Social Impact Bonds – Not a Panacea But Worth Investing In

Social Investment Bonds can increase the scale of resources available to NFPs and ensure that these resources are allocated efficiently, however they are not a panacea, according to Les Hems, the Director of Research at the The Centre for Social Impact. His comments follow the announcement that a re-elected Labor Government in NSW would invest $25 million in a Social Impact Bond Pilot.

CSI Director of Research, Les Hems

The desire to do more and to do better is a common driver for individuals and organisations that are interested in achieving beneficial social impact. For many, this desire is an understandable response to the increasing levels of demand for the services of community service organisations – whether at local, state, national or international levels. The problem is that the supply of resources is not keeping pace with this demand and the current mechanisms for allocating these scarce resources are inefficient.

The 2010 Productivity Commission Report on the Contribution of the Not-for-Profit Sector noted the rapid and sustained growth of the sector in Australia throughout the first part of this century. Funding from both philanthropic and government sources increased. However it is important to note that this growth is partly explained by the ongoing process of governments outsourcing the delivery of public services to not-for-profit organisations (NFPs).

Government funding is often perceived as “coming with strings attached” – where the strings are usually codified in a contract. NFPs are able to rattle off a whole range of problems with government contracts: they are perceived as being too prescriptive, focusing on inputs rather than outcomes, rarely covering the full cost of the service (which means philanthropic funds are used as a subsidy) and often provided on an uncertain annual cycle.

Governments are still learning how to be good procurers of services from the NFP sector. They recognise the limitations of contracts. The focus on inputs, outputs and unit costs has prompted their interest in the use of outcome-based commissioning and results-based accountability. Governments also recognise that it is often difficult for them to fund social innovation and that they are perceived as risk averse.

For these reasons Social impact bonds (SIBs) are currently attracting a lot of interest. A SIB restructures the relationships between government agencies, NFPs and social investors. Under a SIB, a bond-issuing organisation raises capital from investors based on a contract with government to deliver improved social outcomes that generate future government costs savings. These savings are used to pay investors a reward in addition to the repayment of the principal, if the agreed outcomes are achieved.

The first SIB was launched in the UK in March 2010 by Social Finance UK – a social finance intermediary. The SIB aims to significantly reduce the rate of reoffending by short-sentence prisoners at Peterborough Prison through services delivered by subcontracted NPOs. A range of charitable trusts and foundations have subscribed to the bond and have raised GBP5 million of capital. If successful it will lead to substantial future cost savings for the Ministry of Justice.

SIBs encourage social innovation and the development of programs which focus on early intervention, prevention or breaking the cycle of dependence. The performance nature of SIB focuses stakeholders’ attention on the delivery of the agreed outcomes. NFPs will be attracted because SIBs provide them with capital up front and remove government involvement from the day-to-day delivery of programs.

The SIB mechanism is also attractive to philanthropists and social investors who often find it difficult to know which NFP to support and cannot assess what their generosity has actually achieved. For philanthropists with a grantmaking mindset, a successful SIB offers the opportunity to recycle their philanthropic funds. However, it is the potential for SIBs to substantially grow the overall capital and revenue funding base of the sector which makes them most attractive.

Kylie Charlton’s recent blog post sets out the potential for the social impact investing market in Australia, and SIBs may be one of the social finance products that stimulate the growth of this market. Blended commercial and social returns are attractive to some investors, as indicated by the growth in ethical and environmental investments and microfinance. SIBs utilise commercial investment expertise and market discipline for the delivery of public services by NPOs.

To be successful a SIB needs to align the interests of government, NFPs and investors. The downside risks for all parties mean that the SIB has to be built on a shared base of knowledge, including evidence of the efficacy of the proposed intervention program and tangible costs savings for government. Whilst the SIB market is being developed, the structure of a SIB needs to be shaped by detailed and iterative negotiations between government and NFPs, combined with regular testing of the appetite of social investors. NFPs should not underestimate the level of evidence that is needed to satisfy government and investors or the complexity and length of negotiations which will be needed to satisfy government and investors.

A well-structured SIB will be an optimal arrangement which satisfies the upside goals and downside risks of government, NFPs and social investors. SIBs can increase the scale of resources available to NFPs and to ensure that these resources are allocated efficiently.

SIBs are however not a panacea. For some complex societal problems it will not be possible to find such an optimal position and other mechanisms will have to be used. Their use should therefore complement existing modes used to fund community benefit goals.

Establishing and developing a new asset class is challenging. It requires governments, NFPs and investors to take risks. The NSW Government has shown leadership by commissioning CSI to undertake a feasibility study to pilot SIBs in NSW. In the UK, Social Finance UK showed leadership in creating the first SIB and this leadership was rewarded by substantial financial support from the BIG Lottery. President Obama has announced USD100 million to pilot the use of SIBs. Premier Keneally has now made an election commitment to provide $25 million to pilot SIBs in the fields of juvenile reoffending, families at risk and disability services.

Although SIBs may not be a panacea, these commitments suggest that the SIB concept is attracting increasing interest. I’d welcome your views.

Read the Executive Summary of the Report on the NSW Government Social Impact Bond Pilot 
Read the full report 

*This article first appeared on the newly launched CSI Blog and is reproduced here with the author’s permission.

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