26 Jun 2015
Social impact bonds are a unique way to fund social service programs and are growing in popularity. Below, Martin Foo, Research Officer, Australian Centre for Financial Studies describes the industry and how it works.
"How can we better incentivise the use of novel approaches to the delivery of social services without risk to the taxpayer?"
Martin Foo, Research officer at the Australian Centre for Financial Studies
Governments in Australia and overseas are on the hunt for new tools to support social-service programs including in such areas as youth and family services, health, education, and aged care.
In an era of fiscal restraint, how can we create better incentives for the use of novel approaches to the delivery of social services without risk to the taxpayer?
One solution may lie in a relatively new form of public-private partnership known as the social impact bond.
In the usual social impact bond arrangement, private investors commit upfront capital for funding innovative social service programs. These programs aim to improve social outcomes and generate cost savings for the public sector.
For instance, a program supporting in-home care for Alzheimer's patients would lessen the demand for residential aged care; an effective intervention to lower criminal reoffending rates would reduce costs associated with keeping inmates in prison.
The cost savings to the public sector could then be used to pay investors a financial return. The figure below shows the architecture of a typical social impact bond.
In 2013, the New South Wales government pioneered Australia's first two social impact bonds (known as social benefit bonds in that state).
The first, called the Newpin bond, raised $A7 million to finance a program delivered by UnitingCare Burnside that aims to prevent children from entering out-of-home care.
In its first year, the program restored 28 children in out-of-home care to their families and prevented children in 10 at-risk families from entering care, delivering a 7.5 per cent return to investors.
The second bond, called the Benevolent Society bond, raised $A10 million to deliver the Resilient Families Service in NSW. Financial returns will only be paid when the five-year bond expires, subject to program performance.
So what does the future hold for social impact bonds in Australia? Two weeks ago, we brought together a roundtable of senior investment managers, economists, lawyers and government officials to try to answer this very question.
The discussion yielded crucial insights into why the market for social impact bonds is still in its infancy and what policymakers and industry could do to lay the groundwork for the future.
One of the common themes from the discussion was the need to better distinguish philanthropy from investment. In the past, philanthropists and charitable foundations have been the most obvious source of capital for social impact investment.
For-profit investment managers have tended to hold the view there is always an implicit trade-off between financial returns and social returns. The industry has much work to do in dispelling this myth. If successful, bond issuers will be able to look past the philanthropic world and tap the much larger available pools of commercial capital.
Roundtable participants identified achieving scale as a major challenge for the social impact bond market. In recent years there have been several new bond issues, but each has been in the order of only $A9 million to $A10 million – too small to have a significant impact on investor portfolio allocation or government budget design.
According to some participants, one of the key reasons for this lack of scale is the unique structure of social impact bonds, which remain unfamiliar territory for many investment managers.
In fact, the term 'bond' may itself be misleading as social impact bonds are more akin to hybrid instruments.
Some social impact bonds, like the Benevolent Society bond, do not pay a regular coupon. Frequent performance data are often unavailable given the long-term nature of many social interventions, and fund managers that require quarterly reporting of returns may find this problematic.
Some roundtable participants argued there is a need to challenge this kind of short-termism in the investment industry.
Participants suggested social impact bonds could be made more attractive to private investors by structuring them in tranches, with 'safer' tranches providing partial or full capital protection.
On the investment side, the government (as well as large institutional investors) could invest in new bond issues in order to lend them credibility. The government could also act as a cornerstone investor by taking on the riskier subordinated tranches.
There's a role for government to play on the regulatory front too. The Financial System Inquiry found social impact bonds are subject to onerous disclosure requirements and some superannuation trustees consider their fiduciary duties to be a barrier to impact investment.
At the state level, the success of social benefit bonds in NSW seems to be at least partly attributable to the direction provided by former Treasurer and current Premier Mike Baird.
Other states looking to follow suit could develop a formal Social Impact Investment Policy, as NSW has, and identify a 'champion' to advocate the cause of social impact bonds.
Ultimately, if some of these market and regulatory barriers can be addressed, the future of social impact bonds in Australia looks promising.
A recently-concluded Commonwealth review of Australia's welfare system recommended an expansion of the social impact bond model and in a recent speech the federal Minister for Social Services noted social impact bonds “have great potential for helping improve people's lives while increasing public sector accountability".
What's needed now is the political will to originate more social impact bonds in other states and other areas of social service delivery, which will help give the market the momentum it needs.
Martin Foo is a research officer at the Australian Centre for Financial Studies. Also see the full Discussion Paper, including an introduction to social impact bonds as well as policy recommendations.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
26 Jun 2015
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