This is part of The Globe and Mail's in-depth look at the evolution of philanthropy. Read more from the series here.
In Britain, the government is prepared to pay to keep recently released prisoners from winding up back in jail. If that sounds novel, it should – for it represents a new hybrid of investing and charity called social finance.
Champions of social finance foresee a world in which profit motives and the greater good move in tandem. They are hoping that investors will evaluate potential investments not only according to how big the return might be, but also according to how much good it will do. The approach could revolutionize the way social programs are delivered.
The U.K. prison program relies on a type of social finance called a social impact bond. Rather than creating a new government program to reintegrate prisoners into society, the pilot project at the Peterborough prison near Cambridge turns over the task to non-profit organizations. Investors will be funding the non-profits' efforts by buying bonds. The return on the bonds depends on how successful the efforts are, and will be paid out of the money that the government saves in prison costs.
This experiment began last year when £5-million ($8-million) worth of bonds were sold to investors to fund the project at Peterborough, a privatized facility run for the government by the French firm Sodexo. They were the first social impact bonds issued anywhere in the world.
Social finance is embryonic in Canada, where the movement trails the U.K. by roughly a decade. But, having gained some high-profile stalwarts, including former prime minister Paul Martin and Macquarie Capital Markets Canada chairman Stanley Hartt, momentum is picking up. Most significantly, the social finance concept is one piece of the recently announced plans of the Harper government to both boost charitable giving and make non-profit groups more accountable.
The concept is timely. Government budgets are stretched, charitable donations have fallen in the wake of the recession, returns on traditional investments are pitiful, and the capital markets are still confronting an image problem in the wake of the financial crisis. And while Canada has not seen the sort of unrest that has erupted in Europe and the United States over income inequality and corporate greed, there is a growing level of social need here that governments will be hard-pressed to address.
Social impact bonds, one of the most tangible examples of social finance, could be used to finance everything from a reduction in obesity to community development initiatives.
Stealing a page from basic economics, proponents argue that by tying financial returns to the degree to which projects such as the Peterborough pilot succeed will increase the efficiency of the system and lead to better outcomes for each dollar spent.
"It is definitely on its way and as Canadians we can choose to either watch or participate," says Ilse Treurnicht, the CEO of MaRS Discovery District and the chair of the Canadian Task Force on Social Finance, a group of high-profile Canadians who decided to form their own task force without waiting for Ottawa to get on board.
The blurring of lines between charity and business does pose a tricky balancing act. "It's an uncomfortable conversation on many levels," Ms. Treurnicht says. "But our neatly bifurcated world where business makes money and government and non-profits do good, I think that world is just over."
JPMorgan estimates that impact investments – which it characterizes as an emerging asset class that will stand alongside hedge funds, emerging markets or commodities – will attract $400-billion (U.S.) to $1-trillion worth of capital worldwide over a decade, and deliver hundreds of billions in profits. "We believe that impact investing will reveal itself to be one of the most powerful changes within the asset management industry in the years to come," says a report published by the bank.
Sir Ronald Cohen, the billionaire co-founder of private equity giant Apax Partners and a social finance pioneer, says that getting the Peterborough pilot off the ground was a turning point.
"I think the social impact bond is a crucial step in developing this as an asset class, in persuading the banks that this really can become a significant asset class," he said during an interview at his New York loft.
Proponents of social finance believe that many investors will be willing to put their money into investments that offer a slightly lower return than what can be had elsewhere, but which also provide a quantifiable social return.
Part of the challenge will be getting a few more projects like Peterborough off the ground, and establishing a track record of success.
In Canada, in addition to Ottawa's newly bruited intentions in this area, a number of provinces have signalled that they are either open to or actively looking at social finance.
The Mowat Centre for Policy Innovation published a report this year in which it argued that the country's charities and non-profits are facing a "growing sustainability challenge." With government funding and philanthropy on the decline, their only prospect for long-term growth is to earn income, the report says.
But for that growth to materialize, Ottawa and the provinces need to make legislative changes that will give charities more flexibility in terms of how they use and generate funds. For the time being, "Canada's charities are caught in the crosshairs of Canadian federalism," the report says.
Meanwhile, none of Canada's Big Banks has become a champion of the social-finance movement at the institutional level. "I don't think it's resistance," Ms. Treurnicht says. "Banks are distracted right now, there's lots going on in the world and we do need them to keep their eye on that."
One of the barriers that stands in the way of convincing investors to put their money into social impact investments is the need for a standard, reliable set of metrics to quantify social impacts. As the Peterborough case showed, that is complex and time-consuming.
To ensure that investors get what is owed to them, it's been necessary to quantify exactly what recidivism rates are, to estimate how they might have changed in the coming years if the program weren't in place, and to determine the exact cost of keeping a prisoner in jail. It's somewhat subjective work, but it's essential to creating an efficient market for these investments.
The Peterborough bonds will pay out if the number of prisoners who re-offend drops by more than 7.5 per cent within six years. Bondholders could reap potential returns of 2.5 to 13 per cent, depending on how successful the project is. The returns will be proportional to the money that the government saves.
As Canadian governments study social impact bonds, the task force is pressing Canada's public and private charitable foundations to invest at least 10 per cent of their capital in social finance projects by 2020. It is also seeking more buy-in from pension funds, and from Ottawa, through tax changes and the establishment of a Canada Impact Investment Fund.