IFC financial intermediary lending: cause for complaint?

14 June 2011

A case filed by communities in India has prompted the first internal probe of the International Finance Corporation (IFC), the Bank’s private sector arm, for its lending through financial intermediaries, highlighting concerns about the transparency and effectiveness of this lending.

In April, the IFC’s internal grievance mechanism, the Compliance Advisor Ombudsman (CAO), reacted to rising concerns about the institution’s use of intermediaries, such as banks and private equity firms (see Update 73), by announcing a review of financial sector investments. The review will focus on whether the IFC’s social and environmental assurance process – which includes the IFC’s minimum performance standards (see Update 74, 71) – is working for financial sector investments, which now account for around half of IFC activity. Initially, a sample of investments will be studied, with the assessment due by end 2011.

In May, the temperature of this review was raised after the CAO deemed a complaint about IFC lending through financial intermediaries eligible for assessment – the first time this has happened. Community groups in the Indian state of Odisha (formerly Orissa) filed the case against the IFC, complaining of negative social and environmental impacts of the Kamalanga coal power plant. This plant is run by GMR Kamalanga Energy Limited (GKEL), who received financing from the private equity India Infrastructure Fund, who themselves received a $100 million equity investment from the IFC in 2008.

The complainants also allege that the company did not adhere to legally mandated procedures when acquiring land, has not offered proper compensation, and that it used intimidation and force. Amulya Nayak, of community group Odisha Chas Parivesh Surekhsa Parishad, said “the company never shows any regard for community health. It ignores villagers’ requests to not dump its garbage [next] to adjacent agricultural lands. GKEL employs dynamite blasting at the project site, which causes cracks in nearby houses and [the] primary school building. [The] project also extracts [a] huge water volume and we witness in our bore wells the depleting water level, which is the main source of drinking, cooking and washing for thousands of families.”

“Our inability to secure the most fundamental information about this [financial intermediary] loan … shows [the] IFC does not practise its supposed commitment to transparency”, added Vijayan MJ of NGO Delhi Forum, which is one of the complainants. The CAO will first make an attempt to mediate between the parties, but if no resolution can be reached, a full investigation will be launched.

Private equity boom

Over the past few years the IFC has become an active investor in private equity funds. It signalled its intention to make this model core to its global business by announcing in March a raft of new investors in its infrastructure-focussed African, Latin American, and Caribbean Fund (ALC). The IFC has chipped in $200 million itself, with an additional $600 million contributed by others, including the Dutch pension fund manager PGGM, Korea Investment Corporation, the State Oil Fund of the Republic of Azerbaijan, a Saudi pension fund, and the United Nations Joint Staff Pension Fund. The IFC hopes to eventually raise $1billion for this ALC fund, to invest in infrastructure projects in ‘frontier’ middle-income countries — excluding China, Brazil and India. Jeroen Kwakkenbos of NGO Eurodad said, “there’s grave concern about channeling development aid into these types of private funds. Nobody really knows where this money is going to end up and if is going to help the people who really need it.”

The IFC’s Asset Management Company (AMC) manages the fund. The AMC is a wholly owned subsidiary of the IFC, and is headquartered in Delaware in the United States, a tax haven which holds the top spot in international NGO the Tax Justice Network’s financial secrecy index of jurisdictions that are most aggressive in providing secrecy in international finance, and which most actively shun co-operation with other jurisdictions.

Headed by former Goldman Sachs investment banker Gavin Wilson, the AMC was established in 2009 to manage funds that draw in capital from outside the IFC (see Update 66). The AMC is a growing part of the IFC’s portfolio, also managing a $3 billion IFC Capitalization Fund, and a $200 million Africa Fund. The AMC co-invests in projects and companies that the IFC is already supporting. However, much of the external finance for these other funds comes from public institutions, including $2 billion for the Capitalization Fund from the Japan Bank for International Cooperation, and investments in the Africa Fund from the UK’s Department DFID and the European Investment Bank (EIB). The IFC charges market rates to investors for its management of their funds. Private investors in the AMC are only named if they agree to this. Most of the investments will be in banks and the financial sector for on-lending, a practice that civil society groups’ have said raises concerns over reduced transparency, accountability and environmental and human rights standards (see Update 73).

Water equity?

Meanwhile, the IFC drew fire from campaigners for a $20 million equity investment in the $100 million Asia Water Fund (AWF), fuelling the controversy that has long surrounded the World Bank’s support for private sector involvement in water (see Update 72, 69, 62). As with many private equity funds, the structure is complicated and designed to facilitate tax avoidance or evasion, according to campaigners. The fund itself and the fund manager will both be domiciled in the Cayman Islands. The Cayman Islands ranks fourth in the Tax Justice Network’s financial secrecy index, cementing campaigners’ complaints that the IFC’s policy on tax havens is inadequate (see Update 74, 73). Seventy per cent of investments will be in China, where there is little shortage of investment in water, highlighting continued concerns about IFC ‘additionality’ – the extra value of the IFC compared with other sources of finance (see Update 73). Joby Gelbspan, of US NGO Corporate Accountability International, said “this is a terrible case of corporate tax evasion backed by public institutions. In addition, the focus on public-private partnerships and the lack of transparency raise concerns that this will do little to support citizen’s right to water.”

IFC: on the right track?

An April paper, Growing Business or Development Priority, by Guillermo Perry of Washington-based think tank the Center for Global Development, confirmed that “[Multilateral Development Bank (MDB)] operations in direct support of private firms in developing countries, which receded in aggregate terms in 2009 … are returning to rapid growth and will continue to increase their share in overall MDB activities.” The paper noted the irony that “MDBs were until recently advising developing countries against using public national development banks to lend directly to private firms and recommending privatising, liquidating, or transforming these institutions into nonbanking developmental agencies.”

The paper argues that if the MDBs are to use financial intermediaries to reach micro, small and medium-sized businesses, then “one should see more focus on firms in countries with less developed local financial markets (which are usually the lower‐income‐per‐capita countries), as such firms are more likely to be financially constrained and without access to risk management products.” However, previous research has confirmed that only a small percentage of IFC investments are in such countries (see Update 73).

The increasing focus of development finance on the private sector, including money provided by the World Bank, was the subject of an international conference of civil society groups hosted by NGO Eurodad in Rome in May. Commenting on the rising influence and activity of private investors and financial companies in development finance, Richard Ssewakiryanga of the Uganda National NGO Forum asked: “How is it possible that the people who misbehaved so badly three years ago are now, in the aftermath of the global crisis, given the power to lead development?”