It takes more than 2 to tango: Impact bonds in Latin America and the Caribbean

In April 2015, a small but complex development financing experiment began in an unlikely place—the Amazon jungle of Peru—11 hours by car and boat from the capital of Lima. This would be the first pilot of a development impact bond in Latin America and the Caribbean, and in fact, in the world. In this case, the goal was to increase the productivity and yield of cocoa and coffee farms to improve the lives of Asháninka farmers and their families. In an impact bond, which originated in the U.K. to address the high costs of prison recidivism, investors provide up-front capital to an organization to deliver needed services and are promised a return only if results are achieved. Since then, three additional impact bonds have been contracted in Latin America out of a total of 136 globally—only 11 of which are in low- and middle-income countries.

Next week, the Latin American Impact Investing Forum, an annual gathering of impact investors and social entrepreneurs, meets in Merida, Mexico to focus on some of the key social issues in the region.  While many indicators have improved over the last decade, Latin America and the Caribbean continue to face a number of striking challenges. For example, in El Salvador in 2017, only 30 percent of the population aged 18-64 had completed at least a secondary school education. In Mexico, an estimated 13 million people suffer from diabetes, and the country has the highest rates of hospitalization for the disease in the Organisation for Economic Co-operation and Development. In Guatemala, 47 percent of children under the age of five are malnourished.

All of these outcomes, which also have wider social and economic consequences, are preventable. So why aren’t they being prevented? Often resolving these problems requires a complex set of actors and activities, and it is in addressing this complexity that impact bonds, a form of impact investing, have the potential to contribute. In the model, up-front risk capital and capacity building around data and adaptive management practices allow service providers to flexibly navigate what works. For outcome funders, governments in the case of social impact bonds (SIBs) and third parties such as donor agencies or foundations in the case of development impact bonds (DIBs), funding is directed only to the achievement of results.

In a joint report with Ethos Laboratorio de Politicas Publicas, a prominent Mexican think tank that has been exploring payment by results in the region, we analyzed the key considerations for implementing impact bonds in Mexico. Much of the analysis around the legal, fiscal, and political considerations for creating a conducive environment for impact bonds is applicable to the rest of Latin America. Impact bonds are likely not the right tool to solve all of the challenges facing Latin America and the Caribbean, but, where there is complexity in the path to outcomes, this mechanism may have a role to play.

Of the four impact bonds contracted to date in Latin America, three are SIBs (see Table 1 below). After the Peruvian pilot DIB, an SIB for employment was contracted in Colombia. This impact bond focused on achieving sustained employment for vulnerable youth and in particular individuals internally displaced because of armed conflict. Results, just released after two years of implementation, showed that 899 people were placed in formal jobs (117 percent of 766 expected outcome beneficiaries), 677 people retained in their jobs for three months (88 percent of 766 expected outcome beneficiaries) and 309 people retained in their jobs for six months (60 percent of 514 expected outcome beneficiaries). In December of last year, a third impact bond was contracted in Latin America and the Caribbean, in the outskirts of Buenos Aires, Argentina, also for youth employment. Just last week, another impact bond was contracted for employment in Cali, Colombia. There are a further ten deals in design that we are aware of including three for education, criminal justice, and homelessness in Chile; three in Brazil for education, health, and early childhood development; one for economic empowerment in Mexico; another to tackle cholera in Haiti; and one each for cloud forest conservation and sustainable cocoa production in Peru. Some of these have been put on hold while others are near contracting.

Table 1 Contracted impact bonds in Latin America and the Caribbean

Note: *With capital recycling, the total upfront capital committed is $0.95 million.

Early impact bond designers and implementers had high expectations for the potential of these tools in Latin America and the Caribbean, in particular in middle-income countries where the conditions could facilitate their development. Four factors make this region potentially fertile ground for this innovative financing tool.

1. Paying for results isn’t new to the region

Contingent financing has been utilized in the delivery of a multitude of services across several countries in Latin America. Plan Nacer, for example, was a results-based financing initiative of the World Bank and the Argentinean government, which aimed to improve the health system by offering incentives to provincial governments. The program, which underwent a rigorous impact evaluation, led to improved birth-related outcomes and a decline in neonatal mortality. Conditional cash transfer programs, where beneficiaries need to meet requirements to receive the transfer, have been used in several countries including Brazil, Nicaragua, and Mexico. Prospera (previously known as Progresa and Oportunidades), the most well-known conditional cash transfer program in the world, demonstrated promising education and health outcomes in Mexico.

2. Data availability and quality is relatively good

An emphasis on collecting and making use of data is critical to impact bond design and implementation, and, on average, Latin America fares well relative to other regions. In the latest ranking of the Open Data Barometer, Latin America scores higher than the Middle East and North Africa, South Asia, and sub-Saharan Africa. Leaders in the region include Mexico, Brazil, Uruguay, and Colombia—notably there is not a clear correlation between income level and ranking. Civil society in the region has played an important role in encouraging open data. Some country-specific data initiatives stand out—for instance Mejora tu Escuela in Mexico, Semaforo Escuela in Peru, and A tu Servicio in Uruguay. There is room for improvement of course, and impact bonds could potentially serve that function.

3. A strong impact investing sector

Impact investing is alive and growing in Latin America and the Caribbean. In 2016 and 2017, impact investors invested a total of $4.7 billion in the region, with Peru as the top destination, followed by Ecuador. The majority of these impact investors are based outside of the region, however, there has been a steady increase in local impact investors, the majority based in Brazil (18 percent of survey respondents) and Mexico (13 percent of respondents). Furthermore, foundations and family offices increasingly have begun impact-investing activities as demonstrated in the two impact bonds in Colombia.

4. A tradition of social innovation

If necessity births creativity, then social innovation has played a critical role in tackling some of the wide-ranging social challenges in Latin America and the Caribbean, the region with the highest income inequality in the world. Primarily civil society and local communities have led this movement in Latin America, rather than government, due to the risk of failure that comes with the process of trial and error. Government and development agencies working in the region can play an important role in scaling up innovations. One example is the conditional cash transfer program Bolsa Escola in Brazil, which started as a small pilot and was extended nationally. Support from international organizations has also helped to foster innovation in the region as in the case of the two impact bonds in Colombia where SECO has been a joint outcome funder.

Nevertheless, the region’s impact bond market hasn’t grown as quickly as many would have expected, and some deals that seemed quite promising failed to come to fruition. What were the challenges? Interviews with some of the key impact-bond stakeholders have revealed four major challenges: macroeconomic instability, political uncertainty, unfavorable tax regulation, and legal straightjackets. In Argentina, for example, the design stage of the first SIB in the country was quite lengthy due to instability of the economy and political uncertainty. Furthermore, tax codes prevented philanthropic investors from investing in the impact bond. Nonetheless, a progressive and innovative local government allowed for creative solutions to regulatory issues and the initiative took hold. In Jalisco, Mexico, an impact bond in support of livelihoods was close to the contracting stage with the Secretariat of Social Development and Integration as the outcome funder, when upcoming elections caused the project to grind to a halt. Two impact bonds in design in Brazil have experienced setbacks for the same reason.

Given the abundance of opportunity and creativity in the region, new solutions to persistent problems are possible. What is clear thus far is that it will take dedicated efforts and close collaboration among many different actors within government, civil society, and the private sector. We are interested to follow impact bonds’ progress in the region, and in particular to observe closely how government engages, commissions, and finances outcomes. It will be critical for all involved to scrutinize carefully the nature of the problems to be solved and to assess which tools—impact bonds or otherwise—are the best fit.