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The Key Ingredients For An Effective Development Finance Institution

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Canada's Department of Global Affairs has now completed its months-long review of Canada's international assistance priorities. This highly consultative process has touched on Canada's role in promoting global peace and security, delivering humanitarian assistance, promoting gender equality, and helping our developing country partners mitigate and adapt to the impacts of climate change, among other important issues.

Nevertheless, one topic that has received somewhat less public attention during this process has been the role and shape of Canada's new Development Finance Institution, or DFI. So while Global Affairs Canada works to integrate the results of this review into its revitalized international assistance agenda and shape its contributions to the 2017 federal budget, now is a good time to take a closer look.

The first question one might now rightly ask is what, exactly, is a DFI? Thomas Dickinson of the Organization for Economic Cooperation and Development describes them as public institutions that retain considerable operational autonomy to carry out their core mission of "servicing the investment shortfalls of developing countries and bridging the gap between commercial investment and state development aid." Yet these institutions can take many forms, and how they are structured and governed has a large bearing on what they are able to achieve.

This is why it is so important that Canada -- the only G7 country without a DFI -- gets the details right from the beginning by incorporating the best and most relevant elements of what has worked for other DFIs around the world, and to avoid what has not. If we fail to do so, this institution could end up replicating private sector capacity and having little or no significant impact on socio-economic development in developing economies, which should be its ultimate goals.

In this light, we believe that there are three main areas that Canada's DFI -- planned to be based out of Export Development Canada (EDC) -- needs to "get right" in order to succeed: governance and autonomy, development impact, and mechanisms for integrating specialized developmental expertise into its investments.

First, sitting within the commercially-oriented Export Development Canada, there is naturally a challenge to ensure the new institution has sufficient autonomy and suitable strategic direction to allow it to achieve what we hope will be its core mandate: development impact. While EDC is a highly successful and self-sustaining crown corporation, its strategic direction and operational priorities differ in critical ways from a DFI. For one, EDC writes much of its business on commercial terms.

Further, EDC is most comfortable lending at the senior/secured level in a project and almost always demands pari passu terms (meaning equal rights of payment or seniority) to other lenders. This means it could have real difficulty taking risks that other lenders are unwilling to assume. In contrast, the DFI should specifically exist in order to take risks the private sector will not, and to help build private sector appetite for risk by catalyzing good projects in new frontier markets.

Consequently, it will be important that the new DFI's governance structure and operations be made distinct from the mainline EDC business and philosophies and be independent from EDC's current board of directors. Further, the DFI's board should be composed of individuals from the public and private sector and, critically, of people with deep experience in the design and financing of international development projects. This would mirror best practices of the world's most successful DFI's, almost all of which have their own boards made up of a mix of private and public sector members.

Second, the DFI's Board should ensure two clear tests are carried out for every DFI project: development impact and additionality. Development impact for the DFI could be measured by the number of people lifted out of poverty, reached by new social or economic infrastructure, or whose livelihoods have improved as measured by a set of clear and objective results such as increased disposable income. Baseline assessments will need to be conducted and business objectives calibrated and directed to achieve these developmental goals. By pursuing this path, Canada would be joining DFIs in the UK (CDC), Germany (DEG) and France (Proparco) by putting development impact at the core of our DFI's mandate.

With respect to additionality, this concept applies when private sector capacity does not exist for the type of risk being underwritten. If considered a prerequisite for approving each investment, Canada's DFI would seek out and structure only those investments that have the highest developmental impact by avoiding saturated sectors that already attract sufficient capital and carry lower developmental returns on investment. For a bit of context, according to the OECD's latest figures, 'banking and financial services' represented the largest sectoral destination for OECD members' DFI investments as of 2013 followed by 'energy generation/supply' and 'industry.'

Finally, to bring to bear private sector innovation, Canada should look to build into its DFI investments a technical assistance mechanism through which Canadian expertise could be deployed to help maximize promised developmental returns. Indeed, a 2011 review of several European DFIs and regional development banks by France's DFI indicates that such assistance is commonly co-financed with clients or provided as a grant to increase the technical capacity of the beneficiary to implement the investment project.

Should the Canadian government endow its new DFI with sufficient autonomy, allow the institution to take on an appropriate degree of risk, require additionality, and enable the DFI to leverage appropriate Canadian expertise, Canada will be outfitted with a highly effective new tool for expanding our development impact overseas. Now is the time to put these measures in place, so let's be sure to get them right.

Disclosure: The consulting firm for whom the authors work would likely be eligible to carry out the technical assistance noted above.

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