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March 25, 2013

Impact Investing and Innovative Financing for Development

Tomorrow, the Aga Khan Foundation Canada (AKFC), in partnership with Carleton University’s School of Public Policy and Administration (SPPA), is launching the AKFC Seminars on Innovative Financing for Development, explores strategies for financing international development in ways that complement traditional donor-based initiatives. This discussion comes at an important time in the Canadian international development community, given the recent decision to fold CIDA into DFAIT, and controversial decisions to fund corporate social responsibility (CSR) projects in the mining sector. Please join us in person in Ottawa or via the live webscast: register here.

AKFC, as part of a broader set of agencies that fall under the Aga Khan Development Network, is no stranger to the field of impact investing. It runs the Fellowship in International Microfinance and Microenterprise, which provides young professionals with training and an overseas placement. I was fortunate to be selected for such a placement in 2004 (and joined the Carleton SPPA thereafter). This experience sowed the seeds for my current work in impact investing and social impact assessment. Other prominent network affiliates include the Aga Khan Agency for Microfinance, as well as the AKF USA’s Impact Investing Initiative.

In the inaugural talk, Ted Jackson and I will providing an introduction to innovative financing for development (IFD) and impact investing, drawing on the key lessons and implications from our report, Accelerating Impact: Achievements, Challenges and What’s Next in Building the Impact Investing Industry. This industry scan, commissioned last year by the Rockefeller Foundation, describes how impact investing has evolved over the last five years. Examples that are often used around ‘innovative financing for development’ are referenced heavily – notably, vaccine bonds (through GAVI and IFFIm) and green bonds (through the World Bank).

These instruments not only access new forms of capital, they are also conduits to channel finance to projects that deliver financial returns and positive social/environmental outcomes. Innovative finance for development – arguably, like impact investing – has encompassed a fairly broad set of initiatives and lacks a clearly defined boundary. For example, the World Economic and Social Survey 2012 notes the following:

The lack of a precise definition has caused many studies to cover a broad interpretation and consider all types of non-conventional forms of finance under the rubric of innovative development financing, ranging from the mechanisms mentioned earlier, such as securitization of ODA commitments, international taxes and new SDR allocations, to all kinds of “other innovations”, such as local currency bonds and currency hedges, gross domestic product (GDP)-linked bonds, incentives to channel worker remittances to developmental investments and publicly guaranteed weather insurance mechanisms.

Source: World Economic and Social Survey 2012: In Search of New Development Finance.

As a result, there are numerous overlaps between IFD and impact investing (our report also faces this challenge, given the ‘broad tent’ nature of impact investing as current defined, though we have argued for a tighter definition with a higher bar for demonstrating social impact). Nevertheless, there have been attempts to document a typology of IFD approaches – for example, the UNDP Discussion Paper Innovative Financing for Development: A New Model for Development Finance? describes a typology of four mechanisms, distinguishing between approaches that relate to how new capital is raised versus how it is deployed and/or managed:

Taxes, dues or other obligatory charges on globalized activities: this includes initiatives such as the airline ticket tax which is levied at the national level but within a framework of international coordination. The revenues raised are allocated to international development. Proposals for a financial transactions tax and carbon taxes are also examples which fit into this category. These initiatives generate new public revenue streams for development from the private sector.

Voluntary solidarity contributions: under such initiatives, consumers are given the option to donate a small sum to international development at the point of product purchase (e.g. an on-line hotel reservation). Although private in nature, public authorities facilitate such contributions through tax incentives and technical facilitation in the distribution of resources. Examples include Product (RED), the Global Digital Solidarity Fund and MASSIVEGOOD.

Front loading and debt-based instruments: an initiative which ‘front loads’ resources and makes public funds available earlier for development. It does this via the issuance of bonds on international capital markets. The International Finance Facility for Immunisation is one example. Mechanisms which ‘frontload’ public resources for development generate liabilities that are reportable as aid in several years’ time, i.e. when the liabilities fall due. Other debt-based mechanisms include debt conversions (which reduce the amount of debt and debt service payable thereby freeing-up additional resources for development expenditures), diaspora bonds (a debt instrument—issued by a country, a sub-sovereign entity or a private corporation — to raise financing from its overseas diaspora) and socially responsible or ‘green’ bonds (bonds which target investors who wish to invest in development or environment initiatives and so may accept lower rates of return on their investments).

State guarantees, public-private incentives, insurance and other market-based mechanisms: this includes initiatives which leverage public funds to create investment incentives for the private sector, for instance through state subsidies or commitments to purchase a particular product at a set price (e.g. a vaccine). In so doing, these initiatives aim to correct market failures. Other mechanisms aim to reduce sovereign risk and/or macroeconomic vulnerabilities, for instance weather-based insurance or counter-cyclical loans (i.e. they aim to improve the effectiveness of finance rather than create new revenue streams for development).

Source: Discussion Paper – Innovative Financing for Development: A New Model for Development Finance?

Several opportunities have surfaced in relation to both IFD and impact investing. One that is of particular interest is being able to leverage ‘local capital’. Often, the relationships in impact investing (and arguably IFD) tend to mirror those broadly prevalent in the traditional international aid sector, i.e. flows of capital from ‘developed nations’ to ‘developing nations’. This is obviously a simplistic and artificially linear depiction of what happens in real life, and the opportunities to redefine this perception are becoming more tangible:

By far the largest supply of financing for development will continue to come from developing countries themselves. Developing countries’ domestic resources are already much greater than the ODA they receive, and domestic income is also growing much faster than ODA. Sub-Saharan Africa, for example, will almost double its GDP over the next 10 years if it maintains current growth rates. It’s important to keep these projections in perspective. African economic growth is uneven, both between and within countries, and even with rapid growth many countries will remain poor.

Nevertheless, in many cases, domestic resources can pay for the cornerstones of development. Building rural roads, schools, and health infrastructure is a job for governments, and governments’ ability to fund and manage these systems effectively will largely determine their citizens’ quality of life.

Source:  Innovation With Impact: Financing 21st Century Development

There’s a lot more to say on the intersections between innovative finance for development and impact investing, and we plan to break some new ground during our discussion tomorrow.

Please join us in person in Ottawa or via the live webcast; registration for both are accessible at this link.

For those of you who can’t join, the livecast will be archived at the AFC Seminars homepage, and I would invite you to engage in the conversation via this post or in the recap post after the session.

(this post originally appeared at SocialFinance.ca)