The World Bank defines foreign direct investment (FDI) as a “category of cross-border investment associated with a resident in one economy having control or a significant degree of influence on the management of an enterprise that is resident in another economy”.
As such, the key criteria for an investment to qualify as FDI is that the investor has enough control of the underlying asset to directly benefit the local economy in a number of tangible ways including creating jobs, attracting new business and potentially paving the way for more investment.
Like all definitions, however, it has nuances and is subject to interpretation and implementation.
According to the World Bank’s glossary, for instance, the phrase “control or a significant degree of influence on the management” underscores the investor’s lasting interest in the enterprise and it is assumed to be achieved “when a direct investor owns equity that entitles it to 10% or more of the voting power in the direct investment enterprise”.
However, the bank also points out that in practice many countries set a higher threshold.
Stefan Kratzsch, industrial development officer in the investment promotion division at the UN Industrial Development Organisation, wrote his PhD thesis on this topic and refers to the Brouthers and Hennart table to set the terms straight.
In that, FDI is split into greenfield and acquisition, each divided into two sub-categories according to the type of ownership, with joint venture versus whole ownership as the criterion.
“But really, these definitional issues become extremely blurry and that is why there is so much uncertainty about the real levels of FDI stocks and flows,” he adds.
FPI and the link to the real economy
In this fairly broad and interpretable landscape, foreign portfolio investment (FPI) has started to gain ground and its use is being discussed at different levels across the industry.
Strictly speaking, FPI takes place when an investor buys securities on a foreign financial market, mainly including stocks, bonds and funds. As securities can be sold off quickly and do not carry with them a significant share of the underlying assets, the industry’s consensus has traditionally been that FPI does not have a direct enough impact on the local economy to be counted as FDI.
On top of that, investment promotion agencies (IPAs) have their hands full as it is, Kratzsch argues.
“I am frankly not quite sure that IPAs should engage more on FPI in addition to their tasks and mandates to promote both greenfield and brownfield FDI,” he says. “In fact, the IPAs even fall short in properly promoting and facilitating FDI in its various facets, especially on the aftercare front with existing FDI subsidiaries.”
While it is beyond doubt that FPI is further removed than FDI from the real economy, an OECD report argues that both can promote sustainable growth in both developing and developed countries.
“In light of the various capital crises in the past few years, there has been a tendency to denigrate portfolio investment, while singing the praises of direct investment,” the report says. “Yet, it is also recognised that efficient capital markets help to mobilise financing for growth and development.”
According to the report, FPI beneficial effects include increased liquidity, more discipline and know-how, and better functioning equity markets in domestic capital markets.
“FPI increases the liquidity of domestic capital markets and can help develop market efficiency as well,” the report says. “As markets become more liquid, as they become deeper and broader, a wider range of investments can be financed.
“New enterprises, for example, have a greater chance of receiving start-up financing. Savers have more opportunity to invest with the assurance that they will be able to manage their portfolio or sell their financial securities quickly if they need access to their savings. In this way, liquid markets can also make longer-term investment more attractive.”
The role of M&A as a form of FDI
Focusing on FPI as well as FDI to strengthen domestic capital markets is a strategy that makes sense for developing countries that often do not have a healthy market themselves, argues Achim Hartig, managing director at Germany Trade & Invest.
“FPI attraction is something that I have mostly come across in India,” he says. “FPI there makes sense to boost financial investment into the local market. It is less relevant in Germany and Europe where financial and capital markets are already robust and very active.”
While Hartig does not see FPI as creating a similar value for the local economy as greenfield investments, he says that there is discussion around focusing on mergers and acquisitions (M&A) as a new source of FDI for selective investment projects.
“In comparison to greenfield FDI, M&A investments could be mid-term to short-term and less sustainable though,” he adds. “This type of investment tends to be more a commitment to a product whereas FDI is a commitment to an ecosystem.”
Hartig’s preference, however, is not a total ban on the use of capital to boost FDI levels as he concedes that there is a need for it in certain sectors. “Financial FDI [which technically falls under the FPI remit] is needed in infrastructure development, for instance, where capital markets and financial investors can help speed up the process,” he explains.
Infrastructure is definitely an area where IPA ApexBrasil has been working as an intermediary with foreign financial and institutional investors to get them to invest in the country.
ApexBrasil’s chief investment officer Adalberto Netto says that in 2020 34% of global FPI came from private equity and venture capital.
In Brazil, out of the total FPI into the country, 227.5bn reais ($45.16bn) were in the form of private equity and venture capital and 162bn reais was from foreign capital invested by foreign institutional investors, endowments, sovereign wealth funds, pension funds, family offices and corporate investors.
Over the past five years, ApexBrasil has attracted $20bn of capital from investment funds – mostly from North America and Europe – which went into 73 projects.
“The key message here is that there is a very large pool of capital looking for emerging markets opportunities and IPAs can add value to their role by appealing to limited partners around the world,” says Netto.
He is, however, careful to distinguish between this type of investment and the mere buying and selling of stocks on financial markets.
“Private equity and venture capital funds have a very important role when it comes to infrastructure investment and privatisation,” says Netto. “There are specific financial instruments such as bonds, global depositary receipts, American depositary receipts and so on that have an important role to play. However, we do not serve speculative capital and we only see this type of investment as an important vehicle to create liquidity, but only if it is in line with a long-term strategy.”
Tapping into this type of FPI, however, is rather different than navigating the traditional FDI landscape and it requires preparation and expertise.
“Getting access to institutional investors such as fund managers, sovereign wealth funds, funds of funds and companies involved in private equity and venture capital means that IPAs need to understand the financial instruments involved and to build their credibility,” says Netto. “ApexBrasil has created a specific unit to cater to these investors.
“According to Bain & Co, the pool of global private equity and venture capital funds reached $1.2trn in 2021. This is a huge pool of capital that can be useful to diversify markets, especially in the evolving geopolitical and macroeconomic landscape that we are facing at present.”