Jasper - Great thoughts and there is certainly merit to your ideas. SIBs could help many of the non-profits we grants for but I wonder how you take a complicated issue like CDSs and explain that to many of the board members who govern these NFPs? One read of Michael Lewis’ The Big Short and many of these board members will run for cover.
Jasper - Innovation is at the heart of the SIB concept. Your reference to additional financial engineering concepts such as CDS, tranching and retail access are very welcome. However, I would caution in the use of credit ratings, not because of previous failings, but because of lack of relevance to the SIB model. Although there is a measure of credit risk in any SIB, it is only one aspect. The key risks are not credit related, but rather in the “bond’s” social performance and likelihood of the underlying project’s success. An issuance rating based on an independent assessment of the SIBs likely social performance would be much more relevant and useful to social impact investors. The existing credit rating agencies are ill-prepared to address and analyze these types of risks. It calls for a complete different sub-set of criteria and a new methodology. This is a rating service we at Inclusion [Social Ratings] understand very well and which we are actively promoting. Our proprietary methodology for assessing a SIB’s social performance and impact will expand the pool of investors (and further promote the expansion of SIBs globally) by offering a robust and transparent analysis of a social impact bond and providing investors with a useful tool for measuring that bond’s social impact and likely success.
Nick - thanks for your thoughts. I agree, CDSs are not easy to explain. I would explain CDSs as simple insurance payment protection plans (rather than using the overly technical sounding term, credit default swap). At the individual level, most people enter into a type of CDS (insurance plan) in the form of life, health, or car insurance. Certainly CDSs have been viewed in the perjorative since the crisis. Michael Lewis’ The Big Short artfully detailed how CDSs if used solely for individual greed can lead to societal loss. But in that case, CDSs were used for collateralized debt obligations, many composed of subprime mortgage loans by aggressive mortgage lenders. With SIBs, the CDSs are not protecting subprime CDOs, but rather, relatively straightforward debt obligations. For NFPs as investors, this will help increase the likelihood that payments promised will actually be paid. For NFPs as service providers, CDSs will help provide more funding, with CDSs than without, by drawing in more SIB investors, particularly from the private sector. To Andy’s suggestion, such transactions will certainly be overseen/monitored by the SIB parties, especially the external evaluator, in addition to adhering to all other rules/regulations. Overall, SIBs, including those involving the likes of Goldman Sachs, have often provided funding to give people a second chance in life. So why not afford this same opportunity to CDSs—to help provide funding to give such people a shot at such second chances.
Jasper - Still great insight on your points and the NFPs role NOT relative to Goldmans of the world. I’m not sure how many NFPs would even entertain an SIB (even with the good work from Richard’s folks at Inclusion related to the ratings) because of the work involved, having a board fully grasp what risk there is and having to place their trust in a group of investment bankers that they may not have had any interaction with previously. Maybe SIBs are only for huge projects like major hospitals or universities and not the groups I deal with like homeless shelters and Habitat and K-12 schools?
Richard - thanks for sharing the work of Social Ratings. True, the metrics for rating SIBs would be different from non-SIB issuances. So I think it’s terrific and certainly much needed. Nick - true, the admin fees for SIBs have typically been associated with raising funding in the millions rather than below (such as recidivism/rehabilitation programs). But what can be envisioned is a “lean SIB-type” structure to help raise funding for NFPs and similar organizations. If we capture the spirit of a SIB funding effort, it’s in substance negotiated agreements among stakeholders (eg, service provider, social investors, intermediary). The stakeholders would only agree if they were satisfied enough with the potential outcomes. For the NFP as service providers, they would generally always get paid. The challenge however has been garnering interest (funding) from social investors to take a bet on successful outcomes of designated (NFP/state) social programs, particularly from the private sector, which is why I originally wrote my short piece here. So to your comment, investment banks and investment bankers are not required per se, but rather, a person or group with both social finance and legal skill-sets could suffice, geared for smaller programs like homeless shelters and K-12 education.
Jasper - Thank you for the clarity on your ideas. I hope to learn more about the progress of SIBs as there are so many who could use the capital infusion. Have a Happy New Year.
A great discussion and exchange of ideas in this stream. What I see proposed here is a logical maturation path for SIBs - some would say we are still at the very early stages of the SIB innovation curve but it is worth looking ahead to the future to envisage how a well functioning SIB market could operate to provide the desired benefits for society with fair returns for investors according to risk. For some the SIB concept will always seem a bridge too far - no place for market economics in social policy - but the alternative seem to be the status quo of shoestring funding for NFPs and sub-optimal outcomes. At this still early stage of SIB development there will be the natural “lumpiness” in terms of opinions and research outcomes into “do they work or not?” There is still much room for new ideas and innovation in how to make SIBs sustainable and part of the mainstream of tools available to social policy makers.
Jaspar, Thanks for sharing this. At the end of the day, SIBs are financial products with complicated structures that will necessarily require some sort of financial engineering to make the risk/return profiles make sense for mainstream investors - so it’s refreshing to see an article that’s starting to explore these topics!
For me, I’m curious to hear more about your thoughts on Points 1 & 3. To me, the only sources of capital that fit the risk/return profile for Point 1 (providers of insurance) and Point 3 (investors in the riskiest tranches of debt), seem to be philanthropic foundations. Is this where you think most of the capital will be provided to ‘leverage’ larger private capital into the space? If so, will these foundations be bringing capital from the investment, or grant making side of the house - or both, if the financial return component can be scaled up/down accordingly?
Andrew - thanks for your sharing your thoughts. Many potential SIB participants are waiting on the sidelines to see the outcome of the first few SIB issuances. It’s early days, for sure. So for now, CDS providers may initially be philanthropic organizations. Hopefully, as time, trust and public-private confidence builds in the SIB marketplace, others may decide to get off the sidelines and become active participants. These could include traditional CDS providers (insurance companies, financial institutions, etc) as well as philanthropic organizations, subject to relevant rules/regs/oversight. In terms of the riskier SIB tranches, as of now, many SIB investors have been philanthropic organizations. But again, as time and trust develops, others can and arguably should get involved. These could include private sector social investors, such as financial institutions (following Goldman’s lead related to the Rikers program) and mutual funds, as well as state-affiliates, such as sovereign wealth funds and other public funds (particularly with SIBs linked with CDSs that serve as payment protection plans), as Mary suggested. For both points 1 (CDSs) and 3 (tranched SIB investments), we could also envision parties pooling their funds together for good causes (ie, a syndicated CDS funding pool, and as mentioned, mutual fund SIB social investors).
On top of all this would be the government to get more innovatively involved to incentive such public-private SIB participation. For example, the 1977 Community Reinvestment Act (CRA) is a good start, but other new/modernized regulations can also help to change the rules of the game for greater social investment and innovation going forward.
COMMENTS
BY Andy
ON December 29, 2014 11:37 PM
Is that really good for SIB generation to be transformed? Corresponding monitoring regulations should be first made before making it widespread.
BY Nick Walters
ON December 31, 2014 02:00 AM
Jasper - Great thoughts and there is certainly merit to your ideas. SIBs could help many of the non-profits we grants for but I wonder how you take a complicated issue like CDSs and explain that to many of the board members who govern these NFPs? One read of Michael Lewis’ The Big Short and many of these board members will run for cover.
BY Richard Wilson, Inclusion [Social Ratings] ltd.
ON December 31, 2014 07:35 AM
Jasper - Innovation is at the heart of the SIB concept. Your reference to additional financial engineering concepts such as CDS, tranching and retail access are very welcome. However, I would caution in the use of credit ratings, not because of previous failings, but because of lack of relevance to the SIB model. Although there is a measure of credit risk in any SIB, it is only one aspect. The key risks are not credit related, but rather in the “bond’s” social performance and likelihood of the underlying project’s success. An issuance rating based on an independent assessment of the SIBs likely social performance would be much more relevant and useful to social impact investors. The existing credit rating agencies are ill-prepared to address and analyze these types of risks. It calls for a complete different sub-set of criteria and a new methodology. This is a rating service we at Inclusion [Social Ratings] understand very well and which we are actively promoting. Our proprietary methodology for assessing a SIB’s social performance and impact will expand the pool of investors (and further promote the expansion of SIBs globally) by offering a robust and transparent analysis of a social impact bond and providing investors with a useful tool for measuring that bond’s social impact and likely success.
BY Jasper Kim
ON December 31, 2014 07:42 AM
Nick - thanks for your thoughts. I agree, CDSs are not easy to explain. I would explain CDSs as simple insurance payment protection plans (rather than using the overly technical sounding term, credit default swap). At the individual level, most people enter into a type of CDS (insurance plan) in the form of life, health, or car insurance. Certainly CDSs have been viewed in the perjorative since the crisis. Michael Lewis’ The Big Short artfully detailed how CDSs if used solely for individual greed can lead to societal loss. But in that case, CDSs were used for collateralized debt obligations, many composed of subprime mortgage loans by aggressive mortgage lenders. With SIBs, the CDSs are not protecting subprime CDOs, but rather, relatively straightforward debt obligations. For NFPs as investors, this will help increase the likelihood that payments promised will actually be paid. For NFPs as service providers, CDSs will help provide more funding, with CDSs than without, by drawing in more SIB investors, particularly from the private sector. To Andy’s suggestion, such transactions will certainly be overseen/monitored by the SIB parties, especially the external evaluator, in addition to adhering to all other rules/regulations. Overall, SIBs, including those involving the likes of Goldman Sachs, have often provided funding to give people a second chance in life. So why not afford this same opportunity to CDSs—to help provide funding to give such people a shot at such second chances.
BY Nick Walters
ON January 1, 2015 07:39 AM
Jasper - Still great insight on your points and the NFPs role NOT relative to Goldmans of the world. I’m not sure how many NFPs would even entertain an SIB (even with the good work from Richard’s folks at Inclusion related to the ratings) because of the work involved, having a board fully grasp what risk there is and having to place their trust in a group of investment bankers that they may not have had any interaction with previously. Maybe SIBs are only for huge projects like major hospitals or universities and not the groups I deal with like homeless shelters and Habitat and K-12 schools?
BY Jasper Kim
ON January 1, 2015 10:34 AM
Richard - thanks for sharing the work of Social Ratings. True, the metrics for rating SIBs would be different from non-SIB issuances. So I think it’s terrific and certainly much needed. Nick - true, the admin fees for SIBs have typically been associated with raising funding in the millions rather than below (such as recidivism/rehabilitation programs). But what can be envisioned is a “lean SIB-type” structure to help raise funding for NFPs and similar organizations. If we capture the spirit of a SIB funding effort, it’s in substance negotiated agreements among stakeholders (eg, service provider, social investors, intermediary). The stakeholders would only agree if they were satisfied enough with the potential outcomes. For the NFP as service providers, they would generally always get paid. The challenge however has been garnering interest (funding) from social investors to take a bet on successful outcomes of designated (NFP/state) social programs, particularly from the private sector, which is why I originally wrote my short piece here. So to your comment, investment banks and investment bankers are not required per se, but rather, a person or group with both social finance and legal skill-sets could suffice, geared for smaller programs like homeless shelters and K-12 education.
BY Nick Walters
ON January 1, 2015 12:09 PM
Jasper - Thank you for the clarity on your ideas. I hope to learn more about the progress of SIBs as there are so many who could use the capital infusion. Have a Happy New Year.
BY Brian Lee-Archer
ON January 1, 2015 06:26 PM
A great discussion and exchange of ideas in this stream. What I see proposed here is a logical maturation path for SIBs - some would say we are still at the very early stages of the SIB innovation curve but it is worth looking ahead to the future to envisage how a well functioning SIB market could operate to provide the desired benefits for society with fair returns for investors according to risk. For some the SIB concept will always seem a bridge too far - no place for market economics in social policy - but the alternative seem to be the status quo of shoestring funding for NFPs and sub-optimal outcomes. At this still early stage of SIB development there will be the natural “lumpiness” in terms of opinions and research outcomes into “do they work or not?” There is still much room for new ideas and innovation in how to make SIBs sustainable and part of the mainstream of tools available to social policy makers.
BY Mary Kopczynski
ON January 2, 2015 04:13 AM
Great succinct explanation! We’ve been discussing this for awhile ourselves! http://8of9consulting.com/wp-content/uploads/2013/08/How-Credit-Default-Swaps-Could-Change-the-World-22July2013-1.pdf
BY Andrew Wong
ON January 2, 2015 01:01 PM
Jaspar, Thanks for sharing this. At the end of the day, SIBs are financial products with complicated structures that will necessarily require some sort of financial engineering to make the risk/return profiles make sense for mainstream investors - so it’s refreshing to see an article that’s starting to explore these topics!
For me, I’m curious to hear more about your thoughts on Points 1 & 3. To me, the only sources of capital that fit the risk/return profile for Point 1 (providers of insurance) and Point 3 (investors in the riskiest tranches of debt), seem to be philanthropic foundations. Is this where you think most of the capital will be provided to ‘leverage’ larger private capital into the space? If so, will these foundations be bringing capital from the investment, or grant making side of the house - or both, if the financial return component can be scaled up/down accordingly?
BY Jasper Kim
ON January 3, 2015 10:49 AM
Andrew - thanks for your sharing your thoughts. Many potential SIB participants are waiting on the sidelines to see the outcome of the first few SIB issuances. It’s early days, for sure. So for now, CDS providers may initially be philanthropic organizations. Hopefully, as time, trust and public-private confidence builds in the SIB marketplace, others may decide to get off the sidelines and become active participants. These could include traditional CDS providers (insurance companies, financial institutions, etc) as well as philanthropic organizations, subject to relevant rules/regs/oversight. In terms of the riskier SIB tranches, as of now, many SIB investors have been philanthropic organizations. But again, as time and trust develops, others can and arguably should get involved. These could include private sector social investors, such as financial institutions (following Goldman’s lead related to the Rikers program) and mutual funds, as well as state-affiliates, such as sovereign wealth funds and other public funds (particularly with SIBs linked with CDSs that serve as payment protection plans), as Mary suggested. For both points 1 (CDSs) and 3 (tranched SIB investments), we could also envision parties pooling their funds together for good causes (ie, a syndicated CDS funding pool, and as mentioned, mutual fund SIB social investors).
On top of all this would be the government to get more innovatively involved to incentive such public-private SIB participation. For example, the 1977 Community Reinvestment Act (CRA) is a good start, but other new/modernized regulations can also help to change the rules of the game for greater social investment and innovation going forward.