Investing in The Future With Development Impact Bonds

Potential Structure of a Development Impact Bond
Potential Structure of a Development Impact Bond

Earlier this week the Center for Global Development (CGD) held an event in New York promote and discuss their final report on Development Impact Bonds (DIBs). The concept of DIBs has been discussed in a previous CGP blog post but there are some new points worth covering. To briefly reiterate, DIBs allow profit-seeking investors to finance social development projects through intermediaries and make returns on their investment based on a measurable social impact. Donors, such as governments or aid agencies would only be required to pay returns to investors if the agreed upon measurable outcomes are reached. This shifts risk from donors to investors who are incentivized to ensure the project’s efficient impact and proper oversight. The focus on outcomes and cooperation with the private sector allow for innovation in delivery methods and the freedom to adjust services quickly to new information to ensure specified targets are reached.

It is important to note that with this new method of development financing there will be large transaction costs as various actors adjust. The high cost and high risk associated with a new market will likely exclude commercial investors for pilot projects. As Luther Ragin, President and Chief Executive Officer of the Global Impact Investment Network, pointed out during the event; there is still interest in the future of DIBs, though the likely pioneers of this market will be philanthropically minded organizations and high value individuals. The hope is that foundations such as the Rockefeller Foundation will be able to contribute funds to subsidize the initial costs of operating DIBs. In the long term, if the DIB model is finalized and is proven as viable, the impact of money from for-profit entities could be immense.

One of the obvious issues with DIBs is how to decide on measureable outcomes. For one, the donors, investors, and non-profits have to agree on a clearly defined outcome for the DIB. Obviously, certain things are easier to measure than others, but some important social issues may not be simple or the resources necessary for measurement may be too costly. Issues with complex outcomes or measuring difficulties may end up being avoided by investors and won’t be addressed. The DIB working group from CGD insists that this can be addressed with “rigorous oversight” and proper data collection on the part of service providers. In some cases, it should then be possible to compare a project’s impact with an established control group.

Outcomes must be given a monetary value to society in order to determine the payment to investors after outcomes are reached while also incorporating a return for risks taken. While Investors need to make some kind of profit, the contract must also ensure that investors do not absorb the social benefit entirely. The amount for returns on risk can vary based on various aspects of a DIB contract. Risk can be associated with the service provider’s experience, the method of intervention, the political environment, or various other elements. A hypothetical breakdown is provided by the group outlining potential capital classes within a DIB that would appeal to more investors. This can allow investors with a range of risk preferences to finance a DIB.

Potential Capital Classes for DIBs
Potential Capital Classes for DIBs

DIBs are an interesting idea based on the existing success of its predecessor, Social Impact Bonds, which have rapidly spread among developed countries. The focus on outcomes in an international development context may even shift the focus away from strict methodology at the onset of traditional funding methods, allowing for greater innovation in dealing with complex problems. The shift of risk away from donors also may allow delivery service organization to address issues that otherwise would not have been committed to by governments. Investors with “skin in the game” may assist in the organization and development of projects in the field to increase efficiency and transparency. Of course, the future of DIBs is still unknown and no pilot contract has been finalized, it is still encouraging to see a desire to bridge international development with the immense power of the financial sector.

2 thoughts on “Investing in The Future With Development Impact Bonds

  1. Jeff October 14, 2013 / 11:13 am

    hey nice article toni! i had a question – what happens to the returns to investors from a project that has earned profits but has failed to meet the measurable standard dictated by the DIB? Do the returns get reinvested in the project, or something else?

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