Part III: Emerging investment vehicles and innovation
Encouraging innovation and diversifying finance options for
social economy organisations have been key themes in the evidence presented to
the committee. Part III of the report explores these issues.
Chapter 6 explores the emerging field of social impact
investment (which delivers both financial and social returns for investors) and
its potential to increase the capital available to the social economy sector.
This market is steadily taking shape globally and is in early stages of
development in Australia. The committee heard that social impact investment
could become a distinct asset class as a track record of successful investment
deals is developed.
Some options to encourage emerging social impact investment
products are also discussed, including incentivising the social bond market.
The potential benefits and challenges of social impact bonds (SIBs) are also
outlined. SIBs are used to finance preventative social schemes and reward
investors with a financial dividend when the project they have invested in
achieves a specified social outcome. It was emphasised that SIBs can only be
applied to policy areas that have measureable outcomes.
Chapter 7 discusses the critical need to develop a measurement
framework to support these emerging investment vehicles, establish track
records and offer potential investors an assessment of the risks and returns
related to different investments. The chapter also discusses the global trends
to move beyond economic indicators to more holistic measures that include
social and environmental progress. The chapter notes some of the international
social measurement techniques that have emerged to support these developments.
Chapter 8 discusses the specific needs and challenges relating
to social enterprises in Australia, and mechanisms for strengthening the
diversity in social business models. The social enterprise sector has the
capability to foster a great deal of social innovation if financed accordingly.
Methods of directing funding and developing capacity to build sustainable
social enterprise are discussed. Possible legal structures that facilitate the
divergence of the social and commercial sectors are also noted. The benefits of
the government's recent Social Enterprise Development Investment Funds (SEDIF) are
discussed, and options to strengthen social procurement are offered.
Emerging social investment options
A prominent theme during this inquiry has been the potential for Australia
to develop new and innovative financing models to unlock capital for social
good. This chapter examines the global context of social impact investment and
investors' responses to it in Australia. Some specific emerging social impact
investment products highlighted by submitters to this inquiry are also
discussed, namely social bonds and social impact bonds (SIBs).
Social impact investment
It has been noted by several submitters that the potential range of
financing options available to social economy organisations lie along a spectrum,
with gifts and grant money at one end, commercial lending and investment at the
other, and emerging options in between, combining some mixture of financial
returns with a level of social impact.
This is summarised in Diagram 6.1.
Diagram 6.1: Spectrum of potential financing options for the
Centre for Social Impact,
PowerPoint presentation tabled at a public hearing, 1 August 2011.
The emerging options in the middle of this spectrum are referred to as
'social impact investment' options. Chapter 1 noted a growing global trend
towards the convergence of the business and social economy sectors through this
emerging field of social impact investment—the use of investment and financing
mechanisms which deliver some measure of both financial and social returns.
Social impact investment has the potential to greatly increase the pool of
capital available to social economy organisations. This form of capital can
often be invested, recovered (often with additional returns) and then reinvested,
generating significant long term social impact.
The terminology used to describe this emerging field is not uniform,
with the terms 'impact investment', 'social investment', 'social finance' and
'social impact investment' often used interchangeably. Mr Christopher Thorn of Philanthropy
Australia provided the following explanation of impact investment to the
When I think of impact investment, it is really any
investment that is creating social impact. Whether that is more at the
financial end, where more of the return is financial with some social impact,
or more at the impact end, which is more social impact and less financial, you
will have a spectrum. So, part of the challenge is creating the vehicle, or the
instrument, that is actually going to respond or attract the finance to where
you are trying to make a difference. Part of the challenge around the structure
that you are using is that the reason we are moving from philanthropy and
government funding into commercial markets is trying to access capital that is
not available. Going to your point earlier, there are unlimited grant
recipients. What we are trying to do is open up sources of capital that are not
The Global Impact Investing Network (GIIN), an international network of
impact investors, was created in 2007 with the aim of developing the impact
investment industry worldwide. GIIN states the aim of impact investment is 'to
solve social or environmental challenges while generating financial profit' and
it offers a range of investment options 'from producing a return of principal
capital to offering market-rate or even market-beating financial returns'.
Social impact investment can take a variety of forms, from the
traditional through to more innovative financial mechanisms. As JP Morgan
Impact investments take many forms, including structures that
are common in traditional financial markets. Equity and debt, guarantees and
deposits are all examples of commonly used investment structures. Some more
innovative investment structures have also been devised, including bonds that
employ equitylike features that allow the investor to benefit from financial
profits or even, in the case of the UK’s Social Impact Bonds, from successful
social impact. The existence of such innovative structures allows investors
with different (social and/or financial) return and risk appetites to invest
via the vehicles that best align with their goals.
A seminal report on the emergence of impact investment published by the
Monitor Institute in 2009 noted that this emerging field has the potential to
alter the global investment landscape:
There are moments in history when the needs of an age prompt
lasting, positive innovation in finance—from ideas as big as the invention of
money, to the creation of new institutions such as banks and insurance firms,
to the development of new products and services such as mortgages, pensions,
and mutual funds. Evidence suggests that many thousands of people and
institutions around the globe believe our era needs a new type of investing.
They are already experimenting with it, and many of them continue even in the
midst of a financial and credit crisis.
The Department of Education, Employment and Workplace Relations (DEEWR)
and the Department of Prime Minister and Cabinet (PM&C) noted in their
joint submission (the departments' submission) that:
A new social impact investment market is steadily taking
shape globally and is emerging in Australia. It brings new financing methods
with potential to leverage significant new resources and new participants
toward addressing social and environmental concerns in more effective,
efficient and sustainable ways.
Social impact investment includes a broad range of financial investment
vehicles operating in a broad range of geographical and sectoral areas. Social
impact investments are being undertaken in both developed and developing
nations, in fields as diverse as agriculture, water and sanitation, housing,
education, health, job creation, energy and financial services.
GIIN notes that impact investment has similarities with 'Socially
Responsible Investing' (SRI). However, there are some key differences; most SRI
portfolios commit to undertake negative screening of all investments to avoid
'bad' or 'harmful' companies (e.g. companies involved in the production of
tobacco, weapons or other socially harmful products). Impact investors go
beyond this and actively seek to place capital in businesses and funds that demonstrate
a positive social impact.
The size of the social impact
Globally, there have been some attempts to quantify the potential scale of
the social impact investment market. It has been estimated that the potential
size of the impact investment market could be US$120 billion in the United
States and approximately CAD$30 billion in Canada.
Globally, the Monitor Institute has estimated that the impact investing market
could reach one per cent of total managed global assets funds, which equates to
approximately $500 billion.
No thorough research has been conducted into the size of the potential
market in Australia. The Centre for Social Impact (CSI) has noted that the
potential scale of the capital market for social investment in Australia could
be worth $10 billion, with $7 billion identified in managed funds and a further
$3 billion in superannuation funds.
Additionally, Private Ancillary Funds, which hold more than $2 billion of
investment assets and distribute $150 million a year to eligible social economy
organisations, have the potential to support the growth of the market.
PM&C and DEEWR noted several other reference points that could be
useful to help determine the potential scale of the social impact investment
market in Australia. This includes:
$15.41 billion held in Socially Responsible Investment managed
portfolios in Australia in 2010 (representing 1.66 per cent of the total $926.8
billion in managed investment portfolios);
$1.23 trillion in Australia's superannuation system as at June
2010, including many super funds with SRI portfolios; and
Australia's NFP sector made $8.8 billion of capital investments
in 2006‑07, of which 61 per cent was funded from surplus from current
Social Impact Investment – an
emerging asset class
The committee heard evidence that over time social impact investments
could become a distinct asset class in Australia as a track record of
successful social impact investment deals is developed. Mr Michael Traill from
Social Ventures Australia (SVA) told the committee:
I have a strong belief that there is the ability to build a
new asset class... I think if we can go back in three to five years and say,
'Here is a deal where investors got a 12 per cent coupon'... you start to build
credibility for an asset class that provides a reliable return in the range of
eight to 12 per cent.
Sir Ronald Cohen noted in his evidence to the committee that social
venture funds operating in the UK over the last decade aimed to achieve returns
of 10 to 12 per cent, and that the Bridges Venture fund, with the help of some
government incentives, had achieved 20 per cent returns in that time.
JP Morgan argued that impact investments are defined not just by
underlying assets, but by how investment institutions organise themselves
around it. JP Morgan asserts that an emerging asset class has the following
requires a unique set of investment/risk management skills;
demands organisational structures to accommodate this skillset;
is serviced by industry organisations, associations and education;
encourages the development and adoption of standardised metrics,
benchmarks, and/or ratings.
These characteristics are present for asset classes such as hedge funds
and emerging markets which channel significant capital flows. JP Morgan argued
that impact investment demonstrates these traits and should therefore be
defined as a separate asset class.
Attracting social impact investors
The motivations for social investors are varied, with some investors
primarily interested in commercial rate financial returns, and other investors,
particularly some in the philanthropic sector, more concerned about social
For some investors, most notably wholesale investors and superannuation
trustees, returns often must be commercially comparable (see chapter 4).
Social impact investing includes a range of investment
options and financial mechanisms with varying levels of financial and social
returns, made by investors with varied backgrounds and motivations.
The Monitor Institute categorised social impact investors into two broad
impact first investors, who seek to optimise social or
environmental impact with a floor for financial returns; and
financial first investors, who seek to optimise financial
returns with a floor for social or environmental impact.
The Monitor Institute framework on social impact investors, outlined
in Diagram 6.2, noted that in some situations different investors from across
the spectrum can come together to create deals with blended capital inputs from
'impact first' and 'financial first' investors, creating what they term
Diagram 6.2: Segments of social impact investors
Monitor Institute, Investing
for Social and Environmental Impact, January 2009, p. 33.
JBWere agreed that social impact investment could be developed across
many different types of investors in the Australian market:
Impact investments should be for all investors, including
superannuation funds, trusts and foundations, individual investors, managed
funds, pension funds, insurance funds and common funds. If the supply of impact
investment products can be built up to meet the needs of all investors then the
social outcome of an impact investment market will be maximised. To do this the
investments and professionalism of the market and its participants needs to
hold up against traditional and existing non-impact investments.... While it is
not a replacement for philanthropy, nor the ‘silver bullet’ that solves every
funding challenge, it does have the potential to complement and diversify the
funding sources for non-profit organisations and allow supporters to further
aid the community sector with capital otherwise not intended to deliver social
CSI noted that there is potential for philanthropists and high-net-worth
individuals (HNWIs) in Australia to become impact first investors, and that the
social impact investment market is likely to be catalysed initially from
philanthropic sources, with commercial financiers coming on board more
gradually once a track record has been established:
The predominance of philanthropic foundations and HNWIs, as
seen in the UK Peterborough precedent and GoodStart, closely reflects the
experience in other sectors within impact investing such as microfinance or
social enterprise. Philanthropic foundations and HNWIs have typically been the
first movers to prove or mitigate the perceived risk of the asset class to
enable engagement of institutional investors in due course.
Mr Michael Traill of SVA told the committee that anecdotal evidence in
the UK suggests 'if you can get a single-digit to low teens rate of return you
will attract capital for social purpose business driven organisations'. He
argued that the same opportunity is present in Australia.
Recognising the 'blended value' of
social investment opportunities
One of the major barriers to investors of all types becoming involved in
the social economy is a lack of awareness (see chapter 2) and understanding
about the blended value of social investment projects. According to JP Morgan,
most institutional investors, philanthropic fund managers and the community at
large think in terms of 'the binary choice between investing for maximum
risk-adjusted returns or donating for social purpose'.
The idea of blending financial and social value is still relatively new, and
needs developing in the Australian context. SVA commented:
You need to get people away from that binary decision making,
on the one side, of giving donations and grants with their philanthropic hat on
and then putting their money into the most high-yielding investments on the
other side. Anything to bring people into that middle ground I think is helpful
and both improving the tax and legal environment for investing in social
finance and having this social capital discussion that we are having I think is
Investors need clarity around the proposed business and social case for
a particular project in order to be confident enough to put capital into such a
venture. Mr Traill commented:
You need to be very clear about the mix of business and
social returns. We think the core proposition in our social enterprise and
GoodStart funding was the ability to access money from funders who wanted a
'reasonable' but below commercial rate of return. We think the number on that
is a mix of art and science, mostly art.
JBWere noted the importance of being able to measure the social impact
being generated for any reduced financial returns, and articulate the social
dividend of a social investment to investors:
For this type of financing to be successfully supported, the
returns to investors need to be made as commercial as possible. Furthermore,
the social return needs to be measurable and identifiable so that a hybrid
investor is able to assess what level of discount is appropriate for the social
outcome achieved. An informed decision can then be made as to whether the return
is appropriate for the term and risks being undertaken by the ‘investor’.
The need for effective measurement, evaluation and reporting frameworks
for social investment options is detailed in chapter 7.
Developing a track record of social
Without a significant track record of successful social investment
deals, investors will be hesitant to invest in the emerging market. For
example, Community Sector Banking noted that one of the reasons institutional
and wholesale investors have not yet put significant capital into the National
Rental Affordability Scheme (NRAS) is the uncertainty around the performance of
this new investment product:
...the wholesale markets and superannuation funds are still
lagging in [take] up of this asset. Part of the reason is that it is still
considered a new asset class and track record as to how that asset will perform
and compare to traditional residential assets will take some time.
Mr Glen Saunders of Triodos Bank noted that with super funds investing
in the social economy, there will likely be early adopters seeking to enter the
sector, with more funds following after the market is more established.
The need for incentives
Foresters argued that incentives are needed to generate interest among
social investors and 'that at this point in time the market is not ready to
accept the risk-return ratio of investing in this space and needs incentives to
Using superannuation funds as an example, Foresters suggested that government
provide a tax incentive or top-up for returns on social investments that are
Ms Drew: ...So in the context of superannuation funds,
if you are going to offer an investment which is discounted to market there
could be an argument for the gap to be made up through some mechanism.
Certainly in the UK the tax incentive scheme they have used has had some
limited benefit in those institutional settings.
CHAIR: So looking at a mechanism where, in the event
that trustees made a decision to invest for social benefit dividend in addition
to the financial dividend, they could offset the financial dividend they have
forgone by doing that in another way, so still meet the sole purpose test.
Ms Drew: Yes.
The potential role of government top-ups is discussed further below in
relation to social bonds, and more broadly in chapter 9.
The committee recognises that a lack of awareness about the 'blended
value' proposition of social impact investment is a barrier to investors
becoming more engaged with social impact investment opportunities. The
committee believes that this awareness and acceptance of social impact
investment will be achieved over time as a track record develops, however
initiatives to promote social impact investment could help expedite this process.
The committee recommends that programs and workshops relating to social
impact investment be developed by investment organisations to encourage
investors to engage in social investment projects and opportunities.
Social bonds have many of the same features as conventional bonds. Once
purchased, interest is paid throughout the life of the bond and the principal
is redeemed at maturity. Further, bonds typically pay a coupon, or yield, where
the interest rate can be fixed, floating or 'step-up'.
Issuers of a social bond tend to heavily discount the coupons in comparison to
commercial equivalents; this is justified as an appropriate social dividend.
As the interest paid is often less than that of a corporate bond, attracting investors
presents a challenge for the social bond market. The uptake of social bond
opportunities in Australia has thus far usually been limited to investors with
a direct or personal connection with the social venture and the opportunities
have struggled to raise capital from a wider group of investors.
The GoodStart Consortium was an exception to this trend, successfully
raising $22.5 million in social bonds to fund the acquisition of 659 ABC
Learning Centres in 2010. The original GoodStart bond offered a 12 per cent
coupon to investors over eight years and was effectively a mezzanine debt
JBWere observed that a major characteristic of the consortium was the use of
different types of capital sourced from a variety of providers. It argued 'a
major reason this transaction was successful was that those involved had
significant understanding of the various capital markets — philanthropic,
hybrid and commercial'.
In December 2010, the Benevolent Society introduced a series of social
bonds to raise funds for a new model of housing, care and support for older
Australians. The bond issue aims to generate $10 million towards meeting the
$100 million cost of a retirement complex at Bondi in Sydney called Apartments
for Life. The project will be built on an 11,080 square metre site owned by the
Society and aims to include 40 per cent affordable housing. The bond will pay
annual interest of five per cent for up to eight years plus a bonus interest
component linked to the cash flow performance of the project.
The Chris O'Brien Lifehouse at RPA has also utilised social bonds to
generate a portion of the capital required to construct a Cancer Centre in
Camperdown, Sydney (opening in autumn 2013). The project will cost $230
million, $160 million of which will be funded by the federal government and $20
million by the ANZ. The initial offer for the bond closed in December 2010. The
bond offered a fixed term deposit of 6‑8 years of a minimum $20,000 with
an interest rate of 6 per cent paid annually. The interest will be paid from
the operating surplus generated by the hospital after opening. Lifehouse was
able to raise $3 million from the initial bond offer.
A number of submitters, including the Productivity Commission (PC), maintain
that government support is required to stimulate the social bond market.
The Benevolent Society argue a 'functioning social bond market will relieve the
public purse of bearing the full capital burden of social infrastructure
Some submitters offered suggestions to incentivise the market including tax
exempt income returns, government 'top-ups' on coupons and a government
guarantee on bonds issued.
These issues are considered further in chapter 9.
Tax exempt income returns
JBWere and YMCA proposed amending tax legislation to enable charities to
issue bonds that deliver a tax exempt coupon (or yield) from a bond to offset
the lower return, and make the bond more attractive to a wider group of
investors. Mr Colin Organ of the YMCA outlined how a tax exempt charity bond
could leverage capital for the social economy:
The yields on these income tax effective bonds would
effectively be improved through the ability to have an income tax exempt
status. For instance, in the example we have given in our paper, a four per
cent coupon on a bond to a taxable, tax assessed individual who pays the
highest rate of tax would be able to earn a yield of 7.5 per cent. So, it does
not penalise the philanthropist or the investor for investing in this type of
bond, but it gives the opportunity for the charity to raise funds at a
cost-effective level in terms of raising capital.
Mission Australia, a member of the GoodStart consortium, also agreed
that lowering the tax paid on returns from social bonds could help attract
JBWere and YMCA proposed that this mechanism could be regulated by limiting
this form of instrument to organisations with deductible gift recipient (DGR)
YMCA argued that the tax exempt charity bonds would create both a
sustainable option for charities to raise finance, while convincing investors
of a strong probability of the return of capital at the maturity of the bond.
Additionally, YMCA stated that Australia has an underdeveloped bond market relative
to other countries, and that the creation of charity bonds would provide
another option for investors who want to weight part of their portfolios to
fixed income investments such as bonds.
YMCA asserted that Australian charity bonds would not require agreement
of complex delivery measurements such as those of social impact bond programmes
(see paragraph 6.54). Further, the existing mechanisms of the Australian
Taxation Office (ATO) and the Australian Securities and Investments Commission
(ASIC) would avoid the need for creation of additional government bodies to
regulate the bond and that these compliance measures would protect investors.
At this stage the YMCA has not done a scoping study on the cost to
government for the proposed tax exempt coupons.
Government 'top up' on coupons
Lifehouse and the Benevolent Society proposed that the government could
offer a top up on coupons through cash or tax credit to subsidise the lower
return rates of a social bond. This could be done through franking credits, the
advantage being that franking credits are an established form of tax relief and
would 'have the ATO stamp of approval'.
Mission Australia agreed with the approach and suggested it would be best
suited over a long-term period, and would need to offer three per cent interest
in order to bridge the gap between a social and commercial bond offering.
When a company pays tax on its profits and then distributes after-tax
dividends they are described as 'franked'. Franked dividends are distributed to
shareholders with a franking credit which represents the amount of tax the
company has already paid. An investor then receives a credit for any tax the
company has already paid based on the rate of tax the individual pays.
As mentioned, Lifehouse and the Benevolent Society suggest that franking
credits could be a component of certain social bonds to provide a 'top-up' for
returns to investors. They propose that the franking credits be limited to bonds
used for the acquisition of social purpose infrastructure, and that this form
of bond only be issued by Public Benevolent Institutions.
They argue the credits would benefit all types of investors, improving
the tax rates for retirees using their self-managed super fund (SMSFs) and
PAFs, SMSFs in pre-retirement. They will also benefit corporates and individuals
on a high marginal tax rate.
The committee questioned the feasibility of the government giving a further tax
concession to PAFs and SMSFs that already receive preferential tax treatment.
Mr Cubis, Chief Finance Officer of Lifehouse, responded:
...if you offered a neutral tax rate it would not improve the
return for the self-managed super funds and the PAFs. You would get back to the
problem we had with the infrastructure bonds 10 or 12 years ago. When we were
talking to a lot of the self-managed super funds and the PAFs, offering six per
cent return was not enough for them. Most of the trustees of those super funds
and PAFs, quite rightly, are there to maximise the returns. They can distribute
back to charities, in the case of PAFS, or in the case of super funds they have
to try to maximise their returns.
By offering this rebate with the franking credit it lifts it
from six per cent to about nine per cent, which was a level where a lot of the
investors who had said no said they would entertain investing in the bonds. So
it really was just a mechanism to lift the return to a level which corporate
bonds would offer and be more competitive against the commercial sector. We
cannot really afford to pay nine per cent, otherwise we would just go out and
do that straight away. This is a way to try and lift the return and make sure
that the trustees of the PAFs and the super funds can meet their role—their
fiduciary duty to maximise returns for those funds.
Lifehouse and the Benevolent Society estimate the opportunity cost to
government for the franking credit would be $122 million per annum for five
years, and that the proposed bonds could inject $4.1 billion into social
Lifehouse argued that the credit would act as a catalyst for a social
infrastructure market, and the franking credit could be adjusted over time if
the market became oversubscribed.
The Benevolent Society envisioned that the 'incentive that you provide to get
people to start a market would be very different from the incentives you need
to keep a market going' and 'as efficiencies occur the government contribution
to this could be reduced'.
Mr Robert Fitzgerald, the commissioner who oversaw the 2010 PC report,
argued that government assistance to support a system of social bonds should be
considered on a case-by-case basis:
We would imagine that if a particular activity or program was
in the public interest it may well be that on a cost-benefit analysis the
government were to determine that it would be more cost effective for it to top
up the initiatives of another party, that is, for example, social bonds being
offered by the not-for-profit sector, than if it were to bear the whole cost of
that particular initiative. There may well be an exceptionally sound economic reason
the top up by the government might be the appropriate strategy. You can think
of a number of instances where unless the government is prepared to do that
then in fact that particular initiative will not be undertaken by any other
source, but that initiative might be undertaken by a partnership between for
profits, not-for-profits and philanthropy if the government were to provide an
additional input into that...
However, there is one caveat on that. We think the government
has to be very careful about not crowding out other initiatives. This is a term
that people use very dangerously, so let me be very careful. If it is the case
that people believe that the government will intervene and take all of the
risk, then human nature says that is exactly what they will allow to happen. We
would not be supportive of that in these initiatives. We believe that genuine
collaboration between government, philanthropists, for profit and
not-for-profit is a very appropriate way forward, each of those playing a
discrete and important part. What part that is will depend on the actual
circumstances. Our report is open. It does not say that you should and it does
not say that you should not. It says that you should look at it on a
Lifehouse and the Benevolent Society suggested the bond market could be
stimulated through a government guarantee of repayment for qualifying social
bonds. This would bring confidence to investors that they will see a return on
The Federal Government could provide a guarantee of repayment
for qualifying social bonds. Unlike financial institutions, charitable organisations
would be unable to pay for this guarantee. However, if potential investors
could be completely confident of the return of their principal, then we would
expect that significant additional demand would be uncovered.
The Benevolent Society does acknowledge, however, that a government
guarantee on the social bonds may present monitoring issues and a moral hazard
JBWere proposed the use of an arbitrage bond as a means of providing
finance for social ventures, suggesting that 'it has the scope to dramatically
change the way certain social and environmental programs could be funded in
The concept hinges on the establishment of a Special Purpose Vehicle
(SPV) which is guaranteed by government. JBWere proposed an example in which the
SPV issues a ten-year Medium Term Note (MTN) with a five per cent indicative
return. The SPV invests the funds raised by the MTN in a portfolio of fixed
income securities (such as through the major banks) on a return of seven per
cent. The bank then pays a coupon to the SPV, and the SPV distributes the proceeds
to investors. The remaining profit from the fixed income securities would be
used to provide an annual payment to the chosen social organisation. Upon
maturity of the bond, the securities are redeemed by the banks and the SPV
issues the proceeds to repay the investors. 'The ultimate outcome being the tax
pay[er] is relieved of any repayment or funding obligation via this instrument'.
Further, the final 'pay-out' of the SPV places a time constraint for the term
of the government's involvement.
Social impact bonds
Social impact bonds (SIBs) are a new financial instrument to fund the
activity of social economy organisations that address complex societal problems
through preventative social schemes.
A bond-issuing organisation offers bonds to investors, based on a contract with
government, to deliver improved social outcomes that generate future cost
savings for government. The government uses these savings to pay investors a
reward, in addition to their principal, if improved outcomes are achieved.
If improved outcomes are not achieved however, the investor is not paid. For
example, investors could develop a social bond with a juvenile reoffending
program, with a target to decrease reoffending rates by an agreed percentage.
If this target is met then a success fee would be paid to the investors by government.
SIBs have the potential to help fund a number of policy applications, including
rehabilitating prisoners, reducing homelessness, providing parenting skills for
at-risk families and helping ill patients to live at home.
The implementation of social impact bonds internationally has led to a
growing interest and application of Social Impact Bonds (SIBs) to generate
capital for social ventures within Australia:
The emergence of a range of ‘social impact bonds’ in
Australia provides a timely opportunity for Government to take a new concept to
scale quickly and as a cornerstone investor potentially play an important role
in redefining the scale of social finance in Australia. If successful, this
would provide crucial impetus in attracting new players and investment of
resources into this activity.
A number of submitters expressed interest in SIBs.
The Community Council for Australia noted that despite the limited demand for
SIBs and limited capacity currently within social economy organisations, a
number of dedicated organisations continue to pioneer the concept.
Social Finance Pty Ltd found that while many social economy organisations showed
interest in SIBs, few had the experience and the resources required and instead
'are looking for an experienced intermediary to broker the requisite deals and
assume appropriate contract risk'.
Sir Ronald Cohen argued that supply of new investment products such as SIBs
will create its own demand:
First, let’s remind ourselves that all new investment
products begin without a track record and with a very limited pool of available
capital. They have to create their own market. We know that, so far as
entrepreneurs are concerned, the supply of money creates its own demand, and in
the debate about capacity-building and the flow of capital – a debate akin to
the conundrum about whether the chicken or the egg comes first - the answer is
always that both must happen at the same time. Other new forms of investment,
including venture capital, private equity and hedge funds - and, more recently,
micro-finance - have successfully been built from lowly beginnings into
significant new asset classes in a relatively short time. There is a need and
an opportunity for impact investments to do the same.
Developing the capacity of social economy organisations is discussed
further in chapters 2 and 3, and the role that intermediaries play in
developing the capacity of social organisations is discussed in chapter 5.
Advantages of social impact bonds
For governments, SIBs are a way of addressing an intractable social
problem and raising funds for the provision of services. For the private
sector, the bonds are an opportunity to invest in non‑government
Sir Ronald Cohen emphasised the benefit of SIBs in terms of attracting
capital for social economy organisations in a way that is not possible through
philanthropy. He argued that the key to establishing the bonds is the ability
to accurately measure policy outcomes.
The Office for the Not-for-Profit Sector in the Department of the Prime
Minister and Cabinet made the following comment:
We suggest that there are six characteristics that are
important for successful social impact bonds, and they are as follows. Firstly,
they bring new resources to the table. Secondly, they harness social innovation
by both the not-for-profit sector and social investors more broadly. Thirdly,
they support participation and community based action to help solve problems.
Fourthly, they share risk between government and the private social investors.
Fifthly, they have clear and measureable outcomes as the basis for incentive
payments to investors. Sixthly, they focus on interventions that prevent
consequential social problems and their associated costs to government.
In a November 2010 paper, the Young Foundation in the UK identified some
of the following advantages of SIBs:
they act to correct poor incentives and attain new sources of
they promote evidence based action;
they allocate resources to where they can achieve greatest
SIBs achieve real risk transfer.
The Archerfish Foundation contended that SIBs may be utilised both as a
means to invest in social innovation and a way to provide ongoing funding for
proven service delivery methods. It noted that organisations with new ideas for
social service delivery that may need investment funds in order to develop and
scale up their innovations could benefit from small scale SIB opportunities
(i.e. $5-10 million in funding over 2-5 year time periods). Concurrently,
larger scale SIB offerings managed by intermediary organisations, referred to
as Social Impact Bond Issuing Organisations (SIBIOs), could help address areas
of persistent social policy failure by incentivising the provision of clear
Challenges for social impact bonds
The Young Foundation also identified four challenges for SIBs, and the
means to address them:
a general caution that social policy innovations should not aim
to achieve too much—the Foundation suggests that SIBs should aim to achieve an
impact of between 10 and 20 per cent;
investors and the government must be 'confident that the metric
used in the bond has no systematic bias and is on average a fair measure of
be clear about what constitutes a saving to the government purse;
the Foundation noted that SIB partners will take advantage of the scheme design
by putting resources into those aspects of the program that will achieve
greatest savings; and
be aware that unintended consequences from SIBs could potentially
alter incentives for existing funders and providers.
Submitters to the inquiry emphasised that SIBs can only be applied to
policy areas that have measureable results.
Developing a measurement framework is discussed further in chapter 8.
The UK social impact bonds trial
In September 2010, the UK formally introduced a SIB programme based on
prisoner rehabilitation targets. It is the first programme of its kind in the
world and will run for six years.
The scheme is jointly run by the Ministry of Justice and an ethical
investment bank, Social Finance. Investors have bought £5 million in
SIBs—issued by the British Government—to fund rehabilitation work with 3000
Peterborough Prison inmates. They could earn a return of up to £8 million from
the government and the Big Lottery Fund (BLF)
if their cash helps rehabilitate criminals. Reoffending among the target group
must fall by at least 7.5 per cent to trigger the dividend payments in each of
the six years of the bond's operation. It is estimated that the UK government
will save £10 per participant for each pound invested in the resettlement
Sir Ronald Cohen discussed details of the pilot with the committee:
We [Social Finance] use this money to initially fund three
not-for-profits that are working with prisoners—that is, training them while
they are in prison, funding them when they leave prison so they can make it to
their first benefits cheque, helping them to find jobs and giving them the
community and psychological support that they need to reintegrate into society.
If, over a period of six or seven years, these not-for-profits are unable to
reduce the rate of recidivism measured against the control group—this being a
group of prisoners 10 times the size of the assisted prisoners with similar
demographics across the UK—by 7½ per cent then the money is lost by the
investors, so it ends up being a philanthropic donation. But if we are
successful in reducing it by between 7½ per cent and 15 per cent, the
government will pay back the capital and a yield of 2½ per cent to 13 per cent
a year. According to our calculations, government would be paying out one-third
of the saving. So you can see that it is a very powerful instrument because for
the first time the St Giles Trust and the other not-for-profits that are being
funded have access to significant capital over many years and are focused on
achieving social outcomes; their performance becomes crucial to their ability
to raise bonds in the future.
Of the £5
million raised through the SIB, two-thirds of the 17 foundations and charitable
trusts opted to allocate the finance through their balance sheets rather than
out of their grant allocations. Sir Ronald Cohen noted that: 'you have £100 billion of assets in
foundation balance sheets, and you have a couple of billion pounds that are
given away by foundations...so if you can begin to use these financial
instruments to attract capital from the balance sheets...you start off with a
massive amount of money that can be focused on social issues'.
Challenges associated with the
In January 2011, it was reported that the UK Treasury was yet to decide
on how it would underwrite the bonds, and there were departmental questions
about who would issue and pay out on the bonds.
A report commissioned by the UK Ministry of Justice and completed by RAND Europe
in May 2011 examined the lessons learned from the early stages of the
Peterborough pilot, and confirmed that these outstanding issues with the pilot
have been resolved. The report noted that developing the payment model for the
pilot, whereby successful outcome payments will be made by the Ministry of
Justice and the BLF, demanded considerable analysis and resources.
The report noted that future SIBs may share outcome payments across central and
local government departments and other agencies, in cases where potential
savings occur across multiple portfolio areas.
BLF have agreed to contribute to up to £6.25 million to the Peterborough
Sir Ronald justified the involvement of the BLF as a means to overcome
Treasury's limitation in forecasting outcome payments for the bonds in 6-8
The big question is, 'Do we give government departments the
budgets to pay out several years from now?' Again, there was a reference in the
report I read that somehow a weakness of the first bond was that the Big
Lottery Fund in the UK, which is a charitable pool funded by the lottery, had
had to put money up. The only reason the Big Lottery Fund came in alongside
government is that the Ministry of Justice did not have sufficient money in its
budgets, six to eight years out, to pay out in the event the bond was
successful. We are talking with the government in the UK in order to get social
impact bonds going. The second one is being funded now. The first investment of
Big Society Capital is in fact in backing the Private Equity Foundation to
launch a social impact bond dealing with adolescents at school who are in
danger of not finding a job. I think we can already see that governments are
going to need to make a pool of capital available six to eight years out to pay
out on the success of social impact bonds, which government departments either
have a specific allocation from or compete for.
Since the establishment of the Peterborough trial, there has been the
announcement of an additional £40
million SIB trial targeting disadvantaged families in four communities in the
It has been reported that investments in future SIBs will attract tax
concessions under the Community Investment Tax Relief program.
Funding for 'pay for success bonds'
in the United States
The President of the United States, Barack Obama, allocated US$100
million for seven pilot programmes using 'pay-for-success' bonds (conceptually
the same as the social impact bond). Theterms of the US budget appropriations
allows funds for the bonds to support long-term performance agreements, beyond
the traditional 1‑2 year grant programs. It also allows any unused funds
for the bonds to be re-used for other high priority activities in the future. The
mayors of New York City and Baltimore have shown interest in the bonds. A
possible candidate for a pilot in the US is the National Guard Youth Challenge,
which applies military discipline to provide skills training to at-risk youth.
In addition, the state of Massachusetts, USA, has recently issued a call
for information on social innovation financing, including pay-for-success
contracts and social impact bonds.
The New South Wales social impact
In November 2010, the New South Wales (NSW) Government announced that it
would trial SIBs to deliver non-government community programmes.
The CSI was appointed to formally provide advice on the programme:
CSI consulted with a range of potential social investors and
their advisors, who confirmed that there is an appetite amongst investors for
the use of SIBs. SIBs offer social investors a method of achieving blended
value with both commercial and measurable social return on their investment. A
SIB provides social investors with a more effective method of holding a [NFP]
to account in terms of setting targets and monitoring performance akin to that
used in commercial investment decisions.
CSI identified a range of policy areas and program interventions that
address complex problems suitable for a SIB pilot that are close to realisation.
These include juvenile justice, parenting support for vulnerable families,
disability, homelessness and mental health.
Mr Les Hems, Director of Research at CSI, elaborated on how a SIB could act as
a cost-saving measure for the NSW government in relation to foster care:
The idea of being able to restore a child to the family of
origin then when we know that the cost per child in New South Wales is around
$40,000 per year. We know there are 17,500 children currently in foster care.
If there is a program which is efficacious in terms of preparing the family of
origin to receive their child back again, then clearly that presents huge
future cost savings to government. Clearly you would need to measure it over a
period of time, so you structure something like a bond with perhaps a five-year
term and then during that five years you actually seek to restore, say, a
number of children over that period of time. Units of reward payments are paid
to the initial capital investors—the private capital that comes in is from
investors. They will get their principal repaid and also a reward payment on
the basis of delivering a certain number of children.
CSI has also identified a range of social economy organisations with the
capacity to host a SIB program and who have the legal power to issue a bond.
CSI proposes that a social finance intermediary (as used in the UK model) is
not necessary for the NSW pilot as social economy organisations that are
incorporated have the powers to issue bonds.
Larger social economy organisations usually operate within a framework of
result-based accountability, employing professional staff, utilising
professional advice, engaging with social investors and having research or
evaluation teams. They also have large asset bases which could be rated using
an independent rating service to evaluate financial strength and the ability to
pay the bond's principal and interest in a timely fashion.
Christian Super discussed in its submission how the government's involvement in
a SIB contract acts as a form of guarantee, and would in turn improve the
rating of a SIB:
According to the Rating Agencies models, the rating of an
issuance of bonds or loans is as high as the rating of the institution that
guarantees the scheduled principal and interest payments on that issuance. If
the government guarantees issuance of Social Impact Bonds, for example, then
that issuance should have an implied rating of the government i.e. AAA. This
will lower the cost of funds, increase liquidity and diversify funding sources
as institutions with a lot of funds but low risk appetite like insurance
companies and superannuation funds add Social Impact Bonds into their
portfolio. Naturally this is dependent on the details of the each underlying
CSI argued that Australian interest in SIBs is from, 'not just the
philanthropically minded social investors but also some of the mainstream banks
and investment houses like AMP Foundation':
In the UK it was all charitable trusts, but within our
discussions with investors we found a broader set of support. We have spoken to
a number of mainstream financial institutions who have expressed support in
these types of initiatives as long as they are big enough. For them it is the
deal size that is the problem. Fundamentally, it is all about negotiation. This
is all based on an outcome based agreement between government and a not for
profit, but pricing can only be done when governments have agreed what outcomes
it is achieving with a not for profit, the scale and the reward payment for a
child being restored or a period of reoffending. That negotiation is the key.
To articulate how far we have got in some of the discussions, some of these are
pretty close to being investment-grade products, so these will be attractive to
Sharing the risk
CSI has identified a range of options for the terms of the bond that
provide different levels of risk sharing across government, the social economy
organisation and social investors. The options allocate a greater reward to a
high risk capital investment, while the rate of return will be lower as the
At one end of the risk spectrum, the principal and reward payment
(return on investment) to investors is completely dependent on a successful
outcome. In this instance, the full transfer of risk lies with the social
investor as reflected by a higher indicative reward payment. However, the
number of investors prepared to take this option is limited. At the other end
of the risk transfer spectrum is an option for social investors to protect
their capital, where only the reward payment is at risk. This option offers
little incentive to government as there is only minimal risk transfer to social
investors and the social economy organisation.
CSI has therefore formulated an option to balance risk sharing between
government, social economy organisations and social investors. This option
requires that a portion of the costs the social economy organisation incurs
delivering the program is to be paid by government through a standing charge. The
remaining costs and reward payment will be dependent on a successful outcome of
the programme. This risk sharing arrangement will lead to a moderate level of
reward payments. CSI reported that social investors responded positively to the
option which included the standing charge.
Benefits a number of stakeholders
Mr Les Hems of the CSI has outlined the benefits for social economy
organisations as well as financial investors, noting that a SIB can remove the
burden of high-level government involvement in non government organisation (NGO)
SIBs encourage social innovation and the development of
programs which focus on early intervention, prevention or breaking the cycle of
dependence. The performance nature of SIB focuses stakeholders’ attention on
the delivery of the agreed outcomes. NFPs will be attracted because SIBs
provide them with capital up front and remove government involvement from the
day-to-day delivery of programs.
The SIB mechanism is also attractive to philanthropists and
social investors who often find it difficult to know which NFP to support and
cannot assess what their generosity has actually achieved. For philanthropists
with a grantmaking mindset, a successful SIB offers the opportunity to recycle
their philanthropic funds. However, it is the potential for SIBs to
substantially grow the overall capital and revenue funding base of the sector
which makes them most attractive.
The NSW Government is estimating savings of between $4 and $17 for every
$1 it invests
and announced on 6 September 2011 that it will launch a pilot tender process
for 'Social Benefit Bonds'. The first two bonds will be aimed at foster care
and lowering reoffending rates among former prisoners. NSW Treasurer Mike Baird
said the trial provides an opportunity to 'creatively look at delivery of
critical social outcomes while at the same time minimising long-term fiscal
risks to the budget'.
Indigenous impact bonds
Ecotrust Australia highlights the need for innovation to create
sustainable prosperity for Indigenous Australians. Its research indicates that
Commonwealth, State and Territory governments have spent $4.2 billion on
indigenous programs which have been 'disappointing at best and appalling at
Ecotrust proposes the creation of an indigenous impact bond, or I2B to 'attack
intractable problems in the indigenous space'
and facilitate investors’ 'eagerness to invest in better outcomes for
The risk would then transfer to corporate and philanthropic capital, and
government would only reward investors if social impact is achieved.
Ecotrust suggested that the I2Bs will create a different role for
government, one 'that is less about delivery and more about supporting
Ecotrust intend to act as a facilitator for social impact partnerships and
aggregate capital by convening investors for the bonds.
Ecotrust identified three key elements to implementing the I2Bs; interest in
Indigenous communities, willing investors and political will to issue the
Cape York Institute's (CYI) sister organisations have conducted
preliminary studies into SIBs and concluded that they are not appropriate for
them at this stage due to their scale and the lack of measurable outcomes. CYI
was, however, interested in SIBs as a catalyst for the sector to move from
outputs based measurement to outcomes, and how this would specifically benefit
What was particularly interesting to me about reading about
the structure of the UK social impact bond was the clear tie between reward to
investor and actual tangible social outcome. That is not something that exists
in many of the funding arrangements which we have to deal with on a regular
basis. In fact Noel Pearson is on record quite recently for talking about the
nature of incentives to job service providers in remote Indigenous communities;
the extent to which training is incentivised and a churn of people is
incentivised rather than placing and keeping people in long-term employment. A
similar comment could be made in relation to Indigenous health initiatives
where, again, it is the number of healthcare checks you have rather than the
level of, say, blood pressure in the community or the instance of diabetes.
They should really be the guiding principles.
The committee pursued the concept of an indigenous SIB utilising
multiple service providers with Sir Ronald Cohen:
Senator STEPHENS: ...if we were to look at a social impact
bond being developed to address issues of Indigenous disadvantage, we would be
unlikely to have one organisation. We would need to have a network of
not-for-profit organisations involved in trying to really drive a significant
social outcome. Can you see that that would work in that kind of an
environment, where you would have many players?
Sir Ronald Cohen: Yes, indeed. In the case of the
Peterborough bond, we start off with three players. I think the number has been
expanded to five as others are becoming interested in it. I could see that
there would be many bonds that are raised by organisations which have the
internal expertise to deploy the money to a number of not-for-profits and to
test the not-for-profits for their effectiveness and then give more of the
social impact bonds issued in subsequent years to those who are performing
better. So the model does not require you to raise social impact bonds for one
organisation, although there will be some organisations with the credibility to
Ecotrust is currently consulting with a number of governments and
agencies about the potential to run I2B pilots.
Mr Ian Gill, Chief Executive Officer of Ecotrust, maintains that SIBs present a
'leadership moment' for Australia to address the intractable problems that have
emerged in remote indigenous communities:
The government's role in the end in a bond is to basically
say, 'If you achieve your outcomes, which are our outcomes as government, we
will pay for those outcomes. We will be bonded to pay for the productive
outcomes that you have set out and that you are taking the risk on.' The real sticking
point becomes in the end: does the government have the appetite to underwrite
such a bond. To some degree, again not to be impolite, does the bureaucracy,
which at the moment is currently in the grip of this $4 billion box, have the
will to pull back a bit and let Indigenous people and their social impact
partners actually take a lead in delivering outcomes for themselves. If that
magic can somehow be created, then I think there is the possibility well beyond
just replicating CDFIs or doing something like somebody else has done somewhere
else in the world. I think there is a leadership moment for Australia here,
which is not easy to achieve but can be achieved...The need is there. Do we
have the wherewithal to step up is really my question.
Federal government application of a
Associate Professor Cheryl Kernot of the CSI told the committee that a
SIB could work jointly between the Commonwealth and a state government, particularly
in the area of housing, and that the savings could be disaggregated at both
The federal government has been monitoring the progress of SIBs both in
Australia and abroad. The Department of the Prime Minister and Cabinet noted
that while this form of investment vehicle may not suit every situation, there
may be some instances that warrant a SIB pilot at a federal level:
We have been looking at this [SIBs] and carefully watching
some of the examples that are going on both in Australia and overseas and
determining the advantages and disadvantages and some of the pitfalls. As I
said earlier, we are cautious in relation to them. They will not suit every
circumstance, and it has been quite interesting watching where some of the
early examples of social impact bonds are being applied and in what sorts of
...given the pioneering work in the UK and more recently here
in New South Wales, we believe there is merit in considering the potential of
social impact bonds. The groundwork has been done in other jurisdictions and
they provide useful foundations for broader action in Australia. As a new
financing vehicle, social impact bonds appear to provide promising community
The committee acknowledges the global trends in social impact investing,
and the suggestion that a new asset class may well be emerging. There are a
number of measures that can be undertaken in the Australian setting to keep pace
with these developments.
The development of a social bond market in Australia could bring
significant finance to the social economy and thereby relieve the government of
some social infrastructure costs. There are, however, significant hurdles to
overcome in order to attract investors to this market. The lower rate of return
on a social bond coupon (due to the social dividend component) presents challenges
when competing in the commercial market. As a result, the current market for
social bonds would be somewhat limited, and most suited to investment minded
philanthropists. The committee considers that government support is required to
catalyse this market and that further research should be conducted to determine
the feasibility of government top-ups for social bond coupons in the form of
either cash or tax credit, or alternatively tax exempt coupons. A government
guarantee on social bonds should also be examined.
The committee notes the SIB pilots in Peterborough in the UK and in NSW.
SIBs present an opportunity for government to ensure that service delivery
contracts produce their intended outcomes as well as delivering significant
savings for government. They leverage additional capital for the social economy
through government partnerships with philanthropists and the wider investment
community. SIBs also expand the impact investment market by offering an
investment mechanism to diversify the portfolios of investors that may not
otherwise consider social investments a viable option.
The committee considers SIBs to be a mechanism to move beyond funding
regimes for social economy organisations that are built around the three year
political cycle. Although forecasting the government's budget has created some
difficulties in the UK, the committee acknowledges the recent announcement of
the US governments 'pay-for-success' bonds and the special funding provisions
included in their budget papers.
The committee recommends that the government identify policy areas where
SIBs could be applied, including consideration of indigenous policy and
programmes. Partnerships with state governments should be considered in cases
where policy areas, such as social housing, require state government
The committee does, however, acknowledge that SIBs and Social Bonds are
not in themselves a panacea to financing social economy organisations. They are
but two mechanisms among an emerging spectrum of capital options within the
social economy. The committee also notes that SIBs will not apply in the
where there are no clear social performance metrics (see chapter
where the risk is too high; and
where the financial return is too low.
The committee recommends that the Departments of Treasury and Finance
and Deregulation to examine ways to create incentives to invest in a social
bond market in Australia including the feasibility of tax exempt income
returns, a government top up on coupons through cash or tax credits and the use
of government guarantees.
The committee recommends that the Office for the Not-for-Profit Sector
identify policy areas where social impact bonds could be applied, including
intractable problems in indigenous communities. The plausibility of creating
social impact bonds in partnership with state governments should also be
The Office for the Not-for-Profit Sector should work with relevant government
departments and agencies and social organisations to implement a social impact
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