Written evidence submitted by the Emerging
Markets Private Equity Association
1. We are pleased to be given the opportunity to
share our views with the International Development Committee as
to the proposed reforms to CDC and its future role in international
development, with particular emphasis on CDC's role and value
in emerging markets private equity and venture capital.
2. CDC has been an active and supportive member of
EMPEA since its founding in 2004. In 2008, CDC along with peer
institutions in the DFI community, provided EMPEA with critical
financial support for the development of the industry's first
comprehensive database of emerging market private equity investment
activity. This database, which could not have been possible without
CDC's US$100,000 contribution, serves as the foundation for most
of EMPEA's analytical work and research publications in the market
today, and lies at the core of EMPEA's success. In recent years,
at our request, CDC has also played an increasingly active role
in advising EMPEA on our activities and programming via various
non-governing advisory councils. Additionally, 23 of CDC's fund
investees are members of EMPEA, including some of our most active
members and a number of firms represented on our Board of Directors.
3. EMPEA's focus as an organization is to promote
the private equity and venture capital industries in high growth
and developing countries to improve the availability of critical
and efficient financing for growth. Therefore, we do not consider
ourselves in a position to comment on the full range of issues
within the scope of the Committee's inquiry, such as CDC's effectiveness
compared to other similar institutions or the feasibility of the
proposed reforms given CDC's current resources. As a consequence,
our comments below focus on CDC's reputation in the marketplace
and its contributions to our industry, as well as the value of
the private equity and venture capital funds investment model
as a sound and effective way to channel investment into small
and mid-sized enterprises in emerging and frontier economies.
4. Regarding the proposed reforms to CDC's model,
EMPEA recommends strongly against any migration towards either
direct investment or debt at the expense of CDC's participation
in the private equity funds investment model. While there is certainly
a need for greater availability of debt-like instruments in developing
countries, we respectfully challenge the notion that CDC's stated
objectives of pro-poor development can be more effectively executed
by retreating from equity investing in funds.
5. EMPEA fundamentally believes that professionally
managed private capital can be a powerful—and in many instances
the most powerful—tool for helping to lift the poorest countries
out of poverty by offering an optimal mix of long-term capital,
professional investment management and governance, and alignment
of incentives towards sustainable economic outcomes. A model that
skews more heavily towards direct investing could be both costly
to execute and challenging to administer effectively across the
many countries that CDC aims to serve. Direct investment also
carries limitations with respect to the scale achievable versus
deploying the same size pool of assets through funds. Further,
unlike the public service-minded civil servants likely tasked
with managing investments under the direct model, funds are managed
by professional investors armed with both the specialized skills
and the right incentives to select the most promising and sustainable
businesses in the most challenging of investment environments.
Fundamentally, we feel there are potentially greater assurances
of both financial and non-financial returns on investment from
deals that are structured and managed by local business and investment
professionals knowledgeable about the market and the business
community, and who are incentivized to select high-growth companies
with the greatest potential to succeed. This rationale is analogous
to the reasons why an individual retail investor would opt to
access frontier markets through a mutual fund rather than attempting
to pick stocks themselves from London.
6. We would also posit that both CDC and its investees
will gain from continued investment, in a targeted fashion, in
managers with geographic exposure broader than that of only LDC
countries. We agree that CDC's pro-poor mission will be best executed
by focusing resources as they are: 75% in low income countries
and at least 50% in Sub-Saharan Africa, as these are categorically
the most consistently financially underserved economies in the
world. However, we would argue against any further geographic
concentration or hard parameters against exposure to middle income
markets such as China and India.
7. First, the notion that such markets are fully
penetrated for private investment and that finance is therefore
readily accessible for all is flawed. Even in markets where enterprises
at the top end of the spectrum are well served by abundant sources
of capital, early stage and small enterprises remain sorely underfunded.
While many of CDC's early investee funds in India and China have
grown into market leading fund managers, who are now able to raise
capital fully from non-governmental sources, CDC remains absolutely
critical as an early source of investment for newer and smaller
fund managers in these countries and elsewhere in Asia raising
smaller funds that are focused on investing in small and medium-sized
enterprises. There are also vast segments within many more established
private equity markets -rural areas or certain sectors such as
soft infrastructure - that suffer from scarcity of capital. This
is true for many reasons, including: 1) the early stage or scale
of many of these companies makes them unattractive lending risks
for banks; 2) their size puts them below the floor of many equity
investors required to put a minimum amount of capital to work;
and 3) due to the challenging economics related to sourcing, managing
and executing such deals, there are fewer and fewer professional
investors in SMEs, as it's becoming clear that this model must
be subsidized. There is a vast and increasing need for sources
of funding to sustain private investment in SMEs, not only to
provide jobs, but also to create and grow those companies into
the next higher tier of the economy, to fill the pipeline of potential
investees for more commercially-oriented investors who are looking
for companies with strong governance and controls, and responsible
investment practices. DFIs such as CDC are among the few institutions
that are both willing and able to absorb slightly less favorable
commercial terms (eg, lower hurdle rates or higher management
fees) for what is fundamentally a more expensive business model.
Without continued support for SME investment platforms, there
could be a damaging ripple effect throughout many lower and middle
income economies on the cusp of significant strides in per capita
income growth.
8. The second argument against greater concentration
of CDC's footprint at the expense of middle income countries is
the lost opportunity for cross-market business opportunities that
a multi-market or regional footprint can afford. For example,
Olam International, which received US$20 million in seed capital
from Hong-Kong based AIF Capital in 2002, grew from a small family
business in Singapore into a leading global agricultural supplier
serving more than 60 countries. Part of Olam's successful growth
was attributable to the network and the broader lessons that AIF
had gained through their other investments in markets such as
India and China, and which AIF could in turn make available to
Olam. South Africa-based Ethos exited their investment in Dunlop's
South African and Zimbabwean businesses to Apollo, the largest
Indian tire manufacturer, which was eager to take advantage of
Dunlop's footprint in Sub-Saharan Africa to grow into the 12th
largest tire company in the world. Fund managers with relationships
and investment mandates spanning multiple markets have access
to a greater array of exit options, particularly important for
investors in low income countries with underdeveloped or nonexistent
local stock markets. Given concerns about the illiquidity of private
equity investments, maintaining some measure of controlled geographic
diversification in CDC's portfolio could enhance the overall exit
prospects for the portfolio and therefore the availability of
capital to be redeployed into other markets or instruments, wherever
it's needed most.
9. Regarding CDC's reputation in the industry, both
as a source of development finance and as an active investor,
we can unequivocally state that CDC has an excellent reputation
as a thorough, thoughtful and sophisticated provider of capital,
particularly in markets where sources of capital are lacking.
In Sub-Saharan Africa alone, CDC has played a critical role as
a source of funding, not only in seeding the industry's future
leaders but also in playing a catalytic role in drawing other
investors to the region. CDC-backed fund managers account for
approximately 77% of all capital raised for private equity investment
in Sub-Saharan Africa over the last decade.
10. Further to this point, CDC is also viewed as
an influential source of best practices and a professionalizing
influence in markets where professional business and investor
culture is nascent. In fact, we at EMPEA believe that our members,
the majority of whom were seeded by DFIs such as CDC, employ the
strictest standards in the global industry with regards to the
environmental and human rights records of the companies in which
they invest. This speaks volumes to the influence of investors
such as CDC in inculcating robust environmental, social and governance
(ESG) standards and expectations in both the investment process
as well as in reporting. Further, this level of influence on business
practices could not have been guaranteed through a pure debt model,
as the tenure of those requirements is specifically tied to the
maturity of the debt, i.e., those obligations end with repayment,
whereas shareholders providing an equity investment can enact
governance and other provisions that will outlast the participation
of any single shareholder.
11. CDC requires its fund managers to adhere to its
Business Principles (or similar standards such as the IFC Performance
Standards) as a condition for investment. We find, however, that
fund managers in emerging markets absorb these principles and
standards into their DNA and in turn expand on them, even after
they have graduated from reliance on funding from DFIs. For example,
Hong Kong-based AIF Capital, first seeded by IFC and ADB along
with a few others in 1994, and subsequently backed by CDC, has
gone on to cultivate one of the best reputations in the industry
with local governments in Asia, due in large part to the standards
inherited from their DFI sponsors and deftly implemented across
their entire portfolio and successive funds. In another example,
Aureos Capital has built on the reporting requirements inherited
from CDC to create a robust firm-wide system for capturing ESG
impacts at the portfolio company level in a way that can be easily
aggregated for reporting purposes. Aureos, among others, has made
a very clear case for the advantages of a clear commitment to
ESG in both raising funds from commercial investors, and in cultivating
relationships with investees and the communities in which they
invest, which is critical to their success at the local level.
12. That said, we cannot objectively assess how well
CDC measures or achieves development impact through their private
equity investments relative to other institutions. This is not
because CDC has performed poorly in this regard, but rather because
this information continues to be reported on an institutional
basis in aggregate by each of the multilaterals, obscuring the
relative development impact of individual portfolios or assets,
although these institutions now capture and report impact across
very similar metrics. EMPEA is in conversations with the DFI community
exploring practical ways to provide a more integrated impact assessment,
in which CDC will certainly be a participant.
13. In sum, we would urge the Committee and other
relevant bodies engaged in decisions regarding the future of CDC
to acknowledge the value of the private equity and venture capital
funds model in pursuit of economic development, including in the
poorest countries, and to be mindful that reducing or eliminating
this critical, efficient, professional investing source of capital
would unnecessarily retard the growth of sustainable SMEs in Africa,
emerging Asia, and other developing economies.
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