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4.2 Public sponsor ownership functions in a SIF
Ownership responsibilities
Ownership responsibilities of the SIF public sponsor extend from analysis and planning before the SIF’s establishment, through the SIF’s operational phase, and to its closure. These responsibilities outlined in the constitutional documents of the SIF must focus on core rights, akin to those of shareholders of corporations, without infringing on day-to-day management of the SIF. Ownership functions should be limited to (1) defining the mandate and objectives of the fund; (2) capitalizing the fund and defining the withdrawal policy from the fund; (3) appointing a board of directors using a merit-based and transparent process; (4) overseeing the fund’s operations and ensuring compliance with applicable laws, regulations, and corporate governance standards; and (5) monitoring and evaluating performance in line with the mandate of the fund and based on a defined framework (see table 4.2 for details). These responsibilities are essentially the same whether the public sponsor is the government or a development finance institution.
One of the key governance functions of the SIF public sponsor is to ensure that the SIF mandate is clearly crafted and factors in the requirement that the SIF not crowd out private capital. The public sponsor typically achieves this clarity of mandate by investing in feasibility studies (discussed in chapter 2), which
TABLE 4.2 Public sponsor ownership functions in a SIF
OWNERSHIP FUNCTION ROLES AND RESPONSIBILITIES
Planning stage
Mandate • Commission preliminary studies and feasibility studies. • Determine the SIF’s structure and governance arrangements. • Define the fund’s mandate after consultation with stakeholders.
• Establish broad outcomes that the fund is expected to achieve within this mandate, and agree to these outcomes with the SIF’s board.
Macroeconomy Investment policy and strategy
Board • Monitor implementation of the mandate and objectives of the fund. • Ensure consistency of SIF operations with macroeconomic, fiscal, and financial sector policy.a
• Approve the investment policy, with advice from the investment committee (or board). • Set the risk parameters of the SIF, in accordance with the risk tolerance of the political bodies that are the ultimate stewards of the SIF’s assets (see Al-Hassan et al. 2013).
• Ensure public sector representation on the SIF’s board (if needed). • Appoint board of directors using a merit-based and transparent process (the board appoints the
CEO and the investment committee).
• Oversee the board’s activities, and ensure the SIF’s compliance with applicable laws, regulations, and standards.
Capital • Allocate capital to the SIF from the government budget or other sources, subject to parliamentary approval.a • Set clear rules on dividend payments to the state and capital withdrawals, subject to parliamentary oversight.a • Approve SIF borrowing, if the SIF is permitted to borrow or otherwise assume liabilities on behalf of the state.
Management • Establish the criteria and process for the selection and appointment of the CEO, who is then appointed by the board.
Documentation • Determine the SIF’s disclosure policy, in compliance with applicable laws.
Source: World Bank. Note: CEO = chief executive officer; SIF = strategic investment fund. a. Most relevant for public capital SIFs solely owned by the government.
are performed before the setup of the SIF and identify the market gap the SIF must address. These assessments, which serve as input into crafting the mandate of the SIF, are designed to address one of the key challenges faced when setting up a SIF, that is, ensuring that the SIF does not crowd out private capital by operating in markets in which no capital gap exists. For instance, Marguerite infrastructure funds were founded by the European Investment Bank and several European Union national development banks to commercially invest in policy-driven infrastructure projects in the European Union and preaccession states. These funds required considerable planning and analysis before establishment. The public sponsors therefore hired global consulting firm McKinsey & Company before setup to analyze the infrastructure funding gap and pipeline in the funds’ target countries and used the analysis to strike a balance between investment objectives and policy-oriented objectives of the different sponsors.
Oversight
The public sponsor primarily remedies the principal-agent challenge discussed above through the SIF’s oversight structure. The public sponsor constructs a robust oversight structure either through internalizing the management of the fund, taking an ownership interest in the fund manager (if a separate legal entity), or maintaining an advisory role over the implementation of the mandate by the fund manager. Commonly, the public sponsor internalizes the management of the fund within its bureaucracy or organizes the SIF as a corporate body—with investment assets and management assets housed in one entity (Morley 2014)—to increase alignment of interests between principal and agent. This is the case with SIFs formed as corporates (for example, FONSIS), formed as bespoke independent authorities (for example, NSIA), or housed within a government agency (for example, ISIF). If the fund and its manager are organized as separate legal entities, the public sponsor may also choose to take an ownership stake in the management entity to further align interests. For instance, the government of India (and key co-investors) has an ownership interest in both the NIIF subfunds and the manager, NIIF Ltd, which is a separate legal entity. Similarly, ACP’s founding partners—ADB, ORIX, and Robeco— have ownership interests in both the limited partnership fund and its general partner. When the public sponsor is invested in the management of the SIF, oversight of the SIF is performed by a board of directors that actively monitors the SIF management on behalf of the owners, thus reducing the information asymmetry between principal and agent. Conversely, the public sponsor may choose to invest only in the investment assets of the fund and not in the fund management entity. This is the case with Marguerite II, which is organized as a Luxembourg special limited partnership (Societé en Commandite Spéciale, or SCSp) and is externally managed by Marguerite Investment Management, an independent external alternative investment fund manager not owned by the public sponsor or its co-investors. In this case, the oversight role of the European Investment Bank and other public sponsors is provided via investor supervision and approval rights in relation to strategy, waivers on investment restrictions, and other specific areas; it does not play the more active supervisory role of a board of directors.
Most SIFs are set up such that the public sponsor has ownership interests in both the SIF’s investment assets and its management entity, thus ensuring greater control of how the SIF meets its mandate. The following subsections
explore, first, how the oversight function plays out in such SIFs through a board of directors; how these boards are nominated, appointed, and configured; and how they actively monitor the mandate of the SIF and its management. They then explore the more hands-off oversight role played by public sponsors that own only the investment assets and have delegated management of the SIF to an external fund manager.
Oversight structure A: Board of directors When the public sponsor is invested in the management of a SIF (through internalizing SIF management or taking an ownership stake in the management entity), oversight responsibilities rest with a governing body referred to in corporate governance parlance as the “board of directors.”22 The board sits at the nexus between the owner and manager governance tiers and plays an active role in guiding the SIF to meet its mandate and in monitoring the management of the SIF. Because most public sponsors choose to have control over how the SIF is managed, the board of directors is a common governing structure found in SIFs. The specific configuration of the board, its scope of responsibilities, its independence from the owner, and its resulting effectiveness vary greatly depending on country, context, and legal structure. This heterogeneity in approach is explored further in this subsection.
The key responsibilities for a SIF board are to ensure that the fund’s double bottom line mandate is met, manage conflicts of interest, weigh in on strategy, hire the chief executive officer (CEO), and oversee management. The heft of such a portfolio of responsibilities makes the autonomy and empowerment of the board vital. A well-constructed board can be an important independent buffer between the owner and manager, allowing a separation between ownership and control.23 It has a responsibility to act in the interest of the fund’s mandate and its investors, and to do so with utmost care and diligence. The board must therefore have recognized authority over its portfolio, the ability to exercise its authority, and the independence to effectively intermediate between the owner and manager. This in turn makes it important that the board’s role be spelled out clearly, depending on how the SIF is established, either under ad hoc legislation, general legislation, or the bylaws of the SIF and its board charter. Any actions by the public sponsor that short-circuit the board can undermine the board’s efficacy and leave the SIF vulnerable to political interference.
Quality at entry therefore becomes critical to ensuring the board’s authority, independence, and credibility. The public sponsor must bear in mind the importance not only of the board members’ selection and composition but also of the manner in which they are nominated and appointed.
• Boards are composed of three types of directors: (1) executive directors from the management team; (2) nonexecutive directors who may be appointed from the public or private sectors, but who have ties to the owner or the SIF; and (3) independent directors, who have no ties to either the SIF or its owners (World Bank 2014). In mixed capital SIFs, if a board exists, its membership usually reflects the investors’ respective capital allocation to the SIF. For example, ACP’s board consists of one representative from each of the founding investors ADB, ORIX, and Robeco. Depending on country context, SIF board composition may also be guided by the country’s SOE rules relating to boards. For example, Indian SOEs are allowed a maximum of two government board representatives (World Bank 2014). This rule seems to be reflected