Managing sanctions exposure from Multilateral Development Banks: the growing risks for private equity sponsors and asset managers

In response to COVID-19, Multilateral Development Banks (“MDBs”)¹  have pledged US$213.5 billion of financing for projects, in addition to the US$95 billion in new financing commitments pledged during 2019.² As MDBs look to fast track the allocation of this funding into local markets, what were already difficult operating conditions are now compounded by broken supply chains and disrupted operations, which when taken together increase the risks of procurement and supply chain fraud and corruption. In response, MDB integrity and investigation units (“MDB Integrity Units”) have announced they are prioritizing the prevention of fraud and corruption arising from COVID-19 funding which will include an uptick in investigations. 

As private equity sponsors and asset managers (“sponsors”) respond to the growing demand for sustainable investments and with MDBs keen to promote sustainability in emerging markets; sponsors, whose portfolio companies have involvement in MDB projects, face increased risks of MDB investigation exposure and associated fiscal and reputational damage.

Key takeaways 

1. MDB enforcement risks are significant and rising. The impact of cross-debarment by MDBs and the reporting of conduct and findings to national regulators and prosecutors exposes companies, controlling entities and sponsors to different levels of onerous and rigorous investigation risk.
2. The impact of an MDB investigation for an asset manager or sponsor who has control or directorship of an MDB target company may expose the asset manager or sponsor to domestic regulatory attention or prosecution.
3. Investments in MDB backed procurement projects risk loss of revenue streams, damaged reputations, investor withdrawals, funding of compliance programme overhauls and sanctions. 
4. To mitigate exposure to MDB sanctions risk, sponsors and asset managers need to scrutinise and test their own compliance and contractual controls for all their investments.

Sanctionable practices

In FY2019 the World Bank’s sanctions activity, not including sanctions from other MDBs, was matched only by the US Department of Justice. It is now routine for MDB Integrity Units to investigate and enforce against corruption, fraud or other misconduct either in conjunction or independently of national enforcement authorities such as the U.S. Securities and Exchange Commission (“SEC”), U.S Department of Justice (“DOJ”), Serious Fraud Office (“SFO”) or Financial Conduct Authority (“FCA”). 

Whilst there is extensive collaboration and information sharing between MDBs and national enforcement authorities, MDB powers are frequently wider than equivalent local laws. For example, fraud can be committed “recklessly” as well as “intentionally”.³ 

The main MDB sanctions for entities and individuals are: Corruption, Fraud, Coercion Collusion, and Obstruction each of which carries a variety of sanctions but the default sanction mandates a minimum period of debarment (typically three years in the case of the World Bank Group, but in serious cases can be upwards of ten years) and frequently result in cross-debarment from other MDBs.

Risks for Asset Managers and Sponsors

The jurisdiction of MDB Integrity Units captures individuals and firms who are “related” or “affiliates” of entities under investigation. Whether an entity is in scope depends upon the degree of “control” they exercise and the entities through which funds from MDB institutions flow. Possessing the same or similar management, ownership, or principal employees as the entity or person under investigation are typically viewed as indicators of control by the World Bank and would therefore warrant further MDB scrutiny.⁴ Ultimate beneficial holders and majority shareholders may also be caught up in an investigation if an MDB can demonstrate they have “control” over the subject of their investigation.   

The risks of an MDB investigation are not isolated to single entities; MDB investigators can trace funds and extend their remit under the broad powers granted by MDB contracts. This can mean parent companies may fall into the scope of an MDB investigation even if the investigation is limited to a subsidiary and may also impose proceeds of crime notifications. It can also mean that directors of sponsors who hold multiple directorships and who come under investigation could expose other entities in the Sponsors portfolio to MDB scrutiny.

IFC borrowers; companies or investment funds in which IFC makes an investment (both direct and indirect); companies who borrow or issue debt securities with the support of IFC guarantees; sponsors; Advisory Services recipients; and Advisory Services' consultants and service providers also fall within the purview of MDB sanctions regime.  For example, infrastructure funds with a focus on developing or emerging markets in particular, are exposed to project development companies through joint ventures or portfolio companies, which receive MDB funding or guarantees for the development of infrastructure projects in roads, ports, telecoms and power. 

Regulatory Risks

An investigation by an MDB Integrity Unit into suspicions of fraud or bribery in relation to a project development company, may result in interviews with the fund and its manager and an investigation being initiated if the unit suspects the fund or the manager has engaged in one or more of the sanctionable practices. This will also lead to result in the MDB making a separate referral of their findings to either the SFO or DOJ.

In addition to the risks posed by the MDB investigation, the extensive collaboration between MDBs and other enforcement agencies carries further and more significant risks. For example, an infrastructure fund manager may find itself in the cross-hairs of both an MDB Integrity Unit and DOJ or SEC by:

• improper screening of a project development joint venture company’s shareholders, counterparties, suppliers and vendors who may be OFAC-sanctioned persons; and/or
   
• forming a project development joint venture company and opening a bank account with a US bank and thereby facilitating the use of the US financial system for transactions involving OFAC-sanctioned persons who maybe shareholders in that company or suppliers or vendors.

The involvement of national enforcement authorities also carries the significant risk of both criminal and civil sanctions being imposed against individuals and entities. Once engaged, national enforcement authorities possess far greater powers of investigation and compliance than MDB Integrity Units.  As such, sponsors and asset managers should ensure that processes and procedures are in place to ensure that any MDB investigation is addressed swiftly and effectively in an effort to avoid greater national and domestic scrutiny or sanction. 

Commercial Risks

Reputational damage remains a significant consequence of any MDB investigation for a sponsor or asset managers. Should an MDB investigation conclude wrongdoing, this may impact revenue streams (in the form of debarment from MDB-linked contracts), trigger investor withdrawals, and result in additional costs from the enhancement of compliance controls and the payment of sanctions. 

Footnotes

1) The World Bank, the African Development Bank, the Inter-American Development Bank and the Asian Development Bank. 

2) Congressional Research Service, Multilateral Development Banks: Overview and Issues for Congress, 11 February 2020, at page 4.

3) 2011 World Bank Group Procurement Guidelines notes

4) The World Bank Group’s Sanctions Regime: Information Note, page 22.