Tag Archives: finance

Financial innovation for social business: what are the risks?

Antonella Noya all’OECD (grazie!) mi ha passato un loro rapporto, The Changing Boundaries of Social Enterprises, in cui si cerca di fare il punto sugli ultimi dieci anni di impresa sociale nei paesi industrializzati. Sono stati anni importanti per questo settore, da tutti i punti di vista: di crescita e strutturazione, legislativo e anche finanziario. Da quest’ultimo punto di vista un riassunto potrebbe essere questo: le imprese sociali sono sottocapitalizzate, e stentano in particolare ad accedere a strumenti finanziari diversi dal prestito (loan) e dal contributo (grant). Molta innovazione finanziaria ha cercato di risolvere questo problema. Antonella Noya at OECD (thanks!) pointed me to their report The Changing Boundaries of Social Enterprises, in which they attempt to render the past ten years of social enterprise in developed countries. It’s been an important ten years for this sector, from all points of view: growth, legislation and finance too. From a finance perspective, an executive summary could as follows: social enterprises are undercapitalized and find it difficult to access financial instruments other than traditional loans or grants. A lot of financial innovation was thrown at the problem.

Il rapporto OECD fa un elenco impressionante: venture philantropy, prestiti “pazienti”, piattaforme di crowdfunding à la Kickstarter, indici per misurare la performance sociale degli investimenti come i Dow Jones Sustainability Indices e così via. Tutto bene? Sì e no. Sì, perché il problema esiste e si sta cercando di affrontarlo. No, perché si stanno facendo cose che ricalcano un po’ troppo da vicino la precedente ondata di innovazione finanziaria — quella, tanto per capirci, che ha portato alla crisi globale del 2008. The OECD report has an impressive list: venture philantropy, “patient” loans, crowdfunding platforms à la Kickstarter, social performance assessment tools like the Dow Jones Sustainability Indices and so on. All’s well then? Yes and no. Yes, because the problem exists and is being looked into. No, because it is being addressed in a way which is a little too reminiscent of that other wave of financial innovation, the one that gave us the 2008 global meltdown.

Considerate Blue Orchard. La loro idea è semplice: mettere in comunicazione gli investitori istituzionali (per esempio i fondi pensione), che vogliono comprare prodotti finanziari etici, con il microcredito. E come si fa? Per cominciare si fanno molti microprestiti. Ciascun prestito corrisponde a un attivo nel bilancio del microcreditore. A questo punto il microcreditore prende tutti questi piccoli attivi di bilancio, e li usa per garantire l’emissione di un’obbligazione (cioè uno strumento finanziario derivato da quello primario, cioè il microprestito) che poi rivende all’investitore istituzionale. Fatto! Quest’ultimo ha fatto un investimento etico senza bisogno di imparare a distinguere tra loro i microprestiti e i microcreditori. Per contro, l’istituzione di microcredito ha reperito liquidità aggiuntiva, e può fare altro microcredito. Perfetto, no?Consider Blue Orchard. It’s a simple idea: connect institutional investors (say, pension funds) wanting to invest ethically with microlending. How does that work? It begins with some institution making microloans. Each of them creates an asset in the balance sheet of the microlending institutions. Now this microlender takes all of these assets, packages them up and uses them as collateral to back a bond (which is a derivative product, its primary being of course the microloans) which he then sells to the institutional investor. And it’s done! The latter has been enabled to invest ethically without actually having to be able to tell which microborrowers to lend to. At the same time, the microlending institution has gained extra liquidity, and can go on to make more microlending. Great!

Non necessariamente. Questo processo in finanza si chiama cartolarizzazione: il suo effetto ultimo è quello di allontanare il debitore dal creditore finale. Prima della cartolarizzazione i mutui casa venivano concessi da banche locali, che conoscevano il debitore ed erano ragionevolmente in grado di valutarne l’affidabilità. Se quest’ultimo si trovava in cattive acque, la banca locale faceva il possibile per consentirgli di ristrutturare il debito: in fondo si trattava di un cliente e di un membro di quella comunità, ed era interesse della banca che la comunità che serviva fosse il più prospera possibile. Con la cartolarizzazione, però, il mutuo del signor Rossi viene impacchettato con altri in uno strumento derivato, e rivenduto a un investitore non locale: se va bene un fondo, se va male un hedge fund molto aggressivo. Appena Rossi ritarda con un pagamento, questo investitore non ha nessuna ragione di essere comprensivo: farà la cosa che gli conviene nell’immediato, visto che non partecipa alla comunità locale in cui Rossi vive. Cosa faranno i fondi pensione che comprano i prodotti Blue Orchard se dovessero trovare che i rendimenti sono troppo bassi? Se decidono che devono rientrare immediatamente dei loro crediti, quale sarà l’effetto di questo rientro sul microcreditore? Può essere costretto a rientrare a sua volta, compromettendo il beneficio sociale di avere investito sul proprio lavoro?Or is it? The process described is called securitization. One of its effects is to separate the borrower from the final lender (in this example the pension fund). Before they got securitized, home mortgages were issued by local banks, that knew borrowers personally and could assess their creditworthiness reasonably well. If they got it wrong and the borrower found it difficult to repay the debt, the bank would do its best to get him back on track, possibly restructuring her debt: after all, she was a client, and lived in the same local community as the bank. The more prosperous the community, the better things were for the bank. After securitization, all this changed: now John Smith’s mortgage is repackaged and sold to a nonlocal lender — a pension fund at best, a very aggressive hedge fund at worst. As soon as Mr. Smith starts falling behind with his payments, this investor has no reason to be understanding: it will try to maximize its immediate gain, as he has no stake in Smith and his community’s long-run prosperity. What will the pension funds that purchase Blue Orchard’s products if they find that the returns are too low? If they decide to exit fast, what will the consequences be for the microborrowers? Could they be forced to pay their debit back or lose their assets too? Could this wipe out the social benefit of the poorest of the poor investing in themselves?

Discorsi simili si possono fare per i “mercati di capitale etico” in via di collaudo in diversi paesi, come ETHEX nel Regno Unito o la Bolsa des Valores Sociais in Brasile. Il mercato azionario che conosciamo ha portato molti capitali alle imprese for profit, al prezzo di indurle a una prospettiva di breve termine: un buon risultato trimestrale è fondamentale per non perdere la fiducia del mercato. Cosa succederebbe alle imprese sociali le cui azioni (sì, alcune emettono azioni) fossero scambiate alla borsa di Londra o New York?Similar questions can be asked for ethical capital markets being rolled out in some countries, like ETHEX in the UK or Bolsa des Valores Sociais in Brazil. The stock market as we know it brought a fresh stream of capital to for profit enterprises, but at the price of making them focus away from long term growth and onto quarterly results. What would happen to social enterprises once their shares (yes, some do issue shares) are traded in Wall Street or London?

Sono domande inquietanti. Ma fare finta di niente sarebbe peggio: non abbiamo scelta se non cercare le risposte.These are unsettling questions. But looking the other way would be much worse: we have no choice butlook fo the answers.

A new finance for social innovation: why it’s coming and what’s at stake

About a year ago I got curious about finance. Money, whatever else it is, is an infrastructure (like a road) enabling economic activities; furthermore, it is a platform (like the Internet), in the sense that it can be reconfigured ad infinitum, and that you can combine finance to make more finance, layer upon layer, just like this blog is made of code sitting on top of a network protocol.

I am doing work on public policy for social innovation, and social innovation has an access to capital problem. Makes sense: social innovators, even though they might generate revenues and even profit, care mostly about producing social benetits. Capital, on the other hand, is out for monetary returns, not social ones. An investiment’s social benefits, even when enlightened investors care about them (when they do they are said to do impact investment), are subordinate to financial returns.

Last week, in London, I had a long chat on this topic with Karl Richter, a young architect turned financier through urban regeneration. He and others have been designing financial instruments for social enterprises and social innovation. For example, a line of work is to bundle two different financial sources: a core of “philantropic capital”, for which social returns are the main concern, and an outer layer of impact capital, looking for market returns on socially responsible investments. Bundling happens in a way that lets philantropic capital carry the loss (or the less-than-market-level returns) if the investments turns sour. In this way, non-philantropist investors are guaranteed; and the benefits of philantropic capital are greatly augmented, because an euro of philantropic capital activates three euro of credit.

This kind of work is important in the context of the fledgling European strategy on social innovation. However, there is a side to this story that no one is looking at, and that’s the emergent consequences of digging new financial channels for this kind of enterprise. History teaches us that financial innovation often has completely unintended consequences, and some of those are truly evil. For example, stock exchange markets were a great idea, because they allow savers to participate to the risk capital of public companies. Since the return on investment depends on profit, risk is shared across shareholders. Since buying and selling shares is cheap and easy, companies can get cheap access to capital and money flows to those firms that invest wisely, securing high returns and low risk. Over time, though, the existence of stock markets transformed the savings and investment landscape. Individual investors keeping part of their saving in blue chips over the long term went extinct: participants in the stock market are now mostly fund managers, continuously redeploying their money as they try to secure a marginally higher rate of return. Unintended consequence #1: top managament’s obsession for the short term of the quarterly result. Unintended consequence #2: stock market bubbles. Both pretty bad.

You see, channeling finance onto social innovation, difficult as it is, is not going to be enough. We need to do it without distorting the incentives that makes social innovators so good at what they do. For this we need a much better understanding of emergence in the social and economic world than we presently have, and we need it now. I have started doing work on this theme with David Lane’s group at the European Centre for Living Technology, and I really hope I can dig out something to contribute.

Figuring out money to understand the world

It had to happen, sooner or later: money and finance are the most highly visible among the many topics of interest to economists. Since I am an economist, and easily accessible through this blog and my social media presence, Wired’s Fabio Deotto asked me for a comment on a piece of financial news: apparently Facebook is considering bringing Credits, the virtual currency used for buying Facebook apps, to the wider world as a universal means of payment. Is it possible to leverage Facebook’s 500+ million users to launch a new global currency and revolutionize the world of finance?

In the best tradition of economics, my answer was that the question is wrong, for many reasons: there are already dozens of virtual currencies that work quite well but did not revolutionize anything; currencies need to be aggressively backed by reserves and open market operations, or they’ll depreciate; credit card companies have already in place globally accepted virtual money operations with many more users than Facebook — only in the USA there were 1.3 billion credit cards in 2006 (the full article, in Italian, is here. But the real answer is that I know nothing about finance, so I recommended that Fabio talk to a real money expert.

This made me realize that not knowing anything about finance is a bad idea for an economist as of 2010. The rising tide of social innovation contains a lot of financial innovation: just think of internet-based microlending agency Kiva; of Italian “community lending” platform Del community lending dell’italiana Prestiamoci; of crowdfunding services for the arts; of Solidarity Purchasing Groups, another Italian invention (yes, Italians, seem to be right on the frontier of social financial innovation). My conclusion: time to go back to studying money. Money is difficult, counterintuitive: its hard to figure out just what it is and where it draws its magical powers to get us the things we need. Can anybody suggest a book to start from? Rigorous, but starting from the basics, ideally with a historic approach? I tried reading Niall ferguson’s The Ascent of Money, but that’s maybe not advanced enough. Thanks in advance for any suggestions you might pass along!