Investing for impact
The growing social impact bond space brings more than just capital to the social sector
They work like this. Capital is raised to fund the delivery of a service. The government makes outcome payments based on the level of impact of the service, which enables the repayment of the principal and yields, effectively funding the project. The investors take the risk of losing their principal in the event the project fails to reach a pre-agreed level of social impact.
For instance, the non-profit may provide post-incarceration support for recently released prisoners in an effort to reduce recidivism, as in the world’s first SIB, in Peterborough, UK, in 2010; provide support to reunite families and stop children falling into the social care system, as in the case of Australia’s first SIB in 2013; or provide mental health support which keeps people out of hospitals, such as in the recent Resolve Bond in Australia in 2017.
Asia’s first SIBs
Since Australia’s first SIB in 2013, the Newpin Social Benefit Bond, Australia has seen several local governments testing the water with issuances. In an interview with The Asset, Elyse Sainty, director, impact investing, at Social Ventures Australia, who acted as an intermediary on several SIBs, says it was probably the Peterborough bond in the UK which piqued the interest of the New South Wales government.
A pilot programme was put together which survived a change in government. “That was an early sign, at least in Australia, that there was strong bipartisan support,” says Sainty. However, of the first three pilots, one didn’t pass the early stages while the other two became the Newpin Bond and the Benevolent Society Bond. “It was another early sign that they were hard contracts, and they don’t always come to fruition. There was a lot of learning for all parties,” adds Sainty.
Sound carries far over water, and talks in Korea soon started in 2014. Asia’s first SIB was later launched in July 2016 by the Seoul Metropolitan Government and the Daekyo Consortium, with Pan-Impact Korea LLC acting as an intermediary. The project looked to improve the IQs and sociality of children with Borderline Intellectual Functioning (BIF), who were found to be fifteen times more likely to be welfare beneficiaries as adults.
“The traditional administration focuses on budget execution, but the SIB methodology focuses on the performance of the public policy, so as a result the effectiveness of the administration can be enhanced,” shares Hyun-il Kang, director at Pan-Impact Korea LLC, in an interview with The Asset. “[Typically], the government will wait until BIF children develop disabilities, then finally put enormous social expense into them. We want to solve this problem.”
Novelty and complexity proved to be initial hurdles. “When we first try to explain the SIB to anybody, like governments or investors, they cannot understand right away. We tell them that this is a concept that started in the UK in 2010, is now operated in over 17 countries, and then they start to listen,” says Kang. “The Seoul city mayor likes new attempts at social change, so we were able to persuade Seoul city to participate in this SIB project.”
SIBs bring material benefits. The service provider, often a non-profit, gets the working capital it needs. The government saves money by implementing a programme with a proven social impact. Even if the bond fails, the government pays nothing, and learns that the service provider’s solution isn’t effective. “SIBs only use the government’s budget for successful projects. Therefore, taxes can be spent more efficiently and effectively,” says Kang.
SIBs also bring greater transparency. “There’s increased scrutiny if anything,” explains Sainty. “There’s a lot of accountability for the service delivery organization, so if we’re getting outcomes data that indicate it’s not working, lots of people will be seeking to understand why that is.”
For Sainty, the fundraising proved to be a relatively smooth process. This may be surprising, given the possible risk that a service provider underperforms, but Sainty explains that “for the three bonds we launched this year, we closed the books within a few weeks, which is probably a bit unusual in the bond space in Australia”. That said, the fundraising targets are still rather small; the capital raised by SIBs in Australia is typically below the A$10 million mark (US$7.8 million).
SIBs have also managed to attract a broad range of investors in Australia. Across the four SIBs which SVA has helped facilitate, there were 140 investors ranging from HNWIs (high-net-worth individuals) to institutional investors. In Korea, they were usually for-profit institutional investors, says Kang.
“We’ve come across foundations and HNWIs who are happy to take a less-than-commercial return to try and support a social initiative they’re really interested in. We actually haven’t come across too many investors like QBE who are institutional and looking for commercial market returns,” James Pearson, an investor with experience investing in SIBs and the manager of responsible investments at Australia’s QBE Insurance, tells The Asset. “We’ve committed US$100 million [for SIBs], to show other institutional investors that you can invest in this market.”
Investors face their own challenges. “It’s a lot more challenging because, one, there’s not the track record and history of these globally and so you don’t have benchmarks to compare against. And two, you’re dealing with sensitive issues in social areas that most investors don’t have a lot of experience in,” says Pearson. “It requires a greater level of due diligence, because you’re making a financial assessment, and you’re also aiming to make a social impact assessment.”
In Korea, Kang explains that large corporations are scared of being “accused of a misunderstanding that they pursue profit through charitable activities, so they hesitate to participate”. Or they may also “misunderstand SIBs as a policy which is biased towards a specific political party. However, in reality, both conservative and democratic parties in Korea agree with the adoption of SIBs”, adds Kang.
“There is a concern about losses which can result in up to a negative 100%,” Kang continues. “The risk for the investment being a failure is too big for the company manager. He might take the blame for the failure.” Kang suggests that impact funds should be managed separately from general investment or donation funds.
Pearson shares that there’s also an added risk from working with the government: “Some of them [SIB proposals] we really liked, and then a year into the process, the state decided to appropriate the funds elsewhere, so there is a regulatory risk as this is an innovative area for governments.”
“Sometimes when you’re dealing with sensitive impact areas like homelessness, to be having commercial negotiations can be quite challenging,” adds Pearson. “We’re still hoping for a commercial return. So, when we sit down with the parties and the intermediary, and we’re talking about payments and metrics, we’re pushing hard.”
More art than science
More so than any other instrument, data is key. “When we plan SIB projects, it’s impossible to design the project unless sufficient social cost data is obtained,” says Kang.
Sometimes governments don’t have the data, or the data sets aren’t linked across different departments. For instance, an intervention for the long-term unemployed may focus on social welfare savings, but the target group may also have a higher propensity to commit crime and end up in emergency wards. “Often that linking of data sets across government departments doesn’t happen terribly often. So we have to try and piece together bits of information that point to how extensive that problem is,” adds Sainty.
“There’s not really independent data that you can go to, so you’re relying on the quality of information and data from the government, service provider and intermediary,” says Pearson. “Investment is science and art, and in some ways SIBs are more on the art side than science, because there isn’t that historical data to compare to.”
Catching up in APAC
Asia-Pacific still accounts for a small amount of the nearly 90 SIBs worldwide, with around a dozen active and some still in the development stage, but their adoption is becoming more popular. The US has enjoyed the support of large foundations and philanthropic capital, and the UK – being the birth-place of SIBs – has strong government support. Getting governments on board is essential, as they have access to the data sets and know their own budgetary constraints.
The slow adoption may also be explained by the fact that it’s still early days. The Peterborough SIB has only just come to maturity this year, with SIBs in Australia and Korea still in the first few years. It may be that the market doesn’t pick up until there are more success stories. Outcomes payments don’t typically begin until several years into the programme, while fixed payments are made in the meantime.
There’s also some refining to do in Asia. “[In the US], in some instances, they provide first-loss capital, which makes you a senior investor and gives you more confidence you’re going to get your money back,” explains Pearson. “That layered capital approach is quite attractive.”
However, the NSW government, as the harbinger in Australia, now has several SIBs live and has shared information with other state governments, saving time and money. “So you get that standardization and learning, which improves the efficiency of developing SIBs, so you’re seeing South Australia, and now Queensland has got three SIBS currently that are live,” says Pearson.
In Korea, there are now SIB projects being developed in Gyeonggi province and other regions, says Kang. The Seoul Metropolitan Government played a leading role in establishing The SIB Local Government Council in November 2016, with the aim of promoting and expanding SIBs among local governments. Pan-Impact Korea is operating the council secretariat. “We are trying to promote participation by explaining the concept of SIBs to local governments, like Busan and Incheon,” says Kang.
There have also been early issuances in New Zealand, Japan and Malaysia. New Zealand launched its first SIB in February 2017 raising US$1.5 million, focusing on unemployment and mental health. Japan saw a recent 30-million yen (US$270,000) issuance in Kobe in July by the Japan Social Impact Investment Foundation to tackle chronic kidney disease, following a pilot programme in Yokohama in 2016. More recently, Malaysia saw a 100-million-ringgit (US$24 million) issuance on August 8 this year, of a seven-year pay-for-success sukuk, five million ringgit of which was issued to retail investors via a crowdfunding platform, with the proceeds going to improve schools.
Further, there are now SIB-focused funds, such as Malaysia’s three million ringgit Social Outcomes Fund launched in March this year, The Bridges Social Impact Bond Fund in the UK, and the US$10 million SIB Fund created by Reinvestment Fund in the US, to which QBE has committed US$7 million. Social Ventures Australia is also about to launch a A$15 million Diversified Impact Fund, which will invest in SIBs, and debt and equity instruments in the social sector. Vehicles like this reduce the burden of due diligence and regulatory risk for investors.
The future of SIBs
The SIB space will likely grow, due to the use of large SIB funds, structural refinements such as enhanced risk sharing, and the deepening and spreading expertise between local governments and overseas.
However, there is also the possibility that SIBs evolve into a new form of payment-by-outcomes government procurement contract, without the need for risk capital, where a part of the payment to the service provider is contingent upon reaching target metrics. The NSW government now has a payment-by-outcomes contract with Silver Chain Group in the area of palliative care, which is not considered a SIB, as well as another non-bond outcomes contract called On TRACC in the area of recidivism.
“If SIBs stay as they are, that is quite bespoke, with lots of data challenges, time consuming, and all the rest of it, then they will have a very limited application, and they will never grow to be material,” says Sainty. “[But] what’s important is really the discipline and insight that comes with outcomes measurement and payments. To be frank, the investor is just an enabler. Everyone is understandably excited about capital being brought to the social sector, but it is data and measurement that will have the greatest long-term impact.”
Although this brings positives, this is a concern for investors. After investors do the work to invest in one SIB, the government may decide to continue the programme without risk capital, rather than re-engaging with investors to scale the same project or do another project at a larger scale. “That makes sense from their perspective, I understand why they would potentially do that, but in some ways it’s going to be very hard to attract investors to the first deal in the future if there’s no chance of a second deal,” comments Pearson.
However, most non-profits still lack adequate working capital to wait for payments, making risk capital an important component. “So whenever you have outcomes payments that are delayed and contingent, then you will continue to need some form of risk capital to allow for that,” says Sainty.