The Hijacking of Global Financial Governance?

I. Introduction

The April 2018 Spring Meetings of the IMF and World Bank, including meetings among the Group of 20 (G20) officials, set in motion revolutionary and lasting changes in the organization and mission of global financial governance.  These changes will influence the entire system of development finance for years to come since, to some degree, they are orchestrated by the G20 member states – which control the IMF, most of the major national and multilateral development banks, and the Financial Stability Board.

First, this article focuses on the G20 Eminent Persons Group (EPG) on Global Financial Governance which was appointed by G20 officials one year ago to recommend “practical reforms to improve the functioning of the global financial architecture and governance so as to promote economic stability and sustainable growth.”  G20 officials and members of the EPG met with different constituencies at the Spring Meetings to discuss its draft recommendations.  The terms of reference for and membership of the G20 EPG are here, as well as its interim report.  Its final report and recommendations (for implementation over 3-5 years) will be submitted to the meeting of G20 Finance Ministers and Central Bank Governors, which will be held concurrently with the annual meetings of the IMF and World Bank in Indonesia in October 2018.

The article then focuses on reforms already underway at the World Bank Group (“Maximizing Finance for Development”) and given special impetus by the agreement on April 21, 2018 on a capital increase for the institution, which will be formally approved at the October annual meetings.

The coup underway would: 1) give more power to the G20 to steer the course of development finance; 2) promote privatizations or public-private partnership (PPPs) without assurance that they will serve sustainable development or climate goals; and 3) securitize revenue streams from “pipelines” of projects, bundling them into tradable assets on financial markets.  Any projects – public-private partnerships (PPPs); public works; state-owned enterprises (SOE) – can be bundled in this way for trading in markets that shun any barrier to profit-making.  As this article concludes, the development banks should not be turned into tools for hyperglobalization, but rather uphold the role of “patient capital” – public and private – that abides by standards that serve sustainable development and climate goals.  On the current path, the G20 and the international financial institutions will break trust with the public they ostensibly serve.

II. The G20 EPG 

A. Enlarged role for G20 in global financial architecture

Before delving into the G20 EPG’s operational recommendations for the IFIs, three recommendations are highlighted for the way in which they would enlarge the G20’s role in the global financial architecture.  One would require the international financial institutions (IFIs) to be accountable to the G20 as well as their own boards.  The interim report of the G20 EPG states: “The G20 FMCBG [Finance Ministers and Central Bank Governors] is well-placed to forge consensus on key strategic directions for the IFIs collectively to operate better as a system in such areas as common operational principles…At the same time, the G20 could refocus on setting and achieving a multi-year strategic agenda…” Reports on progress in these regards would be submitted by the IFIs to the G20 and their own boards. 

The second proposed reform would bring greater systematic input from the private sector into the decision-making by the Multilateral Development Banks (MDBs). In this regard, the G20 EPG states that “One approach is for individuals with specific [private sector] professional and commercial expertise to be involved as observers or “adjunct” non-voting members on the Board and/or Board committees, or as members of advisory panels on investments.”  A precedent for this exists at the European Investment Bank.

The third reform would institutionalize a high-level forum to address risks to the international monetary and financial system, which are jointly identified by the IMF, Financial Stability Board and the Bank of International Settlements. The forum would focus on: 1) a framework to assess and enable mitigation of excessive volatility of capital flows and exchange rates; 2) a more resilient and predictable global financial safety net (GFSN); and 3) strengthened surveillance and risk identification in a more complex and decentralized global financial system.

Problems with the G20 EPG proposed reforms follow:

1. First, the reforms are proposed by eminent persons appointed by the G20, which is an exclusive “club” with an interest in expanding its own role.  Such proposals should come from more representative and public bodies such as the United Nations or the IMF and World Bank, which have universal or nearly-universal memberships since they will affect all countries and constituencies. 
2. The recommendations would further concentrate decision-making among finance ministers and central bank governors when certain universal goals, e.g., Agenda 2030, the Paris Agreement, require broader mandates and expertise.
3. The G20 primarily engages with transnational corporations and the financial sector through groups such as the Business 20 and the International Chamber of Commerce. A concern is that the interests of small and medium-sized enterprises in the real sector, which actually employ most workers, are not the same as, and indeed can be at odds with, the interests of transnational enterprises. Thus, their interests may not be adequately reflected in the proposed structure.
4. The G20 has marginalized the Civil 20 at a time when civil society organizations around the world are under fire to an unprecedented degree, as reported by the CIVICUS 2017 State of Civil Society Report.
5. The Labor 20 also lacks status with the G20 and the MDBs.  A sign of the waning influence of labor is the concept note and draft of the World Bank’s 2019 flagship World Development Report (WDR), entitled The Changing Nature of Work.  The draft 2019 WDR strikingly overturns the historic notion of the “social contract” by almost completely ignoring workers’ rights and, among other things, proposes extensive labor market deregulation, including lower minimum wages and flexible dismissal procedures. The decline of workers’ incomes would be compensated in part by a “basic level of social insurance” financed by regressive consumption taxes. Although still-unpublished, this report reflects contemporary systemic problems such as subordinating workers rights, and the proliferation of industrial or export processing zones (EPZs) and global supply chains that put women and other vulnerable groups at the mercy of largely unregulated enterprises.

These reforms and others discussed below would alter relationships of accountability in fundamental ways that could undercut country-led development processes, including engagement by citizens with elected officials in advancing progress toward sustainable development and climate goals.

B. G20 EPG Operational Recommendations

The G20 EPG champions six reforms:

1. “The Multilateral Development Banks (MDBs) should agree on a set of core development principles, upon which they would align their operations. Aligning around principles, policies, and key procedures would open space for productive competition in speed, efficiency and innovation in approaches and products, while avoiding competition that lowers standards or uses subsidies on official loans in areas with no clear market failure.”
2. “The IFIs should collaborate through country platforms – in capacity-building, strengthening the investment environment, developing the supply of bankable projects, and sharing knowledge and data.” (See Part “IIIB,” below)
3. “The MDBs should collaborate on system-wide risk insurance.”
4. “The MDBs should collaborate to enable system-wide securitization so as to mobilize institutional investors.” (See “IIC”, below.) 
5. “MDBs’ governance structures and internal incentives should be reoriented towards achieving development impact, rather than deployment of their own financing.” 
6. “Clear visibility of responsibilities and complementarities between the different agencies involved in tackling the challenges of the global commons is needed.”

Section “C” below describes how revenue flows from portfolios of projects, are securitized, and become subject to the whims of international capital markets. The new securitized loan instruments are being engineered with the same types of exotic financial products (e.g., Collateralized Debt Obligations (CDOs)) that contributed to the financial fragilities that led to the 2008 global financial crisis. The new securitized investment vehicles tend to suffer from the same degree of opacity and complexity that undermines the ability of investors and regulators to adequately assess risk. And despite these features, the G20 proposes using such instruments to incentivize much larger private capital flows into arrangements brokered by the MDBs for financing new projects in developing countries.  

Some goods and services should be exempt from financial trading due to volatility, risks, and profit-taking motives.

C. Securitization of revenue flows from project portfolios

As noted above, the G20 EPG’s fourth proposal is that the “MDBs should collaborate to enable system-wide securitization so as to mobilize institutional investors. Securitizing on a large scale, across the MDB system, will in effect create new asset classes and attract a wider range of investors. Equally important, planning for securitization downstream confers significant benefits upstream in the project cycle, by driving standardized documentation and commercial discipline.” (Original emphasis.) 

In other words, the proposed reforms seek to engage the private financial sector not only with regard to financing for individual projects, but also by securitizing the projects’ future revenue streams from the “pipelines” of projects and bundling them into tradable assets on financial markets.  Any projects – public-private partnerships (PPPs); public works; state-owned enterprises (SOE) – can be bundled in this way for trading on financial markets.  Importantly, as development projects are financialized or commodified by new flows from private investors, it frees up capital on the balance sheets of multilateral development banks to make more loans.

With regard to infrastructure, this proposal – dubbed the G20 “Roadmap to Infrastructure as an Asset Class” (endorsed by the March 2018 communique of the G20 Finance Ministers and Central Bank Governors) is one of the two main priorities of the Argentine 2018 G20 process.  In some form, infrastructure will be picked up as a priority for Japan’s G20 in 2019; Japan helps lead the G20’s work stream on “quality infrastructure”.  The dizzying array of tools and standards for this process are laid out by the OECD here.  [They are being piloted in many places, including by the World Bank Group’s Maximizing Finance for Development approach and, specifically, the International Finance Corporation’s Managed Co-Lending Portfolio Program (MCPP) with leadership from the Peoples Bank of China and Allianz Global Investors and Sweden, among others.]

China and the Asian Infrastructure Investment Bank (AIIB) are on board with the G20 proposed reforms.  On February 9, 2018, the AIIB’s “Strategy on Mobilizing Private Capital for Infrastructure” was launched and, although the strategy has since been taken off the institution’s website, it announces that the “Bank will be the champion and leading institution to catalyze private capital for infrastructure investment in the region” and will “work to develop emerging market infrastructure as an asset class.”  APEC’s 2017 Joint Ministerial Statement also endorses this strategy.

Once a project’s future revenue streams are securitized, MDB environmental and social safeguards would not apply. This is because contract for repayment of the securitized debt held by the investor would be disconnected from whatever underlying project the financing had been for, and from any consequences of the underlying project. And, while submissions to the G20 EPG routinely invoke the importance of scaling up development finance rapidly in order to meet the imperatives of Agenda 2030 and the Paris Agreement, the G20 is divided.  Argentina’s G20 Presidency holds the position that there is no consensus among G20 countries on these aspirational sustainable development and climate goals.  No doubt it is influenced by the withdrawal of the U.S. from the Paris Agreement and U.S. challenges to Agenda 2030, including opposition to at least two sustainable development goals (SDGs).

Even without fractured political backing for these goals, once these instruments for project financing become collateralized securities held by investors on international capital markets, the holders of these securities have few incentives to take social or environmental goals into account.  While long-term institutional investors (e.g., pension and insurance funds) have “patient capital” with maturities that may match instruments such as public-private partnership (PPP) contracts of 15-30 years, they invariably work with “impatient” capital -- private equity and hedge funds that have short-term, profit-taking incentives, including asset-stripping, and are not concerned with social and environmental or public interests.

Here, the key concern is whether private capital markets and institutional investors can be incentivized into financing long-term public goods, and if these mechanisms can end up serving the public interest, or not.

There are concerns on this score.  The G20 EPG suggests that “planning for securitization downstream confers significant benefits upstream in the project cycle, by driving standardized documentation…” But some standardized documentation – such as found in the World Bank’s Guidance on PPP Contractual Provisions – can place more onerous burdens on nation states and citizens than any trade or investment agreement or conventional international law.  They heap inordinate risk on the nation state and handicap its “right to regulate” in the public interest, as described here.  

The risks are compounded by the underlying, sub-standard performance of PPPs that has been documented by the PPP Campaign, as expressed by some 150 civil society organizations.

In its interim report, the G20 EPG notes the importance of “arresting threats like climate change, developments in the world’s biological eco-system, pandemics and natural catastrophes, which have large spillover effects across regions and globally”. Yet, it implies that such threats can be addressed by “coalitions of countries as well as public-private coalitions” rather than systemically

III. Multilateral Development Banks (MDBs): Maximizing Finance for Development

A. Introduction

On April 21, 2018, the shareholders of the World Bank Group’s endorsed a package of measures that include a $13 billion paid-in capital increase [$7.5 billion paid-in capital for IBRD (International Bank for Reconstruction and Development) and $5.5 billion paid-in capital for the IFC (International Finance Corporation), through both general and selective capital increases] as well as a $52.6 billion callable capital increase for IBRD.  The press release states that “the boost in capital will be augmented by a broad range of internal measures including operational changes and effectiveness reforms, loan pricing measures, and other policy steps to create an even stronger World Bank Group.”  It notes that “the combined financing arms of the World Bank Group are expected to reach an average annual capacity of nearly $100 billion between FY19 and FY30…”

The media has paid attention to the insistence that loan pricing should redirect MDB capital from creditworthy countries, such as China, to fragile and conflict-affect states (FCS).  Indeed, the World Bank’s soft loan arm, the International Development Association (IDA) is planning to double the volume of its activities in FCS.

Less attention has been paid to the new and revolutionary “Maximizing Finance for Development” (MFD) paradigm – perhaps because the branding for the paradigm has changed (from the “billions to trillions” approach and the “cascade” to MFD).  The MFD approach insists that nothing should be publicly financed if it can be commercially financed in a sustainable way.  If commercial financing is NOT forthcoming for a project, a country must promote a more investment-friendly environment and/or provide private sector guarantees, risk insurance and other inducements.

But what does “sustainable” commercial financing mean?  As set forth by the World Bank Group here, it is a complex term meaning: economically efficient, commercially viable, fiscally sustainable, transparent in the allocation of risks, providing value for money, ensuring environmental sustainability, and ensuring social equity and affordability.  In some descriptions of MFD, the last two elements are excluded and some member countries believe that environmental and social concerns should be addressed in the domestic context, not by international financial institutions. At best, the term “sustainable” is ambiguous.

The MFD approach is set forth in the March 2018 “FORWARD LOOK – A VISION FOR THE WORLD BANK GROUP IN 2030 IMPLEMENTATION UPDATE”, which cites the G20 target for MDBs to collectively increase the mobilization of private financing by 25-35 percent over the next three years.  The G20 will measure the performance of each MDB by the extent to which it leverages private investment and, in turn, the MDBs will measure the performance of many countries by how effectively they leverage private investment.  (The G20 has laboriously laid out the metrics for measuring leverage over the course of a few years.)

There are nine MFD pilot countries (Cameroon, Côte d’Ivoire, Egypt, Indonesia, Iraq, Jordan, Kenya, Nepal and Vietnam) which are intended to introduce private sector solutions in energy, transportation, and other infrastructure sectors. The above-referenced “Forward Look” states that “While initially focused on infrastructure, WBG teams are collaborating to take MFD into health, education, small- and medium-enterprise finance and agriculture. The MFD initiative is supported by new incentives, progress monitoring, and guidance, training, and engagement with WBG staff.”  Thus, MFD applies to the whole portfolios of the MDBs. Arguably, at some point, these 9 pilots cases should be able to show how much new financing for projects had been arranged through the new approach, i.e., how much new financing was brought in from private capital markets, what level of public resources were used, and what types of future loan guarantees and subsidies and other MDB incentives were used in the “de-risking” process that engineered the investment vehicles.

Some features of the MFD paradigm include:   

• a bias toward megaprojects in energy and transport, especially to facilitate trade
• a bias toward PPPs (where for China, one can substitute a state-owned enterprise for the private partner)
• engagement by private investors upfront in the design of regional master plans and project cycles
• accelerated and standardized project preparation processes (e.g., standard contracts, cost-benefit analyses, procurement terms)
• financial engineering that, in key ways, separates performance of assets (in terms of delivery of services) from the contractual return on investment (ROI) to the asset owners
• the contrast between the contractual prioritization of debt repayment to investors with the subordination of environmental concerns and almost complete neglect of social/human rights concerns to project-affected people n the ground in the borrowing countries
• creation of more Export Processing Zones (e.g., the “one country-two systems” of Senegal) that tend to disconnect the activities of foreign firms from the rest of the domestic economy
• a variety of transparency rules 

B. Regional and Country Platforms

As noted above, the G20 EPG recommends that “the IFIs should collaborate through country platforms – in capacity-building, strengthening the investment environment, developing the supply of bankable projects, and sharing knowledge and data. These platforms should be owned by the countries’ governments, with appropriate support and coordination from the IFIs. Country platforms should also enable MDBs and the IMF to leverage the capabilities of the private sector, NGOs and philanthropies – for example to accelerate adoption of technology-driven solutions - drawing on the IFIs’ unique role as honest brokers for country authorities.”

Country platforms are part of regional platforms that harmonize: 1. Project preparation and advisory facilities; 2. Risk mitigation vehicles and guarantees; 3. Co-investment platforms; 4. Project financial instruments; and 5. Blended finance project instruments for Asia, Africa, Latin America/Caribbean, and Europe.  These platforms provide a Global Toolbox to Advance Private Sector Investment and are displayed with the logos of eleven MDBs.

Regional integration agendas encompass cooperation on policy for trade, investment, infrastructure, domestic regulation, and other public goods (e.g., shared natural resources, security). Each region includes infrastructure master plans for energy, transport, water, and information & communications technology (ICT).  These include:

• Europe (Juncker Plan);
• Central Asia (Central Asia Regional Economic Cooperation Program (CAREC));
• Africa (Program for Infrastructure Development in Africa);
• Central America (Meso-America Project); 
• Association of Southeast Asian Nations (ASEAN Connectivity 2025);
• Union of South American Nations (UNASUR) and its Consejo Suramericano de Infraestructura y Planeamiento (COSIPLAN).

China’s focus on enhancing connectivity among these master plans was a motivation for launching the G20 Global Infrastructure Connectivity Alliance (GICA) in 2016.

The WBG is leveraging collaboration in each of the master plans, e.g., the Eastern Africa Electricity Highway and West Africa Power Pool, the Central Asia-South Asia Electricity Transmission and Trade project, the Western Balkans Trade and Transport initiative, and the Pacific Alliance Regional Integration Advisory project, and the Belt and Road Initiative.

At the country level, new diagnostics are being piloted to underpin MFD, including the Infrastructure Sector Assessment (InfraSAP) being applied in Vietnam, Indonesia, and Egypt; the Country Private Sector Diagnostics (CPSDs) and Sector Deep Dives help identify key constraints to market solutions.

The logic of MFD has been challenged by Tito Cordella in his World Bank Policy Research Working Paper Optimizing Finance for Development (January 2018) where he reasons that maximizing finance may conflict with optimizing finance, since “…the overall appeal of government reforms decreases as the associated costs in terms of lost externalities now affect all projects that end up being financed by the private sector.”

Conclusion

The recommendations of the G20 Eminent Persons Group on Global Financial Governance should be submitted to the members of the UN, the IMF and World Bank for consideration and exploration of alternative directions for global financial governance.

As they stand, the recommendations promote what Harvard’s Dani Rodrik has called “hyperglobalization” —the attempt to eliminate most or all transaction costs that hinder trade and capital flows. In “Who Needs the Nation-State?” - Rodrik states that the imbalance between global markets and the domestic rules that govern them can be corrected either by expanding governance beyond the nation-state or restricting the reach of markets. The recommendations of the G20 EPG takes the former route.  Importantly, Rodrik emphasizes that, whether globalization sets off a “race to the bottom” or not, we can break the deadlock between the proponents and opponents of globalization by accepting a simple principle: countries can uphold national standards in labor markets, finance, taxation, and other areas and can do so by raising barriers at the border, if necessary, when international trade and finance demonstrably threaten domestic practices that enjoy democratic support.” (Roepke Lecture in Economic Geography, Clark University, 2012)

The reach of financialization should not extend into countries and sectors that are not either equipped to manage flows by selective raising of barriers or where delivery of public goods is necessary (e.g., to meet other sustainable development and climate targets).

Since 2013, the G20 and the OECD have developed a massive array of tools, rules, guidelines, principles, and standards to expand private investment in development.  But, these need re-examination to ascertain whether or how investment tools reduce greenhouse gas emissions and increase resilience to climate risks, while serving social needs and respecting human rights.  Certain tools are heavily biased toward seeking greater the private sector involvement despite the fact that the private sector has fiduciary responsibilities to provide an adequate return on investment to shareholders, and this goal can often be at odds with goals for public sector financing for development.  (This includes the “screening tool” that determines whether projects, including infrastructure services, will be publicly or privately financed and delivered; the 2013 G20 Principles for Institutional Investment, which are critiqued here, and as noted above, the standard PPP contractual provisions.) More comprehensive tools would first require upfront assessments that public financing is not an effective option before presuming an important role for private financing.

Given that infrastructure contributes to some 60% of global greenhouse gas emissions, the G20 should ensure that before the envisioned doubling of annual infrastructure investment, such investments support the Paris climate goals.

When the risk in project pipelines is inordinately borne by the state, there are dangers of rising debt (as is already seen) and/or that projects (e.g., PPPs) and project portfolios could exacerbate inequality by socializing losses and privatizing gains on a significant scale.  The collapse of the U.K.’s Carillion, manager of 450 public works contracts, illustrates this principle in practice when something goes wrong.  The correlation between inequality and the growing size of the financial sector needs close examination.