Written evidence submitted by Martin Curwin
1. INTRODUCTION
I have been acquainted with CDC and its role in developing
countries from 1970 when I started my 40 year career in development
finance. As a result I have observed and experienced its evolution
from an organisation that in 1970 invested in, leant to and, in
certain circumstances, owned and managed projects (for example
in the agro-industrial sector) to its present-day status of a
purely equity investor, as a Fund of Funds, through private equity
funds and micro-finance vehicles. This has led certain commentators,
not least the Secretary of State for International Development,
to suggest that CDC has lost sight of its original development
mission. Except to say that, in my experience, it has played a
key role over the past few years in promoting industry best practice
in those funds in which it has invested, I will restrict my comments
to two points, namely the sustainability of the development finance
institution (dfi) model and what sort of dfi should the UK have
in the future.
2. The DFI Model
CDC is not the first of its peers to attract criticism
from its stakeholders, starting with its own shareholder(s). In
my opinion, this is an occupational hazard for those managing
such organisations because they are often charged with the arguably
irreconcilable objectives of being financially sustainable, having
a development impact (itself subject to varying interpretation)
and respecting the principle of subsidiarity, ergo of not competing
with the private sector. However, even taking into account possible
partial market failures, if private financial institutions are
not active in a particular country, sector or activity it is normally
because they have assessed that the risks are greater than the
rewards. Indeed, if a DFIonly finances operations that are unattractive
to private banks, the chances are that it will, sooner or later,
make losses that will eventually accumulate to the point where
it will not be able to absorb them without recourse to its shareholders.
And yet as one of my mentors once said "a development bank
that does not make an occasional loss is not fulfilling its role".
The corollary of this is that one or other of the
goals has to become secondary and this has tended, by default,
to be the development impact. A DFI cannot perform any long-term
function, let alone a useful one, if its finances are shaky. So
there is a built-in bias for it to favour relatively less risky
operations (and arguably less developmental ones but this does
not necessarily always follow) even if it concentrates its activities
at the riskier end of the spectrum of those undertaken by private
financial organisations. The implication of this is that, in the
absence of uninterrupted GDP growth or an ultimately unsustainable
economic bubble, a dfi will almost certainly need, sooner rather
than later, some sort of financial cushion. This can come in various
forms from first loss arrangements (not that I am aware of any
cases as yet), over-capitalisation and reliance on part of its
liquid treasury, or cross-subsidisation from safe, profitable
(often non-core) operations, to cover its costs and generate reserves.
In short, the shareholders accept a lower rate of return than
they could otherwise obtain.
This occurs in certain cases but is never spelt out
openly or consciously stated. Indeed, I would go further and say
that the financial sustainability of the dfi model has never,
to the best of my knowledge, been the subject of serious analysis
and discussion between academia, development think-tanks or shareholders.
Any review of the future of CDC, which in its early days, as I
recall, received regular funding from HMG, should start with an
analysis as to the willingness or not, as the case might be, of
HMG to accept, or at least mitigate, possible losses as this will
condition i.e. what sort of business CDC should undertake and
also in what countries it should be active. For what it is worth
I personally feel that the present fund of funds model is too
narrow (and predicated on an over-optimistic assessment of the
possible response from the private sector to better governance
and economic performance in developing countries) and that a well-balanced
dfi should be able to provide both loans and equity, the latter
directly and also through funds. In my opinion, there is still
a need for loan finance from public sector sources even if the
conventional wisdom suggests that the private sector will provide
it
3. WHAT SORT
OF DFI FOR
THE UK
My starting point here is that the development "industry",
for that is what it has become over the past 40 years, is over-crowded
these days and had it been subjected to the process of rationalisation
that private industry and banking has undergone in the last 15-20
years, there would be fewer dfis and the industry would be more
efficient. The counter-argument that the existence of ever more
dfis ensures competition begs the question of whether dfis are
sustainable in a purely competitive paradigm. So far I have seen
no evidence to support this. And if there is one part of the world
which should take the lead in rationalising the industry it is
the member states of the EU, which collectively are the largest
aid donors in the world, are also major shareholders of the World
Bank/IFC and the regional development banks, as well as of 12-15
national dfis such as CDC, which, as a pure equity investor, sits
at one end of the spectrum.
So the issue for the UK, one of the most important
donor countries in the world, is what sort of dfi should it have
in the future. In my opinion, it should be something between the
CDC of the 1970s and the fund of funds model the 2000s, one that
can work with both the private and the public sector, provided
that the projects and companies that it supports in the latter
operate on a commercial basis, and one that can make loans and
take equity investments both directly and through funds. Equally,
a minority private sector shareholding of interested partners
or non-profit organisations is something that should be studied
as I believe that this ensures a better-balanced governance system.
This is easy to say and much of it arguably common-sense
but the devil is in the detail, especially how such an institution
is funded, as well as being financed over time, what its objectives
are and probably, most importantly, what system of incentives/disincentives
is put in place to motivate its staff. With respect to the latter
this goes beyond the pure pecuniary and I would agree with the
Secretary of State when he said that it is possible to attract
people with remuneration that is fair and appropriate. But, it
is more than that and includes the various checks, balances and
public oversight to which dfis are increasingly and rightly subject
today. The shareholders need to take a more active, as well as
balanced and holistic role than, judging from the terms of reference
of the inquiry, appears to have been the case with CDC lately
and I dare say, with other similar dfis. Otherwise, it is difficult
to understand how the criticisms levied at CDC were allowed to
reach the public stage and suggests that the existing fund of
funds model, with its exclusive private sector focus and raison
d'etre, has led to its being treated with a certain amount of
detachment by its shareholder. This is, of course, pure conjecture
but I have observed a tendency towards myopic governance in other
like institutions.
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