Opinion: Why development impact bonds could become a lot more important

Philanthropy is growing but not at a pace sufficient to meet the estimated needs of the United Nations’ Sustainable Development Goals. To do that, we need tools more effective at achieving results. Enter development impact bonds, or DIBs.

DIBs are results-based contracts that fund the delivery of social services.

They are becoming increasingly important as tools for creating measurable impact. Based on Brooking Institution Global Impact Bond Database and UBS Optimus Foundation projections, we have already seen more funding in DIBs in the past two years than in the previous eight and expect the volume of DIBs to increase by over five times to over $2 billion cumulatively by 2023.

While DIBs are not a panacea, they have demonstrated their value both before and during the pandemic. Governments across the world are showing interest in outcomes-based mechanisms, from Singapore to Ghana.

Shifting from inputs to outcomes

Traditional grant-based programs specify detailed inputs for activities, such as teacher training, without any guarantee that this leads to detailed outcomes, such as better learning. DIBs, by contrast, shift the focus from inputs to outcomes in a flexible framework, allowing for innovation and creativity to achieve better outcomes for beneficiaries and benefit partners. The upsides for beneficiaries through better social and/or environmental outcomes can be substantial.

For example, two years into the Quality Education India DIB, funded by UBS Optimus Foundation, we have seen that participating children are learning at twice the pace as those not participating. This is a clear and meaningful difference. The organizations implementing the DIB are incentivized to improve learning and adapt their model so that children can learn as much as possible.

The upsides for funders such as governments are significant. Usually playing the role of the “ultimate payer,” governments now only pay when a third party has certified the outcomes and results have been achieved. The focus on results enables governments to justify spending to taxpayers. In the long-term, it allows governments to mix outcomes-based funding, such as DIBs, into budgets and commission social services more efficiently.

The benefit in times of crisis

A crisis such as the COVID-19 pandemic often creates situations unanticipated in original program designs, or simply not considered for cost reasons. The structure of a DIB and the focus on outcomes acts as a forcing mechanism in such events. It forces partners together to agree on a route ahead. This has important benefits:

1. Ensuring funding predictability in uncertain times is essential, especially if other programs are shutting down, budgets are being cut and other donors pulling out. During the COVID-19 pandemic, swift action from the partners in DIBs funded by UBS Optimus Foundation allowed programs to continue and implementers to serve vulnerable populations.

2. Structural flexibility and focus on results ensure that implementers “automatically” change course and adapt to new situations. This ability to innovate is unique, allowing implementers to think outside of the box. In the Quality Education India DIB, for example, implementers were able to adapt during the COVID-19 pandemic by shifting to smaller groups of children, door-to-door outreach, and remote learning once lockdown made earlier approaches impossible.

Barriers DIBs face and how to tackle them

One barrier to widespread adoption has been the shortage of outcome funding. This has resulted in relatively small impact bonds lacking economies of scale, lowering their appeal to investors. Another is the lack of capacity for implementers to build active feedback loops into their programs for course correction. This requires a culture shift that, in our experience, “high performing” implementers do successfully. Finally, outcome funders must also shift strategically to targeting outcomes rather than input- and audit driven approaches.

To address these barriers, UBS Optimus Foundation is interested in building the market up to scale. With the Impact Bonds Working Group, we have identified three key areas that will help:

1. Sharing best practices.
2. Building an outcomes accelerator providing grants for capacity building and design.
3. Pooling funds on the outcome and investor side of the equation.

Investors have expressed interest in creating a pooled mechanism so that they are not investing in a small, single, bespoke impact bond, rather a diversified pool that will ultimately produce social and financial returns.

DIBs have demonstrated their potential both before and throughout the COVID-19 pandemic and are set for growth. As we look for effective, scalable financing tools to meet the SDGs, and shift our focus from inputs to results, impact bonds are poised to become a valuable option.