22 May 2006

A new type of organisation

I’m often asked about the apparent mismatch between the fluidity of holdings of Social Policy Bonds and the targeting of long-term objectives. At first it seems unlikely that the tradability of the bonds would enhance the achievement of such objectives.

Essentially bondholders would form a coalition whose main interest is to enhance the likelihood of early achievement of the targeted social or environmental goal. The composition of this organisation might be changing all the time because the Social Policy Bonds could constantly change hands. That need be no impediment to solving short-term, small-scale social or environmental problems, where progress toward solution can be readily monitored. But how could such a protean organisation of bondholders work to solve long-term social and environmental problems?

It’s actually quite easy: consider what people buying bonds targeting global climate change might do. They would want to see some appreciation of the value of their Climate Stability Bonds even if they have no intention of holding on to them until the  (in all probability) extremely remote target of climate stability has been achieved. They would quickly see that their bonds will lose value unless they set up some sort of body with a longer-term commitment. One possibility is that larger bondholders would collude to set up an investment company for the lifetime of the bonds. This company would have a stable structure and its job would be to vet potential climate-stabilising projects and help finance the efficient ones. The bondholders, once they’ve set up this company up could of course always sell their bonds on the open market: the setting up of the investment company could be one of the first projects they undertake in order to maximise the appreciation of their bonds. In principle, it’s no different from any other project. Climate Stability Bonds sold after the formation of this company would perform in the market like shares in the investment company. In keeping with the Social Policy Bond ethos, of course, all the company’s activities will be dedicated toward achievement of, in this case, climate stability.  

More generally, in order to maximise the value of their bonds, those who buy Social Policy Bonds at flotation will have incentives to set up the most efficient objective-achieving institutional structure they can. And they will be free to set up any institutional structure that maximises their gains from bondholding.


Anonymous said...

Aren't SPB just the optimistic side of Catastrophe Bonds - bonds whose principal is forgiven if specific triggers are met? Cat bonds on climate change risks are being issued already - see http://www.gechs.org/activities/holmen/Park.pdf

Ronnie Horesh said...

Thanks. Yes, cat bonds, like other insurance concepts, are similar to Social Policy Bonds. It looks as though the main difference is that cat bonds are always held by passive investors, who are not expected and do not intend to do anything about preventing the catastrophic event. Social Policy Bonds would be designed to appeal to active investors. Also Social Policy Bonds may have wider application when it comes to goals other than avoiding catastrophe, such as raising basic literacy rates. But in principle, they do seem to be similar concepts.