Chapter 6. Corruption risks in revenue management

Fraud, diversion of resource revenues for private interest and embezzlement

In the management of natural resource funds, the transfer of funds from the general budget as well as the disbursement of financial resources are vulnerable to risk of embezzlement and diversion of public funds for private interests.

Political capture, bribery, favouritism and clientelism in investment decisions

Financial flows to and from resource revenue funds may bypass the regular budget process and become vehicles for patronage and discretionary allocations (OECD, forthcoming 2016; NRGI, 2014). The press has reported several cases where conflicts of interest and political capture have led to mismanagement, misuse and misappropriation of funds which has severely undermined the performance of natural resource funds. It is common to find government officials or well-connected elite on the supervisory board of these funds. In one particular case, the board was almost exclusively composed of members belonging to the President’s inner circle. This resulted in a series of opaque and high-risk investments in hedge funds and complex derivative transactions.

The management of natural resource funds, in particular investment decisions may be marred by patronage and clientelist practices. Corruption can occur either through direct investments or in the use of asset management contracts. Indeed, suspicions of corruption underlie several cases where non-commercially credible or imprudent investments were made in companies affiliated to (owned, managed and/or advised by) well-connected elites. In all cases identified, the amounts of revenues missing from the funds’ accounts or lost as a result of mismanagement, misconduct and lack of oversight amounted to billions of dollars.

Similarly, the management of portions of the fund’s assets may be entrusted to external managers (e.g. foreign banks) with political ties and affiliations in the country. For example, in one oil producing country, a manager in the national natural resource fund was accused by members of parliament of contracting his former employer, a foreign bank, as an external manager of the fund’s assets without following due process (NRGI, 2014). In another case, a lawsuit was filed by the natural resource fund against a foreign bank for allegedly bribing key officials and top executives of the fund to influence decisions over the fund’s investments.

In some resource-rich countries, in particular oil producing countries, patronage can be a broader feature of the economic and political system under which natural resources are governed and managed (Ramos, 2012).

Use of shell companies

In cases of bribery or diversion of public funds, parties to the corrupt scheme may use offshore companies with obscure beneficial ownership to channel and launder the illegal payments or to conceal the proceeds of corruption. For example, one lawsuit case reports the payment by a foreign bank of advisory fees to a friend of the President’s son through an offshore company.

Use of offshore bank accounts

The proceeds of corruption or diverted funds are usually transferred to offshore bank accounts pertaining to friends or relatives of the corrupt officials in jurisdictions with lax regulations regarding beneficial ownership.

Fraud and misinvoicing

As illustrated in the example above, illegal payments and bribes may be falsely recorded as advisory or consultancy fees. When external asset managers or investment consultants are used, higher than market-rate management fees or commissions may suggest potential corruption.

Lack of a coherent, consistent and disciplined fiscal policy framework

The lack of a coherent fiscal policy framework stating clear medium-term to long-term fiscal objectives and integrating natural resource funds into the general budget may provide ground for corruption in the revenue management phase (IMF, 2007). Overly rigid or inconsistent deposit and withdrawal rules, unclear accounting of revenue flows between the government and the fund, insufficient reporting of off-budget accounts in the general budget and circumvention of the regular parliamentary budget process increase the risk of dual budgeting and encourage corrupt practices to bypass existing rules or take advantage of legislative and regulatory gaps. The lack of transparency and accountability in the use of extra-budgetary allocations and secret bank accounts or deposits outside the national banking system contribute to opacities in the origin and destination of the fund’s revenue flows.

Mismanagement of the fund

Shortcomings in the management of natural resource funds may provide opportunities for corruption. Such gaps may include a mismatch between the fund’s policy objectives and its investment function, as well as between the investment function and the organisational and human resource capabilities and expertise of the fund. In relation to the latter, the lack of staff professionalisation and technical capacity may leave room for unchecked and excessive executive discretion in the budget process, increasing the risk that resource revenue funds become a parallel budget managed under the discretion of the executives (Sharma and Strauss, 2013; Collier and Venables, 2011; Gauthier and Zeufack, 2009).

The lack of transparency in the management of the fund may also encourage corrupt practices. Opacity may result from unclear or vague procedural and operational rules governing the management of the fund, internal controls and monitoring systems. It may also result from the lack of public disclosure on natural resource funds activities and governance structures including: its institutional structure; functions; relations with the executive; investment mandates; investment policy; risk management policy; asset allocation; targets, benchmarks and results for asset classes and direct investment assets; external management fees and fees paid to investment consultants (Gelb, Tordo and Halland, 2014). In some countries, information disclosure about natural resource funds is even prohibited by law (NRGI, 2014; Collier and Venables, 2011; Gauthier and Zeufack, 2009).

Weak governance of the fund

Inadequate governance arrangements may foster discretion in decision-making processes and hamper integrity and compliance in the management of natural resource funds. First, the lack of clear rules defining the roles and responsibilities; between ownership and regulatory/supervisory functions of natural resource funds (Gelb, Tordo and Halland, 2014); and/or between board membership and executive management may result in weakening the board’s oversight function. It may also allow for the exercise of political discretion in changing the fund’s rules and making investment decisions (NRGI, 2014; Collier and Venables, 2011; Gauthier and Zeufack, 2009). Additional risk factors include: the lack of an independent and accountable supervisory board (Collier and Venables, 2011; Gauthier and Zeufack, 2009); the lack of expertise and professionalisation of the fund’s board members; as well as the lack of clear behavioural guidelines and codes of conduct requiring board members, executives and staff to disclose potential conflicts of interest (NRGI, 2014).

Finally, the lack of independent audits and the lack of parliamentary and public scrutiny on the management of natural resource funds may further increase risks of political discretion and associated corrupt practices.

Embezzlement and diversion of revenues

Risks of leakages and revenue diversion may affect the phase of calculation of the share of revenues available for transfer. Embezzlement and misappropriation of funds may also occur throughout the revenue transfer process, from intra-governmental transfers through various designated national accounts all the way through to subnational authorities’ accounts where the revenues are actually disbursed.

Patronage, favouritism and clientelism

The rationale behind central government revenue assignments to subnational governments may be driven by patronage and electoral clientelism with a view to securing loyalties at the subnational level. This can be facilitated in the case of non-statutory assignments that provide for a certain level of discretion in determining the criteria for allocation as in the case of revenue distribution through specific purpose funds or competitive investment grants aimed at supporting specific types of projects (ODI, 2006).

Miscalculation of the share of revenues available for transfer

The complexity of calculations of the share of total revenue available for transfer and the share allocated to each subnational government may provide an opportunity for fraud, misappropriation and embezzlement. This is true in particular in the case of formula-based revenue-sharing types of arrangements for which criteria for allocation and redistribution might be unclear as well as in the case of derivation-based transfers for which determining the proportion of total resource revenues derived from a particular producing state, province, district or affected community may prove challenging (ODI, 2006).

Use of offshore bank accounts

Diverted funds can be transferred to offshore bank accounts pertaining to friends or relatives of the corrupt officials in jurisdictions with lax regulations regarding beneficial ownership.

Lack of clear, transparent and consistent rules governing revenue transfers

Corruption risks in revenue redistribution may result from the lack of clear, coherent and consistent rules governing revenue transfers from national to subnational authorities. Revenue distribution schemes may suffer from inconsistency with national fiscal policy and macroeconomic objectives. Moreover, legislation may fail to set clear and transparent transfer rules and assignments of expenditure responsibilities or when a legal framework exists, it may lack stability or not be enforced (Acosta, 2015; World Bank, 2011). Finally, unclear or vague rules and regulations may provide room for unchecked and excessive executive discretion in the budget process allowing for discretionary or ad hoc transfers (Bauer, 2013).

Lack of co-ordination and asymmetries of information between national and sub-national governments

Corruption risks may arise from the lack of co-ordination and the asymmetry of information between national and sub-national governments (World Bank, 2011). This may take the form of insufficient tracking and transparency over transfer payments from various “disbursement” accounts at national level (ODI, 2006). Moreover, the lack of disaggregated data disclosure by the central government leaves local authorities with insufficient information (e.g. data on volumes produced, consumed and exported, and on the prices actually realised, and the amount the government receives for its share of production) to verify their entitlements (World Bank, 2011).2 This lack of transparency may be due in particular to the confidentiality of contractual clauses on company payments to the national government (Bauer, 2013; Morgandi, 2008). Conversely, asymmetries of information may work in favour of local governments due to the lack of or unclear legal provisions for the reporting of financial accounts by lower levels of government to the central government (NRGI, 2013), as well as weak central government’s control systems (IADB, 2014; Martini, 2012).

Lack of human, technical and financial capacity of subnational governments

Finally, corruption in revenue transfers may thrive where subnational governments lack the human, technical and financial capacity to manage and spend large revenue inflows. In particular, local governments often lack the statistical capacity to measure fiscal performance, model complex revenue streams and verify entitlements (Bauer, 2013). Moreover, local governments may not have appropriate safeguards and transparency mechanisms in place to protect budget levels from potential fiscal volatility (Ushie, 2012; Acosta, 2015).

Reforms towards greater decentralisation have often translated into increased transfers of responsibilities and revenues without transferring the necessary financial and human capacity or investing in building local institutional and administrative capacity to manage these new large inflows of resource revenues. This has led to poor budget execution, difficulties in planning and inefficient resource allocation (ODI, 2006; IADB, 2014; Martini, 2012; World Bank, 2011). Moreover, the high concentration of revenues contributes to encouraging rent-seeking behaviours and dependency on transfer payments at the expense of tax collection (World Bank, 2011).