The Future of CDC

Evidence from Helios Investment Partners

1. 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.

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.