Laboratory technician Viwat Wornoayporn examines tsetse flies. The U.K. Department for International Development will launch its first-ever development impact bond project, which will tackle African sleeping sickness in Uganda. Photo by: Dean Calma / IAEA / CC BY-SA

Girls’ education in India, malaria in Mozambique, African sleeping sickness in Uganda — all are development challenges that will likely be the test cases for a new financing model known as development impact bonds.

Modeled after social impact bonds, DIBs can help leverage private capital to tackle development challenges: Investors put up the money to fund a development project, a service provider or implementer carries out an intervention to tackle a project, and then an outcome payer or group of payers (in this case development finance institutions or donor agencies) pays for the success of the intervention.

Under this pay-for-success model, the outcome payer disburses a return on the initial investment at a rate determined by the progress made in addressing the development challenge.

But while DIBs have been generating quite a buzz, the model has yet to be tested or proven.

Soon though, there will be some evidence. Last month, the Educate Girls Development Impact Bond became the first DIB launched in India. The U.K. Department for International Development announced in April that it would launch its first-ever DIB to tackle African sleeping sickness in Uganda, and committed to supporting a knowledge-sharing platform. A month before that, the Inter-American Development Bank said it would set up a $5.3 million facility to explore social impact bonds in Latin America. And in September 2013, the South African fast food restaurant chain Nando’s decided to partner up with D. Capital to combat malaria in Mozambique with another DIB.

While development impact bonds are in the spotlight, those working on putting together the complex deals say it’s no easy feat, and it’s only the right tool in very specific situations.

Testing the model

These first several DIBs in particular have proven to be quite challenging to set up and will serve as pilots so that future potential organizers can learn from their experiences.

“Outcomes-based contracting is relatively new in the development space and quite a bit of upfront work needs to be done,” Rita Perakis, a program associate at the Center for Global Development, told Devex. While it is too early to assess how DIBs can contribute to funding development, there is a growing appetite for exploring the model.

Those working on DIBs are trying to determine how to craft detailed, sensible propositions for investors and test the model. The first pilots will seek to do those things and likely won’t choose the riskiest project or environments in an effort to learn and prove the case.

For instance, the plan to tackle malaria in Mozambique hit some roadblocks, said Lily Han, an associate at D. Capital who is working to organize the DIB.

Since the bond was launched, the private equity firm began coordinating with the country’s Ministry of Health, and that process continues. Donor priorities have changed, however, and as the government determines its funding and makes some policy decisions, the bond is now on hold.

In the meantime, D. Capital is speaking closely with donors about their long-term funding strategies and working through the process to eventually secure them as outcome payers.

Once the government is on board, the next step is to bring together the potential outcomes payers for a technical meeting to determine the structure and implementation of the bond. At that point, they can pitch to investors.

What they’re learning the hard way is that DIBs require a long development cycle that is complex, politically sensitive, unpredictable and costly, Han pointed out.

In Mozambique, for instance, they did a small spraying project in December before the rainy season to serve as a demonstration project of what the DIB could achieve.

“There is always a chance things will fall through,” she said, adding quickly that the “core stakeholders are still very committed, and the government is as well” but balancing a number of difficult decisions.

While it also took a lot of legwork and is fully funded, the Educate Girls bond launched in June will take another year to deliver services because it will coincide with the start of the next school year. The bond brings together the UBS Optimus Foundation as the investor, Indian nongovernmental organization Educate Girls as the service provider, and the Children’s Investment Fund Foundation as the outcome payer. Instiglio is the intermediary helping to coordinate the DIB, and they’ve also elected to have an independent outcome evaluator and an independent process evaluation.

“This is designed to be a pilot … that tests the waters and that’s why there is a learning agenda that is put around it,” Michael Belinsky, co-founder and partner of Instiglio, told Devex.

This bond is small, with an investment of about $238,000. The foundation is contributing the money upfront to support what should be more than 20,000 students, half of which are for girls to stay in school and meet education milestones in Rajasthan, India.

“We are not putting a whole lot of money in the first one because this is a learning experience,” UBS Optimus Foundation CEO Phyllis Costanza said. This initial bond is funded through the foundation and wasn’t open to UBS clients, but there has been a lot of interest both from investors and philanthropists who want to stretch the value of their investments.

Depending on the success of the model, the foundation is considering creating a development impact fund that clients could invest in, which would be used to fund what the company identifies as the best projects, according to Costanza.

As these early DIBs build new models, which will likely have to be adapted going forward, they are encountering a few key challenges.

While the Educate Girls DIB is a fairly simple partnership because there is only one of each kind of party, it can still be difficult to get the stakeholders together and agree, which may require some cultural change within the organizations, Belinsky said.

He was not the only one to say that the greatest challenge is managing the process and the variety of actors involved, as Costanza and others echoed those comments.

Another problem is setting the right metrics and ensuring the DIB is designed so that the outcome payer is paying for the right achievements and neither overpaying nor underpaying, or producing negative unforeseen consequences.

“I think that there are definitely questions for each deal about the appropriate rate of return for what you’re getting, what the outcome funder has to pay,” Perakis explained.

When to use them?

What’s clear from all of the bonds underway and those developing them is that this new and unique model is likely best suited in certain instances and simply won’t apply in others.

It is important then that DIBs are tested in a consistent basis and that the circumstances for suitability are determined.

We learned from Belinsky, Han, Costanza, Perakis and others what some of the key criteria for a DIB are:

▪ A DIB can only be considered if there is a clear way to define outcomes and measure them in an incremental way over time.

▪ DIBs are not the right instruments for pilot projects.

▪ DIB projects are likely to be too risky to be funded outright by a donor, but have a proven model. 

▪ DIBs work when there is a need to crowd in investors to help take on the project risk or help provide private sector performance.

▪ DIBs require tangible outcomes that can be defined clearly and can be measured in an incremental way.

▪ DIBs outcomes need to be achieved within a relatively short period of time.

▪ DIBs are not a solution if all you need is new money — they don’t necessarily represent a pool of new money, but money that is being spent differently by donors and development finance institutions. They are best suited to a situation where a cost-effective solution is called for.

▪ DIBs support experimentation and innovation. The pay-for-results model incentivizes adaptation to achieve the best results. While this is broadly true, Han said the early DIBs are unlikely to take quite as many risks because it makes the bonds harder to market.

▪ Some fields are likely to be better suited to DIBs as a funding source. Chief among them is health, where outcomes can be more easily measured. It is likely, however, that there will be experimentation in a number of areas.

For those who are watching eagerly and hoping that DIBs will open up a new source of funding for development, it’s not likely to have that effect, but would primarily be a new way to deploy existing funds.

It may be that donor agencies like DfID take the lead on setting up the DIBs but it may also come from the country government, the investors and the NGO. In the India education bond, the idea arose after Educate Girls spoke at an annual UBS event.

“I don’t see this as replacing traditional funding models,” Costanza said. “I think it is a lever to improve broader public accountability, to push donors and development agencies toward what works.”

As these DIBs are tested and others come up alongside them, there will be a growing number of actors who are interested and experimenting with the model, which will require broader market support through new organizations and structures, as well as increased developing country capacity.

Also, transaction costs — which are especially high with these early movers — should be reduced as the model is established and some of the complexities ironed out.

“It seems to me we are going at an appropriate pace,” Perakis said. “We don’t want it to be too hyped up and see too many deals not diligently thought through, but at the same time we want to see enough that we can learn from.”

This story is part of a series on impact investing. For more, check out our Storify page on “Impact Investing 2.0: The evolving social finance landscape” and tweet @DevexImpact using #impinv.

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

About the author

  • Adva Saldinger

    Adva Saldinger is a Senior Reporter at Devex, where she covers the intersection of business and international development, as well as U.S. foreign aid policy. From partnerships to trade and social entrepreneurship to impact investing, Adva explores the role the private sector and private capital play in development. A journalist with more than 10 years of experience, she has worked at several newspapers in the U.S. and lived in both Ghana and South Africa.