While some financiers caused our current economic difficulties, others might just provide investments that our public services desperately require. Joshua Chambers examines some unusual ways of generating funding.
While budgets fall dramatically across the public sector, City investors still have lots of cash. Some of it is ours, of course, after the bank bail-outs and quantitative easing – but we won’t be getting that money back for a while. There is, however, another way in which the public sector might be able to benefit from the oceans of cash still swilling around the UK’s financial sector: via direct, speculative investments.
This idea hasn’t emerged overnight. The Labour government looked into the concept: in 2000, then-PM Gordon Brown commissioned financier Sir Ronald Cohen to look into how private capital could produce greater public benefits. Cohen’s committee published four reports over the next decade, but progress was slow.
The credit crunch provided the impetus to take the agenda further. While Labour’s push on ‘social investments’ – which seek to produce both financial and social returns – concentrated on attracting more money into social enterprises, the coalition is looking for ways to attract venture capital directly into public services. The Ministry of Justice (MoJ) is the most advanced here, with a pilot scheme already running.
The benefits for the public sector are clear. Ian Mulheirn, chief executive of think-tank the Social Market Foundation, explains that there’s an obvious motivation: government lacks the money to kick-start innovative services. Social investment also allows for greater innovation and the avoidance of prescriptive commissioning models, says Adrian Brown of the Boston Consulting Group. With the private sector taking the risk, money can be invested in techniques that public bodies would reject as unproven.
Meanwhile, investors could win both social and financial rewards. Philanthropically-minded investors can contribute to tackling clearly-defined social problems – for example, high reoffending rates amongst ex-prisoners. They can also make a profit, Mulheirn says. “Investors see that the government spends an awful lot of money on curing and mopping up problems once they occur. If they nip problems in the bud, however, government saves a huge amount of money, and companies can take a cut of that saving.”
So how does it work?
The government is trialling social investment by using a ‘Social Impact Bond’ (SIB) in an MoJ scheme to reduce crime rates among offenders leaving Peterborough Prison.
The pilot works with prisoners who have been in jail for under a year, and so aren’t eligible for state-funded support from the probation service. Antonia Romeo, director general of Transforming Justice at the MoJ, explains that “offenders released from prison after serving short sentences have very high reoffending rates, causing huge damage to communities and a considerable burden to society.
“The Peterborough Social Impact Bond is a way of bringing both new investment and the expertise of the voluntary and community sectors to bear on this problem.”
The bond is run by a company called Social Finance, which commissions support and advice services on a payment-by-results basis. The scheme will run for six years, and investors have put £5m into the bond up-front. The MoJ, meanwhile, has put together a fund of £8m – with £5m coming from the Big Lottery Fund – to pay investors their capital and interest if the project is successful.
If the scheme delivers a drop in re-offending of more than 7.5 per cent compared to a control group, investors will receive an increasing return on their investment, capped at a maximum of 13 per cent per year. If the scheme fails to reduce reoffending rates by 7.5 per cent, however, the investors will lose their money. As Romeo says: “Importantly, taxpayers will only pay for what works in reducing reoffending.”
Are there other examples?
The Department for Work and Pensions (DWP) is also working to attract private venture capital into public services. Social investment can only tackle issues where there is a clearly-identifiable cohort, and where success can be defined and measured; the DWP is investing £30m of pump-priming cash over three years in a set of partnerships in which private investors, donors, and delivery bodies work together to hit targets on reducing the proportion of young people who are not in education, employment or training.
Tracy Hughes is the programme manager of the fund, and says it will be used to “generate a credible evidence base to support social investment arrangements, build the capacity of smaller delivery organisations, and support more partnerships that help disadvantaged young people”.
One of the partners on the programme is the Private Equity Foundation, a youth charity backed by finance firms. Chief executive Shaks Ghosh explains that the charity is drawing in cash from philanthropists, and commissioning services from charities and social enterprises on a payment-by-results basis. “Everything that we do is very carefully measured, and for every one of the targets that we meet, government will pay,” says Ghosh, adding that profits will be reinvested in services.
More broadly, Mulheirn suggests that DWP’s Work Programme could also be viewed as a social investment model, because the risk of failure has been transferred from the state to private companies.
Is there demand from the private sector?
At present, the market for social investment is “very, very tiny”, explains Adrian Brown. Brown co-authored a report last year that put the UK’s total social investments in 2010-11 at £165m. “In terms of regular bank borrowing or forms of investment, it’s the [size of a] rounding error,” he says.
The market is dominated by four social banks that collectively were responsible for 70 per cent of all social investment activity last year, Brown explains. Crucially, though, big philanthropic investment trusts and foundations have not yet become involved in the nascent market, so there’s the potential for rapid growth if the government can get the funding models right.
The government has, therefore, set up Big Society Capital (BSC) to help build a bigger market. Labour laid the foundations, legislating for BSC to take control of £400m in dormant bank and building society accounts. It will also receive £200m from the big four UK high street banks, as a result of the government’s ‘Project Merlin’ initiative.
Alastair Ballantyne is a director at BSC, and worked for Sir Ronald Cohen on previous social investment taskforces. He explains that some of BSC’s money will be used to build infrastructure for a social investment market – for example, by creating a social stock exchange that will increase transparency and allow people to trade SIBs. The rest of the money will be put into funds that in turn invest in specific instruments and schemes, in order to encourage others to enter the market.
The onus is on you!
Ultimately, the growth of the market is dependent on the public sector, Brown suggests, not investors: “Government holds the key to unlocking this because it spends hundreds of billions of pounds a year buying social value. If it bought that in a way that allowed social investment models to be developed on the back of contracts, there would be a pool of opportunities.”
Government therefore needs to commission to achieve measurable outcomes that funds can invest against, he says. Further, commissioners will need to be comfortable with the idea of people making a profit from social projects.
The MoJ has started the first scheme, and many eyes are fixed on the project, willing it to succeed – both in the UK, and overseas (see below). DWP is also joining the movement; but for venture capitalists to really make a difference to public services, other departments will also need to develop social investment models. As the old saying goes: nothing ventured, nothing gained.