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Outcome-based financing is here to stay

By Frank Jackman, Jon Hay
18 Jun 2020

It has been a long time coming. Social impact bonds, in which the investor's return is based on the outcome of a social project, were invented 10 years ago. This week, one was issued for the first time by an organisation recognised as a full member of the mainstream European capital markets.

Region Stockholm issued a Skr30m (€2.9m) bond to fund a programme to encourage healthy lifestyles among 925 pre-diabetic people, to reduce the number who develop type 2 diabetes. The investor, Skandia, will make money if the project works and lose money if it fails.

The instrument will not spread as fast as green bonds. It is much more complex and demands more of all parties. Both issuer and investor have to understand the range of potential outcomes of a real world problem, assign probabilities to them and price them.

It is unlikely to suit national governments, because it is too fiddly and granular: they can simply issue huge bonds. It also will not be for banks, including supranationals and agencies: they make loans, rather than conducting their own projects.

Local government and parts of the corporate sector are where this could work — and already does in the US. These organisations are trying to achieve things with limited resources. If an action arises that is too risky or expensive for them to do with normal budgets, but might work impressively, sharing the upside and downside with outside investors makes sense.

There must be many caveats: anything in which investors can make a return linked to social welfare raises ethical questions. But if these are handled carefully, these bonds can be a useful tool for financing creative experiments.

By Frank Jackman, Jon Hay
18 Jun 2020