Expert Insight: Why development impact bonds’ complexity is a guardrail not a roadblock

The global development system is arguably under greater pressure than ever before. Wars, climate change, migration, economic inequality and political instability all have a disproportionate impact on those living in poverty. This is exacerbated by increasingly xenophobic policies and decreasing support for international development, most notably resulting in the future of USAID, the world’s largest single donor, being put in doubt, as well as the announcement that the UK government will reduce its aid spending commitment from 0.5% to 0.3% of national income. We were already talking about a potential funding gap of $5tn-$7tn a year to achieve the UN Sustainable Development Goals by 2030. With USAID and UK government cuts, this gap will just get even larger.

The response of many to this crisis is “we need more money”. But that is not realistic and is not going to happen.

The answer has to be to make the funding that we have more efficient, more effective and more accountable. 

We all know that there are huge inefficiencies in the system, with millions of dollars of philanthropy and government funding being wasted on programmes and initiatives that make little impact, with resources not targeted in the most effective way. There is a responsibility on all of us working within the development ecosystem to do something about this – to innovate, come up with different ways of achieving success, use data and evidence to inform decisions, focus funding on results and so on.

With the fast-approaching 4th International Conference on Financing for Development (FfD4) this summer, there is a great opportunity to be bold and reimagine the whole way in which development is funded and delivered. The outcomes of this landmark conference could shape the global financing landscape and determine the trajectory of sustainable development efforts over the next decade.

We believe that outcomes based finance instruments, such as development impact bonds, offer one of the solutions that must be considered. Outcomes based finance is not a silver bullet and cannot by itself solve the overall challenge, but it does offer a proven way to ensure that funding is tied to explicit targets and spent in ways that drive measurable impact. Initiatives such as the British Asian Trust’s Quality Education India Development Impact Bond and the Skill Impact Bond have demonstrated how outcomes based finance can make development funding more efficient but also achieve impact at scale, transforming entire ecosystems.

• Impact 101: What is an outcomes fund?

We think outcomes based finance definitely has a role to play as part of a broader strategy to realign global economic and financial systems with the SDGs, and the upcoming FfD4 can be a launchpad for systemic changes in how we finance development and reimagine the role of public and private capital.

We began our journey with outcomes based finance and impact bonds in 2018 with the Quality Education India Development Impact Bond (QEI DIB). Since then, we’ve launched India’s first outcomes based finance instrument for jobs, the Skill Impact Bond, in 2021 and most recently, the LiftEd Development Impact Bond, in 2023. Through this work, we have mobilised US$40m and brought together more than 40 partners across civil society, government and the private sector. We are also about to launch the first outcomes based finance instrument in Pakistan.

Using our expertise in financial innovation, we have blended different pools of capital, from return-seeking investments to philanthropic grants to domestic CSR funds, thus ensuring that all our initiatives are well resourced, not too dependent on any one type of funding and can benefit from the strengths that each type of capital brings. Our partners include investment managers such as UBS Optimus Foundation and Bridges Outcomes Partnerships; global philanthropies such as Children’s Investment Fund Foundation, the Michael & Susan Dell Foundation, the Maitri Trust, Atlassian Foundation; and CSR donors such as HSBC India, JSW Foundation and Reliance Foundation. 

While we are still implementing two impact bonds, we have successfully concluded the Quality Education India Development Impact Bond, which delivered an 8% return on investment and achieved 2.5x increase in learning gains.  

All this considered, it’s safe to say that we’ve learnt a thing or two (or ten!) about the approach. And we are also very familiar with the arguments that are made against these approaches. We believe that they work and we are always happy to address certain misconceptions around the approach and share our practitioner's perspective, based on our real-world experience. 

Addressing the elephants in the room: set-up time, complexity and cost 

Much has been said about impact bonds – both positive and negative. The biggest arguments against them are due to the misconception that they take too long to set up and come with high costs and complexity added on. However, these arguments are often made without engaging with the nuance needed to understand why the time, cost and complexity can sometimes be high, whether they are truly as high as we perceive them to be, and how these factors can serve as guardrails, rather than roadblocks.

Time: With any multi-stakeholder collaboration involving multiple organisations, viewpoints and priorities, time is needed to build alignment and razor-sharp focus. We would argue that impact bonds take no more time to set up than any other large-scale initiative, particularly those doing things differently and aiming to transform systems and the status quo. The initial time spent on discussions and design is extremely constructive, setting these projects (which are typically long-term, multi-year programmes) up for success in the long run. Agreeing to what outcomes to measure, why to measure them, how to measure them, and when to measure them is a process that does – and should – take time and be carefully thought out. This helps ensure that success is clearly defined and measurable from the get-go, and that all parties involved are not left wondering about whether or how much of an impact was truly created. 

With any multi-stakeholder collaboration involving multiple organisations, viewpoints and priorities, time is needed to build alignment and razor-sharp focus

The time spent upfront on driving agreement among a diverse group of participants ensures that there is clear alignment on end outcomes, driving greater clarity during implementation and allowing partners to focus on what it would take to generate outcomes. In short, time spent designing the outcomes framework, the heart and soul of any impact bond, is an investment in its success, not a cost. 

Cost: Some of the very first pilot impact bonds had relatively high transaction costs, as with anything new and innovative. But we’ve come a long way since then as a sector and ensured that the costs now compare favourably with other development approaches. Our approach prioritises cost-effectiveness, efficiency and simplicity, resulting in projects that enable us to maintain an ‘80:20 ratio’ on programme and technical costs (a combination of evaluation, legal, performance management, communications, and so on). 

With every project, we can reduce these technical costs further, given that we have the basic blueprints, templates and other resources in place. Many impact bonds are also set up to deliver long-term value beyond the programme itself, which is often not considered when scrutinising costs. The 80:20 ratio can also be considered highly competitive compared with other development approaches, where sometimes even smaller percentages reach implementing partners on the ground. 

Complexity: Impact bonds do not need to be complex, and in its simplest form, the impact bond is one of the most straightforward approaches to achieving impact. 

In a traditional, philanthropic approach, funding is given in advance to pay for activities that are then reported against – and if they do not lead to success the donor will still have paid. With an impact bond the work is funded by a “risk investor” and the donor pays back the risk investor after the results have been independently verified. The donor only pays for success. If the programme has not worked, the risk investor loses their money. That is not that complex to understand!

However, we do recognise that because we are focussing on outcomes, a further degree of complexity does enter and quite frankly – is needed – considering the on-ground realities. For instance, there still exists a massive trust deficit between funders and non-profits, which translates into demands for intense scrutiny on an impact bond’s outcomes evaluation and verification, legal contracting and so on. Similarly, either due to lack of good quality data and cost benchmarks, many impact bonds need to design their outcomes targets and prices from scratch. Additionally, based on legal and regulatory requirements that different kinds of funders may need to adhere to (such as fixed annual utilisation rules for CSR in India), the fund flows within the impact bond need to be delicately structured.

Stakeholder behaviours also play a big role in impacting ‘complexity’. Impact bonds require a certain way of working – where outcome funders relinquish control of on-ground inputs and trust the implementation partners to arrive at outcomes in the manner they see fit; where investors focus on the wider outcomes beyond their returns and support the implementation partners relentlessly; where implementation partners create performance-driven cultures. And where evaluators step in at the start of the journey and stay involved throughout, contributing actionable data and insights, rather than coming in at the end to post-mortem the programme. This process of behaviour change and adapting to new ways of working takes time to arrive at, often requiring handholding and adding to the perceived ‘complexity’ around impact bonds, but transforming the way organisations work – even after the impact bond. 

The proof is in the pudding – and outcomes data show the payoff 

In outlining all these points, we aim not to dishearten or defend but rather, dive deeper into the details that influence our perception of impact bonds, take pause to think about why some preconceived notions pervade, and unpack the context behind them. The silver lining is that the time, cost, and complexity seem to be translating into better and higher outcomes, which is the ultimate goal.

For example, the QEI DIB improved literacy and numeracy skills among its students by 2.5x in comparison with their peers in other schools. Students in the Haryana Early Literacy DIB could fluently read 42.4 words per minute while children in non-intervention schools could read only 30.3 words per minute. Similarly, under the Skill Impact Bond, 70% of enrolled women have successfully joined jobs and 56% have continued to work for three months or more, almost five times higher than other large skilling programmes in the country. 

Of course, we aren’t of the opinion that impact bonds should stay complicated for the sake of it. A core part of our mission is to grow the outcomes-based finance market, demystify and simplify the approach to make it more accessible, share our insights, learnings, data, templates and public goods, and bring more people along as we innovate to address some of the country’s most pressing challenges. We do this, while also holding space for the fact that these solutions do require deep effort and investment – but are worth it if done well and done right.

The 4th International Conference on Financing for Development presents a unique opportunity for the global development ecosystem to be bold, brave, self-critical, accept that fundamental change is required and embrace different ways of working. We must accept that things are not working as they are. We must accept that there will not be trillions of dollars of new money. So, we must accept that radical change is required. We should base these changes on evidence and embrace innovative ways of working that have been proved to be successful. That is the solution to this crisis. And that is what the poorest and most disadvantaged people in the world deserve.

Richard Hawkes is CEO of the British Asian Trust

Header image: Participants in India’s first outcomes based finance instrument for jobs, the Skill Impact Bond. Photo courtesy British Asian Trust