether their contribution would be additional. Additionality should be demonstrable for all investment decisions. CDC should be careful only to invest in funds that are committed to this principle.
Implementation of CDC's Investment Code
3. 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
4. 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.
5. 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
6. 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.
7. 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.
8. 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.
New investment model for CDC
9. 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.
10. 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.
11. 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.
12. 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.
13. 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.
14. 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.
15. 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.
16. 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.
17. 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.
18. 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.
19. 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.
20. 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.
21. 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
22. 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
23. 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
24. 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.