Publish What You Fund’s DFI Transparency Initiative has completed its fourth research work stream (Value of Investment: Mobilisation & Structure of Deal). The research report identifies a number of areas where consistency of reporting and Development Finance Institution (DFI) transparency could be improved. Here our CEO, Gary Forster, speaks with Nadia Nikolova, portfolio manager at Allianz Global Investors about why DFI transparency is important for the private sector.
GF: Could you start by telling us a little about who you are, what your role is and your interaction with Development Finance Institutions?
NN: I am the lead portfolio manager for the development finance strategy at Allianz Global Investors. For the last 6 years, I have been focussing on development investment solutions for institutional capital to access development finance (e.g. emerging markets and frontier markets). We work with DFIs in two ways. First, we co-invest in deals originated by the DFIs. Second, and significantly, DFIs are also investors in our funds. This is important because this is an area where DFIs can come in a subordinated position and act as first loss providers, closing the gap between real and perceived investment risk. This will in turn de-risk investments for institutional and commercial investors looking to invest in these markets.
“I can’t tell you how the market will change, but the power of data in making people think about creative solutions is something that we have seen before. We will see more and more investors focussed on impact investment. DFIs should provide the data, so investors can determine whether a co-investor product with a development bank is an impact product.”
GF: The DFI Transparency Initiative has found that there is a lack of systematic reporting of financial data across DFIs. What might the value of improved transparency of that information be for private organisations like Allianz?
NN: Currently, only a tiny proportion of institutional capital is going to emerging markets and the majority of that capital is going to upper middle income countries. This is partly because investors right now are unable to price risk. When investors don’t fully understand risk the pricing of debt will increase and borrowers cannot support the high costs of repayment. Either the pricing needs to go as high as institutional capital prices or we need to know how the experiences of these markets differ from their official risk rating. From the institutional investor perspective, DFIs tell them not to worry, that actual risk is much lower than what is indicated by the risk rating, but DFIs don’t publish the data that backs this up. This type of data makes or breaks it.
Historical losses of DFIs also need to be published in order to narrow the gap between what is perceived and what is reality. The recently published report from the Global Emerging Markets Risk (GEMs) database was a good first step however it only showed default data (the analysis of the data did not support DFIs view of higher perceived vs actual risk). What was really missing was the recovery rates: investors can understand that when new projects are built defaults do happen; more information however is needed on how DFIs are better at preserving capital vs public markets. There is past evidence of the importance of this type of information. There was a time when very few institutional investors would invest in infrastructure debt projects. But when Moody’s published their default data from the sector it demonstrated that risks were lower than expected and now infrastructure debt is an established asset class for institutional investors. This is the power of data.
GF: If the GEMs database was made available, do you think it would encourage the ratings agencies to change their ratings?
NN: Ratings agencies are very unlikely to change their perceptions. Maybe some credit could be given to DFI transactions due to their halo but I think this is also challenging to do. Institutional investors use ratings so they know how much capital to allocate to cover potential losses for investments. The riskier the investment the more the amount of capital they have to reserve. The more the amount of capital they have to hold, the higher the return that they require. Take infrastructure debt as an example again – data convinced the European regulators that the asset class was less risky and the regulator reduced the capital requirements for this asset class, which in turn drives more capital wanting to invest. Historic data may show that they need less de-risking because historic losses of these funds were different to what it said on the tin. I can’t tell you how the market will change, but the power of data in making people think about creative solutions is something that we have seen before. We will see more and more investors focussed on impact investment. DFIs should provide the data, so investors can determine whether a co-investor product with a development bank is an impact product.
GF: Why is the transparency of financial data other than risk and return rates important?
NN: Publication of the entire data (not just the defaults) from GEMs is a necessary but insufficient condition of market formation. Having ongoing data, including the data that is in GEMs is a basic standard. Investors want to see a pipeline of transactions and they would want to have an idea of what type of projects are being invested in. Transparency of deal data would enable stakeholders, and the DFIs themselves, to better identify where their investments are crowding in capital and where they are crowding it out. Without transparency around questions such as loan pricing and tenor there is no way of telling whether DFIs are distorting markets.
This is also where data included in your other work streams is important. We are seeing more and more investors focussing on sustainable investments and impact investing. It can be hard to find this type of investment, so to the extent that the development banks can provide different data for investors to be able to classify a co-investment with a DFI an impact product, then that could constitute another big incentive.
Note: To hear more about the findings of our latest research into DFI transparency: value of investment, mobilisation and structure of deal join our webinar on 17th May 3-4pm BST.