Report from emerging market

In April 2012, the prime minister launched ‘a £600m fund to support grassroots social projects’. At least, that was how The Guardian described social investment wholesale finance institution, Big Society Capital (BSC), the organisation set up to spend ‘unclaimed assets’ on developing the UK social investment market. Earlier this month, I dropped into BSC’s Fleet Street offices to ask chief executive, Nick O’Donohoe how he thinks it’s going?

There’s been signs of a shift in thinking in recent months, whereas in 2011, as the organisation prepared for launch, O’Donohoe told Third Sector that “We’re not interested in grants or soft loans” and emphasised that: “We are an investment institution“, recent statements have been far more supportive of subsidy. So, what’s changed?

I feel like the first comment is taken a little bit out of context. What I was referring to was the fact that BSC, rightly or wrongly, has been set up under certain principles and one of those principles is that we don’t give grants – that we need to be sustainable and the capital needs to be preserved. We’ve always felt that grants have an important part to play in the development of social investment.

O’Donohoe concedes that: “at the beginning perhaps being focused a bit more on the fact that we can’t do [grants], we’ve changed our emphasis a bit to focus more on ‘there is clearly a need’ and we have a role to play in terms of trying to help.

Sense of commitment

While some in the social sectors may unjustifiable blame BSC for not doing things it is not able, and was never intended to do, the organisation has seemingly also struggled to do what it is intended to do: investing in social investment finance intermediaries (SIFIs) so they can invest in social sector organisations.

O’Donohoe believes his organisation is doing its best to make money available: “If you say, do I feel good about that fact that we’ve managed to commit £150million or so to roughly 30 different organisations, intermediaries of various types? Yes, I think that’s a pretty reasonable achievement, actually – it demonstrates a certain sense of urgency.

He is frustrated, though, at the gap between BSC making commitments to invest and the money actually going out. The problem is that: “Once you make a commitment, then you’ve got to actually close the transactions – sometimes that’s just a legal process and sometimes it’s contingent on [SIFIs] achieving matched finance. I have to say it’s been disappointing how long the closing process has taken.

If you take an LGT for example, they closed a month or so ago, we committed £10million contingent on the fact that they would raise another £10million and it took them a year to do that – they had to meet with 500 different investors.

BSC initially had a policy of only making investments when their money was matched by an equal level of investment from other sources. O’Donohoe felt that approach wasn’t working: “We realised, after about a year, that [closing transactions] was taking longer than we thought. The most important way we tried to change that was to try to persuade our board to make unmatched financing available where appropriate.

Fortunately, the board agreed so: “We have now agreed to fund two organisations on an unmatched basis – that’s just our money. That was quite a big step for us – it’s a way to shorten the period between our commitment and them actually opening their doors to the frontline.

Overall, though, O’Donohoe believes things are going broadly according to plan: “I’m not sure that I’m surprised by what’s happened. A lot of what we do is making commitments to organisations to invest over say a four-year period so, if you take a £150million and divide by four, you would expect £35-£40million a year, based on just that level of investing, to go out. It has been less than that but not to the extent where we think there’s serious issues.

“It’s just not possible”

O’Donohoe is thoughtful and engaging, seeming genuinely interested in the work he’s doing. Maybe partly as a consequence, he doesn’t deliver off-pat answers: responses evolve through a gradual process of mid-sentence modification.

We move from discussing whether BSC is doing as well as could be expected, to considering what other people expect from BSC and whether they’re being realistic.

According to the latest available market data, the average UK social investment is £264,000 and 82% of the current estimated £202million market is made up of investments of averaging £723,000. The latest data from Social Enterprise UK shows the average turnover of a UK social enterprise is £187,000 and the average investment sought by social enterprises looking for finance is £58,000. Can BSC find a way to bridge the gap between where social investment is and where social enterprises are?

O’Donohoe is clear on the answer: “If you’re talking about [investments of] less than £250,000, some part of the investment will always have to be grant.

Without subsidy: “I think it’s just not possible. Small loans are expensive. They’re expensive to originate, they’re expensive to monitor. The default risk is always going to be reasonably high and there’s a point at which the rate of interest is just inconsistent with the social mission of the enterprise.

O’Donohoe understands why this might be unpalatable to many: “I think there’s sort of a mismatch where social organisations will say with total justification that if we have to pay more than, I don’t know, 10% for funds we can’t make that work and it’s inconsistent with our mission. I think they’re right most of the time. Likewise for the SIFIs, they say if we don’t charge more than 10% that cannot possibly – in the absence of any grant support – be sustainable given the size of the loans. I think they’re right too. So the market doesn’t clear effectively. And so how do you square that?

He believes a major answer is more subsidy: “I think you have to accept that and our challenge there is to find out who can bring in that grant layer and that’s what we’ve spent a lot of time talking to people like Big Lottery Fund about.

The point of no return

Some in the social sectors believe that the reason BSC can’t channel investments into smaller organisations is that the returns it needs to generate from its investments in SIFIs are too high. Some critics blame this problem on ‘the Merlin banks’ who invested £200million in BSC to top up the estimated £400million from unclaimed assets and expect a ‘market rate’ return.

O’Donohoe believes the problem is partly overstated and partly unavoidable. He explains: “I know there are people out there who think our cost of capital is too high and if it was cheaper then we’d be able to square the circle. When you look at what we’re really doing – we’re making unsecured lending available on an unmatched basis at projected returns of just over 3%. Now that’s nominal. You take off our own operating costs, which we said we’d try to keep at less than 1%, and you take off 2% inflation that’s zero real rate.

O’Donohoe is not clear what, if any, alternative approaches are available: “I find some people suggesting that our cost of capital should be lower but I don’t really anybody suggesting that we should be running down our capital over time. Forget what the banks may or may not feel like they should be earning, just to preserve the capital, and certainly to preserve it on a real basis, I think we are making money available at the cheapest rate we possibly can.

It takes predictions of billions to hold us back

It may be that BSC is making steady progress based on its terms of reference but given that part of the reasons his organisation came into existence was the massive wave of massive expectation about what social investment could deliver, I wonder if O’Donohoe now regrets some this hype.

For example, the predictions that the social investment market would grow to £1billion or even £3billion by 2015. O’Donohoe is good humoured but unrepentant, paying tribute to the work of BSC’s former chairman, Sir Ronald Cohen, in promoting social investment in the UK: “I can’t remember what the exact figures were either but I think there have been some incredibly visionary people who have been driving the development of the market in this country for over a decade – and obviously Ronnie Cohen the best example. Ronnie sets a big vision and he’s right to set a big vision. It’s worked in the sense that it’s got a whole lot of support that wouldn’t have been there otherwise.

Enthusiastic promotion of social investment is not solely a UK phenomenon. O’Donohoe, who before joining BSC was Head of Global Research at JP Morgan, explains: “We had the same discussion in the US, I was responsible for a piece of research that JP Morgan did where we put a very big number on the growth of the market as well. People get worried that you’re hyping something and it’s not deliberate hype but I do think you have to get people’s attention. If you look at social impact investing here or globally it’s moved forward significantly. So, I don’t know how big it will be but it certainly will be a lot bigger that it would’ve been if we hadn’t talked about it at all.

Our government took our grants away and all they replaced them with was a series of expensively constructed payment-by-results pilots

While many in the social sectors are sceptical about social investment, scepticism about Social Impact Bonds (SIBs) is growing fast even amongst those who like the idea of social investment in a general sense.

SIBs are a way of financing a payment-by-results contract so that charities and social enterprises delivering services are paid upfront by investors for the work they do, with investors getting paid (or not) by the government at the end of the contract based on the outcomes that have (or haven’t) been achieved.

Supporters say (amongst other points) that SIBs are an innovative way of offering opportunities for social sector providers to win new business and offering governments a method of trying new approaches to service delivery at reduced risk.

Opponents arguments’ include the claims they’re too expensive to set up and manage, and are not necessarily a cost effective way of delivering services. Then there’s the hype, which is even more intense than the basic level social investment hype. The Prime Minister loves them so much he wants the rest of the G8 to have them too. New York Mayor, Michael Bloomberg, set one up (and underwrote most of the cost through his charitable foundation).

When I ask whether SIBs really are the answer to everything, O’Donohoe again responds with reference to Sir Ronald Cohen: “Ronnie Cohen has been a big visionary and very visible in terms of this organisation and I think that Ronnie has a real belief that Social Impact Bonds can be transformational, and I respect him for that.

On the other hand: “I don’t think we as an organisation have ever stood up anywhere and said that we believe Social Impact Bonds are the only form of social investment. When you look at we’ve done with our money, in terms of our commitments, less than 5% of our commitments have been Social Impact Bonds.

There’s no suggestion that O’Donohoe is necessarily less enthusiastic about SIBs than Cohen but his support is less visionary, more focused on the nuts and bolts: “I think it’s going to take a long time for that market to develop but I do think its further development would be very valuable.

He’s also noticed social sector scepticism and is wary of it: “I worry sometimes about the fact that the sector seems to be critical of Social Impact Bonds. My experience of talking directly to people who are actually charities who’ve been funded by them – whether it’s St Giles or Action for Children or the other people – is that they actually appreciate the fact that Social Impact Bond gives them a form of funding that’s more flexible than a typical government grant and allows them to take on payments-by-results contracts without taking on the risk of a payments-by-results contract and I think they find that valuable.

So the minister said: ‘we’re giving you £600million’ and everyone clapped

A recurring theme in our discussion is the combination of the practical challenge of creating a new investment market – big enough, in itself – with the challenge of managing the expectations of both social sector organisations and other interested parties.

Most prominent amongst those interested parties are politicians. From the Prime Minister down, many government ministers have been enthusiastic supporters of social investment and BSC is named after what, at time of launch, was the government’s flagship policy idea.

I ask whether this political support been a help or a hindrance. Thinking carefully before offering a response, O’Donohoe concludes that: “It has been a bit of both. There has been a lot of value to the level of support we’ve got from the government, being seen as part of policy – the Cabinet Office have stayed involved, they could’ve walked away after setting us up but they’ve stayed involved providing funding for the Investment and Contract Readiness Fund and the Social Incubator Fund, so in that case it’s been a help.”

“It’s been a hindrance that we’ve been launched at a time when – for better or for worse -there’s been a significant austerity programme been ongoing and it’s sometimes difficult to distinguish between cutting funding on the one hand and trying to do something relatively new, and different on the other hand. This has led to some miscommunication and sometimes some bad feeling.

That sounds great but will it work?

I ask whether some of that bad feeling and miscommunication have been avoided. Could more research have been done before BSC launched to find out what kind of investment, if any, most social sector organisations wanted? “Was there enough work done on demand before we started? Maybe there wasn’t but you learn so much every day here by looking at and trying to evaluate individual and specific transactions. What is possible with forms of funding and what isn’t possible? And what value or social value can you create or can you not create?

So, nearly two years into the job – running BSC and, in doing so, leading the development of the UK social investment market – does O’Donohoe still think social investment’s going to work? “I think the only way you’re going to find out whether an idea like this works is actually trying it in a prudent way.

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13 Comments

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13 responses to “Report from emerging market

  1. Great reporting once again.

    Like others that were wooed into attending the glitzy BSC events, I kind of wonder what they heck they’ve been doing all this time.

    They remind me of Nesta. All talk and no walk, but very very good at judging.

    I once went to a big glitzy BSC launch event in Birmingham where there were about 35 BSC staff there in sharp suits (without ties obviously). SIB’s were all the rage and seen as the only way to get money into the sector but alas as you report, it was all talk and not much else.

    What’s happened to all the suits? Does anyone know? Who pays for them and their expensive sounding accents? I doubt if Ronnie Cohen has put his hand in his pocket to fund them – he’s far too smart to make a punt with his own money.

    Anyhow, why all this picking on BSC? Take a look at Nesta as well and ask them to provide evidence of how they’ve spent their gazillions. Some of us that are based in the north of England are becoming a bit tired of these trendy ex-banker/ex-Whitehall/ex-The Club folk who sit in judgement on proposals they ask for when we know that they don’t know what they’re talking about yet they have the money and we don’t.

    I’d better quit before i get into a rant!

    Keep up the good work!

    thanks, Mike.

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    • Mike, I’ve had the good fortune of late to connect with a dissenter on the inside. His name is Guillermo Maclean, a former director of Merrill Lynch and author of “Understanding DreamFutures Contracts, Securities & Markets”.
      As I read it from him, the rhetoric of social investment without application is far from unique to BSC and can be found at the like of Morgan Stanley who pump out literature without “materially actionable strategies”

      He says “DreamFutures are not Social Impact Bonds, heck, in our opinion we have not seen a single Social Impact Bond that was either truly Impactful or even a Bond, we are starting to believe that news coverage of the Loch Ness monster is more professional and less sensationalistic.”

      At Davos a few weeks ago, It was no surprise to find the crisis in Ukraine under discussion. Tony Blair chaired a discussion on business for social benefit as we’d delivered 8 years ago to government, as a ‘Marshall Plan’.

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      • Wow Jeff – has the emperor got no clothes? I was wondering why Ronald Cohen left his post. He’s the kind of ‘pot-hunter’ that hangs around to win all the accolades. Maybe he sees what’s coming? Thanks J

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    • Beanbags admin

      Hi Mike,

      Thanks for your comments. As a point of information (rather than a defence of Nesta), Nesta do explain how they spend their money: http://www.nesta.org.uk/about-us/how-we-spend-our-money .

      I’m hoping next interview I do will be with a major recipient of funding from Nesta and other ‘social innovation’ budgets.

      I don’t agree with your view that what BSC have been doing is ‘all talk and nothing else’ but I think they do have: (a) problems communicating what they are doing and (b) some big questions marks over whether they’re doing the right things.

      In terms of (a) when the government (in particular) tell everyone that they’re setting up an organisation to make £600million available to the voluntary sector and the reality (by BSC’s own admission) is that over the first two years they’ve been making £35-40 million per year available, mostly to large organisations, the only possible starting point is a major failure to live up to expectations. That would be a big problem whether BSC’s staff were wearing sharp suits, cheap suits or shell suits.

      In terms of (b), I definitely think we’re now seeing the limitations of trying to take particular approaches to funding businesses from (particular bits of) the private sector and ‘copy & paste’ them into the social sectors without seriously considering or understanding differences in motivations and business models.

      More positively, I think people at BSC and others involved in social investment increasingly recognise the problem and want to hear ideas about how things can be done better, so I think there’s going to be lots of opportunities to make positive suggestions.

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  2. Re: “O’Donohoe is clear on the answer: “If you’re talking about [investments of] less than £250,000, some part of the investment will always have to be grant.“ what does Mr O’Donohoe know that we don’t know? Thanks

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  3. Top interview David. To mike r’s question on whether Ronnie Cohen invests- he very much walks the walk.. I interviewed him June last year – can’t quite remember exactly what he said (can check the audio if anyone wants a direct quote) but at the time he had invested in every SIB, all the bridges ventures social enterprise investments and put a lot through Portland trust too. He is committed and fully believes in social investment – he made it happen in the uk.

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    • Fair enough @blackmatty.
      My trouble is that I’ve dealt with the Private Equity, Venture Capital and traditional debt providers (banks) for years and have a very cynical view of their motives and rationale for investment. I wish I wasn’t like that but years of experience with them has taught me to be cautious.
      I think what is interesting though, and which this debate is beginning to highlight, is the future of business enterprise generally.
      Increasingly, I am finding it hard to imagine any enterprise (for-profit / not-for-profit) being able to attract investment resources unless it can prove beyond reasonable doubt that their net impact on the world is a positive one.
      I am convinced that we are on the cusp of a revolution in investment. Why? Because the world is burdened with debt and investors everywhere are fearing a ‘black swan’ event.
      This might be Ukraine, it might be Spain, who knows. The point is that all financial investments are denominated in ‘the currency’ of money and money (because of the outcomes it produces) is morally bankrupt and financially bankrupt (or insolvent) because of the way the principal is lent into existence but not the interest that is needed to repay the loan.
      Investors want a safe haven – somewhere for their money will be safe when the black swan glides into town.

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