Due to COVID-19, unemployment is spiking, food and water insecurity is accelerating, mental health conditions are worsening, and extreme poverty is increasing at a rapid rate. The social safety net is being stretched to the limit and governments around the world are grappling with their financial and budgetary realities. As governments tighten their purse strings in response to the pandemic, Development Impact Bonds (DIBs) may prove to be a worthwhile solution.
What are Development Impact Bonds?
Development Impact Bonds create a results-based financing framework in which a private investor provides upfront financial capital to service providers such as non-governmental organizations (NGOs), social entrepreneurs, and international organizations. Following the capital injection, the service provider performs specific tasks to achieve a development outcome that was previously agreed upon by all stakeholders. If the pre-agreed outcome is achieved and verified by an independent evaluator, the investor will receive their initial principal and financial compensation, which is distributed by an outcome payer. Conversely, if the outcome is not achieved, the principal will not be returned to the investor, nor will they receive a financial return. These types of arrangements are often referred to as Results-Based Financing (RBFs) models because awards are distributed only if results are achieved and verified.
Outcome payers are made up of multilateral aid/finance organizations (e.g., Inter-American Development Bank), philanthropic organizations, or members of the development community. Motivation for investment varies, but by and large, DIB investors see their investment as an opportunity to bring about social change, positively impact their brand, and receive a financial return. Investors are commonly comprised of private equity firms, venture capitalists, high net-worth individuals, or social justice groups with a substantial amount of readily available financial capital.
According to data collected by the Brookings Institution, there have been 210 Development Impact Bonds in 35 countries since they were created in 2014. As of September 2020, 50 of these bonds have been completed and the initial outcome reporting is promising. Social welfare and employment make up most DIB contracts, but there are also contracts in health, education, criminal justice, and agriculture. Out of the 50 bonds that have been completed thus far, 33 have led to positive financial returns, 14 are still undergoing evaluation, and only two failed to compensate investors. The success of DIBs is difficult to measure, but these numbers serve as an encouraging indicator.
In 2015, the world’s first DIB launched in Rajasthan, India and it is a notable example of success. Educate Girls, the service provider, received a $270,000 investment from UBS Optimus Foundation. The initial targets for this DIB aimed to increase the number of girls enrolled in school, as well as the literacy rate among the same group of young women. After three years, the learning target was surpassed by 60%and the enrollment target was surpassed 16%. These metrics were achieved in the absence of public funding, exemplifying the unique possibilities presented by DIBs.
Why Pursue Impact Bonds?
International development programs can be both costly and risky. Foreign aid is also often contentious and can be subject to aggressive political posturing, slowing down the implementation or effectiveness of development programs. By their very nature, DIBs are less risky than traditional development funding mechanisms because they are outcome-oriented and outcomes are conceived with success in mind.
Traditional development frameworks focus on inputs, activities, and outputs (i.e., food for hungry children, prisoner reintegration), and less on overall outcomes. This method is acceptable for short-term resolution, but it may only alleviate the symptom, not the deeper issue. Outcomes are inserted into DIB construction prior to stakeholder engagement and through effective performance management tactics, they are evaluated throughout the entirety of the project. This reduces risk for all stakeholders involved in the DIB. Investors can assess the project prior to putting up the financial capital, service providers can decide how to best allocate resources to achieve the outcome, and outcome payers are only obligated to compensate the investor if the outcome is achieved.
For governments, the reduction of risk and the transference of responsibility is an attractive prospect. Even though they may align with overarching foreign aid objectives, governments are accustomed to pursuing international development goals that may not bear fruit. These shortcomings often serve as an impediment to future development missions as lawmakers become wary of financing a goal that does not directly impact taxpayers and may not be successful. Development Impact Bonds absorb these risks, lessen public opinion concerns, invite private sector ethos to a traditionally bureaucratic environment, and allow for a laissez-faire approach to international development.
“[DIBs] eliminate the risk of governments paying for unsuccessful programs and increase the effectiveness and impact of their social protection initiatives.”
Caroline Bernadi, Village Enterprise’s Senior Director of Institutional Partnerships
Beyond the Virus
The global pandemic has exposed glaring social, economic, and infrastructural inequalities and inequities. By the end of the year, 150 million people will be thrust into extreme poverty, and child mortality will rise by an estimated 45 percent. Rectifying these issues will take many years and cost between $8 and $16 trillion, according the World Economic Forum.
In the years after COVID-19, governments around the world will be primarily focused on restoring societal imbalances arising from the pandemic, as well as immediate issues concerning unemployment, public health, and social services. This will leave little room for domestic or international development, even as grand ambitions such as the United Nations 2030 Agenda for Sustainable Development continue to push forward.
By preventing limitations of liquidity, ensuring consistent completion of development goals, and attracting sustainable private sector engagement, DIBs are emerging as a viable alternative to traditional grant-based development methods. Grappling with the effects of COVID-19 will require an international response and DIBs are poised to be an important part of this rebuilding effort.
WBD is prepared to assist the U.S. Agency for International Development (USAID), the U.S. International Development Finance Corporation (DFC), the Millennium Challenge Corporation (MCC), and other federal clients as they attempt to leverage Development Impact Bonds to achieve the international development and foreign assistance goals of the United States. Our team of financial management professionals have managed countless funding actions for budgets ranging up the hundreds of millions of dollars annually for the Department of Defense and the Department of Homeland Security, and our international development team specializes in private sector engagement through our USAID award. We provide a full suite of Financial Management, Risk Management, and Cost Analysis services as well as Contract and Budget Management.
Author: Jackson Stuteville, Associate at WBD, is a Policy and Governance professional engaged with the Department of Homeland Security (DHS) and the Federal Emergency Management Agency (FEMA).