About a quarter of Finnfund’s investments in developing countries have been channelled via private equity funds. Fund investments are targeted mainly at low-income countries and especially Africa. At the end of 2014 Finnfund was a participant in 40 private equity funds to the total of about EUR 80 million, an average of some EUR 2 million per fund.
Finnfund uses private equity funds to reach small and medium-sized local enterprises that would be hard or impossible to finance directly in a cost-effective way. It concentrates on funds that provide capital for business expansion where the investment would not be possible without the equity-rated financing that the fund offers.
Fund management companies usually have a local presence in the target area. Because risk finance for SMEs is a fairly new thing in low-income countries, the investments are generally made and managed by teams that combine skills in equity investment, obtained in developed markets, with in-depth knowledge of the local market. By using private equity funds, Finnfund reduces the risk of operating in low-income countries.
It has also invested in a few sectoral funds that concentrate on matters like renewable energy, sustainable forestry or micro-financing. These funds typically operate in many countries, transferring skills across borders.
Most fund co-investors are other development finance institutions but there are also insurance companies and pension funds from the investee countries. Foreign institutional investors, on the other hand, usually postpone their involvement until there is a track record of success. As and when a country or sector previously regarded as challenging begins to develop and private equity operations become established, institutional investors start showing an interest in the fund. Then, development finance institutions like Finnfund can move on to new projects where commercial financing is not yet adequately available.
Funds are typically established for a fixed duration of about 10 years. A fund generally invests the subscriptions it receives in its first few years; then its focus shifts to developing its investments and finally to exiting them. Finnfund’s private equity fund commitments generally range from five to ten million euros.
Most of the private equity funds that invest in developing countries are registered in international financial centres. Africa-based funds are generally registered in Mauritius. Another common domicile is Luxembourg (Finnfund not allowed to make new investments in funds registered in the country). The countries of registration are conduits, channelling investments from many different places to investee countries. Funds do not pay taxes in their country of registration but investors and investees pay taxes in their home countries. In 2013 companies financed by Finnfund’s private equity funds paid a total of about EUR 300 million euros in taxes and similar charges in investee countries. This is more than paid by companies financed via other instruments (EUR 133 million).
Finnfund is opposed to tax evasion, corruption and money-laundering in investee countries and domiciles. We conduct background checks on co-investors and management companies, and require diligent reports from funds on their investee companies, taxes paid, and so on. Alongside many other development finance institutions, we urge countries of registration to create transparent regimes by investing only in the funds that are registered in countries observing the progressively stricter demands agreed in the OECD Global Forum. In 2014 there were 24 countries on the updated list of domiciles of funds that Finnfund does not invest in (Brunei, Dominican Republic, Micronesia, Guatemala, Lebanon, Liberia, the Marshall Islands, Nauru, Panama, Switzerland, Trinidad and Tobago, Vanuatu, Andorra, Anguilla, Antigua and Barbuda, Austria, Barbados, Cyprus, Israel, Luxembourg, St Lucia, the Seychelles, Turkey, the British Virgin Islands).
Photo: Kilombero Valley Teak Company, Tanzania