It is time for a new finance paradigm in development


By Arthur R Wood, Founding Partner, Total Impact Advisors; Convenor,

This blog is part of an ongoing series evaluating various facets of Development in Transition. The 2019 “Perspectives on Global Development” on “Rethinking Development Strategies” will add to this discussion

On 27 November 1095, Pope Urban declared the crusades ostensibly a religious call, but one that reinforced the power of the spiritual over the temporal. To support the crusades, the church built a financial institution by leveraging the Templars under the Papal bull Omnes Datum Optimum, creating a monastic banking system that gave birth to such financial innovations as letters of credit, banking and, by extension, fiduciary products like trusts.

In the early 14th century, the creation of the bond market by the Medici family ultimately became the funding basis for the modern nation state.

The battle for domination between Britain and France was eventually “won” by the country with a population and GNP half the size due, in part, to a superior finance system.

Equally, the Bretton Woods system reflected the post-World War II dominance of the Americans.

It is clear from this cursory glance that financial innovation facilitated by legal and technological cannons played a key role in these historical turning points. The way we morally look at for-profit and not-for-profit — at the tension between money and ethics linked to progress — are buried deep in the psyches of both Western and Islamic cultures. We see this in the West from the 325 AD Treaty of Nicaea that first formally banned usury to the constraints on Islamic finance.

Tactically, the history of financial social innovation over the last century has often been the result of scaling an original financial innovation through legal and technological changes. The modern foundation paradigm created by Rockefeller and Carnegie scaled up on the back of legislation in the 1950s. The 1977 Community Reinvestment Act scaled up community foundations first created in 1914. Some would argue that in the 1980s Grameen scaled micro-finance’s roots in 19th century India by adapting technology and risk management. Donor Advisor Funds created in 1931 by the New York Community Trust only scaled after a 1985 tax ruling and technology allowed banks to engage in this area.

The current chasm between the rhetoric of the Sustainable Development Goals (SDGs) and the capital available for development leads to why a new financial paradigm is now needed. UNCTAD projects that this gap will result in a shortfall of about USD 2.5 trillion per year; a market crash would add another trillion per year until 2030. The context cannot be ignored: the twin pillars of demographics – ageing populations in the West/China with substantive unfunded liabilities in health and pensions on the one hand and the pincer of youth populations in the developing world on the other hand – exacerbate instability. The existential threats of world resource usage now estimated by the World Resources Institute at 1.7 times the planet’s ability to replenish and, of course, climate change add to the challenging context.

Measured against the trillions needed to fulfil the SDGs, the reality is clear: We will fail. The Bretton Woods system has around USD 150 billion in capital. The global foundation system with a trillion dollars plus of unaligned capital adds, perhaps, another USD 150 billion. Both processes encourage fragmentation and a lack of scale. Impact investment – primarily venture capital (VC) and private equity (PE) – and green bonds are each at around USD 100 billion per year. And despite the hype and substantive subsidy, social impact bonds, which I conceptualised at Ashoka[1], have sadly only leveraged USD 400 million after 12 years in what some, including me, would argue is a flawed governance framework.

However, the positive news is that the solution is not what we think. It is not a matter of innovation; as former President Bill Clinton noted, “The problems of the 20th century have been solved by someone somewhere – the challenge of the 21st century is in scaling them.” Nor is it a matter of money if we think outside the current grant, aid and impact (VC/PE) paradigm. Let me note some trillion-dollar opportunities:

First, tap foundations. This means align the trillion plus on the core balance sheets of global foundations towards impact investment/social mission in Mission Related Investments (MRI). Simple math tells us that leveraging just 20% of the funds of US foundations in a blended value model would create a capital pool of USD 500 billion. Any loss to foundations assumes that MRI portfolios underperform, but do they? Even a 1% underperformance creates just a USD 1.2 billion opportunity loss versus the creation of a half trillion-dollar capital market. And for the benefits of driving scale and collaboration, look at the Community Reinvestment Act in the United States that moved billions into US affordable housing and that the Congressional Budget Office audits annually (and ignores the value of solving the negative social externalities). Consider also GAVI, now a USD 6 billion global vaccination program that has driven the unit cost of vaccinations from USD 50 to currently around USD 1.42.

Second, leverage local South capital markets. The developing world holds over USD 2 trillion in local pension funds. A guarantor structure could leverage local capital markets for their own sustainable development, taking 60% of development foreign exchange risk out. Well managed, this model is not new. Yet, it is highly profitable and self-hedged with a historically low risk loss of less than 10 basis points.

Third, use financial innovation from the mainstream capital market. Look beyond the VC/PE paradigm to a range of financial innovations. These include using a hedge fund approach of turning social need into equity by looking at negative social externalities as cash flow forgone to create an equity market where social equity equals both financial and social equity. The higher the delta of social improvement, the higher the return. In other words, make the problem the economic opportunity.

Churchill once observed, “The farther back you can look, the farther forward you are likely to see.” Just like the Papal bull Omnes Datum Optimum gave the Templars a legal frame to become the bankers of Medieval Europe, we now need a legal frame, beyond giving money away, that defines multiple points of cross subsidisation between economic and social missions for development. Leveraged perhaps by a tax framework that rewards outcomes and not just giving, foundations could leverage their balance sheets like the Medicis did by creating the bond market. It’s doing what the British did by creating a global credit framework – except this time using modern capital market tools and not a gun boat – set in a hardwired social frame.

In the last ten years, technology, metrics, finance and legal innovations have helped us identify, manage and allocate granular economic and social value to create collaborative scale in win-win scenarios as it has done in other sectors of the economy. As we look beyond silos to collaboration for outcomes, the opportunity is to take substantive structural cost out of the sector. It is surely time now to apply this approach to development. As Shakespeare said, “The fault, dear Brutus, lies not amongst the stars but amongst ourselves.”

[1] Source: Social Finance – Towards a New Social Economy (March 2010)

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