4.4 SIF board functions

• Board members should ideally be compensated on market terms (World Bank 2014). Because compensation is critical to the capacity to select competent board members, it should be competitively set to attract good talent. Restricting executive compensation to public sector pay can undermine the ability to competitively attract talent.

Once the board is constructed, the manner in which the board functions and conducts itself is critical to the success of the SIF.31 As discussed earlier, the board must be empowered by the owner(s) to take on its portfolio of key duties (see table 4.4 for a list of key duties).

• The SIF board’s primary task is to ensure that the double bottom line objectives are met, and to clarify how to prioritize these objectives especially when

TABLE 4.4 SIF board functions

OVERALL BOARD FUNCTION KEY DUTIES

Supervise SIF mandate • Establish and periodically review SIF strategy. • Approve any material amendments to SIF strategy. • Approve the fund’s investment policy, submitted by SIF management / investment committee. • Develop selection policies and criteria for solicited and unsolicited proposals. • Approve the SIF investment strategy, and oversee its implementation. • Supervise the SIF trajectory toward the mandate established by the public sponsor. • Clarify the prioritization or approach with respect to meeting the dual objectives. • Provide approvals for investments, particularly those exceeding thresholds or risk limits if needed. • Oversee SIF representation in the boards of its portfolio companies. • Be vigilant in identifying and managing conflicts of interest that may lead the SIF to deviate from mandate. • Appoint subcommittees of the board. • Monitor portfolio performance and compliance with investment policies. • Approve annual budget and expenditure.

Appoint and supervise fund manager

• Dedicated manager. Appoint SIF CEO, and oversee appointment of senior executives. • External manager. If the SIF has a separate fund management company, conduct a competitive section process and appoint the fund manager. • Establish key performance indicators for the fund manager and oversee the performance of the manager. Audit and risk management Audit • Instate systems of internal and financial controls, and review and monitor the effectiveness of the systems. • Review and evaluate the internal audit process and outputs. • Select and appoint external auditors. • Review and evaluate outputs received from the external auditor through the audit committee. • Ensure the quality and integrity of the financial statements. • Ensure disclosure of related-party transactions and conflicts of interest. • Review compliance function. • Ensure compliance with accounting, legal, and regulatory requirements. Risk management framework • Articulate risk appetite, and prescribe the risk limits and thresholds for the SIF. • Ensure risks are identified, assessed, managed, and reported. • Ensure policies and procedures for risk management. • Monitor adherence to risk governance.

Compensation • Devise, review, and approve compensation plans (including performance-related pay), policies, and succession plans for employees. • Ensure that compensation structure for employees is consistent with the SIF’s long-term objectives.

Reporting • Ensure that financial statements and other disclosures clearly present the SIF’s performance. • Report to public sponsor and other SIF investors on the SIF’s performance.a

Source: World Bank 2014 and original research for this publication. Note: CEO = chief executive officer; SIF = strategic investment fund. a. This follows from Principle 5 of the Santiago Principles: “The relevant statistical data pertaining to the SWF should be reported on a timely basis to the owner, or as otherwise required, for inclusion where appropriate in macroeconomic data sets” (IWG 2008, 7).

conflict may exist between them. Once a clear dual objective mandate has been drafted by the owner(s) and enshrined in law or bylaws, the board’s responsibility is to ratify management’s approach to balancing the two goals by endorsing an investment policy (discussed further in chapter 5). The board may instate processes and build capacity to meet and monitor both objectives.

The board may also require the endorsement of subcommittees or sub management bodies to ensure that the dual objectives are met. • Board members must be vigilant to identify and mitigate conflicts of interest that either jeopardize the SIF’s interests or distort private markets to the detriment of the larger policy goal. As discussed earlier, SIF operations can be jeopardized by conflicts of interest that arise partly because the fund operates at the nexus of the public and private sector realms. Such conflicts of interest can be (1) commercial in origin, when the owner, board, or manager is engaged in related party transactions with a profitrelated interest that conflicts with the SIF’s mandate; or (2) political in origin, when public sponsor representatives at the owner or board level pursue, for political gain, competing interests contrary to the SIF mandate.

Such pressures could translate to the SIF in various ways, including, but not limited to, pressure on SIF management to invest in projects for nontransparent and noncommercial reasons, or preferential treatment given to the SIF on pricing or pipeline that could harm private sector interests, leading to the crowding out (instead of crowding in) of private capital.

Therefore, part of the board’s responsibility is to be vigilant to the multitude of forms such pressure can assume. The board must ensure that SIF management is insulated from both clear and hidden coercions that nudge the SIF away from its long-term mandate. The structure and composition of the board can also play an important role here. For instance, by design, the government of India is a minority investor in NIIF with only two seats on a board otherwise filled with commercial investors. This arrangement tempers the ability of the government to use NIIF to further policy objectives that would be commercially unviable and deviate from NIIF’s mandate. In general, the board must also instate safeguards to ensure that the

SIF does not distort or crowd out private markets. As discussed in chapter 2, ISIF does this, for instance, through investment screening before an investment reaches the board for approval to ensure there is no deadweight—that is, the transaction is not displacing private capital. ISIF takes care not to compete with private capital by also requiring potential investees to do a thorough survey of commercial funding available to them before any ISIF investment (see ISIF case study in appendix A). • Board members must also be alert to their own conflicts of interest and not vote or participate in discussions in which they have personal conflict. The board must ensure conflict of interest procedures are in place, so members have no vested interest in matters considered by the board. At NSIA, for example, board members must disclose the nature of their interest in advance of board consideration, cannot seek to influence a decision relating to that matter, and must leave the meeting during the discussion of that matter. In addition, no board member or other NSIA executive can be involved in a personal capacity, directly or indirectly, in the purchase of assets of or by

NSIA (see the case study in appendix A). • Board structure, processes, and procedures should be formalized in a manual (World Bank 2014). Policies that inform the way the board

functions and governs must be recorded in an operating manual or other documentation designed to reduce unpredictability in board behavior.

Such policies include the code of conduct for the board and management.

For instance, under Ireland’s NTMA Code of Conduct for Members of the NTMA and its Committees, Investment Committee members are required to act objectively and independently (see ISIF case study in appendix A). • The board ideally uses specialized committees to inform itself on key issues such as financial reporting or risk management, thus reducing the information asymmetry that underpins the SIF’s principal-agent challenge. SIFs usually consist of the following specialized subcommittees: investment, audit, and risk management. They may also have committees focused on nominations and remuneration. Some development finance institutions, such as the United Kingdom’s CDC Capital, have a separate board committee for development impact, which could be relevant to certain SIFs. Ideally, most members on these committees, including the chair, should be independent, and the committee reports directly to the board. An investment committee is unusual, however, in that the CEO and SIF management must ideally participate in investment and exit decisions, which are the most important executive actions taken by a SIF. • The composition of the investment committee is important to the fund’s ability to balance its policy and commercial objectives. Like the board, the investment committee’s autonomy, independence, and ability to foster debate are of critical importance (Ohrenstein and White 2017). The investment committee of a public capital SIF should have no government representatives, given the risk of politicizing investment selection. Instead the committee should be powered by independent members and senior management operating at arm’s length from the government. ISIF’s investment committee has no government representatives and no ISIF executives, consisting instead of five independent members from the

NTMA board and outside. By contrast, the majority governmentrepresented board of FONSIS is responsible for approving all investments, and the investment committee (composed of four executive members and two board members) simply validates that disbursements are made per board decisions. In mixed capital SIFs structured as limited partnerships, the investment committee is usually fully empowered to make decisions on the acquisition and disposal of assets. For instance, Marguerite

II’s investment committee has sole responsibility for investment approval, subject to the investment’s compliance with eligibility criteria set by the public sponsor and owners. In public capital SIFs, the board, rather than the investment committee, may be ultimately in charge of investment decisions. NSIA’s board makes investment decisions on a majority basis, after screening and preparatory deal work has been overseen by the

Executive Committee,32 followed by screening by the Direct Investment

Committee, which is populated by three nonexecutive board members.33

The respective compositions of the Executive Committee and the Direct

Investment Committee ensure that six of the nine board members are already comfortable with an investment by the time it reaches the full board for majority approval. NSIA’s board currently has no government representation, but this is not enshrined in law.

• The audit committee is particularly important to the SIF as an investment agency with public assets and must be staffed by a majority of independent members. By selecting an external auditor and overseeing the internal and external audits as well as internal controls, this committee focuses on ensuring that financial reporting and compliance requirements are met. The committee also reviews financial statements and ensures disclosure of related-party transactions and conflicts of interest. Committee members have to be able to assess the accuracy and comprehensiveness of the information being transmitted to them. Therefore, ideally audit committees have at least two or three independent members who are in the majority, including the chair; and the committee has the requisite finance or accounting background.34 • A SIF’s risk committee helps the board and senior management adhere to the risk policy prescribed by the board. It provides oversight of the SIF’s risk management systems and procedures to identify, assess, manage, and report risks. The committee’s responsibilities include ensuring that the SIF operates according to the risk parameters established by the government and the SIF’s other investors. The risk committee provides advice to the chief risk officer and chief investment officer, as well as input to other board committees as relevant. The risk committee is itself supported by the chief financial officer and by the risk manager, and these executives are responsible to the committee for overseeing risk management across the SIF. In some cases, the risk committee may be combined with the audit committee to create a combined audit and risk committee (World Bank 2014). FONSIS, ISIF, and NIIF have adopted this model. Less often the risk committee is part of the investment committee, such as in the case of NSIA, whose Direct Investment Committee is also entrusted to play the role of the risk committee.

Oversight structure B: Financial incentives and limited partnership advisory committee or equivalent When the public sponsor has no ownership interest in the management entity of the SIF, the principal-agent problem is addressed in large part by contractually aligning financial interests between investor and manager rather than by closely monitoring the manager via a board. As discussed in chapter 3, SIFs set up like private equity funds, which mobilize capital from third-party investors, typically employ or mimic the limited partnership structure (see box 3.4 in chapter 3). Governance is commonly effected through fiduciary obligations dictated by regulation (if the fund is set up under public law, such as investment fund legislation; see chapter 3), and contractual measures embedded in fund structure and financial incentives. Employing a finite life fund structure, for instance, provides the manager a clear timeline within which to show the investors results (Ribsteint 2009). The LP can curb the manager’s risk-taking tendencies toward the end of the fund by limiting the investment horizon of the fund to within the first 3–5 years of a typically 10-year fund. Investors can also impose bespoke governance arrangements on the SIF through side letters requiring additional reporting or voting rights (Magnuson 2018). For example, in Marguerite II, side letters with some investors contain investment eligibility provisions—such as adherence to United Nations Principles for Responsible Investment—which apply to the fund as a whole. Financial levers are more easily deployed in mixed capital SIFs that may have more flexible compensation structures than public capital SIFs (see discussion later in this chapter).