In recent years, the public and private sectors have changed like never before. On one hand the changing world and economy has led to a growing consideration of ESG standards in business activities with the aim to spread their social responsibility and increase community involvement and awareness of social issues. On the other hand, consumers more carefully choose goods and services produced by companies that respect these standards.
In this context, we have often heard about “green finance” and ”green bonds” which have the purpose to promote the investments in activities that achieve environmental sustainability. ESG does not refer only to environmental issues, but also to actions that can have a social impact. Institutions engaged in sustainable finance can issue “social bonds”.
Also financial businesses are working to adapt their products and strategies to the ESG standards in order to promote a sustainable financial development. In finance, issuing special-purpose bonds is one of the many ways ESG is being embraced. In fact, Social Impact Bonds derive their name from the fact that their investors are typically interested in not just the financial return on their investment, but also in its social impact.
What are Social Impact Bonds and how do they work?
A Social Impact Bond is an innovative debt instrument issued to finance or refinance social projects whose purpose is to address common problems and help those most vulnerable. More precisely, Social Impact Bonds are issued by governments or supranational organisations that raise funds from private investors, charities or foundations, and distribute them to social service providers to cover their operating costs for the achievement of pre-defined social outcomes, such as employment, healthcare, education, affordable housing, poverty alleviation. If the outcomes agreed upfront are achieved, the government pays back the investors or the organisation that issued bonds.
Why invest in SIBs?
SIBs are considered investments that encourage social innovation, coping with difficult social problems and allowing the government to create partnerships with private service providers in order to achieve the desired outcomes. The main benefits of SIBs are:
- Prevention – SIB programs may create fiscal savings for the government that can be used to finance prevention services.
- Risk transfer – The public sector has to pay only for effective services, while private investors assume all the performance risk of services being potentially ineffective.
- Innovation – Risk transfer encourages investors and service providers to be as effective as possible, because the better impact they have on the outcome, the higher their repayment.
- Performance management – The SIB approach includes ongoing evaluation that allows governments to learn about which approaches are effective and which not in order to fund only “what works” creates transparency for all parties.
- Collaboration – It creates partnerships within service providers and attracts new capital to the social, educational and healthcare sectors.
Risks and challenges of investing in SIBs
Despite Social Impact Bonds constitute an opportunity both for private investors and for governments, there are some challenges that these “players” have to deal with.
First of all, they have to keep in mind that SIBs are risky investments, as they are entirely dependent upon the success of the social outcomes. A SIB is not a regular bond since repayment and return on investment (ROI) occur only if the prefixed social outcomes are achieved, so if it does not happen, investors receive neither a return nor repayment of principal.
As they are based on social impact, which is often harder to quantify and measure, it can be hard to determine the success of social impact bonds. For this reason, it’s hard for SIB to get government funding.
Other challenges are related to the following issues:
- Expense – The expenses of designing the financial mechanisms, program evaluations and management costs may make SIBs an expensive method.
- Investors’ influence – They want to be more involved in the delivery of social services, in order to have control on how their money are spent, but they may also require potential changes to the way NGOs operate.
- Unfair competition – Agencies that secure SIB funds may outcompete NGOs in areas they operate, having greater resources and more limited goals. In this way they have the opportunity to set the standard for government-funded agencies.
- Reduced public responsibility – SIBs reduce the government’s responsibility for delivering services, potentially jeopardising the government’s role in maintaining a civil society sector.
- Non-tradability – As SIBs are not tradable, they favour existing institutions, are narrow and short-term in scope, and impose high monitoring costs.
- Not required – SIBs are used for programs that fit the SIB structure, not necessarily because they are the best solution or the solution urgently needed.
- Financialization of public services – SIBs could potentially shift the attention towards financial objectives instead of tackling the fundamental factors behind social issues.
Moreover, Social Impact Bonds are not affected by interest rate risk, reinvestment risk, or market risk, unlike normal bonds. However, they are still subject to default and inflation risk.
In addition, it must be considered that some bonds may have age or geographic restrictions (such as cultural or educational vouchers for young people, bonds limited to a particular area – town, region, country, supranational union), or also they may be reserved to specific groups of people on the basis of economic and financial considerations. The household income, employment status (for example unemployment, reduced working hours, furlough), civil status and number of dependents (children or family members with a disability) are just some of the determining factors.
In conclusion, it can be stated that nowadays additional research is necessary to better understand the potential of Social Impact Bonds in driving social innovation and addressing society’s pressing needs, because balancing financial incentives with social impact, ensuring fairness, and maintaining public responsibility are still ongoing considerations. Despite that and the arisen debates on the financing and delivery methods of social services, SIBs have shown to be a promising and evolving tool in the realm of social finance and offer the potential to drive innovation, accountability and efficiency in addressing complex social problems, especially in certain policy areas.
As concerns the future of SIBs, robust evaluations and adaptable strategies will be necessary to effectively addressing the underlying causes of social issues, as SIBs represent a step towards a more dynamic and outcome-driven approach to tackling some of society’s most pressing challenges.
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