The G20’s principles on institutional investment: A Trojan horse for finance-driven infrastructure?

By Aldo Caliari, Director, Rethinking Bretton Woods Project, Center of Concern

For the last five years, the Group of 20 (G20) has been discussing policies to finance the “infrastructure gap” – the more than USD 1 trillion of additional investment needed to bridge the infrastructure gap of developing countries. Its main proposal has been to attract the savings of institutional investors (mutual funds, pension funds, insurers, private equity funds). The proposal’s premise is that the long-term financing needs for infrastructure development are a fitting match to institutional investors’ need for long term investment vehicles.

With “marching orders” from the Group of 20, institutions -- including the World Bank and the Organization for Economic Cooperation and Development (OECD) -- rushed to reshape the international economic and legal architecture to support this model. One of the 2013 work products was a discreet set of eight “High Level Principles of Long Term Investment Financing for Institutional Investors” drafted by the OECD and endorsed by the Group of 20 (hereinafter “the Principles”). In subsequent reports,[1] the OECD has now completed guidance that expands on the meaning of each principle.

Several of the principles are unassuming and commonsensical to the point of innocuousness: the fiduciary duty of managers of institutional funds comprises the duty to manage the funds in the best interest of the owners; governments should support stable macroeconomic conditions conducive to longer-term investment; all procurement projects should strive to achieve the most favorable relation between the objective being pursued and the resources utilized; and so on.

But hidden among the maze of more than 400 paragraphs of guidance, there are a number of points that, when viewed collectively, paint quite a disturbing picture, one that would substantially alter the way common citizens may think about infrastructure and their rights as citizens.

Enforceable rights… (for investors)

The principles put the emphasis on a favorable business and investment climate and effective enforcement of the rule of law. Guidance directs governments to “adopt measures that help to create a supportive business environment, by reducing administrative burdens and simplifying bureaucratic procedures to the extent feasible, increasing the quality of contract enforcement . . . in order to provide a good climate for private sector investment.” Governments “support long-term investment by ensuring efficient market functioning, through adequate regulation and supervision…and an appropriate degree of investor protection.”

The discourse closely resembles that of the World Bank’s Doing Business report, which relies on a widely discredited methodology.

Among the rights conveyed by the “rule of law,” as understood by these principles, one will struggle to find any mention of human rights, labor rights, or environmental and social regulations.

The few mentions leave no doubt as to the secondary and optional nature of such considerations. For instance, one of the recommendations says “Governments may establish a “code for responsible investing”, which gives institutional investors guidance . . . . As such, the “code” may contain sustainability considerations, acceptance of responsibilities of . . .  avoidance of potential conflicts of interest situations, transparency about policies, and where appropriate, a collaborative approach to promoting acceptance and implementation applicable codes and standards.”

Decidedly in favor of private provision of services

One of the principles (1.8) says “Where appropriate, governments should provide opportunities for private sector participation in long-term investment projects such as infrastructure . . . via, for instance, public procurement and public-private partnerships,” and, further, to ensure “a regular, coherent pipeline of suitable projects.”

In spite of the qualifier at the beginning of the principle, the OECD guidance takes a more decided position in favor of private delivery: “Governments provide suitable opportunities for private sector participation in all aspects of infrastructure delivery, through call for public tender (public procurement) in which private corporations will provide all or part of conception, construction and other supplies and services, or through structured contracts such as PPP, including the government-pay model and the user-pay model (concession).”

The OECD advises in favor of public interventions in long-term investment projects only in highly selective circumstances when, for instance, “the existence of market failure provid[e] a central argument in favour of public intervention, as in the case of “public goods” (i.e. large externalities, non-rivalry, natural monopoly, and non-excludability)”.

Furthermore, the OECD states that public interventions should “avoid crowding-out private investments” and “should be selected by carrying out appropriate cost-benefit analysis of such interventions.” It also says that ex-ante socio-economic evaluation should be “compulsory for public investment projects.” In spite of the high rate of failure of private service delivery no similar and symmetric requirements are made for private participation.

There is some ambiguity in the call for ensuring that any public support “is appropriately priced and is subject to fiscal considerations,” (because it could potentially mean also applying such criteria to interventions in public-private partnerships) but the context of this point that makes it very susceptible to an interpretation that such appropriate pricing only applies to public investments.

Offsetting investors’ risks at the public expense

The OECD recommends that “governments take steps to ensure that risks in a PPP contract are borne by the party best suited to manage them, which should entail a significant and effective transfer of risks to the private partner.”(Emphasis added.) But this is balanced by a requirement of “giving to the private partner an expectation of obtaining an adequate return on its investment taking into account the type and degree of risks involved and transferred, in order to sustain the private partner’s interest during the contract’s lifecycle.”

Unfortunately, the exemplary balanced nature of this recommendation on transfer of risk stands out as an exception. The OECD reports go out of their way to promote risk reduction for investors at the expense of the public purse. In one place, the OECD recommends that “where there is no conflict with broader public policy,” governments provide “incentives/subsidies during the operational phase of infrastructure development aimed at increasing the cash flow performance of the infrastructure project to attract private investors.” Translated into common English, the OECD is endorsing the use of taxpayer dollars or the levy of higher fees on consumers to guarantee juicy payments to private investors. Should there remain any doubt, this is followed by a list of potential measures to use: “revenue increase/revenue stabilisation or cost reduction” or “any form of tax relief that reduces the tax burden of the infrastructure project and increases the return to private investors.” Another measure is “the provision of a floor protection against a drop in traffic volumes in the transportation sector.” This is also called a “minimum demand guarantee” which pays the private provider even when there is little or no use of the roads it constructed – even if it was a “road to nowhere.”

Moreover, the guidance recommends that governments “remove impediments in the tax system that may discourage private sector investment in infrastructure” (with a reminder that this should be done without sacrificing fiscal prudence), and that they seek “to promote long-term savings by reducing the tax rate on capital market instruments on the condition that they are retained for longer periods.”

Another pot of public money that can be used to guarantee the income of investors is in multilateral development agencies that provide coverage for “government-related, sovereign risks, as well as for specific operational risks including regulatory changes and currency exposure.” Of course, this may end up being the same pot in cases where multilateral development agencies are allowed to recover their insurance payments from the State when one of these risks materialize.

A discretionary approach to environmental, social and human rights safeguards

The concept of regulations to enshrine environmental, social or human rights safeguards in long term investments is completely absent – lest one is inclined to charitably interpret some generic references to regulation and obligations of governing bodies of institutional investors to keep a sound governance framework. In fact, ignoring the growing evidence of adverse human rights and environmental impacts of investments on infrastructure or land – two areas that will oftentimes fit the definition of long term investment -- the OECD seems to take as an unquestionable point of departure that long term investment are always good for human rights or sustainability. With this assumption, references to sustainability or the environment are left as a bonus that investors are welcome – but not really required – to implement, as in the “code of conduct” referred to above (first subsection).

Principle 3.4 states that the governing body of institutional investors should “ensure that the institution can properly identify, measure, monitor and manage the risks associated with long-term assets as well as any long-term risks –including environmental, social and governance risks – that make affect their portfolios.” While this is a positive reference, it is quite unsatisfactory because social and environmental norms may not be a risk for investors – especially if a weak regulatory or remedy framework allows them to get away with violations—and, yet, that should not be a pass to disrespect them.

Similar fault can be found in the OECD guidance that states that prudent investing “gives appropriate consideration to any factor which may materially affect the sustainable long-term performance of its assets, including factors of an environmental, social, and governance character.” Moreover, this is curiously stated as a fact – though with some goodwill one can infer that the OECD intends investors to behave prudently, even if it does not prescribe any regulation to the effect.

Also, among the tasks included in the fiduciary duties of administrators of institutional investors, it mentions “appropriate transparency and reporting on financial indicators as well as environmental, social and governance-related key topics.” Again, this is without any language, such as “governments should ensure” attached, leaving the impression that incorporating this requirement is discretional for different investors.

As for human rights duties of investors, the High Level Principles and their guidance are completely silent. The Preamble states that the High Level Principles are “based on” and “consistent with” other documents, including the OECD Guidelines on Multinational Enterprises which have, as of 2011, incorporated the UN Guiding Principles on Business and Human Rights. Furthermore, the OECD’s interpretation is that investors are bound to respect the principles, even when they are in minority shareholding positions. But one should not need to arrive at this conclusion in such an oblique way.

A lenient hand in regulation of asset managers

Institutional investors are often managers of assets rather than the owners of the capital themselves. This is particularly problematic since asset managers, as intermediaries, may have a shorter term investment horizon than the asset owners that hire them.  After stating the fiduciary duties of institutional investors towards the ultimate owners or beneficiaries of the assets, Principle 3.6 makes similar duties applicable to “persons and entities involved in the management of the assets of institutional investors.”

But neither the principles nor their guidance call for public interest regulations assigning responsibilities for such duties. The OECD has a lot of prescriptions for how the governing body of the institutional investor should consider the roles of its asset managers. For instance, “when outsourcing investment mandates to external service providers, the governing body of an institutional investor retains responsibility for monitoring and oversight of such providers,” it says. The governing body should incentivize “external managers to put appropriate weight on long-term risk factors in order to manage risks which are relevant to the institutional investor’s long-term investment horizon and its fiduciary duties.”

It is fine to ensure asset owners are not “off the hook” for monitoring the conduct of the managers of their investments. However, there are greater interests at stake and more affected stakeholders than just the asset owners, which warrant regulation of the asset managers, too.

Deregulating finance

The OECD calls for governments to “take steps to ensure there are no unnecessary restrictions on the range of long-term government and market financial instruments,” “eliminate regulations that unduly hinder . . .  private participation in long-term investment financing,” “streamline regulation governing the collective investment management sector. . .  in order to reduce the costs related to the compliance by the operators to the existing regulatory obligations,” “reduce costs of savings schemes by removing barriers to non-resident investment,“ and  “remove barriers to international investment by institutional investors, although there may be applicable rules and regulations in certain situations.”

OECD guidance on this matter is particularly startling given that a global financial crisis unleashed by insufficient regulation and controls on capital mobility is not so distant that we would forget it or its continuing impacts.

Moreover, the crisis showed countries that had relied on capital controls on inflows – precisely of the sort that OECD guidance would have countries remove – to ensure the profile of investment received was best tailored to long term goals consistent with countries’ national development objectives.

The idea of having a set of principles on how institutional investors should conduct their affairs may have seemed a good one at the beginning of the project. But the litmus test is in the model of financing it embeds.

This leads to the obvious question that civil society keeps asking: who is served by the G20’s infrastructure finance model? Will it support people, especially the poorest and vulnerable ones that lack access to infrastructure, and bring greater equality? Or is it a means to create another plaything for financial markets to concentrate wealth at the top? The answer lies in the most recent OECD guidance if one can find it, hidden – as in a Trojan horse.


[1] G20/OECD, Report on Effective Approaches to Support Implementation of the High Level Principles on Long-Term Institutional Investment, November 2014, including an extensive Annex. And, more recently an OECD Summary Report to the G20 on Implementation dated September 2015.