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Social Impact Financing – Environmental Impact Bonds

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Description

The Environmental Impact Bond (EIB) is a type of social impact financing that is specifically focused on improving environmental conditions.1 Over the past couple of decades, there has been a renewed interest, globally, in fostering and maintaining a healthy environment. In practice, this involves sustainable consumption of natural resources and minimizing waste. In light of this resurfacing environmentalist movement, there has been a large volume of innovative ideas for solutions that seek to address some of the current global and local environmental concerns. Often, the responsibility to invest in these types of strategies falls on governments since the environment and its many components are considered public goods. Unfortunately, many of these proposed ideas are new and unproven. As such, governments would assume all of the risk associated with investing in a project that is uncertain to achieve the desired goals and would lose out on their investment if the project fails.

EIBs have been developed as a way for innovative ideas to be put into practice without governments assuming the risk and could be utilized to generate funding for lead hazard remediation at a larger scale. Like in Pay for Success transactions, a private investor covers the initial costs of an environmentally focused project. If the project is able to meet an agreed-upon set of performance measures, the government will pay the initial investor an agreed-upon return. Through EIB transactions, governments can transfer risk to private investors.

Example

The first EIB transaction was executed in 2016 between the District of Columbia Water and Sewer Authority (DC Water) and two investors, the Goldman Sachs Urban Investment Group and the Calvert Foundation. This EIB transaction was issued to be the financing mechanism needed to enable DC Water’s plan to reduce Combined Sewer Overflow as required in the 2005 Consent Decree that DC Water entered with the Environmental Protection Agency. Per the Consent Decree, DC Water was expected to “manage stormwater runoff produced by 1.2” of rainfall on 365 impervious acres of land in the Rock Creek Sewershed and 133 impervious acres in the Potomac River Sewershed.” With the upfront costs covered by the investors, DC Water launched a large-scale green infrastructure project. Under the terms of the agreement, DC Water would pay a pre-negotiated rate of return if project success metrics were met. However, unlike traditional Pay for Success transactions, where the investor receives no return if the project fails, DC Water agreed to share some of the risk by paying a portion of the original investment to investors if the project fails. For more information, visit the following three links to read full case studies on the D.C. EIB: the EPA, Neighborly, and the Conservation Finance Network.

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