Written evidence submitted by Helios Investment
Partners
We would like to thank the International Development
Committee for giving us the opportunity to respond to the Secretary
of State for International Development's speech on 12 October
2010 regarding the proposed reforms to the CDC. Firstly, we must
declare that CDC is an investor in two of Helios' funds. Secondly,
our comments will be directed mainly at CDC's activities in Africa
as we are not fully qualified to comment on its activities outside
Africa.
1. CDC is a unique development finance institution
("DFI") as it is the only institution of its type solely
dedicated to the private equity asset class, employing this instrument
as a means to support economic growth and poverty reduction in
the emerging markets, particularly in Africa. There is a plethora
of DFIs, international and local banks with readily available
debt financing to support enterprises in Africa. However, there
is insufficient equity capital in Africa to underpin this debt
to enable new business formations and the growth of existing viable
businesses. CDC, to its credit, has played a significant role
in helping to fill this substantial equity supply constraint over
the last few years in Africa and, in the process has made a significant
contribution towards the creation of new enterprises and the provision
of much needed jobs for the poor.
2. It is inferred that the adoption of the private
equity Fund of Funds structure by CDC has led it to be less directly
engaged in fulfilling its development aims, abandoning its great
tradition of public service to provide capital to fund managers
who are only motivated by the narrowly defined private sector
goals of profit. This is very unfair criticism of CDC and the
fund managers it supports. CDC's Business Principles set out strict
standards to fund managers regarding health, safety, environment
and corporate governance. Adherence to these standards is a precondition
of CDC's investment in any fund. CDC also rigorously monitors
its fund managers to ensure that these standards are adhered to.
At Helios, for example, we engage a reputable international consulting
firm to independently verify that CDC's Business Principles and
IFC's performance standards are being complied with. This we recommend
should be the standard practice for all CDC's fund managers going
forward. The National Audit Office's recent report on CDC acknowledged
that it was difficult to make a worthwhile assessment of the impact
of investment on economic development and poverty. It further
added that the effort in collecting information needs to be proportionate
to its value in decision making. We concur with both comments
and believe that CDC could do better at measuring key tangible
development indicators such as jobs created, tax receipts to government
as well as an evaluation on whether the constituent investments
have led to improved infrastructure and social services for the
communities in which they operate.
3. As with any other DFI, CDC will always be open
to criticism no matter how effectively it monitors it Business
Principles. Moreover, there will always be isolated incidences
where a fund manager falls short of one these standards. Unfortunately,
it is such stories that make the headlines, neglecting the outstanding
work of CDC's staff and its 60+ fund managers. CDC's development
objectives are laudable, but these can only be achieved by creating
economically viable and sustainable businesses in the regions
that CDC entrusts its fund managers to invest in. The only way
to attract private capital is to demonstrate that commercially
attractive returns can be made within the CDC universe from investing
in great businesses underpinned by strong business principles.
The Fund of Funds model has enabled CDC to effectively leverage
its geographic spread operationally across regions that it would
not ordinarily have been able to reach without a significant and
extremely costly on the ground presence. The proposal for CDC
to engage in more direct investing will over time lead to mission
creep and the rebuilding of the costly, complex and burdensome
administrative infrastructure it abandoned many years ago, especially
if the new focus for CDC is mainly on pro-poor investing.
4. We welcome the proposal for CDC to co-invest with
other sources of capital. However, the additional proposal for
CDC to make direct investments may lead to the organization being
in direct competition with the same funds that it invests in,
as well as the Development Finance Institutions that it collaborates
with in its private equity programme. We also welcome the proposal
for CDC to invest in debt instruments and provide guarantees to
enable it to build a more diversified portfolio in terms of risk,
maturity and liquidity. It should be noted that CDC's business
principles are safeguarded longer with equity instruments than
debt. For the reason that, once a portfolio company pays off its
debt it is no longer under the same obligation to adhere to these
business principles, unlike with equity where the business principles
are enshrined in the Shareholders' Agreement and other constitutional
documents of the company for longer periods and, in many instances,
remain in place even after the fund manager has exited. In addition,
it is much easier to monitor and enforce CDC's Business Principles
from actively participating on the board of a company which the
equity instrument affords a fund manager. This entitlement is
much harder to negotiate from a debt perspective. Moreover, the
debt tax shield will deny African governments much needed tax
revenues unlike income and capital gains resulting from an equity
holding which is subject to local withholding tax and corporation
tax.
5. We commend the Secretary of State for stating
that CDC should develop a more active approach to portfolio management.
This, we believe, can only be achieved by permitting CDC to continue
to invest in targeted countries or sectors where capital is otherwise
not available and limited sectors and countries where capital
is available. Not only is this good risk management but also there
are enormous synergistic benefits from this approach. For instance,
Helios' investment approach is to build successful platform companies.
This may, for example, involve making an investment in a relatively
higher income country such as South Africa, where stronger management
teams may exist, but with the express objective of expanding the
business into the poorer but higher growth sub-Saharan African
countries that represent our core focus. Such investments help
drive skills transfer to local management in the lower income
countries. The exclusion of CDC from investing in funds focused
on the emerging market countries with high inward investments
could mean the loss of invaluable cross fertilization of ideas
and technical know-how between investments in high inward and
low inward regions managed by the same pan regional fund manager.
6. The two sectors identified by the Secretary of
State, infrastructure and energy, both demand significant amounts
of readily available debt capital supported by equity capital,
which is difficult to raise particularly in Africa. In 2005, Helios
started an independent telecom towers infrastructure business
in Nigeria, the first of its kind anywhere in Africa. It took
the firm a significant amount of time to raise the equity capital
for the company. With the assistance of CDC and several financing
rounds, including US$250m of debt from a host of Development Finance
Institutions, this company now has revenue of over US$50m and
employs over 250 people. It is estimated that each worker in turn
supports four other people. This illustrates the catalyst effect
of equity and its unique role in job creation and poverty alleviation.
7. Helios' investment in Equity Bank Kenya is another
illustration of how CDC through a fund manager drives pro-poor
growth and development in Africa. Equity Bank is Kenya's largest
bank by number of bank accounts with over 5.5m accounts or over
50% of the Kenyan market. It also operates in Uganda and Southern
Sudan. Equity Bank targets the unbanked population in these three
countries with a tailored distribution (through country wide branch
network, ATMs, internet, mobile phone and mobile banking channels)
and a distinct customer service strategy, leveraged by pioneering
technology. In so doing, the bank has allowed people in rural
and urban areas to access a variety of financial services, including
small scale loans which allow customers to pay for medical and
educational needs. Equity Bank has transformed the lives of a
large number of customers who had previously been excluded from
the formal economic sector and has given them hope, dignity and
economic empowerment. It has won numerous global awards including
the African Bankers award for "Microfinance Bank of the Year
2008 & 2009" and the IFC/Financial Times 2009 award for
"Emerging Markets Most Sustainable Bank of the Year"
(Africa / Middle East). Equity Bank would not have been able to
expand its "unbanked" customer base without the investment
by Helios.
8. We acknowledge that the Secretary of State does
not propose that CDC ends its commitments to new third party funds
since, as he mentioned, this is the most appropriate way to mobilize
funding in some countries and for some investments purposes as
well as effective in mobilizing third party capital alongside
CDC's. We believe that private sector investors, particularly
those with no prior investment experience in Africa look to CDC
for leadership as one of the most experienced Fund of Fund investors
dedicated to the private equity asset class in Africa, to build
comfort and gain conviction. CDC's continued commitment to the
Private Equity asset class is seen as an affirmation of the attractiveness
of the opportunities in the region. The secretary of state also
admits that CDC, on the whole, has been a great success. One finds
oneself asking why change what has been an effective and very
successful vehicle in achieving the developmental objectives of
the UK government. It would be remiss of us to suggest that CDC
is perfect, and as such we agree with a number of the proposals
including increased co-investments and the introduction of debt
instruments albeit not to the detriment of the provision of equity
capital which has made CDC unique amongst the DFIs. We would propose
that CDC set up a number of "not for loss" development
type funds with lower return criteria. These development funds
could focus on specific sectors such as an agribusiness fund or
lower income country specific fund. Nonetheless, CDC should retain
its investment policy of investing at least 75 per cent in low
income countries with 50% in Sub Saharan Africa with the remainder
in middle income countries as it has great portfolio benefits
which we mentioned earlier.
9. Finally, CDC through many of its fund managers
has been doing phenomenal work in Africa over the last few years
in pursuing the UK government's goals of promoting economic and
social development through the creation of viable, sustainable
and profitable businesses. The constant criticism of the organization,
together with the periodic wholesale changes of strategy, must
have a demoralizing effect on its highly dedicated and committed
staff who, by and large, are not driven by financial incentives
but rather the need to make the world a better place by allocating
capital to fund managers who meet CDC's double bottom line of
development and appropriate financial returns.
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