IFI governance

Background

IFC and Financial Intermediary Lending

18 April 2011 | Minutes

Joe Athialy, BIC

  • 229 IFC active FI projects in India, 56% category B
  • Majority are microfinance
  • Problematic loans include Infra Dev Fin Corp etc
  • Include large energy and infrastructure projects – IDFC has 40 coal/ gas power projects
  • IFC funding mainly partial – difficult to trace the flow of IFC finance: little information from either IFC or client.
  • Pattern is that insitutions get IFC loan early in the cycle – gives them credibility and allows them to leverage larger inputs from others
  • IFC must take moral responsibility for whole financing package
  • Communities have little information or ways of seeking redress for grievances.

Vijayan M.J., Delhi Forum

  • Case study from India – funding of India Infrastructure Fund (IIF) managed by IDFC – outlines concerns and how communities are treated as ping pong balls between IFC and clients
  • Money becomes invisible the moment it leaves IFC – taken a lot of work to pull this case study together.
  • Believe that the GMR power project should have been a category A project if it were directly funded by the IFC.
  • Project demonstrates absence of fundamental standards of human rights, sustainability, spared from safeguards and accountability. Development effectiveness is highly questionable.

Issues

  • Failure to disclose fundamental information – communities unable to secure information about FI projects funded by IFC – despite requests to IFC India mission. Little information available on the IFC website – only vague information, mentions size of investment.
  • Until Delhi Forum informed community, they had no idea that World Bank money was included in the project.
  • Lack of due diligence – before and after approving loans. Impact assessment is done by client-appointed agencies – stand to gain from hiding costs.
  • No effort to take into account ‘cumulative impact assessment’ of a region. Indian government has classified whole region as a dead habitat – ‘critical area’
  • Pollution and water contamination – located close to Brahami (sp?) river.
  • Serious violation of social environmental and human rights safeguards – no information about impact assessment publicly available. Indian consitution requires communities get to be involved in planning.
  • Rehabilitation and resettlement issues – 300 families: IFC didn’t seem to be aware of this issue
  • Loss of commons, ecosystem and habitat alike
  • Other issues of safety and security – harrassment of people protesting by state and GMR – has appointed private security firm, blocking traditional rights of way. Girls have stopped going to school because they don’t want to be frisked by security guards.
  • IFC response is – OK what is the problem now? Bank does itself injustice in not recognising it is their problem. IFC response – can’t give you more information; Chinese banker threat; IFC comes in very late into these projects;have an agreement with the client so we can’t give you any information.

Anne Perrault, CIEL

  • FI lending is nearly half of IFC lending – what standards should apply?
  • Communities are struggling to work out what is going on – why is this true?
  • For same types of projects, unlike for direct investments, FI projects have: no presumption of disclosure; no information before approval; high risk – only periodically; medium risk sub-projects – the public will never know anything.
  • Same types of projects – palm oil, mining, roads
  • Unlike direct investments, FI are required to apply standards to high risk projects only – less than 10% of FI portfolio. 35% are medium risk – no performance standards.
  • And category B’s too frequently miscategorised (should be As)
  • FI client determines the categorisation.
  • Risk management – IFC relinquishes responsibility to FI. Motivation for Private equity to do this are very low. FIs will have willingness and capacity issues in dealing with this.
  • Greatest lending of volume is to MIC banks
  • ADB, OPIC don’t shift responsibilities to FI client – they know better than to do this.

John Crutcher, private equity attorney

  • Have represented private equity firms – their motivation is to make money; that is their job
  • What tools are there to address the concerns about the use of PE?
  • In its purest form, PE is ownership of and transactions in assets where the party in question has not relied upon funds from public stock market.
  • Why might DFI use PE?
  • Pool funds from other groups
  • Take advantage of expertise
  • Subcontract to groups with more experience
  • Leverage – by attracting other investment
  • Fund is typically started by General Partner who attracts Limited Partners – relationship governed by Partnership Agreement. Fund is then run by management company – normally the same as the general partner.
  • Partnership agreement is thus the keystone – includes investment guidelines (where they will and won’t invest, amounts etc) reporting duties, veto and opt out rights, information and observer rights, expense allocations, return allocations

Issues raised

  • Partnership agreement drafted by GP then negotiated with key LPs. LPs can insert their preferences – key to be part of this negotiation. LP with concerns will either want to get in early or have enough leverage to get it amended
  • Transparency
  • Inappropriate investment
  • Poor diligence
  • Poor management

Proposals

  • DFI investment objectives not aligned with other players. Other players are in it for money – different motives. You won’t find a financial investor who will accept reduction of returns: (a)Need to dollarise non-financial investment e.g. environmental standards – other partners could agree to these if DFI offsets cost implication; (b) DFI takes on some responsibility for these
  • If investments not aligned to DFI mission: (a) narrow agreement in partnership agreement to prevent this; (b) opt out rights

Transparency

  • PE not a mechanism for denial of information – just a way of structuring. Lack of transparency will arise from requirements of investors
  • Get in early to negotiate agreement
  • Pick the right funds
  • Negotiate, negotiate, negotiate – no investors are going to roll over on provision of information: DFI needs to detail issues that are not transparent (everything but) vs enumerated list: either way requires participation in negotiation.
  • If another LP has reservations, can built a special purpose vehicle to isolate them from having to give information from parent.

DFI-Funded bad investments (bad management, due diligence etc)

  • DFIs are particularly vulnerable
  • Address at the pre-funding stage

Various other problems, but similar solutions. For example can have indemnification provisions.

Diligence/ verification / monitoring

  • Needs to be: extensive; big diligence request list – exhaustive and expensive; accountants; physical visits; data rooms; meeting key people; supplemental diligence request lists.
  • May be expensive up front – but essential to stop things going wrong.

Matters identified are: remedied, costed and baked in / carved out; idemnified for
Typical transaction representation – parties have to provide full information

After the deal – need information rights, reporting requirements, access rights etc

Summary

  • DFI + PE is not a square peg – it just needs a good woodsmith to get it right.
    not PE that matters – what it is, what’s done with it and how it’s done that matters.

Stephanie Fried

  • Not seeing the kind of hard fought battles on the partnership agreements from the IFC that the private sector does.
    Indemnification seems important – clawing back money if there are safeguard violations. IFC must get this in the partnership agreement.

ADB and OPIC standards

  • ADB – after 5 years of consultations, new rules. Handles same kind of PE funds as IFC
  • For example Asian Infrastructure – domiciled in Cayman Islands – now requires 120 day disclosure for all subprojects likely to have significant impacts
  • Must meet safeguard requirements; require that these subprojects are referred to ADB early on, and ADB assists with assessment; ADB also specifies conditions on which project may proceed. ADB has to approve any subproject with significant project
  • IFC don’t even have approval of high risk subprojects

OPIC

  • Subprojects screened and subject to full safeguards
  • Taken back responsibility for managing risk from FI
  • Can add supplemental standards when they need to
  • Sharply limit definition of business confidentiality
  • EITI criteria for projects over $10 million