Paying for social impact, and making social impact pay
The global demand for provision of high-quality social services is increasing at a time when the resources available in the public purse are ever more thinly spread. Palladium’s Peter Vanderwal, Head of Innovative Impact Financing, reflects on the potential of results-based financing to harness a significant pool of untapped private capital.
A growing global pressure on the delivery of social services
Transparency in global norms relating to the provision of social services are increasing the volume of the populations whose voices may have been previously ignored. The social contract between populations and their governments are forcing ever more accountable allocation of resources – pushing services out to previously marginalised populations. People are living longer, expecting more, and becoming increasingly urbanised, with attendant rises in urban-centric issues including crime, chronic diseases and employment.
All this is happening at the same time as the global economy suffers through increasingly erratic cycles, conflict and civil unrest command ever more expenditure, commodities prices are unpredictable but trending towards the subdued, and the mood across the planet is in danger of being trumped by a newly rampant populism.
In the face of this, innovative approaches to financing social initiatives are needed more than ever. Indeed, through the lens of the Sustainable Development Goals, the World Economic Forum estimates that there is at least a USD2.5 trillion financing gap to 2030.
Combining the expectation of capital supply with social demand – and the importance of measuring results
The rise of the power of impact investing is complemented by the commitment of Millennials to make not just profit, but a difference. With USD30 trillion due to be transferred to this generation over the next 30 years, the entire financial system is preparing to adapt to meet their demands.
Furthermore, the impact investment market is currently estimated to total between USD 64 billion and USD 114 billion – even the most conservative estimate equates to just over 0.03% of the USD 210 trillion in global financial markets. There is, therefore, huge scope for the Millennial Impact, as well as the acknowledged need for the diversification of portfolios in every type of fund to avoid the traditional cycles of global financial markets, and to grow into these double- and triple-bottom line investments.
In one very specific part of the impact investment landscape, these changes on the capital supply side are being met with the demand for far greater results orientation in social impact initiatives. For much of the past 70 years social impact initiatives have been based on inputs-based contracting. Non-state actors, whether for-profit or not-for-profit, have been contracted to improve service provision in areas such as health, education, workforce development, agriculture, the environment and other social sectors. These contracts have been costed using a bottom-up approach – identifying how much an activity will cost in terms of time and materials. As the majority of these contracts were grants providing either up-front capital or a very quick invoice turn-around time, the cost of capital was rarely taken into account. Crucially, neither was the risk of achieving the stated objectives of the contract. Whether the hoped-for results were actually achieved or not, the bills still got paid.
While there is no doubt that many good pieces of work are being done, at the same time it is clear that there continues to be a significant potential for wastage. Even when projects or programmes were successful, measurement of what made them a success is too often absent. The last fifteen years has seen an increasing emphasis on robust measurement, using data to prove or disprove hypotheses. The last ten years have seen this evolve into basing payments not on inputs, but on results – broadly known as results-based financing (RBF), or payment-by-results (PBR). Under these types of structures, up to 100% of all contract value can depend on agreed deliverables being accepted, following a review of the evidence. If the data does not bear out the stated results, the service provider or contractor does not get paid. This new approach has forced both sides of the contract to take into account both cost of capital and the risk of being able to deliver the results.
So how can impact bonds help make social impact pay for investors?
The need to demonstrate tangible progress in spending on social impact has created the opportunity, and this opportunity has attracted those with a commitment to investing in social impact. The question is, how to align social and financial metrics when the return on investment is purely based on the realisation of impact?
Over the last seven years, these trends – the growth in the broader impact investment sector, the acceptance within the investment community of a dual investment mandate to deliver financial returns while addressing social challenges, and the emphasis on achieving measurable results in social programs – have led to the establishment of alternative investing structures, and the formation of an innovative financial mechanism known variously as a social impact bond, a pay-for-success bond, a social benefit bond, an impact bond, and a number of other similar terms.
Although the use of the term ‘bond’ is common to nearly all of the nomenclature, it is often misleading in that these instruments do not resemble debt-like instruments. It may be more accurate to describe them as public private partnerships (PPPs) that use a structured financial instrument to mobilise private risk capital to provide up-front funds for performance-based contracts aimed at delivering a social or development outcome.
This new breed of instrument aligns private capital with public good and is one of the most profound examples of the work that Palladium is doing to deliver Positive Impact – that is, the intentional creation of enduring economic and social value.
The Rajasthan Development Impact Bond
Palladium works in a number of areas in the impact investment sector – including facilitating the flow of capital into impact investment opportunities by capitalising on Palladium’s unique visibility across numerous development projects, emerging markets and sectors (led by Head and Director of Palladium Impact Investments Tracey Austin).
In addition to this area of work, a new report will be published shortly which details the advisory, structuring and programmatic design work that we have done over the past year, assisted by funding from Convergence – the world’s first blended finance platform. In this initiative, Palladium has brought together private investors, governments, multi-national corporations, donors and not-for-profits to design a programme to improve the quality of maternal and newborn health services in private facilities across the state of Rajasthan in India. This work will be financed through an impact bond mechanism. It is the first health impact bond in an emerging economy and the report, put together with the Bertha Centre for Social Entrepreneurship and Innovation, will detail the entire design and structuring process.
At Palladium we’re all extremely excited about the work we and our partners have done on the Rajasthan Impact Bond. It’s not only the first of its kind, but it will also substantially add to the global body of knowledge around the use of these innovative financing mechanisms.
I had the privilege of talking about Palladium’s commitment to building this marketplace at the Delivering Change Forum in Mumbai earlier this year and welcome further discussions with friends and colleagues around the world interested in the potential for Innovative Impact Financing.