Environmental Impact Bonds
Environmental Impact Bonds (EIB) are private-sector investors willing to bet on a “pay-for-success” bond offering. This is a unique financial tool that ties rewards to measurable social or environmental outcomes.
DC Water, Washington’s water utility, pioneered the nation’s first EIB bond offering in late 2016 when it sold a $25-million, tax-exempt EIB in a private placement to the Goldman Sachs Urban Investment Group and the Calvert Foundation. The money will initiate the city’s DC Clean Rivers Project, a $2.6-billion program to control storm water runoff and improve local water quality using natural infrastructure. It is believed that this will mark the beginning of a new environmental financing mechanism that could eventually open up funding projects worldwide.
Three key components must be present to make such a financial tool successful:
1. Returns must be determined by outcome
Part of the project’s risk is transferred from the payor – typically a public entity or the government – to private investors such as commercial investors or philanthropies. These investors are then paid conditionally on the project achieving an expected outcome after a third-party evaluation has been conducted.
There would be agreed-upon natural infrastructure performance tiers that may, for example, give investors additional payments if outcomes are better than expected. Likewise, if the project has lower-than-expected performance, the payor could receive back a portion of the interest investors would otherwise earn.
2. EIBs should generate savings on project costs
The payor must benefit financially from implementing the “pay-for-success” mechanism to finance early natural infrastructure investments. In other words, the project should be cheaper even after paying back investors.
3. Performance metrics must be well-defined
The project’s performance metrics should represent a good proxy for environmental outcomes once the project has been completed. Establishing such metrics is one of the key challenges we have identified to bringing this kind of tool to maturity in the green finance market.
EIBs could provide a unique resource to help address many significant environmental needs. NatureVest, the investing branch of The Nature Conservancy just awarded a grant to Environmental Defense Fund to design an EIB to finance a coastal wetland restoration project in Louisiana. We will follow this effort to see how it pans out.
Kristin Carter - Grant Management Associates
kcarter@grantmanagementassoc.com