Localisation requirements in emerging-markets projects are meant to be a way of giving back; an attempt at ensuring a lasting beneficial legacy for the local population of the respective country. But is this ostensibly benign endeavour offering a perfect guise for corruption and bribery? Ollie Gordon reports.
Local Content Requirements (LCRs). Anyone involved in, or in any way familiar with, the development of large capex projects in emerging markets, will no doubt have become increasingly accustomed with the term in recent years. Regulations specifying the proportion of the materials, services and labour of a project required to be delivered by its country of origin, localisation requirements were established to guard against the exploitation of emerging-markets development by richer nations.
A much-lauded example of a highly-localised emerging markets capex project was witnessed in March 2014, when South Africa’s state-owned transport company, Transnet, awarded a R50 billion ($4.16 billion) contract to four global equipment manufacturers for the construction of 1,064 diesel and electric locomotives. Part of the largest rail recapitalisation programme in the country’s history, the order and its subsequent financing were hailed internationally as representing a pivotal moment for African development. The project’s LCRs were predicted to create and sustain 30,000 local jobs, and augment the South African economy by R90 billion rand ($7.5 billion).
An African project for the sole benefit Africans, largely funded by African financial institutions and constructed by African labour: how it should work, right? A wholly benevolent endeavour that should set the standard for emerging-markets projects going forward. Well yes, but that’s certainly easier said than done.
As the old maxim goes: all that glitters is not gold. And in the case of the localisation, this seemingly magnanimous concept is in fact being increasingly bastardised by the few to form the perfect veil for a very specific form of corruption.
The brown envelope: an expiring notion
Over the past decade, national governments and supranational organisations have steadily ramped up anti-corruption regulation. Legislation such as the US’ Foreign Corrupt Practices Act (FCPA) and The UK Bribery Act have made it increasingly difficult for bribery to take place. Companies traditionally most exposed to demands for bribes are now much less likely to fold to those demands out of fear of their own domestic regulatory authorities.
Dr Robert Besseling, executive director of business risk intelligence firm Exx Africa, tells TXF: “Most companies fall under the FCPA as most bribes are paid in US dollars and therefore fall within its remit. Moreover, many companies have some form of business dealings in the US. There are also strong bribery acts in place in the UK, Singapore, Australia, Canada and other developed nations, as well some applicable OECD and UN legislation. So the brown-envelope idea is just not easily done anymore.”
So for bribery to take place these days it needs a more nuanced and indirect delivery system than simple cash-in-hand. Enter localisation. “In the development of projects in capital intensive sectors – such as commodities extraction, construction, heavy manufacturing etc – emerging market governments are coming under pressure from their local electorates to beneficiate more locally,” says Besseling. “The resultant LCRs put on projects local ownership, procurement and employment requirements that are not always easily met. And that’s created an opportunity for emerging markets governments to demand some sort of kickback but not directly in a monetary form.”
In many Africa countries at present those LCRs are manifesting in the form of project-related contracts being awarded to local service providers who are either politically affiliated or owned directly by the local political elite. Those companies then outsource the delivery of the goods or services to a foreign company for an inflated fee. “It essentially allows the local political and business elite to perpetuate the system of corruption without violating any corruption acts in foreign investors’ regulatory jurisdictions,” says Besseling.
A Mozambican example
Mozambique stands as a case in point. The country has vast natural gas reserves, which the current government wants to exploit to establish Mozambique as one the world’s largest LNG exporters. That development relies substantially on local service providers, as Mozambican legislation encourages all logistical services for oil and gas projects to be locally owned. So for a foreign company to provide services to a Mozambican gas project, they have to go through a local firm. “In northern Mozambique, companies such as ENI and Anadarko are having to contract with local – mostly politically-affiliated – holding companies that will outsource the oil and gas services to them whilst effectively still holding a monopoly on those services,” says Besseling. “Many of those holding companies are owned by former generals. Mozambique has copied the system that exists in Angola, except in Angola it’s 100% mandatory for the logistics companies to be locally owned.”
To add insult to injury, adds Besseling, the Mozambican government is attempting to sell this ‘cooperative’ model as adding value to the northern Mozambican economy. In turn, foreign companies can piggyback on the back of that spin for their own PR. And, all the while, the political elite fill their pockets and the endemic system of patronage crucial to keeping them in power is perpetuated.
“The system isn’t new, but it is replacing the simple handing over of the brown envelope,” says Besseling. “It allows the local government and the foreign investor to claim that they are adding value to the local economy in a country that desperately needs it. But at the same time, much of the money is still escaping the local economy and funds goes into the usual back channels.”
Angola, Equatorial Guinea and Mozambique are the worst offenders of this form of corruption; countries most prone to it, according to Besseling, are those in which “political stability is most dependent on political patronage”. South Africa is the exception to the rule: although one of the more developed sub-Saharan African countries, the country has seen government corruption and private sector crime become increasingly entrenched in recent years.
Part of the problem for Besseling is that the localisation requirements for African projects are unrealistic for the scenarios in many of the countries. For example, quotas to hire skilled local workers do not always match the standards existing on the ground, where there very often isn’t enough trained local personnel. That makes it easier for those politically-affiliated companies to justify outsourcing the work to foreign companies, and fill their pockets in the process. “So you’re going to damage your ideas for local economic development by putting unrealistic quotas in place,” says Besseling.
Rationalising LCRs to be more country-specific would make it harder to justify outsourcing to foreign firms and would undermine the political patronage inherent in this form of corruption.
However, it would do nothing to address the original problem of local populations receiving little long-term benefit to the development of projects on their doorsteps. And coming up with a solution for that appears to be trickier.
Setting the standard in the financing
One possible solution might come through the financing of those projects. Most large emerging markets capex projects require international financing. Many, in turn, will require the presence of export credit agencies (ECAs) or development finance institutions (DFIs) to take on market risk. The OECD Consensus, which governs the operations of most of the world’s major ECAs, already has strong regulations in place dictating how much local content ECAs can cover in a deal. Similarly, DFIs have their own set local development requirements that projects need fulfil to access funding. And one export finance banker with considerable experience in financing African projects believes the extension of both sets of guidelines could play a significant role in mitigating LCR-related corruption.
“From a financing perspective, the question is what controls and/or processes could be put in place by the agencies [DFIs], the ECAs and the OECD to encourage more localisation and, at the same time, ensure the best local counterparties are engaged to perform those local works?
“It’s conceivable that by engaging in the process the agencies could play an important role here. For instance, they could make their support of local works subject to the same competitive tender requirements that are applied to their support of the offshore contracts. Local ECAs located in those buyer markets could also play a valuable role in that process and, in addition, could also play a role in financing local content (with foreign agency support or otherwise) and thus focussing on the import (not just export) part of their mandate.”
What seems clear is that despite the limitations of the current OECD rules, Transnet managed to make its localisation requirements work and, as a result, created innumerable sustainable jobs and transferred considerable technology.
The project shows that localisation can work, but this is in large part due to the sophistication of South Africa’s Competitive Supplier Development Programme (CSDP) as well as Transnet’s treasury operation, which is relatively unique. But if emerging market development is going to be done in a sustainable manner, Transnet needs to be the standard, not the exception.
As the NGO world has learnt over the past few decades, it’s no use chucking feel-good money at a country and hoping for the best. And, in this case, there’s similarly no use in setting feel-good local development goals if they’re not going to be administered properly. Those involved in emerging markets project finance are on the frontline here, and there is real opportunity for them to make a lasting difference if they act accordingly.