In the course of my professional engagements on social bonds, and academic deliverables on social impact bonds, recently I have been confronted a lot with questions pertaining to the difference between the two instruments. This has motivated me to look into the instruments in detail and ascertain the variations on my own.
A social impact bond refers to an innovative financing mechanism in which governments or commissioners enter into agreements with social service providers, such as social enterprises or NGOs, and investors pay for the delivery of pre-defined social outcomes (Social Finance, 2011). The first Social Impact Bond was launched by UK-based Social Finance Ltd. in September 2010.
Social Bonds, on the other hand, are relatively new financial instruments primarily modeled around International Financial Corporation’s existing themed bond products -Banking on Women (BOW) Bond Program (2013) and the Inclusive Business Bond Program (BOW). Social Bonds are bond instruments whose proceeds are exclusively applied to finance a project that delivers social outcomes. This can include projects ensuring access to essential services, affordable housing and micro-finance. The structure of the instruments are similar to Green Bonds. It is the market perception that probably it was the success of Green Bonds that led to the recognition of bonds as viable instruments to address non-financial objectives. It worked for the green objectives, so the next step was social projects.
From a governance perspective, the major difference between the two instruments is that while social bonds are being backed by an international finance institution like IFC and despite being a new instrument, regulated to some extent by ICMA’s Social Bond Principles, there is no existing transnational governance on Social Impact Bonds. This is mostly explained on the basis of the difference in the nature of instruments.
While Social Bonds are intrinsically investor-centered, Social Impact Bonds centre around the local public institutions who are more likely to be the issuers of the instrument. In practice, the term ‘bond’ is construed to be a misnomer for instruments like Social Impact Bonds for they are essentially ‘payment by results’ contracts with “outcome funders” like governments and agencies who pay back the private investors funding the project. The repayment of the principal and the interest is solely dependent on the performance and success of the project and investors risk losing everything in case of failure. Social Bonds, on the contrary, are functionally a debt instrument like any other bond with fixed returns and a promise to use the proceeds for the mentioned objectives. The risk is comparatively very low, explaining the investors’ interest in this model of financing social projects.
One would expect that since both instruments target at achieving social outcomes, there would be a similarity in the impact measurement processes and the outcome metrics that are defined to measure social performance. From a practitioner’s perspective, this is not true and the difference emanates from the very nature of the instruments. The success of Social Impact Bonds depends upon effective impact measurement. The outcome metrics are linked to the payment structures and are determined specific to the target cohort, the nature of intervention, and the local context. The structure leaves little flexibility to accommodate investor preferences. Social Bonds, on the other hand, are more flexible instruments and metrics are usually defined on the basis of the investor’s ability to measure with the existing systems.The instrument allows for this flexibility and the rationale is that imposing restrictive metrics will deter investors interest and affect the scalability of the market.
Overall, from a market perspective, Social Bonds are seen more favorable to Social Impact Bonds as emerging innovative financing instruments to address development challenges and that is reflected in the growth rate of the instruments. This stems from the enhanced investor flexibility and lack of need to engage with other stakeholders. Social Impact Bonds are increasingly being perceived as a small market for specific focused projects.