Market maker needed for social investment

Market maker needed for social investment

Market maker needed for social investment

Social investment is a subject about which there is a great deal of exhortation but little analysis. Some have argued that is it a vital third leg in the financial armoury alongside government funding and voluntary income while others have seen it as a dangerous force, useless for the majority of civil society organisations and providing an unnecessary focus on a marginal income stream.

There is no clear agreement of what it is or how it should be applied. On one thing however all are agreed, that the sector lacks sufficient capital to support  the range of activities in which civil society could be engaged and which presently is based on short term revenue funding. Currently our analysis of the sector shows that about 40 per cent of its £35bn income comes from voluntary sources, principally giving, about 40 per cent comes from the statutory sector and about 20 per cent from internally generated funds, foundations and the like.

The story of the sector’s significant growth over the last 10 years can be told fairly simply; while voluntary sources have increased until recently the real growth has come from statutory sources of income and by far the most important part of this growth has come from contracts for purchasing services.  This growth has marginally outstripped the proportional growth in public spending. It is however worth remembering that the sector provides only around 2 per cent of public services. It is in this context that the debate about social investment has taken on more visibility.

What is social investment?

So what do we mean by social investment and what does the typography of this part of the funding mix look like? John Kingston of Venturesome has provided the most developed taxonomy in which he ranges the type of capital required against the wide spectrum of funding needs along a risk continuum.  He would argue, as would I, that grants and fundraising can be seen as part of this mix, but for the purpose of this analysis I want to focus more particularly on those forms of investment which exist beyond the range of grant making, the realm of quasi-equity, patient capital and loans.

It is extremely difficult to estimate the level of this type of financing in the sector as a whole. The NCVO’s Almanac estimates that total debt on the balance sheet within the sector amounts to no more than £3.5bn which would translate to borrowings of less than 2 per cent of the sector’s income if we ignore the element attached to social housing. This is very low gearing indeed.

Of this, the vast majority will comprise lending by mainstream banks against assets leaving a small amount of activity to the specialist retail providers such as Charity Bank, Triodos and Unity Trust. Smaller more specialist organisations like Venturesome operate elsewhere in the market. All of the retailers have reported an increase in demand for funds in the last year, but it is unclear whether this is a result of an expanding market or whether it is just picking up the slack of mainstream banks which are more reluctant to lend in the credit crisis. It may of course be a combination of both.

There has also been the emergence of a new aggressive player in the market in the form of the government-funded Social Investment Business (SIB), which is not a bank but an organisation which lends government funds into the market through three mechanisms; Futurebuilders, a Health Fund and Community Builders. One component, Futurebuilders, is now exhausted of funds to lend having had, it would appear, some money clawed back by Government for reasons which are unclear. It was originally designed to lend for higher risk ventures to organisations that wished to bid for public service contracts, hence the moral justification for the use of public money.

It is not surprising that other social investment banks have expressed concerns about their government-funded neighbour as they are worried that its “speed dating” KPI’s may have displaced loans and distorted the market rather than building one.

To summarise:

•    we don’t know much about the size of the loan market in the sector although it is likely to be small;

•    business for specialist institutions is growing although it is unclear whether this is real growth in the market or taking up the slack created by a reduction in mainstream lending;

•    the loans market has probably been distorted by the introduction of a government-funded agency which is not constrained by banking rules.

However, the main questions remain. We know that the sector is under-capitalised to undertake the tasks and activities that will be required of it. Can social investment in the form of loans and equity provide a bigger proportion of the funding available against a background where general charities have an asset base of £95bn? If the answer to this is ‘yes’, how might the market be developed in a sensible and sustainable way?

A strategic player is needed

The key to this may be the Social Investment Wholesale Bank (SIWB), which is why NCVO has supported it. So what might a wholesaler do and how should it be equipped?

Firstly, a wholesaler should take an independent strategic view of the developing social investment market. It should develop a clear, well researched view of the market, how it might develop over time and identify gaps that need to be filled in terms of the risk/investment/product continuum.  It should be capitalised in a way that allows it to intervene to encourage existing institutions to fill those gaps or if necessary create new institutions and instruments in areas where existing bodies fear to tread.

It should be financed at a level to allow it to do this job properly and with a status and trust that allows it to attract additional capital from the private markets. Its initial capital base could be enhanced beyond the current allocation of unclaimed assets in two ways. Firstly, by arguing for a greater capitalisation from unclaimed assets beyond the £75m already in view. Secondly, by a claim on the existing Social Investment Business.

SIWB should inherit SIB

The second claim is defensible. SIB is simply a government loan fund. It is unlike the other social investment banks in that it has no capital base against which it is lending nor is it regulated as a bank. Unless government continues to channel funds through this institution or it can obtain funds from elsewhere, which is unlikely in the current financial circumstances, it cannot continue to lend. It will however have an order book of loans, the value of which is not known. 

If the SIB loan book was guaranteed at a certain level by government it could be sold and the money released could be used to provide capital to the wholesaler for market development. Failing that, its returns on investment could be used for the same purpose although at a slower rate. Either way the money would not be lost from the sector back to government, an essential test in these cash-strapped times.

Thus constituted and financed and with a small strategic team with a skill set in market-making rather than retail lending, a SIWB could set about assisting the development of realistic levels of social investment in a balanced and sustainable way.

Alongside the SIWB a trade association of retailers could also be formed to act as a representative body to challenge and develop the wholesaler.

Elements of civil society other than those aspects considered here, for example housing and universities, already have a higher level of gearing. If public services are reconfigured more widely, the scope for social investment could expand concomitantly provided that assets and reasonable future income streams are part of the mix.

Social investment is not a magic bullet for sector financing. It does however provide for the possibility of intelligent growth alongside and linked to philanthropy, trading and government funding. Given the asset base of the sector and its low level of gearing it should take its part and a more significant one in the pantheon of sector funding. If done well it will be an asset, if badly a liability.

Stuart Etherington is chief executive of NCVO


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