Tuesday, February 22, 2011

Industry-wide efforts work to protect investors and microentrepreneurs

Eliza Erikson is the Chief Lending Officer at Calvert Foundation.

Eliza Erikson
I have spent almost 15 years working in emerging markets and inclusive finance, starting right after college when I worked with two microfinance institutions in Guatemala. How the industry has changed from those days when sustainability, much less profitability, was just a glimmer in our eyes! Funding for microfinance increased exponentially after the United Nations deemed 2005 the International Year of Microcredit and Dr. Muhammad Yunus and his Grameen Bank won the Nobel Peace Prize in 2006. With additional funding came exponential growth – and additional challenges.

Industry Leadership in Driving Ethical Microfinance Practices

Impact investors like Calvert Foundation face specific challenges when deciding which microfinance institutions meet our social criteria for investment. With an emphasis on ensuring that borrowers in our portfolio are practicing responsible microfinance, we must rely on various sources of information including our own data collection. In recent years funders and borrowers alike have joined to set out common principles for what constitutes ethical and responsible operations in the microfinance sector. The United Nations Principles for Responsible Investment (UNPRI) initiative has more directly targeted the microfinance sector with its recent unveiling of the Principles for Investors in Inclusive Finance (PIIF) initiative. Calvert Foundation is thrilled to announce that we are one of the 40 initial signatories to the PIIF initiative. We encourage you to review the principles more closely, which can be found here.

In addition, Calvert Foundation had an early role in supporting the principles behind the SMART Campaign, another funder coalition which aims to keep clients first in microfinance. By focusing on key issues like overindebtedness of clients, transparency in pricing, and appropriate collection practices, the SMART Campaign has laid the foundation for defining ethical business practices among microfinance institutions. We are honored to have had the opportunity to work alongside our partners on these various initiatives in responsible investment.

Going the Extra Mile – Local Currency Lending

We are also working hard to protect micro-entrepreneurs against currency risk. Until fairly recently, investors were only providing hard currency, in the form of dollars or Euros, to microfinance institutions. The majority of MFIs were turning around and lending that capital either in U.S. dollars or local currency, and absorbing the devaluation risk themselves or pushing it down to the weakest link in the chain, to the microentrepreneurs who were responsible for paying much more in local currency terms when the currency devalued. Not only was this a serious credit risk for investors, but also seemed to me a moral dilemma that social investors should help resolve. Indeed, some of us deemed it microfinance's “original sin.”

Last November, Calvert Foundation closed its first deal with Microfinance FX Solutions, or MFX Solutions, to provide a loan in Kenyan shillings to Kenyan Women’s Finance Trust (KWFT). The loan was fully hedged to the U.S. Dollar, protecting Calvert Foundation and its more than 7,500 investors from the risk that the Kenyan shilling would devalue against the dollar and KWFT would be unable to repay the loan. The loan was denominated in local currency, so that neither KWFT nor its clients would assume that same devaluation risk. It was the quintessential win-win.

In the more developed currency markets of the U.S. and Western Europe, hedging foreign exchange risk is common, widely available, and relatively cheap. Many banks are in the business. The same is not true of less liquid, developing country markets where hedging is prohibitively expensive or just plain unavailable. A group of us came together to try and help address the problem – Calvert Foundation, Calmeadow, ACCION International, Microrate, and Global Partnerships. It didn't stop us that we had little background in traditional foreign exchange derivatives. We did some research, consulted with experts, and wrote a business plan for MFX Solutions, a new social enterprise that would offer modern currency risk management to the microfinance industry. We knocked on a lot of investor doors, most of whom were challenged by the novelty of our model. Omidyar Network was brave enough to step up as a generous anchor investor, along with Triodos Bank and Incofin, two leading impact investors that were interested in using MFX's services for to hedge their own investments. I am thrilled that MFX Solutions is now a reality and has closed more than $50 million in business, helping to fund more entrepreneurs more safely in developing countries around the world.

Looking Ahead to Finance Future Innovation

As an investor, there is often a tension in wanting to support an organization that has an executing business model and is making an important impact, but that has not yet reached a sustainable financial stage; often, in support of those emerging innovators, we will invest a small amount at an earlier stage to catalyze growth and encourage additional investment. Through our Mission Plus portfolio we ensure that up to 3 percent goes to organizations like this. We think it’s our responsibility to finance not just the organizations that are the current leaders of the inclusive finance movement but the future sources of innovation that will push the industry to greater heights.