Foreign Affairs Committee on June 8th, 2017

[James Haga, Vice-President, Strategy and Investment, Engineers Without Borders Canada]

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.

[The Chair, Liberal, Bob Nault]

Thank you, Mr. Haga.

Mr. Lever, please.

[Rod Lever, Vice-President, Cowater International, As an Individual]

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.

[The Chair, Liberal, Bob Nault]

Thank you very much, Mr. Lever.

We're going straight to questions.

Mr. Kmiec, please go ahead.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Thank you, Mr. Chair.

I want to go immediately to talking about risk taking, because with the previous two witnesses, I didn't get a chance to ask them questions about it. Both of you touched upon it, and it's pretty much critical to how this is rolled out, because we are talking about hundreds of millions of dollars of taxpayer money being put aside.

Some witnesses in the past have talked about the portfolio, and how you shouldn't look at individual projects but look at it as a portfolio. In a portfolio you have a spectrum, and I've been looking at some of the different funds. I have the Swedish fund here on my iPad and I can see some of the projects they have been financing. In a portfolio if you try to manage your risk, as has been talked about—allowing the DFI to reinvest the money that it earns off the equity debt and put the financial support it gives out back into itself—that creates a spectrum. If we're going after those LDCs and high-risk programs that have a very high impact for the poorest, that means the portfolio manager will have to go after something like a luxury hotel with a very high return. So how do you balance the two? I have looked at these Swedish projects here and they have luxury hotels in Africa that they've helped get off the ground. Maybe Sierra Leone needs another one; I don't know. On the other end, they have also financed programs that seem to be hitting exactly the poorest of the poor who need the help. How do you balance the two? That is my first question.

What is the acceptable loss percentage, in your view, in year one, year three, and year five for the DFI if things don't go well?

There are also two parts to the risk. There is some talk about accepting below-market returns, and so there are two sides to it. The DFI could lose money on a project it invested in. It could reach all the goals but still lose money off it. Is that acceptable? Or if it invests in a project and earns below market returns, there is also that part of the loss it experiences.

Can I hear both of you expand on both of those?

Mr. Haga, you can go first.

[James Haga]

Great. They are all important questions.

In terms of that balancing out of some of the pieces you were speaking about, obviously it depends on what the mandate is and how precisely that gets defined and set. Some DFIs are purpose-built to be more aggressive in pursuit of financial returns than others are, so Canada could choose to take an approach whereby we are seeking to continue to generate strong financial returns, or you could see—I would actually say that it would be quite okay for us to get to the point where we have a return of capital as opposed to a return on capital.

I say that because if you think about the deal flow of businesses that are currently available, so many people who are operating as investors, whether they are funds or otherwise—in at least the countries across sub-Saharan Africa where I have experience—often talk about an issue of deal flow and pipeline and how there aren't nearly enough strong businesses in which to invest, so in order to play a role that is truly unlocking and catalytic, Canada can choose to build markets by helping to de-risk some of those early-stage enterprises that can then go on to be potentially profitable, and then scale and provide solutions that have a meaningful impact on people's lives.

I think the question of balance really matters for how we set and define this mandate. My personal view is that at least in the first number of years it's perfectly okay to pursue just the return of the capital that we put out over time, but this is going to take multiple years. We talk about seeing to it that Canada actually has returns generated from some of the investments it is making. I think we are looking at 10 or 15 years out, as opposed to thinking about year one, year two, or year three. That kind of patient model is paramount, and particularly so in view of the fact that Canada has already set out certain determining factors like a focus on the world's poorest and most vulnerable and a focus on investing in SMEs that are women- and youth-led. Those are harder.

It is great that we've done that. It is particularly additional and unique for what Canada's DFI can do in comparison to what a lot of our other international comparisons are doing present day, but it does mean we're going to have to be more patient in how we see the expectation of return and on what time frame.

[Rod Lever]

Thanks for the question. I think it's a really good one and is at the core of what we need to figure out.

You talked about the portfolio approach. First of all, I agree with James that the portfolio goal should be long term. If we start to worry and become wound up about the loss percentage in year one or year three, that will adversely affect decision-making and might introduce some self-imposed goals that aren't realistic concerning what the institution can accomplish.

That being said, I think overall that the concept that you look to balance off good risks with the more difficult risks is the way to go. I don't know whether the percentage is 15% or what it is, but there needs to be a concerted effort to take risk capital, which is almost like a pool within the institution, and target it. There should be almost not a quota but a target attached to it saying, “You will deploy this into the higher risk segments of your mandate.” There should be accountability around it to say how this is done, making sure that it's going to the poorest and most vulnerable and making sure that core elements of the strategy, for example, women and girls, are accomplished in an effective way.

Concerning your question about where the lower-risk assets should be, the example of luxury hotels.... Obviously, I don't know whether that's what you want to do. I think that in principle the idea of cross-subsidizing the portfolio by doing lower-risk things—for example, co-investing in funds that have a track record, that accomplish solid things, and where we can be relatively certain that the losses will be contained—should be part of the model. This almost clarifies my opening remark, which was that I'm not against doing lower-risk activities, but the portfolio has to be balanced.

[Tom Kmiec, Conservative, Calgary Shepard, AB]

Can I ask, then—?

[The Chair, Liberal, Bob Nault]

No, I'm sorry, Tom.

Mr. McKay, please.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Thank you, Chair.

Thank you to you both.

It's good to see you again, James.

This is an interesting debate about what this bank wants to be when it grows up and whether it's a bank or an aid agency. I think it's quite instructive to hear what you have to say. I recollect these kinds of conversations with respect to the Business Development Bank and with respect to Farm Credit. When the losses start to mount up, there's a pullback and a re-profiling of what risk is acceptable.

Let me ask you a series of specific questions to get your reaction.

Would you perceive this institution as an agency to lend to, say, an entity such as the Grameen Bank?

[James Haga]

The Grameen Bank is a micro-finance institution. There are obviously very many micro-finance institutions around the world, some of them better than others. Yes, I think DFIs absolutely can have lending to MFIs as part of their portfolio. I think this is well within reason, and it is one strategy to make capital available to institutions, which are then in a position to distribute and make on-lending to smaller business owners—

[John McKay, Liberal, Scarborough—Guildwood, ON]

Would you put this in your 15%, James, or would you leave it as an 85% part?

[James Haga]

I wouldn't put it in the 15%, no, unless it's in very specific adherence to what that MFI is then going to do by way of on-lending through the capital made available through Canada's DFI.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Mr. Lever.

[Rod Lever]

No, I don't think it should be in the higher risk part of its mandate. I think that micro-finance access to finance is critical for development. That's important, but I also think it just goes back to the strategy and the focus: let's decide first where this institution fits and what gaps it wants to address, and let's make sure that it's not doing what everybody else is doing. If a financial institution in Bangladesh or India is adequately served with capital, this might not be the priority; there might be other areas it could go after.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Obviously, it has to need capital. I mean, you wouldn't interfere if it doesn't.

[Rod Lever]

Everybody needs capital, though, isn't that right?

[John McKay, Liberal, Scarborough—Guildwood, ON]

By and large, they accomplish a lot of the government's stated goals, particularly with respect to women and microenterprises.

I just want a gut reaction, if you will, as to whether that's an appropriate investment. What's interesting, in James' response, is that he doesn't see that as a risk investment; he sees that as part of the portfolio.

My second question, then, is, would you take on a Chinese partner?

[Rod Lever]

You do your KYC, figure out who the shareholders are. It's really difficult to be categorical on that. But you raise a red flag.

[John McKay, Liberal, Scarborough—Guildwood, ON]

Exactly.

If you're going to be operating in Africa, you have to come to some accommodation with the Chinese. They are, arguably, the primary players in Africa.

James, what's your reaction to a Chinese partner?

[James Haga]

I don't want to give you a non-answer here, but I think what's important is that, for any DFI, there need to be clear guidelines and standards for how any investment is made and what the impacts of those particular investments are from a social, environmental, and financial perspective.

Insofar as you're trying to crowd in a host of other partners and investors, I wouldn't discriminate against any particular group, so long as they're able to pass our diligence process and demonstrate that they are, indeed, a well-appointed partner for investment in a particular case.

I realize that may sound like a non-answer, but I think it's, perhaps, too specific a question to answer in one fell swoop.

[John McKay, Liberal, Scarborough—Guildwood, ON]

But in principle, you wouldn't rule it out.

[James Haga]

In principle, I wouldn't rule it out.

[John McKay, Liberal, Scarborough—Guildwood, ON]

In terms of trying to build on Canadian expertise.... Canadians are well known for their energy expertise, financial institutions, agrifood, resources, etc. The danger there, if you will, is using the institution as a risk-taker for the areas of expertise. For example, a mining company wants to be in country X, knows that this is a high-risk investment, and goes to the bank and says, “I got turned down by EDC on their criteria, but in this bank, they have an appetite for risk.”

What's your reaction to that kind of potential investment?

[Rod Lever]

I think there are ways to structurally guard against being a lender of last resort or being, for example, deeply subordinated in a capital structure. You make sure that mining investor X has skin in the game, that you're co-sharing the risk, that it's just not a dumb investment.

The concept that mining companies have bona fide...and are contributing to economic growth in, for example, sub-Saharan Africa...I hope we can agree that a lot of good can be done in that area. Just because it's a mining company, just because it's high risk, I don't think the answer should be no.