Have development impact bonds moved beyond the hype?

When development impact bonds were first discussed about three years ago, there was quite a bit of excitement and hype about their potential. While some of that enthusiasm may still exist, the intervening years and initial experiences of trying to launch DIBs have brought expectations down to earth.

Development impact bonds begin with an investor, who provides the upfront capital for an intervention — be it improved education or a reduction in malaria — carried out by a service provider. If the program achieves specific, closely-measured results, then an outcome payor — in the case of development impact bonds, usually a foundation or donor agency, though it could be a private corporation as well — pays the investor based on how well the intervention succeeds.

DIBs are an adapted form of social impact bonds, which have been around for about six years, and are growing, particularly in the United States and the United Kingdom. The chief difference is in who the outcome payor is; with SIBs the outcome payor is the government. Most SIBs are built around the idea that a particular intervention, if successful, represents significant long-term cost savings for the government. But beginning that intervention is risky, which is where the investor comes in, to take on that uncertainty. A fourth party in these deals, the intermediary, helps to structure the deal, bring parties together and see through the implementation.

In many developing countries, governments are unable to play the part of the outcome payor, either because they lack the resources or don’t have the credit rating and track record to give investors confidence. While there are a few examples where SIBs have been applied in development  — the Inter-American Development Bank has a $5 million to test social impact bonds in Latin America, and an early childhood SIB is in the works in South Africa — the alternative for many developing countries will be with DIB.

For now, there are only two operational DIBs. The investments have proven difficult and costly to put together. It is both challenging and critical to successfully coordinate partners and find a good cultural fit, with a service provider that has a deep commitment to outcomes. Ultimately DIBs represent a fundamentally new way of doing things, which means there are all the growing pains one might expect. Still, there the instrument has momentum, with a number of DIBs on the horizon and expected to be launched in the coming year.

Early challenges

DIBs were initially envisioned as a model of development funding that not only focused on outcomes but in doing so required the quick, rigorous use of data to more effectively deal with complexity, said one of the leaders of DIB thinking, Toby Eccles, founder of Social Finance, a nonprofit organization looking for better ways to tackle social issues,.

That underlying thesis holds true. DIBs can generate enormous value, particularly for people on the ground, as a less bureaucratic way to manage aid programs and implementation, Eccles said.

Yet in practice, getting DIBs operation has proven more challenging. The two existing examples are the Educate Girls bond, supporting girls education in Rajasthan, India, and an investment in Peru supporting coffee and cocoa farmers. Both are very small in scale, in part because some of the more ambitious DIBs have proven difficult to get off the ground.

For every 10 DIBs that are discussed, in-depth work is done on three to four and likely only one goes through, said Avnish Gungadurdoss, co-founder and managing director at Instiglio, a company that specializes in providing technical assistance for the design and implementation of results-based financing.

D. Capital Partners’ work on a malaria DIB in Mozambique provides a cautionary tale of what can go wrong when trying to structure a complex DIB. After about two years of work on the DIB, negotiations came to a standstill among the complex coalition they had built, including the Mozambique ministry of health, donors and several corporations.

“What became very difficult was to get all different players aligned,” said Barbara Kong, a senior investment principal at D. Capital, an impact investment advisory firm that is part of Dalberg Global Development Advisors. Political considerations, including changing government priorities and adjustments to the Global Fund’s malaria strategy, also tripped up the process.

With progress stalled, the DIB group decided to run a pilot to test the innovation, and over the course of two years, they observed a 70 percent drop in malaria in the targeted districts. Now that a baseline exists, D. Capital is reshuffling the outcome funding components and has been working for the last 10 months to identify potential outcome funders. They plan to formally launch the bond with a group of corporations as the outcome payors.

In retrospect, it may have been better to start simpler and smaller in designing the mechanism, Kong said. But the experience and all of its growing pains have led to a number of lessons that could impact the industry as a whole.

What’s been learned

As with any new tool, the early days of DIBs have been filled with experimentation and learning. But the Educate Girls bond in particular is making an effort to test the market and share lessons.

The malaria bond’s rocky start has taught D. Capital about the need for stronger stakeholder management, the importance of identifying a champion on the outcome funder side who can drive the process and the challenges of bringing on a group of parties to play any of the roles, Kong said. Building a strong coalition early in the process is critical, she added.

One thing that has been true for all DIBs is that they take a lot of time, effort and resources to put together. Most take 12 to 18 months to design and build, and the up front costs are steep. The cost of DIBs and the time they take mean that it is important to consider carefully whether they are the right mechanism and if they add value. In many cases, DIBs may not be worth the costs.

“In the end, innovation finance, especially DIBs or SIBs, is a means to an end and not an end in itself,” Kong said. “So we strongly believe it’s a very interesting mechanism, but it’s not the one that is going to be able to solve all the development challenges we have. It’s not a one size fits all solution.”

If a government or donor is willing or able to implement the program and measure outcomes, there is no reason to do an impact bond. However, if there is a lack of capital, a lack of political will, or concerns about the risk, then they might be, said Emily Gustafsson-Wright, a fellow at the Brookings Institution.

According to her, there are a few reasons that there have not been more impact bonds in lower or middle-income countries: Only a handful of actors engaged in the space, language barriers and communications issues related to the tools complicate discussions, and political and legal constraints limit DIBs’ applicability. Moreover, impact bonds may be most beneficial in the “mezzanine stage,” and less good for experimenting with untested interventions.

“This is really a new way of doing business, except in cases where results-based financing has been used,” she said. “Contracting based on outcomes is very different.”

In the Educate Girls bond, for example, participants say it is important to build flexibility and wiggle room into contracts to renegotiate margins as information comes in, especially if initially data is suspect.  

“I think the challenges were trying to adapt something so newly tested in developed countries in the developing world context,” said Phyllis Costanza, the CEO of the UBS Optimus Foundation, the investor in that bond.

Outcomes based approaches also change how donors work: They must do due diligence up front and then leave the service providers to do their work — a very different approach from the existing system that is high touch. “[DIBs] hopefully will create a culture of accountability … and build a level of trust don’t see very often in this sector,” Costanza said.

But to have that trust, the right people must be involved and a cultural fit between the various parties is important, Costanza said. Having an implementer with a team that has a focus on outcomes and strong organizational culture and leadership is an important part of any DIB, and she encouraged investors to scrutinize those teams.

Safeena Husain, the executive director of the India-based NGO Educate Girls, echoed those sentiments. Service providers shouldn’t attempt a DIB if there isn’t a significant internal commitment to outcomes. Performance should be tested in advance through a rigorous impact evaluation. In other words, DIBs are not for early stage organizations, she said.

What now

There are a number of DIBs in the work, but the growth of the tool is dependent on how things develop moving forward.

Instiglio, D. Capital and Social Finance all have DIBs or SIBs in developing countries that they expect will launch in the next year: one in Cameroon for cataract eye interventions, another in South Africa for early child development. Health care and education seem likely to dominate impact bonds in the future because of their measurability and overall interest in those areas thus far.

That may not mean a lot of additional capital, but it can involve private investors in the conversation and raise awareness of the interventions or investment opportunities financiers may not look at otherwise.

But for DIBs to grow, and in fact to become true bonds — a tradeable asset class, rather than a results-based financing mechanism — will still require quite a bit of work, said Trevor Davies, global head of KPMG’s Center for Excellence for international development assistance services.

“To justify the complexity it has to grow in size,” he said. “ I also think you’ve got to start to standardize the design and organization.”

One way of reducing the design costs and limiting the risks may be to create pooled outcome funds that focus on a specific area or issue. But that will require a more robust pipeline of DIBs and many more operational ones.

For now, many potential DIBs processes are likely to hold back and watch how some of the early test cases pan out. There is growing interest at donor agencies such as the World Bank, the U.S. Agency for International Development and the IDB. Still, these are large institutions where change is slow; many lack the mechanisms needed to participate in DIBs.

Even at their small scale, the existing DIBs are having an impact already. The dialogue around them has raised the conversation about results-based financing more broadly and pushed development to focus on outcomes, Gustafsson-Wright said.  

“The fact is billions, trillions are being spent on things that are not working, so the development community really needs to continue to push towards that outcomes thinking,” she said.

Join Devex to network with peers, discover talent and forge new partnerships in international development — it’s free. Then sign up for the Devex Impact newsletter to receive cutting-edge news and analysis at the intersection of business and development.