Alice Chapple, Director, Sustainable Financial Markets, Forum for the Future
Forum for the Future is a charity working with business to support sustainable development. We work with business and the public sector. Four years ago we prepared a paper on how financial markets could promote sustainable development. Supported by the City of London, by Gresham College, and by DEFRA, we were looking at what characteristics a sustainable financial market might have. This framework we called the London Principles, and we will hear more about that from Stuart Fraser in a moment. It looked at how financial institutions can support sustainable development, and there would be few people today I think who would question the role that financial markets have to play in allocating capital to activities which promote economic development at the same time as aligning those interests with people and the environment. No longer are banks considered to be intersecting with sustainable development only on how many lights they leave on in their offices and how much paper they use in their daily work.
But the focus this morning is on how new instruments, new structures, and new partnerships are enabling greater access to finance, and therefore greater opportunity for the poorest people in the world, the so-called bottom of the pyramid. In the last four years, much has changed. There is greater recognition of the opportunity for commercial companies serving the poor, and we want to look at how much this might achieve. Mark Napier from the Finmark Trust is going to talk about his work in South Africa, identifying the potential for people to work with pro-poor finance in the African sub-continent.
New partnerships and technologies are changing cost structures and changing the nature of service delivery. Deepak Varghese from ICICI Bank will tell us how ICICI Bank is able to engage with the rural poor and deliver to those people at the bottom of the pyramid. How are individuals and institutions currently investing in poorer countries? Dan Siddy of Delsus will outline the landscape for investment in emerging markets. Roger Frank, from Developing World Markets, will tell us about new structures which are making pro-poor investment happen.
The session at the end of the morning will explore the commercial realities of pro-poor finance: how good are the returns; what are the pro-poor impacts; what are the barriers; and how replicable are the models that we are hearing about today.
We are going to be capturing the presentations and your comments in a detailed research report. We have been working through the summer on some detailed research to supplement the messages we get from today, and we will issue that early in the New Year. We would love to hear your comments. We would also love to have your feedback, so if you have any particular messages you would like to ensure that get through to us or you would like us to pick up with you later on, then please do let us know.
We are very, very grateful to DEFRA, to Gresham College, and most particularly to the City of London for supporting this work. I will now ask Stuart Fraser, who is Deputy Chairman of Policy and Resources at the City of London, to set the scene for our morning session.
Innovations in delivering pro-poor financial systems – new products, technologies and business models
The importance of the City in supporting pro-poor global finance – Stuart Fraser, Deputy Chairman, Policy & Resources, City of London.
For those of you – and perhaps there may be just a few – who are unfamiliar with the term ‘The Square Mile’ and the City of London Corporation, I shall just tell you that the City of London Corporation is the body that looks after the City of London, which I think is, and can claim to be, the financial and commercial heart of Britain. We, the elected members, and we are all elected, are committed to maintaining the strength of the City of London. It is the world’s leading international financial and business centre. The ambition has wider implications, because a successful City can provide a host of services for the benefit of London and indeed the nation as a whole.
It is a little known fact that the City of London is home to one of the greatest concentrations of sustainable development expertise in the country. In 2002, we were approached by the Government and asked to take the lead in preparing the UK’s financial services submission to the Johannesburg Earth Summit. We were well qualified for this role, as we had for several years been actively involved in promoting finance and insurance for sustainable development. Indeed, in 1999 we published research which catalysed the establishment of the UK Emissions Trading Scheme, which then turned into the European Greenhouse Gas Emissions Trading Scheme, which has been growing from strength to strength in the last couple of years.
To this end, we realised that the field of finance and insurance for sustainable development was ripe with possibilities and represented attractive new markets for City-based firms. So, in partnership with Forum for the Future and DEFRA, we prepared a few questions, and we canvassed the opinion of leading organisations in the field. We identified the vital role that the financial services sector played in supporting sustainable development, we established a portfolio of cutting edge studies and, finally, we identified a set of conditions under which financial market mechanisms can most effectively promote the financing of sustainable development. These conditions were turned into a set of seven high level principles of sustainable finance, which became known as the London Principles. However, the London Principles project was never intended to be purely a marketing exercise. Our intention was to establish a legacy project which would encourage debate, growth and development in the field, and this is why, in the four years since Johannesburg, we have continued to develop the programme in partnership with DEFRA and Forum for the Future, and more recently, with the DTI, Department for International Development and, of course, Gresham College - which brings me to the reason we are here today.
Last year, in partnership with the Forum for the Future, we conducted a three-year review of the London Principles project. We found that whilst there had been a major change in industry attitude, progress on two of the principles had not been as rapid as we had hoped, that is Principle 5, which concerned provision of access to finance for environmentally beneficial technology, and Principle 7, the provision of access to finance for disadvantaged communities, both in the UK and abroad.
I think it is probably fair to say that Principle 5 is undergoing quite a considerable change now, as more and more money is beginning to be poured into environmental beneficial technologies, being driven obviously by governments’ taxation and a recognition that this area will be a big growth area in the next few years, or the next 20 odd years.
However, today it is the turn I think of disadvantaged communities. For many years, the City of London has been committed to an extensive programme of activities designed to assist our neighbours to combat social depravation. We are determined that our neighbours and the country will benefit from the wealth that the Square Mile generates. More recently, we have turned our eyes to developing countries, currently with a particular focus on Africa. Now undoubtedly, we are at the beginning of Africa’s century. It has been 10 years since President Mbeki of South Africa forecast the coming of an African renaissance; it has been five years since the African leaders launched NPAD, the New Partnership for Africa’s Development; and it has been a little over one year since Africa was the focus of the G8 Summit at Gleneagles. Africa is currently the subject of massive intellectual, financial and political effort, an effort that seeks to move beyond treating Africa as a homogenous block but as a collection of 56 nations. In taking this approach, we hope to get to the roots of Africa’s development needs rather than just treating the symptoms. The focus is firmly on poverty reduction, but to achieve poverty reduction you need to develop the economy, encourage investment, good governance, transparency, and accountability. But these are not things that can be imposed on Africa, and it is important to remember the Prime Minister’s words, that the only people that will change Africa are Africans.
But the private sector must play its part too. It is estimated that of the world’s three billion poor people of working age, only one sixth currently have any access to formal financial services. If we are ever to reach all the poor people who could use financial services, it will require a whole range of institutions, not just traditional NGOs or micro-finance institutions, to do it. Indeed, the boundaries between micro-finance and the formal financial sector are finally breaking down. In some areas, micro-finance is now an inherent part of the financial system. In other areas, new financial delivery methods are being developed to overcome the barriers of sparse population, large distances between settlements, and poor infrastructure. Technology can also play an important role.
Many of the micro-finance institutions that were set up as community projects are now professionalising, becoming sustainable, and indeed, in some cases, even profitable. Many of these institutions are now seeking commercial funding, and at the same time commercial institutions are beginning to get involved in providing finance services to poorer clients. Successful micro-finance institutions have proven that providing financial services to the poor can be an effective means of poverty reduction and also be a profitable business. Many of the necessary elements needed to scale up micro-finance are already in place. The challenge is to apply this knowledge on a much vaster scale, creating financial systems that work for the poor and boost their contribution to economic growth.
Today’s workshop marks the start of a period of intensive engagement with key players, which will result in a comprehensive assessment of the City’s potential role in promoting pro-poor finance. You will, over the course of this morning’s seminar, hear from a number of extremely well-informed individuals who will discuss various aspects of pro-poor finance. However, it is you, ladies and gentlemen, who represent the unique concentration of knowledge and experience, and we are looking to you to guide us in the future as to how we direct our efforts. What opportunities exist for market participation? How can we convince mainstream banks of the benefits of engaging in this field? What new products, technologies, and business models can deliver effective micro-finance whilst meeting the high standards of governance and transparency that investors demand? Over the course of the morning, I hope that you will help us answer these questions.
I would like to finish by stressing that the City of London Corporation believe that the City has a vital role to play in supporting this new and burgeoning sector. We will continue to work with our partners in business and government and in NGOs to fully realise this potential. I hope you will find this morning’s discussion interesting and stimulating, and I cannot emphasise enough how much your contribution to the debate will be valued.
An assessment of the potential market for pro-poor financial services
Mark Napier, CEO, Finmark Trust
What I am going to talk about mainly now is information, and the power and importance of information in assessing market opportunities but also in promoting policy change in a pro-poor, pro-access way. It seems pretty self-evident to say that we need information, but it is amazing how many decisions are taken not on the basis of information or on the basis of poor information. You as finance sector professionals will understand that the finance sector, above all, is an industry that depends crucially on accurate information and particularly information about consumers.
Finmark Trust was set up precisely to generate knowledge and understanding about the way financial markets operate in southern Africa. Our funding comes primarily from the Department for International Development. We are, in some senses, a kind of think tank, a sort of research centre. Our mission is to make financial markets work for the poor. We are not really ‘funders’ – although we can provide grant funding - we are really there to facilitate market change.
What I want to introduce is the concept of frontier in markets and then to talk about the whole bottom of the pyramid, and the application of bottom of the pyramid thinking to the financial markets in particular. I am going to go on then to talk about the centrality of the consumer at the heart of financial markets. I think we are very often very technocratic in the way we analyse markets. Actually, at the heart of financial markets is the consumer, so we need to understand what the consumer wants. I will briefly talk about technology, and then a little bit about the opportunities for capital markets, for example, here, and what can we do to support these sorts of initiatives.
When we are talking about measuring a market, I think we just need to understand the totality of what is going on in a particular market. In South Africa’s financial markets, 46% of people have a bank account. A number of other people have another kind of formal product, such as an insurance product or a formal micro-finance product. There are then a number of people who may have a bank account, who may have insurance, but who also have informal products. Some people only have informal products, and in South Africa, that means a burial society product (funerals are very big deal in South Africa), or one of the group savings schemes that we call stock folds. Outside all of those people are people who are simply outside the financial system altogether, and this is one of the points I want to make. When you are looking at informal and formal, I think there is a tendency to think that if you are not in the formal system, you are probably in the informal system, you are using some kind of informal product. Well, you are not, actually. A lot of people are not using any form of financial product at all, whether formal or informal. Is that a bad thing? Not necessarily, but I think what I am saying is that you need to think about the way financial markets are structured. In South Africa, and South Africa is a little bit unusual, there is a very big overlap between the formal and the informal. Most people who have an informal product also have a formal product, and that I think says a lot about the sort of opportunities and the linkages between the formal sector and the informal sector. There is a great deal of overlap. In South Africa there is a huge difference in terms of the number of people with banks and the number of people without.
When we look at financial markets, we try to look at the frontier in the way that I think banks look at markets. Banks do not start by saying, ‘Okay, we’ve got 46%, how can we get to the poorest part of the population?’ We need to find the ways that we move through the market opportunities in order to reach out towards people who have less money, and that is just the way markets operate. And so when we look at the market, we say, well, what is the current frontier of that market? And then we say there is probably a part of the market that really is not ever going to be market-enabled – they are just simply too poor – but in between, there is a vast mass of people who are not served, and we need to do something to move that frontier of access out. What we are suggesting is that in the middle are the sort of enablement-zone and the development-zone. So what are the regulatory interventions or the information-based interventions or technology-based interventions that would cause that frontier to move out much further and maximise the potential of the market for the delivery of financial products to poorer people?
Concentrating on the current market does not mean that we are ignoring people in the redistribution zone. There are an awful lot of linkages between people who have and people who will never have, and that includes the whole remittance industry, for example, that is such a big issue. It includes people who have indirect access, through a family member who might have direct access, and includes the whole issue of employment creation. If you are in the business of trying to generate equity or debt for small businesses, you are creating employment and so you are, by definition, increasing the access of potential employees to finance. So I think it is entirely legitimate as a pro-poor strategy to be working at the left hand side of this spectrum in order to move that frontier out towards the end; you do not have to start in the redistribution zone.
You can then drill down into markets to say – and this is the savings market in South Africa –who is saving with which kind of institution as well. This kind of analysis, starting with that full picture of what is happening in the markets, begins to then help support the analysis of where you, as a financial institution, might concentrate your efforts. Again, here, we are saying that roughly 70% of people in the sort of richer part of the population, what we call LSM 6-10, have some formal saving product, or save with a bank I should say, whereas only 32% of poorer people do as well.
I am now going to drill down into a particular market, which is probably the most controversial market, which is that of credits. Again, I do say that South Africa is a slightly special case, but I think it helps to point up some of the issues to do with market measurement, the importance of market measurements, and I think it addresses this whole question of bottom of the pyramid. Credit is controversial obviously because banks are worried about credits; regulators want credit to be extended to poorer people, but they worry about consumer protection, and so there is always a tension, there are always trade-offs in the credit market in the way that you do not quite see with, say, the savings product, over which everybody can agree; but credit is quite a vexed issue.
In South Africa, we have a developmental micro-finance sector, at the NGO sector, but it is extremely small. There are about 124,000 signed-up members of the developmental micro-finance – this is clients, with current borrowings – 124,000 out of a total adult population of 30 million, so it is not reaching very many people. One institution alone, the Small Enterprise Foundation, has 32,000 of those. The total principal outstanding is 56 million Rands, so it is a very small industry.
By contrast, the commercial micro finance sector, which comprises commercial micro lenders, has a total loan book of 30 billion Rands, compared to the 56 million in the NGO sector. It has experienced massive growth, partly because of the lifting of the interest rate cap rules that used to exist in South Africa, and that led to a huge explosion in consumption lending by profit-making institutions that came from nothing to this really quite substantial loan book. I should say that the micro-finance sector in South Africa of 30 billion seems quite a big number, but actually, in the context of borrowings as a whole, it is still only 2% of the entire credits in the market, so it is still quite small, but nevertheless, very rapid growth, and a huge demand for that kind of product, but of course we are only talking about salaried workers. It is consumption lending to salaried workers. People do not want to lend to people unless they have got a payroll, and that obviously excludes a vast proportion of the population any way.
One particular bank – we are talking about bottom of the pyramid – one particular bank called Capitec I think is living proof that there is a fortune if not quite at the bottom of the pyramid then nearly at the bottom of the pyramid, and these are stellar numbers that I think any financial organisation would be very proud of in terms of its headline earnings. It has gone up from 30 million Rands in 2003 to 116, and that is 57% annual growth. Return on equity, 23%, pretty good, compares very much with the sort of returns that the big banks in South Africa are also achieving. It is a substantial organisation. It has got a proper branch network, it has got 2,000 employees – this is a real bank, making real money, but focused very much on the lower income people, with a particular offering that seems to work for them. They are in the deposit-taking business as well as the lending business, although obviously most of their money comes from the lending side. So this is a very interesting case study of a bank that has thought about its business model and wants to do things in a different way. They are doing things like opening branches at the right time of day for people who are, for example, migrating from townships into cities, and staffing them with people who can speak the local languages and so on.
Within the credit market in South Africa is also quite a series of conflicts. We have done some research, just published, which showed that what was happening with this micro lending business is that the micro lenders were not actually reaching poorer people, or the poorest of the poor; they were competing in exactly the same space as the banks, and were suffering as a result – the banks were doing a lot better. So you could start to say, well, what is the role of micro lending institutions? Is the role to compete in some sort of different way with the banks, or is it to look at much more of a developmental model and go down-market? The question for us is, well, will they? I know, I do not think they are going to have any option, they are going to have to move down-market into a different market segment, but right now, they are competing squarely banks who have much deeper pockets and access to much cheaper sources of long-term finance.
So the issue for the South African micro credit market is that there are large numbers of people, and there is therefore a need – I think there is a clear need for credit. Credit is reaching very few of the poorest, at least not directly, but in South Africa, perhaps you could say, well, social grants play the role in South Africa that developmental micro finance plays in other parts of Africa where you do not get a social grant regime. Around about 50% of income into rural areas in South Africa comes from social grants, from welfare payments of one kind and another.
There are in fact, controversially, it is argued, positive developmental impacts from consumption lending. A recent study, just out, indicates that the money that people borrow from a commercial micro lender actually is used very often for the purposes of transport, transport to get to a job, and therefore that person can take a job and therefore, in the end, that household is better off. That is quite a controversial comment because a lot of people say, well, consumption lending does not do anything for an economy; well, this research seems to be indicating something slightly different.
The last point is, for whatever reason, mainly because of cost, Grameen-style models do not scale in South Africa, so there are some issues for the credit market here. So the bottom of the salaries pyramid in South Africa is contested, but actually interest rates are still resolutely high, and we have to ask why is that, what are the dynamics in that particular market? All I am really trying to say is that I think it is just very important not to look at consumer markets, particularly poorer consumer markets, as a homogenous whole. There are real differences in what people need, and we need to unpack markets, because there are markets within markets.
In terms of other frontiers that I think we should be looking at in Africa, if you look at the different functional headings of finance, from my point of view, I think in the transaction banking space, clearly cellphone banking is one of those. Banking into rural areas would be another one – how do we get formal banks to reach out into rural areas? – the whole concept of branchless banking, which is the agency bank model that you see in Brazil and I think it is being tested out in India and other places, where you get a small retailer to act as your deposit-taking entity. That kind of model I think is very important. We cannot do that in South Africa at the moment because the legislation does not permit it, but these sorts of interventions I think are very, very valuable.
We need to look at how you get credit into the non-salaried space. In South Africa between 28 and 40% of people are unemployed, so you are excluding a very large part of the market.
In housing finance, the emphasis is very much on long term mortgages. Is there some sort of hybrid instrument that is neither a personal loan nor a long term mortgage? All the evidence says that actually poorer people do not want long term mortgages; they do not want to be saddled with that kind of debt. Is there something in the middle that isn’t quite a mortgage, that is nevertheless a very big market that capital markets could intervene to support?
On the SME side, the emphasis very much, up till now, has been on debt. We need to refocus that on to some kind of equity product, but equity for smaller businesses. I understand fully the whole issue about how you get economies of scale – or how you cannot get economies of scale out of investing in smaller businesses, but this is a big need.
And on the insurance side, this is very much an infant industry across Africa. There are very few products that are suitable for households, even though the risks are very great.
A quick word on the whole Prahalad debate at the moment. I think it is very interesting. Essentially the debate is about whether you can treat poorer people as consumers. Is it right to treat poorer people as consumers, or should we not rather look at them as producers, and the focus should be not on trying to sell people more and more washing products, or washing powder products, in different ways; you should rather look at how you can give them sort of productive capacity in order to lift their real incomes. There are huge arguments on both sides as to why one is right and one is wrong. Prahalad’s comment is that it does not really matter, when we are talking about measuring markets, to get the absolute last 0.1% right – it doesn’t much matter. What matters is what he calls dimensionality and directionality, which comes back to the access frontier concept. We need to understand what is causing market frontiers to move, and how fast are those frontiers moving, and what is causing those drivers of change. So dimensionality and directionality, measuring access to finance, is not the end game; the end game is providing good solutions for poorer people.
A recent survey we have been doing in South Africa has been looking at small business activity in the Johannesburg province. Examples include a lady making beer; a guy making cabinets; a man doing welding. This is the sort of business that accounts for around about 70% of business activity or businesses in the Johannesburg area – the so-called spazashop. The reason I am telling you this is because I think we do need to get behind the statistics, behind the pie charts and the pyramids, and actually understand what it is about the consumer that really motivates that consumer to take on financial product usage, and what their capacity for engaging with the financial system really is. That is what our product, Finscope, is really all about and what Finmark Trust is really trying to say – what is it about them that would make a bank be interested in them as a potential consumer?
There are a huge number of conflicts and contrasts about small business activity in the Jo’burg province. On the one hand, people are saying we like banks, we think bands are doing a perfectly good job; actually, as many people, in terms of affordability, are saying that bank charges are not very high as they are saying that they are very high, so there seems to be a lot of different views about banking. In general though, banks come out quite positively in terms of brands and reputation, which is a good basis. The three aspects to access that are so important are convenience in terms of time and place, affordability, and appropriate products. On a number of those, there is good news and bad news coming out of the research that we are doing. I think the bad news is that people are travelling a long time in order to get to their banks: round about 50% of all business takes 20 minutes to an hour to get to the bank to do the business that they need to do in a bank. Their needs, clearly, are for capital, which is why the equity point is an important one. They cannot take on debt, but they need some other kind of finance. They do need branch networks, but they prefer to use cellphones, so I think there is a little bit of a move towards the technology space, but they are not there yet. People do also need to have the technology angle.
We have a product that is designed to address consumer needs, trying to paint a complete picture of what consumers really are using in terms of their financial products. The segmentation that the survey uses has been widely accepted by the banking industry in South Africa as being a predictor of people’s financial product usage, and that means that the banks are now buying into this data, which I think is a very interesting kind of public/private model of how you can bring information to bear on financial market development.
You can also map the data spatially. If you are being serious about trying to extend financial access, you need to be able to take your data and be able to lay it over a particular map and understand where people are in relation to banking outlets, to post offices, to sports facilities that could be used as an outlet for financial services. We are beginning to start to do that.
Just a quick word on technology. We need to be a little bit cautious about the potential for technology. We need to celebrate its potential, and I think there is unquestionably no alternative but to look at the potential impact that technology has on the outreach of financial services, particularly into rural areas. In Namibia, the population density is around about half a person per square kilometre. There is no way on earth that a bank is going to set up a branch. There is no way on earth that a bank is even going to set up some kind of kiosk in the middle of nowhere. They are just not going to do that. So we do need to look at the potential for things like cellphone banking and for other forms of technology, but the challenge is really very great. You can see that in South Africa, where we have I think 17.5 ATMs per 100,000 people in South Africa; in Tanzania, the number is 100 times less – it is one per 600,000 people in Tanzania – so that the capital investment deficit in terms of technology infrastructure is really very great, and the question is, what is the scale of usage of that kind of more formal type of technology? Is it something that we are going to need to look at investing as donor organisations or is it just something that we are not going to be able to do?
There are obviously all the other cross-cutting issues that do matter in this context as well. It is not just putting in the infrastructure. It is also worrying about the power supplies, worrying about the payment system, and the interoperability of that that also goes to make sense, or not, of an investment in technology of this kind. So we do need to be a little bit cautious about it. We need to look at the regulatory environment for technology. We need to look at customer adoption issues as well, in particular the low levels of financial literacy, which is a major issue across the whole of Africa, including South Africa, actually at the richer end of the population as well as the not so rich. And we have this sort of Catch 22: unless people experience the benefits of so-called externalities, in other words, everybody is on that network and so everybody can experience that benefit, until you get to that point, people do not really see that it changes their life very much, and so that kind of issue needs to be addressed, and there is no easy answer.
I am going to finish by talking about the opportunities for capital markets. I think there are a number of opportunities. Clearly, we have seen a real explosion in philanthropy of one kind or another, which I think is really exciting. What is very exciting is the way ‘big capital’ is now engaging in the whole micro finance institution area in a way that probably we would not have dreamt about 10 years ago. Citigroup has just announced a new fund. The Deutsche-led, DFID-supported, initiative around their global debt fund last year, or two years ago, I think was very exciting. We need to celebrate those achievements. The private equity industry also is quietly in its own way doing a great deal to support the development of micro finance.
But we need to think about what happens next, because there are a lot of micro finance institutions that have up-scaled into fully-fledged banks – that is great. What happens next? How do we make a change for people who are not served by a particular institution? The reality is that those institutions, although they are doing a great job in areas where they are reaching out, their scale is quite small. We just have to recognise that. There are a lot of people who are simply outside the financial system, including outside the informal system too. The question is what can we do in order to support the extension of financial markets to poorer people who are not served by institutions?
Should we be thinking, for example, about the establishment of pan-African angel networks for equity finance? That is something that could be explored. There are a number of organisations, people like the International Finance Corporation, who are very engaged in developing networks of banks, looking much more creatively at the whole small business arena. Is there some way that one can map a network on to an initiative like that, that the IFC is producing? There are a lot of people who do want to get involved in some way or another.
There is a lot in the market development activity world, which is more the Finmark Trust’s world. It would be crass of me just to stand up and fund raise and advertise, because our funding is secure because of DFID support, but I do think, when we look at supporting innovation, what comes back time and time again is that it is not so much the money that is needed, it is more the technical know-how and the support and the bright ideas. That is what is critical to what we are trying to do. Nevertheless, money sometimes helps, and there is a lot to do in terms of technical support to capital markets’ development, particularly at the small business end. People often say it is because there is no exit, that is why small businesses do not develop. I think there is something in that.
I think there is a lot that the City of London could do to invest collaboratively in some kind of think tank activity. ICICI Bank notably has its own think tank, its own research organisation that is looking very much at market development issues, and it would be great if London could do something similar, with perhaps a more global vision about supporting market development activity across financial markets in the world. That would be very exciting. We need to map out much more what consumers are doing across the world, and to help direct innovation and support. Another idea that we have been talking to banks about is to ask is there some way that money can be pooled into some sort of product factory? We have got all this information coming out, telling us what consumers’ needs seem to be. Can we get some bright people together and develop some products that people could then take on and use in their competitive environments?
The unmet demand is very great, clearly, but the access strands, and in particular the access frontier concepts, help us to move towards finding a solution for market development. Understanding the needs of the consumer is absolutely paramount. I do not think access, or lack of access, is the only reason why people do not bank - there are a number of other reasons – but because access is dependent on issues that we can influence, it makes it is a much greater reason why we should focus on access and sorting out the access issues. Then we can start to talk about some of the more intractable points later on, such as why consumers self-exclude for example. Technology, let’s celebrate its potential, but let’s also keep a perspective too. Capital markets can play an enormously valuable role, even from afar.
New business models and partnerships
Deepak Varghese, Head of Retail and Private Banking, ICICI Bank UK
I am a conventional banker of the old school. Over the last one year, I have been addressing forums on financial inclusion, and what it is for us, because, for us, it is a business line. Even in my mind, about a year and a half back, sustainable development was: can I turn the lights off or can I get my people to switch off the lights and save paper, and can I get double-sided printers happening?
As presented by Mark, you saw an explosion of the number of customers that we acquired. The number stands at a million. The first two or three years were extremely slow, but it is a function of attitude. This is now our fourth business line, so very clearly it is sustainable to us as a line of business.
ICICI is the second largest bank in India. We have a book of 60 billion; half-year profits of 120 million. We have been here in the UK for three years. We have built this business from scratch. We have a book of 4 billion here in the UK, and a half-year profit of 24 million. At the end of the day, it is profitability that drives us, and if this business, and all the businesses that we have been doing have been profitable, we believe that this business too, which is business from the poor, is profitable. The model, simply, is that of technology, partnership, and what is it that ICICI can do? What is the situation that some of the poor are in, and what are some of the innovative thoughts that have gone behind to enable this for us?
What are the fundamentals of looking at a poor segment per se? One is managing risk cost effectively. The price of risk or the price to borrow is extremely high when it comes to this segment. The second one is, if you have opportunities for growth, where is it that you can encash your opportunities? Invariably, all the access channels that we have seen back in India are informal in nature.
What are the kinds of risks that you see? From a developed nation’s perspective, the seemingly risks are pretty flat, but from a third world segment, or from a growing developing nation, what we see are vagaries of weather, climate, crop, price fluctuations of output. I would like you to look at this in the perspective that the people that you are looking at probably earn a dollar a day, or two dollars a day. Your probably weekly savings could be 50 cents, or a dollar. The sum of money that you are looking for to borrow would be $100 or $200.
You have sudden disruption, which is idiosyncratic risk, so you are talking about health, which comes at the back of floods. I am sure you have seen newspaper reports on floods, but you have not seen what happens after the floods. Probably more people die from ill-health as a follow-on effect than as a function of the floods.
And how do they cope? Coping mechanism is pre and post. Pre is informal in nature, so you form self-help groups, you save by using gold, you use houses, livestock; but if you are looking at the third world, you need to have infrastructure that is going to support de-risking of calamities, which today, in many situations, does not exist. These are common place, which are going to keep occurring, and in many cases, people actually get wiped out, which includes houses, infrastructure, as well as livestock, so the only probable reason for consumption of gold in India, which is the largest consumer is gold, is because of this vagary of weather.
What are the post mechanisms that they use? They cut down consumption, postpone health as well as education expenditure. You go into financial intermediation and borrow at extremely high cost. In due course, you will discover that some of the high costs that we are talking about is as much as 10% a month, or may be, in certain cases, as much as 10% a day. So the key here being that high cost risk management strategies adversely impact consumption as well as strategy.
What is the response that they have to growth opportunities? There are growth opportunities – it is not that they don’t have growth opportunities - but the key here being that it is not available to all, and if it is available, you do not have adequate amounts. For example, livestock: the cost of a buffalo is 200USD, but the maximum that you can borrow is 160USD. When you look at savings, of 50c to $1 a week, where is it that $40 is going to come about? Costs, 10%.
What are the mechanisms to substitute debt? We all have opportunities of switching our mortgages and going to a low-cost mortgage service provider; opportunities there do not exist, because you probably have the same money lender in that one little village who is the sole person that you can probably go to, and there are no re-negotiations.
Where is it that you can add value back into your farm inputs? You could probably have land which is cultivatable, but you do not have the resources to continue cultivation. Neither do you have resources to upgrade your skills.
You have imbalances of labour, just like Mark mentioned in South Africa. Where is the ability to transport surplus labour from one location to another, because they probably cannot afford the costs?
Therefore, what is the response that you see from financial institutions towards these households? The market is estimated between 10-30 billion USD, but the total supply is no more than 1.5 billion, so there is a huge gap and an opportunity that we see in this market.
You have more than 30,000 rural bank branches serving over 600,000 villages, so there are those bank branches too.
Premium is less than 10% of the population. That means 90% of the population is not covered. Now, look at the scenario of a population that is a billion, of which more than 50% are spread across rural areas, where the majority of the driver income is coming from the top 30 to 40 cities, and you probably have 30-40,000 locations which are without a bank.
Challenges to risk management: the inability offer physical collateral, because most of these people are migrant population or restricted to a region. They do not have land, which is a typical collateral that people look forward to lending in rural zones. The second one is the ability to evaluate collateral. How is it that you are going to evaluate a buffalo, and probably lend against a buffalo, or a chicken, or a goat that is brought up to you? Again, because of the vagaries of the weather, you are unsure that at the end of the cycle, what is the ability of the person to repay? Lastly, your transactions are extremely small, as I have mentioned earlier. So what is the cost that a branch manager is going to put behind this venture to go across and do a transaction which is probably $10?
There is a fair degree of cash that changes hands. Low usage of technology – it is only over the last 15 to 16 years that you have seen the nationalised banks, which cover the rural branches, move towards a technology platform, and we still know that there are branches back there which run the old system of bookkeeping. You are talking about physical records. So how is it that we can scale up our own backbone and infrastructure to reach out to the customers over there, through our branches, if the branches are technology-enabled?
Incentives are most important. If one is talking about staff of a certain bank which is running against regular banking targets of sourcing in savings accounts and current accounts, how is it that you will have an incentive structure to ensure that these people also recognise the poor as customers of the bank?
In all this, what seems to be the right response, it is a commercial model that we need to build, models which can combine financial intermediation, the ability of measuring risk in a mainstream method, the origination of business from a grass root, which is how much can you reach out to your customer, and how do you use agencies to evolve the whole structure?
The last one, invariably, the old. What we have seen in the last four or five years is a single product pitch. Is it possible for us to bundle multiple products, and therefore in one contact is it possible to get in two or three more products into the bank to make this whole proposition, or venture, seem a profitable piece?
So the core elements of the strategy of ICICI when you look at this business is as follows: you have, (a) a comprehensive product suite; (b) equity, in which we are talking about partnerships, infrastructure, by advocating the same, through regulatory bodes, through local agencies which are developmental agencies, ensuring that we are at the cutting edge of change, through research which is put back in there for action to be taken.
Looking at each of these elements, what is the partnership model that we are looking at? On the extreme left, you see the bank. In the middle, you see micro finance institutions. On the right, you see clients. We use micro finance institutions to go and source the customers for us. There is a fee that is collected from the customer for processing the transaction. The pricing that the bank gives to the client at the end of the day, for the segment, is as prime as it gets for the segment of customers. So we are talking about rates which are in the region of about 2% a month, which we are now evening out probably to even lower than that price. The pass-through effect of the service charge is rendered back into the bank, after keeping aside a sum of processing fee of course that is undertaken by the MFI, which also is used as a function of incentivising the people who work for the MFIs. So it is not just the non-profit organisations that we are looking at; we are also looking at organisations for-profit. So if you have an MFI, micro finance agency, which comes over to you saying that I have a book of probably $100,000, we also provide overdrafts against the whole book to the MFI, by taking over the liability. These loans are treated as pass-through loans, originated by the MFI and finally resident with the bank, and the bank looks at this as a complete portfolio of risk.
What we then attempt to do is advise MFIs also on efficient use of capital. A lot of MFIs have gestation period before the capital is deployed, and as a trend, we see that being maintained in accounts where yield is far lower, so what are methods that we can advise them for their funds too, until it gets deployed?
Going through the points again, the second point is assessing historical loss for MFI. The ability to advise and gauge risk that an MFI takes on clients, which we measure through a method called first-loss before guarantee. This is the sum of money that we seek as a guarantee from an MFI in the presumption that this is the sum of money that you could probably lose on your population. This is a non-performing asset, or probable net credit losses from this lending business. Keeping this sum of money aside and looking at a benchmark, this sum ranges anywhere between 4 to 6%, going market to market, and assuming that your conditions are normal. This assumes the role of mezzanine capital, which you set aside, and at the end of every year, you measure this against what is the credit risk that you have actually taken and what are the losses that you have actually written off, and this is also reserved for the MFI that you keep in place. The risk of the MFI is set aside, and therefore overdraft and funding for the rest of the portfolio is provided by the bank,
I would like to take you through one case of Share MicroFin, an existing NGO with us. Share MicroFin is the largest MFI in India, replicating the Grameen model. ICICI Bank securitised all the receivables of MFI from Share, which is about $4.5 million worth. The loans made by Share to MFI clients are principally for agricultural purposes. In fact, a fair amount of loans – if you were to classify, goes either into agriculture, livestock, or building house. The calculation was calculated by using NPV and bringing it back into current price. We took an 8% guarantee off the total portfolio as the receivables.
What we are looking at, which we are not seeing today because of the depth of the market, is the ability to securitise this, just like you can securitise any sort of a loan portfolio, but we do believe that, lobbying with the appropriate regulatory authorities, we will start seeing securisations of these loans as soon as we can actually start offering a track record of how the portfolio behaves. Now, we have got about 2.5 to 3 years off a track record, and some of the larger MFIs today have the opportunity, probably in the next 6 to 8 months, that you will see as securitisation.
What are the implications of such partnerships? The MFIs obtain funds at lower costs. It is a model which is priority sector assets. In India, there is a classification that a percentage of your total assets needs to go across to priority sector, so this gets classified under that sector towards sustainable development. There is a secondary market, where you have buyers of these assets, a new class of assets for investors, so it increases yields for each one of those who are looking at a portfolio of building assets. Overall, it brings a much wider perspective to micro finance, which is, as of this point of time, narrowed to certain geographies or certain institutions per se.
The other key enabler that we look at is kiosks in villages, kiosks in which you have entrepreneurs who use our technology backbone, which is provided by ICICI, across to MFIs as well as individual entrepreneurs. One thing that we noted was that some of the larger MFIs were still using Excel. I mean, Excel is good for 400 customers, 600, 1,000 customers, but what happens if you have 40,000, 100,000? So the first thing that we noted was the need for a platform which is common, not proprietary, open to all, and that is the same platform which goes across to every single touch point, whether it is the entrepreneur at the front end, the MFI, or us. It is a shared service model which can be used by all. It is real time. It is on line. We now have over 6,000 such kiosks across the country. So it is networked, the front end, behaves like a branch, for transactions. We provide the hardware and the back-up.
A little more about FINO, which is our platform – that is Financial Integrated Network Organisation. This is a separate company that we have floated. The reason why we floated a separate company is to ensure that every agency which wants to access this platform has the freedom to do so. It is in partnership with IT telecom companies. It is also in partnership with Grameen of US and Citibank. We have floated a separate non-banking finance company in order to support this venture of ours. It is low technology. It is hand-held, so it is not a bulky computer, and you are using mobile technology to log on with your ‘handheld’. It supports Smart Cards, BOS, banking software, credit bureaus – credit bureaus, the single reason being that if you look at poor, you have a probability of double-dipping. The person could approach you from one village, move on to the second village, and you could have a credit situation on some of these. It also has character recognition, so it recognises your fingerprints, because in many cases, we have come across illiteracy being one of the largest hurdles in going past this.
Who are the participants of FINO? Who is meant for? As I said, it is local financial institutions, MFIs. It’s end-to-end, it’s common to all, and it is open to all.
What are the products that we are looking at? It’s beyond transaction. It is also insurance as well as some of the weather-led derivative options on crop. By this way, you’re looking at containing risk that you have in a regular cycle, besides just being one who can process transactions or give out advances.
We found research key, and I think the larger key is action research. It is pretty good presenting data, but what is it and who are the people that are presenting data, is key to the way we have ramped up our business.
Social Initiative Group is a non-profit group, which supports the MFI initiatives, supports us, in providing data for us, which we use, along with regulators, in making a case where we see hurdles from local regulatory bodies in going through.
MicroSave, another organisation and partner that we’d like to talk about, based out of Chennai in Southern India, one of the largest training organisations for MFIs – the ability to assess risk, assess people, therefore to make MFIs profitable.
Using this research, we approach regulators to provide incentives for expanding access for financial service to the poor, priority sector being one of them. How is the ability that ICICI can pool in the funds which are allocated by various banks in India for the priority sector? How is it that you can show that even this portfolio is probably far superior?
Using third-party networks for cash handling – how is it that you open ATMs, access to ATMs, partnership models for ATMs? In the initial stages, the regulators themselves were looking at some of the ATMs given out to franchises in not so fair light, because they believed that regulation of some of the technology with franchises was not as good as the bank itself was managing networks.
At this point of time, we open an average of about 1,000, 1,500 accounts a day. The goal that we want to reach is 10,000 accounts a day in the next 12 months. That is when we feel that we are actually doing something to this initiative fast.
What does the market look like? 200 mature MFIs – these are people that we want to partnership and drive through; each MFI to have an average of one million customers, taking our total client base to 200 million customers. That’s our target market. Today, the number you are looking at probably is in the region of about 2 million to 3 million. A hybrid network of 300,000 touch points, village points, for transactions through our BOS machines, which currently is 6,000, and comprehensive range of transaction, credit, as well as insurance products.
That’s the market size again – 10 to 30 billion, what you’re looking at as of today. A population that can be insured, which is today uninsured, completely, with respect – not even a single insurance product. 200 million.
An example of another agency which facilitates for us – NDDB is the National Dairy Development Board, one of the most successful agencies that we have in India, in the state of Gujarat, which has yielded extremely high milk production in the country, end-to-end from livestock, to treatment of milk right down to city locations where you have a delivery system. NDDB – we support NDDB, which ensures that there is funding for livestock, right down at the villages, to an individual level, there are a fair number of vets, vaccine, fodder, which is all supported by multilateral agencies by way of supplying to each one of these, and therefore supply of this milk comes back to NDDB, which started off as an NGO but an extremely profitable organisation.
Emerging investment opportunities in pro-poor finance:
creating attractive products to fit different investor profiles
The landscape of commercial investment opportunities
Dan Siddy, Director, Delsus Ltd
First of all, forgive me, but I need to get my shameless piece of self-promotion out of the way. For those of you who have not heard of Delsus, it is a specialist boutique consultancy working with public/private sector clients, providing support and advice around sustainable and responsible investment in emerging markets. I set the firm up in September this year. Prior to that, I worked for 8 or 9 years with the International Finance Corporation, which is the private sector arm of the World Bank Group. In 2002, I set up a programme at the IFC, with about $15 million of funding from the Swiss, Norwegian Governments, and a few other governments, basically to promote and do research and development and advocacy work around sustainable private sector finance in emerging markets. I spent quite a few years trying to look at the opportunities and the risks and find ways to make interesting things happen, so I hope at least some of my presentation today will be useful in that respect.
Alice gave me the title ‘What is the landscape of commercial investment opportunities?’ which I think was a generous way of allowing me to think of anything at all that I wanted to say! So what can I say about the landscape? Well, it’s hilly, there are some nice hills, a few valleys, some nasty cliffs and crevasses, and the forces that work on that landscape range from volcanic through to other forces, particularly international organisations, that work at glacial speed and sometimes at the speed of plate tectonics. But the landscape is not flat, it is not a flat earth, and I think at least we can agree on that.
Essentially, the way that I look at it is that the capital markets have a very central role to play in a range of interlocking aspects of international development, international trade, etc. Without alleviating poverty, without economic growth in developing countries, we are not going to be able to continue the lifestyles that we have in the Northern economies. Even with that growth, we are probably not going to be able to enjoy those levels of prosperity over the very long term. But the capital markets play a huge role in developing the economy in the South, and that in turn depends largely upon the role of responsible business, both multinationals and, increasingly, the roles of southern companies, whether they are southern multinationals or SMEs or at the micro finance end of the spectrum.
I think the point I want to make is that we need to regard the capital markets and the role of the financial services industry, in London in particular, given the subject today, the capital markets, the full spectrum of the capital markets, has an opportunity and, some might argue, a responsibility to play a very significant role in the potential of developing countries to grow their economies in a sustainable way. They have a significant potential to have both a positive and indeed a negative impact on that, and whilst issues like micro finance, access to finance, base of the pyramid are tremendously important, tremendously important, it is also important to bear in mind that the agenda does not start and finish there, and that we should not be looking at micro finance as some kind of anecdote to what one might perceive as the worst excesses of the wider financial system.
I want to cover four main themes. Underpinning them all I think is a central theme, which is one of championship, leadership, and this is very much I think where, for the purpose of this seminar, one needs to look closely at the role and the potential of the City of London and the financial services sector here.
I want to start really with a conclusion, or may be with two conclusions. There are, without over-estimating the challenges, tremendous opportunities for sustainable, pro-poor finance in the emerging markets, tremendous opportunities for the UK financial services sector, but the UK financial services sector is not. It’s close in some respects, it is doing excellent work in segments of these opportunities, but it is not taking advantage of the unique potential that it is at the moment. Mark Napier, earlier this morning, made a very polite suggestion that there should be some type of more concrete focus for thinking in this area in London, the idea of some type of think tank. I think the fact that there really isn’t one that is really powering ahead in London is criminal, and that there really ought to be one It isn’t just that it would be a good idea. It’s a crazy idea not to have that kind of think tank activity going on in London.
So just to take my first theme, which is why I think the timing of the seminar today and looking back to the foundation provided by the London Principles at the time of the Second Earth Summit, if we’re talking about pro-poor or sustainable finance in developing countries in 2006, there has never been a better opportunity to look at this realistically and with a realistic degree of commercial success. Most of the mega factors that drive that opportunity are aligned now. If we are looking at the very large amounts of money that are held globally by institutional investors and pension funds, many of those asset owners now are under tremendous pressure to diversify their portfolios and look for new places to invest their money and new sources of long term income, and for many, many of them, that is going to mean a need to look towards the emerging markets, whether in terms of listed equities or bonds, but there is a great deal of capital now that needs to look further afield.
Even in the South, in developing countries themselves, you’re seeing a tremendous growth in pension fund assets and savings, we are seeing globalisation of the financial services industry, we are seeing a greater common vocabulary, partnerships, willingness to cooperate, expertise, between the development organisations, like the World Bank, DFID, and many others, and the private sector on this area. It is often very difficult for development institutions and private sector organisations to work together on issues that could be loosely called CSR, but in the financial sector, I think you’re seeing a much greater alignment, much greater common understanding, and a much greater appetite on both sides to do innovative things that support mutual interests. In the emerging markets themselves, whilst it’s impossible to regard them as a homogenous asset class, but generally speaking, tremendous progress is being made on the kind of reforms and economic stability measures that are needed for long term investment. We’ve got successful business models that are now beyond doubt in terms of being tried and tested, and we heard some fantastic information from ICICI earlier on, and we’re seeing also – and I think this is not to be under-estimated – the emergence of Southern multinationals, in India, in South Africa, in China, and in many other countries, and they have a tremendous role to play in this, in various ways. But also, from the point of view of poor-poor agenda, if you look at the development industry as an industry, there is still a lot of opportunity out there for professionals in the development space, because we have a long way to go, still, towards meeting the Millennium Development Goals, and there are still very, very serious challenges ahead that affect us all globally, which can be looked at as an opportunity.
I would like to give an overview of, across the financial sector, of examples of innovation that’s taking place at the moment, just to give you a sense of the breadth and depth of what is going on and where that innovation is coming from.
I am not going to talk about micro finance. I’m not an expert in it. Suffice to say that in terms of micro finance, micro credit, access to finance initiatives, there is a tremendous amount going on there. There are still challenges in terms of scaling up, in terms of regional specificity, but there is a lot going on in that space.
Moving slightly up the pyramid to the micro enterprise and SME segment, there are some very interesting examples of where financial institutions are aligning their interests with those of their clients, around issues like corporate governance, environmental protection.
In Brazil, a subsidiary of a Dutch bank, ABN AMRO, has a very successful credit line that it extends to SMEs, and basically, if the SME clients who take that finance can achieve directional progress on some objective measures of corporate governance, and basically improve in a measurable way their corporate governance, they get interest rate – a reduction in interest rate, and a partial forgiveness of the capital. So there is an economic incentive for SMEs to improve corporate governance, and that, in turn, makes those SMEs more attractive in the supply chain and more attractive to other investors.
In the investment banking field, many of you, I hope, will have heard of something called the Equator Principles, which is an initiative by most of the world’s project finance banks to apply the IFC Environmental & Social Safeguard policies to their lending. Out of that investment actually, by the likes of HSBC, Barclays, Citi, ABN AMRO, and many others, is springing a tremendous amount of energy and innovation, looking at the upside, the opportunity, and how can they harness the expertise that they’re gaining in this space, on the risk management side, which is what the Equator Principles is primarily about, onto the opportunities side.
So, we have in the audience, Jane from HSBC, for example, which is putting a tremendous amount of long term effort into developing new products and services, globally, that tap into the agenda for environmentally and socially sustainable finance.
You also have organisations like Goldman Sachs, with its recently established Centre for Environmental Markets, which is investing money and reputation, over the long term, in looking further ahead at where the new products and services could emerge from, and they are providing that kind of think tank activity that is so badly needed I think in London.
In the private equity space, you have very good fund managers who provide specialist expertise around things like infrastructure, in the power, in the water industry; others, like Orios, which is very much focused at the SME end of the market in developing countries; and you also have quite a strong growth, small but pointing in the right direction, of venture capital oriented towards clean tech in developing countries - investment in Chinese businesses, for example, that are positioning themselves to tap into the huge market opportunities there in the clean tech segment.
I mentioned earlier that pension funds, with their vast amounts of assets globally, are now having to look more closely at emerging markets, and you are seeing innovation in that space at the moment. Those of you who are familiar with the term socially responsible investment in relation to portfolio investors, SRI, a figure that is often bandied around, using a very, very loose definition of what is socially responsible investment, is that there are about $2.7 trillion of SRI assets under management. It’s a very loose definition, but of that $2.7 trillion, research that I commissioned at IFC a couple of years ago, tried to find out how much of that is going into the emerging markets, and the answer was less than 0.1%, which begged the question to me, how many of these firms who are purporting to offer socially responsible investment products, to pension funds and retail investors, truly are making any difference whatsoever? But you do have innovators in this field – State Street Global Advisors, in association with Rexiter and Innovest, is doing pioneering work in this area, as is First State Investment and many others.
In the insurance field, there are some interesting things going on. I think in the ICICI presentation, you alluded to looking at a broader product range, including insurance for weather-related risks. This is an interesting area that’s developing.
The World Bank and IFC have recently committed to put in about $10 million to a new programme that will be run by a firm called Aquila Inc. providing global weather risk insurance and reinsurance products, primarily in the transport and agricultural sector in emerging markets. I think what is notable behind that scheme, which is really innovative in a way, but it’s not necessarily reinventing the wheel. If you look at who’s behind that, Aquila is based in Kansas. The other investors and backers of this scheme are Munich Re and a couple of other organisations – and if I had my bit of paper I could tell you who they are! – but there is no British firm involved. There is no UK firm involved in that product, and surely the expertise is available here.
Looking at another example in the insurance field of innovation, in Mexico, my former employers are working with a something called Paralife, which is a life insurance product aimed at the disabled and what they call the sub-middle class segment in Mexico and then to replicate that in other emerging markets. That business model is coupled with strong partnership with foundations at a grassroots level to work with the insured to give them the skills required for entrepreneurship and entry into the formal economic sector.
There are a lot of interesting things happening! So, it should be a money tree! It should be relatively easy; so why aren’t we all flocking to the emerging markets and making money hand over fist? Well, obviously it’s not that easy, but that’s only one of the reasons. There is a real need for leadership and market development of the type that several speakers have alluded to, and this is where London really should be standing up to be counted, whether we are talking about the City institutions or UK plc through the Government. There is a real need. For people who have the time and the space and the willingness to do some blue sky thinking, to put some money on the table, to do some of the research and development work that’s needed, to provide the comfort level that is often needed to work in partnership with Southern-based organisations, to facilitate technology transfer and know-how transfer, and also give the players in developing countries an equal voice in mapping out this agenda and coming up with the solutions, because it is patronising to think that this is a one-way flow of ideas, and I think personally, if you look at ICICI’s business model, there are many components of that that could be brought into the UK, and that there are market opportunities for many of the things that ICICI is pioneering in India that could be applied equally in the UK. But there are a number of things going on.
The Global Compact at the UN, which promotes, essentially, corporate social responsibility at the multinational level, has done some tremendous work in mainstreaming the idea of sustainable and responsible investment in the financial industry, through its ‘Who Cares Wins’ initiative.
Other organisations have taken a leadership role here: the Johannesburg Stock Exchange launched its Sustainability Index two or three years ago; and I had the honour, whilst at IFC, of helping the San Paolo Stock Exchange do similar work in this area. The impact of these types of indices is tremendous, not necessarily in terms of trading volume, but in awareness-raising and sending a signal out to various stakeholders.
You have unique and very, very valuable organisations like ASRIA, the Association for Sustainable and Responsible Investment in Asia, doing tremendous work around advocacy, awareness-raising, market research, looking at emerging Asia and how sustainability should be built into the financial architecture there.
A couple of things that I was able to do at IFC, in my time there, with the generous funding that I had from donor governments, to provide some of this development leadership, included a competition where we put half a million dollars on the table and challenged the private sector to come forward with ideas about how we can get more research done on emerging market companies, given that research and the lack of information was one of the barriers to socially responsible investors putting more assets there. That competition began in March, and the results were announced in Zurich a couple of week ago. Two projects will be funded through this initiative. One is a collaboration between Trucost, a UK-based firm, and CLSA to do sustainability research on 500 emerging market stocks in Asia, and then to feed that into the sell side research provided by CLSA, and I think that is a tremendous example of partnerships between a regional player and a centre of UK excellence.
The second is a collaboration between an Indian brokerage house, CRISIL, together with S&P and KLD in the US, which is essentially to develop a sustainability index of Indian stocks. So it is nice that at least one UK company came out of that competition as a winner, but also to be mentioned as sort of notable runners-up, runners-up include Iris, which is a London-based specialist research house, ISS, Innovest, and Reputex.
Another thing to mention is work that Forum for the Future is now taking forward, with funding from IFC and the backing of the UK Government through DFID, and the support of HSBC and a number of other players and key thinkers in this field in London, is looking at how one might be able to use an asset-backed securitisation model to get long term patient capital, with a 20, 30, 40 year investment horizon, into developing country forest resources that are managed in a sustainable and pro-poor way, and that is work that is now being taken forward by Forum for the Future. That is a unique thing that I think London is doing, in a collaborative way, and it would be terrific to see much more of that type of activity taking place.
But it is essential to have this kind of blue sky thinking go on. There are other initiatives and other forms of innovation that are going on out there. From the UK point of view, tremendous work has been done by Just Pensions. At a more international level, you have the UNFI and the Principles for Responsible Investment. I think cutting across all of this comes the heartbeat of the London Principles in one form or another. The DNA of the London Principles runs through a lot of these activities at an international level.
Okay, a bit of crystal ball gazing as to where I think some of the new interesting areas of work may be coming from. High net worth individuals, family foundations, etc. We are not just talking about European high net worth individuals, but you are seeing a growth in high net worth individuals who are coming from what one might call developing countries, and I think many of them are very interested in this area, and I know many of them are looking for viable and bankable investment products that harness capital appreciation with positive development impact, and I think that is an area that London should be looking at.
Another area that players in London should be looking at is around the creation of new trading platforms, and rather than go into this, maybe I’ll just leave the opportunity dangling in the air for members of the audience, but there is expertise in London, through the Stock Exchange and in many other places, that could be tapped into to get patient and sustainable capital into the SME sector, for example, and into the kind of high impact projects that don’t get the kind of headlines and the profile that many other listings achieve here in London. The London Stock Exchange has been doing tremendous work with Henderson’s in showcasing sustainable energy investment opportunities, and I think a lot more effort of that type can go on.
I gave a couple of examples of new types of financial product opportunity, around life insurance for example for the disabled, but I think there’s some interesting examples there. It’s difficult ground. If you’re looking at private finance solutions around healthcare and education, for example, it can be difficult ground. IFC, for example, is working with a sponsor in Mexico to develop a financial product that will provide student loans. So there is some interesting issues there equally around health insurance, but there’s a lot of opportunity. The development of secondary markets is tremendously important, particularly secondary markets for mortgages, in order to get capital coming in for low cost housing in developing countries, and also opportunities around structured finance and derivatives of the type that I’ve mentioned. Asset backed securitisation has worked well in the micro finance arena; surely we can look at how it might be applied to other asset classes. There’s a lot of opportunity to do more in the private equity and clean tech venture capital sectors, and again, given the huge volume of money that is managed in London and the tremendous expertise that London has in this space, more could be done there.
If you look at the reports issued by the likes of KPMG or Price Waterhouse Coopers when they are looking at the FTSE 100, FTSE 500, they will make estimates along the lines of 50% of a company’s market value is intangible value – 50-60% of a company’s worth is intangible value – and a large part of that is related to corporate governance, corporate social responsibility, how it treats its local communities, its employees, etc. I’m sure that emerging market stocks, those are listed or those that are coming up for IPOs in the next 3 or 4 years, are not being valued in that way, and that there’s undervaluation going on of these investment opportunities. Private equity investors do a tremendous amount of work to add value to their assets, and I think many of them could tap in more to the environmental and social and pro-poor expertise that’s available elsewhere in London and harness that.
To conclude, there’s a lot out there that can be done, there’s a lot out there that should be done, there’s a lot of talent and a lot of energy, and there are a lot of unsung heroes working in this country and elsewhere to move this agenda forward. Three things in terms of getting this moving forward: there is a real problem with many of these ideas in getting the space and the time and the protection to incubate these ideas within organisations, and incubation of these ideas is a talent in itself, and I think this is an area that would be interesting to look at – how can the UK financial services sector configure itself to harness and incubate and protect these new ideas, which require quite a long development time?
Thought leadership is the second area that I want to turn to. There are a lot of organisations, Forum for the Future being one, that would aspire to be providing leadership in thinking and awareness raising in this space, and I have tremendous respect for Forum for the Future and many of the other organisations in this space. But there are also organisations that are occupying this area and need to spend more time concentrating on being credible and being in there for the long term.
The FT today, for example, provided a quote from Paul Wolfowitz, the President of the World Bank Group, basically complaining that Chinese banks, who are financing investment in Africa, are not following the Equator Principles. I don’t want to comment too much on my previous employers, but it’s also worth bearing in mind that the World Bank has just closed its Environmental & Social Development Department, the World Bank private sector arm does not hold its own financial intermediaries up to the Equator Principles as a requirement, and is now disassembling a 7-year training programme for financial institutions in emerging markets. It’s very important that organisations taking leadership space in this area remain there and remain credible and committed.
Having said that, organisations like the IFC and many others are doing very innovative things, and I think one of the most interesting things that’s happening is around clever, alternative use of subsidies, of concessional capital. Partial risk guarantees are one area that can make this kind of money go further and avoid distorting the market. I think there is a lot of innovation that could be done, and if one can find a way to harness the entrepreneurial financial innovation that exists in London with the kind of large amounts of concessional capital that are available from donor agencies and find ways to use that money more effectively and without distorting the market, there are tremendous opportunities there.
Using sophisticated financial techniques to create investable solutions that meet both investor and investee needs
Roger Frank, Managing Director, Developing World Markets
In very simple terms, we are an investment bank, but we take a somewhat iconoclastic view to the whole notion of investment banking. Personally, I’m a reformed investment banker; I’m on stage eight of the programme, and delighted to say it is going very well at this point. Important to emphasis that we’re actually a for-profit institution, we are very interested in sustainability – our own. What does that mean, besides the fact that I have two children I need to put through college? It means for every dollar of capital that we raise through our projects, there’s no less than a large group of people on the other end who are actually the beneficiaries of that.
What is micro finance? I don’t think I need to spend a lot of time on this, but there are 2 things I’d like to highlight: first, total demand. It’s like we’re looking in a crystal ball, and frankly, at the end of the day, nobody really knows quite how big that demand is going to be, because you tell me what the world is going to look like in 5 to 10 years. I like to tell the story of a recently hired MBA graduate that we brought to our team, and he was doing his due diligence on us and the marketplace, and he asked us about our pipeline of transactions, and I paused for a minute, and I said, ‘You know, last time I counted, there were about 2-3 billion poor people out in the world, so I have a feeling we’ll be busy for a long time!’
Okay, micro finance investment vehicles: the size of the market for the poor, it’s changing pretty quickly, but it’s estimated about 1.5 billion in special purpose vehicles, approximately 54 funds, you can see, the overall demand, 150-250, but as I’ve suggested, pick a number – it’s big and it’s going up, but hopefully going down eventually.
How does this work? In very simple terms, what we do is simply put a frame around a cash flow. On the one hand, we take investors’ money, we create a vehicle, whether it’s a collateralised debt obligation, a fund, a securitisation, and we in turn channel that capital directly to the micro finance institutions, and they in turn channel that capital to the micro credit entrepreneurs. Hopefully, it also works in reverse, which, if you look at the default rate of MFIs, for the most part it does. The micro credit borrowers pay their MFIs, the MFIs in turn pay us or our special purpose vehicle, and we turn around and are able to pay investors on the back of that.
There have been several mentions of securitisations. Well, what is it and how does it actually work? This is a fairly simplified model, but it’s really an elaboration of my earlier comments – essentially, we’re taking a cash flow and we’re putting a frame around it. Whether it’s David Bowie selling his songs and the cash flow that’s generated from that, whether it’s credit card loans, auto loans, mortgages, it’s a cash flow which is measured and tracked and put into a package, repackaged and sold to investors. In this case, the recipients of the capital on the other end are the individuals that we’re talking about, and the vehicles and the dynamics of the arena are the emerging markets.
What we do is to take a note, to take a security, and to identify different levels of risk, different levels of return, that ideally will attract investors based on what their investment objectives are and their risk profiles are. If you look at the equity tranche, which typically is the most vulnerable and the highest paying tranche in these transactions, very interesting to see some of the trends that are happening.
There was a mention earlier of philanthropy. You know, we have seen some philanthropically motivated foundations, there’s a lot of discussion about social entrepreneurship. This is really where a very dynamic and very exciting type of capital has really been put to work in some of our transactions. The senior notes, which typically pay a little bit less, are a little bit more protected, are the kind of instruments that we’re seeing the more traditional money managers attracted to. Mezzanine notes, junior notes, you know, it really gives us flexibility, whether high net worth or a foundation. Essentially, what we’re doing is taking risk, taking return, and segmenting it to appeal to different investor types.
Let say, for example, we had 10 MFIs in a transaction. If one of them goes belly-up, the equity tranche gets completely lost. If 2 or 3 of them go belly-up, the equity tranche and the junior notes start to get lost, and so on and so forth, and that’s the way that we can actually protect the different investors along the food chain.
Issues and challenges of micro finance asset. Let me share with you anecdotes for the road, because I think that’ll give you some good insight in terms of what the real issues are at a grassroots level. The most fundamental one, as far as I’m concerned, is really understanding the asset class. Let me give you a specific illustration.
We were doing some marketing for a fund that has been successfully completed. I was on the road, and we were talking to an industrialist. This is somebody who had historically actually given to this network An industrialist means that he owned a company that manufactured trucks. We’re in his office, and there was this large plate glass window in the back, and the trucks were coming in and out, and he had a cellphone in one hand and he had his fixed line in the other hand, and if I could be politically incorrect for a moment, there were some large calendars with scantily clad women draped lovingly over the hoods of these trucks, and his secretary came in, whose dress was closer to her belly button than her knees. And I’m there with my slide shows, and I’m showing the pretty pictures of the women and the children, and talking about micro finance, and the voice in the back of my head is going, ‘What time is lunch and what am I doing here?’ but I’m nevertheless going through the motions and talking about micro finance.
So in the middle of this presentation, suddenly the trucks stop coming in and out of the parking lot, the light came through the windows, the phone stopped ringing – the only thing we were missing was the music, and this guy pushed back from his desk in the chair, and he paused for minute and he said, ‘This is about women taking care of their children, isn’t it?’ I just looked him in the eye and said, ‘You got it!’ He said, ‘That’s what drives this whole thing. That’s why these banks are so profitable, right? That’s why the default rates are so low. It’s all about women taking care of their families.’ And from years in the financial trenches of Wall Street, you know, I know how to run spreadsheets and analyse things, but if you look at the psychology of this, this is really what makes this whole asset so robust and so attractive. Anyway, we walked out of there with a cheque for $100,000.
Liquidity, can’t do much about that, we’re not there yet. When I talk to institutional investors, we can’t really check that box. Ratings, still early days. We recently completed a $60 million transaction. It was the first ever rated micro – it was the first ever rated micro finance security that had an A rating. Certainly helped in liquidity, but you know, we can’t pretend to look an investor in the eye and say, ‘This is a Fitch rating’ or ‘This is an S&P rating’. Hopefully one day we’ll actually be able to get there.
Correlation and diversification and risk management: Let me share with you another story from the road because I think, in a very granular way, it will illustrate some of the issues and the power and the impact of what this means. I spend a lot of time, as you would imagine, talking to a pretty broad spectrum of investors and interested parties, and I love to go to people who are actually managing foundations, because typically they get it, they really understand on the grassroots what we’re trying to do. I’ll show them the pretty pictures of the women and the children, and we’ll push the pillows back and we’ll hold hands and we’ll sing ‘Kumbaya’ and they’ll give me a big hug and they say, ‘We love you, we love the work you’re doing, but there’s one problem.’ I’ll say, ‘What is that?’ of course already knowing what the problem is, and the problem is they give money away, they don’t invest. She says, ‘You know, you need to talk to Charlie down the hall,’ so I pick up my briefcase, with the pretty pictures of the women and children, and I go talk to Charlie down the hall, and I kind of give him the whole overview, and Charlie typically will say, ‘You know, I’ve got a fiduciary responsibility to my investors. I can’t invest in this.’ After years of being an institutional broker, I look him in the eye and say, ‘I know. That’s why I’m here.’ Suddenly, you know, he’s sort of taken aback because I’ve shifted the conversation.
We have sponsored the first study which actually shows the correlation of micro finance relative to other assets, and guess what, it’s relative uncorrelated. So I’ll put on my investment banker broker hat and talk to him about, well, what’s the beta of your portfolio? Suddenly you can see the sweat start to come from his brow because, after showing pretty pictures of women and children, people are not used to people talking about the beta of their portfolio! The long and the short of it is that I’ll really shift the conversation and talk about the growth of the underlying assets. I’ll talk about the growth in these emerging economies. You know, I won’t go too much into the psychology of a woman trying to protect and improve the lives of her family, because that, I might as well be speaking Greek, but if I talk about correlation and risk diversification, that’s where it really starts to resonate.
Other examples, you know, talking to investment groups about some recently completed projects, they said, ‘You know, we love the work you’re doing, we know you guys well, but we’ve used all up our SRI funds.’ I said, ‘Yes, I know that. That’s not what I want to talk about. I want to talk about taking some of the instruments that we’ve created and getting them into your mainstream portfolio,’ and going through the same conversation of correlation, return, looking at emerging market yields relative to the kind of yields we can provide. We’ve been able to shift the conversation and get some mainstream investors who’ve actually put capital to work.
Nuts and bolts - things like ISI numbers and CUSIP numbers - it’s about as unsexy as you get, but these are the kind of things that institutional investors actually need. Same thing with pricing and liquidity.
As I mentioned, correlation, this just gives you sort of a summary or the conclusion, and we have to qualify this, because, frankly, there’s not a lot of data out there, but what it’s saying is something that we all intuitively know: if an emerging market economy is blowing up, people are still going to be eating sandwiches, they’re still going to be going to the local fruit vendor at the end of the street. Interestingly enough, the only market in the world where there is a higher correlation between micro finance in the more developed economies is Bolivia. But this is really behind – the analysis here is behind why I can look chief investment officers and portfolio managers in the eye and say, ‘Uncorrelated lower beta.’
Risk diversification: This is just kind of a generic structure that we’ve used in some of the products that we’ve created, but it’s a way to show that if one country blows up, it’s okay, because it’s a diversified enough portfolio. This is basic portfolio construction 101.
Investor profiles: Let’s start with the big news about TIAA-CREF. I suspect some of you might have seen the fact that they’ve put over $40 million into pro-credit. Guilty! We’re the ones that did it! The interesting thing is that I’m still eating the same breakfast cereal today that I did 2 weeks ago, but the fact that TIAA-CREF has put over $40 million into the asset class – oh and by the way, Muhammad Yunus won the Nobel Prize, did you see that piece of news? - it’s starting to give a lot more credibility and a lot more momentum to the kind of work that we’re doing. We’ve worn out a lot of shoe leather to get here.
Who are some of the investors? You can see a bit of a profile on the top. One thing I’d like to highlight, that is I think to your credit actually, we found – to Mark, I have to pay homage and thanks – but the UK institutional investor market is, frankly, a little bit further along than we find the US institutional market is. Likewise, I think where we can claim credit on our side of the pond is that the foundations over in the States are a little bit more receptive, and you might know some of the fairly well known foundations, particularly technology-based, that really are doing some very exciting, and very dynamic, and very innovative work in these types of transactions.
I talked earlier about sustainability, and our interest in being very sustainable. This is one project that we recently completed – Microfinance Securities XXEB. You just start to look at the dynamics there and the social leverage, if you figure 300,000 micro loans times 4 people in a family, that’s a pretty significant number of people whose lives we think we’ve been able to impact, just on the back of one project.
DWM firsts: I have to brag a little bit because we’re pretty proud of what we’ve done. If you look at it, it’s a real social experiment, it’s a real hybrid, a real mix of social finance and capital finance, and what’s exciting about each one of these transactions is: one, they’ve taken a tremendous amount of work; two, it’s not like we go to the shelf and grab a boiler plate and re-create another transaction based on everything we’ve done, but each one of these has really presented its own opportunities and challenges. Just for example, the first multi-tranche debt for smaller MFIs – this is done by a group called Global Partnerships, who’s doing some very exciting and very innovative work in terms of using MFIs as a delivery channel for healthcare. Back to that crystal ball model, who knows what the world is going to look like, but we know that it’s a very dynamic, it’s a very fluid landscape, and there are just going to be some exciting opportunities and challenges along the way.
The point on the bottom, as I say, you know, I’m perceived as being smarter now than I was 2 weeks ago, even though I’m eating the same breakfast cereal and it’s really nothing more than I think finally having some momentum and the external markets beginning to recognise the work that we’re doing – but not just us, it’s really everybody in the room, because we’re all, collectively, working towards the same end.
The ‘Chinese Restaurant Approach to Financing MFIs’! What does that mean? You want debt? We have debt. You want equity? We have equity. You want long term? We have long term. You want short term? We have short term. The goal is if you get back to segmentation, through the work that we’ve done and through the types of projects that we’d like to do in the future, we’re able to appeal to a variety of investors and a variety of investment objectives.
And finally, in conclusion, this is really what we are proudest of all. From my years as an institutional broker, you would start a presentation by talking about use of proceedings – you know, it’s for land, it’s for paying down debt, it’s for getting new MIS systems. In this case, it’s really all about the people on the other end, so with that, I’d like to conclude.
© Gresham College, 24 October 2006