HUMA Committee Report

Dissenting opinion of the Official Opposition NDP, submitted as part of the Standing Committee on Human Resources, Skills and Social Development and the Status of Persons with Disabilities study on the potential for social finance in Canada.

The Official Opposition members of the HUMA Committee would like to thank all the witnesses who appeared before them as part of the study on exploring the potential for social finance in Canada.

The NDP agrees with the intent to explore new forms of social innovation, but it wishes to register its disagreement with the Committee’s recommendations. It is unfortunate that the final report on the study presents an unbalanced view of the potential for social finance, one that does not reflect the concerns; the dire, appropriate and constructive warnings; or the appeals for caution voiced by many of the witnesses who appeared before the Committee.

Social finance and its instruments such as social impact bonds (SIBs) have the potential to greatly influence how the Government of Canada administers its social programs. The NDP believes that these issues warrant  further examination and documentation than they have received to date before their implementation is considered nationally.

I.                   Role of social finance and its emergence

Social finance initiatives involve mobilizing private capital to invest in social programs as a way to diversify funding sources. The social finance marketplace is made up of three components. There is the supply side, which includes players interested in providing capital, such as financial institutions, foundations and private investors. The demand side includes organizations looking for sources of funding, such as charities, not-for-profit organizations and social enterprises. Then there are intermediaries, the third type of player whose role is to bring the two other components together.[1]

The NDP recognizes that these initiatives can play an important role in community economic development, particularly by investing in social enterprises or cooperatives.

However, the NDP notes that there is a growing trend towards applying social finance and its instruments to public services, which would lead to a privatization of social programs.

This trend was first observed in the U.K., when social finance appeared. John Shields from Ryerson University pointed out that social finance and SIBs in particular “…were very much part of Big Society in the U.K., which was about … cutting various types of social programs, and then expecting philanthropy, local governments, and non-profit organizations to fill some of those gaps.”[2]

Some witnesses provided the Committee with evidence that this trend is also observable in Canada and that, far from being  purely experimental in its approach, the federal government is  in the process of applying social finance and its instruments to its programs.

Marie France Kenney, President of the Fédération des communautés francophones et acadienne, said that “…a push is currently on to adopt social finance in a slew of government programs and initiatives …. The perception is that the government is trialling the model in a very limited and exploratory manner through pilot projects. The reality, however, is quite different. The fact of the matter is that Employment and Social Development Canada and other federal institutions have already changed how they deliver their grants and contributions programs, bringing them more in line with the social finance model.”[3]

The NDP believes that the application of social finance must be limited to appropriately targeted groups. Employment and Social Development Canada officials responsible for developing social finance policy concluded: “… that social finance isn’t necessarily suitable for every social issue or for every target population.”[4]

The NDP is skeptical of the implication that there is consensus for applying social finance solutions to federal social programs given the supposed beneficial impact these solutions would have on the cost and effectiveness of these programs.

Interest in social finance and related instruments such as SIBs certainly stems from dwindling public funding for not-for-profit organizations and social programs, as several witnesses pointed out.

David Juppe, Senior Operating Budget Manager with the Department of Legislative Services for the Maryland General Assembly, said: “One of the reasons I think social impact bonds have become more popular recently is that since the recession of 2008 the government in the United States, and state governments especially, have not seen a robust economic recovery, as was hoped…. This is one mechanism for providing additional funding for government services without government providing the funding up front.”[5]

Barret Weber, Research Manager with the Parkland Institute, echoed this view: “In the current tax-cutting frenzy among governments of the day, there’s a keen interest to find solutions to the underfunding of social problems.”[6]

Employment and Social Development Canada officials did not hesitate to establish  that one of the goals of social finance is to cut government expenditures: “A mature social finance marketplace … would unlock new sources of capital for community organizations [and would provide] realized savings for governments.”[7]

The trend toward developing social finance is resulting in policy choices focused on cutting spending, thereby forcing not-for-profits involved in delivering social programs to diversify their funding sources in order to maintain service levels.

This certainly raises a whole range of risks, issues and concerns for which we do not have the proper perspective to perform an objective analysis.

II.                 Risk of cost overruns

The NDP believes that public funds should be managed properly and used effectively, and it wishes to emphasize that there is a risk of cost overruns for governments that choose to fund their social programs through social finance and instruments such as SIBs in particular. This risk should not be underestimated, as it is inherent in the structure of social finance and its instruments.

First of all, the government must guarantee a certain rate of return to encourage investors to support social finance instruments, which adds to the cost of delivery. Andrew McNeill explained the situation clearly: “One of the misconceptions we see is that social finance is being viewed as free money, and all too often when we hear social finance discussed for public services, it’s portrayed as a new source of revenue. What is ignored is the fact that while people investing in social finance are willing to accept a lower rate of return to accomplish social objectives, they still do expect some return on their investment, and the ways to use social finance to fund public services, such as social impact bonds, will add new costs to the delivery of public services.”[8]

In addition, investors expect a much higher rate of return on SIBs than the Government of Canada currently pays to borrow money. “The first social impact bond project in Peterborough, England … is expected to provide a rate of return of between 7.5% and 13% per year. Based on a survey by the MaRS Centre for Impact Investing and Deloitte Canada, expectations of potential investors in social impact bonds here in Canada are very similar. By contrast, the federal government was paying an average of 2.37% to borrow money in 2013-14, which is roughly a third of the minimum amount Peterborough social impact investors are likely to receive.”[9] This gap between the expected rate of return on SIBs and the Government of Canada bond rate show that SIBs are an expensive way to borrow.

As David Juppe pointed out, there are currently no limits on the rate of return on SIBs: “From what I can see, the rate of return is not limited in any way. As we know, in the bond market, risk is measured by interest rates. The riskier it is that repayment may not materialize, the higher the interest rate a government is going to pay on a capital bond. The social impact bonds or pay for success is a form of borrowing. If the program works then government will pay this rate of return, which happens to be whatever was negotiated, whether 10%, 15%, or 20%. There appear to be no limits on that amount.”[10]

Social finance and instruments such as SIBs may lead to cost overruns because the government and recipient agencies would have to establish new layers of administration to manage them.

Managing social finance, and SIBs in particular, would also require the introduction of new intermediaries and mechanisms to deal with the complex and cumbersome procedures — both of which add to management costs. “First, there are the intermediary organizations that are required to find investors and to find an organization or business to deliver the service and oversee the service.”[11] Second, “[t]he agreements under which social impact bonds operate are a second layer of administration.”[12]

The advocates of SIBs believe that the savings to government make up for the difficulties in implementing these instruments. However, the potential savings may be overestimated. David Juppe explained that while SIBs may lead to savings in the variable operating costs of government programs, the same is not true for fixed costs, which are higher. “In our research we have found in many cases that the proposed savings are overstated. … [I]f advocates are proposing that the savings are going to be the full fixed and variable costs divided by the caseload, that’s overstating the savings.”[13]

Lastly, there is a significant risk that any potential savings will be offset by the funds that the government must set aside so that it can reimburse financiers for their full investment plus the rate of return. David Juppe noted this issue when studying the use of SIBs in Massachussetts.[14] He refers to the concept as “funding logistics,” a situation in which actual costs are delayed rather than significant savings being achieved. 

III.              Operational risks

Social finance poses a number of significant operational risks that should be identified. These risks involve the demand side of the social finance marketplace in particular and could lead the government not complying with its obligations.

To begin with, not-for-profit organizations that want to access social finance and instruments like SIBs must have the materiel and human resources and the technical abilities to solicit and obtain this financing. As Barret Weber explained, “[S]ince this new financing model is based on markets and competition, which are not areas the not-for-profit sector is accustomed to dealing with, non-profit agencies find themselves having to hire or contract professional staff whose tasks include writing grant applications.”[15] In future, the organizations that already have significant financial and technical resources may be the only ones able to attract investment, to the detriment of other organizations.

To address this imbalance, the proponents of social finance and SIBs suggest that organizations receive government funding to strengthen their capacity to attract investors in the social finance marketplace. The NDP believes it is illogical to make cuts to social programs in the name of curbing government spending, and then subsidize charitable organizations to help them attract private investors.

Lastly, the NDP is concerned that the desire to mitigate risk will significantly influence the type of social programs that investors support. As Andrew McNeill noted, “Minimizing risk also means that investors are going to be unwilling to fund innovations in service delivery. Under the model for social impact bonds, if the agreed-upon outcomes aren’t achieved, investors lose their original investment. Again, it would be hard to find anybody who is willing to put money into a project if they feel it’s likely that they’re going to lose their original investment.”[16]

On the subject of risk mitigation, investors may tend toward what David Juppe calls a “flight to quality”: “[R]ather than encouraging innovation, social impact bonds or pay for success will actually encourage a flight to quality. Investors are going to want to see programs that work and programs that are successful” in order to ensure a return on their investment.[17] What this means is that only the programs deemed the most successful, and therefore profitable, will attract investors and offer a reasonable rate of return.

IV.              Critical mass

Critical mass — the presence of a sufficiently large target population — is a key condition for attracting social finance investors.  However, in Canada, the existence of small communities that lack critical mass is an important consideration when implementing national policies that involve social finance, particularly in the case of minority language communities.

Marie-France Kenny explained this issue to the Committee in very clear terms: “Official language minority communities will feel the impact of an approach where requests for proposals are based on major projects and private sector contributions. The government runs the risk of creating an environment where, instead of having access to French-language services that fit their needs, francophone communities will, at best, receive bilingual services delivered by majority language organizations, or even services delivered by Quebec-based organizations with little understanding of our communities’ needs.”[18]

The NDP wishes to point out that, in situations like this, federal institutions are at significant risk of not meeting their obligations under Part VII of the Official Languages Act, which requires federal institutions to take positive measures to enhance the vitality of English and French linguistic minority communities and support their development.

V.                Evaluation and accountability

Like all the witnesses who appeared before the Committee, the NDP believes that programs involving social finance must be subject to evaluation and accountability. Senior officials from Employment and Social Development Canada stressed this point and we concur: “[S]ocial finance also requires rigorous use of metrics and evaluation to determine if expected outcomes have been met, thereby ensuring effective use of resources and accountability for the use of public funds.”[19]

However, it was clear by the end of this study that qualitative evaluation tools are not suitable for measuring the impacts of a program’s social finance components.

In addition, the NDP is concerned about the way in which the desire for a return on investment could influence evaluation methods and results. David Juppe raised two points that speak to this concern.

The first is the pressure to produce a positive outcome: “Evaluation concerns that I have are first and foremost that, because you have this return-on-investment component, there is a greater pressure to produce results and you may have a situation where one study produces an outcome that’s positive resulting in payment to the investors and to the service providers, but in many cases in public policy it can take years and sometimes multiple observations and multiple studies to determine if a program is really successful or not.”[20]

The second involves the composition of evaluation samples: “Also there’s the question of methodologies and whether or not there’s a treatment and control group and full randomization to ensure that fair and objective analysis and evaluation are completed. The U.S. Congress was considering social impact legislation last year in 2014, and I noticed in that legislation that they were considering allowing quasi-experimental designs, which may not require this sort of randomization.”[21]

The NDP is also troubled by the pervasive lack of transparency regarding the actual cost of implementing social finance. Many witnesses shared this concern, which was neatly summarized by Andrew McNeill: “Another concern is the loss of accountability. Contracts for services funded through social impact bonds are rarely made public. In fact, as far as I know there has not been a single contract made public. The public cannot find out the details of the services being provided or the details of the costs. This means that the public has no way of knowing whether they are receiving the services they’re paying for.”[22]

VII.           Conclusion

The NDP supports the intent to explore new forms of social innovation. However, given the lack of tangible evidence that social finance and social impact bonds lead to positive outcomes in the delivery of social programs, the NDP wishes to emphasize in this dissenting opinion that there are considerable risks to this approach.

The NDP recommends caution when introducing social finance to the Government of Canada’s social programs.

It also recommends that the subject be studied more extensively to determine the potential risks and benefits, and that pilot projects be conducted and evaluated. In order to arrive at a definitive conclusion, the NDP believes that new and more thorough analyses should be carried out using more advanced technical and research methods than were available to the Committee for the present study.

Lastly, given that introducing social finance, and instruments like social impact bonds in particular, could influence the implementation of federal social programs, the NDP maintains that this is an issue that requires public debate. The Canadian public must be properly informed of the approaches chosen by the federal government to finance and implement social programs. The NDP therefore recommends that public consultations be held before this type of initiative is implemented more broadly.