Social Impact Bonds: Doing real good or a wolf in a sheep’s clothing?

By Juan Fernández

Impact investing is on the rise. This is mainly fuelled by the rising public awareness on the societal and environmental impacts of investments – in both the positive and the negative sense. A 2020 report by the International Finance Corporation (IFC), estimates the size of the impact investing market between $505 billion and $2.1 trillion in managed assets.

The broad and fast-growing idea of impact investing encompasses different types of investments. There are, for example, environmental, social and governance funds (ESG), socially responsible investing (SRI), or impact entrepreneurship. Social impact bonds (SIBs), however, differ from the others, in so far as a real and measurable impact is a sine qua non condition to recover the investment and make profit.

They are designed as a results-based funding mechanism where private investors fund some or all upfront costs of a social oriented intervention. In a nutshell, if the intervention successfully delivers the pre-agreed outcomes for the recipients, investors recover their investment plus a return, normally paid by a central or local government. If the pre-agreed outcomes are not achieved, investors do not receive a return, and lose some or all their investments.

The first SIB funded project was born ten years ago at the Peterborough Prison in England. A non-profit organisation called “One Service” provided prisoners serving sentences of less than 12 months with individualised and needs-based support and access to services such as mental health and employment advice – with the ultimate objective of reducing reoffending. The English Ministry of Justice, with the support of the Big Lottery Fund, had reached a pre-agreement with the investors to refund the investment plus a return if a reduction of 10% in the frequency of reconviction was to be achieved.

The overall results of the pilot were positive. In the final report of the Peterborough pilot project, interviewees stated that one of the most innovative aspects of the pilot project was that it allowed a quick mobilisation of financial resources based on project and user needs, compared to traditional funding where spending decisions could be slower and more limited. Another innovative aspect was that instead of sticking to the initial project planning, interviewees considered that SIB funding led to a focus on outcomes and allowed for greater flexibility and adaptability to the changing necessities of the project. Ever since then, the use of SIBs has been steadily increasing. Many countries such as the United Kingdom, the United States and Portugal have contracted multiple SIB projects.

Solutions to one of the non-profit sector’s deepest problems?

This is because social impact bonds seem to have the potential to provide the solutions to some of the non-profit sector’s deepest problems: inefficiency and insufficient funding. The idea is that opening up to private capital will attract not only better funding, but also the expertise, discipline and efficiency of the private sector. Together with the support of the public sector and the non-profit sector’s philanthropic delivery, so the idea, this will significantly improve the general outcomes of projects.

So, it comes as no surprise that proponents of SIBs call them a Win-Win-Win situation for all parties involved. For governments because they are an effective way of tackling social issues: all risk is transferred to the investors, and governments only pay for a delivered service and achieved results, which is not the case with traditional funding. For the non-profit organisations involved, it creates a context where they can focus solely on generating better outcomes and a bigger impact. Last but not least for the investors who make a return and can market their positive impact if the objectives are met.

Too expensive?

Of course, there are also sceptics about the possible success of SIBs. First of all, SIBs have been proven to make projects more costly. This is partly due to the intermediate costs of developing the agreement, and partly to the additional profit for the investors if the outcomes are achieved. Being a more expensive mechanism than traditional funding makes this a difficult hurdle to overcome for a new alternative funding mechanism ultimately funded with public funds.

An example for the dimensions of SIB’s additional costs  is the Humanitarian Impact Bond launched by the International Committee of the Red Cross (ICRC) in 2017. The project will fund the construction of three rehabilitation and orthopaedic centres in the Democratic Republic of Congo, Nigeria, and Mali, and it aims to successfully treat patients at a rate 80% faster than existing centres. If the objectives are achieved, taxpayers in Switzerland and Belgium will pay up to $25 million for a project that would otherwise  only cost $18 million.

However, the price tag isn’t the main problem, as SIBs could still be useful in situations of budgetary problems. They allow a government to solve a pressing problem and pay for it five years later, and only if the problem has been solved. In the end, SIBs fundamentally encourage innovation in a sector where it is noticeably absent.

A wolf in a sheep’s clothing?

From an ethical standpoint, SIBs might diffuse the need for more structural approaches to solving major societal problems: they simply lack the capabilities to tackle problems such as poverty, inequality, or environmental degradation. In fact, as Alec Fraser, professor of Government & Business at King’s Business School, puts it, SIBs can in some ways seem like a wolf in sheep’s clothing, as they suggest that socio-economic issues can be solved by the commodification of these problems, potentially opening the door for individuals with large financial resources to profit from people in vulnerable situations.

Regardless of the challenges that this new funding mechanism poses, SIBs should be understood as a mechanism to prevent the waste of financial resources due to its results-based approach rather than a cost-cutting one. Its success will highly depend on when and where they are used, due to the cultural and political singularities of each country; a failure in Europe may be a success in another part of the world. Only time will tell if they succeed or remain a promising idea.

Note: This article gives the views of the author, and not the position of the EADI Debating Development Blog or the European Association of Development Research and Training Institutes

Juan Fernández is master’s student in Barcelona at the Universidad Oberta of Catalonia. His research focuses on new funding alternatives for the third sector, with a particular interest in impact investing.