BUSINESS DEVELOPMENT SERVICES SOCIAL IMPACT BOND: POLICY PAPER PRESENTATION

1

AGENDA 2

1. Welcome & Introductions

2. Presentation of Policy Paper

3. Presentation of Policy Recommendations

4. Comments from Advisory Group

5. General Q&A

INTRODUCTION TO SOCIAL IMPACT BONDS 3

‘Social Impact Bonds are an innovative method of financing social programmes in which governments partner with service providers and private sector investors to fund social programmes. Investors are repaid if and when improved social outcomes are achieved. Thus, government pays only if the services are successful at meeting the needs of its citizens.’ - Kippy Joseph, Rockefeller Foundation, 2013

Typical Structure of a Social Impact Bond1

1. Social Finance

PETERBOROUGH – THE FIRST SOCIAL IMPACT BOND 4

Social Finance launched the world’s first social impact bond (SIB) in September 2010. It aims to reduce reoffending among short-sentence prisoners in the UK:1

Providing a community base

INVESTORS

£5 million

SOCIAL IMPACT PARTNERSHIP

Support in prison, at the prison

gates and in the community

Support to prisoners’ families while they are in prison and post

release

Support needed by the prisoner, in

prison and the community.

Funded as the need is identified

3,000 male prisoners sentenced to less than 12 months

Reduction in re-offending

MINISTRY OF

JUSTICE /BIG

LOTTERY FUND

Payment based on reduced convictio

ns

St. Giles Trust Ormiston Trust YMCA Other Interventions

Return depends

on success

1. Social Finance

SIBS HAVE GLOBAL MOMENTUM 5

More than 20 SIBs raising over US$100 million have been commissioned globally

Impact bonds are under development in the UK, US, Australia, Canada, Portugal, Israel, Colombia, South Africa, Mozambique and Uganda among other nations

£60 million of funding has been allocated by the UK Cabinet Office and Big Lottery Fund for SIB Development in the UK and SIBs were included in the 30% Social Investment Tax Relief in the UK budget

US$300 million was allocated in the White House FY2014 budget for SIB development

Organisations developing SIB policy include the Taskforce on Social Impact Investment (established at G8 Social Impact Investment Forum in 2013), the UK Centre for SIBs and the US Harvard Kennedy School SIB Lab

OVERVIEW OF BDS SIB PROJECT 6

Objective: Assess the feasibility of a SIB focused on SME development, and the potential for SIBs more broadly, in South Africa

Commissioner: National Treasury of South Africa and Flanders

Primary research question: Can a BDS focused SIB be a viable vehicle by which to drive SME development and thereby employment creation in South Africa?

Project process:

1) Industry research to define the need for and potential benefit of a BDS SIB

2) Interviews of BDS providers to define the potential social impact, target groups, interventions and outcome metrics of a BDS SIB

3) Workshops to gather feedback on potential benefit and design of a BDS SIB

4) Presentation of Policy Paper

POTENTIAL OF SIBS IN SOUTH AFRICA7

SIBs hold promise to improve service delivery in South Africa through:

• Rigour: SIBs bring greater focus on agreeing the outcomes desired by a programme upfront, and then measuring the effectiveness of delivery in order to decide payment

• Innovation: SIBs transfer risks to socially-motivated investors who have a greater appetite for testing innovation and funding new models

• Flexibility: SIBs create incentives to put in place the necessary feedback loops, data collection and performance management systems required to learn from local circumstances, resulting in a bottom-up, client-centred, and potentially a more effective approach to service delivery

SIBS OFFER ADVANTAGES TO KEY STAKEHOLDERS 8

In addition to the potential to improve service delivery, SIBs offer:

• Service providers: Upfront funding paired with extensive data collection and analysis, which allows providers to to expand their services and adapt and learn from the data to improve their programmes and achieve greater impact

• Outcomes funders: Transfer of outcomes risk through payment only for results

• Social investors and foundations: Opportunity to invest in outcomes related to important social issues with possibility of recycling their capital

• Target group: Outcome focused service delivery from evidenced based interventions

IDENTIFYING STRONG OPPORTUNITIES FOR SIBS 9

Experience has shown that SIBs add the most value in situations where:

• a pressing social problem has been identified which is a priority for both outcomes funders and investors;

• a target group has been identified with sufficient clarity;

• evidence-based interventions are available for the target group;

• robust outcomes metrics can be developed to measure and attribute success;

• a viable investment proposition can be developed; and

• there are willing outcomes funders who will pay for the identified outcomes if they are delivered.

A PRESSING SOCIAL PROBLEM 10

• Unemployment is one of South Africa’s most pressing social and economic challenges

• Potential exists to generate employment through strengthening SMEs in South Africa:

• SMEs in South Africa account for approximately 55% of GDP and 61% of employment1

• But the failure rate of SMEs is high, with only 2% established for over 3.5 years2

• BDS could generate employment through strengthening SMEs, but the link is tenuous

• BDS is defined as “… services that improve the performance of the enterprise, its access to markets, and its ability to compete”3

• But BDS may lead to job cuts in the short-term with the aim of achieving business sustainability, and thus does not always generate employment

• This issue will need to be addressed through defining intermediate outcomes that potentially lead to job creation, e.g., survival or growth rates of SMEs

1. Abor, J. and Quartey, P., 2010. Issues in SME development in Ghana and South Africa. International Research Journal of Finance and Economics (39), pp. 218-228. 2. Global Entrepreneurship Monitor (2012). 3. UNDP, ‘BDS How-to guide’, 2004.

Conclusion: A valid social problem can be identified although the link of BDS intervention to the social outcome is more tenuous than would be ideal

TARGET GROUP 11

SMEs with the following characteristics could be suitable for a BDS SIB:

• Geography: Located in an SME “hub” e.g., Gauteng (~30% of SME owners), Kwazulu-Natal (~20%), Limpopo, the Western Cape and the Eastern Cape (~10% each)

• Sector: In the trade and hospitality sectors, which form 45% of all SMEs, the manufacturing and financial/real estate services, which employ the highest number of workers on average, or in the construction, transport & communications sectors that have had double digit growth in the number of SMEs in the past 3 years

• Business Stage: At the early stage, where failure is most likely, or growth stage, where business processes need to mature for sustained success

Conclusion: A target group of SMEs will likely share some combination of geographical location, business sector and business stage so as to enable a clear definition of target impact and to increase successful attribution of outcomes

There are thousands of BDS providers in South Africa and during our research many providers expressed interest in or volunteered to participate in a SIB

Yet, there is little evidence on the effectiveness of different types of BDS:

• Broad-Based Black Economic Empowerment and Enterprise Development environment has provided significant funding for SME development

• But, the high availability of this capital has led to limited accountability for BDS providers and lack of evidence about the success of interventions

EVIDENCE-BASED INTERVENTION 12

Conclusion: Several BDS providers could be contracted under simplified tariff-based SIBs to deliver interventions to SMEs in order to test the effectiveness of different types of services

ROBUST OUTCOME METRICS (I) 13

Outcome metrics form the foundation of the contract between the outcomes funders and investors in a SIB

• An outcome metric must be objective and improvement in the metric must be measurable and achievable within a reasonable timeframe

• Care should be taken around perverse incentives

Research identified several desirable outcome metrics for a BDS SIB, including: Growth in SME survival rates, revenue, profitability and number of employees

• These metrics could also be overlaid with empowerment credentials

Due to the often short-term need to reduce employment during the first stages of a BDS intervention, jobs created as a sole outcome metric would not be suitable

Conclusion: A basket of outcome metrics or a mix of output and outcome metrics could be used to capture the wider impact of an intervention

ROBUST OUTCOME METRICS (II) 14

While control groups are often used to determine whether outcome metrics have been achieved, application of this approach is challenging for a BDS SIB:

• SMEs in the target group and control group need to be equally high potential

• Control group SMEs are likely to receive services from BDS providers outside the SIB

A simplified approach where payment is made on a tariff-basis for outcomes achieved regardless of attribution is recommended:

• Level of payments would be informed by a combination of historical results for an equivalent population of SMEs, past results of participating SMEs and predictions of how external factors will affect outcomes

• Accordingly, SMEs are not excluded from receiving the SIB intervention and the approach is simpler to apply

• But as a result, this approach is less able to identify and take into account the impact of external factors on the outcomes achieved by the SIB intervention.

Conclusion: In a simplified tariff-based SIB, payments would typically be made on a tariff basis

INVESTORS 15

Investors, including DFIs, high-net worth individuals, impact investment funds, corporations and foundations, have expressed interest in SIBs.

Key SIB design features that are important to investors include:

• Investment term: Needs to balance having a lengthy period that enables time for learning and adaption to improve outcomes and measurement of the impact of the intervention, and a shorter period that reduces the riskiness of the proposition for investors

• Level of risk transfer: Layered investment structures, first loss guarantees, and risk-sharing with service providers have been used to make investment opportunities more compelling for investors

Conclusion: There appears to be a market of SIB investors, although their interest would need to be tested more specifically

OUTCOMES FUNDERS 16

Outcomes funders are critical to a SIB, as they ultimately determine what outcomes are being targeted and paid for. Potential outcomes funders identified in this research include:

• National government departments (e.g. the dti, National Treasury, dst, DoL)

• Public sector agencies (e.g. Jobs Fund, National Empowerment Fund, SEFA, SEDA)

• Provincial departments

• Donor agencies and development finance institutions (DFIs) (e.g. Flanders, SECO,

GIZ, IFC, USAID, EuropeAid, IDC, DBSA)

• Private sector foundations (e.g. Ford Foundation, Omidyar Network)

• Companies (e.g. PPC Ntsika, Anglo/Mondi Zimele, SAB Kickstart Foundation)

Conclusion: Initial interest from outcomes funders has been expressed, but the next step of designing a SIB should not proceed without firmer commitment

SIB STRUCTURE 17

Two structures for a SIB in the BDS space in South Africa have emerged:

• Traditional Structure: Objective is to improve the quality of a particular type of BDS and build up the evidence base for what is effective to deliver the target outcomes

• Simplified Tariff-Based Structure: Objective is to pilot a number of different forms of BDS interventions in parallel and targeted at the same outcomes and target population

SIB STRUCTURE - TRADITIONAL 18

Example: Tradition SIB providing BDS to early-stage SMEs

INVESTORS

Money in

EARLY-STAGE SMES

OUTCOMES FUNDER(S)

(Government, donor agency or

corporation)

BDS PROVIDERS

Return on investment depends on success

SOCIAL IMPACT PARTNERSHIP

Payment based on improved outcomes

Independent verification of

outcomes

PERFORMANCE MANAGER

Performance management For instance SME

survival rates, revenue and profit growth and

employment levelsEach BDS provider

creates a customised programme for each SME

SIB STRUCTURE – SIMPLIFIED TARIFF-BASED (I) 19

Example: Simplified Tariff-Based SIB providing BDS to early-stage SMEs

SIB STRUCTURE – SIMPLIFIED TARIFF-BASED (II) 20

Process to launch a simplified tariff-based SIB structure:

1. The outcomes funders would invite BDS providers to tender

• Specifying what outcomes they are willing to pay for and the maximum amount they are willing to pay

2. BDS providers would bid

• Outlining their proposed intervention and the amount they wish to be paid for the relevant outcome(s)

3. Outcomes funders would choose multiple BDS providers

• Enabling multiple projects to be piloted in parallel and to develop a view on the most effective providers and types of BDS

4. BDS providers would secure working capital to undertake interventions

• Model would be prescribed by the outcomes funder

5. Payments would be triggered by outcomes achieved

CONCLUSIONS 21

SIBS are an exciting opportunity to shape private and public capital in South Africa

• Throughout the research stakeholders were enthusiastic about the potential of SIBs

• Global and local momentum has grown substantially

• Timing is ripe for South Africa to commence commissioning SIBs

But, the BDS space is not yet ready to pilot a traditional SIB

• The first SIB in a country is an oft cited and deeply scrutinized example. Accordingly, for further development of the market, it is necessary to tread carefully

We recommend:

• Potential outcomes funders explore setting up a structure for simplified tariff-based BDS SIBs or supporting development of SIBs in another topic area

• National Treasury issues several directives on SIBs and social investment

RECOMMENDATIONS FOR OUTCOMES FUNDERS 22

Explore creating a simplified tariff-based SIB structure:

• Work with an intermediary to identify a set of outcomes and values to ascribe those outcomes and invite BDS providers to tender for contracts

Support development of SIBs in additional sectors:

• Commission feasibility studies to explore the applicability and design of SIBs in a particular focus area e.g. early childhood development, education and health issues

• Consider adopting a coordinated approach to developing the SIB market e.g. the Multilateral Investment Fund, a member of the Inter-American Development Bank Group, announced in March a $5.3 million program to test SIBs in Latin America and the Caribbean. This program will include $2.3 million in grant resources to build the SIB ecosystem and another $3 million in investment capital to facilitate the launch of up to three pilot SIBs and establish a proof-of-concept

RECOMMENDATIONS FOR NATIONAL TREASURY 23

Issue a directive that SIBs could be a vehicle for national, provincial and local governments to evaluate as a funding mechanism for social services

• Throughout this research project, the coalition found significant enthusiasm for exploring SIBs by members of government agencies and departments provided the National Treasury sanctioned the use of these alternative forms of financing

Issue a directive that Enterprise Development spend could be channelled through a SIB

• Corporates presented themselves as a key potential investor group in SIBs during this research. If government were to affirm the possibility of using ED funds to support SME focused SIBs, this could mobilize a large pool of capital for SIBs

Explore tax relief for social investors

• In the 2014 UK budget, a 30% tax relief for social investment was announced. This tax relief is expected to generate £480 million in social investment over the next 5 years. Similar legislation could help catalyse social investment in South Africa

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THANK YOUQ & A