With limited public funding available for socially and environmentally responsible programs, a variety of initiatives have been developed to attract private capital into sustainable development. Although still in their infancy, social impact bonds (SIBs) offer a promising outlook for sustained public-private partnerships.

Social impact bonds are gaining momentum around the world. Also called “pay for success bonds” or “social benefit bonds,” SIBs are outcome-based contracts in which a commissioner (usually a public institution) agrees to pay private investors back if, and only if, pre-established social outcomes are reached. Specialized service providers are hired to carry out social interventions, and an independent firm measures the outcomes. An intermediary organization plays a critical role in structuring the SIB and coordinating the implementation of the interventions.

In a context of limited public funding and increasing corporate responsibility, SIBs create a mutual “public-private partnership” benefit. By enabling the transfer of specific social interventions from public institutions to specialized providers, SIBs contribute to more effective and cost-efficient outcomes for the public good. They also draw private investment — repaid from net taxpayer savings — to fund projects.

The first SIB was launched by Social Finance UK1 in 2010, aiming to reduce recidivism among ex-offenders leaving prison. Since then, more than 20 of those bonds (raising nearly $100 million) have been launched in the U.S., the U.K., Australia, and the Netherlands. They target a range of social issues, from homelessness to early childhood education. A similar financial tool, the “development impact bond,” is being created in emerging markets aiming, for example, at improving female education or reducing malaria prevalence. Development impact bonds differ from SIBs only in who repays the investors (donors, rather than public institutions).

In parallel, “green” bonds (to finance environmental projects) saw massive growth in 2013. Historically, green bonds have been issued by institutions such as the World Bank, with relatively limited uptake. Last year, however, the International Finance Corporation (the World Bank’s private equity branch) raised a $1 billion green bond. Corporate bonds are also growing dramatically: in 2013, Électricité de France (EDF Group) raised a $1.9 billion green bond that was twice over-subscribed; and firms like Toyota and Unilever have raised billions in the last year.2 Dealogic recorded 29 deals worth a total of $11.2 billion last year and so far this year has reported more than $6 billion deals. Financial institutions also show growing interest: a consortium of leading banks recently published voluntary guidelines for such bonds. In late 2013, Zurich Insurance Group committed to investing $1 billion in green bonds, starting a new trend for private sector investors.

Although SIBs represent a nascent market of a few hundred million dollars, their positive preliminary results offer significant opportunities to scale up interventions that have strong evidence of social impact and economic value in emerging markets. Through Co-Emergence work in those markets, we have identified access to water in Africa as one opportunity. Based on our preliminary research and interviews with water experts and a February 2014 field assessment in Kenya, we believe interventions to reduce water losses — thereby increasing access to clean water — are viable candidates for SIBs: execution risk is limited, benefits are clear and measurable, and, as far as Kenya is concerned, large areas of operation are “investment ready.”

The Water Problem

Around the world, 1.1 billion people have no access to any source of improved drinking water; billions more have access only to an interrupted supply or to water of uneven quality.3 A major barrier to increasing access to clean water is the high level of water loss in distribution networks. This loss, called non-revenue water (NRW), is the difference between the amount of treated water in the distribution system and the amount billed to consumers. NRW averages 40 percent in developing countries,4 significantly limiting water utilities’ ability to provide residents with 24/7 water services and extend water to new areas, including to poor communities.5,6 NRW is also associated with increased risk of contamination through broken pipes, posing “a significant public health risk.”7

Non-Revenue Water in Kenya

    • 16 million Kenyans (39%) lack access to clean water
    • Illnesses and conditions related to water, sanitation, and hygiene are the No. 1 cause of hospitalization in children under age five
    • Non-revenue water averages 45%

Sources: World Health Organization, Kenya Water Services Regulatory Board

Evidence in developed and developing countries shows that a mix of technical and capacity building interventions can reduce NRW to less than 20 percent without massive capital investment.8,9 Such interventions include controlling physical losses through pipe maintenance and water-pressure optimization, ensuring customer metering accuracy, and improving governance and performance of water utilities through information and pay-for-performance management tools. Projects around the world, including those in emerging markets, have documented returns on investment in fewer than five years.10,11 To date, however, few NRW interventions have been implemented at scale. Reasons include the misperception that they require massive infrastructure-type investment (to replace all pipes), lack of financial capacity among local water utilities or governments to pay for NRW interventions up front, and the challenge of improving governance of water utilities to ensure that gains are sustained.

Co-Emergence has selected Kenya as the first country qualifying for a SIB for the following reasons:

•  Kenya’s central and local governments have expressed strong political will to reduce NRW, which averages 45 percent.12 Ongoing decentralization reform creates an urgent need for countries to improve their financial situations while increasing citizens’ access to clean water.

•  Leading organizations from the nonprofit and commercial water sectors have prepared the ground, establishing reliable NRW baseline data, developing effective approaches to improve water utilities’ performance, and conducting successful pilots in collaboration with local governments and service providers. As our main partners, they bring years of experience and connections with the main stakeholders in Kenya.

•  Impact investors have an increasing and stated interest in funding water and environmental initiatives. Kenya is a high priority for investment in Africa and a focus for institutions that provide debt guarantees, such as OPIC and USAID’s Development Credit Authority.

Repayment to private investors will be based on reaching key social and financial targets. A strong monitoring and evaluation system will therefore be embedded in the SIB structure. Indicators to measure social impact will include NRW level, hours of daily water supply, and additional people served (or clean water covered).

Using lessons from this first SIB, we plan to scale the approach to other parts of Kenya and other African countries, leveraging capital from impact investors. The Monitor Group estimates that the impact investing industry will grow from $50 billion to $500 billion in assets in the current decade,13 creating an increased demand for investment-ready social interventions like NRW. With a successful first SIB, we hope to structure an SIB fund that will invest in multiple NRW projects in selected countries in Africa, thus widening our impact. We also expect lessons from this SIB to have a demonstrative effect for the use of SIB in other sectors and other developing countries.

Claire Champion is President of Co-Emergence.
Clemence von der Schulenburg is Finance Director of Co-Emergence.
Co-Emergence is a U.S. company whose mission is to nurture and scale market-driven solutions to increase access to high quality, affordable health and education services in emerging markets.

 

[1] Social Finance UK: http://www.socialfinance.org.uk
2 The Economist. Spring in the air: Bonds tied to green investments are booming. 22 Mar. 2014. Accessed at www.economist.com/node/21599400/print on March 24, 2014
3 World Health Organization (2014). Health through safe drinking water and basic sanitation. Accessed at http://www.who.int/water_sanitation_health/mdg1/en/ on March 17, 2014.
4 Kingdom B., Liemberger R., Marin P. (2006). The challenge of reducing non-revenue water in developing countries. The World Bank. Accessed at http://siteresources.worldbank.org/INTWSS/Resources/WSS8fin4.pdf on March 17, 2014.
5 Ibid.
6 Frauendorfer R., Liemberger R. (2010). The issues and challenges of reducing non-revenue water. Asian Development Bank. Accessed at http://www.miya-water.com/user_files/Data_and_Research/miyas_experts_articles/2_NRW/92.pdf on March 17, 2014.
7 Frauendorfer R., Liemberger R. (2010).
8 Kingdom B., Liemberger R., Marin P. (2006).
9 Frauendorfer R., Liemberger R.  (2010).
10 Kingdom (2006).
11 Ndirangu N., Ng’ang’a J., Chege A., Blois R.J., Mels A. (2013). Local solutions in non-revenue water management through north-south water operator partnerships: the case of Nakuru. Water Policy 15: 137-164.
12 Water Services Regulatory Board (2012). IMPACT Issue N.5. Performance Review of Kenya’s Water Services Sector – 2010/11. WSRB. Nairobi.
13 Freireich J., Fulton K (2009). “Investing for environmental and social impact”. Monitor Institute. Monitor Institute