The International Finance Corporation's approach to combating fraud and corruption in project finance
As the world's largest source of financing for private sector projects in developing countries, International Finance Corporation (IFC) is deeply concerned about the potential for corruption in the projects it finances. In congruence with the World Bank's perspective, the IFC must act to fight corruption in order to retain the confidence of its shareholders and the financial markets on which it relies. Moreover, the avoidance of corruption is necessary to ensure that the IFC's investments are successful, that its resources are being used effectively, and that its developmental objectives are met.
The IFC's strategy to combat corruption in its operations is concentrated in the following two areas identified in the Bank's strategy:
The IFC's efforts to combat corruption in the private sector will complement those of the Bank in the public sector to the extent that the IFC's activities focus in the private sector.
Control of fraud and corruption in projects. The IFC controls fraud and corruption in the projects in which it invests by employing appropriate methods and procedures at every stage of the investment process.
The IFC's investment staff conduct a due diligence review of the individuals involved and their primary businesses. On-site visits are made to both project and nonproject installations to obtain a first-hand impression of the sponsor/operator and its affiliated companies. The IFC generally will not invest in a project if it does not know the identity of its partners, or if it believes that a sponsor/operator may be controlled by an undisclosed third party, or if the project may be sponsored, directly or indirectly, by individuals holding public office.
Before making an investment, IFC staff perform an investment appraisal in which the IFC must be persuaded that the interests of the sponsor/operator in undertaking the project are compatible with those of other investors. The appraisal must establish to the IFC's satisfaction that the contractual undertakings made to structure the project (such as supply, distribution, and off-take agreements) do not unfairly benefit some of the parties to the transaction at the expense of others. Each party's share of the investment's rewards must be known by the IFC and judged to be commensurate with the risks taken and the contributions made by the party. This analysis is a necessary step to uncovering potential conflicts of interest, as a project typically brings together both strategic and passive investors with different agendas and motivations.
The IFC's first line of defense against corrupt costing is its extensive experience and familiarity with industry best practices, technologies, and capital costs in a broad range of industrial sectors. The IFC's project team of investment officers, engineers, and lawyerswhich sometimes includes outside specialist consultantswill be familiar with best practices, time to completion, and current world prices of capital goods in the major industries. Thus the team can identify significant price anomalies and distortions that may mask corrupt practices. The IFC will not finance a project if material deviations from fair pricing cannot be explained by specific, acceptable circumstances.
The IFC will not invest in a project if a lack of transparency in the awarding of a concession or a contract makes it impossible to determine that business is being conducted on an arm's-length basis between a government and a project company. At an early stage in the process of evaluating a proposed projectthe initial project summaryIFC management reviews the structure of the project and examines the relationships between the parties. If a project is found wanting in any of these areas, management directs staff to agree on improvements with the various parties to the transaction.
After making its investments, the IFC supervises them closely and on a regular basis. The IFC consults periodically with the management of investee companies, sends field missions to visit the enterprises, and requires quarterly progress reports during project implementation. In some projects a full-time, on-site lender's representative may be required during the project's construction phase. The IFC requires, in its capacity as lender, that investee companies provide it with quarterly and annual financial statements (the latter are audited) and insurance reports and give it direct access to the company's external auditors for the purpose of reviewing the company's accounts, operations, and the management letter.
The IFC's direct presence and relationships in developing countries also aid in supervision by alerting it to problems that may indicate the occurrence of a corrupt practice in an IFC-financed project. Staff of the IFC's resident and regional missions assist in this process by maintaining direct contacts with various government agencies, NGOs, and other parties in local financial business communities. Outside counsel employed by the IFC to help prepare legal documentation and negotiating terms and conditions for an IFC investment also may transmit information to the IFC that they are uniquely positioned to obtain because of their contacts in local legal and business communities.
Institutional Strengthening. The strengthening of institutions in developing countries sometimes occurs as a secondary effect of the IFC's efforts to control fraud and corruption in projects. However, the IFC also engages in activities whose primary purpose is to build and strengthen institutionsand these activities help combat corruption. In this regard the IFC advises its member governments on how to create new institutions and strengthen existing institutions so that disclosure and transparency in the conduct of financial transactions will be improved and administrative discretion conducive to corruption will be eliminated. The IFC's Capital Markets Department plays an important role in this areafor example, providing advisory services for the establishment of stock exchanges and securities commissions in IFC member countries.
The IFC also combats corruption through operations of the Foreign Investment Advisory Service (FIAS), a joint service of the IFC and the Bank. FIAS works at the request of IFC member governments, helping them to build effective institutional frameworks for investment promotion strategies and to interact with potential foreign investors. FIAS helps governments achieve their foreign direct investment objectives. Its advisory services seek to stimulate inflows of foreign direct investment by creating a more favorable investment climate in the member country. FIAS's advice typically focuses on reforming laws, policies, and procedures needed to increase those inflows.
The Multilateral Investment Guarantee Agency's approach to combating fraud and corruption in guarantees
With a mandate to encourage the flows of foreign direct investment (FDI) to developing member countries and transition economies, the Multilateral Investment Guarantee Agency (MIGA) has a natural interest in the issue of corruption as an inhibitor of FDI flows. While there may not be hard and fast evidence on the role corruption plays in deterring FDI, anecdotal evidence suggests that it is an important factor. Companies are often concerned not only about the initial payments to be made to make a deal but also about their inability to predict the scope and extent of future possible payments. Moreover, as noted elsewhere in the report, companies from some countries, such as the United States are prohibited from paying bribes or offering other extraordinary incentives in order to make a deal. Thus they are at a disadvantage in doing business in countries in which corruption is endemic.
MIGA's focus on corruption comes through both its guarantees activity and its technical assistance programs. In terms of guarantees, MIGA can cancel a contract with an investor if it learns that the investor is not complying with the legislation of the host country. Moreover, MIGA is not legally obliged to pay compensation on a claim against its insurance if it can prove that the investor did not comply with the laws of the country receiving the FDI.
As part of its technical assistance to member countries on attracting FDI, MIGA's technical assistance arm, Investment Marketing Services, includes corruption in its training sessions on attracting and retaining foreign investment. The topic is treated under the heading of investor decisionmaking, stressing the need for transparency and clearly identifying the payment of bribes as an important issue that needs to be addressed.