All change for Cameron's social capital market revolution

In December 2006, the UK Prime Minister David Cameron made the following comment in a speech: “I believe that this generation could see a revolution in our social economy comparable to the revolution in the commercial economy in the 1980s. That is the revolution that I want to lead... Don’t we need the same transformation in the social sphere that we have seen in the economic sphere?“.

These were and are highly laudable sentiments about a system’s change, and like the UK Government’s attempt to place this revolution in the context of social investment on the G8 agenda earlier this year, they are only to be praised. However, judged by the harsh realpolitik benchmark of G8 success, it failed to make the communiqué – the statement issued jointly by all the G8 leaders at the conclusion of the summit.

Why was this? Well, when you listen to the speech in detail, it was an iteration of Big Society – a domestic policy which was at best marginally successful to this point. This time it came thinly wrapped as the opportunity of “Impact Investing” with the sugar coating of “Britain leading the way” – showing Johnny Foreigner how it’s done – a sure way of getting the French to veto it behind closed doors apart from the fact that it is not completely accurate. Think of Germany’s record on funding sustainable energy, and the welter of finance innovation you see in smaller countries like Luxembourg, Holland, Sweden, and Switzerland. In the US look at the vitality of social entrepreneurship (the $40 bn Donor Advisor Funds, the Community Reinvestment Act and the CDFI movement, OPIC’s innovation, the $200m (annual lending to US domestic social entrepreneurs) by the National Finance Fund, an actual legal code (PRI) that defines the use of social investment for foundations (addressing the points about political contributions that David Cameron made later in his speech).  

In the developing world how about the $10bn of lending done by Grameen, or BRAC - the world’s largest Citizens sector organisation - employing 125,000 people. Or the Aga Khan Development Network employing 75,000 with $2.7bn in annual revenue. Or at the multilateral level the immunization alliance GAVI – a $3bn structure, (which to be fair was UK inspired).

I could go on – but you get my point. There is a plethora of innovation – the real challenge is how you move it to scale and address the structural constraints and vested interests.

On the positive side, the speech meant that the UK Government has grasped that the same “new” financial tools and innovation of Impact Investing can be applied to both domestic and international issues (unlike the EU who now have two reviews ongoing of Impact Investing done by two different commissioners and appear to view this from the viewpoint of the status quo players).

At the end of the day, social entrepreneurship and impact investing are simply the injection of modern capital and commercial practices into the provision of social goods. In financial and strategic terms, the opportunity and paradox is that in the traditional “for” profit world we are reaping the whirlwind of over leverage, whilst in the “not for profit” world there is under leverage.

 It is, to quote Stephen Lloyd – the UK’s leading charity lawyer – “pre capitalist” – with just two dominant funding structures: Western Government concessionary loans and aid delivered centrally mostly through other governmental institutions – the Bretton Woods system of May 1944 – and the foundation system, in banking terms a closed ended Investment Trust that allocates hardly any of its caucus funds to social purpose and just 5% of its annual capital a grant also at negative 100% – a  funding structure originally invented in 1903 by Rockefeller and Carnegie.

Moving from finance policy to "Policy Finance"

Social investment is not just about sticking the word “social” in front and legitimising a subsidy or tax break for your silver bullet – it is also about a fundamental change in the social contract. It is about a move from being cynically seen as an aspect of the finance policy to reduce the deficit, to "Policy Finance" – a move which applies a plethora of existing investment and commercial tools to social purpose with the objective of modernizing the sector and changing the incentives to scale, collaboration and partnership.

The irony is that this is not ultimately about money, it is about change management, or “a revolution in our social economy” – the systemic banking question is: What is the alpha of collaboration and scale in an unleveraged, un-annuitized capital market with externalities measured in the trillions, serviced with only two financial structures created  in 1903 and 1944?

Or since in the social sector we are told to avoid facts and tell stories – the current social investment market is like blindfolded men and women feeling the proverbial elephant – except that each elephant of the herd is also blindfolded in its sectoral silo (functional and governmental), having multiple providers of food, who feed it at different times for different reasons, who regularly change how, where and what they want to feed – and then look for the elephant to produce a pint of milk – and then also expect the herd to pull in one direction.

A sector that spends huge resource talking about the impact and dangers of systemic outcomes but then applies the solutions in micro bilateral outputs

There is no alternative to breaking eggs

This is an issue that should be bipartisan, as it drives resource to issues the left care about and to the to the right as it is about driving modern commercial practices and efficiency into a sector they have always regarded with some suspicion. But what both the “Big Society” policy and the G8 Summit on Impact Investing lacked / lack is a statement of why it’s so necessary – TINA (There Is No Alternative) in Conservative language. A sense of urgency.

It lacked a clear vision as to what will be better, and indeed as is implicit in any revolution, a clear identification as to what institutions and practices need to change and what regulatory structural framework do you need to have in place. As Mrs Thatcher understood in her commercial revolution in the 1980s , borrowing Lenin’s words – “to make an omelette you have to break the eggs”.

And here is my primary criticism (and opportunity) for UK plc. Impact Investing was presented as something nice to have rather than a critical strategic building block of our societies.

The practical reality is that this crisis is structural as well as cyclical. The chart above by the Canadian Finance Ministry (2011), taken from UN figures, indicates the ratio of people aged 15-64 to people aged 65+ in a selection of key countries. It tells a stark story of ageing populations. What is of greater concern is that current accounting policy, future unfunded pension liabilities and health costs are simply ignored.

To spell out what that means as you move from the black column to the blue column on the chart – America (as the best case in this example) has unfunded pension liabilities (ignoring health, and some say these could be ten times as high) of $3 to $9 trillion alone, and Italy’s real debt to GDP is not the 125% the markets are fretting about but probably nearer 330% – and the Germans won’t be in a position to bail them out.

So the concept of “Government knows best” and more money for development coming from the top down – if it ever could have solved the problem – will simply not occur. Domestic politics will see to that. In real terms aid flows are already plateauing.

Paradoxically, in the developing world you have the exact opposite of an ageing population – namely a huge growth in youth populations that threaten political destabilisation, compounded as Kofi Annan recently noted, by social media that makes social injustice painfully visible – the results of which you can already see being played out on the streets of the Middle East.

Compound that by issues that dwarf the resources allocated in the current social investment system and you understand the need for a “revolution” in thinking.

Just to pick three cases - Water and Sanitation ($600bn annual externalities – accounting for a sizeable proposition of the 11,000,000 deaths of children under five every year from preventable causes);  Climate ($2 Trillion + annual externalities) arguably  threatening our existence on this planet; or road - the biggest killer of 15-24 year olds (annual externalities estimated by McKinsey of $523bn). And one has not even started on Food, Resilience, Education, Pestilence and Disease. 

This is no longer just a moral issue, these costs now threaten destabilisation and limit growth of the corporate sector.

If we stay with the current paradigm, the signs are worrying. In the US, total foundation core endowment funds are about what the Pentagon spends in 9 months – and one should add that 98% of those foundation funds are actually unaligned with social mission.  Let us also be very clear that the foundations and “the community”  on the income side (either domestically or internationally) simply have not got the scale to cover the retrenchment of Government – to stick to the same analogy, the Gates Foundation’s annual give away is about what the Pentagon spends in 36 hours.

Some advocates to the traditional foundation world will tell you that the largest transfer of wealth in human history – around  $41 trillion in the US alone estimated to transfer  from one generation to the next over the next 40 years – is going to result in a new boom in philanthropy and impact investing. But when you run the maths through under the current foundation banking paradigm, you get a depressing amount being deployed relative to the problems noted. 

Let me give you the US example, of the $41 trillion – 60% of those assets are owned by 3% of the population. These are the people who have the ability to give in scale – this brings you to about $24 trillion – of course this is over 40-50 years so about $500bn annually. They will of course not give it all away – say 10% will do so, leaving us $50bn. Then of course under the current paradigm only 5% will be allocated annually – say around $2.5bn to $10bn in additional annual funding, perhaps reaching $50bn maximum with compounding.

This is fine for the status quo  – a doubling of resource in monetary terms over 50 years. But systems changing? No.

Action to match the rhetoric

It was here in the latter part of David Cameron’s speech and the responses to questions that it became clear that action did not match rhetoric, The Prime minister re-announced  a number of domestic initiatives, all of which again are to be praised. But since this was G8 – why did he or the UK’s International Development Secretary Justine Greening not announce an extension and development to the UK’s CDC Impact Fund – where was the international dimension of the UK leading the way ?

Internationally, the Prime Minister also noted the opportunity of departmental budgeting – as a mechanism to more intelligently apply resource. His example was a marriage in international affairs of the Foreign Office and the Ministry of Defence, to synchronise soft and hard power. Again, this was to be praised – but surely as we cut hard military power – it makes sense to boost soft power ? So why as part of that process cut the BBC World Service budget (at a cost of around one Eurofighter, or £70 million) – one of the true global tools UK plc retains in strengthening international civil society.

Which raises the question: ‘How will impact investing play into that agenda?’ Or the question raised at the meeting by Stephen Lloyd  – the legal advisor to Lord Hodgkinson on Charity reform – about alignment of the core foundation funds with social mission. This is an issue resisted by some in government – and by many in the status quo foundation world where this throws up real organisational issues.

As Stephen noted in his question, this issue is in danger of being kicked into the long grass. The PM  in his response referred it to William Shawcross, the new Charity Commissioner. This was worrying. Let us hope, as David Cameron promised, he has taken the issue away to address – it is a clear marker of whether his government has the stomach for real structural reform – and one his government can address

It is here that the PM should recall that a key stanchion of Mrs Thatcher’s reforms in the civil economy was the reform of the banking system – namely the Big Bang deregulation of the City in 1986 – and that the foundations as bankers to the not for profit world control substantive assets of globally nearly a trillion dollars –  which surely they should be allowed to align with social mission?

To give you an idea of the impact, in the US example just a 5% allocation would unleash as many assets as currently applied annually to the philanthropic agenda. Just 20% by 2020 – a less than 2% annual change in core asset allocation for foundations between now and 2020 –  would align $125bn. Indeed, these assets could be leveraged a further three times – a sum equivalent to current total core funds. There is evidence that this may even be revenue neutral to positive for government.

The impact would also be to drive economies of scale into the sector – the comparison to business as usual noted above could not be starker.

There is now a clear debate in the US about Mission Related Investment. Take a look at The World Has Changed and So Must We, by Clara Miller, the CEO of the Heron Foundation.

All about the money

Will Britain also lead in this debate?

Indeed this issue is not ultimately and ironically about money – It is the difference between an unleveraged pre capitalist system and a modern one; it is about leveraging capital effectively and changing the incentives for collaboration and scale. When you look at the current innovation through the prism of a range of financial products, you can only be surprised at the opportunities presented. What is only too clear to protagonists is that the supporting infrastructure is unaligned and unfocused with little clear idea as to how to achieve this. It is here that Government must again play a clearer structural role.

There is a plethora of “new” financial tools that can be applied to this market in real scale. The Prime Minister repeatedly mentioned Social Impact Bonds – an innovation I was involved in from birth. They are in fact not Bonds but the application of structured products to this market – see US SEC code 434 – and if one was to securitize the cash flow from the contingent payer you would actually create equity (where social equity = financial equity and could be shared out). This vehicle would then trade and have a value as a function of the achievement of the social parameter.

This would be a tool to move from the dominant, bilateral output models or input models to multi stakeholder partnership structures where the incentives are geared towards collaboration, scale and rapid achievement of social objective.

Or to take another example, according to the World Bank, there are nearly $2 trillion in local capital pension fund markets that could be aligned with a Western guarantee structure to  their own sustainable development profitably in their own currency. These issues are not about funding Newcastle Swimming Pools or individual social entrepreneurs, as critical as those steps are, but about changing the fundamental flows of capital.

To drive real change policy finance requires a clear understanding from Government – as to the nature, ecosystem and regulation of this developing trilateral relationship between the corporate sector, civil society and government.

The corporate sector will increasingly drive this process as business growth in Asia and Africa shifts their view as to the risks to their core business models of not addressing the  social externalities. The banking world, deterred traditionally from a sector it sees as fragmented and un-investible, is beginning to look more closely – if ‘SIBS’ (Social Impact Bonds), ‘DIBS’ (Development Impact Bonds) and what we at Total Impact Advisors have called ‘SYNs’ (Social Equity with social mission hard wired) open up investment product for the core funds of foundations – then it is an interesting question to ask who will structure this market, who will manage the $1 trillion of endowment funds – and who and how will  we regulate for social mission? Behind closed doors large foundations and banks are already having this conversation.

The tight rope government needs to walk is ensuring it creates a social capital market that moves in scale. But if we argue that the bilateral application of capital at negative 100% (a foundation model) needs a mechanism to ensure social mission is hard wired – how much more do you need it where you have multi stakeholder players each taking a different economic / social return?

Again, one can only commend David Cameron and the UK Government for the stance they have taken through the G8 on pushing this issue onto the international agenda. The question is whether rhetoric will match action in scale when it comes to the required structural change. If it is “a revolution in the social economy” that David Cameron requires, he should remember the words of Lenin: "Revolution is impossible without a revolutionary situation; furthermore, not every revolutionary situation leads to revolution."

Or to pick a more acceptable name in the halls of Conservative power, it is as Churchill once commented: “It is not the end, it is not beginning of the end, but perhaps it is the end of the beginning.” Like Mrs Thatcher (the only other PM in Conservative Association offices usually found in a picture frame as opposed to a poster) we will now indeed see with what metal he is made.