CDR Finance Authority Policy Recommendations
Development Finance Institution (DFI) is a term that refers to a range of alternative financial institutions that support private sector growth-focused development by providing finance and seeking to limit risk in environments where commercial banks do not operate. These institutions play a crucial role in providing credit in the form of higher risk loans, equity positions and risk guarantee instruments to private sector investments in developing countries. The purpose of DFIs is to ensure investment in areas where otherwise the market fails to invest sufficiently in countries and sectors that represent development priorities. DFIs aim to be catalysts, helping companies implement investment plans. DFIs especially seek to engage in countries where there is restricted access to domestic and foreign capital markets, and provide risk mitigation tools that enable investors to proceed with plans they might otherwise abandon. In OECD economies, Small and Medium Enterprises (SMEs) and microenterprises account for over 95 percent of all businesses, 60-70 percent of employment, 55 percent of GDP and generate the vast majority of new jobs. Therefore, DFIs play a critical role in support of sustainable development and economic growth by supporting the entry of private sector investment and the maturation of indigenous commercial sectors.
The United States employs its development finance agencies in support of helping countries achieve gains in market-based development and employment, with a secondary potential benefit of increasing jobs and building new markets for U.S. goods and services. Development finance programs also can help to level the playing field for American businesses vis-à-vis international competitors through the provision of finance capital and the shared assumption of risk in developing markets.
With the majority of capital flows into developing countries coming from the private sector, the U.S. government should expand and improve its development finance capabilities in order to steer private investment towards key development sectors and to better align private sector investment with development grants. It should also be noted that many of the United States’ European and multilateral partners are way ahead of the U.S. when it comes to the utilization of development finance programs and tools.
Perhaps most important in these budget-constrained times, U.S. development finance agencies operate on a self-sustaining basis, with their lending portfolios directing profits back to the U.S. Treasury. Likewise, new authorities that will increase the strength of these institutions can be paid for out of current profits, requiring no additional discretionary (appropriated) funds. For all of these reasons, the U.S. government must make a commitment to strengthen its development finance tools thereby increasing opportunities for market-based solutions to international development.
U.S. Development Finance Institutions
Overseas Private Investment Corporation (OPIC)
OPIC financing provides medium- to long-term funding through direct loans and loan guaranties to eligible investment projects in developing countries and emerging markets. By complementing the private sector, OPIC can provide financing in countries where conventional financial institutions often are reluctant or unable to lend on such a basis.
By mobilizing private capital across the developing world, OPIC also allows U.S. companies to expand into high-priority countries where investment possibilities would otherwise be prohibitively challenging. OPIC’s mandate and capabilities make it unique among U.S. agencies. Not only is OPIC flexible and able to operate in areas too unstable for others, but it also returns money to the U.S. Treasury annually.
OPIC manages a $15 billion portfolio of projects in more than 100 countries. In 2010, OPIC generated a net income of $260 million, and over the entire 40 years of OPIC’s history, the program has generated a net profit of more than $5 billion for the U.S. Treasury. OPIC has supported $188 billion in investments that have helped generate 830,000 jobs.
Unlike other development finance banks, OPIC does not have the authority to use a portion of its proceeds for equity investments in the projects it finances. The lack of this authority prohibits OPIC from making strategic, minority-share equity investments into the countries and regions with the most opportunity for growth and enormous strategic importance to the United States. OPIC has forged partnerships with other grant-making agencies (e.g. USAID, State Department) and development banks (e.g. the World Bank’s International Finance Corporation), but this does not create sufficient nor reliable access to technical assistance resources. The end result is that OPIC is forced to leave hundreds of millions in promising finance deals on the table because of its inability to provide technical assistance. If OPIC were able to re-invest $20m to $30m of its own profits into technical assistance programs, its reach and impact would be vastly improved.
U.S. Trade and Development Agency (USTDA)
By encouraging U.S. business involvement in emerging economies, USTDA achieves its dual mission of supporting priority development projects in partner countries and opening new markets for increased exports for U.S.-manufactured goods and services. USTDA focuses on trade and investment, resulting in increased exports, economic growth and U.S. job creation.
The partnerships established by USTDA foster mutually beneficial results in terms of their development impact on host countries and the commercial opportunities that are opened to U.S. firms. Over the past 10 years USTDA has generated $58 in U.S. exports for every $1 programmed.
Development Credit Authority
The Development Credit Authority (DCA) allows USAID to mobilize local financing to support the development objectives of the U.S. government through partial credit guarantees. Guarantee agreements encourage private lenders to extend financing to new sectors and regions. By encouraging local channels of financing, USAID is empowering entrepreneurs in developing countries to improve their lives through their own business ventures. DCA plans to triple its finance portfolio to a total of $2 billion over the next five years.
In order for USAID to successfully adopt a more private sector-friendly approach to development, it will be necessary to develop a workforce that possesses greater industry knowledge and experience. To this end, USAID deployed Field Investment Officers to regional USAID Missions. This overseas presence will allow USAID to inject capital markets expertise into its field offices, ensuring the local private sector becomes a critical component of USAID programming. These officers are tasked with initiating innovative deals that leverage private financing and facilitate linkages between investors and the local private sector for development activities. It will also be critical for USAID to develop incentive structures for its field and headquarters personnel that sets private sector partnerships as a performance measurement tool for career advancement.
Enhanced Development Finance Tools
The international landscape has evolved dramatically since the 1961 enactment of USAID, and the U.S. government’s approach to development must recognize that the private sector is now the driving force for economic development and poverty eradication in the developing world. The U.S. must look forward and act on the need to forge dynamic partnerships with the private sector, ensuring that every taxpayer dollar is fully leveraged in U.S. development efforts.
As outlined above, OPIC, USTDA, and DCA are the U.S. government’s leading development finance institutions with proven track records that should be replicated and expanded, but also can benefit from a variety of reforms. Larger agencies such as USAID, Treasury and the Small Business Administration also have international finance functions, which must be considered within the context of any reforms.
1. Equity investment authority
Equity investment authority enables DFI’s to make small, minority-share investments in businesses and projects of strategic importance. By providing a limited equity investment authority, OPIC and other U.S. development finance agencies would be better positioned to influence the performance and development impact of financed projects through improved oversight of corporate policy and environmental, social and governance issues. U.S. development finance agencies would also benefit from the higher returns equity investments have consistently been documented to provide to other DFIs.
All other G8 nations with DFIs (Canada is the only G8 country without one) and the World Bank’s DFI, the International Finance Corporation (IFC), utilize this equity investment capability. Equity investments account for a very high percentage of the profits that IFC and other G8 DFIs earn each year. Without equity investment authority, OPIC is losing out on potentially enhanced revenues to return to the U.S. Treasury for deficit reduction and, more importantly, enhanced development impact.
2. Improved political risk insurance and first loss guarantees
As globalization increases, corporations are increasingly expanding into emerging markets that present greater risk/reward investment opportunities. In order to better facilitate private sector investment in these emerging markets, the U.S. government should reassess its current political risk insurance policies across the various agencies that provide international finance services, and where warranted, allow for more risk to be assumed by the government to further increase international private sector investment. In the long run, this will lead to higher returns and recapitalization within U.S. development finance agencies.
Another mechanism for U.S. development finance agencies to provide risk mitigation tools is through the provision of first loss guarantees. Certain high risk environments require greater development finance tools in order to lure private sector investors to the table. In countries and sectors that are a strategic priority to U.S. development and foreign policy interests, development finance agencies should have greater authority to early equity stakes or grants that operate as a first loss guarantee for private sector partners. Such risk enhanced risk tools can either be provided directly by OPIC and other U.S. development finance agencies or provided in partnership with development grant-making agencies, such as USAID.
3. Enhanced technical assistance
OPIC is active in some of the world’s most challenging environments, such as the response to the earthquake in Haiti or the aftermath of violence in Egypt and Tunisia. Yet, OPIC does not have the authority or budget to provide technical assistance, requiring instead that it rely on other agencies to provide necessary technical assistance, putting OPIC at a comparative disadvantage
Developing an internal office of technical assistance would greatly enhance OPIC’s ability to address capacity building and sustainability issues by providing borrowers with concrete tools to enhance their program management skills, and increase on the ground capacity in host countries. Alternatively, Congressionally established partnerships and transfer authorities with USAID or the Treasury’s Office of Technical Assistance could enhance the financing and strategic long-term development emphasis of OPIC’s current portfolio. OPIC’s role in the aftermath of the Arab Spring is a good example of its utility in post-crisis response, and argues for the benefit of creating an established mechanism to quickly transfer funds between the agencies.
Following the revolutions in Egypt and Tunisia, OPIC received a transfer of $2 billion from the Department of State to engage in three forms of development assistance: debt-financing loans to small businesses; private equity funds; and political risk insurance. The funding was not intended for major corporations, but instead was geared toward small and medium enterprises, which contribute to over 90 percent of employment in the region. In the past, OPIC has cooperated with diaspora businesses in the U.S. with ties to such countries as Pakistan, Afghanistan, Haiti, and India, and because of the $ 2 billion grant, it is now likely that OPIC will pursue similar investment opportunities in the Arab world.
4. Improved coordination of development finance tools
The U.S. Government currently has a large number of existing programs, policies and institutions to encourage entrepreneurship and commercial activity abroad. To date, these tools — technical assistance, credit lines, seed capital, risk insurance, and other mechanisms — have not been deployed in an efficient or strategic manner. The fragmentation of effort and lack of cohesion across multiple agencies means that the sum of these parts is far less than optimal.
The Executive branch needs to develop a strategy for how the various development finance and grant tools can be better aligned and, where appropriate, combined to achieve more lasting results. As the leading development finance organization, OPIC should lead this effort to identify new partnering opportunities across agencies. Such a review should also consider whether there is merit in developing a true development finance bank that would combine various government finance programs within a single, independent agency. A Development Finance Bank integrating OPIC, USTDA, DCA and the international finance functions of Treasury and SBA could present an opportunity to create a more transparent and business- centric agency that allows American businesses a single point of access to emerging markets while promoting economic growth at home.
Should the U.S. create a single Development Finance Bank, merging the full range of existing policy tools and mandates under its authority, it should, however, proceed with caution. Although there is a need to refine policies and reduce redundancies within the agencies, grouping very distinct, high-performing independent agencies, could ultimately marginalize their unique missions, hobble their efficiency and dilute their operational effectiveness.
5. Multi-Year reauthorization
In recent years, a major obstacle to the growth and success of U.S. development finance efforts has been the uncertainty created by patchwork reauthorizations in Congress. OPIC has repeatedly been forced to operate under short-term authorizations that limit its financing authorities and prevent it from making long-term finance deals that would have a greater strategic impact in emerging markets. OPIC has not had a multi-year reauthorization since 2007. In order for U.S. development finance tools to achieve their potential, they must be operating under a permanent, or at a minimum a multi-year, authorization from Congress.
A permanent or multi-year reauthorization of U.S. development finance agencies would also provide the appropriate vehicle to enact the enhanced lending and risk mitigation authorities that are recommended in this paper.