Raising funding to address certain social issues can prove to be extremely difficult for local authorities, especially with the cost of borrowing at extremely elevated levels compared to the ultra-low interest rate environment of the last ten years. Innovative financing mechanisms such as social impact bonds (SIBs) present a potentially useful tool for local authorities to fund public services.
SIBs are a form of partnership in which investors provide upfront funding for a social program where their return on investment is linked to certain predetermined performance targets. This can be a partnership between government, social organisations, charities, and private companies.
One of the main advantages of SIBs is that they allow local authorities to access private funding for programs that may not be able to attract traditional forms of public funding. For example, a local authority may wish to implement a program to reduce recidivism rates among ex-offenders but may not have the necessary funding to do so. By issuing a SIB, the local authority can raise the necessary funds from private investors, and only pay them back if the program is successful in reducing recidivism rates.
This structure allows for the interests of local authorities and private investors to be aligned for the life of the project. As the private investor’s return on investment is linked to specific targets, SIBs create an incentive for both parties to work together to achieve the desired outcomes which takes pressure off the local authority to both fund and deliver the outcomes themselves.
There is scope for these projects to be applied across the UK with wide reaching benefits for investors. Some asset managers have even launched funds in this space which allows multiple private investors to pool their money together in a fund which then is used to provide funding to social outcome projects with the return split amongst the pool of investors once the outcomes are met.
Since the first SIB was launched by the Ministry of Justice in Peterborough in 2010 with the purpose of reducing prison recidivism rates, there have been 80 successful projects funded through this model. This includes a project in Essex to improve employment prospects of ex-offenders and a project in Manchester to reduce the number of children being taken into care. These are just a few examples and SIBs are now used worldwide to address social issues such as homelessness, improving mental health and improving education.
Despite the potential benefits of SIBs, there are also drawbacks to be aware of. These contracts are quite complex and expensive to setup due to the coordination between the local authority and private investors as well as any service providers that may also be used in the contract. As they require specific, measurable targets to be set for the outcome they also tend to be better suited to local social issues which the authority will be very knowledgeable about. This way the targets can be specific, achievable and monitorable. However, this does mean that SIBs can be difficult to scale up to a more national focus.
To decide if a SIB would be appropriate for your authority, it is important to weigh up the feasibility and business case for this approach against alternative funding options. The project must also have a clear and measurable outcome which can be clearly improved through the assistance of a third party (that would not have occurred anyway). This way the outcomes can be monitored to ensure outcomes are met before investors are repaid.
Funding can be difficult to find for social issues which is why these innovative financing mechanisms have more of a place in the local authority toolkit. If you would like to discuss your local authority borrowing strategy, project appraisals, or funding option analysis we would be happy to help and can be reached by emailing treasury@arlingclose.com.
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