Response letter from IFC on investment in the financial sector
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18th April, 2013
Dear Mr. Chowla and other civil society colleagues,
Thank you for your email letter addressed to Dr. Jim Kim, President of the World Bank Group, dated 12th March 2013, and your clarifying email of 27th March, relating to IFC investments in the financial sector. In this regard, following Dr Kim’s response to you, he has asked us to provide a detailed response to your messages. While we do believe that many of the points raised in your letters have been addressed in IFC Management’s response to the CAO report, we are providing some additional information below.
It is important to understand the larger context of our work with financial intermediaries (FIs) to promote positive development outcomes, and some key points are outlined below :
- Our primary focus is working with FIs to increase access to finance in ways that target poverty reduction and job creation.
- We leverage our FI client network of over 900 partners to target key WBG development priorities such as food security and agribusiness, climate finance, gender equality, reaching IDA countries, and promoting investment in Fragile and Conflict affected States.
- A relatively small proportion of IFC’s funding for FIs is used to support projects with significant E&S impacts – estimated to be around 10% of our new FI projects. This is typically where we work with Private Equity (PE) funds or large banks that handle project finance or long-term corporate finance supporting critical economic sectors such as infrastructure development.
- In these cases, we ensure that our FIs apply the Performance Standards for each project, and we have a high bar for review, supervision and disclosure for these projects.
- In the balance of our work with FI’s on SME’s, Micro and other sectors, where the focus is other development goals, and on job creation and poverty alleviation, we apply screening methodologies that are commensurate with the FI’s operations, but not the Performance Standards.
For all our FI projects, we go through a systematic discovery process for environmental and social (E&S) risks that is outlined in our Policies and Procedures, a summary of which is outlined below:
- All projects are reviewed at the concept stage to assess if there are any existing or potential E&S issues. Issues are flagged, and in some cases, new or additional IFC investments are rejected because of E&S issues.
- During the mandate stage, the FIs are informed of our E&S review and due diligence processes and requirements. If a client does not agree to this, we do not work with them.
- During appraisal, we review the portfolio of the FI, its E&S capacity and commitment, and arrive at client-specific E&S management system (ESMS) requirements, and a tailored action plan which includes specific time frames for implementation.
- The ESMS requirements, and the specific action plan, are incorporated as covenants in the loan agreements, and their breach can trigger a default.
- In cases where we have equity investments, we work through the corporate governance process to improve standards, and ultimately, our only recourse is sale of our stake where feasible, should our agreements not be honoured.
The assertion that we do not know the E&S risks of half of our portfolio is simply not true and is misleading. It is important to recognize that the regulatory constraints that prevent our public disclosure of information about our FI portfolios in no way imply that IFC is not aware of the underlying E&S risks in our FI portfolios. To implement our E&S commitments, we engage in an ongoing, systematic and risk-based supervision process:
- We review all annual reports provided by FI clients;
- All FI investments (other than some category FI-3 projects with no E&S risks) regardless of the identified risk, have to be physically visited at least once every three years by an E&S specialist, and all high risk FIs are visited every year; and
- Where we believe that E&S risks could be material (high and medium risk FIs), we also take a random sample of the client’s portfolio to test the efficacy of how E&S standards are being applied and enforced by the FI. We have conducted over 150 sub-client field visits for sub-projects since the 2006 Policy framework to validate the work of our FIs, following a risk-based approach
We seek to determine whether clients share our values including on E&S. If they indicate that they don’t, we do not work with them. If they indicate that they do, we agree on an appropriate ESMS, try to assess, and document these shared values in our legal agreements. But things can go wrong.
- We can have cases where the clients initially indicated commitment is not genuine.
- We can have clients who face insurmountable operational or market challenges in implementing these requirements.
- We can face delays in implementation given the time it takes Banks and FIs to implement operational procedural changes that an ESMS typically entails.
Our pre-investment review processes and our ongoing supervision and enforcement processes are designed to ensure that our client FIs do implement their ESMS and apply these to their sub-clients on an on-going basis.
Given all of these scenarios, the sample of the CAO audit showed non-compliance in approximately 10 percent of the random sample. We have strengthened our Performance Standards and added additional resources for supervision since the period the audit sample was taken from, and will continue to take steps to further improve our implementation.
Your letter calls for a suspension in those investments where there is known harm caused by IFC clients and/or sub clients and that affected communities are compensated for any losses that were suffered in the light of the above. Recognizing this is only relevant to a small portion of our FI portfolio, which is managed with a high level of attention, this is not something that can be generalized. As stated earlier, where there are persistent issues of non-compliance, IFC looks at taking action within the context of the legal agreements with the client and the relevant country banking regulations. IFC is constantly reviewing its investments, including where E&S implementation falls short of the requirements, and once we have ruled out client corrective action, we actively look at legal remedies where feasible or an early exit.
The question of investments by our FI partners in companies that have exposure to our exclusion list was also raised in your letter. Most often exposure to the exclusion list already exists in the FI portfolio when IFC engages, and it becomes a question of limiting the growth of that exposure and ensuring that IFC funds are not used in these sectors. All such projects are done on an exceptional basis, taking into account the economic, social and cultural context of the countries in which these FIs operate, and never to include aspects like child labour, nuclear, hazardous or prohibited materials. These projects are done with full disclosure to the Board and only with the Board’s approval.
With regard to IFC tracking development outcomes from its FI funding, we use the IFC’s DOTS system, which is considered good practice for development outcome and results tracking amongst development financial institutions, and is being emulated by other DFIs. We however remain committed to improving this further.
Notwithstanding the identified challenges and limitations of what we do, our policy is still considered good practice, and our approach to FIs in particular, has been adopted in substance by the ADB, EBRD and all the EDFIs. We therefore see the CAO report, as being less about a fundamentally deficient or flawed policy framework, and more about improving our implementation, which is an on-going endeavour.
In this regard, while we are taking on the findings in the CAO report and looking at how we can improve our implementation, we do not see justification for a new or a different strategy for our Financial Sector work. Some of the key steps of what we are committing to are:
- Strengthening and scaling up of our Advisory work on E&S risk management for FIs;
- Exploring how we can articulate a better business case for E&S risk management, while recognizing that this will need to continue to be managed as a compliance function in the short to medium term;
- Engaging with all stakeholders including Civil Society and our Board, on an on-going basis, to communicate about our work, and solicit practical suggestions on how we can improve; and
- Continuing to review and tighten our work to further improve our compliance rate and implementation success.
It is important to recognize that it is neither useful nor feasible to apply the Performance Standards to all our FI business, which is why we follow a risk based approach. E&S issues are not material in a large portion of our business that covers micro, retail and SME and E&S risk management is therefore not a development outcome we are seeking or claiming for a majority of our FI portfolio.
Our approach to continual improvement in E&S risk management began in 2006 and continues. We are currently exploring options with the CAO, on how we can, with their support, realize additional value from the report to enable any feasible course corrections. Given that larger development imperative associated with developing a sustainable and responsible financial sector, as IFC is striving for, we were a bit surprised to see the call for a cessation of business through FIs, and we welcome the subsequent clarification provided by Oxfam indicating otherwise.
We reiterate our strong commitment to remain in dialogue with our stakeholders to seek feedback, but also to create awareness of our efforts regarding development impact measurement, transparency, accountability and the promotion of global best practices, including on E&S risk management. We look forward to the continuation of our meetings to discuss these and other topics, as we seek to build the channels of dialogue and communication, and most importantly a shared understanding of our work and its impact.
Director
Global Financial Markets Department
International Finance Corporation
Director
Environment, Social and Governance Department
International Finance Corporation
