The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

With good governance a top priority for investors, donors, and regulators, it’s time to ask exactly what good governance looks like. A recent debate about the Anglo-American (shareholder) versus the European (stakeholder) models of governance set out to answer that question. The Governance Working Group (GWG), a 25-member group of microfinance professionals focused on governance, hosted by CFI, sponsored a webinar to discuss the characteristics of the two models and their implications for microfinance institutions, equity funds, and clients.

Lauren Burnhill of One Planet Ventures started off the debate by describing the model of single tier governance commonly used in the U.K. and U.S. In this model, each company has a single board that includes both executive directors, who are employed by the company or have significant ties to its corporate management, and non-executive directors who have no direct relationship with the company or its management. The company CEO may serve as chair of the corporate board, in which case a great deal of power is invested in that board position. The overarching duty of the board is to protect the interests of shareholders. In this model, particular importance is given to the protection of minority shareholder rights.

Judith Mayer of the Technische Universität München described the European (stakeholder) model. It is a two-tier model, with both a management board and a supervisory board, and it focuses not only on the interests of shareholders, but also of employees and clients. The management board is comprised of the executive committee of an organization that manages the day-to-day affairs and represents the organization. The supervisory board is not involved in day-to-day management, but instead shapes strategy, oversees the management team, and safeguards the institution overall. Underpinning the European model is the view that management should make decisions for the benefit of all stakeholders.

Both models have their advantages. A single tier board is more cost-effective, and its significant disclosure requirements provide transparency. In the European model, diverse groups have a stake in the functioning of the firm, and employees often participate on supervisory boards. During the debate it was evident that the members of the Governance Working Group generally preferred the European stakeholder model due to its inclusive nature. The Anglo-American model, with its singular focus on shareholders, places a large emphasis on profit with little attention to the role of the corporation in modern society. As a result, there is less emphasis on the social or environmental impact of corporate decisions.

The GWG members strongly agreed that a profit-maximizing lens should not be the only view represented within the boardroom and considered how best to ensure that governance practices reflect the values and principles inherent in their mission statements, including the voice of the client. To date, few MFI boards count clients as board members. Fonkoze in Haiti and CARD in the Philippines are noteworthy exceptions. Bringing the client voice to the boardroom remains an important challenge for both models.

One possible approach is a hybrid governance structure for microfinance. Lauren Burnhill challenged the GWG to follow global corporate governance trends and engage in the broader dialogue about “good practices.” For instance, Norges Bank Investment Management (NBIM), the arm of the Norwegian central bank that runs the Government Pension Fund, has put forward an “applied ownership” model as the next phase of corporate governance. This approach moves away from a rigid and detailed rules-based approach to governance and stresses a relationship of trust and accountability between shareholders and company boards, featuring high-level principles.

Is it possible to integrate shareholder and stakeholder-focused governance models or is there a need for a broader multiple bottom-line framework of some kind?

Image credit: University of Maine

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If social change is hard to achieve, raising funds for innovative programs that target social change is twice as difficult, but things are looking up! Recently, the White House Office of Social Innovation announced a proposed change in the rules governing program related investments (PRIs) made by foundations.

Every microfinance, social impact or environmental group that has tried to mobilize foundation resources for innovative concepts, pilots or ventures knows how difficult it is to access PRI funding. For fear of endangering their tax status, most foundations have exclusively focused on making grants to non-profit organizations.

In other words, under existing regulations, foundations believe themselves limited to making grants or supporting studies and research related to social enterprise and the impact investment industry. Yet when we look at obstacles to catalyzing private investment, there is a strong need to find actors that can change the risk profile associated with funding these activities, in order to facilitate the entry of new private investors. Foundations seem like a logical candidate to play this role, but until now, they have not felt empowered to do so.

What’s exciting about the new PRI rule change? It would allow PRIs to support a much wider array of instruments. Hybrid structures (B-Corps and L3Cs) and for-profit ventures (social enterprises, and impact investment vehicles) would be able to obtain loans, guarantees or equity from philanthropic sources to help leverage private capital. This has been almost impossible under the old rule. The amended regulations explicitly allow these sponsor and instrument options to be supported through PRIs, which should be a game-changer for all of us.

The proposed amendment to PRI regulations will empower foundations in two ways. First, the rule change offers an expanded list of permissible and “exempt” activities, together with a clarification of the principles that govern these exemptions.  Additional clarity paves the way for foundations to fund a wider range of interventions without fear of excise taxes, lost exemptions or forced dissolution. Equally important, these changes should alleviate board and donor concerns with respect to their exercise of standards of care and prudence on behalf of a foundation.

Key things you need to know:

• PRIs can now be structured as debt, equity or guarantees, including to for-profit companies;
• Treasury has stated that taxpayers may rely on these new examples even before the ruling is finalized;
• Current legislation will remain in force and essentially unchanged, except for the addition of the new examples;

From now until July 18^th, you are invited to make comments or suggestions on the proposed rule change here: Federal Register: PRI Examples and I urge you to do so! The amended regulations are intended to be inclusive, but they may or may not cover the innovative work your organization is engaged in. If you think something is missing, now is the time to comment.  I’ve written in to suggest a specific example that permits PRIs for structured impact investment funds. I also suggested that the text make explicit reference to hybrid structures rather than just non-profits and for-profits.  If we don’t make our voices heard now, we won’t have anyone to blame but ourselves for regulatory constraints on venture philanthropy.

Image Credit: harmonywishes.com

Lauren Burnhill writes regularly on impact investment. Her detailed comments for the Federal Register can be found on her blog: The Money in the Middle. Lauren Burnhill is the former Chief Investment Officer of Accion, and is currently Managing Director of One Planet Ventures (OPV), a consultancy that brings creative, pragmatic thinking to triple-bottom line strategies and financial product innovation, particularly those that can improve quality of life for the working poor. Lauren has structured and managed innovative funds and ventures for decades and is known for her commitment to good governance and responsible investment. 

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