Variations on the impact bond concept: Remittances as a funding source for impact bonds in low- and middle-income countries

As the world comes to grips with the scope and ambition of the Sustainable Development Goals (SDGs), one theme continually rises to the surface: financing.

The figures are daunting, at a scale that is difficult to comprehend. According to the World Investment Report 2014, developing countries face an annual investment financing gap of $2.5 trillion. The 2015 Addis Ababa Action Agenda on financing for development, agreed upon by all countries in the lead-up to SDG endorsement, rightly established financing of the goals as key priority.

In the education sector, the International Commission on Financing Global Education Opportunity, the Global Partnership for Education, and others are grappling with ways and means of closing the estimated $39 billion funding gap per annum in low and lower middle income countries to meet the ambitions of SDG 4 (ensure inclusive and equitable quality education and promote lifelong learning opportunities for all). To put the education funding gap in perspective, $39 billion represents just 1.6 percent of the $2.5 trillion annual investment shortfall (the Financing Commission calculates an even larger education funding gap, and advocates for annual spending to grow steadily from $1.2 trillion per year in 2016 to $3 trillion per annum by 2030).

It is generally agreed that partnership will be crucial to SDG progress, both in terms of financing and know-how. On the numbers side, domestic resources mobilization is a key source for funding national development plans, including in emerging and developing economies. Private sector contributions—contributions by civil society, remittances, foreign direct investment and official development assistance (ODA)—all have critical roles to play in bringing the necessary resources to intractable problems. Most important is the effective use of available resources, but therein lies the rub: With insufficient resources, excellent plans, and admirable intentions will only get you so far.

To crowd in more resources in support of SDG ambitions, there exists a substantial—but largely untapped—opportunity to create attractive investment options for the vast diaspora community. It is a call for the diaspora to act as angel investors, channeling a portion of remittance flows to social investments—with returns.

Remittance flows are significant. Officially recorded remittances to developing countries amounted to $431.6 billion in 2015, with flows to all parts of the world. Remittance flows are substantially larger than ODA, and historically more stable than private capital flows (see this World Bank report, Figure 5).  While remittances tend to have positive countercyclical effects—increasing during economic downturns or after a natural disaster—funds typically flow to the household level.  Broader societal benefits are harder to define. As Dilip Ratha,  lead economist and manager of the migration and remittances unit in the World Bank, writes, “Governments have often offered incentives to increase remittance flows and to channel them to productive uses… efforts to channel remittances to investment have met with little success. Fundamentally, remittances are private funds that should be treated like other sources of household income.”

Diaspora bonds, however, provide useful precedents in directing remittance funds towards national development priorities. As outlined by Ratha and economist Suhas Ketkar, and reflected upon recently by financial specialist Mayumi Ozaki, diaspora bonds have been used extensively by Israel, and periodically by India and Nigeria, with sparse uptake elsewhere.  Diaspora bonds operate like traditional bonds—to provide predictable financing for governments sourced from their diaspora community. Bond issues tend to be untagged, meaning that the issuer has latitude around the use of funds.

Given the significant financial flows involved, commentators (including those cited above) wonder why diaspora bonds haven’t caught on more widely. Possible reasons include the need for trust in home country systems. Perceptions of system governance, levels of sovereign risk and financial sector stability will color investment decisions—even with the “patriotic discount” touted in diaspora bond issues, there is a limit to the amount of investment risk that may be accepted. The unfocused nature of who or what will benefit from a bond issue may also be a limiting factor: Some may be motivated by contributing to the general betterment of a country (Israeli bond issues are a stand-out in this regard), but others may be insufficiently energized to put their funds into a generic pool. Greater specificity of beneficiaries, with clear and measurable results, could be a powerful motivator.

Building upon the diaspora bond concept, there are real opportunities to attract diaspora finance in support of clearly defined actions with known beneficiaries. A relatively new financing tool—social impact bonds (SIBs) and development impact bonds (DIBs)—fits the bill. DIBs and SIBs typically address specific challenges, with identified targets, and known investment risks and returns. Technically, SIBs and DIBs are not bonds, since they don’t guarantee a financial return: Pre-defined performance targets must be achieved before initial investors receive returns—this payment-for-results is a central attraction of the model.

Diaspora angel investment in DIBs and SIBs is a niche that bears investigation. Impact bonds have been applied to social welfare, criminal justice, education, and employment contexts.  To date, investors have tended to be governments, philanthropic foundations or trusts, institutional investors, banks, and high net worth individuals. Outcome funders (i.e., those who “pay for success”) have tended to be domestic governments (for SIBs) and foundations or bilateral development partners (for DIBs).

Further information on the characteristics and applications of social and development impact bonds is available in two recent Brookings studies: one landscape study examining the first five years of impact bonds and another study examining the application to early childhood development.

Bringing diaspora finance or remittances to social/development impact bonds could produce several potential benefits:

  • Encourages external private investment in a developing country, via an intermediary institution (i.e., to structure the SIB/DIB and manage risk)
  • Allows the targeting of remittance funds beyond family networks and in support of a societal good attractive to the investor (e.g., health systems; education; early childhood development; employment)
  • Uses a structured financing vehicle that provides known rates of return and known levels of principal recovery/risk
  • Targets the diaspora, but could be presented as a retail investment option more generally (diaspora bonds have varied on this: the Development Corporation for Israel’s bond issues were targeted towards, but not limited to, the Jewish diaspora; India’s bond issues were limited to investors of Indian origin)
  • Accesses a multi-billion-dollar global resource pool, in which everyone (potentially) wins: returns for the investor if the intervention succeeds; achievement of a societal and developmental good (the activities supported by the SIB/DIB); and potentially reduced risk for outcome funders (through “payment for success”).

Given the scale of the issues and the numbers involved, diaspora angel investment does not represent a silver bullet. Attracting diaspora investors to a DIB or SIB will require an active communications strategy in diaspora concentration countries (there are valuable lessons from diaspora bond issues, and the Education Commission refers to the potential of education bonds).  Confidence in the process—from investment design through to intervention and monitoring, within overall bond security and oversight—will be critical to any roll-out.

But if more resources can be directed towards defined development action—with a known rate of return for participating “retail” investors—it might just have a catalytic investment effect, across sectors, and across countries.

David Coleman is Senior Education Advisor at the Australian Department of Foreign Affairs and Trade

DISCLAIMER: The Australian Department of Foreign Affairs and Trade provides financial support for Brookings. The views expressed are the author’s and do not necessarily represent the views of the Australian Department of Foreign Affairs and Trade