CDC: going offshore to help the poor?
In 1948, under the premiership of Clement Atlee, the British Government created CDC (the Colonial Development Corporation). Being pretty much what it said on the tin, CDC's initial mandate was to strengthen the economies of the former UK colonies by providing finance for businesses.
In following decades CDC changed its name to Commonwealth Development Corporation and invested directly into emerging Commonwealth businesses, helping to provide financial backing in sectors which purely commercial investors wouldn’t touch. The result was important: the development of business and industry in territories which otherwise struggled to attract investment, and so languished in poverty. In 1969 it was given the authority to invest outside of the Commonwealth, thus extending its programme of assistance to some of the poorest nations in the world.
For decades CDC was a feather in the cap of the British Government. Quasi-independent as a statutory corporation, it was closely affiliated with the ODA (Overseas Development Administration), a wing of the Foreign and Commonwealth Office. From 1948 to 1997 CDC invested directly in emerging economies, aiding the development of some of the most deprived places on Earth.
The election of Tony Blair in 1997 marked a sea change in British development policy. The ODA was renamed DfID (the Department for International Development) and CDC was transformed. Renamed and reclassified as CDC Group Plc, it ceased to be a statutory corporation and became a Public Private Partnership. CDC is now an “arms-length corporation” – Dfid owns it outright, but CDC’s board of directors are independent. Dfid will occasionally “direct” CDC – but for the most part it operates as an independent company.
This was Blair’s continuation of privatisation policies, applied to international development. Rather than investing in the developing world directly, since 2004 CDC has been directed to act as a global “fund of funds” in the private equity market. This means CDC’s role is to invest money in “fund managers”, who are charged with investing that CDC money (plus other money they can raise from private investors) into “investee companies” in developing nations. The fund managers receive a rate of return on their investments in investee companies, and a proportion of this is paid back to CDC relative to what was originally put in. This is the private equity model applied to international development.
The rationale for the switch is indicative of the fin-de-siècle consensus. Direct investment was seen as out-dated, and development was thought best achieved via speculative investments motivated by maximisation of returns. The system that (until August 2007) seemed to be working so well for global laissez faire capitalism.
But does this model work for international development? It depends what you mean by “work”. CDC has done extraordinarily well since 1997 – in terms of generating returns on its investments. It has beaten the market every year except 2003 (which, strangely enough, was the year before independent and privately controlled investment fund Actis was spun out of CDC, and 60% of its shares sold to former CDC affiliates for the bargain price of £340,000).
Despite having a torrid year in 2008 – and given the global economic meltdown, that is hardly surprising – it still outperformed the market indices. When the Public Accounts Committee published its report on CDC in April of this year, CDC was sitting on a whopping £1.4billion of un-invested cash, and from 2004 to mid-2008, CDC’s net assets had more than doubled from £1.1billion in 2004 to £2.7billion.
Considering CDC had been loss-making on average for 8 years prior to this, it appears that the private equity model is working well - for CDC. Whether it’s working well for developing nations is another question entirely. CDC claim that:
Our investment is aimed at the private sector, as the engine of growth. The scarcity of long term risk capital, particularly equity capital, is one of the factors which constrains the private sector in the developing world.[1]
Accordingly it can be argued that private equity investment is essential to development: no private equity, no private sector growth, no development. Yet the House of Commons Public Accounts Committee 2009 report on CDC was unconvinced that this approach was yielding significant gains in poverty reduction:
Although CDC invests more of its resources in poor countries than any other Development Finance Institution, there is limited evidence of CDC's effects on poverty reduction.”[2]
The reasons for this are multiple. Partly, there has been some evidence that CDC’s fund managers have targeted nations like China and India which, whilst classed over-all as developing, have pockets of business and industry which are already extremely developed – and offer attractive rates of return to the private investor. As the PAC noted:
Since 2004, a growing proportion of CDC's portfolio...has been deployed in Nigeria, South Africa, India and China. These countries contain some 62% of the world's poor and include some very poor districts, but they also contain well established locations for foreign private investment. Because CDC uses fund managers to invest on its behalf, it has less ability to direct its money to disadvantaged districts within a country than if it were a direct investor identifying its own opportunities using its own staff...[W]hen funds come up with first-class commercial propositions in urban areas, CDC is constrained as to how far it can direct the fund managers elsewhere.”[3]
In fairness to CDC, post 2009 its investments are to be directed increasingly out of India and China – but the fundamental problem of how to target investment remains.
For it remains unclear whether investing in independent fund managers is a productive way to generate development. A fund manager’s goal is to maximise returns to an investment. This means investing money where it’s likely to make the most profit – and there’s no guarantee that the investments which turn the most profit are those that do the most to alleviate poverty. As a purely hypothetical example, imagine I’m a fund manager and I can choose to invest (using, in part, money invested in me by CDC) in either a golf course in Kenya, or a water sanitisation plant in Liberia. The former is likely to yield higher returns than the latter – so which do I go for?
The problem is, CDC can’t direct me to invest in the latter on the grounds that it’s most conducive to development. CDC doesn’t do that, under the private equity model. It simply puts money in fund managers, who then put it into investee companies in the developing world. Of course, if you are of the opinion that “all investment is equal, because all investment leads to development”, then you’ll have no problem with this model. If you believe that investing in water sanitisation is manifestly more conducive to development than investing in golf courses, then the hands-off CDC approach may seem considerably less desirable.
And it gets even trickier. CDC claims that:
We require all our fund managers to subscribe to our best practice policy covering health and safety, environmental, social and governance issues.
Which sounds very grand. But the problem is, CDC has no mechanism – as far as this blogger is aware - for ensuring that their fund managers do comply with these “best practices”. To this blogger’s knowledge, there is not one single example of CDC withdrawing funds from a fund manager on the grounds of violation of “best practice policy”.
Although CDC has some knowledge of the investee companies its fund managers use, it’s not clear that CDC money isn’t finding its way into investee companies that exploit their workforces by, for example, paying them slave wages or forcing them to work in unsafe conditions. Again, it must be stressed: we do not know that this is the case – we simply lack a guarantee that it is not the case. And that is worrying.
Of course, if we were able to obtain the accounts for CDC’s fund managers’ investment companies, then we’d be more able to check that the businesses receiving CDC cash are scrupulous. Yet appeals to CDC for investee company accounts will result in your being told that either CDC don’t hold the accounts or that even if CDC does hold the accounts, it can’t release them due to commercial confidentiality.
This argument is not completely implausible. So, naturally, one applies to Dfid – CDC’s 100% shareholder – for the accounts. Except that won’t work either. All Dfid will provide is a sample list of CDC investee companies – and none of them with accounts.
If these investee companies were UK registered companies, their accounts would be a matter of public record – but they’re not, so they’re not. Yet this lack of accounting transparency points to another dark patch in CDC’s present constitution.
As a development organisation which ostensibly exists to alleviate poverty, CDC will no doubt agree that taxes are essential for development. The governments of developing nations need secure tax revenues so that they can invest in the basic infrastructure required to move out of poverty.
However, at present we have no guarantee that CDC’s investee companies are paying their fair share of taxes in developing nations – how can we, when we don’t have their accounts? CDC has claimed that it’s 600 plus investee companies paid £250 million in tax to developing nation governments[4] - but this figure is based on information supplied by fund managers.
Information which – without the relevant accounts – CDC simply cannot verify. How many CDC investee companies are shifting their profits off-shore, depriving developing world governments of much-needed revenue? We simply don’t know. But given the prevalence of tax avoidance and evasion in many developing nations – which are estimated to lose revenue amounting to $160 billion annually just arising from transfer mispricing and false invoicing – the fact that we don’t know is cause for alarm.
And it’d doesn’t stop there. According to the PAC report, 40 of CDC’s 72 fund managers are themselves based offshore[5]. CDC claim that this is because:
The reason for investing through offshore centres is to help attract third-party money to increase the amount of long-term capital invested in developing countries. This is a common way of structuring private-equity investment involving investors from different tax jurisdictions to make sure they do not get taxed twice.[6]
We might be a little quizzical at CDC’s insistence that investors don’t get taxed twice – after all, if tax promotes development, does not more tax mean more development? In fairness, CDC might reply that such gains would be more than offset by the discouragement of investors who don’t want to be taxed twice. But that is the purpose of having double taxation agreements, which now cover most countries.
Yet there is a deeper problem here. CDC is a development organisation, but it invests money in fund managers based offshore in tax havens (we prefer the term "secrecy jurisdictions") despite the fact that secrecy jurisdictions are at the heart of the processes of capital flight, which is the very antithesis of development. It’s through secrecy jurisdictions that corporations and individuals remove wealth from developing nations and spirit it into western bank accounts. According to PERI (the Political Economic Research Institute at University of Massachusets, Amherst) the scale of outbound illicit financial flows from Africa runs to hundreds of billions:
Real capital flight over the 35-year period amounted to about $420 billion (in 2004 dollars) for the 40 countries as a whole. Including imputed interest earnings, the accumulated stock of capital flight was about $607 billion as of end-2004.
Again, we cannot prove that CDC’s investee companies or fund managers engage in tax avoidance and evasion, or that they facilitate capital flight out of the developing world.
Of course, if CDC or Dfid revealed the investee company accounts, we’d be closer to knowing one way or the other. In lieu of such disclosure, we must raise serious questions about the consistency and appropriateness of a development organisation which sees fit to put money into fund managers based in secrecy jurisdictions, who invest in companies whose accounts we are denied access to.
We must ask whether this is really the most appropriate development strategy Britain can pursue in investment terms – and what sort of a message we are sending to the rest of the world.
And we must wonder why CDC continues to put money into the offshore system, 10 years after then Minister for International Development Claire Short said this:
It is obvious that the CDC has to be able to compete with offshore funds, if it is to achieve its goal of investing in developing countries using capital raised in a competitive private investment market dominated by offshore funds. From the start, it was clear to me at least that it would be unacceptable for a major instrument of the UK's development policy to be based offshore.”[7]
SOURCES:
[1] http://www.cdcgroup.com/development_philosophy.asp
[2] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9404.htm
[3] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9406.htm
[4] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9405.htm
[5] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9405.htm
[6] http://www.guardian.co.uk/business/2008/nov/24/taxavoidance
[7] http://www.publications.parliament.uk/pa/cm199899/cmhansrd/vo990524/debtext/90524-11.htm
In following decades CDC changed its name to Commonwealth Development Corporation and invested directly into emerging Commonwealth businesses, helping to provide financial backing in sectors which purely commercial investors wouldn’t touch. The result was important: the development of business and industry in territories which otherwise struggled to attract investment, and so languished in poverty. In 1969 it was given the authority to invest outside of the Commonwealth, thus extending its programme of assistance to some of the poorest nations in the world.
For decades CDC was a feather in the cap of the British Government. Quasi-independent as a statutory corporation, it was closely affiliated with the ODA (Overseas Development Administration), a wing of the Foreign and Commonwealth Office. From 1948 to 1997 CDC invested directly in emerging economies, aiding the development of some of the most deprived places on Earth.
The election of Tony Blair in 1997 marked a sea change in British development policy. The ODA was renamed DfID (the Department for International Development) and CDC was transformed. Renamed and reclassified as CDC Group Plc, it ceased to be a statutory corporation and became a Public Private Partnership. CDC is now an “arms-length corporation” – Dfid owns it outright, but CDC’s board of directors are independent. Dfid will occasionally “direct” CDC – but for the most part it operates as an independent company.
This was Blair’s continuation of privatisation policies, applied to international development. Rather than investing in the developing world directly, since 2004 CDC has been directed to act as a global “fund of funds” in the private equity market. This means CDC’s role is to invest money in “fund managers”, who are charged with investing that CDC money (plus other money they can raise from private investors) into “investee companies” in developing nations. The fund managers receive a rate of return on their investments in investee companies, and a proportion of this is paid back to CDC relative to what was originally put in. This is the private equity model applied to international development.
The rationale for the switch is indicative of the fin-de-siècle consensus. Direct investment was seen as out-dated, and development was thought best achieved via speculative investments motivated by maximisation of returns. The system that (until August 2007) seemed to be working so well for global laissez faire capitalism.
But does this model work for international development? It depends what you mean by “work”. CDC has done extraordinarily well since 1997 – in terms of generating returns on its investments. It has beaten the market every year except 2003 (which, strangely enough, was the year before independent and privately controlled investment fund Actis was spun out of CDC, and 60% of its shares sold to former CDC affiliates for the bargain price of £340,000).
Despite having a torrid year in 2008 – and given the global economic meltdown, that is hardly surprising – it still outperformed the market indices. When the Public Accounts Committee published its report on CDC in April of this year, CDC was sitting on a whopping £1.4billion of un-invested cash, and from 2004 to mid-2008, CDC’s net assets had more than doubled from £1.1billion in 2004 to £2.7billion.
Considering CDC had been loss-making on average for 8 years prior to this, it appears that the private equity model is working well - for CDC. Whether it’s working well for developing nations is another question entirely. CDC claim that:
Our investment is aimed at the private sector, as the engine of growth. The scarcity of long term risk capital, particularly equity capital, is one of the factors which constrains the private sector in the developing world.[1]
Accordingly it can be argued that private equity investment is essential to development: no private equity, no private sector growth, no development. Yet the House of Commons Public Accounts Committee 2009 report on CDC was unconvinced that this approach was yielding significant gains in poverty reduction:
Although CDC invests more of its resources in poor countries than any other Development Finance Institution, there is limited evidence of CDC's effects on poverty reduction.”[2]
The reasons for this are multiple. Partly, there has been some evidence that CDC’s fund managers have targeted nations like China and India which, whilst classed over-all as developing, have pockets of business and industry which are already extremely developed – and offer attractive rates of return to the private investor. As the PAC noted:
Since 2004, a growing proportion of CDC's portfolio...has been deployed in Nigeria, South Africa, India and China. These countries contain some 62% of the world's poor and include some very poor districts, but they also contain well established locations for foreign private investment. Because CDC uses fund managers to invest on its behalf, it has less ability to direct its money to disadvantaged districts within a country than if it were a direct investor identifying its own opportunities using its own staff...[W]hen funds come up with first-class commercial propositions in urban areas, CDC is constrained as to how far it can direct the fund managers elsewhere.”[3]
In fairness to CDC, post 2009 its investments are to be directed increasingly out of India and China – but the fundamental problem of how to target investment remains.
For it remains unclear whether investing in independent fund managers is a productive way to generate development. A fund manager’s goal is to maximise returns to an investment. This means investing money where it’s likely to make the most profit – and there’s no guarantee that the investments which turn the most profit are those that do the most to alleviate poverty. As a purely hypothetical example, imagine I’m a fund manager and I can choose to invest (using, in part, money invested in me by CDC) in either a golf course in Kenya, or a water sanitisation plant in Liberia. The former is likely to yield higher returns than the latter – so which do I go for?
The problem is, CDC can’t direct me to invest in the latter on the grounds that it’s most conducive to development. CDC doesn’t do that, under the private equity model. It simply puts money in fund managers, who then put it into investee companies in the developing world. Of course, if you are of the opinion that “all investment is equal, because all investment leads to development”, then you’ll have no problem with this model. If you believe that investing in water sanitisation is manifestly more conducive to development than investing in golf courses, then the hands-off CDC approach may seem considerably less desirable.
And it gets even trickier. CDC claims that:
We require all our fund managers to subscribe to our best practice policy covering health and safety, environmental, social and governance issues.
Which sounds very grand. But the problem is, CDC has no mechanism – as far as this blogger is aware - for ensuring that their fund managers do comply with these “best practices”. To this blogger’s knowledge, there is not one single example of CDC withdrawing funds from a fund manager on the grounds of violation of “best practice policy”.
Although CDC has some knowledge of the investee companies its fund managers use, it’s not clear that CDC money isn’t finding its way into investee companies that exploit their workforces by, for example, paying them slave wages or forcing them to work in unsafe conditions. Again, it must be stressed: we do not know that this is the case – we simply lack a guarantee that it is not the case. And that is worrying.
Of course, if we were able to obtain the accounts for CDC’s fund managers’ investment companies, then we’d be more able to check that the businesses receiving CDC cash are scrupulous. Yet appeals to CDC for investee company accounts will result in your being told that either CDC don’t hold the accounts or that even if CDC does hold the accounts, it can’t release them due to commercial confidentiality.
This argument is not completely implausible. So, naturally, one applies to Dfid – CDC’s 100% shareholder – for the accounts. Except that won’t work either. All Dfid will provide is a sample list of CDC investee companies – and none of them with accounts.
If these investee companies were UK registered companies, their accounts would be a matter of public record – but they’re not, so they’re not. Yet this lack of accounting transparency points to another dark patch in CDC’s present constitution.
As a development organisation which ostensibly exists to alleviate poverty, CDC will no doubt agree that taxes are essential for development. The governments of developing nations need secure tax revenues so that they can invest in the basic infrastructure required to move out of poverty.
However, at present we have no guarantee that CDC’s investee companies are paying their fair share of taxes in developing nations – how can we, when we don’t have their accounts? CDC has claimed that it’s 600 plus investee companies paid £250 million in tax to developing nation governments[4] - but this figure is based on information supplied by fund managers.
Information which – without the relevant accounts – CDC simply cannot verify. How many CDC investee companies are shifting their profits off-shore, depriving developing world governments of much-needed revenue? We simply don’t know. But given the prevalence of tax avoidance and evasion in many developing nations – which are estimated to lose revenue amounting to $160 billion annually just arising from transfer mispricing and false invoicing – the fact that we don’t know is cause for alarm.
And it’d doesn’t stop there. According to the PAC report, 40 of CDC’s 72 fund managers are themselves based offshore[5]. CDC claim that this is because:
The reason for investing through offshore centres is to help attract third-party money to increase the amount of long-term capital invested in developing countries. This is a common way of structuring private-equity investment involving investors from different tax jurisdictions to make sure they do not get taxed twice.[6]
We might be a little quizzical at CDC’s insistence that investors don’t get taxed twice – after all, if tax promotes development, does not more tax mean more development? In fairness, CDC might reply that such gains would be more than offset by the discouragement of investors who don’t want to be taxed twice. But that is the purpose of having double taxation agreements, which now cover most countries.
Yet there is a deeper problem here. CDC is a development organisation, but it invests money in fund managers based offshore in tax havens (we prefer the term "secrecy jurisdictions") despite the fact that secrecy jurisdictions are at the heart of the processes of capital flight, which is the very antithesis of development. It’s through secrecy jurisdictions that corporations and individuals remove wealth from developing nations and spirit it into western bank accounts. According to PERI (the Political Economic Research Institute at University of Massachusets, Amherst) the scale of outbound illicit financial flows from Africa runs to hundreds of billions:
Real capital flight over the 35-year period amounted to about $420 billion (in 2004 dollars) for the 40 countries as a whole. Including imputed interest earnings, the accumulated stock of capital flight was about $607 billion as of end-2004.
Again, we cannot prove that CDC’s investee companies or fund managers engage in tax avoidance and evasion, or that they facilitate capital flight out of the developing world.
Of course, if CDC or Dfid revealed the investee company accounts, we’d be closer to knowing one way or the other. In lieu of such disclosure, we must raise serious questions about the consistency and appropriateness of a development organisation which sees fit to put money into fund managers based in secrecy jurisdictions, who invest in companies whose accounts we are denied access to.
We must ask whether this is really the most appropriate development strategy Britain can pursue in investment terms – and what sort of a message we are sending to the rest of the world.
And we must wonder why CDC continues to put money into the offshore system, 10 years after then Minister for International Development Claire Short said this:
It is obvious that the CDC has to be able to compete with offshore funds, if it is to achieve its goal of investing in developing countries using capital raised in a competitive private investment market dominated by offshore funds. From the start, it was clear to me at least that it would be unacceptable for a major instrument of the UK's development policy to be based offshore.”[7]
SOURCES:
[1] http://www.cdcgroup.com/development_philosophy.asp
[2] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9404.htm
[3] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9406.htm
[4] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9405.htm
[5] http://www.publications.parliament.uk/pa/cm200809/cmselect/cmpubacc/94/9405.htm
[6] http://www.guardian.co.uk/business/2008/nov/24/taxavoidance
[7] http://www.publications.parliament.uk/pa/cm199899/cmhansrd/vo990524/debtext/90524-11.htm
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