By Hugh Gammon
First created by the UK to fund a rehabilitation program for convicts in 2010, Social Impact Bonds (SIB) provide a meeting place for charity and capital, promising a return on investment from funding social initiatives and charitable efforts. The concept is now gaining increasing traction and publicity in the financial sphere as organisations develop bonds to support social ventures such as healthcare for an ageing Japanese population and rhino conservation.
Much like traditional bonds, investors are paid a dividend dependent on performance, however for SIBs these performance targets are contingent upon achieving specific social milestones, such as a decrease in the recidivism rates of convicts or increase in the rhino population. The funding for this return on investment is either provided from the long term savings achieved by institutions from early intervention with private capital or from the pocket of third party donors, such as charities in the cases of unprofitable social projects such as conservation efforts. This actor is referred to as the outcome payer. Whilst this framework diversifies the sources of funding for social and charitable projects, it brings no additional or new funding as it is inevitably still the outcome payer who refunds the capital and return on capital of the investors either philanthropically or from long term savings created by the project. However, the model retains a large number of benefits over traditional financing methods.
The main attraction of Social Impact Bonds from the perspective of investors is supporting socially productive ventures whilst still receiving a return on investment. Meanwhile, should defaults occur if a project fails to meet its targets, losses are contributed to socially beneficial causes rather than anonymous markets. From the receiving side of the model, theoretically there is greater accountability and ownership for the efficient use and deployment of capital within an investment rather than a charitable framework, as shareholders demand transparency. SIBs allow large amounts of capital to be concentrated and channelled to provide a bridging finance role for a project in a small timeframe.
This structure has a broad spectrum of proponents. Kobe, Japan recently launched a ¥ 31 million bond to fight kidney disease, and early indicators suggest widespread success, bridging the deficit between stagnant tax revenues and the increasing costs of caring for an ageing population. SIB investors will be repaid on their original capital from the healthcare savings created upstream by early intervention. The Rhino Bond has also recently been established. Given the lack of profit created from conservation efforts, investors will be payed a percentage return on their capital by a philanthropic outcome payer. The size of the return will directly correlate to the scale of increase in the rhino population at selected sites across Kenya and Southern Africa.
SIBs have also met with criticism, however, with claims that Social Impact Bonds lead to the de facto privatisation of public services and that the targets set for payouts can be arbitrary and shift the focus from real systemic improvement to delivering payouts to shareholders. From a practical perspective, setting up an SIB is costly given the large number of parties involved in the contract. Complex contracting arrangements and accountability chains can lack proper oversight, leaving policy objectives reporting to private stakeholders and investors whose main motivation is profit. Nadine Pequeneza, the most vocal critic of the framework, observes that a Chicago SIB supporting schooling ‘incentivises the reduction of public services’ as payouts for investors are provided for every year a student doesn’t require special education. Hence the reduction of school support for at need students becomes the goal instead of effecting systemic change to reduce the need for school support. Her criticism demonstrates the need for investor milestones to be measured by outcomes (systemic change) rather than outputs (surface level indicators of change).
There is also real potential for exploitation of the bonds on an open market. The potential for shorting SIBs especially means that social ventures and charitable causes need to undergo rigorous safeguarding procedures to ensure they are protected from outside interests. The financial incentivisation of the failure of social projects on the market needs to be approached with enormous care. It is of vital importance that should the SIB framework be adopted on a wider global scale, targets are protected from those who would have an interest in their failure.
Successfully implementing SIBs to both profit investors and have positive social impact means presents a challenge. To set their payouts, issuers of SIBs must rigorously analyse their target issues to find quantifiable measures of systemic change. The long-term success of the rhino bond shall be decided by sustainable growth in the African rhino population, not just an increase in numbers at specific sites. Yet despite potential pitfalls, Social Impact Bonds hold promise for social and environmental funding and as a vehicle for capital distribution for socially conscious investors. The most likely place for these bonds will be as a percentage of ESG portfolios which include other traditional impact investment in social ventures, such as green investment. Combining SIBs with more traditional investments would mitigate risk for investors and provide a suitable testing ground for the expansion of SIBs on a larger global scale. The interface between private capital and charity is highly promising for a future capitalist society in which growth is measured in terms broader than monetary gain.
The opinions expressed in this article are the author’s own, and may not represent the views of The St Andrews Economist.