FinDev Canada turns 1, seeks to be impact-led

WASHINGTON — A year ago FinDev Canada consisted of Managing Director Paul Lamontagne and one other employee, working out of a WeWork in Montreal. But the Canadian development finance institution recently marked its first birthday in a proper office with about 15 staff. FinDev spent the year in startup mode, working to build Canada’s capacity to work directly with the private sector for the first time. It has learned from others, created a development impact framework, and made its first two investments. FinDev Canada is an independently governed subsidiary of Export Development Canada, with Global Affairs Canada as its shareholder. Much of its initial work involved figuring out how to coordinate with its parent agency to share services to remain lean, and with its shareholder to advance Canada’s feminist international assistance policy. In an interview with Devex, Lamontagne said FinDev Canada aims to be an impact-led “DFI of the future,” defined by six key factors: clear core alignment with the Sustainable Development Goals; an impact-first orientation; an innovative culture that embraces technology, digital, data and is able to fail; being a risk taker by investing in least developed countries; scaling quickly through partnerships; and mobilizing private capital. Building an institution FinDev got a big assist from EDC to get off the ground. The young agency was able to tap into EDC’s operations — from its research team, to staff around the world, to human resources, and finance capabilities — as it started up. That made it easier for it to focus on building its autonomous deal origination and asset management operation and just buy the other services from its parent. “I felt very strongly that at the start, we would set ourselves up more like an impact player than a development financier.” --— Paul Lamontagne, managing director of FinDev The agency spent its early months focused on hiring key staff and building out a development impact framework. “I felt very strongly that at the start, we would set ourselves up more like an impact player than a development financier, and therefore that we would spend lots of time on our theory of change so we understood what actions we wanted to take, the outputs we were looking for, and the long-term impact that we wanted, because we felt that this would lead to a far more strategic outcome and a more sustainable development model,” said Lamontagne. That development impact framework, which went through several rounds of stakeholder engagement, is now a tool FinDev Canada uses as it evaluates each potential transaction. The tool allows investment officers to score projects based on gender, climate, and local economic development — including factors such as job creation. In building the new institution, FinDev wanted to learn from the successes and shortcomings of other DFIs, as well as international finance institutions and multilateral development banks. So it spent time with peers collecting insights about what has and has not worked, aligning itself “with what we saw as like-minded actors in the market,” Lamontagne said. The result, in part, was four memorandums of understanding signed last year with the British DFI CDC Group, the Dutch DFI FMO, the African Development Bank, and the Finish DFI FinnFund. Those agreements are designed to share best practices, and more are likely in the year ahead. As Lamontagne was looking at potential models for FinDev, he felt the Nordic DFIs, most of which have portfolios of about $1 billion, were most aligned with Canada’s “social democratic approach to development” and were about the size he envisioned the organization would be in about five years. FinDev also helped launch the G-7 2X Challenge, a commitment made last year among the G-7 DFIs to mobilize $3 billion for gender lens investing, which Lamontagne counts as one of his agency’s first milestones. The gender lens investing work has been informed by others’ efforts, including those of Overseas Private Investment Corp., whose own 2X initiative launched ahead of the G-7’s, as well as the Swedish feminist international assistance policies and Swedfund’s work. The institution also created an enterprise risk management framework and a risk appetite statement. Through that process, it identified some 30 countries — a mix of developing, middle income, and upper middle income — that it would invest in. The goal, Lamontagne said, is to create a portfolio that is “being bold, yet being sustainable,” though exactly what that means, or how its investments will be distributed, remains to be seen. FinDev’s five-year corporate plan for 2019-2023 — which included the development impact framework, the risk appetite statement, and more — was submitted to the government and will eventually be made public. While building its systems, FinDev Canada also made two investments, one alongside the CDC Group in M-KOPA, the Kenya-based off-grid solar provider, and a second alongside FMO in Climate Investor One, a climate fund. The year ahead While learning from other DFIs, FinDev also wants to set itself apart from them. Lamontagne said he noticed that a minority of DFIs are doing a lot of equity investments, and he believes DFIs should be doing a lot more of them. He’s not alone in the belief that there is a need for more equity investment; the U.S. will have that capability for the first time when its new Development Finance Corporation launches, but sourcing deals in low-income countries has proved to be difficult for some DFIs. “You need to gear your organization and capacitate it differently. The skill set of doing debt, senior debt, or unsecured debt is different than the skill set of doing equity investments,” he said. “So clearly if we want to be different and address gaps in the market as far as bilaterals, we need to be able to do a lot more equity than we might have originally envisaged, because there are still far too few that lead with equity.” Over time Lamontagne would like FinDev to build a pipeline and robust equity portfolio, but that will require that the organization have a longer term timeline, with deals lasting five to 10 years, if not longer, he said. That’s difficult if an organization is pressed to cover its costs in two to three years. “By saying within the next five years we won't reach break even, we’re giving ourselves as much opportunity as we can to go to places that take time to get a return on your investment.” --— Lamontagne, FinDev managing director Lamontagne said FinDev is not under big time constraints to prove its profitability. The agency may have up to 10 years to prove its sustainability, and it may make deals at a slower rate than other DFIs, given its size and focus. FinDev will need to raise more than the $300 million it started with to get there, he added. “By saying within the next five years we won't reach break even, we’re giving ourselves as much opportunity as we can to go to places that take time to get a return on your investment, where there may be higher default rates, where there may be the requirement of more market readiness before you can actually invest in those markets,” Lamontagne said. FinDev is prepared to make some mistakes along the way, Lamontagne said. Employees will not be penalized for trying and failing, as long as the organization can learn from those errors and grow, he said. Another critical discussion in the DFI space today, he explained, is about the need to drive down the size of investments, to help fill the gap that exists in the small and medium enterprise market for funding of between $1 million to $3 million. FinDev Canada will not be able to fill that gap right now, as it can do investments of between $5 million and $20 million, but Lamontagne said he would like to eventually get to smaller deal size. The challenge many DFIs have faced is that the transaction cost and due diligence costs of those smaller deals mean that they don’t often make financial sense. So with a much smaller budget than most at $300 million currently, FinDev could struggle to deliver on that goal. “With no legacy systems and a blank canvas, there is a huge opportunity to embrace a lot of these leading edge and new technologies.” --— Lamontagne, FinDev managing director Lamontagne said FinDev is lean and small, with less overhead than some institutions because of its structure in EDC, and that it may be able to use technology to do some of those smaller deals. FinDev Canada is working on an IT roadmap that is focused on how to use data, artificial intelligence, and smart contracts that might be based on blockchain in its work. And it will convene others on the subject during the upcoming World Bank Spring Meetings. “With no legacy systems and a blank canvas, there is a huge opportunity to embrace a lot of these leading edge and new technologies and also work with our fellow DFIs and IFIs on perhaps areas of innovations that they are looking at,” he said. FinDev Canada wants to work with the poorest countries in the world, but it will need to do so in partnership, and work closely with Global Affairs Canada, which can help provide technical assistance to help businesses, particularly in fragile or low-income countries, be investment ready. FinDev will be announcing a technical assistance strategy and initiatives designed with Global Affairs Canada aimed at helping improve deal flow in more fragile economies, Lamontagne said. Other countries have also announced the intention to invest more in least developed countries, and as a recent report about the CDC Group’s efforts indicated, it doesn’t always go according to plan. So it will remain to be seen how these efforts play out, although several DFIs have learned that technical assistance can be key to improving success. As the organization designs its investment strategy, it is looking at where there are gaps in markets or in sectors it could fill, likely in power, agriculture, and financial services. It expects to do about six deals this year and is focused on building a diversified portfolio — both in where it’s investing and the type of investments it is making, Lamontagne said. FinDev is looking to Latin America, and potential debt investments or other equity fund investments moving forward. “There's no pressure on us and no reason we would do what everybody else is doing. We've got to do what we feel will be the most impactful,” he said.