A handful of countries dominate the impact bond market. The first impact bond was launched in the UK in 2010. Its goal was to prevent short-sentenced offenders from leaving the Peterborough prison to commit new crimes.
According to the latest data of the Brookings Institution, the UK is still by far the front runner when it comes to impact bonds, with a total of 73 bonds; the US is in second place at a considerable distance with 27 impact bonds, followed by Portugal (16), the Netherlands (15) and Australia (14).
It’s striking that the situation in each of these countries is so different, says Emily Gustafsson-Wright, senior fellow in the Global Economy and Development Program at the Washington-based Brookings Institution.
An impact bond is a “contract with the public sector or governing authority, whereby it pays for better social outcomes in certain areas and passes on the part of the savings achieved to investors,” according to Investopedia.
As such these bonds are not a bond, per se, since repayment and return on investment are linked to the achievement of desired social outcomes. Read more about whether these bonds succeed in our article Impact bond market continues to grow despite lack of hard evidence of its success.
Few impact bonds in emerging markets
“In the UK, the central government played a large role in stimulating the creation of impact bonds. Further, several funds that contract impact bonds have been launched."
In the US, the government and non-profit entities have driven the growth of pay-for-success projects, Gustafsson-Wright says. In these projects, governments only pay the implementers of a programme if it delivers on its promised results.
“In the Netherlands municipalities have played a key role, while in Portugal a government social innovation fund (working with EU money) serves as outcome payer.”
In emerging markets, the growth of the impact bond market has been relatively slow compared to the global market. Despite considerable interest from global development actors, low- and middle-income countries have issued fewer than twenty impact bonds.
India has the highest number of impact bonds contracted in a developing country. Despite the small number overall, the projects target an astounding number of more than 800,000 children in the education system.
An example is Quality Education India launched in 2018 to support education providers in India to improve learning outcomes for primary school children across 600 schools in Delhi and Gujarat. This $9.1mn development impact bond was sponsored by charities like The Michael & Susan Dell Foundation (MSDF), Comic Relief, BT, The Mittal Foundation and The Ellison Foundation.
Drawing investors into new markets
According to the Brookings research most impact bonds have more than one investor, including at least one charity or a foundation. Other common investors include investment funds, non-profits/NGOs, financial services firms and impact investing firms.
One of the impacts of impact bonds has been that they draw private investors to new or additional sectors and geographies, where they may not traditionally operate. Gustafsson-Wright cites the example of Goldman Sachs in the US; it invested in a New York City impact bond preventing former convicts from committing new crimes.
In the Netherlands, ABN Amro’s Social Impact Fund has positioned the bank as a key investor in six of the country’s first impact bonds. The UBS Optimus Foundation has provided investment funding for all three impact bonds in India.
Makes sense for insurance companies
A number of insurers who are not traditional impact investors have recently been drawn to the financial instrument. An example is Swedish Skandia. The insurance company and investment bank recently invested in a diabetes-prevention intervention, in which the Stockholm regional government is the outcome payer and SEB (one of Sweden’s largest commercial banks) is the structural advisor and financial intermediary.
In the Netherlands, health insurance company Aegon is participating in the Ministry of Defence’s Joining Forces impact bond, which aims to reintegrate long-term sick defence personnel into the labour market.
Another Dutch health insurance company, CZ, is investing in the Social Hospital impact bond in The Hague, which aims to support vulnerable families. “It really makes sense for insurance companies to invest in prevention,” says Gustafsson-Wright.
Social investment funds
Historically, most projects have raised the capital they need directly from asset owners. One way to improve the efficiency and effectiveness of impact bonds is changing the way investment capital is raised and managed, according to the Brookings research.
“The problem is that generally it is not possible to raise this capital until the project has been well-developed, with clearly articulated estimates of the risk profile and the amount of capital likely to be required,” says Gustafsson-Wright.
“One way to overcome this is to create social investment funds. In the UK, the Cabinet Office launched such a fund in 2008 to provide risk capital for outcomes contracts and to social enterprises directly.
After this £12.5mn Social Entrepreneur’s Fund, several similar funds followed. Today the £35mn Social Outcomes Fund II is managed by Bridges Fund Management, with Big Society Capital as a cornerstone investor.
In the US, Maycomb Capital established the Community Outcomes Fund, raising over $40mn from a dozen investors to invest in human services in low-income communities.
A new project on the horizon is a partnership between the UBS Optimus Foundation and Bridges. It aims to be the first global fund to invest in impact bonds and outcomes-based mechanisms. The target is to raise $100mn (with up to 20% first-loss guarantee), with a focus on South Asia and Africa.
According to Emily Gustafsson-Wright, Bridges Fund Management is one of the most interesting actors in impact bonds. “They’re an investor but essentially act as a performance management intermediary. They manage their investments closely, and in that process, they build the capacity of these service providers," she says.
“I know people may be sceptical about investors getting so closely involved in social services. But I think their heart is in the right place, and they’re doing really great work.”
Bigger deals needed
For institutional and more commercial investors to enter the impact bond market, the deals need to be a lot bigger. “Unless their organisation has some kind of philanthropic arm, it’s not interesting to them,” says Gustafsson-Wright.
Outcomes funds, also born in the UK, might be a way to scale up the market. “Outcomes funds were originally created to lower the transaction costs of impact bonds,” says the Brookings researcher. They do so by pooling several impact bond agreements, through streamlined and shared contract templates, metrics and evaluation systems. “But they can also spread the risk to the investor across a portfolio of projects and outcomes.”
In the UK, outcomes funds have been launched in recent years that focus on investing in specific social sectors, such as reducing homelessness and education and employment for young people.
In the Netherlands, two outcomes funds are in the making: a social innovation fund commissioned by the Ministry of Social Affairs, and one that focuses on improving social prospects for young people with chronic diseases, created by the social asset fund FNO.
An example in the developing world is the Education Outcomes Fund, which with the help of private investors aims to strengthen education systems in African countries. Gustafsson-Wright is optimistic about the role these new outcomes funds can play: “They really may have the potential to scale up social impact.”