How DFIs use Corporate Governance in Emerging Market Investment Decisions

Over the last several years, PGS Advisors has had the opportunity to work with public Development Finance Institutions (DFIs), in particular the Deutsche Investitions- und Entwicklungsgesellschaft (DEG).

We thought it would be interesting to share the common approach to integrating corporate governance (CG)  into investment decisions that 34 DFIs have adopted. DFIs cover emerging markets around the world, including Africa, Latin America, the Caribbean, Asia, Middle East, North Africa, Europe and Central Asia, with total assets of more than $850 billion. DFIs investin equity, debt and mezzanine deals.

What does it provide?

The corporate governance framework establishes a common approach for evaluating governance practices in the due diligence phase of a deal and subsequently improving the corporate governance of investee companies.

While not designed as a one-size fits all approach that can easily result in undesired tick-the-boxes behavior, a unified approach makes it more predictable for investee companies what to anticipate in terms of corporate governance expectations by investors. By signing on to the framework, the DFIs hold themselves accountable to actively implement the common approach. In addition, the framework initiative provides a set of corporate governance tools such as corporate governance assessment methodology and guidebooks that are ready to be used. It also establishes incentives for investee companies to embark on governance reforms.

The signatories of the framework undertake to:

1. Integrate Corporate Governance (“CG”) in its investment operation

a. Adopt CG procedures and tools in line with the Framework’s methodology;

b. Where considered appropriate, conduct CG assessments of investee companies and develop CG action plans;

c. Monitor progress of the implementation of CG action plans.

2. Ensure internal responsibility

Identify and assign an internal function that is responsible for the implementation of the Framework.

3. Provide or procure training

Ensure capacity building and knowledge transfer to staff for the implementation and further development of the Framework.

4. Collaborate with other signatories

a. Share experience and resources in training and implementation

b. Contribute to developing case studies and progress reports on the above.

5. Report on implementation

Report annually to the other signatories on the internal implementation of the Framework.

What can private investors in emerging markets learn?

The take-away for private investors is at least two-fold.

1. Coordination of efforts can be effective.

We don’t expect private investors to share their evaluation methodologies any time soon, but the increasing focus big private investors such as Black Rock put on governance and sustainability issues can ha e a significant impact on company behavior and efforts. Coordination efforts by pension funds in some emerging markets such as Chile, where the Administradoras de Fondos de Pensiones (AFP), the country’s private pension funds, operate a shared data base for independent directors show that cooperation can take many different and fruitful forms.

2. Emerging market companies want to improve their governance.

The DFI experience over the last decade shows that there is appetite by emerging market companies to implement corporate governance reforms. If investors provide additional incentives to their investee companies, governance reforms are even more likely to be initiated.