Catalyzing capital markets the social sector to achieve sustainable development goals

By R.R. Prasad*
The social sector is rarely financed for capacity and scale. In fact, government cannot afford to meet all of the growing demand for social services, and that philanthropy and generosity are insufficient to fill the gap. One highly effective solution would be to create an enabling environment in which government and the private sector can come together on a common platform to catalyze efforts towards achievement of the sustainable development goals.
Private investment and a robust private sector are fundamental drivers of economic growth and job creation, which are key ingredients to help tackle poverty. The private sector can have a transformational impact on peoples’ lives as a creator of jobs and producer of goods and services that poor people use.
Our social sector needs the creation of instruments that will allow market forces to enter it, and there are in fact a number of well-meaning backers of this plan who are working to extend capital markets into the social sector. The important challenge therefore is to make development a profitable enterprise in order to attract private sector investments to diffuse the deficits in development finance. Examining how private sector development can be leveraged to support poverty reduction and promote sustainable, equitable and inclusive economic growth is very crucial.

Impact investment

As government funding for social welfare declines, attention has been focused on new financing mechanisms — such as social impact bonds and pay-for-success contracts — that may be able to attract private investment to meet society’s critical social needs. Impact investing or purpose-driven finance are the new investment approaches that have emerged globally amongst governments and markets in response to this important challenge. Impact investment refers to the provision of finance to organizations with explicit expectations of financial returns as well as measurable social outcomes. The distinguishing feature of impact investing is the intention to achieve both a positive social, cultural and/or environmental benefit and some measure of financial return.
Impact investment is already having a positive effect globally in catalyzing new markets and encouraging entrepreneurship and innovation for the benefit of society. A hallmark of impact investing is the commitment of the investor to measure and report the social and environmental performance of their underlying investments.

Outcome-based funding

Over the past decade, outcome-based funding mechanisms have attracted a great deal of attention. The growth of outcomes-based models is evident in the growth of impact bonds, a category of outcome-based funding. Outcome-based funding models (also known as “Pay for Performance” and “Results-Based Financing” models) refer to financing mechanisms in which a funder makes payments based on specific achievement of predetermined outcomes.

Impact bonds

Impact bonds (IBs) are one type of outcome-based contract. In contrast to traditional public service contracts which tend to link payments directly to the inputs and activities of the service, outcome-based contracts focus on improving the level of life for service users, rather than individual services, by linking payments to outcomes. Social impact bonds (SIBs) are a form of outcomes-based contracting, in which a third-party investor provides the upfront capital to finance service delivery, and is repaid (with a premium) if specified outcomes are achieved.

Pay for Success

Payment for success (PFS) is an approach to outcomes-based funding. PFS provides payment for services based on measurable progress and outcomes. It has been used to support initiatives such as early education, job training, criminal justice reform, and health interventions where the most desirable results are achieved over time (elementary-school readiness, long-term employment, reduced recidivism, improved health). The up-front costs of implementing these programs are usually covered by mission-focused investors.

Social Impact Guarantee

The Social Impact Guarantee (SIG) is a new type of outcomes-based funding model that offers money-back guarantees in order to accelerate innovation and improve program results. SIGs combine the core benefits of outcomes-based funding models like the social impact bond (SIB) and development impact bond (DIB) and enable public, philanthropic, and impact investing organizations enjoy the SIG’s insurance-like features.

Community Investment Guarantee Pool

The Community Investment Guarantee Pool (CIGP) is a first-of-its-kind vehicle within community development finance. It pools the guarantee commitments of a wide spectrum of mission-minded investors into one entity. In turn, the Pool provides guarantees to intermediaries, such as community development financial institutions (CDFIs), for three sectors: affordable housing, climate change and small business. With a pooled model, philanthropies prorate their risk, find new ways to collaborate, increase their impact, and give intermediaries a one-stop-shop to turn to when they need credit enhancement to get a project financed.

Overhead costs

While Indian companies have primarily trusted nonprofits to implement their CSR programs, they would benefit from partnering with organizations with other kinds of competencies. Nonprofits have been campaigning for years for funders to end their practice of providing full support for programs and services while cutting overhead costs. As a result, organizations are caught in a vexing “starvation cycle” that constrains their ability to invest in essential infrastructure and creates conflict, even dishonesty, between grant makers and grantees. Many funders and intermediaries have recently joined nonprofits in calling for a new approach to grant making. The model they collectively support centers on an idea that we call “Pay-What-It-Takes” (PWIT) philanthropy—a flexible approach grounded in real costs that would replace the rigid 15 percent cap on overhead reimbursement followed by most major foundations.

Regulatory frame

The impact investing market infrastructure is not fully developed, as current intermediaries are relatively small. Further, investment incentives and a supporting regulatory frame are missing. The impact investing market can be developed if actions are taken to establish a functioning ecosystem. It is essential to equip key stakeholders with the core conditions for decision-making across different facets of impact investment market activity in India.
By themselves, Indian companies are cognizant that they may not move the needle on critical development problems. CSR funding, is a fraction of the overall funding needed for social development in India. However, catalytic models like those highlighted here leverage traits unique to companies—including rigor, the ability to innovate, and the willingness to collaborate—that can lay the groundwork for greater efficiency and impact, and facilitate scaling.

Creating functioning ecosystem

Mobilizing market forces for contributing to social welfare is a great challenge. We need plenty of investment-ready social entrepreneurs with an understanding of the investment landscape, a risk-taking mindset, and sufficient expected returns to offset the investment transaction costs. Companies need to shift focus in two ways: from individual to ecosystem, and from delivering services to building capacity and enabling the market. In other words, companies need to deploy their own capital in high impact startups that can deliver a risk-adjusted commercial return, and take the lessons from these business models to government to enable better regulation, leveraging market principles to catalyze key social sectors like affordable housing, waste management, education and agriculture.
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*Professor (Retd.), National Institute of Rural Development & Panchayati Raj, Hyderabad