New financial instruments will help increase money flows and scale our impact

1.4 trillion dollars, that's how much extra money will be needed each year so low- and lower middle-income countries can reach the ambitious sustainable development goals and lift the world's poorest 700 million people out of poverty by 2030, according to a recent UN report (PDF, 2 MB). That's a huge price tag especially when you contrast it with the fact that this year the OECD reported that Official Development Assistance totaled a "mere" 134 billion dollars.

By John Fairhurst, Executive Director of Programs, UBS Optimus Foundation

So how are we going to bridge this funding gap? It seems clear that getting more people and more money involved will be crucial given pressures on traditional funding streams. We, and many others, believe this means there must be a major role for the private sector. And to some extent it is already happening. Today, global aid is dwarfed by the flows of investment, remittances, and other sources of private capital to developing countries. Encouragingly, the UN report recognizes this and estimates that countries will be able to raise the money from public funds and through private sector financing. But simply increasing the levels of aid alone is not the answer.

Despite billions being spent on aid programs each year, all too often it's not clear if this money is being used effectively. And even with the best will in the world we have not achieved the results we, both donors and the people we support, should be entitled to expect. So what needs to change? We need more money for sure, but it’s also about how that money is used, how we identify promising programs, nurture them, and bring them to scale. It will take a shift in mindset, and it's definitely not about more of the same.

Entrepreneurship, innovation, scale, and money –we want it all, and we want it now

Many of today's development success stories are driven by innovation, often from outside the traditional development framework. For example, the Brookings report “Millions Learning” showed that new approaches and ideas are often allowed to develop and grow on the margins, and are then scaled. It’s true in education, in health, and in many other sectors. And these success stories, these innovations, tend to be led by strong entrepreneurs who want to change the world. So the question for us is how do we mainstream this more efficiently?

Attracting new finance

Attracting new finance from people who are not currently engaged in the space is crucial. And that is already underway. There are new instruments that are generating a lot of interest, for example the world's first Development Impact Bond (DIB) in education we launched just over a year ago. We have seen huge interest in the mechanism pretty much across the board, from private finance, development organizations, governments and philanthropists. And instruments like the DIB offer valuable lessons on what can make such instruments attractive for to stakeholders.

DIBs provide clarity on “what” the money is being used for. The impact element is clearly defined. The same rigors and tests of value-for-money, as well as next-best alternatives, are applied in defining what exactly is being financed.

Their definition of “how” best to deliver is less prescribed, empowering implementers to use their expertise and capability to deliver the impact. It allows them to do what they do best, encouraging them to innovate to overcome challenges as they grow, not putting them in an operational straightjacket designed thousands of miles away from the front line.

And, importantly, DIBs are also highly performance driven meaning an investor's risk is actively managed by people who understand the space and the intervention context.

It may sound obvious, but it is also crucial to remove the three big barriers to increasing financing from the private sector; a lack of clarity on value-for-money, poor transparency about performance, and weak risk management. And this doesn't apply only to DIBs. Removing these obstacles is necessary to ensure the success of any new instrument or vehicle, whether loans, equities or bonds, looking to increase the flow of capital into a new space.

Entrepreneurship, innovation, and scale

Scaling traditional commercial ventures is rarely a linear process. The same is true for social ventures. The financial or social valuation of a venture with the potential to scale tends to grow in steps. These include key events or milestones that take it to the next level and a new valuation multiple (social or financial value) because, for example, it has new RCT impact evidence, or a new contract establishing it as a government's preferred supplier. So when we look at financing an organization we should keep in mind these points of value creation and finance to get to those key points in the organizations growth.

Of course money helps, but money alone isn’t usually sufficient. A growing organization's needs, challenges and opportunities change over time. And many aren't equipped to cope. They need scaling partners who can provide things like supply chains, brand development, or technical know-how. Others may need advice, mentoring, and partnerships, or guidance on how to broaden their investor base.

So what does this mean?

We believe that by developing new instruments like DIBs we can bring new financial flows to social ventures. But we would not claim that DIBs are a panacea. They are not always the right tool, and that means there needs to be a suite of different options available. But new instruments, framed to provide clearly defined value and a social and, possibly, financial return-on-investment, will undoubtedly help increase money flows, and scale our impact too.

Catalyzing such new instruments will require the acceptance of finance and inputs from many sources – philanthropists, investors, bilateral and multilateral donors, as well as the private sector. And, encouragingly, we have seen that this is already happening as donors realize the huge potential of co-creation and co-investment. Vehicles that combine the best of these inputs and cultures can create much more than the sum of the parts. While finance is crucial, the combination of skills and networks new instruments can bring is potentially even more potent. Watch this space.

(Article first published on UNDP's Social Good Summit 2016 blog)