Given BELOW is Hugh Sinclair's Response to my earlier posts - Regulation and Supervision of Micro-finance Investment Vehicles (MIVs): A Suggested Practical Framework, Part I, Part II and Effective Control Systems at Micro-Finance Investment Vehicles (MIVs): The Key to Accountable Investing and Responsible Micro-finance Globally!
Hugh
Sinclair's Response:
First
of all, I would like to thank Mr Arunachalam for the work he is doing in this
regard. I am pleased my book has helped place these issues on the table. MIV
regulation is long overdue.
I
produce this current text in response to Mr Arunachalam’s three recent posts on the topic of MIV regulation: Regulation
and supervision of microfinance investment vehicles - Part I and Part II; and Effective
Control Systems at Micro-Finance Investment Vehicles (MIVs).
I
think two points need to be raised here. First, the focus on ASN Bank and
Triple Jump should not distract from the fact that there may be other
MIVs/banks that are equally guilty; and second, the implied ignorance of ASN
Bank as to the underlying truth regarding LAPO may not necessarily be accurate.
ASN
Bank invested in LAPO via Triple jump alongside Oxfam Novib. The ASN Novib
fund, the first ever retail microfinance fund in fact, stood at €181 million at
the end of 2011. However, let us not forget the other investors in LAPO:
Deutsche Bank, Citi, Grameen Foundation, Calvert Foundation, BlueOrchard,
responsAbility, Incofin etc. Each, to a greater or lesser extent, may be as
guilty of the charges made in these documents as those investors explicitly
mentioned. Kiva also pumped in approximately $5m, but is not a mainstream MIV.
What is interesting is that most of these players knew precisely what they were
doing either at the point of investing (had they bothered to read the rating
reports as part of their due diligence) or shortly afterwards (when I pointed
this out to most of them, as described in the book). They chose to do nothing
until the New York Times began questioning them. In the case of BlueOrchard and
responsAblity this is clearest, as they invested after the NYT
article, by which point there was no excuse for ignorance.
However,
the comment "The [ASN Novib] fund perhaps took at face value, the
information that was provided by the fund manager [Triple Jump] and assumed it
to be ‘correct’ and hence, did not do its own checks with regard to the
reliability/validity of information" could lead a reader to assume that
ASN Novib were somehow deceived by
Triple Jump, and were thus largely innocent, or guilty only of failing to
scrutinize Triple Jump sufficiently. This may not paint the complete picture.
Consider
first of all that some (not all) information regarding the questionable nature
of LAPO was in fact given to ASN Novib, and other information was publicly
available. However, even after I raised the issue extremely
openly with Triple Jump; after I directed a specific
complaint to Ab Engelsman (Chairman of
the board of Triple Jump, Chairman of the
Netherlands Platform for Microfinance, multiple other positions including with
ASN Bank and Oikocredit); and after I had explained the situation
in some detail to Bruno Molijn of Oxfam Novib, they still managed to invite the
LAPO CEO as their guest speaker to their AGM that year. When a rather
embarrassing question about LAPO's interest rates exceeding 100% was asked
publicly in the meeting (footnote 8),
they failed to answer the question and in their next Spaarmotief newsletter, published by ASN Bank (not Triple Jump)
they reassured their investors of interest rates charged to the poor of 25-30%
(page 10). Although
ASN Bank did eventually stop financing LAPO, to suggest that they were simply
duped by Triple Jump may not be entirely accurate.
A
broadly similar pattern took place with Kiva and Calvert Foundation. I document
conversations (email and audio, both reproduced on the book website) which
demonstrate prior knowledge of the specific activities of LAPO, but were
ignored. Only when the NYT contacted Calvert/MicroPlace did they withdraw LAPO and
shortly afterwards Kiva followed suit, but they had demonstrably known about
this for some time and consciously failed to take corrective action. Calvert
continues working with Triple Jump to this day.
Take
the case of BlueOrchard, for example. When confronted about their investment in
LAPO following this scandal, they issued a press release of questionable
integrity which I analyse in the book and reproduce in
full on the website. The CEO of BlueOrchard was replaced
recently.
Thus
we could potentially have an even more serious case on our hands. Not only are
the fund managers not behaving entirely ethically, but even when the funds
detect this, they chose not to act.
While
I applaud Mr Arunachalam’s work, and believe this is a vital first step in
regulating the MIVs, he is perhaps being
generous with the actual integrity of some MIVs!
Even
when they KNOW things are going wrong, they continue to invest if this is a
profitable investment opportunity, and they are willing to present knowingly flawed
information to their own investors in the meantime. This could be considered
criminal in some sectors, in the microfinance sector it is "best
practice". Indeed, one recent book review
used precisely this term. And let's not underestimate the magnitude of the
charges: the list of implicated parties includes many of the largest MIVs on
the planet. This is, in short, a total disgrace.
But,
be warned: were any sensible regulator to hold these MIVs accountable to
anything like the standards expected of regular investment funds, we may indeed
see a number of MIVs close. Their deviation from legal, best or ethical
practice, is so far off the mark that one wonders if it is indeed possible to
fix such errant institutions. The question of whether or not MIVs need to be
regulated is, in my opinion, so blindingly obvious that it is an indictment on
the entire sector that the issue is only now being raised. They absolutely need
to be regulated immediately and with genuine scrutiny. The more interesting
question is whether or not some of these MIVs should be allowed to operate at
all, particularly when taking government funding or money from the general
public.
One
can anticipate precisely where the most vehement resistance to MIV regulation
will emerge from: the MIVs themselves. They are delighted to have rating
agencies examine their MFIs (although they don't necessarily take note of any
inconvenient findings, as the LAPO case demonstrates), but who does the ratings
of the MIVs? There is none in practice (LuxFlag is largely ineffective
rubber-stamping). Transparency when it suits them, opaqueness the rest of the
time. Damian von Stauffenberg summarised the majority of MIVs succinctly to the
House of Representatives in 2010: “not terribly transparent”.
Allow
me to suggest a possible solution: as with the independent rating agencies (I would exclude only Planet Rating
from this category not for any question regarding its integrity, but because it
is part of the larger Planet Group, who engage in investment activities, and
thus it may not be considered entirely independent),
why don’t we establish a genuine,
in-depth ratings for MIVs? This would have to go beyond the current
superficial analyses and actually scrutinise the processes, interest rates, due
diligence activities, monitoring, social performance etc. of the MIV and its
investees. As long as this was a profound rating, and not a window-dressing
exercise, then investors could decide whether or not to entrust their money to
an MIV based on such information. This is, essentially, precisely what the MIVs
supposedly do with rating reports of MFIs, after all.
Regulators
could then insist that any tax-payer funding or capital raised from the general
public must go through an MIV that has achieved a certain minimum rating. Naturally
the MIVs will not support such a rating service, and would be hesitant to fund
it or encourage its use, for fear of what the ratings would uncover (look at
the information we can gather about their integrity from publicly available information!). However, if this became a
condition for the MIVs to access capital from state or general public purses,
this could be a step in the right direction. An MIV would be free to continue
operating without such external scrutiny, but would be unable to tap public
funding. Those with nothing to hide will jump at the chance, and gain access to
substantial sums of capital. Others would have to rely on purely private
investors, some of whom may wonder why the MIV failed to obtain such a rating.
Transparency at its best.
The
advantage of this structure is that it would not have to be self-initiated within
the microfinance sector, which has a tendency to select its own acolytes. As
long as a number of important capital providers and countries initiated such a
move and provided the initial funding, this could quickly achieve critical mass
and become best practice within the sector, as MFI ratings did. The countries
to consider are, obviously, Holland, Luxembourg, the US, Switzerland and
perhaps the UK. The All Party Political Group for microfinance is specifically examining
the issue of microfinance regulation in both developing and developed
countries. Indeed, such a measure could possibly persuade the Norwegian
government back into the microfinance sector following their recent departure.
Local
regulators in developing countries could also use this service. For example,
the Indian regulator could insist on a rating above a pre-determined level in
order for an MIV to invest in India. Indeed, this could become a powerful tool:
if a country believed its microfinance sector was over-heating (Peru, Mexico etc.),
they could increase the threshold correspondingly to reduce the number of MIVs
able to invest, and raising the quality of those MIVs in the process. This
would be a powerful tool in the hands of regulators. One possible danger is
that the less scrupulous MIVs would then be driven to the countries with the
least stringent regulations and rating criteria. However, developed country
governments could restrict such MIVs from raising funds in their countries. Dodgy,
unethical MIVs raising capital from unscrupulous investors and incorporated in
shady tax-havens investing in desperately vulnerable developing countries with
zero regulations would slip through the net, but no regulation is perfect!
This
could largely circumvent the problem of off-shore funds. Obviously if Luxembourg
tightened its regulations the funds could simply move to the Cayman Islands or
some less-regulated jurisdiction (regulatory arbitrage), but an MIV rating
would be applicable for any MIV in any regulatory state, and the US/UK/Dutch
regulator would determine, in part based on the rating, whether it would invest
its own funds or allow funds from its general public to be invested in this
vehicle. For example, MicroPlace allows funding ONLY from US investors.
Countries such as India would grant permission to MIVs to operate in their
jurisdictions based partly on the rating report, regardless of the legal
jurisdiction of the MIV.
Of
critical importance in such a policy is that the rating agency is both entirely
independent, entirely free to perform any analysis it deems required, and
equally free to publish such findings openly. No “private ratings” should be
allowed. And the staff of such an institution would have to be carefully
selected, to not only have excellent microfinance and MIV experience, but
retain an arms-length relationship to those being rated. The MIVs would have
huge vested interests to place their own loyal supporters within such an
institution. Who would finance the rating agency? Initially this would require
two key factors: an initial subsidy (not from an MIV) and a handful of
confirmed clients, most likely public sector funding bodies (DFID, NORAD, Dutch
government etc). NORAD could be particularly suitable for this, as it already
places public funds in microfinance through MIVs, via the Norwegian Microfinance Initiative. OPIC
invests US tax-payer funds through Triple Jump, as does the Dutch government
via Oxfam Novib.
A
final consideration is that an MIV rating would have to be affordable for all
MIVs, and thus should be priced according to the size and complexity of the
MIV. Otherwise a danger is that smaller MIVs may be excluded from obtaining
such a rating, enabling only the “mega-MIVs” entry to the club. Also, some may
be sceptical of the role of rating agencies in general, particularly in light of
the recent financial crisis. While I do not wish to debate the merits of rating
agencies in general here (and I share some of these concerns), I state a
personal opinion that the specialised rating agencies are actually surprisingly
effective, as described in the book.
This
suggestion is but one of many possible means to reign in the unscrupulous
practices of some MIVs, it is not perfect, but the current situation of zero
practical regulation is clearly sub-optimal, and this may be a step in the
right direction. It may restore some faith in the sector amongst investors, and
may lead to a greater positive impact on the poor.
To
bring this back to the original point of ASN Novib and Triple Jump, it is worth
pointing out that the Dutch television station KRO is broadcasting a
documentary precisely on this topic later this month. The press release is
in Dutch, but it is likely that the pressure will rise yet further in the
beleaguered Dutch MIV sector.
