The Future of CDC

Evidence submitted by Oxfam


2. Oxfam welcomes the opportunity to make a submission to the International Development Select Committee’s inquiry into the future of CDC. Oxfam works with partners around the world to find lasting solutions to poverty and injustice. Currently, we work in more than 70 countries – including the UK – and respond to an average of 30 emergency situations each year. Oxfam believes that people are entitled to five fundamental rights: a sustainable livelihood; basic social services; life and security; to be heard; and equity. We work to support people in realising these rights and fight poverty and suffering through campaigning, long-term development work, and emergency response. Oxfam GB is a member of Oxfam International, a confederation of 14 Oxfam affiliates around the world.

3. The effectiveness of the CDC, compared with other similar institutions

4. CDC has been effective in: a) being financially self-sustaining; b) catalysing some private capital into developing countries; c) developing ESG risk management tools. However, it is less clear to what extent CDC has invested, and catalysed private capital, into regions, sectors and activities that are particularly important for poverty reduction and development but which are perceived as too risky or unprofitable by mainstream investors, and thus have received little or no attention from private investors. CDC seems to operate almost as a ‘mainstream’ fund of funds investor with a good policy on ESG risk management (e.g. similar to many signatories to the UN Principles for Responsible Investment) and a geographical mandate, but CDC’s track record in terms of delivering development, as well as financial, returns is more difficult to assess.

5. There are different models amongst Development Finance Institutions (DFIs). Some are more commercially-oriented, such as IFC and CDC, which tend to invest in large funds with diversified investment portfolios that include companies in high-growth sectors such as telecommunications, financial services, and information technology, which provide the best opportunity to raise additional equity from private investors. Other DFIs, such as Norfund and Swefund, have helped to establish local financial institutions in countries with severely underdeveloped private sectors, such as Angola. These latter fund investments entail significant investment risk and could not be realised without some concessional financing and long investment horizons. In turn, the potential to raise additional private capital in these types of investment in the short- to medium-term is severely restricted. Although it is necessary for those DFIs that are self-funded to strike a balance between financial and development returns, in Oxfam’s view, as development agents, they should at minimum:

- Prioritise investments in regions and sectors where private investors would not invest on their own, catalysing long-term responsible investment in under-capitalised geographies, sectors and ventures e.g. agri-SMEs or least developed countries; and

- ensure environmental, social and governance (ESG) standards are met in all their investments, direct and indirect.

6. CDC appears to be investing in some funds, and companies, where private capital would potentially go anyway. Finding the right balance between development and financial returns to make a clear positive development impact, whilst remaining self-financing seems to be the biggest challenge for CDC. With the exception of its geographical mandate (and some sector exclusions), CDC operates almost as a ‘mainstream’ investor fund of funds with a policy on ESG risk management similar to many UN PRI signatories.

7. The reforms proposed by the Secretary of State for International Development on 12 October 2010 and the feasibility of achieving desired results given the CDC's current resources, including staffing; the extent to which the proposed reforms will be sufficient to refocus CDC's efforts, especially with respect to poverty reduction

8. We agree with the Secretary of State that the CDC should become more pro-poor in its approach and activities, and that CDC investments need to be targeted in (potentially more risky) regions and ventures that will generate higher development returns. This includes being prepared to invest for longer than the average investor to achieve development – alongside environmental, social and governance - outcomes, and to be ready to accept lower returns than the average private investment actor would typically accept.

9. We encourage the Secretary of State explicitly to incorporate a pro-poor development strategy in CDC ‘s mandate, including clear objectives and targets, that is, laying out development and poverty reduction aims e.g. targeting women entrepreneurs, promoting small and medium-sized agri-businesses.

10. Currently CDC’s mandate focuses on geographical areas and the exclusion of a few sectors (goods that are deemed illegal under applicable local or national laws or banned by global conventions or agreements, arms production or trade, businesses significantly involved in tobacco, pornography, gambling). While welcoming that the current mandate is biased towards Sub-Saharan countries, Oxfam believes that CDC’s mandate should also include a clearer development strategy identifying which sectors, and why, will be favoured based on the development needs of the recipient countries, for example, infrastructure for rural areas (e.g. improved energy, water and transport infrastructure that provides basic services to farmers at lower cost, making them more competitive), agriculture, financial services e.g. developing local financial institutions versus consumer-oriented investments.

11. CDC should work over time towards the development of concrete quantitative and/or qualitative indicators relating to development and poverty reduction alongside its existing ESG criteria, which would allow its performance to be assessed against its stated development objectives. CDC’s approach should change from focusing on ESG risk management to focusing on development (including ESG) outcomes.

12. We agree that CDC should significantly increase its directly managed portfolio, and take a more active approach to portfolio management. In so doing, if it is to remain self-financing, CDC will need to find a balance between undertaking direct and indirect investments, and between delivering financial and development returns. This could potentially be done by establishing a percentage of direct investments (say, at least 50%), for example, balancing financing given directly to small-scale farmers in rural areas where poverty rates are high and the short-term ‘social’ impact is the greatest with indirect investments in agri-businesses such as food processing, packaging, and distribution companies.

13. According to the current CDC Investment Code, CDC’s Fund Managers are required ‘to procure that such portfolio companies sign an undertaking confirming that they will operate in line with sections 1-3 of this investment code" (covering CDC’s principles, objectives and policies, and exclusions). Understanding the complexities involved in fund managers enforcing explicit commitments to the code when they lack effective control or significant influence over portfolio companies (that is, typically, where they own less than 20% of the company), CDC should require ALL portfolio companies to commit to delivering certain development goals and to comply with the code; even if it means ensuring more than 20% ownership over all portfolio companies, and thus reducing the overall number of CDC investments.

14. In order to properly manage an increased number of direct investments, DFID will need to consider: a) increasing human resources, particularly managerial staff with development expertise; b) exploring innovative models of collaboration with other parties, private, public or civil society to help monitor CDC’s investments; and c) increasing CDC’s advocacy and influencing role in the fund management and private equity industry to promote higher standards, greater transparency and reporting within the industry in general and, for CDC indirect investments in particular.

15. We agree with the Secretary of State’s proposal to demand from CDC more effective treatment of environmental issues, greater transparency and a rigorous approach to tackling corruption.

16. The current CDC Investment Code leaves considerable room for interpretation, and thus for free riding, e.g. many of the policies are applicable "as/when appropriate", as are requirements for verification of results or setting improvement targets. The Investment Code should be reviewed and strengthened to remove loopholes and ambiguity, particularly in relation to the management of CDC’s fund managers e.g. by changing the current wording "encourage the managers of portfolio companies to adopt and implement policies relating to ESG matters, particularly where businesses entail significant risks" to a more concrete requirement that "managers adopt and implement effective ESG policies over time and that investments comply with ESG goals by the time CDC exits the investment.".

17. For its indirect investments, when operating as a fund of funds, CDC should establish clear criteria and procedures for selecting, and assessing financial intermediaries, including that intermediaries:

· have policies and a strong track record of performance on ESG matters, including reporting, as a key criterion for selection;

· are explicitly required to demonstrate results in terms of their ESG performance, as well as meeting specific development targets, in their contractual agreements, and due diligence;

· maintain oversight of, and engage with, the funds they invest in regarding their ESG and development performance and progress. This includes requiring them to report on ESG (and development) performance and progress.

18. In addition, CDC should:

· engage with other DFIs to harmonise standards and increase their capacity to influence private investors in developing countries, by raising awareness of the importance of managing ESG issues, sharing expertise and tools, and improving standards across the private equity industry (including standarising private equity reporting frameworks); and

· establish a process to manage non-compliance by fund managers and private equity firms they invest in, and to improve monitoring and reporting of their investments.

19. Oxfam acknowledges the efforts and progress made by CDC in developing a comprehensive tool kit and ESG management system for fund managers. However, the delegation of investment decisions in the fund of fund model requires the development of stronger management systems for fund managers, to compensate for the absence of direct DFI control and civil society oversight of the investments, including specific criteria and procedures for selecting and appraising fund managers, as well as a system and procedure for dealing with ‘non-compliance’ with CDC’s Investment Code by fund managers.

20. The application of CDC’s policy and geographical mandate to its indirect investments is unclear as CDC’s Board has discretion over decisions to invest in any particular investment vehicles for fiscal, regulatory or any other reasons. This potentially leaves the door open for CDC to invest in funds which lack transparency, and which are hard to track/monitor and influence, and which might be domiciled in offshore financial centres, which could potentially damage the reputation of CDC.

21. Internal and external verification: There is a case to be made for involving third parties as monitors of and reporters on investee companies, as the relationships between DFIs, fund managers, and investee companies involve potential conflicts of interest. Some DFIs (e.g Norfund) have employed consultants to report on the development impacts of a sub-set of their investment portfolios. DFIs could broaden and systematize this practice by collectively creating an independent ombudsman mandated to conduct field missions to monitor and report on both fund managers and investee companies, and to publicly report on the development impacts of their activities.

22. Corporate Governance and accountability: CDC currently has an independent Board, with no representation from DFID. We propose that DFID should consider having a permanent representative (non-executive director) on the Board who would hold overall responsibility for the establishment of, compliance with and reporting on CDC’s development strategy.

23. Transparency: CDC should regularly report on its performance against its development strategy, in terms of the extent to which it has meant its development objectives, how its activities have contributed towards this, and on the development, as well as the financial, performance of its investments; a full development report should be made publicly available on an annual basis.

24. Should alternative options, including the abolition of the CDC, be adopted?

25. We understand that there needs to be a balance between CDC’s ability to catalyse private capital (that otherwise will not invest in certain regions or companies) and CDC’s ability to manage and ensure social and environmental returns.

26. Intermediary financing (such as the fund-of-fund model) involves significant delegation of investment decisions to private parties (e.g fund managers, loan officers), which undermines the ability of DFIs to directly select and appraise investments and report on their development results. Moreover, intermediary financing reduces the public availability of information to the point where civil society is unable to fulfill its traditional role as a ’watchdog’ that could provide a useful informal accountability mechanism and a strong incentive for DFIs to improve their performance in terms of development results.

27. In our view, an alternative model worth considering would be a combination of fund of funds with direct investments, when and if, the indirect investments follow the above proposed policies and practices. Direct funds require more human resources, and thus, are more costly (management intensive) yet, they have greater potential to focus on higher risk and potentially lower (financial) return investments, and/or investments that might require much longer holding until they become sustainable, that could deliver greater returns from a poverty reduction perspective. Increasing the proportion of investments in higher risk/lower financial return regions and sectors could be compensated by CDC’s indirect investments, which are likely to continue to be more profitable. Notwithstanding, a shift from financial to development returns will inevitably imply smaller overall profits, not least because focusing more on direct investments will require either providing CDC with more resources (human particularly) or focusing on an overall smaller number of investments.

28. DFID's shareholding in Actis, CDC's largest Fund Manager

29. DFID’s shareholding in Actis should be reviewed in line with the new CDC model and investment strategy that emerges from DFID’s review of CDC.

30. Conclusion

31. Oxfam intends to undertake further research and analysis of the role that private finance can play in development, including the role of DFIs in harnessing the potential of private investment for poverty reduction, which we will feed into DFID’s current public consultation on reforming CDC Group plc.