I'm sorry I'm not in Ottawa. I love going to Ottawa. I go about twice a year. I go for the sugar pie and the maple syrup, so I'm sorry I'm not there with you in person, but I'm in Rome instead.
It really is an honour to be with the distinguished members of this committee. Thank you for inviting me to testify before you today.
I hold an endowed chair at the Center for Strategic and International Studies, CSIS. It's not that CSIS, not the intelligence agency. Although my mother still thinks I'm a spy, I'm not a spy.
In past experiences I was in the Bush administration at USAID, which is the foreign aid arm of the U.S. government. I worked at the International Finance Corporation, which is the development finance arm of the World Bank Group. I had previous lives at Citibank in Argentina, working in commercial banking, and I started my career in investment banking in corporate finance at what is now Deutsche Bank. I bring a lot of experience in international development and development finance to this presentation, to what we're going to be talking about.
I want to first congratulate Canada on deciding to create a development finance institution. I spoke before to this committee, I believe in 2011, when I suggested in my prepared remarks that Canada ought to develop certain forms of development finance authorities or instruments. I didn't go so far as to say to stand up its own institution, though that was certainly at the back of my mind, and I think it's great that Canada is doing that.
I also wrote an article in Forbes.com in 2015, talking about the fact that the previous Canadian government had included in its budget contemplating creating and standing up a DFI, so this is not something that's new for Canada. I know there has been a lot of thought that's gone into this by many of your professionals in Global Affairs Canada and EDC. I know many of the folks who have been thinking about this and working on this. You have some really very fine civil servants who have been thinking about this for a long time, but also one of the things that's great about this is that I think it enjoys broad support across the political spectrum in Canada.
The other thing I'd want to note is that Canada is, if not the last, the second to last G7 member to stand up a DFI. All the other countries, including France, the United Kingdom, the United States, and Japan, have a stand-alone development finance institution, so Canada will be in very good company standing up this institution.
I want to also remark on the following. This is not your grandparents' developing world. It's richer, freer, more capable, and with more options, and as a result of that the role of the private sector in development is critically important. Countries develop by having good governance, like Canada has, like the United States has, and by having a robust, formal private sector like Canada has and countries like the United States have. So it's very important that we find ways to work and empower a formal private sector.
I'm going to submit for the record a report we did with the European development finance institutions called “Development Finance Institutions Come of Age”, which was published in October. I commend it to all of you, and I hope the clerk will share that with the committee.
If you look at all the foreign assistance that's being spent right now by all the countries like Canada and France and the United States and others, as well as multilateral institutions, you'll see it's about $130 billion or $140 billion U.S.
We looked at the amount of all the development finance investments catalyzing private sector activity by development finance institutions, and we saw that last year it was about $70 billion. There has been a doubling of traditional foreign assistance in the last 15 years, and there has been an increase of seven times the amount of private capital catalyzed in the last 15 years by development finance institutions.
I would submit to this committee that sometime in the next five years those lines are going to cross and there will be more private sector activity catalyzed by development finance institutions than traditional foreign aid. That's not because we still don't need foreign aid. We do need traditional official development assistance as provided by Global Affairs Canada and institutions like USAID for things like good governance, certain instances of humanitarian assistance, fighting corruption, promoting good democracy and human rights, and certain kinds of technical assistance to governments, and in some cases providing basic human needs or supporting fragile and weak states, in particular.
But what you're going to see, because the developing world is evolving and you have 60 or so states that are proving to be middle-income countries that are going toward following the path of South Korea and Taiwan, is that their needs are very different.
What they need much more, instead, are things like infrastructure or enabling private investment or encouraging more trade, not so much financing basic human needs. I think the development ecosystem, things like Global Affairs Canada or the new development finance institution.... It's important that we have these different instruments to meet the changing world that we're in.
Let me make some points about Canada's new DFI.
I think that Canada's new DFI should reflect strategic and geographic interests of Canada, as well as global business opportunities for Canada. I would just name some. The Francophonie is certainly very important to Canada, so I would think francophone Africa should be very important for this new DFI. I think Haiti and Ukraine should be very important to this new DFI.
I also think that the new DFI should be willing to take on heavier investment risks if it's going to be asked to operate in francophone Africa and countries like Mali or Haiti or Ukraine. There's an implicit expectation that it's going to be taking on a higher level of risk than if it were investing in telecom projects in Brazil or Turkey or China, which, let's agree, are perhaps a bit of a more benign risk profile than the kinds of places that are important to Canada.
I'd encourage the DFI, if it's going to operate in countries of priority to Canada, to take on a higher risk profile as a result of that. I think the political leadership that stands behind the DFI needs to be prepared to support that higher level risk. That's my second point.
The third point I want to make is that while it's excellent that Canada has stood this up, I want to encourage the committee to begin to plan ahead and think out three to five years from now on a number of fronts. There's going to be a period of time, three to five years, to stand this institution up, to create an investment track record, to create various processes for making decisions about what transactions should be in. I expect that it will piggyback on other DFI deals, and I'll come back to that in a minute.
I think it's going to require that the DFI is given some time to demonstrate its worth, so I want to encourage this committee to provide a bit of patience and give it several years to get its sea legs.
Those are my three points: focus on strategic and geographic interests of Canada, as a result of focusing on country interests and priority interests of Canada; accept a higher level of risk; and then, third, I ask that this committee give the DFI several years to stand up and get its sea legs.
Also, as an additional point, consider perhaps a different kind of structure in the future. It may need to make different kinds of structural arrangements, and I'll get to that as well.
Let me address those three points.
I want to re-emphasize that the success of a country's private sector is critically important to development. The best social program in the world is a good job. The World Bank has data that says that in the developing world nine out of 10 jobs are in the private sector; so if nine out of 10 jobs are in the private sector, standing up this DFI makes a lot of sense.
Let me come to my first point, that Canada's DFI should reflect regional and topical interests, strengths, and relationships of Canada. As I said, francophone Africa, Haiti, and Ukraine would be a first area of focus, a first bucket of focus.
A second would be Afghanistan and Pakistan, given that Canada has put a significant amount of resources into and focus on Afghanistan and Pakistan over the last 15 years. Those are two countries where it would make a lot of sense for this DFI to be operating.
Third, I would posit the northern triangle of Central America as a region of importance to Canada. I've met with Global Affairs Canada representatives in Honduras, Guatemala, and El Salvador in the last couple of years when I've been down there. I'd also posit Colombia as a country of focus, given Canada's significant investment of time and effort in enabling the peace process that's going on there.
Regionally, those are the three buckets I would consider geographically.
Thematically, I want to suggest a couple that also reflect the priorities of the Canadian government.
I think women's economic empowerment, of course, is a central focus of the government. I think Canada's DFI should also prioritize this.
I would specifically look to the International Finance Corporation, which has spent at least 10 years looking at how to enable women's business both in terms of analysis and technical assistance and in providing lines of capital to a number of different banks to provide lending to women-owned small and medium-sized enterprises around the world. The new Canadian DFI could piggyback on what IFC is doing in that specific area.
I want to also encourage post-conflict recovery and fragile states as an area of focus for post-conflict situations. It will be very important.
A third area is global health. I want to make reference to Canada's incredible legacy of leadership on mother-child health. What is not known about health is that there was a study done about 10 years ago by the International Finance Corporation, which I will also submit for the record, showing that about one half of all health care expenditure in sub-Saharan Africa in 2005—this is a little bit dated, but it's important for you to understand—was through for-profit private sector health care providers. If that's the case, and I believe it's still the case in sub-Saharan Africa, then it would make sense for this DFI to make investments in the health care sector. We need to make a bit of a mental mind shift to think about how health care is actually delivered. It's not always done through non-profit NGOs or government; it's often done through the for-profit private sector.
A fourth theme for Canada's DFI should include what I'm going to describe as an “all of the above” energy strategy. I absolutely think this DFI should be financing oil and gas projects. I frankly think that on an appropriate basis, it should considering financing coal projects. I know that's not necessarily where the government is going to be, but I want to emphasize that a number of other DFIs are going to be doing so.
I met with the leadership of the Asian Infrastructure Investment Bank and the New Development Bank in the last month, and they are clearly going to be doing that. In certain contexts, say in the case of Haiti or francophone Africa, if it's the best option, then coal ought to be considered.
I'm not saying we should invest in coal willy-nilly, but I think we should consider it. I certainly think oil and gas are going to be a part of it. I believe that 53 of the 54 sub-Saharan African countries have oil, gas, and mining activities going on right now, and so I think this is only appropriate, especially in francophone Africa as well. Of course hydroelectric, wind, geothermal, and solar are a given, but I want to emphasize an “all of the above” energy as a fourth sector.
Finally, given Canada's excellent companies that work on global infrastructure, the 30 or so fragile states need certain kinds of assistance, but the 50 or 60 countries that are on their way to middle-income country status are extremely hungry for infrastructure. Look at the Asian Infrastructure Investment Bank's success. Canada is a member of the Asian Infrastructure Investment Bank, and the fact that it has 80 or so members now speaks to the fact that there is a major infrastructure deficit. I hope that the new DFI will consider this as a fifth area of focus.
Let me talk about planning for risk. I think that—
It's a pleasure to be here. Thank you for the invitation.
I'll jump right into it. A number of my remarks will complement what the former speaker just mentioned, and clearly the first part about this not being your grandparents' developing world.
With my time I'd like to make three areas of introductory points. I'll push for one group of points that I've made that will be submitted to the committee and that I think the committee could push the government on, to clarify further the thinking on the DFI as it stands. Then I'd really like to focus on the parts about recommendations.
I'm at the Norman Patterson School of International Affairs. I lead the Canadian International Development Platform, which is a data analysis platform focused on Canada's engagement with the developing world. A lot of my presentation will reflect that perspective.
Really, to echo the first point, the landscape of development and development finance is changing quite dramatically. We know that global poverty reduction is a good-news story, and I won't belabour the statistics too much, but even out to the 2030 date of the sustainable development goals target, I believe the hardest mile in development will still be remaining and pending.
I think that for two key reasons. One, global poverty will be increasingly concentrated in the most stubborn pockets, which are the hardest, costliest, and riskiest to reach. Second, we're living in a new normal of low growth and, in the context of poverty reduction, lower responsiveness to the growth of poverty. We can discuss further the factors behind that.
Traditional donors are facing resource constraints from the combined effect of constrained budgets and growing needs. Think of costly or more frequent emergencies, humanitarian crises, the refugee crisis, and broadening agendas. I see a risk here—as I have put it in the brief that will reach you soon—of asking the leopard to grow stripes.
Essentially, this really echoes what's in Daniel's report. I know a number of the co-authors of that report. As they put it, DFIs are becoming increasingly, in this context, the instrument of choice for any and every development-related challenge. What's happening is there's a risk that they are pushed more and more outside of their comfort zone and pushed to cover a wider and wider mandate, including from NGOs and civil society organizations, CSOs, I would argue, which will push DFIs increasingly to act more like aid agencies than like institutional investors. This is a risk I think we need to keep in mind.
The other introductory point I'd like to make is that DFIs are in the space I call where the puck is going. I'll make some quick points on this. Since the Financing for Development conference in Addis in 2015, there is now a consensus on the need to go from billions to trillions in development finance. Going beyond ODA and core aid is no longer a matter of debate.
Most donors, Canada included, clearly realize this. The real question is how. Now DFI flows already exceed ODA by multiples. We know that. Conservative projections for capital flows to developing countries by 2030 are of the order of $6 trillion. The gaps in development finance, which are in the trillions, seem daunting when we look at them in isolation, but when we put them in the perspective of what I call some of the broken plumbing of the global financial system, it helps us reorient our thinking.
Think about the fact that, as of February and March 2016, about $7 trillion was lying in bond markets globally earning negative yields. You have negative yields and assets lying there. I'm not suggesting that all of this can be intermediated for development, but certainly we could do a better job.
As the previous speaker has already mentioned, DFIs are growing at a rapid pace, 10 times as fast as ODA over the 2002 to 2014 period, whichever way you slice it. But we need to remember where we find investments. They are mostly in lower and upper-middle income countries, and not in what we call the poorest LICs and LDCs, or small-share LICs and LDCs. They are primarily in five sectors: banking and financial services, industrial infrastructure, energy generation and supply.... I won't go on with the list. We can go into a Q and A on this.
I think therein lies the space and the relatively limited purpose of DFIs as additional, catalytic, self-sustaining financing in the space between public foreign aid and private investment. DFIs are financial institutions with a development mandate that provides additional and complementary financing distinct from ODA.
There are three areas that I think the committee should push the government to clarify. I don't have time to go into all of this because I want to focus on my recommendations instead, but I'll submit one. In the context of the discussion around the Canadian DFI specifically, there are semantic issues. The way this has been discussed, even the acronym DFI, has been extremely inconsistent. It was DFI, the I being an “initiative”; DFI, the I being an “institution”; and most recently, in the announcement in Montreal, the I being “institute”. Which is it, and does it portend anything about scale, ambition, remit, or limit? I think that's useful to clarify.
The second point is this notion of $300 million over five years as a capitalization. Are we to understand the capitalization in the normal financial sense, as something the institution can go and lever further, or are we to understand it more as a limitation in terms of what it can do and what it will have over five years? Capitalization, and then that time period of five years, together makes no sense in the standard financial sense. This is another thing that the committee can clarify.
The next point on pushing the government to clarify is around the source and reportable use. The source, the $300 million that is coming into the DFI, is it entirely off-budget? Is it coming from the international assistance envelope, IAE? Is a proportion of it coming from the IAE? This is unclear, and I think this should be made clearer.
Secondly, on the reportable use, is the entire capitalization going to be booked as ODA or not? This is another point that I think is important to clarify because it has an implication for what Canada's ODA numbers will look like, especially going into the G7 next year.
My recommendations are, first, I think Canada and this committee should push for formally placing development additionality and sustainability in the mandate of the DFI. Unless they have a tight mandate and governance, it's been shown that DFIs are prone to drift away from their developmental purpose and more to financial and commercial purposes. This is obvious, and it makes sense for good reasons. Incentives, therefore, need to be formally aligned around development additionality.
Additionality is a concept that many DFIs use, but it's not straightforward. I'd like to offer a very simple way to think about this. That is, the investment thesis at various levels, whether at the portfolio level overall or at an individual investment level, should be able to clearly articulate how and why the involvement of the DFI's investment is expected to drive development outcomes and what those development outcomes are. That's a very simplistic, characterized way. I think we could make a contribution in this space by pushing for development additionality to be the core of the mandate.
The second principle is sustainability, by which I mean sustainability in terms of what the DFI invests in but also financial sustainability. Over the medium term a DFI should be self-financing, and it should be able to, from the evidence we have at hand of other DFIs, finance itself through retained earnings, and profits and so forth.
I'd like to quickly move to the next point, that Canada's DFI should be given the space to take risks. The key point here is risk. This fits with the earlier point I made about where global development is, the hardest mile remaining to go. If you believe that, then focusing on the poorest and most vulnerable, in large part, means increasing one's risk tolerance. One of the key criticisms of DFIs is that they don't take enough risks. EDC is good at many things. They have very strong financial capacity and capability, but they are not known as a high-risk-taking institution. This should be kept in mind.
It should be remembered, as the previous speaker said, that while there's a lot of talk about making money while doing good.... It's noted often that OPIC, the U.S. DFI, has returned $5.7 billion to the U.S. Treasury since 1971, has not required additional capital, and yet is under threat of closure. DFIs can and do lose money. I provide an example of Sweden's Swedfund. It has a specific target in terms of its benchmark, which for the past couple of years it has missed and has lost money. Development is a risky business. This is a risk-taking institution, and this should be kept in mind if development additionality is to be the core of the Canadian DFI.
I do think that DFIs with a wider slate of instruments and offerings have a better chance of driving development outcomes, so while most DFIs focus on the debt and loan end of the capital structure, only some go and offer equity. Those are the ones driving development outcomes, in my opinion, more seriously. Examples and data are provided in my brief on the CDC Group of the U.K., FMO in the Netherlands, and Norway's Norfund.
The third recommendation is that Canada's DFI will be small, and therefore by definition needs to find a niche.
According to our analysis, it will be about the second- or third-smallest of the bilateral DFIs. I think the Canadian DFI will need to strike a key balance, which is between supply and capital to existing opportunities and investing in longer-term capacity to increase the pipeline of what we call “bankable projects”.
What does it do? With the small corporates, what does it do? One way to think about this is to go where larger pieces of Canada's development financing and development investment are. One example would be the transition to low-carbon growth in developing countries, which is the focus of a lot of the investment of the government. It is also an area where Canadian innovation could be brought to market, to globalize in developing countries.
A second area, I would argue, which stems from what I see as a key problem in terms of why investment doesn't go to poor countries, is a lack of local capacity to promote investment and package bankable deals. This points to a powerful sector that Canada's DFI can focus on: building financial sector capacity in developing countries. By focusing on the local financial sector, Canada's DFI could balance both providing capital to existing opportunities and building that longer-term capacity of bankable projects.
Finally, my last recommendation around Canada's DFI is that it has the opportunity to set the standard when it comes to development outcomes measurement and transparency. DFIs, by and large, don't do very well on reporting development outcomes and impacts. This is, in a sense, a function of the renewed interest in DFIs. It's new that they've been called on to talk more about their outcomes and impacts.
Canada's DFI, I believe, should not only track and report progress and indicators at the project level, but should combine project mezzo- and macro-level impacts. Generally, DFIs report outcomes in the form of first-order effects, primarily on employment generation, contribution to government revenues, investment outcomes and financial rates of return, environmental and social outcomes, and catalytic effect in terms of co-investment and crowding-in other players. The Canadian DFI could go further to develop a methodology on development impact measurement that also looks at its contribution to second-order growth in activity and investment and their impact, however indirect, on poverty reduction.
I will leave my remarks there. I've gone a little bit over the time, but I appreciate your patience.
I'd just echo the points the previous speaker just made.
I think there's a danger. If I may, I think you're falling into that danger of this idea I posited of the risk of asking the leopard to grow stripes. In my mind, the DFI is not going to be in villages, supporting in a very direct way. In no sense is that going to be, as the previous speaker said, a big proportion of its portfolio.
For some of the bigger financial institutions, some of the bigger DFIs, their portfolios and their footprints, as it were, are so large that if you wanted to show a focus on women and girls, or if you wanted to show a focus on climate, or if you wanted to show a focus on agriculture and climate, it would be pretty easy to show that. IFC is an example. I'm not saying that there isn't a substantive focus there—there is—but it's also scale that's at question here, in terms of how much and what you're going to do.
Really, again, I'll push back with the element of risk. There is this danger of pushing DFIs to act more like aid agencies than like institutional investors. We should try to remember or at least keep in mind, when we're thinking about mandate, what we are aiming for here. Are we aiming for another aid agency, and if so, why? Or are we aiming for what DFIs really do? They catalyze private finance, which is a limited-use case, if you will.
Really, there are points I made about supporting local capacity, specifically in the financial sector, building the financial sector capacity, even something like building land titling and so forth so that you have better tenure systems. Those are a prerequisite to having a property market that is stable, and that's a prerequisite to having a mortgage market, which is a prerequisite to having future investment in real estate investment trusts. These things don't exist in most of the developing world, so we have to think in a long-term, big-picture sense. We have to pick areas in which that gestation is long and broad rather than giving in to the temptation that, just because we're calling one thing “feminist” we should try to show the direct one-to-one linkage that every investment is feminist.
We need to remember that with the macro impact of DFIs, there's a potential to move the needle in terms of driving investment, driving productivity, and driving growth over the long term. That ought to be the focus, rather than looking to just celebrate projects.
Excellent. Thank you so much.
I'm sorry that I can't be there in person, but I'm very thrilled to have the opportunity to address you today. I know that for each of you this kind of proceeding is pretty normal for your day-to-day, but for me to have the opportunity to interact with all of you as decision-makers is really a thrill. I'm very happy, on behalf of my organization, to have that chance. Thank you for extending it to me and to Engineers Without Borders.
I think, first and foremost, it's important to affirm that we really want to give kudos to the government and to everyone involved. Development finance has been an issue that a number of governments and individuals within all parties have been looking at for many years, and folks have worked really hard on it. Those of us who sit outside of government have also played an active role for many years. I know that I, and people like Aniket, whom you heard from this morning, have been speaking on this issue for multiple years. We really support the progress that has been made on the commitment to create this kind of an institution, progress that does it in an innovative way that really adds to the tool kit that Canada can bring to bear in trying to address global-scale challenges.
I'm going to try to focus my comments on things that I believe will be a bit different from what you might have already heard from other people's testimony. I know Brett House from Scotiabank very well. He's someone I've worked with on this issue over the years. I've read his testimony. I just want to say that I really support and second most of the things that Brett said, so I'll save a whole bunch of time by giving my vote to many of the things that Brett offered to you as advice and counsel. I didn't hear Aniket this morning, but having worked with Aniket over the years, I also think that he has a lot of expertise and salient points to make, and I would second those, as well.
I just want to start with a very basic story that I think is important to help position the context in which a DFI really exists. I've been working across east, west, and southern Africa for the past 12 years. I essentially have the opportunity to speak to these issues in an informed way by virtue of having interacted with hundreds of entrepreneurs across the African continent, and having seen first-hand a lot of the challenges that people face in building sustainable and inclusive markets. I've heard from a number of people who have been working on that continent for a long time that the scale and the barriers to entry to do business in developing countries are so much more than an issue of capital. While we are obviously having a conversation around development finance, I also just want to say that the capital side of how we address these challenges is only one part of that. The issues of human capital and of understanding how to deploy capital in a way that is risk-adjusted to the kinds of needs and contexts in which we find ourselves operating in developing countries are as important as the availability of capital itself.
A story that I've heard and shared with many people before is that it took Coca-Cola, one of the largest and most efficient companies in the world, over 12 years to break even in its operations in sub-Saharan Africa selling a sugary and slightly addictive beverage in a context where the company has global experience with its value chains and distribution. So, when you think about trying to have impact through business development in ways that address the needs of the poorest and most vulnerable people, I think that can really help situate the challenge, and the scale of the challenge, of doing that. It's very hard to be an entrepreneur anywhere in the world. I know some of you on the committee have experience as entrepreneurs, and if you don't, you know entrepreneurs very well. Many entrepreneurs in Canada fail. Just to sort of add to the degree of challenge, it's far more difficult, in terms of the environment and the operating context, for entrepreneurs in developing countries to succeed.
It's very important to bear that consideration in mind in terms of the expectations we have for a DFI in this context and the kind of patience that Canada and other countries that have already established DFIs need to be able to demonstrate in order to be useful. Part of what I want to say from a design perspective, in terms of setting the mandate of this DFI, is simply that we have the opportunity to make a series of decisions around how and where we want to situate ourselves in the continuum of existing development finance institutions and to bring to bear some of the lessons and experiences others have had by virtue of being in operation for many years.
I think when the Prime Minister and Minister Bibeau made comments a few weeks ago in Montreal, when they announced that the institution would be set up in Montreal, they said a number of really critical things. I would like to highlight a couple: first, focus on addressing the needs of the world's poorest and most vulnerable, which is very important to say specifically; and second, do so by leveraging the expertise and potential of small and medium-sized enterprises, particularly those led by women and youth. All of those statements we really strongly support and believe in. We think a development finance institution can and should be innovating and taking on the kind of risk that allows us to be additive and useful and building markets in ways that address those specific needs.
I think it's also important to name that this is exceedingly hard to do. While it might seem innocuous to talk about a focus on the world's poorest and most vulnerable, the truth is that a lot of DFIs end up placing their capital in business opportunities that by design are not aimed, I would say, at addressing the needs of those particular distinct target populations. That's not to discredit them. Markets need to be built in diverse ways across the world, and that is something that DFIs should continue to do. It's only to say that as Canada has said very clearly in their own language, that they want to have a focus on those hardest-to-reach populations, then in doing so we need to take on a different kind of design approach in how we think about how our DFI will actually be able to do that in an operational way.
I'll just share a few recommendations that are quite specifically drawn out in view of that language around the world's poorest and most vulnerable. We know that nine out of 10 jobs in the developing world are provided by the private sector, and yet at the same time the access to long-term financing for many small business owners is an exceedingly difficult issue. SMEs themselves represent just about 66% of full-time employment in developing countries. Employment, in this case creating jobs, is crucial if you think about the fact that by 2050, I think, there will be over a billion young people on the continent of Africa alone. The importance of being able to provide good and viable job opportunities for people to contribute to society is something that all of us have a very significant interest in ensuring happens in as expedient a way as possible.
At the same time, obviously Canada has taken an approach, in many ways through its foreign policy, to affirm the importance of women and girls in all things that this country does, knowing that women and girls face distinct and terrible disadvantages in terms of their opportunity to engage in a productive life, and particularly so in the economy. Some of my recommendations are very specific to how Canada can essentially put that into action.
First, I want to talk about the importance of a portfolio approach where we're balancing out risk across that portfolio, knowing that some of our investments will be designed to see very a specific return, while others will accept a different return expectation by virtue of having a development goal associated with it that needs to be attempted and pursued in a more patient way.
Thus the first recommendation I would make is to dedicate 15% of the development finance institution's portfolio to providing patient capital to very-early-stage, higher-risk small and medium-sized enterprises and those that are specifically focused on creating targeted and tailored market solutions for the poorest and most vulnerable people living in low-income countries.
Canada can really distinguish itself by intentionally pursuing a risk-adjusted, below-market return in order to support companies that can catalyse new markets for the poorest and most vulnerable. Many DFIs end up making deals in low-income countries. Canada can go beyond that by trying to actually provide some of its DFI capital to business solutions that are tailored to meet the needs of those who are presently underserved or fully under-represented in the market today.
That is a harder thing to do. That's why I recommend that only 15% of the portfolio go towards those really high-risk investments, because in seeing this as a broader portfolio, it's important to take on those risks, but also not to have Canada's full scope of its institutional mandate be saddled with that kind of risk.
The second thing I want to suggest is making loan guarantees available for women-owned SMEs. As Minister Bibeau and Prime Minister Trudeau discussed, wanting to have a focus on women-led businesses is also still going to put an extra degree of challenge on Canada's plate concerning the way we do it, because systemically, women entrepreneurs in developing countries the world over face many more challenges and are discriminated against in that pursuit.
Women have lower non-performing loan rates—they simply default less than men—and yet they're viewed by financial institutions as a far riskier bet to receive financial investment. Existing multilateral and bilateral development finance institutions already use loan guarantee facilities targeted at women as a way to decrease the risk perception that continues to be hung around the necks of women the world over on the part of banks, and consequently do so in a way that encourages lending to those kinds of entrepreneurs. This is a very effective and well-substantiated way for a development finance institution to do something that commercial financial institutions and markets will otherwise not do. In view of our strong focus on women entrepreneurs, we think this is a very effective way for Canada to make a dent in that kind of issue.
The last recommendation I would offer really hearkens back to something I said off the top, which is that the challenges experienced by small and medium-sized entrepreneurs today are so much more than the availability of capital. If Canada's DFI wants to take a comprehensive approach, technical assistance and the whole suite of business support services that need to be made available to entrepreneurs are of great importance.
We therefore encourage Canada to have a technical assistance facility that can be extended into the kinds of investments and partnerships with financial institutions that our own country will try to pursue. At the same time, it should also provide technical assistance directly to entrepreneurs, and particularly to women entrepreneurs, so that the investment we make in those people vis-à-vis our DFI is more secure and we know that we will be able to support them through the growing pains and challenges of building a business. Many case studies indicate how critical it is to follow on investment with technical assistance, but I'm happy to speak to that issue in questions that you might have after my comments.
With that, I'll wrap up and just again say thank you for giving me the opportunity to be here.
Mr. Chairman, honourable members, I also want to thank you for the opportunity to come here and speak on this topic that I have long held an interest in. In the last 20 years, I've spent a lot of time both in development finance and in export finance. I was 16 years at EDC and now going on two years at Cowater International.
I want to preface my remarks by saying that the views I'm going to express here today are my own. They don't necessarily reflect the views of my current employer or my past one, but I'll get into it. Bear with me, I have prepared remarks. I thought about what I wanted to say; I'll go through it, and it's timed to about eight minutes.
I'll start with some working assumptions about the DFI and I'll lead into what I would call “danger areas”, what I think the DFI should not aspire to be. I'll explain why, and then I'll move to what I think the DFI should aspire to be and achieve, and what that means for its mandate, its governance, and its strategy. I'll do this through talking through real examples of peer institutions, what I have observed during my time in this area.
I'm starting with assumptions and dangers.
The new DFI will aim to be self-sustaining, i.e., it will need to cover its operational costs and fund its investments and lending through paid-in capital and provisions for losses. Its management and presumably its board of directors will be responsible and accountable for executing its mandate and responsible stewardship of financial results. This means its risk appetite, its scope of operations, and its strategy will necessarily be circumscribed to a certain extent. In other words, it will not able to be all things to all people. It will need to pick areas of operations, both geographic and sectoral, and will need to define its box of deals and structural solutions.
While this is simply reality and not necessarily a problem, it could lead the institution down a path that we don't necessarily want. What do we want? I would argue, first, we want this development finance institution to be additional, so that means it won't do what private sector financial institutions already do, and second, put developmental impact at the very centre of how it measures results.
You may think these goals are self-evident, but we need to fully consider the implications of being self-sustaining: it will certainly face pressure to minimize excess risk and moreover to find projects and deals that minimize the operational burden of originating and leading complex financing transactions, and instead possibly follow the lead of others and follow the market. This is a possible scenario.
We know that DFIs worldwide can compete for the best deals. Everybody wants to be associated with successful projects and companies and, just as in the private sector banking world, DFIs have been known to trip over each other for the best assets.
Again, not to be overly critical and certainly lots of good models are out there for DFIs, I would suggest that kind of behaviour of trying to seek the chosen assets is behaviour we don't want, and by definition that's not really additional.
For the DFI to effectively balance its self-sustaining and developmental priorities, it needs to achieve the right balance through an appropriate governance framework and clear strategic guidance and priorities. These goals can and should be balanced, and the institution—and this is the previous speaker— will then be forced to innovate to find strong, developmentally impactful and additional deals that on a portfolio basis—again coming back to the previous speaker—are not loss-making. That's to frame the risk-balance discussion.
We'll talk about mandate and governance.
My first recommendation is therefore that the DFI be required to demonstrate clear additionality and development impact for every transaction. There are established methodologies in the development world on how to measure development impact, and I suggest the DFI look to learn about them and incorporate them into its own metrics.
For example, GAC has many experts, as we do at Cowater, in designing robust performance measurement frameworks that are fundamental to results-based management. In our projects we must commit to achieving very specific developmental results in the development world, right down to the number of people receiving a certain type of training, or a certain number of enterprises reaching new markets with their products. Why should the DFI not look to use similar practices, adapted of course for the more commercial sphere in which it operates?
This goes to my second recommendation, that the DFI build a robust results-management framework based upon best private sector practices in the sphere of international development.
I will talk a little bit about strategy. I would hope to see GAC develop a capacity to approach its interactions with the DFI strategically and to play a well-defined part in developing the DFI's priorities. This is easier said than done. At a high level and strategically, the DFI should fit into the tool box of policy instruments available to the Government of Canada as it works to support developing economies worldwide, with the ultimate aim of reducing poverty, inequality, and spurring economic growth and livelihoods.
Conceptually and temporally, the DFI fits at a later stage in a country's economic development than traditional development programs, as in the earlier example of CDC versus DFID.
The main idea is that sustainable enterprises exist. They have the capability to pay back their loans and investors but for various reasons, including underdeveloped local financial markets, they cannot access the capital to grow and carry out their business plans.
So how does a DFI relate to traditional development programs? GAC should identify one or two programs, desks, or divisions, focus on economic growth in developing countries, and look to hand off beneficiaries for scaling up by the new DFI, which, in my mind, is the third recommendation. It's really about getting organized and making sure that, if we talk about a coherent development policy where you have early-stage interventions and later-stage interventions, the mechanism exists for that to happen.
Let's look at an example. In our projects worldwide, in Cowater, we work with different donor agencies, and for that reason, we're in a relatively privileged position of seeing various project designs, some good, some bad. I'll pick a good one. DFID, the U.K. Department for International Development, has been a leader in what are called market systems approaches to development. They invest in helping countries, enterprises, and subnational governments address market barriers systematically in least developed countries, and they set the stage for financial sustainability from those interventions.
They are doing this, for example, in renewable energy. They have many large programs helping African countries invest in climate-mitigating technologies and build sustainable business models in the energy sphere. From these programs come candidates for development financing. You could have, for example, a small solar farm operator who has recurring cash flow and proven expertise and wants to replicate her business model across many other projects. Although assisted by DFID, she is without access to capital or is facing high capital costs, effectively hobbling her growth.
These are the kinds of ways GAC and the DFI can work together by taking a long-term coordinated approach, investing in basic enterprise development, and by ensuring that the DFI looks at suitable candidates for scale-up and growth when they are ready.
My fourth recommendation is that the DFI should focus on sectors and geographies where SMEs are viable and have the potential to scale up in a financially sustainable way. Examples include the renewable energy sector, the water sector, and small infrastructure. Incidentally, I do not believe the DFI should consider larger infrastructure projects. These should be the province of private capital and are unlikely to be candidates for capacity building for SMEs or for the micro-level enterprises that are so important to economic development in developing countries.
I'll talk a little bit about instruments and mechanisms. Successful development finance institutions combine their financial instruments with grant-based technical assistance, TA, which is fundamental to providing the capacity the beneficiary needs. For example, in the former Soviet Union, the IFC was quite successful investing in small regional banks and bringing the risk management of those banks to international standards, which was also a risk mitigant to the IFC in their underlying investments and lending. In order for the bank to steer clear of systemic risks and counterparty risks, they needed the risk management practices to do so at the bank.
Donor funding, enough to pay for an embedded team of advisers for a few years, associated with another investment, is the key to accomplishing this and is the reason the IFC was able to achieve relevant and real developmental impact.
The Canadian private sector would be extremely well positioned to provide this kind of TA and to help bring world-class Canadian expertise to developing countries.
My final recommendation is therefore that the DFI set up a mechanism to work with the Canadian private sector to identify pipeline projects with strong developmental impact in the success of which Canadian expertise can play an instrumental role.
Thank you for listening to my remarks. I'm happy to take any questions.