I am delighted to be here today to support the committee in its study of Canada's development finance initiative.
My comments this morning focus on two ideas: first, the private sector's role in international development; and second, the positive contribution that development finance institutions, or DFIs, can make in supporting growth and prosperity directed by the private sector.
While public development assistance has contributed to major gains in international development, more resources are needed than what governments can provide in order to achieve the goals of the United Nations' 2030 agenda for sustainable development.
According to the World Bank, there is an annual shortfall of $2,500 billion to meet the needs of developing countries in essential sectors such as infrastructure, clean energy and agriculture.
There is a growing consensus in the international development community that the private sector has an important role to play as the key driver of economic growth and development.
The Addis Ababa action agenda, a foundation working towards the achievement of the 2030 agenda, recognizes that private and public investments are very important for the financing of infrastructure, in particular through development banks and development financing institutions. In fact, the 17 sustainable development goals recognize the need to mobilize additional resources for developing countries from multiple sources, including the private sector.
At the same time, developing countries themselves are turning their attention to increasing private investment, in addition to public development assistance, of course. Direct foreign investment and other private capital currently exceed development assistance by a ratio of five to one.
Yet the private sector is very often unable or unwilling to make what are seen as risky investments in such countries without support. For this reason, international donors have acted to optimize the contribution of private investment to development, with development finance institutions, DFIs, often being the most visible form of support.
DFIs respond to the specific challenge faced by companies operating in developing countries in getting the financing they need to grow their operations and their businesses. In doing so, DFIs provide an innovative, cost-effective financing tool to support economic growth in developing countries. According to some estimates, for example from the Overseas Development Institute, $1 invested by a DFI has the opportunity or possibility of crowding in an additional $12 in private investment, depending on the product, of course. In addition, DFIs are self-sustaining over time because they balance the risk and focus on sustainable business ventures. In turn, these profits can be recycled and reused to further fund projects that have development outcomes. DFIs also complement, not substitute, private investment and ODA, official development assistance.
With respect to Canada's DFI, I note that the new crown corporation will be headquartered in Montreal and established as a subsidiary of EDC. It will be capitalized at $300 million over its first five years of operation and will operate in countries eligible to receive ODA.
I'm sure committee members will have numerous questions about that. As such and in closing, let me simply say that DFIs can play a catalytic role when it comes to supporting private sector-led growth in developing countries, a role that fosters increased investment and development outcomes, leverages additional private finance and expertise, promotes policy objectives such as green growth and women's economic empowerment while creating jobs, and complements traditional aid, which remains important.
With that, I would be happy to take your questions.
That is a very good question.
First, it will be up to the government to determine the main direction of the institute. As I mentioned earlier, we already know the priorities. They pertain to renewable energy, young entrepreneurs and women. We already know that the government is starting to indicate the entity's direction. Will the government add other priorities? We will see that in due course.
Then, once the entity's areas of focus have been defined, it will in a sense market its objectives and its services, nationally and internationally.
The entity will promote its directions and abilities to other DFIs, regional banks, and, as I said earlier, to clients, that is, to the private sector in Canada and abroad.
It will be able to cultivate its relationships. Through those relationships, it will also be able to develop its pipeline. That is the term we use for the list of potential projects and investments. That means that the entity will be required to and will do a lot of networking, as all banks do, in any case.
The entity will also liaise with key government departments, such as Global Affairs Canada and the Business Development Bank of Canada as regards trade and development. The BDC has a good list of potential clients. In particular, SMEs might be interested in international trade or trade with developing countries that offer development benefits.
Let me break that down into two: first, the Government of Canada community, if we can call it that, other government departments or agencies; and second, the issue of non-governmental organizations and civil society organizations.
On the other government departments, the relationship will need to be variable, and it will be variable for at least two reasons. The first is that this is an organization that will be privy to great market intelligence and therefore great opportunities that need to be relayed and shared, but it also is going to want market intelligence that exists in other parts of the Government of Canada family.
When I think of the trade commissioner service, and even at times when we look at development programs in other countries, for instance, it may come across in consultations with the governments in Africa that they want to build an electricity grid. That type of information is a development issue, but it's the type of thing that can be beneficial to give a line of sight to a broader community of players in Ottawa.
The trade commissioner service is obviously on the ground and is working with the private sector trying to find business-to-business opportunities. You have EDC out there as well, and BDC domestically, looking at SMEs. You have a community of departments that's going to want to bring in this new DFI and create a community of interest around it. I think, on the one hand, from a market intelligence perspective, there's going to be a strong desire amongst the federal family to bring this new member of the family into the fold.
I say “variable” relationship because this is an organization that, from a development perspective, can be—and obviously, we're talking about it here—a huge partner for the development program.
One of the things we're going to be working on over the near term is more of an institutionalized relationship between the development programming at Global Affairs Canada and this new DFI, new crown corporation, over the issue of technical assistance. Technical assistance is something that Global Affairs Canada does extremely well. It knows where to find expertise that can be brought to bear to help bring about, and buttress perhaps, the development outcomes—environmental outcomes, for example—of a given project that the DFI might want to be pursuing, or that the DFI, in pursuing something, may want to augment and amplify, and therefore, would go over to Global Affairs Canada to seek that. We'll have to formalize that arrangement and codify it in some manner.
With respect to NGOs, generally speaking, DFIs work with the private sector, and NGOs are not-for-proft organizations. However, within that context CSOs, have been able to work closely with DFIs. Just as I mentioned from a technical assistance perspective, CSOs, particularly Canadian CSOs, have tremendous expertise in various areas, whether that's environmental issues, gender issues, social policy issues, and so forth, that they can bring to bear to complement a private sector initiative on the ground. It's not something that would be “part of”, but definitely coordinated and paralleled with the activities of DFI.
There are two really, one conceptual and one very pragmatic or practical issue of bodies and services. Let me take them in reverse order.
The DFI will have to establish its own team over the coming months. The government will work closely with EDC to define the core functionalities of the DFI, and its core team headed by a CEO, or a head, for the organization. It will therefore need to figure out what its core mission is and what type of work it could actually “outsource”, if I could use that term, to EDC, things such as IT systems, HR, potentially even treasury functions.
You know, the scenario where through a service-level agreement EDC is actually providing back-office support, if I can put it that way. This has the virtue of accelerating the speed with which the organization can be stood up, rather than starting from scratch, as well as leaning on therefore a stable foundation and the institutional foundation and know-how that exists currently in EDC.
That was definitely part of the rationale for pursuing this model.
The other issue, though, is the relationship between EDC and the DFI on the ground, and the issue of risk. What I find interesting is that in many respects the trade mandate, and what's important here with the DFI is that the trade mandate needs to be and continue to be.... The integrity of the EDC trade mandate needs to be preserved and protected at all costs. We don't want EDC doing the types of things that DFI would do, because basically we would be running up against trade rules and being inconsistent with our obligations under the WTO. That's not to say that EDC isn't active in certain emerging markets, developing market contacts, but this is a different instrument that would be able to complement that.
The extent to which EDC takes on more risk, so long as it's consistent with trade rules and so forth, is a good thing, particularly from a development perspective.
Thank you very much for the kind introduction.
My thanks, as well, go to the honourable members for the opportunity to speak with you about the proposal for a Canadian development finance institution.
I am very pleased to have this conversation with you today.
It is I think a terrific mark of the openness of this government that it has decided to reconfirm the proposal for the Canadian development finance institution that was brought forward in the 2015 budget under the previous government, and which has been, as you know, a topic of discussion for some 40 years in development circles in Ottawa. I salute both the government and its predecessor for bringing forward what I believe is a proposition that should receive support from all sides of the political spectrum.
In doing so, I should note that I am speaking in a personal capacity here, rather than on behalf of Scotiabank. The development finance institution proposal is one that I wrote on long before joining Scotiabank six months ago, and one that I will continue to engage on, and I hope to support your process as you go forward in pinning down design considerations on the DFI.
Really, design considerations will be the focus of my remarks today, given that the logic of private-public partnership in development assistance has probably already been well discussed by members of this committee and by members of all parties in the lead-up to this discussion.
I also want to say at the outset that I see the discussion of the Canadian DFI as one that needs to be grounded in a precursor understanding that it is additional to existing official development assistance. ODA is not a substitute, nor is the DFI a substitute for ODA. In fact, we should see them as complements, and, really, the creation of a Canadian DFI should be brought forward in the context of and in conjunction with a scaling up of Canada's development assistance.
At our current ODA levels, trying to do more with less is really a recipe for failing to meet our global obligations. Aid and market financing really do different things. There are some public goods that only aid and public resources can provide, and market financing, either alone or in conjunction with public support, complements those public goods rather than replaces them.
I should also note that the logic of engaging in a public-private partnership for development is driven by some very clear math. That math says that overseas or official development assistance will not be enough. Even if all OECD countries were to meet the 0.7% target of GDP articulated by Lester B. Pearson, total ODA would amount to about $350 billion to $375 billion U.S. per year, when at the same time, good estimates of what is required to reach the sustainable development goals, at a minimum, are around $500 billion additional in financing per year and go upward to around $3 trillion in additional dollars per year, depending on the extent to which you include things such as climate change mitigation and adaptation in your figures.
The need to bring private sector financing into the development process is ineluctable. There is no way to avoid it. ODA cannot be enough. I think the things we need to focus on today are about how we design a potential Canadian development finance institution to be as effective, as complementary, and as additional as possible to the existing work being done by other development finance institutions, and under bilateral and multilateral aid budgets.
Here, I think one of the key things we need to focus on is the need to help direct finance into places where it is currently not going. About 40 to 50 countries in the world receive almost no direct financing in the form of capital or investment from abroad, outside of their resource sectors, so the first objective of a Canadian DFI really is to be focused on catalyzing investment and capital flows into the places where such flows currently don't happen.
If I may, I'll recapitulate a few of my initial points so that they can be interpreted for everyone in the room.
First, I want to emphasize that a Canadian development finance institution needs to be additional to existing official development assistance. It needs to add to the total envelope of financing that Canada provides to developing countries, either in partnership with the private sector or in the form of grants that come from the public sector. Aid and private financing are complements to each other. There are some public goods that can be provided only through public financing. There are other, complementary activities that are germane to public-private partnerships. A Canadian DFI should be an additional source of financing on top of official development assistance, not a substitute for that assistance.
At the same time as we commit to bringing in a Canadian DFI, we should also be concerned with ensuring that Canada's official development assistance is increased toward the long-term goal of 0.7% of GDP. That said, even if every OECD country were to raise official development assistance to Pearson's 0.7% goal, development assistance in that form would not be enough to reach the sustainable development goals. At 0.7%, total ODA flows would be at about $350 billion to $400 billion U.S. per year. Most estimates of what is required to hit the SDGs imply that somewhere between $500 billion and $3 trillion U.S. extra in financing are needed annually between now and the SDG target year of 2030.
Engaging the private sector and catalyzing private capital for development assistance are really not things about which we have a choice. We absolutely must do what we can to ensure that capital begins flowing to the 40 or 50 countries that receive almost no foreign direct investment at the moment outside of their resource sectors. That, to me, is the global case for Canada engaging in public-private partnerships for development.
The rest of my remarks will focus on design considerations for a Canadian development finance institution.
First, you may reasonably ask why Canada needs a DFI. Why has it been under discussion for almost 40 years, yet we haven't followed through on the creation of a DFI? I'll leave the question of why we haven't followed through to those who understand the ways of Ottawa better than I do. The logic of a DFI is inescapable. Every other G7 country has one. Almost every OECD country has one. Put bluntly, by not having a DFI, we are leaving good money on the table for others to benefit from.
Other countries' DFIs have a long history of making profits by doing good. Britain's Commonwealth Development Corporation hasn't drawn on the public purse for over 15 years in its development financing. The United States Overseas Private Investment Corporation, OPIC, estimates that it earns $8 for U.S. taxpayers for every $1 invested in its overhead. In the case of the world's DFI, the International Finance Corporation, which is part of the World Bank, we know that its profits get recycled directly back into expanding its lending portfolio.
A DFI for Canada makes a lot of sense because it provides an opportunity not only to do more, but to actually finance doing good in a way that does not imply further drains on the public purse.
Looking specifically at the design of a Canadian DFI, I want to recapitulate and essentially repeat a few messages from my submission to the pre-budget consultations in which I participated in 2014. The logic and the design considerations for a DFI have not changed in the intervening two and a half years.
First, I am heartened to see that it is being considered as a subsidiary institution under EDC. It is critical that it have an independent-minded and risk-loving board, perhaps more risk-loving than EDC's board, because of the nature of the financing in which it would be engaging: in more difficult circumstances and more challenging countries, and in sectors where the returns may have a much longer horizon than in the areas in which EDC traditionally invests.
On sizing the Canadian DFI, I should say at the outset that the government's inclusion of a $300-million, five-year capitalization in its budget proposal needs further fleshing out. If $300 million is considered the initial capital overhead to set up the offices and the operations of the DFI, then I'm encouraged that we're speaking about the DFI in an appropriate scale and size. But if that's meant to be the lending portfolio over the next five years, then it's woefully inadequate. Of course, in any context about development assistance, you're going to hear people saying we need more. Now, I'm not simply adding a voice to that chorus and saying, “More, more, more.” I'm adding what I think is a very practical point, which is that for $50 million a year, the overhead to do a lot of small projects would not justify the impact of that small-scale lending. The $300 million really ought to be the basis to get this institution going and provide the underlying overhead or framework by which this institution goes out and catalyzes substantial additional financing.
To give you a sense of the scale we're talking about, the six existing G7 DFIs provide annual commitments equivalent to about 3.3% of their countries' private capital flows to developing countries, or about 0.024% of their national GDPs. Translated into Canadian terms, that implies an annual lending portfolio somewhere between $350 million and $500 million Canadian. That looks at an annual commitment that is larger than the five-year commitment that has been articulated in the budget.
My deep concern is that at $300 million over five years, we don't have enough committed to even launch what is going to be a successful pilot or proof of concept. We need to look at a much greater scale. The way to do so, I believe, is to ensure that the DFI's lending portfolio is financed largely out of capital-raising through private markets, that is, through the issuance of debt or bonds, or private placements in international capital markets, much as EDC does right now, though likely at a much longer maturity and with perhaps contingent payback valuations or provisions to reflect the impact aspect of the financing the DFI is providing.
The DFI could also be involved in issuing debt into local and developing capital markets that don't currently have established benchmark yield curves, much as the World Bank did in places such as South Africa and Greece in the nineties. That provided a benchmark by which public institutions could then also go into capital markets, and private companies could also raise debt.
The DFI should also be empowered to retain the profits that it makes from its lending operations. We may not see returns for several years, but if we are to grow the institution, much as its corollary institutions in other G7 countries have done, those profits should be largely recycled back into, first, paying off the initial capital commitment from the Canadian government, and then expanding its existing portfolio. This is what happens with other G7 DFIs. Other G7 DFIs, such as KfW in Germany, issue debt in the way that I'm proposing. I believe this is the way to ensure that we have an institution that operates on the scale that's needed to have true impact and to ensure the ratio of overhead to returns is appropriate.
Thirdly, I want to focus on what activities a Canadian DFI should engage in. Looking at 30 or 40 years of activities of other DFIs, we see that a few salient findings have come to the fore, two of which are really critical here.
One is that unless the development, impact, and financial imperatives of the DFI are written firmly into its governance from the outset, into the DNA of its board and into the incentives provided for its staff, the development impact will always play second fiddle to the financial imperative. We need to ensure that the entire institution is built to balance those two imperatives.
Second, a Canadian DFI needs to be substantially more risk loving than other DFIs. One of the consistent findings of review of existing DFIs is that they tend to invest in sectors that are already receiving foreign investment: the fifth cellphone provider in Ghana, the 12th luxury hotel in Nairobi. This is not the way to have impact nor to justify the expense and the effort of creating a Canadian DFI, which needs to be focused on higher-risk lending in places where no other investors will go.
To do so effectively, it needs a full range of financial instruments, everything from loans to the ability to take equity shares, provide guarantees, and provide risk insurance. The multilateral provider of risk insurance, MIGA, under the World Bank Group has shown in its annual reports that it has a very small payout rate on its insurance policies.
In one way that would be an indication that it's writing incredibly good policies. I take it as an indicator that it's not providing insurance in the places that truly need it, where there is truly great risk. That leaves open a huge swath of the developing world where a Canadian DFI could provide guarantees for insurance that draw very little on its balance sheet or its portfolio, yet at the same, have great impact.
A Canadian DFI, unlike some others, should also be unconstrained by nationality. It should be able to work with the best investors, the best projects, and the best ideas, regardless of which passports they hold, be they Canadians, members of the Canadian diaspora, or foreign companies.
The Overseas Private Investment Corporation in the United States has found its hands substantially bound by a requirement to only work with U.S. companies. It has found ways to get around that by declaring a U.S. company to be anyone that has a substantial degree of activity on American soil. But why create an institution that needs to engage in such gymnastics to do good work? Let's be as open as Canada is in every other way to good ideas, good people, and good capital in constructing the DFI to work with anyone who meets its standards.
As I mentioned earlier, our DFI should be focused on the regions and sectors that are not receiving financing in a substantial way. It should always be judged by not only whether it is meeting its development and its fiduciary impacts but whether it is also going where other institutions will not go.
Lastly, and this may sound like a small point—even a pedantic one—in talking about nomenclature, but in the discussion of this project three different terms have been used between the previous federal government and the current one in describing it. The 2015 budget referred to a development finance initiative. The 2017 budget referred to a development finance institution. The May 5 announcement that the institution or initiative would be located in Montreal, referred to it as an institute. Those three words in this space define very different things.
An institute is denoting something like a research body or think tank. We don't need another research body or think tank in this space. Other organizations and countries have already developed a huge body of best practice that we can implement. We know where the gaps are. We know which countries and sectors are not getting financing. We know which ideas are not able to move from conceptualization to implementation. We don't need another institute.
An initiative, under the 2015 budget, bespoke something with small ambitions. There is no reason for Canada to play small in this space. We should be leveraging our strengths and doing something truly impactful.
As the 2017 budget said, I think this should be a development finance institution. We should see it as a thriving subsidiary to EDC with an independent, risk-loving board able to invest in areas that are not receiving support at the moment, leverage good ideas, and complement what I hope is an expanding envelope of official development assistance, and it should be able to receive support from all members of the House in going forward.
Thank you. I look forward to your questions.
I see in the Canadian discussion of a DFI, in some ways, too much focus on how much money is being provided for initial capitalization. In some ways, that number could be almost any number. What is important is how much is provided in an annual lending portfolio.
I'd like us to look at the $300 million that has been mentioned over five years in the budget as the money to capitalize the overhead and operation of the institution for its first five years. We can then look at issuing debt to finance the lending portfolio, or the financing portfolio, for the insurance guarantees or equity placements of the institution. On that front, you mentioned that there is competition, but I think there would be enormous demand for the paper issued by EDC in the name of the DFI.
Why? Canada is now one of only about nine or 10 AAA credits in the world. We are a sought-after sovereign issuer. The DFI would have the full faith and backing of the Canadian government behind it. If you look at countries like the U.K., or even Mexico, they've been issuing at maturities of 50 to 100 years, in what is historically an incredibly low interest rate environment. That provides a context in which we would actually be able to raise private financing through bond issues at the kinds of maturities that are consistent with the long-horizon lending that the DFI would need to provide for projects that might not see substantial returns for five to 10 years. There's a really rare opportunity to align private and public capital markets at this point.
What share of financing for any one project or portfolio of projects would come from the DFI? It ought to be relatively small. Our financing ought to be catalytic. It ought to be the thing that tips a project toward being financeable from not being financeable. It ought to provide financing in that missing middle size of organization, and in the process of bringing a project to market from the initial angel investor stage to an IPO or a debt issuance, or some kind of partnership agreement where there are clear stages that need to be financed but are difficult to finance.
It may also partner with local governments in financing operations. It should be something that helps stimulate local engagement rather than simply providing outside financing.
When you look at some of the other major DFIs, the share that they provide in some projects can be as low as 5% or 10%, but what is important is that they often take the first loss risk. They have, in some ways, the least senior financing in the project, and by taking that risk out of the process of financing a project or an activity, they are able to catalyze private sector money to come in.
I see the private capital engagement here on two fronts. One is financing the equity, loan, guarantee, or insurance participation by the DFI itself, and the other is coming in beside that financing.
I would say, as a precursor, there is nothing wrong with financing the fifth cellphone provider or the 12th luxury hotel. To drive business, capital cities need good places for people to stay. They need good cellphone networks.
The point I'm making is not so much about the nature of the investment in terms of the type of project the money is going toward. Rather, it's about the fact that it's already a crowded space. If you want to finance a hotel, which I think is a legitimate thing to help catalyze investment, think about doing it in N'Djamena, Niamey, or Ouagadougou, rather than Nairobi or Accra, which are already attracting a lot of that kind of investment.
As to the sorts of projects that can be really game-changing, it varies from country to country. As an easy example, consider Haiti, where I did a lot of work with the UN in the wake of the earthquake that was so devastating. Rebuilding there is substantially constrained by the fact that there is only one cement plant. You simply cannot build infrastructure when you have only one source of cement in the country. You have to look at key bottlenecks like that.
Often the transportation grid or network between ports and capital cities is inadequate in some form or another. There may not be a decent road. There may not be electricity along that road. The port itself might not be great. There might not be a cold supply chain from the interior to the port. Those are all key bottlenecks.
If you look at the Democratic Republic of the Congo, they have the potential for such massive hydro development in the south of the country that they could be supplying electricity to all of southern Africa and most of east Africa. There are some pieces of the grid there that, if filled in, would permit that kind of network effect to take place.
It is useful to look at projects that relieve bottlenecks and allow a lot of other complementary aid-financed and private sector activity to flourish, because such projects provide a way for a DFI to have a truly major impact for a relatively small amount of catalytic financing.
I think one of the things that the financing provided by a Canadian DFI could focus on is sectors, activities, and projects that are particularly labour-intensive and that really do require large-scale involvement by people, in either their realization or their day-to-day conduct.
When we look at the history of development across the last 200 years or so, no country has moved into the middle income ranks without basing, from its early stage, development in agriculture and then very labour-intensive manufacturing, and then later in some more sophisticated and higher-tech industries. I think we need to look at those sectors as some of the places that can be most likely to generate jobs in low-income countries and that provide the stepping stone upward to higher value added.
When we look at the history of development across most of east and southern Asia, we have seen what some economists call the flying geese model of development, where early developing areas have seen wages go up to the extent that some of their activities are no longer affordable. They then move to other neighbouring areas that have a greater supply of labour, more unemployed people, and as a result, lower wages.
We continue to see those shifts, whether it's from China's coastal regions that have become relatively high wage, moving some industry inland where wages are lower, or moving some of their activities to neighbouring countries like Bangladesh or Burma, or in some cases, into lower income countries in Africa as well. That kind of chain, or moving geese pattern—where rather than trying to jump multiple rungs up the ladder too quickly, but instead focusing on a deliberative process of moving up the value chain—I think is one of the best ways that we've seen over decades to create jobs.
At the same time, we need to ensure that basic labour rights and basic standards in the conditions of those working environments are respected. Those should not be ways in which countries or companies compete on cost, and that's where we can play a substantial role through our engagement through multilateral bodies to ensure that's the case.
Thank you very much, Mr. Fragiskatos.
Thank you very much, Mr. House.
Our time has lapsed again.
As I understand it, colleagues, the bells will start at 11:05 a.m., so you will have plenty of time to get yourselves to the House.
On behalf of this committee, Mr. House, I want to thank you very much. I've noticed over my 18, almost 19 years in Parliament that mandates and what we call the design of these institutions are extremely important, so we very much appreciate your comments today. It brings to mind the federal development bank of Canada. When it first started, it was supposed to be a bank for high-risk and/or risk-loving lending because, of course, in regions like mine, you couldn't get loans from the regular banks. However, they changed the mandate over the years. It became just like a regular bank; in many ways, it was not prepared to take any risk.
The design of this institution is extremely important, and I appreciate the opportunity to use your expertise to explore that somewhat. I'm sure the committee will do more of that over the coming discussions with other witnesses. Again, thank you. We very much appreciate the opportunity to dialogue with you today.
Colleagues, that will wrap it up for today. We'll see you on Thursday. It's been a good meeting with good questions.
The meeting is adjourned.