Water Online

January 2017

Water Innovations gives Water and Wastewater Engineers and end-users a venue to find project solutions and source valuable product information. We aim to educate the engineering and operations community on important issues and trends.

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confident to tackle by knowing that if they don't get the (full) results they hoped for, there's someone there to share some of the pain. If it does work out, then everybody wins, including/especially them by growing their business." Impact Investing Sector Impact Bonds are one of the innovative financing mechanisms within the impact-investing sector. ii The term "impact investing" was first coined at a convening of investors and philanthropists organized by the Rockefeller Foundation in 2007 to brainstorm how to entice private capital to fund programs and projects for the public good. Impact investing quickly evolved into a nascent global industry, iii and by 2010, it was officially recognized as a separate asset class by JP Morgan, Goldman Sachs, and other global financial institutions. iv The objective of impact investing is simple: "unlock significant sums of private investment capital to complement public resources and philanthropy in addressing pressing global challenges." v While sums are still small in comparison to total investments, in the 2016 Annual Impact Investors Survey from the Global Impact Investing Network (GIIN), a reported $15.2 billion in impact investments was made in 2015, with respondents expecting to increase investments in 2016 by 16 percent, to $17.7 billion. vi Impact Bonds were an impact-investing tool that gathered momentum initially in the U.K., ultimately resulting in the Social Impact Bond (SIB) to reduce recidivism at HMP Peterborough in 2010. Since then, more than 60 impact bonds have been launched worldwide, with the DC Water EIB being the latest example of innovation as the first-ever "2.0" version of an impact bond. Impact Bonds 2.0 Based on the collective experience of impact bond veterans Goldman Sachs and Calvert Foundation, the DC Water EIB was designed as a model that other municipalities and companies can use to attract traditional fixed income investors, not only to fund reduction of CSOs but to encourage the use of impact bonds and to scale the use of proven environmental solutions to infrastructure needs. Before coming to Calvert Foundation, Strocher was a member of the Working Group for Development Impact Bonds vii during his tenure at the World Bank. He is especially well positioned to contrast the EIB with early constructions of impact bonds. "IBs 1.0 were investments in projects," Strocher comments. "If the project failed for any reason (e.g., the service provider turned out to be inadequate, the potential results were overestimated, etc.), then the investor likely lost their money .... Investors in IBs 2.0 are fixed income investors that largely aren't seeking significant risks (e.g., new intervention approaches, sovereign risk, risk of inexperienced service providers, etc.) in a project structure, all for a modest return. viii The 2.0 model offers those investors the support of a company's underlying business, on top of which they share (to varying degrees by structure) the outcome risk. That risk profile can reach typical fixed income investors." Strocher explains the attraction of impact bond investments for a mission-oriented investment firm, such as Calvert Foundation and for fixed income and impact investors generally. "We analyzed [DC Water] (for credit risk) and the outcome return as a separate risk analysis to determine whether the financial return potential [as risked] combined with the Impact potential would meet our Impact investing hurdles. The first risk analysis is very common for a fixed income investor, and returns are commensurate. The second risk analysis, which layers on a second level of return/or repayment, is where the innovation lives. The risk we are sharing is about the success or failure of green infrastructure to deliver its intended results. We can do that by funding the project through a company and not having to put our principal at the same risk as project financing. We still accept DC Water's credit risk ... (or) other service providers in other deals. So, while this deal carries little principal risk for investors (and hence returns are commensurate), it carries substantial total return risk based on the success of the green infrastructure. In 1.0 models, there was a need for an intermediary to "manage" the performance of the service providers, but in a 2.0 model, the incentives are aligned much better because the service provider is highly motivated to manage performance because their company is underpinning the project and will benefit by producing successful outcomes, even though that means paying a higher (success) return on the IBs. This is the big difference between 1.0 and 2.0: the service provider (the one creating the Impact) has full skin in the game." Green Bonds: The City of Gothenburg, Sweden In 1987, Gothenburg's Board implemented a comprehensive environmental strategy to remediate the consequences of the city's history of heavy industry and move toward a sustainable urban environment. As one of Sweden's largest enterprises, the city 36 wateronline.com n Water Innovations FINANCING Performance Tier Outcome Ranges Contingent Payment 1 Runoff Reduction > 41.3% DC Water will make an Outcome Payment to Investors of $3.3M. 2 18.6% <= Runoff Reduction <= 41.3% No contingent payment due. 3 Runoff Reduction < 18.6% Investors will make Risk Share Payment to DC Water of $3.3M. Table 1: Tiered Payment Structure (Source: DC Water EIB Fact Sheet). Gothenburg, Sweden

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