Social benefit bonds: Make a difference and a profit

4 September 2012 | By Jeremy King (Partner)

Can a program to reduce the number of children in foster care ever be an appealing investment proposition for the private sector? The NSW government thinks so.

In an Australian first, NSW Treasury is trialling social benefit bonds to attract private funds into social programs aimed at reducing foster care and preventing young repeat offenders from returning to prison.

Social benefit bonds emerged out of the UK, where they are known as “social impact bonds”, and are about to be trialled in New York and Massachusetts in the US. 

In the social benefit bond model, private investors replace government in providing up-front funding to not-for-profit organisations (NFPs) to deliver community programs.  Government only pays for the ongoing costs of the program which includes regular repayments to the private investors.

In return for funding, the NFPs agree to deliver improved social outcomes. It is this focus on improved outcomes which sets the bond model apart from traditional government funding of social benefit programs.

In the NSW trial, a $10 million bond is being developed by Westpac and CBA to reduce the number of days that children spend in foster care. The money will be channelled into a program delivered by the Benevolent Society to support more than 500 at-risk families over five years. A separate bond is being developed with the goal of reducing the number of repeat young offenders in prison.

Improved outcomes, measured as lower demand for foster care, translate to cost savings for government, which can then be directed to other government services.  The fee that government pays to the Benevolent Society will be used, for the most part, to fund the ongoing provision of services.  The balance will be used to pay back the up-front capital as well as provide a return on capital to investors. Ultimately, however, investors only make a return if outcomes are delivered.

Social benefit bonds therefore appear to be a win-win for all stakeholders. But these instruments need a liquid market if they are to succeed in Australia. This means making an innovative, structured product attractive to a broad range of investors in a challenging financial climate.  A tough ask, but not impossible.

From a stakeholder perspective, investors will need assurance that the NFPs responsible for achieving the social outcomes are up to the task.  If not, investor capital is at risk.  NFPs will need to demonstrate a track record of strong governance, financial control and successful service delivery. Those with a history of working with financial institutions and government are likely to be preferred.  Investors will also demand that the procurement process run by government to select the NFPs be efficient and transparent.

From a commercial perspective, the terms of the bond instrument will be crucial.  If returns are capped, or if the principal investment amount could be lost due to failure to achieve certain outcomes, social benefit bonds will initially only be attractive to philanthropic foundations or social impact investors. 

Full risk transfer to the private sector will be difficult for superannuation funds, banks and financial investors to accept as they are not usually in the business of making charitable donations with the funds they manage.

The terms of the bond instrument must otherwise contain the usual commercial terms for a debt instrument: the purpose to which funds may be applied, payment of interest (including any deferral and capitalisation of interest), repayment of principal, and whether the investors have recourse to assets other than moneys received from government. 

Further, the bond instrument must be offered in a way that complies with ASIC prospectus exemptions, and investors would also value clarity from the ATO on deductibility of an investment in, and assessability of interest received from, a social benefit bond, and the impact of the Taxation of Financial Arrangements rules on investment in social benefit bonds.

Finally, the outcomes based agreement between government and each NFP must clearly define the outcomes and provide for a transparent process to assess and measure the delivery of services. The agreement must also detail the outcome payment mechanism including those components that are outcomes based and those that are standing charges.

Despite the challenges faced in developing an active social benefit bond market, they are a progressive step forward in funding programs that address complex social problems.  The community benefits, with fewer children in foster care, or lower recidivism. Government benefits, by not having to contribute upfront amounts, and saving money on preventative programs which can be redirected to other critical services.  Investors benefit by the creation of a new asset class in ethical investing: and an opportunity both to improve society and potentially make a stable financial return.

Click here for more detailed thinking on social benefit bonds.

The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.

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Jeremy King

Partner. Melbourne
+61 3 9672 3431