The arcane US budget rule that could help Putin dominate global nuclear markets

Why it’s long past time to fix equity scoring at DFC

Sometimes national security policy is a chessboard of great power competition or an epic battle of human freedom versus totalitarian repression. And sometimes it’s about an arcane accounting rule. Here’s a little tale of the latter that’s especially frustrating – and now urgent. 

Private investment can be a weapon of US foreign policy. Promoting market capitalism, providing a credible alternative to China, and helping deliver rapid development progress are the reasons why Congress passed the BUILD Act in 2018 and the US International Development Finance Corporation (DFC) was launched in 2020. The agency – of which I played a small role in creating – is supposed to be the tip-of-the-spear for US policy to catalyze private investment for infrastructure, economic growth, and job creation around the world. As I’ve written already, the DFC’s energy portfolio is far smaller than it should be. But I’m still a huge fan as the agency holds immense promise. 

One of the primary enhancements Congress gave to DFC over its predecessor is equity authority. This means the agency can, in addition to traditional loans and insurance, make direct investments in high-impact projects. Equity is an important tool because many projects, especially those at an early stage, won’t have immediate cashflow to service more loans. That’s why equity can be especially useful in riskier emerging markets, which is exactly where DFC is supposed to operate. And it’s why all of DFC’s peer agencies use equity. 

A budget nerd revolt

However, DFC’s equity plans ran into a snag. While Congress gave it authority to make such investments, it did not direct the administration how to score them in the budget. The Office of Management and Budget (OMB) decided to score equity exactly like a grant: investing $1 million for a stake in a solar farm in Indonesia or a data center in Kenya would count exactly like giving away $1 million in food aid. But of course grants are never coming back, while the stake in the solar farm or data center has a tangible market value – and one that would go up if the project is successful. If DFC acted like other equity investors, they would help get the project going, boost its value, and then sell its stake off, with the funds returning to the agency. (Yes, some individual projects will fail, but the overall portfolio of equity investments should make positive returns.) Alas, OMB decided to value all equity stakes at zero. 

Put another way, the budget scoring assumes that 100% of DFC’s equity investments will have a 100% failure rate in year one. That’s quite a vote of confidence in our shiny new foreign policy weapon! 

Other agencies like DFC – the British, French, Dutch, Germans, Danes, etc all have them, as does the World Bank – score their equity holdings at some reasonable market value. The US government even has a law – the Federal Credit Reform Act – which scores government loans and guarantees using “net present value.” But DFC’s equity is being counted as an immediate 100% loss.

In practice, this accounting decision means DFC can’t make equity investments – except in tiny amounts. It’s a ridiculous outcome that violates Congressional intent and ultimately hurts the agency’s ability to fulfill its foreign policy mandate.

The nuclear option?

One area where DFC’s equity problem is glaring is nuclear power. Advanced nuclear is one of the prime areas of competition with Russia and China, is a zero carbon source of power, and is a technology where public finance will be critical to exports. In 2020, DFC lifted an old rule barring nuclear investments and it has signed nonbinding agreements with South Africa and Romania, while lots of other countries are potential partners. As the agency gets ready to eventually finance small modular reactors (SMRs) and other next generation nuclear, it’s going to face the equity problem head on. Most of these projects will require equity investment (in addition to debt), but DFC won’t be able to take more than a token stake. Unless the scoring rule is changed.

The accounting snag opens the door to Russia. The Russians are already way ahead: they have a state-owned nuclear company selling SMRs that come with public finance and aggressive diplomatic marketing. Russia has nearly 4x as many nuclear agreements as the United States. And American SMR firms are private outfits, mostly operating like startups, that will need public financing like DFC if they want any hope of competing.

Source: Energy for Growth Hub & Third Way

NDAA to the rescue?

Fortunately, Congress seems to recognize the problem. DFC will be coming up for reauthorization in 2025 and equity scoring should be high on the list of issues to fix. More immediately, Arnab Datta and Alex Williams of Employ America have a terrific article out today, Accounting For Industrial Policy: How An Obscure Rule Is Holding Back US-Led Commercialization of SMRs. They write: 

This year’s National Defense Authorization Act (NDAA) is currently being finalized in the Senate. A few weeks ago, Senators Chris Coons and John Cornyn introduced a bill that would fix the budgetary treatment of equity investments, which has now been offered as an NDAA amendment. 

I have no idea if this specific amendment will stick – probably not. But it does show that the Hill is getting serious about finally giving the DFC the tool it needs to support nuclear exports, clean energy, and all the other technology and private investments that the agency was built to deliver. With or without Congressional action, we have to find a way. If we don’t, this will be yet another example of the United States talking big about global leadership but in reality showing that we’re not actually serious — or able to get out of our own way.