BPR Interviews: Oliver Withers on Rhino Impact Investing

In his capacity as the Head of Conservation Finance and Enterprise at the Zoological Society of London, Oliver Withers leads the Rhino Impact Investment Project which finances the conservation of black rhinos through impact bonds.

Glenn Yu: What is an impact bond?

Oliver Withers: The first impact bond was launched in the UK and focused on prisoner recidivism. The hypothesis of that bond was that because it costs the UK government fifty thousand pounds a year every time a released prisoner ends up back in the prison system, any intervention costing less than that value which prevents that outcome is actually cost-effective for the UK government. This hypothesis allowed Social Finance, a firm based in the UK, to use what seems like a boring contractual framework to turn a social challenge into an investable opportunity. More particularly, under this model, the UK government first decides on interventions and then raises investment capital upfront to fund those interventions from investors who are essentially taking on an upfront risk around performance and underwriting a program of interventions to deliver specific targeted results. If those target results are achieved, the UK government steps in and pays back the investors their principal, plus a pre-agreed, yield (or coupon) based on the degree to which the results have been achieved.

This transfers the risk of delivery from the outcome payer to investors. Because investors are taking on some degree of additional risk, they need to be compensated for that risk, and that’s where the yield or coupon comes in. In this case, the UK government was in a position to repay the principal plus a coupon as long as the total cost of those interventions is less than fifty thousand pounds a year.

GY: Where do you see impact bonds in 20 years? Do you think that it might become this major way in which many social, conservational, and developmental programs are funded?

OW: There’s a great UK government resource on this called to The Government Outcomes Lab. I mean, listen, I think like many of these financial instruments, there are conflicting interests all trying to promote the growth of this sector. I acknowledge that impact bonds have been used with varying degrees of success. One infamous failure was when Goldman had a deal around Rikers Island to reduce the juvenile offender recidivism rates. It did not go well and got cleaned up fairly quickly. 

One fundamental issue with these bonds has to do with credit risk. Obviously, with these bonds, the main risk in one of these bonds has to do with the underlying performance risk of delivering the impact. The other risk on the table, however, is credit risk, which has to do with who the outcome payer of a bond is. Credit risk a large impact on the pricing of the yield, and it’s why Western economies generally market their outcome bonds a lot faster. In the development sector, where you’re often delivering outcomes in frontier markets who might not be in a position to pay for results, these bonds tend to be a bit tricker. 

I think there are certain people who have made their money in impact bonds and will promote impact bonds as the absolute solution to everything, but I simply look at them as one arrow in the quiver of innovative finance arrows. It’s not a threat to every stock. It’s not a threat to every management agency. It’s foolish to think that it is the panacea or a silver bullet that’s going to solve everything. It’s certainly not. But it does have a huge ability to deliver management and cost-effectiveness in certain scenarios.

GY: Are these bonds priced at a market rate?

OW: Our team spent a lot of time looking at the impact bond market, and we found there was no clearly defined approach to pricing or determining what that yield should be. Pricing is highly dependent upon the donor outcome payer so we have seen yields that have ranged from 2 percent to 12 percent. 

GY: Who tends to buy these rhino bonds? Why don’t these people care about their returns in the way we think normal investors do? Is there an altruism premium on these sorts of bonds?

OW: The harsh reality is that when we look at the spectrum of the products and opportunities under an impact investing label, not all of the products offer the commercial returns that will bring institutional investors. In response, we are beginning to see higher degrees of financial engineering occurring within these products, and we’re beginning to acknowledge that because institutional capital can provide a degree of scale, there is a need to provide risk tranching that de-risks institutional exposure to these structures. That’s where you’re seeing a really important role for catalytic finance, where institutions and high net worth individuals are taking on extra risk in order to catalyze additional capital into the structure.

An example of this is the Seychelles Blue Bond. What happened there, crudely, is that the Seychelles government could only afford to pay a 4% coupon, but the market wanted around 8%. So, the Global Environment Facility stepped in and picked up that difference because they could see very clearly that they were the difference between this deal happening and not happening. In other words, for the GEF, the calculation was something like: “We might lose on this 4% coupon on fifteen million dollars, but because of this role, we’ve catalyzed an additional $50 million.”

GY: What do your rhino bonds pay for? 

OW: So we have these criminal syndicates who are profit maximizers and who see dead rhinos as assets whose horns are worth anywhere between 50 and 60 thousand dollars a KG. There are maybe two KGs strapped to this animal while it’s wandering around the bush, and the harsh reality is that in pure economic terms, these rhinos are worth more dead than alive. As a result, these criminal syndicates are actually fairly sophisticated in how they approach this stuff. On the other side, you’ve got these conservation managers, who have to fight these guys. Most of these managers are getting one-year, two-year, maybe, at best, three-year contracts. These contracts will often state something like, “John, you are committing to training 200 rangers over the next two years.” But then a flood or some other natural disaster happens, and John, the manager, loses his fence line. He now carries more risk of losing his rhinos because he has no fence line than from not having enough trained rangers, but he’s got no money to rebuild the fence since he’s only got money to train rangers. In other words, these managers end up in this really unenviable position where they might have some money, but they have no flexibility on where that money can go, so they lose all ability for adaptive management. Meanwhile, these criminal syndicates are profit maximizers. They are not sending memos saying that they’re coming over the Western fence at 2AM on Friday. I mean, imagine trying to run a national defense force in an army without the ability to adapt to the realities on the ground. But that’s the unfortunate reality that these particular area managers face, and for us, the impact on model is actually a framework that allows us to create that adaptive management ability.

GY: Why do you need rhino bonds to do this? Why can’t the government just be less bureaucratic and fund the best agencies themselves with the level of oversight you’ve decided to give them?

OW: To be quite blunt, the perception, and arguably rightfully so, is that African management agencies are grossly ineffective. They have lots of allegations of corruption. To give you an idea, one management agency has acknowledged that in order for them to replace a tire, it would take six months. Now, again, a criminal syndicate doesn’t wait six months. 

The unfortunate reality is that not all management agencies are equal. For us, the management agency that is willing to acknowledge that six months is too long to wait for a tire is the management agency we want to work with. From a private equity lens, it’s like, “Okay, here we’ve got this fantastic asset that could generate enormous value in terms of rhinos, but we can’t throw money at this if we don’t have the right team on the ground and the right management enabling environments.” In other words, the idea is to transition from a handout mentality to a more commercially minded governance approach that can be more flexible because it is less bureaucratic. 

GY: What’s the process for identifying a rhino site?

OW: We’re really looking as if from a private equity lens for two things. First, we’re looking for an asset itself that holds the value. Of the 130 sites in Africa with rhinos, for instance, 15 sites hold 70% of the continent’s rhinos. So, we focused on these because these had the highest biodiversity value in terms of rhino in Africa. Second, we’re looking for management agencies that are sophisticated, have their houses in order, and don’t need handholding. This is really important. Our impact bonds are not a one size fits all and don’t fit every management agency. The idea here is that we have really talented protected area managers on the ground. If we just let them get on with doing the job with a certain degree of oversight, we can generate far better results. Our baseline performance across all five sites is 3-3.2%, but we expect that at the end of five years, we will get that up to around 5.5%. That’s over a 75% pick-up in yield over a five-year period. We have not found any magic button, no new way of growing rhinos, or protecting rhinos. We just have a better management framework.

GY: Impact bonds have been used and tested in social and development sectors, but they are new to conservation. Does conservation pose any distinct problems to the impact bond model?

OW: While governments, researchers, and even voters are able to adjudicate the cost of social and development outcomes, in biodiversity and conservation, we don’t get to do that. When it comes to healthcare, for instance, we might have a very good sense of what things ought to cost and what the implications are if healthcare fails. On the other hand, in conservation, we have to ask: What is the value of biodiversity? It is something that the world is grappling with at the moment, and unfortunately, the real value of rhinos is quite esoteric at this stage. We’re seeing some strides in a natural capital valuation approach driven by payments for services that require biodiversity. For instance, we might look at Mzima Springs in the Tsavo Conservation Area in Kenya which feeds Mombasa, Kenya’s second-largest city, with around 40 to 60 percent of its water. Historically, Mombasa’s water company has not paid a single cent for that water. But, now, people are starting to calculate things like the risk price on what happens when Mombasa loses 50 percent of its water, and in the next few years, we’ll probably see more metrics for the return on investment of biodiversity so that we can start allocating capital more efficiently across the swathe of biodiversity hotspots.

It’s also worth noting why the KPI [Key Performance Indicator] that we measure is the growth rate, as opposed to actual numbers of rhino. One reason is that when we look at species recovery, realistically, this is a 20-year timeframe. While outcomes and impact can be generated a lot quicker in the social and the development sectors, in the biodiversity space, impacts often take longer. So, although we set out to create the longest-term impact bond product we could, the reality is that we’re talking about a brand-new product that’s never been done before, and the market will only take so much. So, our first iteration is a five-year pilot. The idea is that if it performs well, we will roll those investors to our new product.

The other goal of this pilot is to form an idea of baseline performance. So, to give you an idea, on our current portfolio of five sites, the baseline performance is sitting around 3-3.2% growth. Because you’ve studied economics, you should understand that the key here is the simple compounding going on. What’s been interesting for us is that the finance people really understand this. They really understand the benefits of maximizing those growth rates over the next five years in order to catalyze species recovery over the next 20 years. Whereas, if I’m brutally honest with you, a lot of the conservationists themselves can sometimes battle with the compounding narrative.

GY: What are some other ways in which conservationists and economists tend to differ in this field?

OW: There is an amazing microcosm of this exact conflict that plays out in Africa between East Africa and Southern Africa. In Eastern Africa, the state generally owns a lot of wildlife. In South Africa, where I’m from, private people can own species, so I can own a conservancy and the wildlife on that conservancy. What this has created is the legal trade of species in South Africa, and this has had a really positive impact on the levels of biodiversity compared to a number of countries where they don’t have the ability to realize biodiversity is an asset on a private balance sheet. 

Additionally, in Southern Africa, we are all brought up with a narrative of sustainable use that has come to see hunting as a necessary evil because hunting has the ability to generate enormous revenue to fund biodiversity, and so Southern African countries have, for a long time, promoted the outright sale of rhino horns. We have stockpiles of rhino horns that have been accumulated over 50, 100 years which have all come from natural mortalities. But the question is: To what extent will legalizing trade fuel demand beyond what it is now? 

There’s actually a guy named John Hume based in South Africa. Because you can own rhinos in South Africa, John owns about 10% of the world’s white rhinos and farms them by cutting the horns off, which he can do since they grow back. He’s got a stockpile of horns, and he’s obviously keen on legalizing the trade. He’s also clearly running out of money, so it’s this bizarre scenario where 10% of the world’s living rhinos are potentially about to be homeless. What do we do with those rhinos? The idea of moving sixteen hundred rhinos practically is just… I don’t know how we would begin. And then we’re left with this whole stockpile of horns. What do we do with it?

Trade makes sense if you can regulate it so we’re only selling horn that has come from natural mortalities, but the blunt reality is that we cannot guarantee the transparency of that system and unless we can, it’s very risky. Additionally, there’s this second fundamental question. If we were to sell the stockpiles, what impact would that have on the price of rhino horn and the demand for it? There are arguments on both sides of that. But I like to think that if we were to trade it, we would want to trade it the way DeBeers trades diamonds, releasing a few at a time to keep the prices high. That way, we could generate an enormous amount of money to fund more conservation.

GY: Scientists at Oxford recently created fake rhino horns out of horsehair. Many conservationists are opposed to releasing these substitutes into the market. What’s your perspective?

OW: The first concern that people have with the project you mention is that there’s been very little consultation from that project with the experts. Second, while Louis Vuitton publicly denounces fake copies of its bags, it’s not clear to me that these fakes are really bad for Louis Vuitton’s brand. These fakes are also good to a certain degree because they hold the aspiration of having a Louis Vuitton handbag. In other words, we need to understand why people use rhino horns before we try to replace them.