By Maria José Romero

The International Finance Corporation (IFC), the largest global development institution focused exclusively on the private sector in developing countries, “knows very little about potential environmental or social impacts of its financial markets lending” and cannot even claim that it meets a “do no harm” requirement. This is an alarming finding just released by the Compliance Advisor/Ombudsman (CAO) – the IFC’s arm length watchdog – from an audit into environmental and social (E&S) outcomes of a sample of IFC’s financial intermediary (FI) lending between 2006 and 2011. This echoes concerns raised consistently by civil society organisations, including in a recent Eurodad report.

The IFC had a total portfolio of $ 45 billion at the end of its last financial year (June 2012) and its FI activities constitute over 40 per cent of its portfolio, a proportion that is growing steadily. From 2007 to 2011 the IFC’s FI portfolio commitments grew from $3.62 billion to $8.18 billion. These are private sector projects in developing countries and emerging markets through third-party entities, such as banks, insurance companies, leasing companies, microfinance institutions and private equity funds.

IFC corporate message vs reality

The IFC claims to be the global leader in “sustainable banking and in other areas such as E&S standard-setting for the private sector.” For instance, the IFC Performance Standards are the basis of the Equator Principles, which are an independently managed financial industry benchmark for assessing and managing E&S risk in project finance.

Even more, the IFC’s corporate message also implies that its “E&S requirements have an impact beyond doing no harm,” and concrete steps have been already taken in this direction. While the 2006 Policy and Performance Standards can be summarised as “avoid adverse impacts” or “do no harm”, the revised 2012 Sustainability Framework has expanded the IFC’s specific E&S objectives to having a “positive development outcome.”

However, during the CAO’ audit, the team in charge “identified a tension between trying to increase investment and imposing the appropriate E&S provisions.” More generally, the CAO also finds that the “IFC’s E&S processes and results do not fully correspond to [the] IFC’s overall corporate message.” In fact, as the CAO report highlights, the IFC addresses E&S impacts in three ways but “none of these approaches systematically tracks or measures E&S impact at the subclient level” and the IFC conducts “no assessment of whether the E&S requirements are successful in doing no harm.” Another challenge for the future is that “they also do not measure the expanded objectives of the 2012 Sustainability Framework,” that aims to ensure a positive development outcome.

As a result of this lack of systematic measurement tools, the CAO says, damningly,  that the “IFC knows very little about potential environmental or social impacts of its FM [financial market] lending.”

Compliance with IFC’s E&S requirements: Striking figures

The CAO report finds that 10 per cent of the sample was not compliant with the IFC’s environmental and social requirements, and a further 25 per cent were only partially compliant or there was uncertainty. The CAO was “surprised” to find cases where failure to comply with the requirements included in legal agreements between the IFC and the FI, “did not cause the IFC to refuse additional IFC financing” to the client. In fact, according to the CAO report “there were no examples in the CAO sample of IFC directly using the provisions to exit a facility, even though in a few cases, a client’s noncompliance had proved intractable.” In one specific case, for instance, “national authorities removed a FI subclient’s license to operate due to a major pollution incident, but the IFC client had failed to undertake the required due diligence.”

The CAO emphasises how the requirements focus on the client developing a social and environmental management system (SEMS), rather than actual social and environmental outcomes. This requirement creates the risk of a reporting and compliance orientation on the part of the client. The SEMS “can become merely an end in itself (a box-ticking exercise) rather a means of enhancing environmental and social performance outcomes on the ground.”

The report puts forward a further two striking figures:

• “around 30 per cent of investments in [the] CAO’s sample were not regarded by the CAO panel as to have “improved” outcomes as a result of the application of IFC’s E&S  requirements at the client level”.
• “the proportion of cases of non-improved performance was around 60 per cent at the subclient level, which is where IFC seeks to really have an impact.”

These figures challenge the IFC’s additionality argument when it comes to lending through FI. Generally speaking, the CAO concludes that the “IFC does not currently have the tools to measure E&S additionality” other than for specific focused products.

Harmonisation amongst the DFIs

As the IFC usually co-invest with some of the other development finance institutions (DFIs), the CAO panel also discusses the issue of alignment of development finance institutions (DFI) E&S requirements. Some of these institutions include Deutsche Investitions-und Entwicklungsgesellshaft (DEG), the European Bank for Reconstruction and Development (EBRD), and Nederlandse Financierings-Maatschappij voor Ontwikkelingslanden N.V. (FMO).  In this regard, the CAO report concludes, in line with the recent Eurodad report Private profit for public good?, that there is currently no harmonised approach amongst the DFIs in terms of measuring development impact.

Particularly, the CAO finds that “the differing E&S requirements of the various development finance institutions places a burden on IFC’s clients  and fails  to take advantage of potential opportunities to increase the efficiency and leverage of the DFIs, individually and collectively, effectively wasting development resources.”

What about transparency?

As the CAO report clearly mentions, “disclosure of investment information is a central tenet of the accountability of publicly funded multilateral finance institutions.” The IFC’s Policy on Disclosure of Information states that “there is a presumption in favour of disclosure”, but the “IFC does not disclose to the public financial business, proprietary or other nonpublic information” with the argument that “to do so would be contrary to the legitimate expectations of its clients.”

The CAO is aware of the challenge when working through intermediaries, because in fact it means that “there is no information publicly available about the end use of IFC’s funds.” The IFC discloses information about its client (that is, the financial intermediary), but depending on the type of client and investment, there were parts of the CAO sample portfolio where “IFC itself did not have the information on the end use of funds available, other than on an aggregated level collected by the client.”

Recommendations and reactions

While the CAO does not enumerate recommendations, throughout the audit it makes suggestions for improvement, including “requiring clients to report and disclose [environmental and social] performance and to engage third-party assurers to provide an independent check” and helping clients to implement a “more fundamental change management process”. It also suggests harmonisation of the environmental and social standards of different private sector lending institutions.

The IFC response, in its turn, does not make any commitment to change its practices or policies to address the CAO’s findings, instead championing the finding that 90 per cent of IFC FI clients are in compliance with the performance standards. In relation to sub-client social and environmental impacts, the IFC staff said: “We do not consider this necessary or efficient as our intent is to have our partner FIs manage this.”

As a result, civil society organisations, including Oxfam International and the Bretton Woods Project  launched a joint press release , calling for a “fundamental overhaul of the way the IFC does FI lending.” According to Peter Chowla, Coordinator of the UK-based Bretton Woods Project, a World Bank watchdog, “despite its mission to reduce global poverty, it seems as if the IFC is choosing to remain ignorant. This report questions the basis on which the IFC is currently lending to financial institutions and whether this lending really achieves good value in use of public resources.”

Additional information:

* Read media briefing note

* Read Eurodad report Cashing on climate finance?, which found important gaps in the knowledge of how money is leveraged through financial intermediaries. According to the report, FIs and existing investment instruments are very limited when it comes to targeting Low Income Countries and supporting small and medium enterprises in sectors which are particularly vulnerable to climate change.