Development Impact Bonds: A New Paradigm For Public-Private Partnerships?

Part 1 of a two-part series[1]
(Read Part 2 here.)

By Julie King

Water is squarely on the World Agenda.  Access to clean drinking water has been recognized as a human right, five of the Post-2015 Sustainable Development Goals (SDGs) involve water, and the World Economic Forum’s 2015 Global Risk Report places Water Crises as the highest risk for impact to society.[2]  

With the international spotlight on Water, one clear problem remains, which requires new thinking and urgent action: How to bring clean water to the 750 million[3] people worldwide without access to it?  The underlying dilemma, however, is that while there is a human right to water, it does not extend to a right to water for free.  Financing solutions to bring affordable drinking water to those without it, is a practical challenge for all parties concerned – corporate and not-for-profit service providers, financiers, foundations, non-governmental organisations (NGOs), governments, and beneficiaries alike.

Financing the Human Right to Water

Public-private partnerships (PPPs) are a commonly used mechanism to finance public sector projects with private investment, such as water and infrastructure projects.  The general consensus is that there is no agreed definition of a PPP; multiple structures and relationships exist under the general rubric, be that in legislation or in commercial practice.[4]

“Anytime you bring together and try to align public and private parties in financing a project, I believe you have to call it a ‘public-private partnership,’” says Linda Habgood, a Director at Delphos International.  “But the focus has to be on the results, not on worrying about the definition of PPPs.  We have to be open to new ways of bringing together public and private sector goals.”

Rasoul Dashtbani Mikkelsen, Director of Grundfos Lifelink agrees: “Most of our projects are PPPs...Each one includes a government entity – generally a water service provider – an implementing NGO and a funder...” 

Development Impact Bonds (DIBs)

While use of PPPs has become an accepted mechanism for financing infrastructure projects in emerging markets, international development leaders have been searching for new approaches to their work in developing countries.  This has caused a seismic shift away from traditional donor funding, towards sustainable, market-driven solutions to society’s most daunting challenges.

One of the results has been the emergence of “Impact Investing.”[5]  The underlying expectation is that investors can ‘do well and do good’ at the same time, receiving not only a financial return on investment, but a social return, as well. Development Impact Bonds (DIBs) are one of the tools in the Impact Investment tool kit for delivering long-term solutions to social problems.

Characteristics of DIBs

DIBs are not actually traditional bonds.  Instead, they combine debt and equity, and are for a fixed period, with no fixed return.  DIBs have a “pay for success” structure, as well as a being a business model, providing a contractual framework for facilitating collaboration between project stakeholders. This includes co-ordinating and managing not-for-profit service providers through an Intermediary, which acts on behalf of investors.   

DIB-funded projects are designed to transfer risk from the public to the private sector. They focus on achieving impact “outcomes” – not “outputs” – e.g., the objective is not exclusively to drill a borehole or build a dam, it is also to provide a sustainable water supply solution to communities in order to, for example, reduce waterborne illnesses within the target population.  DIB investments provide up-front operational capital to service providers with proven solutions for achieving the project’s impact outcomes.  These results are validated by an independent third-party at milestones throughout the project lifecycle.

Successfully accomplishing the project’s impact requirements is the trigger for re-payment by the contracted Payer[6] of the investors’ principal and possibly a financial return, based on a capped, sliding scale.  As such, the project’s potential financial return is contingent upon the degree of success in achieving its social return. If service providers fail to reach the impact requirement, the Payer is not required to make payments of any kind, placing investors at risk of losing not only a return, but part or all or their principal, as well.   

Specific Aims

DIBs aim to impose market discipline on the delivery of public services and create an accountability system for not-for-profit service providers for monies received.  DIBs are also designed to promote government efficiency, as public monies are not spent until services or assets are proven.  Additionally, DIBs shift the funding emphasis away from the remediation approach of government programmes towards preventative solutions.  DIBs are data-driven, and are structured to provide flexibility for service providers to make adjustments in delivery, based on measured results, in order to reach the agreed impact-outcomes.  Finally and critically, the focus of DIBs on successfully achieving impact goals brings the actual needs and interests of beneficiaries into the planning, execution and implementation of each project.

DIB Principles:  A New Paradigm for PPPs? 

The current practice for PPPs is for government financiers from developed countries to use performance clauses in ‘conditional’ loans to reinforce compliance from project developers and service providers with social and environmental standards.

“[P]ublic money is setting these standards,” explains Linda Habgood, Director at Delphos International.  “If a transaction requires parties to tap into government agency money – for whatever reasons – everyone in the deal is held to these standards. [They] are contained in contractual terms – e.g., loan agreements from multi and bi-lateral organizations, [and] require express agreement to human rights, labor, and environmental standards – and agreement to being audited against them.” 

Stuart Orr, Head of Water Stewardship at the World Wildlife Fund, suggests PPP performance requirements should be extended to include DIB impact standards, as well.  “PPPs need to...include ‘social impact’ objectives in the legal requirements of the project design.  From our research...into hydropower projects, we have seen that poor design and implementation has lead to few impact-goals being delivered on, in spite of claims that projects are pursuing such objectives.  If [impact objectives] were planned and wired into PPP contracts, the problems could have been mitigated and greatly help the chances of success.”

Collaboration And Accountability

“A crucial question is ‘how are companies going to operate in a world of increasing scarcity of water?’” observes Orr.  “The question becomes ‘how are you a constructive partner in the management of, say, a water basin?’  There is no longer room for fighting and co-operation; it must be collaboration.  The issue is then how to ensure quality collaboration.”

Perhaps this, too, is a point where the DIB structure could be integrated into PPPs in order to facilitate collaboration between all service providers, for-profit and not-for-profit alike, as well as enhanced accountability to investors. For example, a water project might include not-for-profits, which specialize in developing community buy-in for the project, or focus on conducting sanitation and hygiene training to ensure the project’s contractually required impact goals are being achieved.

DIB Principles, CSR, and Mitigating Risk

Including DIB principles into PPP contracts may also assist companies in mitigating risk if CSR areas are not prioritized. Alternatively, it may encourage companies to align their CSR commitments with their business-activities, or give them a framework for doing so.

“Human rights and environmental issues within a project fundamentally affect the value and risk strategy for a company...Such a challenge is significant with water,” says Stuart Orr from the WWF. “[We] have seen companies in the water sector moving away from CSR to business-strategies.  [They] see a project in terms of...the cost of loss of water. This leads to other risks within CSR areas. Companies are looking for anything to immunize themselves against the risk and the sometimes fluctuating rules of the game.”

Linda Habgood of Delphos International sees significant potential in harnessing the CSR movement to achieve broader social impact:

“Corporations have always had philanthropic divisions. But they are increasingly leading with CSR and I think we will see a really big impact from this on how things are done”.

Rasoul Dashtbani Mikkelsen of Grundfos agrees, “CSR is interesting to incorporate throughout a business, not just pay money to a NGO for projects and then put it into the annual corporate report.  For CSR to be successful...the whole organization needs to be engaged and there needs to be an accountability for the money given out.”  Mikkelsen adds, “I see a huge movement among corporations towards CSR within the whole company.  [But it] has to come from senior management.  That is what drives the social commitment and responsibility...  It cannot be just one department dealing with CSR as a side issue.”

Last but not least, integrating DIB impact principles into PPP contracts would help to ensure that real and positive impact is achieved for project beneficiaries, and that they are included as participants in the process.  This is particularly necessary for water infrastructure projects, both large and small, and has clear implications for a project’s sustainability and financing options.

Mikkelsen relates, “The community receiving the solution [has] experience[d] that [a water] project will probably collapse after two years and not function after that...Our experience is that if people trust the water system, they will pay [for water].”

Conclusions                                                                                       

Like PPPs, there are problems and criticisms to consider with DIBs.  What is promising, however, is the convergence of interests and efforts by stakeholders to effect genuine social change.

There is clear overlap between commercial projects in ‘emerging markets’ and ‘international development’ projects in ‘developing countries’ – water, energy, food security, construction, banking, etc.  Instead of ‘reinventing the wheel’ – and in light of the urgency of water issues – perhaps time would be well spent on identifying the strengths, weaknesses, opportunities, and threats to financing access to water. Spending time on forging practical collaborations between the commercial service providers under PPP contracts and international development organisations under DIBs could significantly push-forward the human rights and SDG-goals of supplying clean drinking water to the project’s target populations, as well as create a win-win scenario for all stakeholders. A more technical “SWOT Analysis” such as this is the subject of the second part of this article.

Julie King is Managing Director of the Galileo Agency, a boutique agency, which packages and develops projects and commercial opportunities for both for-profit companies and not-for-profit organizations to monetize social impact — particularly in the water, environmental, and education sectors.