International Development Committee

Call for Evidence

Investment for development: The UK’s strategy towards Development Finance Institutions

Introduction

By way of brief introduction, I’ve spent most of my career living and working in East and Southern Africa, including periods of employment with CDC (now BII) from 1997 – 2001.  I have also worked for Oxfam, the International Red Cross, AgDevCo (2017 – 2018) and, most recently, served Palladium as Team Leader for the FCDO Impact Programme, a long-standing UK Aid programme designed to support the growth and development of the impact investing ecosystem. . I also spent 11 years in Uganda from 2005 – 2016 developing one of Africa’s first dedicated agriculture-related SME impact investment fund managers, Pearl Capital Partners with, among other investors, the Gatsby Charitable Foundation (one of the Sainsbury Family Charitable Trusts.

General Comments

In my own direct experience with CDC, I spent several years working at a CDC subsidiary company in Tanzania, Tanganyika Wattle Company (Tanwat) as its financial controller.  Tanwat was a great example of the positive economic and social impact that large employers can have in rural areas.  Not only did it employ several thousand people, but (among other things) it provided a regular source of electricity to the town of Njombe, it provided access to training for numerous Tanzanians in practical vocational skills, and it provided health services through its small hospital and clinic to the local community.

While Tanwat was a creature of its time, it had an exceptionally positive economic impact on the town of Njombe and its surrounding communities at a time of widespread and grinding poverty in Tanzania.  CDC could point to many similar interventions in other businesses and countries throughout East and Southern Africa.

However, Africa has changed hugely over the last 60 years. What was needed in the period from 1960 – 2000 is no longer what is needed today. And, although I am firmly convinced that economic growth via private sector development has all sorts of beneficial economic impact, I am not convinced that the UK aid budget should be used for private sector investment.  I can see an argument to support the use of aid money to stimulate increased investment (eg through blended finance), but only where the developmental rationale is very strong. I will elaborate further on these broad views in my responses below.

• How does the BII’s strategy align with the FCDO’s development agenda?

The FCDO’s development agenda has been something of a moving target over the past ten years, given the rapid turnover of ministers first at DFID and latterly at FCDO. Changes of strategic direction do not sit well with the long term investment approach required by Development Finance Institutions.  This may seem to be a minor point, but in some ways it goes to the heart of the challenges facing BII: it is probably unrealistic to expect that a Development Finance Institution can create investment strategies which serve short-medium term development policy strategies and tactics.

It was therefore interesting to read in BII’s 2021 investment strategy that “[BII] will use our proximity to the City of London to mobilise commercial investors to cement the UK as a development finance hub. We will invest in or with British businesses that operate in developing and emerging economies….”[1]

This is a major shift in focus. It sounds as if BII is being directed into using its capital to support the international expansion of UK business in developing and emerging economies, and in mobilising capital from UK-resident investors. The former seems pretty far from being an appropriate use of the aid budget. The latter, I think, does have some potential for additionality: if CDC can use its capital to attract in new investors, its capital can stretch, so to speak, but this comes with two major risks.

• First in order to mobilise capital, CDC will increasingly focus its attention on the sort of mega low-investment-risk deals like its partnership with DP World, and stop looking at smaller transactions (and smaller countries)
• Second it may – depending on how it structures deals – simply end up “subsidising” investment returns to private capital via blended capital transaction structures. In other words, it may take on greater investment risk than its institutional investment partners, where it is not necessary to do so.

• How does BII’s strategic outlook compare with that of other comparable overseas institutions?

BII’s investment strategy differs slightly from most other DFIs due to its emphasis on making equity, as opposed to debt, investments in its portfolio businesses. This has some advantages to its investees (equity finance is lower risk capital to a business than debt), but it also means that BII’s capital is at greater risk, and that it has little or no income from its investments until the point of sale.  This means that BII is unable to cover its management costs (which have risen rapidly over the past 4-5 years due to a major expansion in staff numbers) from its income from investments, as it used to do in the 1980s and 1990s.

The BII (CDC) that I knew and worked for guarded its independence from Government. It pursued its mandate by investing in an investment portfolio that mixed debt and equity, guaranteeing an annual cash flow from its investment activities without requiring funding from Government

• How effective are the governance structure and internal oversight mechanisms of BII (e.g., oversight over direct investments, fund investments, BII controlled companies)?

CDC traditionally maintained close supervision over its investments through its wide network of international offices. CDC country managers would often sit on the board of directors of portfolio businesses (or as a minimum observe proceedings) and of course their country knowledge and connections within national economies would provide them with important market intelligence.  However, from the early 2000s, CDC dismantled its network of local offices and, in so doing, lost a rich reservoir of knowledge and networks which had taken decades to establish. While in recent years it has taken some steps to establish an international presence, there seems little doubt that to have re-embarked upon a programme of direct investment without local presence will have meant that BII’s oversight of direct investments has been less rigorous than in the past.

Although BII has departed from its fund-of-funds strategy (2005 – 2012), which led to the closure of its international offices, it continues to invest a substantial part of its funds in “intermediated equity” (fund vehicles). It therefore came as a great shock that it failed to identify and address the weaknesses and failures in governance of one of its largest intermediaries, Abraaj Capital Partners, much earlier than it did.  This was the subject of a book (The Key Man) by Simon Clark and Will Louch, and more recently of a TV documentary. It is to be hoped that BII has learnt from this expensive failure and tightened up its attention to good governance in its intermediary partners.

• How is BII’s budget determined? How does the budget inform BII’s programme of work and to what extent can BII scale up or scale down on its investment activity?

BII’s investment strategy (see above) focused on equity investment means that it needs substantial inward investment in order to make new investments (unless it accelerates its portfolio “churn”, of which further below). At the moment, BII’s inward investment is sourced wholly from the British Government.

Some other DFIs and IFIs source capital from the commercial markets, and it is rather odd that BII has not hitherto investigated sourcing capital from the capital markets (especially when interest rates were much lower than they are now). It is most unusual for a financial institution – indeed, for any substantial business - to be funded entirely by shareholder equity when it has an asset base as deep as BIIs.  In my view, BII could and should fund new investments from self-generated funds (equity disposals) or from debt raised on the capital markets. There seems no good argument for the British Government to invest scarce funds in BII when it does not need to do so.  Further, one of BII’s strategic objectives is to build closer links with private financial institutions, and one of the ways it could do this is by issuing bonds to private institutional investors as a means of raising impact investment capital from new sources. Mobilisation of new capital has been largely neglected by BII for too long, representing a missed opportunity in using its asset base and investing track record as a means of crowding-in new capital.

• What criteria does BII use to determine investment decisions and how are financial returns balanced with achieving impact?

BII is and has always been an “impact investor”, investing with the intention of creating positive impact and to generate a positive financial return.  In recent years (and with the support of DFID and then FCDO), impact investing has moved from being a niche for philanthropists to a significant movement attracting interest from many private asset managers and asset owners. BII has formalised the way it thinks about impact and builds impact (and good Environment, Social, and Governance (ESG)) procedures into its modus operandi, to a far greater extent than in my days with the organisation. It has signed up to the Operating Principles of Impact Management and been subject to review by an expert third party to assess its adherence to those Principles.

However, something that BII appears to have lost from its processes is the concept of additionality. The principle of “additionality” – as I knew it in the CDC of old –required CDC to ensure that its capital was filling a gap that could or would not be met by the market. For many of BII’s more recent investments, it is by no means obvious that private investors would have been unwilling or unable to invest. If that is the case, then in effect BII is crowding-out, rather than crowding-in, private capital, which is surely at odds with its original mandate and with the principle of additionality.

To illustrate this point, in late 2021, BII announced a huge investment commitment of $320 million in partnership with Dubai Ports (DP World) to invest in port redevelopment in Somaliland, Egypt and Senegal. This commitment may rise to more than $700 million.  With the best will in the world, it is difficult to believe that DP World did not have alternative sources of project finance for this venture. One might say the same about another recent high-profile BII deal as a partner investor in the Safaricom-led Ethiopia telecoms consortium.  While it is no doubt the case that these projects, if successful, will deliver positive developmental impact, both direct and indirect, it is manifestly not obvious that such investment would satisfy the additionality principle in the deployment of BII’s cash balances. We can only imagine what hundreds of millions of Dollars might have been able to do for the health, education, and WASH sectors in Africa and South Asia, and indeed the types of aid programmes which have borne the brunt of the reductions in the UK Aid budget.

• How effectively does BII manage funds following its initial investment?

• How does BII evaluate the impact of its investments?

In recent years FCDO/DFID has chosen to invest large sums of money from the aid budget in CDC (and, to a lesser extent, AgDevCo) but they seem to have done very little to preserve the concept of additionality in either organisation.  CDC seems to have persuaded DFID/FCDO that it could not change its investment strategy to use its balance sheet to invest in businesses which serve the bottom of the pyramid, and that it needed additional capital to do so (through its Catalyst portfolio). However “additionality” – as I knew it in the CDC of old – used to require CDC to ensure that its capital was filling a gap that could or would not be met by the market. In other words, making investments in exactly the sort of businesses that CDC’s Catalyst programme invests in – for which it was given new money from the aid budget despite having more than ample financial resources at its disposal!.

For example, CDC recently announced a huge investment commitment of $320 million in partnership with Dubai Ports (DP World) to invest in port redevelopment in Somaliland, Egypt and Senegal. This commitment may rise to more than $700 million.  With the best will in the world, where is the additionality in that deal?  Do we believe that DP World did not have alternative sources of project finance?  One might say the same about another recently-announced CDC deal in the Safaricom-led Ethiopia telecoms consortium.  I can certainly see that these projects will deliver positive developmental impact, both direct and indirect – no question – but is this a good use of CDC’s cash balances, not forgetting that CDC is receiving aid transfers from FCDO?  Imagine what that $320 million might have been able to do for the health, education, and WASH sectors in Africa and South Asia, the types of programmes which have borne the brunt of the cuts in the UK Aid budget.

(At AgDevCo, the situation is arguably worse, if on a smaller scale).  While AgDevCo is making investments in agriculture-related businesses in Africa, it has shifted its investment policy away from “social venture capital”, as it used to say, towards the much vaguer statement “we are long term partners for growth and impact”. On closer inspection, it no longer mentions additionality as a criterion for investment, and in at least one of its recent investments[2] it has actually replaced commercial bank finance by offering cheaper loans. In other words, UK aid money is crowding out – not crowding in – private capital, and there is zero additionality.) 

Conclusion

and restore its focus on additionality and supporting economic growth in poorer countries (including the development of SMEs by supporting entrepreneurship and SME-focused funds as well as larger businesses). To do this will require a full overhaul of its investment strategy and, I would argue, no further allocations from the aid budget.  CDC functioned very well for a long period through the 1980s and 1990s without receiving any support from the Government of the day and, to be honest, its current challenges are to a large extent driven by growth. As its balance sheet has grown, it has focused attention on larger and larger transaction sizes, and moved away from the sort of pioneering work which underpinned so many of its investment and impact successes in the past.

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