CDC kicks off new strategy with eye toward riskier investments

With British funding from the CDC, Umeme is helping provide electricity as well as jobs for local engineers in Uganda. Photo by: CDC

LONDON — The United Kingdom’s Department for International Development will invest an average of 620 million British pounds ($815 million) per year in its development finance institution, the CDC, until 2021 — with the option to increase its average investment further to 703 million pounds ($925 million) per year depending on need — the Secretary of State for International Development Priti Patel announced at the World Bank on October 16.

The investment kicks off the CDC’s new strategy, published in July, which will see 20 percent of its capital invested in higher risk ventures with a lower guaranteed return on investment, for example, through its impact accelerator and new impact bond. CDC, which began investing exclusively in Africa and South Asia in 2015, will also take full ownership of those tools, which have formerly been owned by DFID but managed by CDC. They will now come onto CDC’s balance sheet, and will be funded through the increase in money.

With the new resources, the U.K. will increase its use of development capital from 4 percent of the aid budget to 8 percent, placing it behind the Netherlands, Germany, and France for its use of development capital as a percentage of aid, according to statistics compiled by CDC.

But while a new, less risk-averse CDC will allow the investor to walk the line between traditional development finance and traditional grantmaking, its Communications Manager Rhyddid Carter explained to Devex that it is still bound by the U.K. Treasury to deliver a 3.5 percent return on investment across its portfolio. As a result, Carter said, the majority of CDC’s work will seek safer, higher return investments, in order to finance those riskier ventures.

“Following the increase in funding from government, we expect to be able to maintain current levels of investment of around $1.6 billion a year. Of that, up to a fifth — or $300 million a year — could go into higher risk, higher impact investments designed to tackle market failures that hold back development.”

“[Those investments] will play a small but significant part, although the bulk of what we do, like other DFIs, will still be investments in businesses ready for commercial capital. We back businesses that are going to create jobs and make a massive difference using that commercial approach,” Carter said.

Risky enough?

Carter said a new arrangement with the Treasury will allow CDC to average out its ROI over time, and officials from the Treasury have agreed to exclude the riskier investments — namely those through the Impact Programme — from the 3.5 percent benchmark. CDC was criticized within the development community in years past for taking too few risks with its investments. In the past few years, for example, the CDC far exceeded its benchmark for returns, achieving on average a 7 percent ROI across its portfolio.

“We did some work for the CDC reform in 2011, and so then and in our advice to the House of Commons, we realized CDC had been quite financially successful and had been able to increase their base successfully, but actually they’d lost sight of development impact,” Dirk Willem te Velde, head of the International Economic Development Group at the Overseas Development Institute and a research leader for the DFID-ESRC Growth Research Programme, told Devex in a phone interview.

“At that stage, the question was — and it was also raised to [the International Finance Corporation] — are you sufficiently innovative? Are you sufficiently targeting the frontier markets?”

Already focused on riskier geographies than traditional DFIs such as the IFC, CDC appears to be mindful of those past critiques. The new strategy and its new understanding with the Treasury will allow the investor to maintain strong returns while also increasing risk.

“The U.K. Treasury said we want you to continue to do well on the main, commercial portfolio, so have maintained the minimum 3.5 percent return target. But these higher risk ways of investing, they’re prepared to look at those and say, ‘OK, we may not have the same expectations around returns on investment.’” Carter said.

“This increased flexibility means CDC can respond to opportunities to achieve additional impact, but the requirement to break even across the whole portfolio also means CDC does not require ongoing capital injections from the U.K. taxpayer unless an explicit decision is made by the government to scale up in the future,” he said.

Asked if restricting CDC’s riskier investments to less than 20 percent of its capital base is sufficient given the gap in financing for less traditional ventures — for example, smaller manufacturing outfits or more innovative energy distribution schemes — te Velde said any increased risk is good news, but that in the future, CDC could do even more to target frontier markets.

“With their existing capital base, I think they need to take risks,” te Velde said. “They need to look at it from a sector perspective; they need to look at what other actors are doing and other DFIs are doing, so it needs to be a different way of looking at things, a more collaborative way, but they’ve now got the capital to be more bullish.”

Te Velde said observers will begin to see whether the new strategy is delivering on claims over the next six months.

Asked what kind of investments it hopes to make, Carter pointed to ventures in the energy, health, and agriculture sectors, including debt financing for off-grid solar power, improving the access and affordability of health commodities, and a grantmaking program for feasibility studies across CDC’s investment portfolio.

Space for new partners

As a result of its new strategy and more focused geographies, CDC is also set to expand its presence in recipient countries: it opened a new Africa hub in Johannesburg, South Africa, this year, will open another in Nairobi, Kenya, and a third in West Africa in 2018.

“My feeling is they will begin to be more visible in policy debates, both here in London and in-country,” te Velde said.

Carter confirmed CDC hopes to grow its presence in-country, including through partnerships with organizations working in the region. Asked if the CDC will open up to partnering with development organizations in-country or with other development investors, Carter said: “Yes, definitely.”

“At a corporate level, we’ve worked alongside civil society organizations such as the Ethical Trading Initiative on standards used by CDC investee businesses to improve their supply chain standards, and one of our investee companies, Jabong, was the first India-based company to join the Ethical Trading Initiative,” he said.

He also said CDC is continuing to work with ETI in more recent retail investments, including companies Daraz in Pakistan and Jumia in Nigeria.

CDC also works with academic organizations to help evaluate their impact, he said.

“We know that several of the companies we work with would benefit from the expertise and partnership that local civil society organizations can bring, so we’re always keen, when appropriate, to connect them with the right support that’s out there,” he said.

Measuring impact

In the past CDC was critiqued by academics and the development community for its focus on measuring impact through job creation. Counting jobs is among one of the clearest metrics for assessing economic impact, but reliance on this strategy, some studies have found, can lead to ambiguous and in some cases non-inclusive growth.

Carter confirmed the organization is working on a new framework for measuring impact in an attempt to look closer at how investors evaluate the effects of development capital.

First, across its portfolio, CDC says it will continue to show annually how many jobs have been created, both directly and indirectly, using methodology “developed for us by industry experts,” Carter said. In addition, CDC will publish the taxes contributed to local exchequers and how much third-party capital is mobilized through its work.

They continued: “Secondly, at a sector level, we’ll collect and publish annual data for certain metrics. In infrastructure, for example, we will track power generated and added capacity. We will also monitor and report selected job quality, gender, and climate change indicators.”

Finally, at the “individual investment level,” CDC will track progress toward the intended impact for every new investment or fund commitment, using “whichever metrics will help us best understand if we are achieving our ambition.” Carter said this may include “indirect as well as direct impact, for example, if investment is in a manufacturing startup, the desired impact may not just be creating jobs and paying taxes, but new businesses created in the supply chain.”

He said CDC can then compare these to its long-term vision of impact. With the new measures in CDC’s portfolio management process, Carter said the investor will be able to agree what to do to enhance impact, “in the same way we use financial measures to guide our strategic and operational work during the life of an investment.”

He added CDC will also commission and publish at least 10 independent evaluations to better understand important related themes, such as the affordability of products and services for poorer groups in society and the impact of private health care companies on overall health care systems, “in order to bolster CDC knowledge, guide our future investment decision, and contribute to the wider understanding of the development finance community.”

Update, Oct. 25: This article was amended to clarify that the U.K. ranks behind the Netherlands, Germany and France for its use of development capital as a percentage of aid.

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About the author

  • Molly Anders

    Molly Anders is a former U.K. correspondent for Devex. Based in London, she reports on development finance trends with a focus on British and European institutions. She is especially interested in evidence-based development and women’s economic empowerment, as well as innovative financing for the protection of migrants and refugees. Molly is a former Fulbright Scholar and studied Arabic in Syria, Jordan, Egypt and Morocco.