A development impact bond is a type of financial security that is used to finance development programs in low-resource countries by attracting private investors. Development impact bonds are considered a sub-type of social impact bonds. Similar to other social impact bonds, development impact bonds are new financial instruments that were introduced only in 2012.
Purpose of Development Impact Bonds
The main purpose of development impact bonds is to attract private investors to subsidize development projects in poor countries.
Although the security is called a bond, it lacks most of the features of conventional bonds. The bonds come with a fixed term, but they do not offer a fixed rate of return to the investors. Instead, the repayment of the bonds primarily depends on the success of a project that’s been subsidized using the proceeds from the sale of the bonds.
If a project is successful, the investors are repaid by the outcome funder (a philanthropic organization or an aid agency). However, if the project fails, the investors do not receive anything. Therefore, development impact bonds are high-risk instruments for investors.
How Does a Development Impact Bond Work?
Social impact bonds are differentiated from other fixed-income securities by the number of major players involved in the fundraising process.
Generally, the process starts when a philanthropic organization identifies projects that can help solve problems in low-income countries. The organization reaches out to potential investors and agrees to repay the principal amount plus some premium to the investors if the development of the project is successful. In addition, the service provider who will run the project is determined.
The parties then determine the quantifiable metrics that will measure the project’s success. Interested investors inject the required capital by purchasing bonds and the service providers use the funds to finance the project’s development.
At the end of the fixed term, an independent evaluator performs an assessment of the project’s success based on the predetermined metrics. If the project meets the criteria, the outcome funder repays the principal and premium to the investors.