The International Finance Corporation (IFC) has two very important missions when investing in developing countries: development and poverty reduction. These missions present unique opportunities for the IFC and its counterparties to make significant development impacts and grow in previously untapped markets, while mitigating integrity risks through close collaboration.
Faisal Siddiqui, the IFC’s Deputy Chief Compliance Officer, and Lachlan Jackson, the IFC’s Global Lead for Equity Investments, recently discussed with us about how borrowers, sponsors, and multilateral lenders like the IFC can promote integrity in development finance.
The IFC, the World Bank Group’s (WBG’s) private sector lending arm, provides financing for projects that seek to reduce poverty and foster economic development in developing countries. The IFC provides financing to private sector entities through project finance, corporate finance, equity investments, private equity funds, bonds, and trade finance. Given its development mandate, the IFC necessarily operates in riskier markets than the typical commercial investor. It often weighs the risks associated with a project against the potential to generate a significant development impact.
Through its integrity due diligence process, the IFC examines different types of integrity risk, such as corruption, fraud, tax evasion, money laundering, lack of transparency, undue political influence, and other regulatory risks. It also seeks to identify the ultimate beneficial owners of its potential counterparties that have a 5 percent or more stake in the investment, a percentage that is considerably lower than the typical 20-25 percent industry standard. In this process, the IFC leverages the local knowledge of its staff in over 130 offices across the globe, along with the expertise of industry specialists.
The IFC further assesses the maturity of a counterparty’s corporate governance and internal compliance controls. Limited compliance track record can be offset by periodic program assessments – sometimes tied to disbursement covenants in the investment agreements – and the engagement of personnel with the right qualifications. Ultimately, the IFC balances any potentially adverse findings with a proposed investment’s development impact.
At the contract negotiation stage, the IFC and its counterparties seek to establish a governance framework for the investment that will provide all parties involved with reasonable certainty that, should integrity issues arise during implementation, the parties can work together to remediate them. The IFC typically includes provisions to exit the investment for integrity violations, but it may consider the negative development impact before invoking them. To this end, investment agreements may include cure periods for integrity violations. The IFC understands that counterparties are often reluctant to voluntarily disclose integrity challenges or incidents and seeks to imbue its relationships with counterparties with trust.
During implementation, the IFC business teams actively demonstrate their commitment to the counterparty’s success by providing improvement advice across the counterparty’s operations, including on integrity matters. IFC seeks to add value to the relationship, reduce the overall risk of all parties involved, and increase returns. At the same time, several independent reporting and grievance mechanisms exist, including a hotline to the WBG’s Integrity Vice Presidency (INT) and to the independent IFC ombudsperson.
The IFC is required to notify the INT of any allegations of misconduct in IFC-funded projects. The INT may then initiate an investigation. The IFC and the counterparty may also seek to jointly remediate the allegations.
Counterparties should seek to be transparent and honest about pre-existing and newly discovered integrity challenges at each investment stage, while at the same time being cognizant of the risk of enforcement by national authorities. Building trust and credibility starting at the appraisal stage can prove beneficial for the counterparty.
First, it can benefit from the IFC’s technical assistance to resolve such challenges.
Second, if an integrity incident is significant enough to jeopardize the future of the investment, goodwill generated from the beginning of the relationship can lead to greater flexibility to remediate the incident prior to initiating an investigation by the INT or the exercise of contractual remedies by the IFC. During implementation, the counterparty should ensure that it has sufficient visibility into the operation of the investment, typically through frequent site visits and the implementation of advice and reporting channels. Implemented genuinely, such measures promote a grassroots ethical business culture.
Finally, counsel for counterparties should seek to educate them on the IFC’s unique role in the market and risk management approach, which entails contractual remedies that may seem draconian. Provided that a counterparty is willing to collaborate, the IFC may invoke its contractual remedies as a last resort. The counterparty and the IFC are business partners with common objectives. Balancing integrity risks with the development impact ultimately enables an investment that would otherwise be likely impossible to finance.
A recording of this discussion with Faisal Siddiqui, Lachlan Jackson, Thomas Hechl, and Shelita Stewart here.