CAF Venturesome Consultation Response to SIWB

8/7/2019 CAF Venturesome Consultation Response to SIWB

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Response to the Office of the Third Sectorsconsultation on

Social Investment Wholesale Bank: Aconsultation on the functions and design

October 2009

For more information contact:Hannah TerreyHead of Policy and Public Affairs03000 123 [email protected]

CharitiesAidFoundation,7thFloor,StAndrewsHouse,18 20StAndrewStreetLondonEC4A3AY
mailto:[email protected]:[email protected]


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CAFVenturesome:SocialInvestmentWholesaleBank:Aconsultationonthefunctionsanddesign

CharitiesAidFoundation(CAF) is a registered charity that works to make the most of money for

charities and social enterprises. CAF believes that access to capital is vital for a healthy and

thriving charitable sector.

Over the years, CAF has been instrumental in pioneering and incubating funding solutions;

including Venturesome, a highrisk investment fund and Charity Bank, which became independentin 2002.

Venturesome provides capital to charities and social enterprises, operating in the space between

providers of charitable grants and providers of bank loans at market rates. Since launch in 2002,

over 15 million has been offered to over 250 organisations. In addition to accumulating practical

deal experience, Venturesome has endeavoured to have a central role in building a robust social

investment market (including chairing the Social Investment Market Group (SIMG)), adopting an

openbook approach to share knowledge and build experience, but also ready to operate in

ndards.competition so as to raise sta

or more information, visit: www.venturesome.org F

enturesom acts:V e cont

PaulCheng E: [email protected] T: 03000 123 256

EmilieGoodall E: [email protected] T: 03000 123 258

JohnKingston E: [email protected] T: 03000 123 224

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mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]


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Contents

Overview p.4

ResponsetoConsultationQuestions p.5

AppendixI(AccesstoCapital) p.15

AppendixII(SocialInvestmentWholesaleBanking) p.30

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Overview

Charities Aid Foundation (CAF), and its social investment arm Venturesome, welcomes theopportunity to respond to the Office of the Third Sectors (OTS) consultation entitled SocialInvestment Wholesale Bank: A consultation on the functions and design.

Before responding to the specific consultation questions, we set out below the key ideas andprinciples that have guided our approach to this response:

1. Access to capital for charities and social enterprises is needed, indeed is vital to build theircapacity to achieve social impact. However, demand remains in its infancy, as does thesupply of social investment in general. Encouragingly, a social investment market isemerging: see Appendix I (Access to Capital).

2. A wholesale function is necessary, and would be timely. Such a function (which must beclearly separated from a retail function) should aim to be a market builder/catalyst using a

range of wholesale financing techniques: see Appendix II (Social Investment WholesaleBanking).

3. Alongside the above, as the Consultation paper recognises, a range of other marketfacilitation roles is required. The SIWB is necessary but not sufficient in itself to achievea robust market. It seems neither appropriate nor feasible to have one entity delivering andnurturing the full range of market development roles required. Yet failure to develop anyone of the four pillars outlined in Appendix I as being necessary for a robust market risksfailing to achieve a robust market; and the SIWB, as wholesaler, also risks failing.

4. We believe that a coordinating body should play a central role in ensuring the ecology of

the market is nurtured and developed by recognising the importance of cross-cuttingissues and integrated solutions. This body should be different and separate from theSIWB. Its task would be to oversee the social investment market in its entirety, i.e. (a)building the demand side (through capacity building and investment readiness); (b)developing intermediaries/brokers; and (c) encouraging mechanisms that meet the broadfinancial needs of charities. Each of these functions must be delivered by a range oforganisations, in order to develop plurality and diversity in the market.

5. The key components of the wholesale function would centre on the provision of bothcapital and liquidity to retail intermediaries, including the structuring of new productsthrough aggregation and the creation of new secondary markets for specific social

investment products. See Appendix II.

6. The SIWB should seek to achieve as far as possible the optimal mix of both social andfinancial returns. Those organisations (both retail funders and frontline organisations) thatrequire legitimate, upfront investment must be distinguished from poorly-run, loss-makingenterprises. The business model of the SIWB must have clear social and financialmetrics. We do not believe that the SIWB can be a purely profit-maximising entity.

7. We believe that the SIWB should always act in the interests of the sector overall and,therefore, independence and impartiality must be reflected in its governance. The SIWBshould be entirely independent of government and sector intermediaries with vested

interests.

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ResponsetoConsultationQuestions

In response to the questions as set out in the consultation document:

1. Do you agree with the vision for a Social Investment Wholesale Bank set out in thisconsultation?

We believe that the vision set out in the Consultation paper reflects current needs, but in theirbroadest sense only (i.e. from charities needing access to capital right through to commercialfunders looking for CSR-type investment options) (see Appendix I).

It is not, however, a coherent vision for a specific institution called the SIWB.

This is because the vision for the SIWB as set out does not clearly define the role of the SIWB,and the distinction between wholesale and retail operations is not sufficiently unambiguous.

The SIWB must have a clear, defined and focused role.

We do not entirely agree with the diagram Figure 1 on page 10 of the consultation paper(reproduced below). For example, Second-tier support organisations are important but theyare not retail intermediaries in the sense of being retail funders. Generally speaking, Grant-makers, trusts and foundations, philanthropic resources and corporate responsibilityprogrammes etc do not operate on the wholesale level but on the retail level (one exceptionto this so far is the Finance Fund of the Esme Fairbairn Foundation).

We believe that no one single institution can or should perform all the functions as set out in thevision. The needs of the market are wide-ranging they are likely to be met by a diversity ofdelivery mechanisms operated by a diverse range of organisations.

Diagram as set in the consultation paper:

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Diagram as reworked by Venturesome:

2. Do you agree with the economic case as it is set out, and do you have further evidence,case studies or detail in its favour or evidence to the contrary? To what extent does the

evidence suggest problems are short term (for example, linked to the immaturity of the

market or perceptions) or intractable?

Yes, there is an economic need for the SIWB (see Appendices I and II for our reasons for thisbelief).

However, we will not know whether problems are short-term or intractable until the markethas developed further and an evidence base around what is and is not working is built up.Strong anecdotal evidence from Venturesomes and others experience of the market is that the

social sector is massively undercapitalised (i.e. weak balance sheets is the rule rather than theexception in this market)1.

Venturesomes experience with the market adoption of loan finance has been encouraging.Seven years ago, loan finance to charities was virtually non-existent. Now, although there isstill much risk aversion to taking on debt, the idea of loan finance is by and large accepted. Wedo believe that the better supply of capital should create better, more informed demand.

There is a need for consistent, in-depth market-level research about both the supply anddemand sides of the social investment market. Few market intermediaries have either the

1 See NCVO Funding Commission reports.

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inclination or resources to invest in such research. This might be a legitimate ancillary role forthe SIWB to undertake.

3. There are five potential functions for the Bank outlined in this consultation: achampion for sustainable social investment; raising capital; investing and providingcapital; market-making; and advisory services. Are these an appropriate response to

best address the problems identified? If so, why? If not, why not and what are the

alternatives?

Our reaction to these five potential functions is:

a champion for sustainable social investment NO. The market does not needa public relations cheer-leader but there is a role for an objective, impartial,critical, data-driven, research-based entity that facilitates market growth anddevelopment.

raising capital YES. Provided that this means helping market intermediaries(retailers) to leverage in both philanthropic and private capital (rather thancompeting with those retailers for funds).

investing and providing capital YES. But the examples given in theconsultation document confuse wholesaler/retailer models. KfW Bankengruppeappears to act like a wholesaler. But Norfund seems to be a retail intermediary(because it deals directly with frontline organisations).

market-making YES. This should be a key function of the SIWB. It mustfocus, however, on supporting and working with retail intermediaries (and notwith the ultimate investees/frontline organisations directly).

advisory services NO. This is not the function of a wholesaler. Such servicesshould be provided by other market intermediaries (e.g. UnLtd Ventures, SocialFinance Ltd, CAN Breakthrough, Social Enterprise Coalition etc.)

4. Each potential function will have costs and benefits over time (both direct and indirect,social and financial). What is your view about these costs and benefits, and what

evidence is there to back this up?

See answer (6) below.

It should be noted that the business model of the SIWB should recognise that some costs of

building a new market will require upfront investment which may not generate financialreturns. The SIWB cannot be purely profit-maximizing if it wishes to fill in the market gaps andperform a market-building function.

A low risk provider of capital (i.e. one which guarantees its investors 100% capital protection)should be careful not to displace existing (and successful) commercial activity in this space(e.g. Triodos Bank). In addition, purely providing low risk capital (0%+) will only meet part ofthe sectors needs. There is a need for below commercial-rate capital and this will require theuse of philanthropic/non-commercial money.

Implicit in Figure A below is the notion that purely commercial investors cannot achieve certain

social impacts because a trade-off must be incurred. At present, this trade-off is poorlyarticulated for the most part. A wholesale function should engage with the full range of

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potential and existing investors to explore the appetite and potential for funds and products inthis trade-off space.

Figure A

The benefits will be found in a thriving and resilient third sector, enabled by access to newmoney and more efficient use of existing money.

5.

Should advisory services for front-line third sector organisations and social investmentintermediaries accompany the provision of capital or be provided separately?

Advisory services should be provided separately. This is not the function of a wholesaler. Asindicated previously, however, advisory services are a necessary part of the development of themarket.

At a much later stage, perhaps when a more mature market has developed (say, 10 or moreyears from now), the SIWB may evolve to provide high-level corporate finance expertise forlarge-scale capital raisings. However, such a market is still many years away.

6. When raising capital, what combination of social and financial risks and returns wouldbe attractive to investors? What evidence is there that the Bank could attract investment

on these terms, from whom and through which investment products?

See Appendix I Variety of investment mechanisms

See Appendix II Thinking about the risk/return spectrum (Appendix C)

It must be appreciated that there are a range of investors across the whole spectrum ofrisk/return. Each investor, depending on their risk profile, will be able to provide some products(but not others). It is important that the right product is used to meet the appropriate financial

need.

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The SIWB would be most effective if it can deploy a range of capital (with different returnexpectations) so that it can perform a coordinating and aggregating role in the sector. This rolemust appreciate that different retail intermediaries involved in different activities may havediffering capital needs at different stages of their life cycle, just as frontline organisations do.

The SIWB has an important role in aggregating fragmented pools of capital into something thatis investable by larger, more commercially orientated investors. Also, the SIWB has a role toshowcase/innovate around social wholesale investment products in order to attract investmentand encourage other wholesalers (as in Appendix II). The SIWB should aim to crowd in otherinvestors, such as pension funds, trusts and foundations, rather than crowd them out.

High risk funds which expect to operate on the negative return spectrum are unlikely toleverage in commercial funding unless there is a very large, first loss tranche provided bygrants. High risk funds are best funded by gift capital because the expected loss rate is(generally speaking) too high to be absorbed by first loss tranches or diversified away.

8. Which combination of functions would be most effective and deliver best value formoney?

As a general rule, the use of money in a leveraged way (e.g. underwriting, guarantees, first losstranches etc.) is more efficient than using money directly to fund services (see Appendix II case study Appendix A).

Furthermore, the principle of additionality is a good guide to ensuring best value for moneyby avoiding situations where the SIWB duplicates services/products that are already beingprovided (or could be provided) by other players.

Of course, some things will legitimately require non-commercial funding (funding that does notachieve 100% recycling and is provided at below market rates) because they cannot inherentlydeliver positive financial returns. Such cases must be clearly distinguished from those thingsthat can deliver financial returns but fail to do so through lack of skills or throughmismanagement.

9. Do you agree that eligibility should be based on potential social and environmentalimpact, rather than defined by legal or organisational form? If so, would it be necessary

to ensure that the Bank ultimately supported a diverse range of enterprises, for examplesmall, black and minority ethnic-led and rural projects?

Yes, eligibility should be based on potential impact (not legal form).

This question seems to be based on an assumption that the SIWB might commingle wholesaleand retail functions. We emphasise that the SIWB should only fund retail intermediaries (notthe ultimate beneficiaries/frontline organisations).

To ensure that the SIWB supported a diverse range of enterprises, the SIWB would need tothink about how the retail intermediaries that it transacts with would in turn support ultimate

beneficiaries who are diverse.

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We note that there is an emerging belief that social enterprises, as viable and self-sustainingorganisations, offer a complete range of social solutions. In our experience, very few socialpurpose entities, whether classified as social enterprises or not, have the potential to be fullyself-sustaining. Only a small minority have the potential to achieve the optimal mix of bothsocial and financial returns.

In some cases, this is because their business models are poorly conceived, or badly executed, orboth. For others, the nature of the needs the organisation aims to meet means that they willlegitimately require some element of grant funding. It is critical to distinguish between theformer from the latter cases when assessing funding requirements. This applies to both frontlineorganisations and the retail funders themselves.

10.This consultation suggests that the mission of the Bank could be to create social andenvironmental value through increasing investment for a social or environmental

purpose. How do you think the mission of the Bank should be defined?

The SIWB mission should be clearly defined as a wholesaler of capital, designed to increasethe availability of appropriate capital for social purpose organisations.

SIWB should see itself as a market-builder (not as a retail player at all). Otherwise, there is areal danger that the SIWB will become unwieldy, unfocussed and disruptive of the emergingecology of the market. The risk of mission drift will be virtually unavoidable if the SIWBconfuses wholesale and retail functions.

Unfortunately, the language and examples in consultation paper seem to confuse thewholesale/retail functions. There must be a clear separation between the two functions (e.g.

paragraph 82 states to support demand for finance in the third sector could be misleadinglyinterpreted as the SIWB playing a retail agency role).

11.Do you agree that the SIWB would need to be flexible and adaptable to address evolvingissues as the market develops? How could it be ensured that the Bank would respond

appropriately to the evolving market?

Yes, flexibility is preferable to rigidity provided that the SIWB operates in a definedterritory of activity (and does not morph into a retail intermediary).

12.How best could the Bank be structured and owned in order to deliver its functions andmeet its mission?

SIWB governance must reflect its independence and impartiality.

We believe that a wholesaler must be impartial otherwise, it has the potential to powerfullydistort the market. Moreover, it is unlikely that any retail intermediary (current or future) canrun the SIWB without conflicts of interests. Impartiality must not only be effective but alsobe seen to be effective (otherwise, the reputational damage to the SIWB would destroy its

credibility in the market).

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In particular, we believe that it is crucial that the SIWB has an independent board and isentirely independent of both government and all sector intermediaries with vested interests.

This is because:

Conflicts of interest must be avoided; There must be no possibility that the government has any claim or claw back2 on the

profits or assets of the SIWB.

The issue of how the SIWBs independence can be protected is a difficult one that leads to noeasy answers. The key questions are:

If the SIWB is independent, from whom is it independent?

If the SIWB is capitalised with public money, then to whom does it report?Parliament? MPs? The Treasury? A select committee?

13.Under what circumstances could an SIWB carry out activities itself, rather than beinglimited to financing and offering support to others?

The SIWB must never carry out retail activities itself. That is the role of a retailer (notwholesaler).

Furthermore, such activities are best provided in any case in a dedicated way by specialistorganisations. The experience of credit unions in the United States may provide a usefulanalogy. There, a number of US Community Development Credit Unions (CDCUs) have

developed separate businesses to provide advice services. Their experience suggests thatsuccessful advisory models require time to develop their management and governancestructures.

The SIWB could perhaps fund other intermediaries to carry out retail functions such asadvisory services (i.e. outsource the advisory function to a third party). But the questionremains as to what meaningful criteria the SIWB would use to select such third parties, if itsmission is to increase the availability of appropriate capital to social purpose organisations.

14.Do you agree that the Bank should seek to report transparently against a triple bottomline of social, environmental and financial value? What ideas do you have for how thiscould be achieved?

This question implicitly confuses the wholesale/retail function.

Wholesalers, retail intermediaries and frontline organisations are all responsible formonitoring and reporting on their triple bottom line albeit with differing levels of intensity.The onus should be on frontline organisations to provide evidence of their triple bottom lineto their retail funders, who in turn should provide evidence of their triple bottom line to theirwholesale funders. In particular, wholesale and retail funders should seek to demonstrate that

2 For reference, see the claw back provisions in Private Finance Initiative (PFI) arrangements.

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their investments build organisational and financial capacity, rather than directly attributingproject outcomes to their investments.

The SIWB should avoid crude or simplistic SROI metrics that unduly restrict the market. IfSIWB is a catalytic market-builder, then it will not be measured on its own triple bottom line,

but on its success in developing the social capital market. The SIWB can then elect to workwith those retail intermediaries which most effectively manage their triple bottom line.

This, of course, raises questions regarding what rational assessment criteria the SIWB woulduse for assessing which retail intermediaries to support and why. This is likely to includecriteria around:

robust/smart income and expenditure models

recycling of a pre-defined proportion of capital that reasonably reflects the financialmechanisms deployed and the financial needs they are meeting

clear understanding of social returns they expect to see and how these will be tracked(but without striving for attribution of frontline charities outcomes).

In any case, the SIWB must look at the effect on the overall market rather than assessingeach retail intermediary in isolation.

The SIWB will require skilled staff to carry out its functions. It will be an organisationalchallenge to recruit and train such staff and the investment required to implement thisshould not be underestimated.

15.Do you agree that the Bank would not distort competition to an extent contrary to thecommon interest if it followed the guidelines set out in this consultation? What

mechanisms or safeguards could be put in place to ensure this, while still enabling the

Bank to effectively carry out its mission and functions?

The guidelines as set out in the consultation paper are confused and not sufficiently focussed.Therefore, the guidelines (if followed) would probably distort competition.

In order for the SIWB to focus exclusively on its wholesale role, the SIWB must refrain fromcompeting with retail intermediaries (e.g. direct investing in frontline organisations orindividuals, advisory services etc.). Otherwise, the market will be distorted and adversely

impacted.

16.How would you make a robust assessment of the necessary financial requirements overtime of a SIWB, and what evidence is there to back this up?

We do not believe that the SIWB can or should be a purely profit-maximising entity. This isbecause a purely profit-maximising entity would be unable to operate on those parts of therisk/return spectrum that require a trade-off between financial and social returns.

It is likely that the capital base of the SIWB would require at least two types of capital: (i)

capital that requires a financial return of some sort (but typically less than market rate) and

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(ii) gift, patient or non-commercial capital that can be eroded over time in order to guaranteeor sit along side the first type of capital in order to leverage it.

17.The Government recognises uncertainties around the capacity and willingness of thethird sectors demand for finance. How could the risk of this undermining the successof the Bank be mitigated?

It is important from the outset to be clear what the success metrics of the SIWB are.

This question once again appears to confuse the wholesale/retail function of the SIWB. Therisk of the SIWBs success being undermined by the capacity and willingness of the thirdsector demand for finance is a risk that should be the concern of all market players operatingat the wholesale, retail and front lines.

A more relevant issue is how the quality of retail funders/specialist lenders should be

assessed? What meaningful benchmarks should be used by the SIWB?

18.Do you agree with the principles for the design of an SIWB outlined in thisconsultation?

Our response to the principles are:

outcomes focused YES. But the real question here is outcomes for whom?A key outcome for a wholesaler is that retail intermediaries are strengthened,their quality and therefore impact increases, and that there are more retailintermediaries because they have increased access to capital from anorganisation performing SIWB functions.

additionality YES. This is a fundamental principle with which we fullyendorse.

sustainability YES/NO. It depends on what it meant by sustainability andfor whom. Yes, if this means that triple bottom line outcomes are achieved forfrontline organisations. No, if this means that financial returns are paramount,and that no trade-off can take place along the negative part of the risk/returnspectrum. SIWB is a market-builder, and this means it must be judged on itsimpact on the development of the social investment market. It will also requiredoing some activities that generate no financial return (and therefore erode

capital). It may also require that it is superseded by other wholesalers/supplyfunctions i.e. it may not necessarily itself be sustainable.

independence YES. The SIWB must be entirely independent of governmentand sector intermediaries with vested interests.

ambition YES. But scale and replicability by themselves have no value.They are only valuable if what you are scaling up and replicating is useful andeffective in achieving the social, financial and environmental objectives that youhave set.

transparency and accountability YES. Provided that you are also effective.Mere compliance with the principle of transparency and accountability isnecessary but not sufficient to achieve effectiveness.

flexibility YES. But be clear about the SIWB role (and be vigilant againstmission drift).

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APPENDIXI

ACCESSTOCAPITAL

Abriefingpaper

Venturesome

September2009

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Charities Aid Foundation (CAF) is a registered charity that works to make the most of moneyfor charities and social enterprises. CAF believes that access to capital is vital for a healthy andthriving charitable sector.

Over the years CAF has been instrumental in pioneering and incubating funding solutions;

including Venturesome, a high-risk investment fund and Charity Bank, which became independentin 2002.


providers of charitable grants and providers of bank loans at market rates. Since its launch by CAF

in 2002, 15 million has been offered to 250 organisations. In addition to accumulating practical


investment market, adopting an open-book approach to share knowledge and build experience, but

also ready to operate in competition so as to raise standards.

For more information, visit: www.venturesome.org

If you wish to receive information from Venturesome, please send your contact details to:

[email protected]

About the authors

Emilie Goodall joined Venturesome as Investment Manager in late 2007, having previously workedas a Research Analyst at the charity New Philanthropy Capital (NPC).

John Kingston is the founder Director of Venturesome. After 15 years with 3i Group and 10 yearsat Save the Children, he joined CAF in 2001 to explore the potential of a risk capital fund forcharities and other non-profit organisations. John is Chair of the Social Investment Market Group(UK) and a trustee of a small charity and of a grant-making foundation.

Venturesome

The text in this document may be reproduced free of charge providing that it is reproduced accurately and not used ina misleading context. The material must be acknowledged as Venturesome copyright and the title of the documentspecified.

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Preface

This paper is an update to Venturesome (2008) Financing Civil Society3, prompted by the Office of theThird Sectors consultation regarding a Social Investment Wholesale Bank. It was written as a discussion

paper, providing context for a CAF-hosted roundtable held in August 2009.

There was consensus at the roundtable regarding this papers proposed four key pillars to a robustsocial investment market, and a positive discussion ensued as to how a social investment wholesalermight contribute to building those four pillars. Some key questions emerging from that discussion areincluded at the end of this paper.

We publish this paper as a contribution to the current thinking on social investment, and the role that aSocial Investment Wholesale Bank might play in supporting the existing ecology of this emerging andstill fragile market.

Introduction

It is increasingly recognised that lack of access to capital is acting as a barrier to charities4achieving theirsocial mission.5

There is limited quantitative research on the capital need of charities, but ample case studies of charitiesstruggling to manage working capital, deal with the unexpected and invest in innovation, growth anddevelopment.

This paper paints in broad brushstrokes a picture of the current situation and outlines the characteristicsof a robust social investment market. By robust market, we mean a world in which informed charities

have access to appropriate capital, from a resilient capital supply, distributed using a variety of financialmechanisms.

We believe there are four critical pillars to a robust social investment market:1) confident and informed demand from the voluntary and community sector (VCS)2) efficient matching of supply and demand3) variety of investment mechanisms4) resilient supply of finance

Each of these are explored in turn in this paper, in each case, laying out the following elements:- where we are now- characteristics that would be evident in a robust market

- key barriers to progress towards that robust market- some emerging ideas and solutions

We invite comment on the subsequent sections of this paper. The paper is by no means comprehensiveor exhaustive, and suffers from bias (reflecting as it does a social investors perspective). The purpose isto provide a framework for discussion, debate and reflection.

3 Available at www.venturesome.org4 In this paper charities or voluntary and community sector (VCS) is used as a catch-all term for the broad range of

social purpose organisations, as identified in Venturesome (2008) Financing Civil Society. See Figure 1, p.6.5 NCVO Funding Commission initial findings, Office of the Third Sector (July 2009) A consultation on the functions anddesign

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1)Confidentandinformeddemandfromthevoluntaryandcommunitysector

(VCS)

Currentsituation:an undercapitalised but inarticulate VCS?

The need for access to capital is increasingly recognised by sector commentators. Traditionally, sectorresearch has focused on income and expenditure patterns across the sector, with less attention paid tocharities balance sheets. The exception has been high level research undertaken first by the Commissionon Unclaimed Assets and more recently NCVO6 which highlights that the bulk of the sector has arelatively low level of reserves.

However, the there is no strong or coherent voice clamouring for access to capital, other than a handfulof sector intermediaries7and specialist lenders themselves. It is possible that the need for capital issimply an as yet poorly defined subset of the wider funding issues facing the sector, 8 which are wellrehearsed.

It could be that an open debate about the need for and access to capital has been obscured by the focus

on social investment/alternative forms of finance, particularly the provision of loans, as opposed to whysuch a form might be needed and/or appropriate. In any event, the greatly increased supply of loans,from specialist lenders such as Futurebuilders, has undoubtedly moved the debate forward.9

But many, if not the majority, are not willing to take on loans genuine aversion to debt finance is notuncommon. The focus on loans, rather than a wider debate regarding access to capital, may not behelpful; particularly during a credit crunch largely understood to have been caused by inappropriatelending.

Characteristicofarobustmarket:a confident and financially literate VCSGenerally, the sector would benefit from recognition that all organisations need capital (as doindividuals), whether internally generated or externally accessible not just for-profit models, or social

enterprises, or charities that trade.

For a robust market, we need a VCS that is: confident10 in identifying its own financial needs aware of different mechanisms (grants/loans/equity) available to support those needs, and the

associated risks aware of different providers (from income to capital suppliers), and their motivations confident in seeking appropriate capital from a variety of sources for this, the sector would arguably benefit from stronger finance functions, i.e. financially confident

CEOs/Directors/trustees, and a greater pool of chief operating officer/finance director /treasurer-types attracted to the sector

Many of the characteristics above would need to be mirrored in funders, both institutional (foundations,government) and individual donors (particularly high net-worth individuals): Funders able to distinguish between income and capital Recognise different capital needs (fixed assets, working capital, rainy day reserves and

growth/development)

6 NCVO, Guidestar research shared at the recent 2009 Recession Summit (June 2009), taken from the NCVO Almanac2009.7 Namely, NCVO and ACEVO which, admittedly, are representative bodies, but on this particular topic seem to betaking a lead rather than being pushed by members.8 Reflected in the fact that the NCVO Funding Commission has picked access to capital as one of its three focus areas.

9 Futurebuilders has stimulated demand, through a combination of scale/PR, the carrot of grant money alongsideloans, and the advice and support provided by the programme.10 Conversations with NCVO Sustainable Funding Project indicate that confidence is currently a major barrier.

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Identify themselves as givers/shoppers/investors11, and adopting the funding tools commensuratewith their chosen role - either in-house, outsourced or in partnership

Keybarrier:cultural tensionThe importance of building up and maintaining reserves may well be recognised by charities, butinvariably is not prioritised. It is quite common for small- and medium-sized charities (the bulk of thesector) to run on a cash in, cash out basis. This is, in many ways, perfectly understandable: charitiesexist to help their beneficiaries, and the priority of the charity is meeting the needs of those beneficiaries.Money is a means to the end of helping beneficiaries which is often translated into every pennyreceived should be spend on direct activities.

This view is the popular one. The general public can be sceptical of reserves 12, in the same vein as theyare sceptical about administrative costs. As can be individual donors, as well as institutional donors,including some foundations and sector commentators.13 These views influence charities. Not only isthere is little external pressure to prioritise capital, indeed charities may even be discouraged fromdoing so by perceptions of unreasonable levels of reserves.14

The issue runs deeper than donor perceptions. Research into finance in the arts world highlighted thatsome arts organisations see a financial deficit as a badge of honour; one measure of the excellence of theartistic product is the size of the deficit.15 This tension is not unique to the arts sector. It is not hard touncover through discussion with charities or the wider public the suspicion that financial strength, oraiming for a surplus as opposed to break even, is somehow inconsistent or even incompatible withsocial mission.

Grants and donations are the lifeblood of charities, and will remain critical to the future health of thesector. They are the form of funding charities are most comfortable with. Yet grants and donations are afinite resource, and therefore it is important to use grants where they are most needed.

There are a variety of reasons behind the sectors preference for grants, beyond familiarity, including:

The lack of recognition, mentioned previously, of a distinction between different types of money the basic income/capital distinction, the various forms of capital need, and how these are best met(using different financial mechanisms).

The perception that grants and donations are free money. This ignores the fact that such money israrely free. Establishing the costs of raising funds, sector-wide, is very difficult, but in the UK mostcharities find it costs between 15 and 25p to raise 1.16 Finally, the costs of reporting on the grant canbe high; one research report identified that the average cost of the reporting burden ran to 6% of theoriginal grant, over and above what the charity would spend on its own reporting.17

In some quarters, a sense of entitlement, along the lines that charities do good work and shouldtherefore be given the money.

Scepticism regarding the motives of suppliers of alternative forms of finance. Why do specialistbanks and lenders, and those who invest in such institutions, do so? Are they really interested in

supporting charities in their mission, or are they interested in getting their money back, or indeedare they getting involved because they are aiming to make money?

11 As identified in Julia Unwin (2004) Grant-making tango12 Most recently seen in the lack of support for charities claiming compensation for funds invested in Iceland.13 For example, Charity Navigator in the US; see www.charitynavigator.org/index.cfm?bay=topten14 An acceptable level of reserves is usually seen as being equal to three months worth of expenditure, with significantlymore or less giving rise to concern. This rarely takes into account the make up of the charity in questions balancesheet, however, or its activities and therefore its particular capital needs.15 New and Alternative Financial Instruments, final report of Mission, Models, Money programme, available at

www.missionmodelsmoney.org.uk16 Charity Facts website, www.charityfacts.org/fundraising/fundraising_costs/index.html17 NPC (2008) Turning the Tables in England

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EmergingplayersandideasGenerally speaking, there seem to be fewer initiatives in this particular pillar area than in others. Oneapproach has been to argue that a steady stream of capital supply will unlock demand. Arguably supplyon its own is proving insufficient, and proactive demand-focused initiatives are required.

Below are some of the ideas underway for tackling some of the issues identified above. The NCVO Sustainable Funding Project, which has been running for several years, takes alternative

finance to the sector through open access tools and training. The latest phase is focusing on trainingintermediaries, across the UK. www.ncvo-vol.org.uk/sfp/

Mission, Models, Money (MMM) New and Alternative Financial Instruments (NAFI) pilot has beenforging a path in the arts sector: www.missionmodelsmoney.org

The downturn, funding permitting, may provide the opportunity to recruit those with financialskills from other sectors. The Institute of Chartered Accounts for England and Wales has launched aTalk Charity website, in recognition that members have or may have interests in supportingcharities.www.ion.icaew.com/charity

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2)Efficientmatchingofsupplyanddemand

Currentsituation:inefficient meeting of supply and demandThe limited understanding of the need for capital is the first barrier. But once charities and funders have

identified capital needs, there are further barriers.

There is something of a disconnection between revenue funders and capital investors. The world ofsocial investment operates on the margins. This is reflected in the language; alternative finance, asopposed to mainstream funding. It is often, wrongly, conflated with social enterprise - anotherseparate sphere of activity, which is seen and sees itself as distinct from charity.

On this theme, it is worth reiterating that capital is required across the spectrum of organisational forms(indicated in Figure 1), and that that capital need can be met using a range of capital investmentmechanisms. In other words, alternative finance is not just for trading organisations. It can be of use tocharities that rely exclusively on grant funding.

Figure 118

Socialbenefit

enterprise

Socialpurposebusiness

Sociallyresponsiblebusiness

Commercialenterprise

Charity withfundraised/

grantincome

Charity withon mission

trading/contracting

Businessgeneratingprofits forcharitable

spend

Grey area in which organisations are oftenloosely referred to as social enterprises

Supply itself is fragmented. Suppliers of capital do not always recognise themselves as operating in thesame space or to the same ends; supply is more easily categorised by type of product offered rather thanby motivation or intent. This means that institutional and individual donors, as well as intermediaries,do not always recognise where they could signpost demand, or when they may learn from one anotheror co-invest. To return to an earlier point, indeed, some revenue (grant) funders are unknowingly orunwittingly providing capital investment, while capital investors can end up subsidising revenue.19

Even if supply wasnt so fragmented, the routes to market evident in commercial markets are few andfar between in the VCS. There are no real connecting mechanisms, beyond directory listings and ad hoc,informal signposting between specialist lenders. These issues are symptomatic of a young andimmature market. The offer from suppliers in recent years has evolved, and swiftly. A clear productoffer (i.e. loans at 6%) has only relatively recently emerged (largely through big suppliers, namelyFuturebuilders). It has therefore been difficult for charities, and referring agencies, to establish whoprovides what.

The result is that organisations which could benefit from the increasing supply of capital are not doingso, whilst suppliers are distracted by inappropriate demand. There is anecdotal evidence of charitiesshopping around, an encouraging sign, except where it is ill informed and inappropriate, wasting timeand effort of both charities and suppliers.

Charities need timely access to capital, not lengthy application processes and opaque decision making.Again, confidence in spotting need and identifying appropriate mechanisms should help speed up theseprocesses.

18 Taken from Venturesome (2008) Financing Civil Society19 For a discussion on the commingling of revenue and investment, see Olverhoser (2004) Nonprofit Growth Capital:Defining, Measuring and Managing Growth Capital in Nonprofit Enterprises. Part One: Building is not Buying

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Barriers There are few clearly defined and universally understood terms in the world of capital investment.

The jargon of investors can be alienating for charities, while the jargon of the VCS can be alienatingfor more commercially-minded investors. Individuals and institutions can find themselves talkingat cross-purposes through lack of agreed terminology.20

The lack of informed demand means suppliers spend time educating charities in one-on-onesituations, which is inefficient. Business advisers, sector intermediaries and fundraising expertsneed to be equipped with knowledge and tools to help charities find help.

Differing motives (i.e. commercial/philanthropic) on the part of suppliers can result in suspicionand wariness. Also, intermediaries (Community Development Finance Institutions, specialistlenders) compete for investment to distribute, as capital investment is in limited supply (we returnto this point later). These two factors can impede working together (learning from one another, co-investment, syndication) and effective signposting.

Characteristicsofrobustmarket:Efficient meeting of supply and demand Informed, confident and appropriate demand and supply is a prerequisite Timely matching of demand and supply financial difficulties become exacerbated when not met

when required Transaction costs need to be kept as low as possible. This applies to administration, assessment,

monitoring and evaluation and ongoing fund management. Transactions also need to be as simple as possible; the challenge is to ensure innovative mechanisms

are understandable and that suppliers of capital remain approachable. Informed intermediaries (e.g. Capacitybuilders, local CVSs) and business advisers of quality Corporate finance-style advice available Supply side actively promoting co-investment/layering/signposting Virtual or actual connecting mechanisms, between suppliers but also to connect them direct to

demand

Emerging

players

and

ideas

NCVOs Funding Central, a website of funding and investment opportunities which aims to gobeyond a directory listing, helping charities navigate different mechanisms and suppliers.www.fundingcentral.org.uk

There is an opportunity to build on the Social Investment Market Group, chaired by Venturesome,and develop an active forum for co-investment and syndication

NESTA has provided finance for advisors/investment readiness work via UnLtd Advantage (seebelow) as part of its Methods Lab strand of work. www.nestalab.org.uk/methods-lab

UnLtd is directly engaged in investment readiness work through its Ventures and Advantageprogrammes, supporting social enterprises looking to scale.www.unltd.org.uk/template.php?ID=13

Futurebuilders is piloting a consortia approach (i.e. pulling together suppliers/advisers) to support

charities interested in working together to win public sector contracts. www.futurebuilders-england.org.uk/what-we-offer/services/pilot-consortium-to-help-the-third-sector-win-contracts Social Finance is working with a handful of charities in a corporate finance role, helping structure

and broker capital investment. www.socialfinance.org.uk Several virtual connecting mechanisms are in various stages of development (and with varying

degrees of success):- ClearlySo is an online marketplace for social enterprises and investors: www.clearlyso.com- Social Finance more recently launched a Social Investment Hub, a searchable directory

aimed at bringing together those providing funding and those looking for funding:www.socialfinance.org.uk/sihub

20 Recent market research undertaken by Venturesome indicated that among three distinct groups donors/investors,intermediaries and charities understanding of social investment was limited, most starkly among charitiesthemselves.

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3)Varietyofinvestmentmechanisms

Currentsituation: increasing but limited range of financial mechanisms in useThe sector is dominated by grant funding, both in terms of the amount of supply and the cultural

dominance of this form of funding, as discussed previously. On occasion, grants are used where analternative tool may be more appropriate/efficient.21 There is a finite supply of charitable money, andinsufficient to go round a situation which will only worsen in the coming years. Therefore, the efficientuse of those funds becomes imperative, to ensure that grants are used where most appropriate.

No research has been undertaken that decisively maps the availability of capital (how much, in whatforms, from where). Venturesome22, and more recently Social Finance23, have attempted to capture thedifferent forms of capital in use, based on observation.

The majority of capital funding available is for fixed assets. This applies to both capital grant funding(from foundations, institutions, etc) and loan finance. Borrowing to buy a building, in the form of amortgage, has become more normal among charities. This has principally come from clearing banks,

although there is anecdotal evidence to suggest reducing appetite from banks in recent times.

There is some evidence of banks providing secured lending for more general purposes, although this ofcourse relies on charities having assets (or directors being willing to provide personal guarantees) andwe know charities are undercapitalised.

The handful of other mechanisms available underwriting, unsecured loans, quasi-equity, equity arebarely used. Furthermore, where they are used, they are available in the short- to medium-term (overthree to five years). The exception is long-term, secured loans (i.e. mortgages). Little genuinely patientcapital/soft loans are available, yet such finance would seem necessary in a sector in which success israrely achievable in the short-term (tackling poverty, improving education, etc).

Financial mechanisms in use have been adapted from commercial use and rarely take into account thesocial return element of the investment. Social return is assessed in wildly different ways, by charitiesthemselves as well as by social investors. Investors take different approaches to assessing risk, return(financial and social) and how their pricing reflects that. Few are transparent about their approach,making it difficult for charities, among others, to assess who is providing what and why. Indeed, thepricing of investment rarely links coherently to the expected social return of the investment, leading toconfusion.

A framework capturing risk, financial return, social impact and pricing is not yet available to us. Thefirst step is for donors and investors to recognise their appetite for risk, and how far they are preparedto go with their money in order to achieve the(ir) desired social impact.

All donors and investors, whatever their approach, have a particular risk appetite determined by anumber of factors, not least their expectation of financial/social return. Across their portfolio ofinvestments/grants, they will be aiming for a pre-agreed overall level of financial/social return.Grantmakers, for example, take 100% risk on their grants they will never see those funds again butthis is accepted as it is being traded for social return. Social investors (such as community developmentfinance institutions), on the other hand, seek a financial return usually the aim across the portfolio is toat least recover the capital so that it can be recycled elsewhere - but may charge below-commercialrates, and overall aim to break even as opposed to generate financial returns. Figure 2 reflects this idea.

21 Discussed, with examples, in Venturesome (2008) Financing Civil Society.

22 Venturesome (2008) Financing Civil Society. Previous publications have tracked the development of the market year onyear.23 Social Finance submission to NCVO Funding Commission, available at www.ncvo-vol.org.uk

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Figure 2

Figure 2 also sketches out how investors weigh up how to price the level of risk. The level of risk iscommensurate with the nature of the capital need, but for social investors, pricing will also factor in theexpected social return financial return is traded for social return.

Finally, and linked to the above point, few suppliers have demonstrated a robust and resilient incomeand expenditure model themselves aside from those operating at scale at the lower risk end of the

spectrum, and even there all is not well. Many are greatly threatened by the current economic climate oflow interest rates; most suppliers required subsidy of some kind, and/or made losses, even before therecent downturn.

Characteristicsofrobustmarket:clarity Clarity regarding how the three dimensions of risk, financial and social return, and price work

together. Clarity regarding where donors/investors place themselves on this three dimensional spectrum. This requires established asset classes, resulting in a genuine range of mechanisms that meets the

financial needs of charities (senior debt through to grant capital).

Barriers

It is likely that the limited range of mechanisms in use reflects the small size and immaturity of themarket. But it also reflects: Risk aversion, on both demand and supply sides Funder motivation. For example, underwriting is barely used. There seem to be two reasons for this.

One, the benefits of underwriting are difficult to articulate. Over 100 underwriting investments havebeen made by Venturesome, and in close to 90% of cases the funds go undrawn. The impact doesnot come from drawing the funds, but in having a safety net which enabled the charity to proceedwhere otherwise it might not have done. But pointing to what might not have happened otherwisedoes not provide a particularly tangible success story or, rather, it does not fit the paradigmfunder success story. Two, much supply is under pressure to get the money out of the door, as ifthis were a measure of success. Linked to this are pricing difficulties; how to cover costs ofsupplying underwriting, if the funds are not drawn, in this low interest rate climate.

Lack of quality advisers / corporate financiers in the sector. The bulk of strategic and financialadvice typically points charities to fundraising (raising grants), the mainstay of the sector.

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Legal structures within the sector limit investment (e.g. equity is not available to charities, asset lockon community interest companies).

Clearly, a variety of investment mechanisms relies on a resilient supply of capital, which can be used ininnovative ways. This is covered in the next section.

Emergingplayersandideas Venturesome has divided its fund into a series of experimental funds, including:

- Development Fund, testing connections between providing development capital, thecapacity building that enables and ensuing social impact

- Innovation Fund, testing out new financial mechanisms- Standby Fund, scaling low-risk investments (e.g. underwriting), as an offer to philanthropic

investors Social Finance is developing thinking around a Social Impact Bond, linking investment directly to

social outcomes, with investors and investees rewards linked to success in delivering pre-agreedoutcomes. See www.socialfinance.org.uk/downloads/SIB_report_web.pdf

New Philanthropy Capital (NPC) has historically taken a broad church approach to methods ofmeasuring social impact (all were welcome), but is moving towards generating common tools foruse by the sector, and benchmarking. See www.philanthropycapital.org

The CIC Regular recently closed its consultation, results pending, on lifting the dividend lock onCICs, which has for some restricted access to capital. Elsewhere, the Charity Commission has beenworking for some time on a new form of legal structure, the Charitable Incorporated Organisation,partly intended to simplify reporting and regulation. www.charity-commission.gov.uk/registration/charcio.asp

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4)Resilientsupplyofcapital

Currentsituation:no clear supply of capitalAs discussed previously, the bulk of funds available to the sector take contract or grant form; whether

via public donations, high net worth giving, trusts and foundations or central or local government. Thesize of capital supply available to the sector is unclear; it has been estimated at 1 billion but there is norobust evidence to support this figure.

Estimates are hampered by the lack of transparency and lack of agreed definitions. One can observe,however, that supply is dominated by government funds (of which ACF manages the bulk, c415m24).Very few philanthropists are engaged in social investment, indeed there are limited opportunities forthem to do so. There are even fewer opportunities for the general public to get involved aside fromputting funds on deposit with specialist banks (e.g. Triodos, Unity Trust Bank, Charity Bank), in orderto see funds used to support charities via low-risk financial mechanisms.

There is gathering interest in mission-connected investment (investing endowment funds in social or

environmental opportunities, for market return) from foundations, but programme-related investment(investing funds at below market return, to generate social return) is proving a bigger step.

As indicated previously, banks have become more active in this sector over the last ten years or so,largely through the provision of mortgages. Government schemes, such as the Enterprise FinanceGuarantee Scheme, are ostensibly open to the sector but subject to the same decision criteria as banksoperated previously.25

If we look at how the sources of supply, above, are distributed, again the majority of supply is at the lowrisk (secured lending) end. Figure 2 indicates the range of mechanisms in use, and for what capital needthey are most appropriate the lightly shaded area indicates where supply is dominant, and the darkshaded area where funds are in shorter supply.

Figure 326

UnsecuredLoan

Overdraft

Quasi-equity

Equity

Grant

StandbyFacility

PatientCapital

Securedloan

Increasingevidence of

commercialfinance available

Need for further supplyof capital anddevelopment offinancial instruments

Appropriate funding(correlation)

Pre-funding offundraising/income

Growthcapital

Property/assetpurchase

Cash flowneeds

24 Funds under management include Futurebuilders, Health Social Enterprise Investment Fund andCommunitybuilders.25

Leading to concerns that the lack of take up/accessibility may be translated (wrongly) as indicating that the sectordoes not need working capital support.26 Adapted from Venturesome (2008) Financing Civil Society

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Specialist banks are increasingly active (particularly over the last nine months) and strong, but themajority operate at the relatively low risk end of the spectrum. The remainder (most) suppliers areindependent, small specialist lenders. Most suppliers are national, although there are a number of localinitiatives (for example, Key Fund Yorkshire).

In some ways, the need for access to capital is a symptom of another cause, hinted at earlier in this paper namely, the revenue funding market. This paper is not the place to discuss this issue27 but it must berecognised that some capital investment is effectively compensating for poor (income) donor practices.

Characteristicsofrobustmarket:diverse supply of capital No one dominant source of supply, but a diversity of supply from public, private and individual

sources As before, a sector in which funders/donors themselves recognise capital needs and understand

what type of donor they are (giver, project grant-maker, purchaser, investor) and adapt appropriatetools/ways of working that reflect that intention

A diversity of supply therefore requires an up-skilling of current sources of supply, if they are toadopt capital investment mechanisms themselves, and/or a variety of distribution routes, that aretransparent about risk/returns/pricing so that suppliers can select appropriate partners throughwhich to distribute funds

Referring back to Figure 2, a greater supply of capital that is at genuine risk (i.e. source of supplythat are able and willing to sustain losses), recognising that for the majority of charities it is notpossible to deliver both financial and social returns. Of particular concern is the increasing hypearound the potential for commercial investment into the sector (with the ultimate aim of extractingfunds from the sector for distribution to private/commercial investors).

This, of course, requires distributors (social investors, community development finance institutions)that can demonstrate resilient (sustainable) income / expenditure models. Only a handful havedemonstrated a resilient income/expenditure model, without recourse to external (grant) subsidy,and that was prior to the current low-interest rate climate which is extremely threatening to manyproviders.

Barriers Not only is the financial climate threatening charities themselves, it threatens the resilience of retail

investors and indeed sources of supply. Continuing dominance of government funding in this spaceis unlikely, while foundation endowments have typically dropped by 20-25%, squeezing incomeavailable for distribution. This may offer an opportunity for alternative, recyclable mechanisms but not if it cannibalises existing sector (income) funding.

Among potential sources of supply that are socially motivated (foundations, philanthropists), thereis some scepticism re. the social benefits of social investment why social investment is beneficialfor the investee/what connection it has to the outcomes delivered by the investee. Specialist lendershave struggled to articulate their role and its value to the sector more work is needed here.

There has been no coherent offer to philanthropists as to how to get involved in this area. This may

be compounded by the lack of tax incentives; donors receive relief on charitable donations, as doinvestors in venture capital at the other end of the spectrum, so why are there no tax breaks forthose wishing to invest capital for a period of time to finance social investment?

The charitable world is arguably divided into (financially motivated) investors and(philanthropically motivated) givers this dichotomy is found within foundations, and withinindividuals own behaviour. It is a bigger psychological/cultural leap than might at first appear, togo from giving money away to investing it, not for commercial return, but so that it may be recycledfor social impact. Products are required that will entice investors in. The challenge is succinctly put

by Sasha Dichter28

of the Acumen Fund: As a sector I think we could get a lot more sophisticated inexplaining that theres a big space between a negative 100 percent financial return (for grants) and double

27 See Clara Miller (2005) The Looking-Glass World of Nonprofit Money: Managing in For-Profits Shadowfor an excellentoverview of the difficulties.28Good Capital newsletter Issue 15,Acumen Fund Puts Its Money Where Its Mouth Is, Kevin Jones

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digit returns for private equity. We need to define that middle ground if we expect to see significant influxesof new capital.

EmergingplayersandideasThe financial crisis has catalysed a number of debates, if not concrete action, around finance andwhether it ought to be more socially-minded. A number of ideas and movements are gatheringmomentum: Commission for Unclaimed Assets laid considerable ground for the potential for unclaimed assets

to capitalise a social investment bank. The debate has evolved since, culminating in the CabinetOffices current consultation around the potential role a Social Investment Wholesale Bank mightplay in supporting access to capital, and the potential sources of supply for such a bank.

Mission-connected investment is gaining ground in the UK, taking learning from the US. Seewww.neweconomics.org/gen/climate_ecodebt.aspx

Venturesome and the Esme Fairbairn Foundation collaborated on a programme-related investmentpilot. The Foundation has subsequently launched a Finance Fund. Venturesome is exploring otherpotential partnerships with a view to unlocking charitable funds for capital investment.

Citylife bond issues; generating income for charities by unlocking philanthropic capital (fromcommunities of interest) that is then invested in registered social landlords, with the interestdistributed to charities: www.citylifeltd.org

Considerable momentum is gathering behind the concept (and practice) of community share issues,the old idea of public subscription reinvented for current times, spearheaded particularly by theDevelopment Trusts Association and Cooperatives UK. www.communityshares.org.uk

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Postscript

A number of key questions arose from the roundtable which go beyond the issues identified in thispaper. These are included here as additional points to reflect upon:

Social investment for whom? This paper uses charities as short-hand for a broad spectrum oforganisations identified in Figure 1, but this spectrum is biased towards charitable institutions -what of public sector organisations, individuals, or groups of individuals? Do they, equally, requireaccess to capital, and in what forms? Are the barriers the same for these groups? Equally, we shouldnote that access to capital is more of an issue for smaller entities than large, establishedorganisations.

Capital from where? Sections 3 and 4 of the paper touch on the range of supply required, and thepotential sensitivities of commercially-motivated investors extracting capital from the sector. Howcan we ensure that funds flowing to the sector are catalytic, i.e. help develop the sector, as opposedto flowing out as quickly as they flowed in which risks weakening the existing ecology?

How do we capture social capital in this debate? This paper focuses exclusively on financialcapital; should social capital (the confidence and capacity built up within social networks) befactored in to the debate? And how?

The importance of research as Section 1 indicates, evidence of need and demand relies too heavilyon anecdote. Research into the understanding and needs of charities themselves in relation tocapital is overdue, perhaps particularly in relation to trustees perspectives.

Who pays for investment readiness support, and how do we ensure its quality? A mix of partiespay currently; third parties, suppliers of capital themselves and charities themselves. This is linkedto the latter point as to who delivers investment readiness and the quality of the work (how do we

recruit skilled people into this field?), because whoever funds the work they will only be willing todo so if confident of the quality.

The need to develop financial mechanisms that capture appropriate social returns. Building onSection 3, third sector funding (income for day-to-day activities) increasingly specifies desiredoutcomes as a condition of funding, whether in a formal or informal contract arrangement(particularly with the increase in commissioning and contracting from government). Contractfunding is wholly appropriate in certain circumstances, but if all funding took this form there wouldbe little room for innovation. Suppliers of capital ought not to fall into the trap of seeking projectoutcomes as the indicators of success for their funding; capital investment is directly linked tobuilding the capacity of organisations, and indirectly linked to the impact on beneficiaries. Morework is therefore required on capacity building monitoring and evaluation tools. CAF, via its

Advisory programme, has developed work in this area (among others). VenturesomesDevelopment Fund is applying such capacity building measures to its investments.

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APPENDIXII

SOCIALINVESTMENTWHOLESALE

BANKING

Providingcapitalandliquiditytomarketintermediaries

Abriefingpaper

Venturesome

September2009

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CharitiesAidFoundation(CAF) is a registered charity that works to make the most of money for

charities and social enterprises. CAF believes that access to capital is vital for a healthy and

thriving charitable sector.

Over the years, CAF has been instrumental in pioneering and incubating funding solutions;

including Venturesome, a highrisk investment fund and Charity Bank, which became independent

in 2002.


providers of charitable grants and providers of bank loans at market rates. Since launch in 2002,

over 15 million has been offered to over 250 organisations. In addition to accumulating practical


investment market, adopting an openbook approach to share knowledge and build experience,ompetition so as to raise standards.but also ready to operate in c

For more information, visit: www.venturesome.org

f you wish to receive information from Venturesome, please send your contact details to:

[email protected]

I

v

Abouttheauthor

Paul Cheng previously worked as a corporate finance lawyer with Slaughter and May in London

and founded an NGO for lawyers in China, before joining Venturesome in 2006 as an Investment

anager. After completing his MBA from The Kellogg School of Management in the United States,

aul worked as a business strategist for Microsoft.

M

P

VenturesomeThetextinthisdocumentmaybereproducedfreeofchargeprovidingthatitisreproducedaccuratelyandnotsedinamisleadingcontext.ThematerialmustbeacknowledgedasVenturesomecopyrightandthetitleoftheocumentspecified.ud

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refaceP

This paper discusses the meaning and practical implications of wholesale banking in the contextof the UK social investment market, prompted by the Office of the Third Sectors consultationregarding a Social Investment Wholesale Bank.

We publish this paper as a contribution to the current thinking on social investment, and therole that a Social Investment Wholesale Bank might play in supporting the existing ecology ofthis emerging and still fragile market.

Introduction

Financial intermediaries, such as Venturesome, exist to provide investment into charities and

social enterprises. Such intermediaries perform a retail funding function because they investdirectly into frontline, social-purpose organisations through repayable financial instrumentssuch as loans, quasi-equity and equity.

Generally speaking, non-governmental funders rely for their own balance sheets either ongrants which are hard to raise (e.g. Venturesome, Fair Finance etc) or depositors who must berepaid (e.g. Charity Bank, Triodos Bank etc). The consequence of this is that the supply side ofthe market consists of relatively few social investments funds (because of the difficulty ofattracting gift capital), small funds that are unable to scale up, and funds that are risk averse.

One solution to this market failure is a social investment wholesale banking service which

aims to strengthen the financial capacity of these financial intermediaries. Such a service doesnot necessarily need to be performed by any one institution (and this paper will argue that it ispreferable for a variety of players to deliver this function for the market).

We outline some practical ways in which such an investment banking service might transact ona day-to-day basis with retail intermediaries with a view to providing both capital andliquidity to this nascent market. In the Appendices, we provide a step-by-step case study 29 ofhow a social investment wholesale bank might actually deploy its funds in a deal, in addition toexploring some fundamental market concepts (such as the nature of capital, risk and return) 30.

The purpose of this paper is to provide a framework for discussion, debate and reflection. It is

by no means exhaustive. We hope that these ideas trigger constructive debate.

29 See Appendix A30 See Appendices B and C

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Bankingforbankers

In this paper, we use the phrase Social Investment Wholesale Bank (SIWB) to denote ageneric institution which performs social investment wholesale banking functions.

However, it is important to note that the SIWB need not be a single institution but perhapsshould more accurately be seen as a banking function which could be performed by a number ofplayers. Indeed, in the future, every major grant-making trust may have their own SIWBdepartments.

The SIWB function can be effectively performed by any organisation which:

Has a large balance sheet (50m or more)

Is willing to invest over long time horizons (5 to 10 years)

Is motivated to act in the wider interests of the market.

In the same way that specialist lenders and intermediaries (such as Venturesome, Triodos,Charity Bank etc) provide working capital and development capital to charities and socialenterprises, a SIWB could in turn provide similar investments directly into those sameintermediaries (e.g. gearing lenders balance sheets so that they can do more and reach morecustomers).

USCalvertFoundationawholesalerandthemarketleader

In technology circles, there is a saying the future has arrived its just not evenly distributed.

In the world of social investment, the future vision of a brave new world in which an institutionperforms market-level SIWB functions already exists. In the United States, the CalvertFoundation has been successfully performing such a role for over 12 years.

Through its Calvert Community Investment Notes31 product, Calvert has succeeded in creatinga social investment platform which connects the retail investor with a range of socialinvestment funds. The Calvert Notes product (essentially a bond with a coupon of between 0%and 3%) is available to individuals in 49 states (financial regulations in Pennsylvania precludethe sale of the Notes there) through brokerage accounts and an online platform. Calvert has ahistorical loss rate of less than 0.25%, and as a result, retail investors in Calvert Notes havenever lost principal or interest. To date, over $350m has been raised from over 5,000 investors.

With the money raised, the Calvert Foundation then acts as a wholesaler of capital. It allocatescapital (mainly through low interest debt) to 250 market intermediaries in the United Statessuch as Acumen Fund32 and RSF Social Finance33 (who in turn invest directly into frontlinebeneficiaries around the world).

As a measure of how robust this product is, Calvert reported that since the financial crisis of2007 investor appetite for their Notes product has significantly increased. Calvert closed 2008

31

See: http://www.calvertfoundation.org/invest/community_investment_notes/index.html32 See: http://www.acumenfund.org/33 See: http://rsfsocialfinance.org/

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with $207m in assets, up 22% from 2007, and with more than $42m deposited into the CalvertNotes (up 33% from the previous year).

Howarenewmarketscreated?

In order to achieve optimal market effectiveness in which SIWB functions thrive, we need avariety of market players who are both able and willing to strike a balance between beingcompetitive and being collaborative. Being too competitive too early will stunt the overalldevelopment of the market. On the other hand, being too collaborative later on might perhapsreduce individual market players to below their true potential.

Retail funders must collectively focus on both their own slice of the pie and the overall sizeof the pie. Single-minded focus on either one or the other consideration will lead either tounhelpful market behaviour or the bankruptcy of the funder.

Wholesale funders, however, should be primarily concerned with the overall size of the pie. ASIWB should see its public interest role as enabling flows of capital to support specific marketinfrastructure. The diagram below illustrates this tension:

COMPETITIVE

HIGH

Funders

market

share OPTIMUM

Profits

COLLABORATIVE

LOW

Totalsizeofsocial

investmentmarket

SMALL LARGE

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Awholesalerofcapital

The [Social Investment Wholesale Bank] would support the long-term growth of a thriving

third sector by working with investors and lenders at the retail level34

It is important that a social investment banking function carried out by a government entityoperates at the wholesale level because this:

1. Minimises the danger that public money crowds out private investment;2. Builds on the expertise and hard-won experience of existing retail intermediaries,

thereby reducing (i) the risk to the public purse of repeating the mistakes of previoussocial investors and (ii) the search costs of identifying and assessing social investmentopportunities;

3. Avoids the risk of opportunistic behaviour by a government-backed entity which mightbe tempted to compete unfairly for the best social investment deals.

Any organisation performing SIWB functions should respect the emerging ecology of theexisting market. The guiding principle should be coordinate and cultivate (not commandand control). In this way, the SIWB could provide helpful signals to the market which thengently influences how others decide to allocate capital (both philanthropic and commercial).

Above all, a government-backed SIWB should not behave as either a regulator or an all-powerful central bank.

Resilientsupplyofcapital

In the Venturesome Access to Capital paper35, a resilient supply of capital was identified asone of the four critical pillars to a robust social investment market. A number of key barriers toprogress were also drawn attention to.

A SIWB function could help to alleviate two of those barriers identified:

(1)Dominance of government funding the SIWB could identify, select and invest in thebest, private sector specialist lenders (especially those that can demonstrate resilient(sustainable) income/expenditure models).

(2)Specialist lenders have struggled to articulate their role and its value to the sector the SIWB could enable those specialist lenders with a proven track record to do moreand act with greater flexibility in the market. The SIWB could play a supporting role incoordinating the patchwork of private funders.

34

Social Investment Wholesale Bank (July 2009), A consultation on the functions and design (Office of the ThirdSector)35 Venturesome (2009) Access to Capital (E Goodall and J Kingston)

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HowaSIWBfunctioncouldhelp

Social investment wholesale banking could help resolve the following situations whichcurrently trouble social investors and specialist lenders:

(1)Leveragingupfunds

See Appendix A for a detailed case study of how a SIWB could help a retail funder attractmainstream banking facilities to gear up its fund with commercial debt. Of course, the SIWBwould need to have the skills to work closely with such funders/borrowers to ensure that theyhave the necessary capital to achieve their missions without the burden of an inappropriateamount of debt.

(2)Leveragingupdeals

Problem: A specialist lender wants to make a 500k loan into a charity but the size of thelenders overall fund precludes single deals of that amount because it would increase the fundsidiosyncratic risk to an unacceptable level.

Solution: The SIWB could co-invest with the specialist lender on a pari passu basis (say, aneven split 50:50 or perhaps 75:25 in those cases where the SIWB feels that the specialist lendershould shoulder more risk). This solution does not violate the principle that the SIWB shouldonly act as a wholesaler of capital provided that the SIWB only acts in this supporting role atthe behest of the specialist lender. The SIWB should refrain as far as possible from imposing itsown terms on the deal (but, of course, may reserve the right to refuse to participate in the deal

in the first place). Again, the guiding principle is coordinate and cultivate, thereby respectingthe ecology of the market.

(3)Refinancingloanportfolios

Problem: A specialist lender has 3m of low risk loans to charities in its portfolio. It nowwishes to refocus its portfolio on a new customer segment, but does not have sufficient capital.

Solution: The SIWB could refinance the portfolio by purchasing the low risk loan book.

In the United States, the Community Reinvestment Fund36 (CRF) has purchased more than2,100 loans worth almost $1 billion from community development corporations and othercommunity development leaders whose portfolios are not large enough to attract institutionalinvestors directly. Since its inception, CRF has provided liquidity for loans that have generatedor retained more than 35,000 jobs, financed almost 600 women or minority-owned businesses,and built more than 16,000 housing units.

36 See: http://www.crfusa.com/Pages/Default.aspx

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(4)Providingexitstrategiesforsocialinvestors

Problem: Potential social investors are frequently deterred from making equity investmentsinto social enterprises because there is no prospect of an exit.

Solution: The SIWB could offer to buy out equity investments in key sectors (e.g. socialenterprises engaged with environmental issues or delivering services to old people) in order toprovide such an exit thereby encouraging more investors to enter those markets.

(5)Creatingliquiditythroughsecondarymarkets

There is a role for the SIWB to create liquidity through setting up secondary markets in:

Revenue Participation Agreements (quasi-equity)37

Social Impact Bonds38

Community shares39

Community bonds40

A secondary market for these financial instruments would enco

Documents

CAF Venturesome Consultation Response to SIWB