Examination of Witnesses (Questions 1-19)
LORD CAIRNS, DR ALAN GILLESPIE, MR RICHARD LAING, MS GILLIAN ARTHUR
TUESDAY 2 JULY 2002
1. Lord Cairns, welcome. We will ask some questions but we will leave it to you between you as to how you allocate the answers. This session really arises out of the fact that there has been by any criteria a fair amount of adverse comment and criticism of the CDC and so we thought, in fairness as much to you as to anyone, we should give you the opportunity of responding to that. We will take today's evidence. I suspect that we may then have some questions that we might wish to put to the Secretary of State. We will the write to the Secretary of State with those questions, whatever they might be, following today's session, which will then provide the Secretary of State with the opportunity of coming back to the Committee, probably in the autumn, with her responses to those questions and anything further that the Department might wish to say about CDC. At that stage, we will publish the minutes of evidence for this session, our questions to the Secretary of State and the Secretary of State's responses as a coherent package. Having read your submission to the Committee and DIFID's submissions to the Committee, how do you now differ in any way from a normal commercial venture fund? If you are having to make commercial rates of return on your investment, how do you differ in any way from an Africa fund, an FSA regulated Africa fund, being operated by a venture capital trust in the City of London or anywhere else?
(Lord Cairns) That clearly is something that has concerned people. If you look at what we are trying to do, we have a mandate with three parts: a mandate to help sustain businesses, to support local entrepreneurs; it is also a prime target of ours to try to attract further capital from other sources; it is also to set standards for what we can broadly call good corporate governance. We see that as just one part of the UK effort. We say in our submission that 6 per cent of the total government effort is in that sense. We are constrained to operate within the poorest companies in the world. No other organisation from the private sector would be similarly constrained. We are further constrained with our 70 and 50 per cent rules. With that background, we have to operate, unlike other organisations within those territories, whereas a similar organisation from the private sector would dip in and out of the territories that we are talking about from time to time. Rather than having that as the sole area in which we can operate, an operator might operate from, say, Hong Kong and be in India at one moment and Taiwan the next and somewhere else at the next moment, outside our area. I do not believe that a purely private sector organisation would set itself up in a manner which constrains itself in the way that we do. Secondly, I do not think we would see out of those the clear ethos that everything that we do is looked at very carefully in terms of its development objectives and how we meet those. It is not purely to make money. We believe that it is right to make money and to put money where it can best be used but that is part of the answer, not the whole answer.
2. My question is a three-pronged one. First of all, which sectors does CDC consider lend themselves more easily to an investment under a public/private partnership? Secondly, what returns is it reasonable to expect on such investment? Thirdly, what impact is such investments expected to have on poor people in the recipient countries?
(Dr Gillespie) The first point of the question is: what sectors are we most focussed on? We have organised our effort around industry teams and, just to list them, there would be an emphasis on the power sector - electricity; and a new sector in the last two or three years would be the health care sector, particularly in Africa; we have a strong agribusiness portfolio and set of people focussed on agriculture; we have a financial institutions group which is focussed on the investment in banks and local financial institutions; and we have a minerals, oil and gas group. Those would be the principal sectors. Obviously you could say that there is a broad infrastructure emphasis as well which may incorporate aspects of transport. Within Africa, we have a small group focussed on property. That would be an African-specific sector. Then, within India, we have a group of people who are quite focussed on the new technology businesses in India. Those would be the sectors. Looking ahead, as we seek to raise additional capital in CDC, we think a number of those are of interest as target sectors to third party investors. The second part of your question was on returns. We believe that investors will follow CDC in to some of these difficult markets for a net return in the order of 15 to 17 per cent per annum internal rate of return. That requires the generation of a gross return in the area of 22 to 25 per cent. There is a well-documented set of rules about the difference between gross returns and net returns. We believe to bring investors in that net returns should be 15 to 17 per cent. Right now, we have some businesses that we invest in which are achieving those returns, others are not, across the portfolio. For example, the power sector on which we are placing considerable emphasis gives a certain stability of return. We believe that the investments that we make in electricity generation are capable of retuning to investors 17 to 18 per cent net returns. The third part of your question was about impact. I can honestly talk about that all morning. At the back of our submission I think the list is of 270 separate companies in which we invest across the poor countries. I cannot think of one of those countries we are investing in that is not making a positive impact locally, and that might be through the offering of employment. In order to look at impact, we have calculated right now that there are approximately 190,000 people working in companies in which CDC is invested, so there is a benefit to employment. There is a benefit through backing entrepreneurs and creating a stronger private sector. If we just listen to comments from the G8 last week, there is strong evidence that, alongside government funding in these poor countries, there has got to be a stronger private sector. What CDC is doing is strengthening that private sector and the private sector will have to be an anchor to development.
3. Can I follow up the health care issue that you mention? How does PPP actually help poor people and provide health care for them?
(Ms Arthur) In terms of looking at the health care industry, one of the things that we have been trying to do, particularly in Africa, is to understand how the system works, with particular emphasis on looking at those poorer, lower income people, not necessarily the poorest people. We hear a lot about AIDS and about malaria. There certainly is a case to be made which says a lot of people are economially disadvantaged by what are at worst very minor illnesses. Things such as Prime Cure clinics, which we invest inbased around townshipsare at the lowest economic end of providing basic kinds of intervention. We are trying to see whether these models can be built on and if we can take a bigger part in that portion of the health care industry.
4. Really what I am asking you is how very poor people pay for private health care.
(Ms Arthur) I think you find that even very poor people are paying for certain lower level medicines and intervention. Of course, the challenge is: how do you do it better and more efficiently, so that you can drive those costs down still further, and also drive them down for employers. Remember, there are large employers who have a big blue-collar workforce. They are certainly trying to provide what they need for the health of their workforce. They are constrained by costs as well.
5. Just to be clear about what you can invest in and what you cannot invest in and what you would or would not invest in, let me mention something that in your report seems to be conspicuously absent. There is never any mention of water. Water is crucially needed in these poorer countries. How is it to be funded? If they are in a HIPIC agreement, it is going to be very difficult for them to take on debt because a lot of debt has been forgiven? Then we get a lot of criticism, say, from Trade Justice and other people, about simply inviting in French and British firms to invest and make a profit out of water. I would have thought it was an area in which you could make a considerable contribution. As I understand it, you would not because you would not be able to make the scale of profit that is now demanded of you. Is that right?
(Lord Cairns) Mr Worthington, I think there is a number of things that we could do, one of which would be in water. Water is clearly an extremely important area.
6. You are not doing anything in water at the moment?
(Lord Cairns) We have fought shy of it, very largely because we find it a very difficult area in which to encourage the private sector to operate. The whole business seems to me to come very much more closely to a public sector entity. The whole issue of what you do when people do not pay and the alternative is to deprive them of water is an area that we find, frankly, very difficult in political terms, domestically and elsewhere, and one in which we have felt the public sector should play a major part.
7. In economic terms, it is difficult to think of anything more important for a country, other than it gets basic servicesyou mentioned power in particularsupplied in an economic, efficient, maybe not a highly profitable way, but we are not now making any kind of contribution to that area through CDC.
(Lord Cairns) We have chosen a number of sectors. We have not chosen water as being one of them. We could have done. I think politically it is a very difficult area for us to involve ourselves in as private sector supporters because, and this is a personal view, I find great difficulty in seeing that as being a service which should be provided on a profit-driven basis.
8. But on an economic basis, with private sector skills?
(Lord Cairns) Our mandate is to support the private sector. I am saying that I do not see this as being the most natural area for the private sector to develop and thrive in.
9. One of the investments identified in the 2001 Annual Report is a health care investment in South Africa. What is it seeking to do?
(Dr Gillespie) We have four health care investments in South Africa that have been made just in the last two years. One of them is the provision of clinics. I think from memory there are about 60 clinics in poor areas providing basic health care to blue-collar workers, mostly funded by the employer paying for the service. We then have a second business, which is really a financial reimbursement business, sitting between the clinics, the insurance companies and the service providers. The third is more an IT business around the health care sector. The fourth is a fund which invests in other health care businesses. Why have we done this? It seemed to us that in this twin objective of seeking to make investments which are beneficial and financially viable, health care in Africa was crying out for a response from us. Inasmuch as there are some things that we have not done, health care is one of two things where we have made a start. We are encouraged that these businesses which are quite young appear to be financially robust and certainly are providing levels of health care to people in South Africa who deeply need it. What I am encouraged by is that two of those businesses are now, under our auspices, looking at establishing in East Africa, particularly in Kenya, a South African health care model and applying it in another part of Africa. We see that across a lot of our businesses where something that has happened in South Africa spreads northwards through the continent. It is early. It is frustrating because we have not yet been able to make additional health care investment. We are on the lookout for them.
10. Twice I have been to South Africa to look at health care. It strikes me that it is unlike many other developing countries in that the central problem rather than an absolute lack of resources is poor distribution of resources. I would be very interested to have a list of the locations of the clinics, how many of them are in the northern province, and to know more about the income position of those using the clinics because blue-collar workers are unlikely to be the poor in South Africa. First of all, they have got jobs and they are not unemployed; secondly, they are urban rather than rural.
(Dr Gillespie) It may be but I also believe that a healthy workforce in South Africa is essential for the economic development of the country. It may be that the mission for these particular clinics is not to be right out in the depth of rural poverty but rather servicing an urban community who are at work. It is akin to private health care provision, mostly financed through employers. Many of these clinics are based around the mines, for example. We would be happy to provide information and, if you would like to visit, we would be happy to arrange that as well.
(Lord Cairns) It is a most impressive operation.
11. I know that we will be returning in a moment to deal with the poverty focus of CDC, but may I take you back to the financial architecture around CDC partners now? In view of the limited interest, I understand, shown by private investors so far in buying in to CDC, what measure does CDC consider it should now change to make itself more attractive to private investors by ensuring that the development impact of its investment is not lost? I am a bit surprised that none of the ethical investment funds, if you like, have decided to work with you. What measures do you think are needed to make you more attractive?
(Lord Cairns) We have obviously talked to potential investors at various levels. We have had a fair amount of success in raising some monies alongside ourselves, which we see as being just as important as any sale of the existing assets of CDC. We think that the majority of investors will be less interested in buying into CDC across the board; they will be more interested, because most of them think in this way if they want to buy into a basket of assets, to do so either on a geographic basis - there are people who are interested in India and others who are interested in Africaor on a sectoral basis. There is a number of people who are interested in the global electrical generation game. There is also a number of people who may not be fully private sector investors, who are interested in investing in the SME sector. That is why we have separated out the funds which we now jointly own with Norfund, to appeal to that particular community. We are trying, as it were, to package part of CDC in ways in which we think we are most likely to succeed. We have some evidence that we are successful. For instance, we have a new SME fund for poor countries in Central America which is just about completed now. That is a $33 million fund. We have plans for SME sectors; basically one for East Africa, one for West Africa and one for southern Africa. We are re-packaging bits of CDC into a format where we think we are most likely to gain support. That is clearly at one level. The other level, of course, is that on individual projects we will try, when appropriate, to bring other investors alongside us on a project-by-project basis. Our submission talks about our investments of $1.3 billion generating of the order of $6 billion of funds coming in to work alongside us.
12. Why do you think the ethical investment funds have not picked up on you? Is it because they do not think you are on an environmental ethical basis?
(Dr Gillespie) The reason is that most of them at this stage are still invested in quoted/listed stocks. We have talked to the Friends Ivory & Sime and institutions like that. They are almost all wanting to get into the listed area. We are encouraging them to come with us in terms of exposure to private equity.
13. What comparative advantage do you think CDC has as a PPP over the existing commercial bank and investment agencies which target the same markets? For example, how would you see you are different from any other blue chip investor in India with or without a corporate social responsibility edge, as it were? What makes you different? What is your comparative advantage?
(Lord Cairns) Just to give you perhaps one example, and I was there fairly recently, one of the government institutions said to me that they very much wanted to reorganise one particular sector. They thought that the people which they would like to work with on helping to create that reorganisation was CDC. That might be because it is partly government owned or because we have been seen as a particularly responsible investor or because our team there has been very successful; it is probably some combination of all those three. There is a sense that CDC is there for good and not in and out on an opportunistic basis, that we have a real commitment to that country, which goes beyond today and tomorrow and what happens over a particular short period of time. I think that is different.
14. My colleagues might like to follow that up. Could I say that DFID sent us a memorandum, which is evidence item 3, about CDC. In paragraph 3 they say that they do not believe it is possible to sell a majority of CDC shares in the near future and that they are exploring alternative ways. You have talked about these individual funds. What other ways do you think could be explored in terms of how you would be able to go forward into the future? What do you think is in DFID's mind?
(Dr Gillespie) It is quite collaborative at this stage. We have been asked by DFID to put forward our ideas from the sharp end as to other ways in which private capital can be mobilised. If we go back to the 1997 statement around PPP, the essence of it was to say: government is not putting more money into CDC in order to make it do more; let us find a way to raise private capital alongside the government capital. That was the essence of the public/private partnership in CDC. It was hoped that ordinary shares in CDC could be sold to investing institutions. As the Chairman said, there is no demand for ordinary shares, buying into the whole of the entity. One way we are looking forward is to say, "Let us put forward a series of discrete entry points in to CDC, whether it is to invest in a power fund or an SME fund in India". That is one way. Another way, though, that we marshal private capital is at the level of the individual company on a co-financing basis. I give you one example from this year. We have completed an investment in a hydroelectric power scheme in the Peruvian Andes which supplies power down to the cities. We have succeeded in getting Scudder, which is a Boston fund manager, to subscribe $33 million to that investment with us. So they have not come in at the top level; they have not come in at the fund level but at the level of the project. We would see that as increasingly a way of mobilising investing institutions to invest with us.
15. You are providing mezzanine financing?
(Dr Gillespie) We are providing core equity and they have come in as an equity provider. There is vendor debt finance in the structure as well.
16. If the funds roll out, do you see yourself having a majority shareholding in those funds? What would be the financial architecture of the fund?
(Dr Gillespie) We need not have a majority. We would be the fund manager and we would control the fund management company, but underneath that we would seek to encourage as much other people's money as possible. To come back to the fund we are raising as we speak in Central America, we have committed $5 million; other investors have committed $28 million. I think that is a very attractive ratio of non-government money to our money.
17. Would there be anything to prevent you from listing part of CDC's operations? For, example, I am a director of one or two AIM companies, companies listed on the AIM exchange. One of the reasons why people invest in AIM companies is that they get a variety of tax reliefscapital gains tax relief and so forth. It seems to me that from the point of view of investors investing in CDC, there are not any of those opportunities available to them whilst you remain a wholly government-owned fund. Maybe there is a variety of things that you might be wanting to do, in addition to setting up discrete geographical places to fund, such as ring-fencing and putting some part of CDC on one of the exchanges.
(Lord Cairns) Of course, Mr Chairman, we do try and often succeed in listing a number of companies in which we have investments on the local markets. A large number of the Indian companies in which we invest are then quoted on the market and we may realise part of our holding out of that exercise. Perhaps Richard Laing can tell me how many of our investments are quoted. It must be several dozens.
(Mr Laing) Certainly it is.
18. That is a slightly different point to the one I am making. What is to stop CDC setting up a part of its operations as, say, an AIM listed company on the UK stock exchangenot all of your operations but part of themso that you are then able to lever in finance from institutions or from high net worth individuals who may well be prepared to invest in an AIM-quoted company because they get the benefit of various UK tax relief as a consequence?
(Dr Gillespie) The test marketing we undertook on a very discreet basis a year ago offered a number of investors the option of coming into a CDC that was listed. I do not think the issue was whether it was listed or unlisted. At that point there was just no interest in the risk inherent in the countries in which we operate. You are right, we could have part of CDC listed; we could have it in AIM with various other tax arrangements around it. I think, from the work we have done with advisers recently, it is not the tax regime or the listing that is the issue but the fact that we are working in some of the most difficult and risky countries. When investors are interested in the emerging markets, they tend to think of South Korea, Turkey and eastern Europe, countries we are not in. We will aggressively seek the right structure, but behind that we have got to make sure there is investor interest. As we have said this morning, we think that investor interest is best coming into individual funds, individual investments. Maybe they will be listed in due course. Can I just go on to talk about power for a minute? We see right now that one of the most profound development needs across all our countries is the provision of electricity. That is something that CDC has done over the years and does well. Right now we have 21 investments in electricity. On the back of Enron, there is a huge crisis in many of our countries where first world operators are leaving and there are greenfield generation and distribution businesses that will not be built. We see an opportunity for CDC to step into some of those businesses. There are large amounts of money involved in the power sector. W e would be quite hopeful that in the next two years we could raise a significant fund for investment in electricity. We started down that road in fact last autumn and the timing worked out to be terrible, given that Enron happened. We have a model. We have called the company Globeleq. We believe it is capable of raising several hundred millions of dollars for investment in power. It could be that that company is a listed company in order to make it a more attractive investment vehicle for us.
19. Could I ask about the poverty focus. The impression I am getting is that CDC is trying to live in two worlds, the ordinary private sector world and the world where it has a development focus. I am not so clear about the development focus. The language you use is about the constraints of working in poorer countries. You accept constraints that other private sectors do not. I am tempted to wonder whether you want to be free of those constraints. I would like you to disabuse me of that. In another way, I have heard other companies, indeed in the power sector, telling me that they work in very difficult and very risky places, namely the North Sea and Alaska, in places that could hardly be described as having a poverty focus. I would like to press you to say more about what you see as the basis for CDC Capital Partners as a poverty focus and does CDC at board level assess the alleviation impact of its activities? Do you ever relate to the millennium development goals, as regard to the general trickle down effect? Do you have targets for poverty alleviation at board level?
(Lord Cairns) The answer to that is that CDC is committed and convinced that it is right and that it will make a contribution to poverty alleviation by helping the private sector to succeed in the poorest countries of the world. In terms of what we are and what we are not, I think we are not an aid organisation; we are part of a very much broader picture. Our specific skills and concentration is on creating a private sector which can add value within the countries in which we operate. We believe that while this may not have a one-to-one effect upon the poorest of the poor within those countries, and it is not our mandate to deal with that aspect, we can make a contribution to the effect on businesses which are successful and on whether that success will be shared across a whole range of people. We are not going to solve the issues of poverty ourselves, but we think that we can be a significant part. Quite frankly, nobody would be working in CDC that I am aware of if he did not feel that was the case.