Creating blended finance architecture for catalysing impact investment in Bangladesh

Feisal Hussain, Team Leader, BFP-B

Over the last four years, BFP-B has made three investments in Alternative Investment Vehicles (AIV). We did this to find an alternative instrument, particularly in terms of equity for small businesses. There has been a lot of discussion around this issue including commitment from the government. 

Around 17 fund manager licenses have been issued, out of which only two actually applied for a license. The government is providing licenses to fund managers but the registration has not happened because the fund has not been organised yet. It is a challenging situation. So, we will try to figure out what the major paying points are in terms of regulation, investment, pipeline and deal flow and so on. Hopefully, we will be able to generate some effective recommendations for both the government and investors from today’s discussion.

First, a big structure and cost are required for discovery and origination.

Second, there is not sufficient investment in capital, which can then be re-invested.

Third, costs of regulations. If small companies have to go through the same processes as others, their costs would get pushed upwards.

Fourth, general regulations. Although the regulation environment was there for licenses to come along, issues about repatriation, taxation and dividends still remain.

Fifth, there aren’t enough players in the market. People are not aware of these sorts of investments.

Hasan Imam, Chairman, Bangladesh SME Corporation Ltd.

SMEs are large in number. Most of them are financially disorganised with no income statements, balance sheets or cash flows that banks need in order to check their creditworthiness. It discourages banks from targeting the SME segment. 

However, in terms of creditworthiness, SMEs are not lagging far too behind compared to corporates. In fact, micro-finance organisations in Bangladesh have far less non-performing loans (NPLs) than banks. Yet, SMEs still face many challenges in getting financing.

Usually, angel investors provide few lakhs to help start a business. But during the scale-up period, micro-entrepreneurs do not get the required funds. The effective interest rates of Microfinance Institutions (MFIs) are very high, around 25-29 percent. Beyond MFIs, funds should come from formal institutions such as banks and impact funds to decrease the cost of funding.

The entire non-urban market is absent from the capital market because there is no institutional presence there. A big ecosystem needs to be developed to create access for the institutional investors to reach these untapped areas.

Azad Chowdhury, Secretary General & President, Impact Initiatives, the STEPs

The problems faced by non-urban MSMEs are complex, and skillsets required to derive solutions do not reside within a single entity or type of organisation. We need a multitude of skillsets to come together for a successful intervention. At STEPs, we have built a unique platform that brings together the collective strengths and insights - to apply technology as an enabler; to democratise financial products that are fit-for-purpose; and to provide the monitoring capabilities for the last mile. The impact arena is new to Bangladeshi investors, particularly for banks. The overall global impact investment capital is an area where Bangladesh has not tapped into efficiently. At STEPs, we have established the entire infrastructure necessary to do such an intervention, which will enable local and international investors to access a variety of creditworthy MSME investees. 

Present regulations do not allow the open-ended fund structure that international investors need for impact funding. The limited three-year capital raising period for alternative investment funds (AIFs) works against our agenda – having an open-ended structure creates a continuous process of liquidity injection and repatriation of dividends which is required for a sustainable investment lifecycle mandated by all institutional investors. Moreover, AIFs are allowed to invest via equity only, no debt - which is not in line with the real needs of the market and not in line with global impact investors. 

It has been reported that Bangladesh is behind by USD 1 trillion in reaching SDGs. A lot of international investors are SDG-focused impact investors. So, we have developed a way to track investments in a way that measures specific contribution to the SDGs (at both a singular and portfolio level).

Almost all international investors want to see active Bangladeshi investors in a fund before they make an investment. Lots of banks exist in Bangladesh, but not a single one backs an impact investment fund - we need to give incentives to these actors to join our efforts.

There are challenges in bringing money into Bangladesh, as international investors continually question the repatriation process. The track record of our country in this regard has not been encouraging.

The size of investment we need for our first fund is around USD 50 million. To be able to deploy USD 50 million, we have already a footprint that can deploy, monitor and recover investment returns. The brick-and-mortar infrastructures that BSCL has built can cater to this for now, but to do it at a national scale (i.e. USD 1+ billion), we need to be able to reach millions of people with SME ideas.

Arunangshu Dutta, CEO , Acacia SRIM Ltd

We have to find ways of disintermediation for SMEs and MSMEs. Matters like RJSC registration are heavy on regulatory compliance issues. If we can find alternatives to these methods, we would be able to attract foreign investors.  Also, the convertibility issue of our capital hinders investors. The central bank has two ways of repatriation. If it is listed, one is free to repatriate. Unlisted companies have to go to the central bank and it is not an easy process. 

Bijon Islam, Co-founder and CEO, LightCastle Partners

Financing partially solves MSEs growth problem. That is why we developed SmartCap where we combine growth-oriented financing, capacity building, latest Ag-tech and forward-market linkage via a three-step accelerator programme. We have partnered with Syngenta Foundation, who has a programme called Farmers’ Hub to scale Ag Entrepreneurship. Venture Investment Partners Bangladesh is supporting by providing working and growth capital linkages and investments.

Till date we have mobilised around GBP 110,000 in seed investments. The  instruments are designed as self-liquidating assets like revenue/profit sharing or convertibles tied to milestones. In the future we want to keep on mobilising institutional capital as impact investments/sustainable finance in the sector.

Zia Ahmed, Chairman, Venture Investment Partners Bangladesh Ltd (VIPB)

Our model is based on risk-sharing. If customers end up losing their own money, we lose our investment. Banks do not do that. We can upgrade our ecosystem and overcome the prevailing mindset.

Bangladesh Bank has made progress in the overall institutional structure. But commercial banks are yet to get active in alternative investments. We, as facilitators, try to reduce banks’ risks and provide better returns. Commercial banks usually are charged a tax rate of 42 percent on their income. It is estimated that 90 percent of their income is interest income. With dividend income charged at only 20 percent, which is less than 50 percent of what they are paying now as taxes on normal income. They should continue their main focus on commercial banking while working with other Alt Fund Managers for impact investment. This would be a win-win collaboration between banks and Alt investors.

We are approaching commercial funds because of the absence of specialised financial institutions. Once we have the other financial institutions such as pension funds, we can get better response from the investors. The potential return after tax from commercial banks is likely to be high.

Sharawwat Islam, Managing Director, Truvalu

We have seen that there is ample demand for alternative financing of SMEs. Sometimes, SMEs know that they need funds but they do not have knowledge about the different financing options. They approach the banks for loans, without actually having a solid plan. In the agricultural sector, there is high demand for value chain development. We have also discovered that value added services are just as important as investments.

Our experience with equity financing has shown us that working capital is an integral part of any investment and should be provided alongside growth capital. Any impact investor should consider it as at least a small percentage of their investments.

We would like to work with banks for SME development where banks can provide the working capital and we can help with growth capital. Together we can monitor them and help them grow. Market linkage is a big problem for any SME, particularly in the agri-value chain sector. We are working to link SMEs to the local and European market.

The repatriation process is another concern for foreign investors. We are thankful to Bangladesh Bank that three valuation methods presently exist. However, investors are concerned about exit value of the investments and would like to know which method is preferred by Bangladesh Bank i.e the exact weights that will be used for each method. We also want to know whether call and put options would be permitted by the regulators. Clarities in regulation and an easy repatriation process would help bringing in more FDI.

Also, there are a limited number of financial instruments for foreign investors. We usually invest as redeemable convertible preference shares. It would have been better if structured financing options such as Revenue Sharing Agreement for foreign investors were permitted.

Shamira Mostafa, Challenge Fund Co-ordinator, BFP-B

Our experience with equity investment projects have shown that there is a significant gap in the MSEs being investment ready. All the projects had to prepare the MSEs first before going through with the investments. Some of the significant business development services that are required: financial statements, transaction visibility, identifying financing requirements of potential investees are some of the significant business development services that were required. Even though these services are costly, these are essential. At this point, it is not commercially viable for the investors or investees to bear the cost fully by themselves.

For an ecosystem to work properly, different actors of a market system need to play significant and specific roles. We propose a supported ecosystem, where donors and development finance institutions (DFIs) can assist business development service providers, who can in turn provide deal pipelines to investors.

Syed Javed Noor, General Manager, IDLC Finance Limited

The focus of current funds of IDLC is to interact with digitally enabled businesses. IDLC was set up back in 1985, when there was a dearth of long-term investment or financial instruments. IDLC added value in this situation by supporting the balancing machinery and having quick response.

Thus, we were looking for the next big things that is going to gain the most - the asset management business and alternative investment (especially venture capital) are two of them. Now the lease business makes up 0.1 percent of our portfolio.

Mostofa Meer Khaled Omar, Senior Vice President, Southeast Bank

As far as lending is concerned, our bank is doing pretty well as one third of our business is in SMEs. To invest in the venture capital market, we need a subsidiary organisation. We are closely working with VIPB. We are open to be a part of their development.

Mahmoodul Haque, Director, Bangladesh Security and Exchange Commission

There are two separate issues: one is related to fund managers and the other is registration of the funds. At present there are 17 fund managers and so far, we have only approved three sets of funds. Without the approval of the trustee, the permission for registration cannot be obtained. 

Another thing is that mutual fund has both open and close infrastructures. We need to figure out why all the high network clients are not coming forward to purchase units. I would like to urge our policymakers to look at the funds for both open-ended and close-ended structure.

Md. Shaheen Iqbal, Head of Treasury and Financial Institutions, Brac Bank

Bangladesh Bank has given scope of investing in alternative investment but yet there are certain limitations as well. Commercial banks can create separate subsidiaries from which it can run the alternative investment activities. But the difficulties in this are, inexperience of banks in the capital market and the difficulty in getting approval and registration process done.

Tina Jabeen, Investment Advisor, Start-up Bangladesh, ICT Ministry

One of the observations is that the ecosystem players are not actually knowledgeable enough for eco-related financing. The banks are not ready yet. We need to talk to the high-neck investors and focus on private equity investors. 

The other observation is that we are working in a silent environment. Making thousands and thousands of investments is not easy here. In Bangladesh, it is an immature industry; the goals cannot be achieved in five years’ time. The focus should not only be on the SMEs. The start-ups are doing good as well, we should focus on them. And encourage the network of angel investors to focus on the start-ups.

Nirjhor Rahman, CEO, Bangladesh Angels

Angel investment ties up with strategy and skills development. The sort of ecosystem landscape we are talking about, there should be room for quasi-investments for SMEs. We should try to create a syndicate of investors and split their investments for minimising risks. A package of expertise is required. 

The challenge with angel investors is that they are always curious about the exit option. Investors in general follow the hard mentality. Wherever there are good investors, other investors intend to follow them, and mainly in cases where government back-up is good. 

Benozeer Ahmed, CFO, Community Bank 

Whenever a funding issue arises, we think of banks. Banks have limitations. They cannot invest more than a certain percentage of their investments in equity. And for the venture capitalists, there is no exit strategy. The insurance funds have their limitations as well, since they have to face the trouble of approval regarding government security instruments. 

Md Amirul Islam, Joint Director, Foreign Exchange Investment Department, Bangladesh Bank

The current account of Bangladesh has been convertible since 1994. Therefore, we can conduct international trade and business through current account transactions. However, our capital account is yet to become convertible as there are some barriers. We have slightly opened up the capital account based on which external foreign direct investment (FDI) and foreign portfolio investment can be done.

Today, we are discussing private equity, alternative investment funds or impact investments that are based on alternative investment fund rules formulated by Bangladesh Security and Exchange Commission (BSEC) in 2015. Based on that Bangladesh Bank issued a circular where scheduled banks can make investments worth Tk 2 billion in such sorts of funds through a subsidiary company.

We have permitted the foreign investors to invest in alternative investments for all the funds that are listed with BSEC. They can remit their funds and put their funds in NITA (Non-Resident Investors Taka Account); they can purchase units of alternative investment funds and sell the shares and units. They can even remit the return in the form of dividends in NITA. They are also free to repatriate the sale proceeds, be it capital or any sort of return or even the liquidation of the company. Therefore, I do not think there is any barrier to take money back to their country, from investments that has been made in alternative investment funds or impact investment or private equity.

There are some questions such as, fair value of the share units, preferred methods of valuation by regulators. Regarding share value, there is no established market price for shares. There is no preference by regulators in terms of valuation method either. Share value and method will depend on the type of company we are dealing with. There is also a question on the amount of money that can be repatriated in favour of non-residents when the holding of the non-residents is transferred to residents. We have formulated a circular regarding this which is simple, easy and globally acceptable.

An agreement or MoU on share sales/purchase where shares can be transferred from non-residents to residents and vice versa should be signed. They must consider the fair value before transferring the shares.

Afsana Islam, Private Sector Development Adviser, DFID

There is a need for a platform for companies to come together in one place, share their knowledge and experience, collectively demand the clarifications needed from the regulators in terms of policies and facilitate the growth of impact investment. The infrastructure that we are talking about involves heavy investments. Can we come up with a solution where we can raise our voice and share our own investments?

We can take examples from countries like India, China, and Japan in terms of the contribution of SMEs to their GDP. We should try to implement that standard in our country.