Financial innovation for social business: what are the risks?
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.
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.
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!
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?
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?
These are unsettling questions. But looking the other way would be much worse: we have no choice butlook fo the answers.
Alberto




