Navigating the complexities of social impact bonds for the SDGs
The potential of social impact bonds (SIBs) to contribute to an estimated US$2.5 – 3 trillion in annual investment for the UN’s Sustainable Development Goals (SDGs) has attracted increased attention over recent years. A social impact bond is a contract with the public sector in which a commitment is made to pay for social services which result in public sector savings. It originated in the UK to address the high socio-economic costs of prison recidivism. Governments reimburse investors in the case of social impact bonds, while third parties, such as donor agencies or foundations, are the outcome funders in the case of development impact bonds (DIBs). Under the model, risks are shifted from the public to the private sector.
For the public sector and aid agencies who want to demonstrate impact for scarce public funds, the appeal is clear; it allows them to pay directly for results, rather than for input. The impact bond market is growing steadily. According to the Brookings Institute, in 2019 there were 135 impact bonds in 28 countries, in areas such as employment, social welfare, health, education and criminal justice. With only 10 in developing countries, such as India and Peru, there may be a major growth market for approaches that draw on elements of impact investing or blended finance, as well as public-private partnerships.
Yet, despite the hype, impact bonds are fewer and smaller than momentum would suggest. The impact bond market remains small at about US$370 million, according to research by Brookings. This is compared to the US$228 billion in impact investing assets, according to the Global Impact Investing Network (GIIN). They remain highly niche products with a US$3.7 million average upfront capital investment. The extent to which such models are scalable, represent value for money or are a good idea relative to more traditional financing approaches can be confusing.
What is our work telling us? UNDP, like the World Bank and the UK’s Department for International Development (UKAid) and USAID is entering this territory. The tool is still relatively new in developing countries and is often poorly understood. UNDP has tended to focus on early stage exploration and financing for impact bond feasibility studies. These include an impact bond to reduce rhino poaching in Southern Africa, one to support tobacco farmers in Zambia transition to alternative farm and other livelihoods, and another to help dairy farmers in rural Armenia improve productivity. The UN is also developing an impact bond to halt cholera in Haiti. Many are still in the design phase, and only some will come to fruition.
Expertise is certainly on the up. UNDP is identifying greater opportunities to design and structure impact bond deals, as well as to share experiences, tools and models within our organization.
But it’s not easy; there are many moving parts. From feasibility, design, and due diligence it takes considerable time to originate and close an impact bond deal. This can be a significant investment, especially where it is not certain the project will ultimately materialize. In the developing countries where we work, investors sometimes do not understand the local market and have concerns about economic and political instability. These increase costs. Impact bonds can be constrained by legal issues, including the ability of donors to use outcomes-based contracting modalities. On the impact side, there is the attribution challenge; to what extent can positive outcomes or failures be isolated to the impact bond? Impact bonds also demand timely high-quality usable data, or a means to collect it in a cost-effective manner. Strong local service providers are also needed who can adjust their programmes where delivery is weak. Realistically, some developing countries have a better ‘enabling environment’ for impact bonds than others; a tradition of active civic engagement, strong local service providers and good quality data are all helpful, but are less present in some developing countries. Technical support for project preparation is needed in most developing countries.
There are heavy transaction costs associated with designing each impact bond contract, and the market is highly fragmented. Aid organizations are aware of these challenges and are addressing them. UNDP is part of an ‘International Development Bonds Working Group’ which convenes leaders from the public aid sector, philanthropy and multilateral financial institutions. Amongst other initiatives, it has proposed a design grant facility for SIBs/DIBs, a knowledge-sharing platform, building a forum for industries to engage in forward looking ideas around the strategic direction of the market, and creating a facility for the pooling of funding for outcomes-based initiatives.