· 7 min read
With the emergence of ESG investing, more and more people are trying to introduce innovative approaches to release positive impact or reduce negative impact by financial tools. International institutions such as Principles of Responsible Investment (PRI), CFA Institute, and Global Sustainable Investment Alliance (GSIA), have defined ESG investing in numerous categories, including negative screening, best-in-class, thematic investing, norms-based screening, ESG integration, corporate engagement and shareholder action, and impact investing (definitions may slightly vary in different institutions).
Among these approaches, impact investing is a rapidly growing field. According to a survey by the Global Impact Investing Network (GIIN), the scale of impact investment in 2021 reached US$116 million, an increase of more than three times compared with 2018. Impact investing participants utilize various tools to provide funding and measure their impact, one of which is called Social Impact Bonds (SIBs).
What is the mechanism of Social Impact Bond (SIB)?
SIB is an outcomes-based financing tool created with specific purpose of improving social outcomes and improving efficiency of the capital allocated (Berndt & Wirth, 2018). SIB projects typically involve five sectors (see the graph below).
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A commissioner (e.g., a government agency) identifies the social need and pays for outcomes.
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Investors provide the working capital needed for the project and are repaid based on the achievement of outcomes.
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SIB specialized intermediary meets the needs of actors involved in the partnership and defines the transaction agreements, as well as for the raising of capital.
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A service provider delivers the service to the beneficiaries of the project.
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An independent impact evaluator evaluates the impact and communicates the results to the commissioner.
In general, SIBs link investor repayment to achieved outcomes, transferring risk to investors rather than service providers. Also, SIBs typically concentrate on preventive measures and public cost savings. Additionally, these projects heavily depend on independent evaluators to confirm their outcomes.
SIBs leverage private investment for social programs where governments pay based on achieved outcomes. It encourages private investors to fund interventions for issues like homelessness and juvenile delinquency (Warner, 2013; Casasnovas & Jones, 2022). These kinds of bonds involve agreements among governments, service providers, and investors to finance specific social outcomes, securing funds from investors and paying service providers upon meeting agreed-upon goals. In practice, labeling them as "bonds" is misleading. From a financial standpoint, SIBs function as future contracts based on social outcomes. They are alternatively referred to as Payment-for-Success bonds in the USA or Pay-for-Benefits bonds in Australia (OECD, 2015; Fraser et al., 2016).
Example for SIB: Peterborough SIB
The first instance only emerged in March 2010 with the Peterborough SIB in the United Kingdom, which was pioneered by Social Finance with a contract duration of 96 months. In this example, a set of service providers were funded to decrease the reoffending rates among 3,000 short-term (sentences of less than 12 months) male prisoners aged 18 and older released from Peterborough Prison. The bond met its targets, and the investors were repaid (Disley et al., 2014).
From 2010, the A package of intensive support services (called ONE Service) at Peterborough Prison aimed at reducing reoffending among male offenders with short sentences. It provided pre and post-release support for up to 12 months, including housing assistance, drug and alcohol treatment, employment assistance, parenting assistance, and mental health support. Investors were paid back if targets reduction in re-offending by 10% for any of the three cohorts of 1,000 ex-prisoners, or 7.5% across all 3,000 were met, making it the first of its kind globally. The intermediary, Social Finance UK, raised £5 million from 17 investors, most of which were charities or foundations. Social Finance indicated that if reconviction events were reduced by 10% in one or more individual cohorts, investors can expect the equivalent of an annual IRR of around 7.5% (up to a maximum of around 13% form U.K. Ministry of Justice and the Big Lottery Fund, depending on the scale of the reduction in reconviction events). If there were no reductions in reconviction events investors would not get a return and would lose their initial investment. The Ministry of Justice placed a cap of £8 million on the outcome payments to ensure that its liability is limited (Disley et al., 2016; Emily Gustafsson-Wright et al., 2016).
Pros and cons for SIBs
Impact bonds offer a compelling approach to driving innovation and addressing complex social issues, particularly in preventive measures. They present a system where the public sector pays solely for proven results, transferring the risk of service effectiveness to third-party investors. Moreover, Tortorice et al. (2020) showed that when the government is unduly pessimistic (or averse to projects with greater costs than benefits) SIBs can finance positive net present value projects that debt finance cannot.
On the other hand, the challenges are that these bonds foster collaboration among diverse stakeholders but demand adaptability due to their complexity and time-sensitive nature, often proving to be costly. Giacomantonio (2017) suggested that SIB-financed initiatives are not attractive to investors but are rational choices for governments. In addition, Mazzuca et al. (2023) indicated that SIBs investors are mainly altruistic, risk-averse, not particularly interested in financial returns, and therefore detached from the main logic of traditional finance. To date, the SIB market remains limited, with a total upfront capital invested of nearly $463 million, and their use is controversial also due to an intense political debate (Edmiston & Nicholls, 2017; Mazzuca et al., 2023).
As the SIBs market emerges, stakeholders start to exam the impact of existing cases and to delve into the financial structures or determinants contributing to SIB success. Despite this, some view SIBs as excessively risky with limited potential. Debates surrounding SIBs persist. These innovative tools hold promise in creating impact, yet to gain a comprehensive understanding, further evidence, robust evaluations, and empirical studies are essential.
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References
Berndt, C., & Wirth, M. (2018). Market, metrics, morals: The social impact bond as an emerging social policy instrument. Geoforum, 90, 27–35. https://doi.org/10.1016/j.geoforum.2018.01.019
Casasnovas, G., & Jones, J. (2022). Who has a seat at the table in impact investing? addressing inequality by giving voice. Journal of Business Ethics, 179(4), 951–969. https://doi.org/10.1007/s10551-022-05154-6
Disley, E., & Rubin, J. (2014). Phase 2 Report from the Payment by Results Social Impact Bond Pilot at HMP Peterborough. https://doi.org/10.7249/rr473
Disley, E., Giacomantonio, C., Kruithof, K., & Sim, M. (2016). The Payment by Results Social Impact Bond Pilot at HMP Peterborough: Final Process Evaluation Report. https://doi.org/10.7249/rr1212
Edmiston, D., & Nicholls, A. (2017). Social impact bonds: The role of private capital in outcome-based commissioning. Journal of Social Policy, 47(1), 57–76. https://doi.org/10.1017/s0047279417000125
Environmental, social, and governance issues in investing - CFA Institute. https://www.cfainstitute.org/-/media/documents/article/position-paper/esg-issues-in-investing-a-guide-for-investment-professionals.ashx
Emily Gustafsson-Wright, V. P., Tamar Manuelyan Atinc, E. G.-W., Sophie Gardiner, E. G.-W., Moustafa, N., & Brad Olsen, M. E. (2016). Social Impact Bonds for early childhood development: Making “dollars and sense” in developing countries. Brookings. https://www.brookings.edu/articles/social-impact-bonds-for-early-childhood-development-making-dollars-and-sense-in-developing-countries/
Evaluating the world’s first social impact bond | rand. (n.d.). https://www.rand.org/randeurope/research/projects/social-impact-bonds.html
Fraser, A., Tan, S., Lagarde, M., & Mays, N. (2016). Narratives of promise, narratives of caution: A review of the literature on Social Impact Bonds. Social Policy and Administration, 52(1), 4–28. https://doi.org/10.1111/spol.12260
Giacomantonio, C. (2017). Grant-maximizing but not money-making: A simple decision-tree analysis for Social Impact Bonds. Journal of Social Entrepreneurship, 8(1), 47–66. https://doi.org/10.1080/19420676.2016.1271348
GIINsight: Sizing the impact investing market 2022. The GIIN. (n.d.). https://thegiin.org/research/publication/impact-investing-market-size-2022/
Global Sustainable Investment Review 2020 - gsi-alliance.org. http://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf
Mazzuca, M., Panzera, E., & Ruberto, S. (2023). The investor’s participation in Social Impact Bonds. International Review of Economics & Finance, 86, 349–363. https://doi.org/10.1016/j.iref.2023.03.017
OECD (2015), “Social Impact Bonds-Promises and Pitfalls”, Summary Report of the OECD Experts Seminar, Paris, 15 April 2015, France, http://www.oecd.org/cfe/leed/SIBsExpertSeminar-SummaryReport-FINAL.pdf
Rizzello, A., & Kabli, A. (2020). Sustainable Financial Partnerships for the sdgs: The case of social impact bonds. Sustainability, 12(13), 5362. https://doi.org/10.3390/su12135362
Tortorice, D., Bloom, D., Kirby, P., & Regan, J. (2020). A Theory of Social Impact Bonds. https://doi.org/10.3386/w27527
Warner, M. E. (2013). Private Finance for Public Goods: Social Impact Bonds. Journal of Economic Policy Reform, 16(4), 303–319. https://doi.org/10.1080/17487870.2013.835727
