A new type of financial instrument is challenging the idea that giving and investing are separate and distinct. The social impact bond (SIB) is an experimental hybrid that applies a profit motive to some of the most intractable social problems. In November, the government of Canada added itself to a short list of agencies around the world considering SIB programs. “As we continue to struggle with social and economic challenges that appear to defy resolution— think of homelessness, youth crime and persistent unemployment—we recognize that we must look at new ways to unlock innovation in local communities,” Human Resources Minister Diane Finley said in a speech in Toronto. She invited proposals from the business and nonprofit communities to meet Canadian objectives.
The prototype comes from a U.K. pilot project designed to reduce re-conviction rates. In 2010, the British government commissioned a private organization to work with released prisoners. The project was funded by an SIB issuance that raised about £5 million. The return the government pays to those private investors depends on the success of the program. If recidivism drops by more than 7.5% within six years, the bonds pay out a return of up to 13%.
“Bond” is a bit of a misnomer in this case. SIBs don’t necessarily pay back the principal if the program fails to meet its goals. That makes them riskier than typical securities. But really, they are an alternative to charitable donations. “There are investors looking to place capital in a way that will generate economic and social value at the same time,” says Adam Jagelewski of the Centre for Impact Investing at the MaRS Discovery District in Toronto. “Traditionally, that hasn’t been easy to find.”
Social finance, also known as impact investing, itself is not new. In 2007, Toronto Community Housing Corp. raised $250 million through bonds to help fund the rebuilding of social housing in Regent Park, for example. SIBs go a step further in raising money for projects that might not generate income. “For example, there’s no revenue stream from correcting, curing or treating substance abuse,” says Stanley Hartt, chairman of Macquarie Capital Markets Canada who served on the Canadian Task Force on Social Finance.
The appeal for governments is obvious. The private sector provides the upfront funding, while taxpayers pay only if the programs work. “It’s a way of allocating public-service dollars to where you get results, as opposed to renewing budgets like a machine every year,” Hartt says.
A JPMorgan report estimates that social finance could draw up to US$1 trillion in capital over the next 10 years. Critics counter that SIBs privatize social values. “Some of the common narrative is that this is a way for government to shirk its responsibilities,” Jagelewski says. Despite the theoretical merits or shortcomings of SIBs, the instrument is simply untested, he explains. Before condemning or endorsing SIBs, he says, it’s worth at least seeing if they work.