Rethinking the Role of Capital Markets in Enabling Social Progress

14 January 2013

 

Earlier this week at the Global Philanthropy Forum, Tracy Palandjian, CEO of Social Finance, Inc., served on a panel discussion around the challenges and opportunities of impact investing. In the below interview with Tracy, we discussed her career trajectory, the first-ever social impact bond in the United Kingdom and its potential to be replicated in the United States, and much more.

A nonprofit dedicated to connecting the social sector with the capital markets, Social Finance structures innovative investment instruments which generate both a beneficial social impact and a financial return. The Social Impact Bond, which is core to Social Finance’s current work, has been recognized for its potential in providing innovative financing solutions to some of the most persistent social problems in the US and globally.

Rahim Kanani: How did you first get involved with the intersection of investment capital and social change?

Tracy Palandjian: I started my career in the private sector: private equity in Hong Kong (where I grew up), at McKinsey in New York, Wellington Management in Boston and most recently the Parthenon Group in Boston, where I worked for a dozen years and where I led the Nonprofit Practice to bring the consulting framework and private sector tools to some of the most committed and innovative organizations in the social sector.

Of course, fundraising is always the biggest challenge for nonprofits.  Having straddled the private and nonprofit sectors, I was always frustrated that I couldn’t leverage my investment background for the benefit of my foundation and nonprofit clients or my board work.  All that changed around 2008 when I met Sir Ronald Cohen, one of the founders of Social Finance in the UK and the US, who worked with me to co-author a report with UK-based Bridges Ventures on the impact investing industry.  That project convinced me to rethink the role of the capital markets in enabling social progress, and to explore the opportunity and the need to connect investment capital and the nonprofit sector.  Leaving the private sector to co-found Social Finance in the US with Sir Ronald and David Blood (of Generation Investment Management) has been one of my most important life decisions.

Rahim Kanani: Having worked quite closely with Social Finance UK, which launched the first social impact bond in the fall of 2010, what was the nature of this bond and how did it perform?

Tracy Palandjian: The basic objective was to see if private investors could fund and expand nonprofit prevention programs in order to reduce government spending around remediation services.  The starting point was the Peterborough prison outside of London, which houses offenders serving sentences of 12 months or less.  When the prisoners are released, they typically have no job prospects, little community support, unreliable housing, and substance abuse problems, and they receive virtually no government support.  Not surprisingly, about 60% of them are back in jail within 12 months.

The U.K. Ministry of Justice signed an 8-year contract that required Social Finance to raise about $8 million for established nonprofit organizations to provide reentry services for 3,000 prisoners.  If this initiative reduces re-offending by 7.5% or more, the government will use a portion of their net savings to repay investors. If the project fails to achieve the predefined metrics, the investors lose their entire investment.  Hence, the risk of failure is transferred away from government to private investors, who are more able to price and bear that risk.

Shifting the financial risk away from government also provides investors (and Social Finance as the intermediary) incentives to deliver prevention programs that reduce the need for more expensive incarceration and give these ex-offenders a much better chance at reintegrating into society.  We won’t know if the programs are working until 2014 when we start getting data about recidivism rates.  At this point, Social Finance is working with the prison and the charities to enroll participants and deliver effective services.

Rahim Kanani: Now that you’re leading Social Finance U.S., what is the potential for launching social impact bonds to the American market?

Tracy Palandjian: We hope that 2013 will be a pivotal year for getting Social Impact Bonds (SIBs) off the ground here.  Quite a few thought leaders, including McKinsey, Harvard Business School, the Nonprofit Finance Fund, the American Enterprise Institute, and the Center for American Progress, are taking a close look at this new instrument as a way of promoting more effective and accountable government at reduced taxpayer expense.  We are also fortunate to have the partnership and support of several leading foundations, such as The Rockefeller Foundation, Pershing Square Foundation, Omidyar Network and The Boston Foundation.  Several states and a number of federal agencies are moving ahead with pilot projects.

For example, Massachusetts is the first state in the country to formally solicit proposals for “social innovation financing” using pay-for-success contracts to address pervasive problems like chronic homelessness and at-risk youth aging out of juvenile detention and probation.  Governor Patrick submitted legislation in January that would commit the state’s full faith and credit to repay investors up to $50 million, which should provide the kind of security that investors will be looking for.  Several other states are watching Massachusetts closely and preparing their own initiatives.  At the federal level, the Department of Labor is launching a $20 million grant program for states to improve workforce development programs and the Department of Justice is offering state grants under the “Second Chance Act” for prisoner reentry programs under pay-for-success contracts.  All of these efforts are designed to move SIBs from the drawing board into the field.