Social Investment in Scotland

Social Investment in Scotland
August 2012

A Discussion Paper

1.0 Introduction

1.1 Big Society Capital (BSC) – the UK Govt’s new social investment bank – is not reticent about its core strategy.  Founding chair, Ronald Cohen is unequivocal – BSC’s mission is to grow the market in social investment by tapping into the vast wealth of capital markets.  But in order to become an ‘asset class’ – worthy of city investment – Cohen warns that the ‘social sector’ needs to change; most controversially by being prepared to pay dividends to investors

1.2 It is not really surprising that recent UK Governments have moved to ‘marketise’ the third sector – but it has surprised many people how little protest this policy direction has aroused.  The indications are that, in England, this exposure to market forces has been accepted – that BSC will nudge the third sector towards what Cohen calls ‘a new paradigm’ – based on the favoured norms of the private sector.  In Scotland, the situation is different – various models of social investment are still being discussed – the debate is underway.

2.0 The BSC Model is mistaken.

Senscot believes that the BSC model – of seeking to involve capital markets in social investment – is fundamentally flawed and could potentially harm the third sector – for the following reasons:.

2.1 Third sector organisations typically operate in the wake of market failure – where the private sector can’t generate the profit if requires or where the public sector offers an inadequate service.  A financially ‘marginal’ enterprise (break even) could be of spectacular benefit to a community.  Very few third sector organisations are going to generate profits of a scale to interest commercial investors.  In this respect, BSC has misjudged its market – with the likelihood that there will be little demand for its products.

2.2 When BSC realises too few third sector organisations are willing, or able, to use investment on the terms it offers – it will widen its definition of what it calls the ‘social sector’.  It’s CEO Mike O’Donohoe asked recently whether a Tesco branch – offering employment in a deprived area – could be considered a social enterprise (unfortunately, he wasn’t joking).   We can expect an increase in the range of ‘vaguely social’ private businesses. (some cynics observe that this has always been the intention). 

2.3 There are moral objections to ‘marketising’ social intervention.  In the end, the question of markets is a question of how we want to live together.  Do we want a society where everything is for sale or are there certain moral and civic goods that markets don’t honour – and money can’t buy? Many would argue that much third sector activity falls into this category.

2.4 There is a fundamental tension between the values of the private and third sectors; this ‘radical incompatibility’ is arguably the weakest aspect of the architecture of the BSC model.  Partners have to want roughly the same thing.  The money markets don’t have social objectives; that’s not what they’re for; they perform a different function for society.  As Lord Turner (FSA Regulator) said in 2009, “Much of the City’s activities are socially useless”.

2.5 The third sector, on the other hand, exists expressly for social purposes; the notion of tackling disadvantage; the quest for social and environmental justice; the realm where society generates much of the social capital for the health of our communities. By regarding money as subordinate to social mission – the third sector positions itself outwith the trust of capital markets.  The City regards the market as the one true arbiter of value. It doesn`t compute social capital. The BSC model is a mismatch.

3.0 A Scottish Solution

3.1 Given the general lack of confidence in the UK economy – the supply of social investment available in Scotland at this time – probably exceeds demand.  It is also the case that the majority of organisations in our third sector are content being small, local operations; involving them in debt finance would do them no favours.  Nevertheless, our members who are active in social and community enterprises report a demand for different types of social investment.

3.2 Some of the broad areas identified are: Risk capital (for start ups); loan funding (secured and unsecured); patient capital (long term return and relationship; layered finance (mix of grant and loan); mezzanine finance (with investment readiness support); short term bridging (where awaiting contract payments); bonds of whatever sort.

3.3 Financial products which can be used and enthusiastically promoted by the third sector need to accord with our values and ethos.  It would be helpful, if discussions in Scotland about social investment landscapes – could identify acceptable parameters.

3.4 There is nothing, in principle, wrong with ‘Front funding’ contract delivery from non-governmental money.  It can enable third sector organisations to undertake contracts beyond their financial reach.  It can also relieve pressure on cash-strapped councils.  But the acid test must be whether the tax payer gains or loses.  The PFI programmes were, and are, a disgraceful scam. 

3.5 There is nothing wrong in principle with ‘payment by results’ contracts – funding attached to outcomes; we all want results.  But there is a real issue around what is measured – and how.  A narrow focus on simple numbers, can distort delivery – in favour of ‘low hanging fruit’ – and does not capture what’s really going on.

4.0 Sources of Finance

4.1 The potential economic impact of our Scottish third sector is considerable – but unrealised; the reason is that most of us do business with financial institutions which have no commitment to our core values; our collective impact is dissipated.

4.2 As the third sector in Scotland considers our social investment landscape for the future – we should plan, as far as is practicable, to source investment from within our own community.  In this way, we can build our collective strength – ensure a value match – and minimise the influence of commercial lenders who don’t understand our work.

4.3 Senscot has suggested that one way to do this would be for the third sector to create our own Scottish Community Bank (SCB) by ‘piggy-backing’ on Charity Bank (separate concept paper).  SCB’s mission would be to try to attract investment from all across Scotland: third sector, civil society, housing sector, public sector, trusts and foundations.  And not least from ordinary citizens – from individuals who wish to share our mission.

4.4 A Scottish Community Bank is seen as only one player among many in a vibrant landscape of retail providers – collaborating and competing with each other to offer new models of social investment.

4.5 One also senses that the emerging vibe of ‘crowdfunding’ has the potential to transform banking.  Person to person lending could capture the imagination of the general public; the idea of local people clubbing together to buy their community shop is exactly what the third sector is about.

5.0 Some issues for discussion.

5.1 Is there a difference between paying loan interest and dividends?

5.2 Should the third sector include enterprises which distribute profits?

5.3 How can we defend the third sector brand against ‘vaguely social’ private businesses?

5.4 What are the parameters – moral and practical – of social investment products acceptable to the third sector? Is front-funding of social investment products acceptable to the third sector – e.g. front-funding bonds like Perth YMCA??

5.5 How can we promote the development of these products – is there an available mechanism for collaboration?

5.6 Should we draft guidelines for the measurement of payment by results contracts?

5.7 Would the realisation of a Scottish Community Bank improve the social investment landscape?