Could social impact bonds make a comeback as part of the Covid recovery?

Bodies in talks with UK and US governments on potential

One of the prominent effects of Covid-19 has been job losses globally. In the US, the unemployment rate jumped in April last year to a level not seen since the 1930s — and still stood at almost 6% in May this year, compared with 3.5% in February 2020.

Non-profit Social Finance US was focusing on tackling unemployment just before the pandemic escalated through ‘career impact bonds’. As the US gears up to fund a post covid recovery, early stage talks are underway on whether these and other types of impact bonds can play a role, and similar discussions are being held in the UK.

Impact bonds, which celebrated their 10th anniversary last year, have had a shaky history. The first-ever social impact bond focused on tackling recidivism in UK city Peterborough, was abruptly cut short after a change in government policy. It was a similar story for the first social impact bond in the US, launched in 2012. It also focused on tackling reoffending, where it was cut after missing targets and saw high-profile investor Goldman Sachs lose money.

Some interviewed by RI for this article even complain that the name ‘impact bond’ is an obstacle, given that it has no relation to a “bond” in the traditional financial sense, causing confusion in the market.

There is not one definitive model for impact bonds also known as ‘outcomes-based financing’, ‘results-based financing’ or ‘pay-for-success’  but broadly such models see an investor pay the upfront cost of tackling a social or environmental problem, and the cost is repaid, often with a return, by an ‘outcome payer’ if measured targets are achieved.

The investor is usually a philanthropic investor such as a foundation or high-net worth individual, who are socially-motivated and want to back a results-based model to tackle social need – and more recently commercial investors have got involved too. The outcome payer is often a government motivated by the potential savings to the public purse through the delivery of more efficient social services – ie. less recidivism means less cost to house prisoners.

Alasdair Maclay, Chief Funds Officer at the Global Steering Group for Impact Investment (GSG) says currently the total market for impact bonds, according to the Brooking Institute, is only $460m globally, and admits the lack of scale is frustrating.

“There’s about 210 impact bonds globally contracted across 33 countries mostly focused on social issues in education and health care,” he explains. He recently co-wrote a technical paper on result-based financing models that can help foster a just Covid recovery – including the newest iteration in the impact bond family – the career impact bond.

Speaking to RI, Tracy Palandjian, CEO and co-founder at Social Finance US says the goal of a career impact bond is to ensure people get decent jobs in sectors that are resilient even in economic downturns such as IT and health care.

The model involves an ‘income-share agreement’, which has emerged in the US in recent years as an alternative to student loans, and wrap-around services. It sees a provider pay a student’s tuition who contractually pays a percentage of their income after graduation for a fixed period of time. What makes the career impact bond unique is that students only repay programme expenses if they successfully find and keep a job in their chosen sector.

Social Finance has raised $50m to support eight to 12 career impact bonds from charitable foundations investing to provide the cost of upfront training to students. The student, who acts as ‘outcome payer’ only pays back their their program expenses if they get a decent job meeting pre-defined conditions. The training programs involved also do not get paid in full until job outcomes for students are met.

“We’re actually requiring the school and the training programme to have skin in the game,” Palandjian explains. “That alignment of interest and incentives is critical to the model. We’re really trying to change the paradigm that the education and training providers have an incentive to make sure that students find careers with upward mobility.  Traditional programs do not guarantee career success and students are often saddled with debt regardless of the outcome.”

Social Finance US is in talks with states about the model and hopes state governors will apply the career impact bond model in a policy setting.

Significantly, Palandjian says Social Finance US is in talks with different departments of the US Administration about the role impact bonds can play in the Covid recovery. US Secretary of Commerce Gina Raimondo recently spoke at a Social Finance US event on the importance of new partnerships to reinvigorate the US workforce.

“Upskilling and developing our talent pipeline and our workforce development agenda is economic development and industrial policy. It’s one and the same. And everyone benefits with this more holistic approach rather than a siloed approach. So we’re in conversations with the Biden administration. There’s a lot of receptivity,” she said. “We’re going to write all these big checks for the American Rescue plan, the American jobs plan. And it’s going to land on the front door of states and counties and cities. And the question is if it is going to be spent well? Taxpayers are saying we need to make sure that it needs to be spent effectively. And that is the social impact bond refrain.”

This is also the case in the UK, where impact investor Big Society Capital is having conversations with the Treasury department – including senior ministers – on the role of impact bonds in the UK’s Covid recovery.

Aman Johal, an investment director at Big Society Capital, explains: “As you can imagine, there’s very little bandwidth within government at the moment but the early indications of conversation that we’re having is that it’s definitely an area of interest. Individuals at the Treasury definitely felt it was something that needed to be looked at again and could contribute.”

The barrier to scaling up the market is to unlock government support on a systematic basis, she says. Investor demand, on the other hand, is high, she adds.

In the UK, Big Society Capital transferred part of a social impact bond fund it has exposure to into a social impact investment trust invested across asset classes and noticed the impact bond element “was the bit investors really liked and there was consistent feedback that they wanted more of it”.

It is a similar story for impact bond products that GSG is involved in, says GSG’s Maclay. Two ‘education outcome funds’ focused on educational attainment in Ghana and Sierra Leone were three times oversubscribed and raised £30m each from investors which were a mix of large international NGOs, charitable foundations and institutional investors.

Institutional investors in the UK social impact bond market have included UK local authority pension funds and international institutions who have invested in the UK to learn about the model. Such organisations can only viably invest through dedicated specialists such as Bridges Fund Management or Big Issue Invest, who pool impact bonds and give institutional investors access to the scale they need in order to invest.

In the early days of impact bonds, there was talk of double digit returns, but one investor, who asked to be anonymous, says: “There has been a lot of misinformation out in the public domain around the level of return that investors have been making.. And I can say as one of the investors, it’s not huge.”

With career impact bonds, Palandjian also says returns will be modest. “No one’s getting rich,” she says.

Palladium Impact Capital, a capital advisory services company focused on impact investing, says the impact bond market at the moment is only viable for “pretty committed investors”.

Steven Van Weede, Managing Director at Palladium says: “These investors have to feel pretty strongly about the intervention. If you think about what investing is, it’s the ability to assess risk and ensure that it is priced properly. That is difficult for many of these interventions, where there is so little track record still. It’s not always easy for an investor coming in from the outside. That’s quite a big step but as cases grow it will be easier for people to make that leap.”

Preeth Gowdar, Director at Palladium agrees, saying the model is also often bespoke, adding to cost and complexity. But he adds that investors today are helping to prime the market, such as UBS through its philanthropic foundation and corporates in countries like India, which are exploring whether funding impact bonds can count towards government mandated CSR spending.

Australia-based insurer QBE and French bank BNP Paribas are also among keen mainstream supporters of impact bonds.

Gowdar says: “There is probably an additional or more aspirational idea to create blended structures whereby a concessionary funder is able to de-risk someone else’s investment in an impact bond. There is some potential there.

“It’s a little bit of a lofty idea bringing blended finance to developing impact bonds. It may not happen tomorrow, but it’s a possibility for the future to be able to get more traditional money involved.”