Municipal bonds have helped pay for some our country’s most iconic projects, including the Erie Canal and the Golden Gate Bridge. Today they help pay for the full spectrum of critical infrastructure, from schools, roads, and airports to hospitals, water systems, and affordable housing. But while municipal bonds have helped animate the growth of the United States for the past 200 years, to meet our nation’s infrastructure needs for the next 200 years, new financing tools are required.
Critical infrastructure across the United States has fallen into disrepair, and traditional finance approaches for improvements have struggled to keep up. In June, the American Society of Civil Engineers (ASCE) gave the country’s infrastructure an overall rating of “D+”, estimating an additional $206 billion per year above current projected spending that’s needed to improve our water, waste management, energy, and transport systems and restore their basic function. If that gap isn’t filled, the ASCE predicts that poor infrastructure will cost the country $3.9 trillion in lost GDP, $7 trillion in lost business sales, and 2.5 million lost jobs by 2025.
On top of dealing with this backlog, we also need to enhance the “resilience” of our infrastructure, a concept that encompasses the ability to adapt and prepare for new, long-term physical and environmental challenges, like natural disasters and climate change. Research has shown that investing in resilience not only strengthens and empowers local communities, but also makes economic sense – for example, the United Nations Office for Disaster Risk Reduction (UNISDR) estimates that every $1 spent on disaster risk management produces $60 in avoided damages and other benefits. But in exchange for these long-term benefits, our cities will need to invest an additional 9%-to–27% over basic needs to make our infrastructure resilient, adding an estimated $41-to–$124 billion per year to the American infrastructure spending gap.
Taken together, our country has a gap of up to $330 billion per year in infrastructure funding needs. So how can we fill that gap? While traditional municipal bonds and other existing financing models have worked to deploy tried and true projects, they may be insufficient in meeting our current and future needs. The scale of these issuances has been inadequate to reduce the growing gap for even basic infrastructure upgrades – in part because they are contingent on macroeconomic factors, such as national policy changes and the federal reserve lending rate. Further, while resilient solutions like green stormwater infrastructure, microgrids, or coastal restoration can better equip our communities for natural disasters, sea level rise, and other emerging challenges, they are typically newer and thus their performance may be riskier than traditional infrastructure. As a result, these projects are often less able to compete for critical budget allocation from municipal finance departments.
Fortunately, new tools are emerging to fill the gap. Pay-for-Success financing, advanced evaluation models, and impact investing are some of the innovations that will allow us to not only access new sources of financing for resilient infrastructure, but also to make sure this money is spent in the most effective way, with the costs of projects directly connected to the outcomes they produce. Looking at outcomes in infrastructure is not new – performance-based contracting has become relatively standard for governments at the municipal, state, and federal levels – but better evaluation methods and innovations in financing structures now enable us to take a more nuanced approach. Pay-for-Success approaches can hedge against not just delivery and execution risk, but also risk of performance of infrastructure to serve its intended goals. EIBs can help governments fund social, health or environmental outcomes by sharing performance risks with private investors. By providing up-front capital to pilot innovative solutions, and structuring these transactions as bonds, those private investors can now have a stake in the successful outcomes of the municipal projects they help fund.
At the same time, the range of capital sources is also expanding as investors look for new approaches for deploying capital. Impact investors and philanthropic organizations are increasingly looking to finance organizations and projects that produce environmental and social impact, such as building long-term resilience, to both support their missions and diversify their portfolios. The impact market is worth $114 billion as of May 2017, according to the Global Impact Investing Network, with investors increasing their capital outlays by about 15% over a year ago. Often, these foundations and impact investors are willing to take on some of the performance risk of innovative programs like resilient infrastructure if it means scaling projects with meaningful environmental or social outcomes.
Innovation in both financing structures and sources gives municipalities across the country the opportunity to make smarter choices with their funding, and invest in new and better infrastructure. This opportunity is what allowed the Water and Sewer Authority in Washington, DC (DC Water) to issue the first Environmental Impact Bond (EIB) in the country last September, which financed green infrastructure to help manage the city’s stormwater management and water quality issues. EIBs are structured using a Pay-for-Success approach, meaning that payments on the bond are contingent on the performance of projects to meet environmental targets – in this case, stormwater retention at the site of the green infrastructure project – rather than a set interest rate.
Green infrastructure, which includes natural solutions like rain gardens, permeable pavement, and bioswales, is often more cost-effective than “grey” alternatives in meeting stormwater control and water quality targets, while enhancing the resilience of surrounding communities by providing local flood control, green space, air quality improvements, and jobs for maintenance. However, as a new and location-dependent solution, the performance of green infrastructure is often seen as risky.
DC Water worked with Quantified Ventures, a Pay-for-Success firm, to design an EIB that would allow it to finance green infrastructure without the risk. In that $25 million deal, DC Water pays an interest rate that’s similar to those of its traditional municipal bonds, but protects its ratepayers in case the project fails to mitigate stormwater runoff. In a downside scenario, private investors will make a performance payment to DC Water, taking on risk of the project. The EIB was bought by the Calvert Foundation and Goldman Sachs’ Urban Investment Group, leveraging new sources of impact capital.
By shifting the risk of innovative projects from public agencies to investors, the EIB model presents an opportunity for municipalities across the US to invest in better, cheaper, and more resilient infrastructure and environmental solutions, and funders are starting to pay attention. The Rockefeller Foundation recently issued Quantified Ventures a grant to offer our services pro bono to more cities through an EIB Challenge. Working with Neighborly, an online broker-dealer for municipal finance, the next EIBs will also be the first publicly marketed EIBs, allowing these cities to access a broader investor base. As the market for EIBs continues to grow, more state and local governments around the country can benefit from greater and easier investment in innovative projects.
As our country grapples with the growing gap in infrastructure spending and urgency for resilient solutions, our cities and towns need to move beyond traditional financing methods to fill backlogs and make sure these investments are made in the most effective way. Fortunately, new models, such as Environmental Impact Bonds, are helping to create the conditions for us to meet this gap while making our communities stronger, healthier, and more resilient.
Eric Letsinger and Jase Wilson are the CEOs of Quantified Ventures and Neighborly, respectively. To find out more about the EIB Challenge, visit quantifiedventures.com/rockefeller-eib and neighborly.com/environmental-impact-bonds.