The Future of CDC

Evidence from Martin Curwin

1) Introduction

I have been acquainted with CDC and its role in developing countries from the time in 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

2.1) 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".

2.2) 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.

2.3) 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

3.1) 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.

3.2) 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.

3.3) 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 in this 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. In this 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.