By Pierre Heistein
Finding ways that the private sector can play a role in humanitarian relief was the focus of the inaugural UN World Humanitarian Summit (WHS) held in Istanbul this week. But as Alexander de Croo, the Deputy Prime Minister of Belgium, succinctly said: “It is not giving that is the strength of the private sector; it’s managing resources and risk.”
Typically, the private sector plays a role in logistics, communications, consulting or construction in humanitarian projects. Companies are simply service providers rather than invested partners.
Another area that is underutilised is the financial expertise of the private sector and its innovative models to manage debt, revenue and spending. An example of such a model was launched at the WHS.
Speaking on the panel, De Croo contributed his support for a new Humanitarian Impact Bond implemented by the International Committee of the Red Cross (ICRC). The bond allows private capital to support health programmes of the ICRC in fragile and conflict-affected countries.
The mechanics of the bond are simple. Whether it will work or not remains to be seen. When asked whether this could be scaled up to assist other development funding, the deputy prime minister said that the concept needed to be proven before it was rolled out any further.
The bond involves three parties: the social investors (private sector); the ICRC; and outcome funders (typically charity foundations and government institutions).
The ICRC proposes a project that has easily quantifiable outcomes – such as providing prosthetic devices to violence victims in Sudan. A time scale for completion is set (three or five years) and the parties agree on what a realistic outcome is for that time – let’s say 5 000 prosthetics fitted.
The outcome funder will eventually pay for these prosthetics, but only once the project is complete and they will only pay for the actual outcome of the project.
Potential premium
To implement the project, the ICRC raises the entire funding for the 5 000 prosthetics from the social investor.
At the end of the time period, if the ICRC did not reach their goal and fitted less than 5 000 prosthetics, then the social investor loses because they paid for 5 000 devices, but the outcome funder pays an amount for less than 5 000 devices – this is the potential risk. If the ICRC exceeds its target, then the outcome funder is liable for more than 5 000 devices and the difference is earned by the social investor – this is the potential premium.
The ICRC is able to receive the entire budget for the project upfront instead of relying on annual donations, making planning easier and implementation more efficient. The outcome funders only donate funding for work that is completed and where impact is already achieved.
Assuming that the incentive for the social investor is purely financial, the return relative to risk of the Humanitarian Impact Bond has to be higher than standard government bonds. Given the current market, the ICRC would need to offer a return between 1 percent and 3 percent – depending on the investor’s perception of the ICRC’s ability to complete projects.
The fragility of the arrangement lies in how expectations are set and how they change over time. To attract investors, in this example, the ICRC needs to repetitively exceed their targets by 1 percent to 3 percent. But constantly exceeding targets means that achievable targets will be more accurately calculated and the bond will tend towards a zero-return investment.
It may be enough for altruistic investors to accept a zero return on average knowing that, without losing money, they have supported a humanitarian cause. But relying on altruism limits scope.
For the bond to attract private investors on financial grounds, the outcome funders will have to allow the ICRC to constantly set the arranged outcome of the project artificially lower than the expected outcome. This may work – the outcome funders are ultimately interested in impact and may be willing to accept the arranged premium as financing costs for the project.
Mixing incentives is like a conversation in two different languages – it can work, but only if the goals of the humanitarian sector can be translated into the goals of the private sector.
* Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein.
** The views expressed here do not necessarily reflect those of Independent Media.
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