Social impact bonds (SIBs) are among the newest and most promising innovations within the impact investing space. As financial instruments that mobilize investment capital to tackle social challenges, they have the potential to create shared value—financial returns for investors, social benefits for underserved communities and individuals, and enhanced efficiency for governments and social service providers. Until their promise is demonstrated, however, the future of SIBs is far from certain.
Social Finance UK launched the world’s first SIB in 2010 to fund interventions aimed at reducing the rate of recidivism among ex-offenders leaving Peterborough prison.1 In 2013, New York City launched the first US SIB in partnership with Bloomberg Philanthropies and Goldman Sachs.2 While many SIBs are in the pipeline, this is still the only SIB on the ground in the US today. In contrast, there are now 16 operational SIBs in the UK, and more are planned.3
HOW DO SOCIAL IMPACT BONDS WORK?
- A SIB begins with a social challenge. Take, for example, the issue of prison recidivism in the US. Over the past 40 years, the country’s total incarcerated population has grown by more than 700 percent to 2.24 million mostly minority and poorly educated men. After their release, 50 percent of former prisoners are unemployed and more than 50 percent will return to prison within three years.
- Based on a desire to ameliorate this problem, a partnership forms to include an intermediary, best-in-class service providers, government, and investors.
- Partners agree on an investment structure, including desired program outcomes. In the recidivism example, targeted outcomes could include the number of prisoners staying out of jail and finding gainful employment over a period of time.
- Private investors provide up-front working capital to service providers. The funds can be used, for instance, to scale up prisoner re-entry services, including workforce skills coaching, stable housing, and employment services.
- Independent validators conduct a rigorous program assessment to determine whether the target outcomes have been achieved.
- Government pays back principal and provides a rate of return to investors based on the program’s successful delivery of pre-agreed outcomes; if these outcomes are not achieved, investors risk losing their capital.
The reality is that the US SIB market is untested, with plenty of potential pitfalls and much work to be done before a stable and efficient market is in place. Demonstration and early-stage projects are getting underway, but the fundamental market ecosystem and infrastructure are in the process of being established. Participants still quibble over terminology (is a SIB the same as pay-for-success financing? Is a SIB really a bond?), while each SIB requires high levels of start-up and development costs. Serious doubts remain about the ultimate efficacy of SIBs and their potential to fund social interventions at a large scale.
Tracy Palandjian is co-founder and CEO of Social Finance US, co-chair of the U.S. National Advisory Board of the G8 Social Impact Investment Task Force.
Jane Hughes is director of Knowledge Management at Social Finance US, adjunct professor of international finance at Boston College and Simmons College, and co-author of the book Separating Fools From Their Money: A History of American Financial Scandals.
Social Finance US is a 501(c)(3) nonprofit organization that is dedicated to mobilizing investment capital to drive social progress.