COVID Social Bonds: Innovative Assets in Unprecedented Times
By Ash Ahmed
In times of crisis, society looks to its past. The COVID-19 pandemic has forced policymakers to react quickly to an economic recession. While the magnitude of the virus varies across the world, one solution seems unanimous: fiscal and monetary stimulus. Stimulus packages, which attempt to prop up faltering economies via slashing interest rates and increasing economic activity, were successfully utilized during the Great Depression and the 2008 financial crisis. Tax rebates, quantitative easing, bailouts, and many other policies have empirically boosted GDP and averted further catastrophe.
A pandemic, however, brings unprecedented challenges. Global quarantines have diminished government aid effectiveness, with businesses struggling to get customers in the door. Even in an age of online transactions and communications, health guidelines have halted the production of raw materials and essential products. Reducing unemployment - a key goal for stimulus packages - is difficult when nearly all jobs must be remote. Rather than providing a much-needed jump-start to economies, stimulus packages have only increased debt to GDP ratios.
Social Impact Bonds
Social Impact Bonds (SIBs) may offer new tactics in the fight against COVID-19. SIBs finance a social project (healthcare, education, human rights, etc.), with return for investors contingent upon predetermined goals. Historically, social bonds have comprised a small portion (16.7 billion dollars in 2019) of the overall bond market (115 trillion dollars in 2019), with the market for sustainability and green bonds, designed to finance environmental projects, significantly larger (323 billion dollars in 2019). Despite being relatively new in the financial world, widely-accepted guidelines regarding investment practices and the allocation of funds are in place.
What have past SIBs looked like? One of the first major SIB programs in the United States was the NYC ABLE Project for Incarcerated Youth, created in 2012. Financed by Goldman Sachs, the program sought to reduce recidivism rates among youth at New York’s Rikers Island jail complex through a cognitive behavioral therapy program. Goldman Sachs would be reimbursed if recidivism rates were cut by 11 percent or more.
COVID-19 has led to a surge in SIB popularity among financial institutions and governments, with an issuance of 11.58 billion dollars in 2020 as of May 15. Near-zero interest rates and massive debt from traditional stimulus packages have diminished the power of central banks and opened the door for SIBs. COVID SIBs provide funding for organizations producing healthcare equipment, invest in research on vaccines, and give financial assistance to companies and unemployed individuals.
The key distinction between SIBs and traditional stimulus packages is the primary actor. While governments enact stimulus packages, capital markets can contribute to relief efforts with SIBs. At a time when investors are becoming more conscious about what they invest in, SIBs can draw in wealthy institutions in the fight against global injustices. Furthermore, SIBs offer targeted aid for specific industries or populations (e.g., producing face masks or providing food for the elderly), while stimulus packages tend to take a “one-size-fits-all” approach (e.g., blanket policies for all citizens, businesses, etc.).
Areas for Improvement
While the ABLE SIB received sufficient funding, most SIBs do not. As a relatively new financial asset, low liquidity levels for SIBs can hinder project development. A lack of funding creates a vicious cycle of failure, where a lack of sufficient capital results in suboptimal outcomes, thereby reducing the likelihood of future investments. As financial institutions look to become more socially responsible, social issues are no longer addressed solely by non-profits. Even the general public could get involved, with individuals investing in bonds that address a cause they care about.
As a result of low liquidity, transaction costs become vital for prospective investors. A 2016 report by the Harvard Kennedy School found that transaction costs include “intermediary services and technical assistance, evaluation, and legal fees.” Such transactions can disrupt the timeline for a SIB, where essential projects are delayed due to legal proceedings. Especially during a crisis, SIBs cannot afford to be mired by technicalities.
Assuming that SIBs have sufficient capital and neglecting transaction costs, a significant barrier to scalability is the lack of quantifiable data regarding project outcomes. While some projects, such as improving infrastructure or donating food, can have their progress clearly measured, many projects, such as implicit bias training or mentorship programs for children, cannot.
Indeed, the downfall of the ABLE SIB was that it relied on a cognitive behavioral therapy program that lacked quantifiable data. Scientific studies had previously found that the program could reduce recidivism rates, but no study was conducted on the target population of incarcerated youth at Rikers Island. As a result, an independent evaluation found that ABLE failed to reduce recidivism rates, and the program ended in 2015 after just 3 years in operation. Future SIB programs must understand that every issue and population is unique, and data cannot always be generalized.
Furthermore, it is difficult to measure the return for investors without quantifiable data. “Social washing” - the overstatement of results regarding a project - has created a bad name for SIBs in the past and increased risk. Quantifiable data would prevent issuers from deceiving investors and hold them accountable for exaggerating results.
One possible solution is to create structured contracts that include issuer risk retention, make SIBs tradable, and protect the principal for investors upon bond maturity. A more fundamental solution would direct a portion of funds to quantify the progress of a project and provide investors with precise data. Transparency is essential for SIBs to become mainstream.
In the fight against COVID-19 and an economic recession, we must look beyond traditional stimulus packages. New financial assets such as social impact bonds can bring more investment to at-risk populations, vaccine research, and struggling businesses. If current challenges are addressed, SIBs could become an essential tool in fighting not only COVID-19 but future social issues as well. In the uncertain months ahead, innovative financial solutions will be a shining light.