It's a pleasure to be here. Thank you for the invitation.
I'll jump right into it. A number of my remarks will complement what the former speaker just mentioned, and clearly the first part about this not being your grandparents' developing world.
With my time I'd like to make three areas of introductory points. I'll push for one group of points that I've made that will be submitted to the committee and that I think the committee could push the government on, to clarify further the thinking on the DFI as it stands. Then I'd really like to focus on the parts about recommendations.
I'm at the Norman Patterson School of International Affairs. I lead the Canadian International Development Platform, which is a data analysis platform focused on Canada's engagement with the developing world. A lot of my presentation will reflect that perspective.
Really, to echo the first point, the landscape of development and development finance is changing quite dramatically. We know that global poverty reduction is a good-news story, and I won't belabour the statistics too much, but even out to the 2030 date of the sustainable development goals target, I believe the hardest mile in development will still be remaining and pending.
I think that for two key reasons. One, global poverty will be increasingly concentrated in the most stubborn pockets, which are the hardest, costliest, and riskiest to reach. Second, we're living in a new normal of low growth and, in the context of poverty reduction, lower responsiveness to the growth of poverty. We can discuss further the factors behind that.
Traditional donors are facing resource constraints from the combined effect of constrained budgets and growing needs. Think of costly or more frequent emergencies, humanitarian crises, the refugee crisis, and broadening agendas. I see a risk here—as I have put it in the brief that will reach you soon—of asking the leopard to grow stripes.
Essentially, this really echoes what's in Daniel's report. I know a number of the co-authors of that report. As they put it, DFIs are becoming increasingly, in this context, the instrument of choice for any and every development-related challenge. What's happening is there's a risk that they are pushed more and more outside of their comfort zone and pushed to cover a wider and wider mandate, including from NGOs and civil society organizations, CSOs, I would argue, which will push DFIs increasingly to act more like aid agencies than like institutional investors. This is a risk I think we need to keep in mind.
The other introductory point I'd like to make is that DFIs are in the space I call where the puck is going. I'll make some quick points on this. Since the Financing for Development conference in Addis in 2015, there is now a consensus on the need to go from billions to trillions in development finance. Going beyond ODA and core aid is no longer a matter of debate.
Most donors, Canada included, clearly realize this. The real question is how. Now DFI flows already exceed ODA by multiples. We know that. Conservative projections for capital flows to developing countries by 2030 are of the order of $6 trillion. The gaps in development finance, which are in the trillions, seem daunting when we look at them in isolation, but when we put them in the perspective of what I call some of the broken plumbing of the global financial system, it helps us reorient our thinking.
Think about the fact that, as of February and March 2016, about $7 trillion was lying in bond markets globally earning negative yields. You have negative yields and assets lying there. I'm not suggesting that all of this can be intermediated for development, but certainly we could do a better job.
As the previous speaker has already mentioned, DFIs are growing at a rapid pace, 10 times as fast as ODA over the 2002 to 2014 period, whichever way you slice it. But we need to remember where we find investments. They are mostly in lower and upper-middle income countries, and not in what we call the poorest LICs and LDCs, or small-share LICs and LDCs. They are primarily in five sectors: banking and financial services, industrial infrastructure, energy generation and supply.... I won't go on with the list. We can go into a Q and A on this.
I think therein lies the space and the relatively limited purpose of DFIs as additional, catalytic, self-sustaining financing in the space between public foreign aid and private investment. DFIs are financial institutions with a development mandate that provides additional and complementary financing distinct from ODA.
There are three areas that I think the committee should push the government to clarify. I don't have time to go into all of this because I want to focus on my recommendations instead, but I'll submit one. In the context of the discussion around the Canadian DFI specifically, there are semantic issues. The way this has been discussed, even the acronym DFI, has been extremely inconsistent. It was DFI, the I being an “initiative”; DFI, the I being an “institution”; and most recently, in the Prime Minister's announcement in Montreal, the I being “institute”. Which is it, and does it portend anything about scale, ambition, remit, or limit? I think that's useful to clarify.
The second point is this notion of $300 million over five years as a capitalization. Are we to understand the capitalization in the normal financial sense, as something the institution can go and lever further, or are we to understand it more as a limitation in terms of what it can do and what it will have over five years? Capitalization, and then that time period of five years, together makes no sense in the standard financial sense. This is another thing that the committee can clarify.
The next point on pushing the government to clarify is around the source and reportable use. The source, the $300 million that is coming into the DFI, is it entirely off-budget? Is it coming from the international assistance envelope, IAE? Is a proportion of it coming from the IAE? This is unclear, and I think this should be made clearer.
Secondly, on the reportable use, is the entire capitalization going to be booked as ODA or not? This is another point that I think is important to clarify because it has an implication for what Canada's ODA numbers will look like, especially going into the G7 next year.
My recommendations are, first, I think Canada and this committee should push for formally placing development additionality and sustainability in the mandate of the DFI. Unless they have a tight mandate and governance, it's been shown that DFIs are prone to drift away from their developmental purpose and more to financial and commercial purposes. This is obvious, and it makes sense for good reasons. Incentives, therefore, need to be formally aligned around development additionality.
Additionality is a concept that many DFIs use, but it's not straightforward. I'd like to offer a very simple way to think about this. That is, the investment thesis at various levels, whether at the portfolio level overall or at an individual investment level, should be able to clearly articulate how and why the involvement of the DFI's investment is expected to drive development outcomes and what those development outcomes are. That's a very simplistic, characterized way. I think we could make a contribution in this space by pushing for development additionality to be the core of the mandate.
The second principle is sustainability, by which I mean sustainability in terms of what the DFI invests in but also financial sustainability. Over the medium term a DFI should be self-financing, and it should be able to, from the evidence we have at hand of other DFIs, finance itself through retained earnings, and profits and so forth.
I'd like to quickly move to the next point, that Canada's DFI should be given the space to take risks. The key point here is risk. This fits with the earlier point I made about where global development is, the hardest mile remaining to go. If you believe that, then focusing on the poorest and most vulnerable, in large part, means increasing one's risk tolerance. One of the key criticisms of DFIs is that they don't take enough risks. EDC is good at many things. They have very strong financial capacity and capability, but they are not known as a high-risk-taking institution. This should be kept in mind.
It should be remembered, as the previous speaker said, that while there's a lot of talk about making money while doing good.... It's noted often that OPIC, the U.S. DFI, has returned $5.7 billion to the U.S. Treasury since 1971, has not required additional capital, and yet is under threat of closure. DFIs can and do lose money. I provide an example of Sweden's Swedfund. It has a specific target in terms of its benchmark, which for the past couple of years it has missed and has lost money. Development is a risky business. This is a risk-taking institution, and this should be kept in mind if development additionality is to be the core of the Canadian DFI.
I do think that DFIs with a wider slate of instruments and offerings have a better chance of driving development outcomes, so while most DFIs focus on the debt and loan end of the capital structure, only some go and offer equity. Those are the ones driving development outcomes, in my opinion, more seriously. Examples and data are provided in my brief on the CDC Group of the U.K., FMO in the Netherlands, and Norway's Norfund.
The third recommendation is that Canada's DFI will be small, and therefore by definition needs to find a niche.
According to our analysis, it will be about the second- or third-smallest of the bilateral DFIs. I think the Canadian DFI will need to strike a key balance, which is between supply and capital to existing opportunities and investing in longer-term capacity to increase the pipeline of what we call “bankable projects”.
What does it do? With the small corporates, what does it do? One way to think about this is to go where larger pieces of Canada's development financing and development investment are. One example would be the transition to low-carbon growth in developing countries, which is the focus of a lot of the investment of the Trudeau government. It is also an area where Canadian innovation could be brought to market, to globalize in developing countries.
A second area, I would argue, which stems from what I see as a key problem in terms of why investment doesn't go to poor countries, is a lack of local capacity to promote investment and package bankable deals. This points to a powerful sector that Canada's DFI can focus on: building financial sector capacity in developing countries. By focusing on the local financial sector, Canada's DFI could balance both providing capital to existing opportunities and building that longer-term capacity of bankable projects.
Finally, my last recommendation around Canada's DFI is that it has the opportunity to set the standard when it comes to development outcomes measurement and transparency. DFIs, by and large, don't do very well on reporting development outcomes and impacts. This is, in a sense, a function of the renewed interest in DFIs. It's new that they've been called on to talk more about their outcomes and impacts.
Canada's DFI, I believe, should not only track and report progress and indicators at the project level, but should combine project mezzo- and macro-level impacts. Generally, DFIs report outcomes in the form of first-order effects, primarily on employment generation, contribution to government revenues, investment outcomes and financial rates of return, environmental and social outcomes, and catalytic effect in terms of co-investment and crowding-in other players. The Canadian DFI could go further to develop a methodology on development impact measurement that also looks at its contribution to second-order growth in activity and investment and their impact, however indirect, on poverty reduction.
I will leave my remarks there. I've gone a little bit over the time, but I appreciate your patience.