Results-based financing for social impact: Mutual benefits and mutual gains
Head Of Innovative Financing, Palladium
Results-based financing is becoming an increasingly popular mechanism for investors to deploy their capital to generate social and environmental impact whilst also making impressive financial returns. This trend has come about from an increasing global demand for the facilitation of high-quality social services without solely depending on philanthropic donations or the government pot.
Worldwide, people are living longer, expecting more, and becoming increasingly urbanised. It’s meant that rises in crime, chronic diseases and employment need to be dealt with in a sustainable way. With the combined issues of heightened concern over geopolitical risk, protracted conflict, civil unrest, and unpredictable commodity prices, the stability of the global economy is being severely affected. Consequently, the focus is very much on the financing gap for much-needed social initiatives, currently standing at least USD2.5 trillion, according to the World Economic Forum.
Innovative approaches to address this gap are now what is required. Traditionally seen as a ‘bolt on’ in most investment models and focused primarily in private equity within the illiquid sectors of health, education and microfinance, results-based financing for social impact is now gaining traction amongst wealth managers, family offices and the mass consumer market. Interestingly, millennials are twice as likely as other investors to put money into funds and organisations focused on achieving social or environmental goals, according to Morgan Stanley’s Institute for Sustainable Investing. This is a marked shift from mere harm reduction to being proactive participants in bringing about positive impact.
More and more fund products are now available to investors (already around 90 so far) to take a stake in the sustainable investments market - currently estimated to total between $64 billion and $114 billion. EQ Investors, for example, provides a range of positive impact portfolios that have all met their financial objectives to date. Advisers have also started doing their homework on how to integrate these kinds of investments into their portfolios, especially bonds and equities, to avoid the traditional cycles of global financial markets.
Social Impact Bonds (SIB) are one of several innovative mechanisms where the return on investment is based purely on the realisation of impact. An example is Palladium’s Development Impact Bond (DIB) targeted at improving the quality of maternal and newborn health services in private facilities in Rajasthan in India.
Unlike traditional bonds, however, these are not debt-like instruments. It is 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.
The introduction of tax relief has attracted an increasing number of investors to results-based financing. In April this year, the UK’s tax authority HMRC implemented legislative changes for social investments allowing a 30% income tax break for eligible organisations or products. The first SIBs saw predicted returns enhanced from 7% a year to equivalent 19.3%.
Beyond certain products and incentives, the increased supply of capital for results-based financing has led to the creation of networks that seek to help investors build portfolio strategies. These include the likes of The ImPact, Toniic and 100 per cent Impact Network. Furthermore, an increasing number of platforms are providing the means to categorise and assess funds and products by risk, return and impact.
A key component and obvious benefit of results-based financing is the requirement for clear reporting, measurement and evaluation structures. A range of methods are currently used depending on the objective of the project or initiative. This is in contrast to the previous model of inputs-based projects which had little consideration for what success looked like and how it was measured. The bills still got paid regardless of whether the stated objectives were achieved or not.
It is only in the last decade that there has been an evolution from basing payments on results as opposed to inputs. 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 the cost of capital and the risk of being able to deliver the results.
Campden Wealth’s Global Family Office (GFO) Report 2016 revealed that 61% of family offices are active investors in the field of sustainable investments. With the expanding conscience of millennials to invest ethically, this figure is likely to grow substantially over the next few years. And this is a smart choice, especially for the longer term. As the world makes its transition to a low carbon economy, companies that don’t keep pace with sustainable practices will have to pay out for their negative impacts. It goes without saying that the current generation deserves much more credit than it gets for trying to making the world a better place.