Notes of IFC-CSO discussion of CAO financial markets audit

Notes of a meeting from 19 April 2013

17 May 2013 | Minutes


IFC has published its response to a letter from a number of NGOs sent to President Kim. A letter from President Kim and a more detailed response from James Scriven and Bill Bulmer was sent and copies were handed out in the meeting.

James Scriven, IFC’s Director of Financial Markets began the meeting by noting that IFC has had a number of discussions with civil society in the context of the review of IFC’s Sustainability Framework and on its work with FIs. He also said that IFC will continue to engage with civil society and will plan other consultations in Europe and Asia. To date, James said the tone of the conversation has been very open, constructive and professional. James also discussed the recent meeting with CODE, where there was a very good discussion of IFC’s FI lending. The response to CSOs includes much of James’s remarks to CODE. James began the session by setting the context of why IFC works with the financial sector. Below are the highlights of those remarks:

  • Important to stress that there are 2.5 billion adults and 200 million small businesses that could pay for financial services but do not have access to them. So we’re in the business of providing financial inclusion.
  • SMEs say the biggest constraint for SMEs in emerging markets is access to finance, saving accounts, credit, and insurance. This is very aligned with what JYK aims for in poverty reduction and job creation. Also a study saying financial markets translate investments into jobs.
  • 50% of IFC’s FI business is in IDA countries.
  • The biggest concern we’ve always heard is the impact of FI lending on the environment. Most of our FI investments have low impact on the environment. There is some business that we do in the financial sector that could be called high risk (corporate lending or funds) – this is only roughly 10%. Most of our work is in SMEs and microfinance – they have a much lower or no impact on the environment.
  • If there is any reluctance by banks to abide by our standards or to enhance their ESMS, then we don’t engage. The ESMS is tailored to each institution.
  • IFC does know what’s in our portfolio. We do look at our clients’ portfolios on a regular basis. For areas of higher risk we visit once a year and also do audits of sub-level projects. For lower risk we visit once every three years.
  • We include covenants to our legal agreements. If the client does not abide by these, IFC can exit.
  • We are ramping up our advisory services to help clients improve their capacity.
  • We are also exploring carrots and sticks (like FMO).James cited a few examples:
    1. In Latin America, a bank moved from mortgage to corporate loans, which increased the risk. The bank transformed when IFC threatened not to go ahead with a new transaction.
    2. We were not comfortable with the ESMS in place in the subsidiary of a European bank. IFC is selling our stake. Will cost money and hurt IFC but it is the right thing to do.
    3. One client didn’t understand why standards are important – 5 years later, they have a great system and implementation and have now signed the Equator Principles.
  • It is important to note that we don’t operate in Wall Street or in developed countries – we operate in difficult countries – a lot of financial institutions ask why we need to apply standards when local laws don’t require that.
  • We do believe we’re leaders among other DFIs. A lot have adopted our standards.
  • IFC has ramped up its capacity to support the E&S review and supervision function for its FI business and has seen a significant improvement from an IEG report of a few years back where our implementation gap was over 50%. IEG’s assessment of IFC’s improved work quality at appraisal (84%) and supervision (86%) for the period 2010-12, is reflective of this attention and focus.
  • In the future, we will continue to engage with the CAO and civil society.

Bill Bulmer, IFC Director for the Environmental, Social and Governance Department then discussed IFC’s approach to supervision. Below are highlights of those remarks:

    • IFC has big development objectives in relation to access to finance.
    • We follow a risk-based approach. FIs providing long term funding such as corporate and project finance for high risk projects are required to have these projects apply the Performance Standards.
    • Sometimes the FI does not have a long-term relationship with its client, and has no reasonable way to impose lending conditionality through covenants. In these situations we have screening criteria. For example, this is the case for trade finance for high-risk commodities.
    • As James indicated, less than 10% of our FI clients are lending money to provide capital for high-risk projects. Most is deemed lower risk.
    • We are working with clients to improve their capacity to implement an Environment and Social Management System. Some clients don’t have the expertise or capacity to interact with management consultants about the design of an ESMS. So now we’re engaging with advisory services to improve this.
    • IFC assesses our FI client’s ESMS systems during an appraisal and where appropriate, an action plan is prepared to remedy any deficiencies or gaps. The Action Plan is disclosed. We think we have a very good risk management approach and good collaboration with other DFIs.
    • This is a challenging situation and extremely resource intensive. Clearly, there are areas we can and will improve.

CAO audit

Henrik Linders, the CAO’s chief compliance specialist for this audit went through the key findings of the audit report.

  1. IFC resources: quality of E&S assessment has improved; allocation of E&S supervision resources are not cost-based.
  2. IFC toolkit: IFC focus on ESMS does not necessarily achieve a broader mgmt and cultural change process (tick-box); IFC’s requirements not adapted for clients; the approach to ES requirements has precluded assessment of client capacity and commitment; standardized implementation requirements don’t allow for different levels of ES development. (microfinance and PE funds had much more E&S awareness than commercial banks – that differentiation was not reflected in where IFC decided to spend its resources).
  3. IFC strategy: does IFC’s approach meet the intent of the policy provisions? What does IFC want to achieve in ESM in its approach re do no harm? Also does IFC’s concept of E&S include credit risk? The big question is what kind of risk – IFC staff talked about E&S risk, clients talked about credit risk. IFC should spend more time with clients to explain about risk. IFC has three types of E&S objectives.
  4. IFC standards: If seven DFIs invest, client must report to each, so differing standards are a burden for clients. IFC can do much more to encourage a shared vision and industry standards.
  5. Key challenges: re-affirmation of IFC commitment and approach; measuring and supporting improved performance among clients; measuring impact and outcomes at sub-client and end-use levels. CAO acknowledges difficulties in acquiring this data on sub-client activities – but we need IFC to come up with innovative ways of measuring this – like third-party verification, increased reporting etc.

Q&A Session

The first round of questions raised issues of how IFC measures the impact of FI investments through the lens of “doing no harm”, whether IFC also has anti-corruption requirements, and how investments are screened to prevent “land grab.”

James Scriven: – When we engage with a FI we look at the business they are in and do a screen, we look at clients as extension of the partnership with IFC. – We do a full investigation, do IDD (integrity due diligence), look at past history, media E&S events. A lot of clients complain about the cost of doing business with IFC. There is zero tolerance for money-laundering. – At the moment 10% of our business is high risk (that’s determined both by the type of client and its activities). That will not grow. At most we support 1 infrastructure fund and about 15 private equity funds annually- that’s out of three hundred projects.

The next round of questions raised issues related to how IFC supervises sub-clients and determines the risk category for an FI.

James Scriven: – FI portfolios are different and change over time. We do an assessment for the risk at the time of our investment, and then we monitor and adjust that over time as needed. – At the recent CODE meeting, members rose how we determine field visits – we’re going to go back to the Board with a comprehensive response in a few weeks. The Board thought 150 site visits was not enough. We want to hear back from the Board about what more can we do. Bill Bulmer: – When determining categorization, IFC takes into account the type and tenor of the investment activity to be undertaken by the FI. Project and corporate finance is viewed as mid or high risk activity depending on end use. – We disclose the rationale for FI1 or FI2, and then we disclose every year what happened in response to any action plan required in relation to the FI ESMS. – We feel we’re making progress in terms of info disclosure. Not here to say we’ve got it all right. – We pay a lot of attention to any complaints or concerns from communities. Need to recognize that there are also a lot of communities benefitting from the activities IFC supports.

The last round of questions focused on how to measure impact at the end-user or community level, disclosure, use of offshore financial centers, and how IFC screens for anti money-laundering requirements.

James Scriven: – We invest for development outcomes. We have a huge amount of people benefiting from projects we support, including from higher-risk investments. – We’re genuinely concerned about communities who are adversely affected. – It’s not a perfect system, but in most cases we’re managing this risk effectively. We are responding to any cases where there are faults in the systems. Henrik Linders: – Of 188 projects in the audit, 17 had legal agreements with no E&S requirements, 34 required the Performance Standards, exclusion lists and national laws. Three required PS and national laws. – Clients in secrecy jurisdictions – there were maybe 3 or 4 out of 63. It’s definitely a small minority. James Scriven: – One challenge on the disclosure front is that most of our actors are regulated like banks. – Private Equity Funds are not as regulated, so we now disclose those high-risk subprojects. – Re AML, IFC generally will not invest in a project or engagement if it is sponsored, directly or indirectly, by a Politically Exposed Person (PEP). Extending IFC’s support to such engagements, or other engagements with PEP involvement, must be reviewed on a case-by-case basis using a risk-based approach that considers all aspects of a project’s circumstances. Therefore, projects involving PEPs require a higher level of due diligence and disclosure.

Summary of discussion:

– Most of areas of concern are around high-risk projects.

– How can we make it easier for affected communities to complain to IFC? – Frequency of IFC site visits for high risk FI sub-projects is not considered to be enough. – Many participants thought disclosure of information is considered to be insufficient. – IFC will finalize the note to CODE and make it public. – Continue the open dialogue, and make better effort of explaining how we categorize. – There will be several more discussions, part of an on-going conversation.