Thursday
September 13
2012

Valerie Dao

Impact Bonds: Boon or Boondoggle?: Before we hop on the bandwagon, let’s scan the road ahead

Earlier this month, Mayor Michael Bloomberg announced that New York City will issue the first social impact bond in the United States. Since announcing that Goldman Sachs would finance a social impact bond to decrease recidivism for incarcerated adolescents at Rikers Island, Mayor Bloomberg has energized the social finance community and left it to ponder the limits of what social good can be created by this nascent tool.

The HMP Peterborough prison in the United Kingdom first introduced the world to Social Impact Bonds (SIBs) in 2010 when it provided social programming to prisoners with short sentences in an effort to reduce reconviction rates. Since then, a few states in the U.S.—including New York, Massachusetts, and Minnesota—have explored using similar tactics to remove public risk from financing socially motivated service organizations.

But SIBs have potentially game-changing implications for the next generation of finance outside of the U.S. and Europe. Now, others are exploring the application of this finance innovation in the development space, resulting in what the Center for Global Development (in cooperation with Social Finance) has coined development impact bonds (DIBs). DIBs take the same constructs of a social impact bond and apply them to issues facing international development.

Although there are no proven models of effective SIBs (Peterborough is still inconclusive), their promise has won them the praise of social finance gurus because they offer social benefits, government accountability and theoretically harness market powered pricing efficiency all at once. This appeal originates from the structure of the contract between the government, the service providing organization, and the private investors. The private investors front the capital for the service organization to operate. If the service organization achieves targets agreed upon by the investors and the government, the government will pay the investors back the principal amount with the possibility of interest. If the service organization fails to deliver results, the government has no obligation to pay—saving taxpayer dollars from supporting an ineffective program.

Media covering New York’s SIB announcement have described Impact Bonds as a “win-win-win,” while others have taken to borrowing Benjamin Franklin’s statement that “an ounce of prevention is worth a pound of cure” to describe the projected benefits of these new financial instruments—so, what value can social and development impact bonds generate?

Increased accountability and transparency

Skeptics have voiced their concern over the potential profit that Goldman Sachs, and other private investors, can make from investing in Impact Bonds. A stipulation built into the impact bond structure is the potential for a low return on investment if the target outcomes are achieved. In the context of the recidivism programs in NYC, this means that if the $9.6 million dollars that Goldman puts in to run the service providers saves New York $12 million in costs associated with incarceration, they could profit some percentage of the $2.4 million difference in savings.

Potential profits have been criticized as perverse incentives—it would be in private investors’ interests to skew measurement outcomes for financial gain—a particular concern in developing countries where financial indiscretions are commonplace. This concern, however, is mitigated by the requirement that a mutually approved independent evaluation organization conduct the performance assessment. Both the public and private partners would agree on an outside entity to evaluate the outcomes produced (or lack thereof) from the supported program. The existence of the measurement organization is key in two ways:

1) It provides a rigorous assessment of the outcomes produced by the programs.

2) It provides accountability by virtue of its impartial stance.

Tying outcomes to funding may not thwart all complexities associated with development aid, but would create a more intentional process for allocating resources and measuring outcomes. Simply put, impact Bonds can help us shift the discussion in the development space toward accountability for producing specific, high-value outcomes—a discussion that has unfolded all too slowly.

Improved efficiency

Although there are many benefits to impact bonds – make no mistake – they are complicated to implement. Because they are new tools (with DIBs in an incubation rather than implementation phase) and because it is in the interests of all parties involved to reduce risk, only strong programs with proven statistical success are likely to be supported by a social or development impact bond. The rigor associated with a vetting process characterized by higher standards of measurement will weed out less-than-effective organizations, and force nonprofits that want to survive to find more effective and efficient ways to deliver the services they provide.

Perhaps for this reason, SIBs have gained political traction on both sides of the ideological spectrum. A Bloomberg article recently reported that President Obama recommended $100 million for SIBs in previous budget proposals and noted a supportive opinion article written in the Washington Post by James Q. Wilson, known for being a conservative voice as a Ronald Reagan professor of public policy at Pepperdine University.

Owen Barder and Rita Perakis, from the Center for Global Development, further explain that in development, unintended consequences create avenues of preventable inefficiency:

“Much of the money can end up in the overhead costs of organizations that pass the money along very long supply chains, or end up paying for the bureaucracy of planning, monitoring and reporting how the money was used.”

Unlike more developed nations, intended aid beneficiaries generally lack the ability and/or structural mechanisms to formally represent their voices. To address this, Barder says DIBs can provide a “bottom-up pressure to improve” by being outcomes driven. Now that we have seen that social impact bonds have the clout to pull together support from various types of stakeholders, we can’t help but wonder if development impact bonds might elicit similar levels of support.

Innovation

Entrenched in bureaucracy and tight budgets, it is difficult for governments to innovate. Many developing countries face shared problems that require various permutations of effective solutions—where they need to contextualize aid efforts to local circumstances. Impact Bonds allow governments to transfer the risks associated with researching, developing or scaling an effective social program to private investors. Foundations, with limited endowments, also face constraints and could benefit from social or development impact bonds. Foundations already have the intrinsic motivation to support social programs (with no intention for return). By providing a means for foundations to earn their initial investment back while still creating the change a foundation is passionate about, these financial tools could help foundations or other private donors leverage their restricted endowments.

These benefits do not come without constraints. In a paper for the Center for American Progress, Jeffrey Liebman cautions that five conditions need to be present in order for an SIB to be successful. High economic net benefits and credible assessments are included on the list. Surprisingly, a seemingly obvious condition is missing: finding the right impact buyer.

Alicia Glen, the head of Goldman Sachs Urban Investment Group in New York says in the Bloomberg article that she sees a path toward turning companies into Impact Buyers:

“If the capital markets and financial institutions can get comfortable with the return profile and the risks associated with it, and also have a double bottom line as part of their business, that’s really a game-changer.”

Social impact bonds are rapidly gaining traction in the U.S. and Europe, providing an outcome-oriented model for funding with remarkable potential. While still in their infancy, development impact bonds also hold promise in establishing clearer links between outcomes and funding and opening up new channels for investment throughout the developing world.

Impact bonds are not without their caveats, but a steady consensus is growing around the value of SIBs as a tool for change in cities from New York to London. And thanks to work being done by the Center for Global Development to develop and test several DIB business models, we might not have to wait long to find out the value of development impact bonds throughout the developing world. It could be a game changer for the development sector.

Valerie Dao is an associate at Mission Measurement, a firm that helps its clients to create value through social change. She regularly advises nonprofit and philanthropic leaders on strategies for promoting international development. Follow her on Twitter @MissionMeasure

Categories
Entrepreneurship, Impact Assessment
Tags
Impact Assessment, impact investing, social capital