Bill Young makes a provocative argument for more public regulation of the way charitable foundations deploy their assets for public benefit. He suggests that the government force foundations to redirect 100 percent of their assets to impact investing.

But is regulation of this kind the best public-policy response to the need for more public-benefit capital?

I would say no. Here’s why.

First, while regulation is often necessary to ensure that no harm is done to the public, often it is not the best tool to ensure that good is done. Regulation is heavy handed and requires definitions, categories and rules to allow regulators to determine what is and what is not being done “correctly.” It rarely gives room for, nor does it keep up with, innovation or rapid changes in markets. Regulations can save consumers and citizens from hurt, but they do not necessarily promote benefit. Regulation of investment choices could well lead to unintended consequences, including foolish rather than wise use of capital. Foundations might choose to make investments without doing due diligence; they might invest without referring to their mission goals, or the investment might end up skewing their asset allocation preferences.

Second, it is suggested that governments have an interest in shoving charitable foundations into social investing more rapidly. But this attacks the essential notion that the roles that governments and markets play in our economy are different. In capitalist democracies, governments are referees but not coaches when it comes to investments. Governments set the rules that permit markets to operate efficiently and allow a free flow of information and fairness for buyers. Governments do not tell individual investors which specific products to buy in those markets or encourage them to invest in specific companies or funds.

Markets operate on the basis of supply and demand. Today investors, including foundation investors, are demanding investment products with a social benefit. The demand is being met through investment opportunities in areas like affordable housing, clean energy and sustainably produced food. More such products are coming onto the market and more investment advisers are suggesting these “impact-investment” opportunities to their clients.

There is no doubt that interest in impact investing, which uses a social (as well as financial) purpose and return, is growing in Canada. Bill Young cites the example of the Heron Foundation in the United States. This organization has moved to direct investment of its entire capital in ventures that provide a social as well as a financial benefit.

In Canada, the Inspirit Foundation is committed to achieving a 100 percent impact portfolio. Inspirit defines impact investments as investment in companies that are top performers with respect to environmental, social, and governance metrics that are associated with the foundation’s organizational vision. This is a model that more of Canada’s larger private foundations are exploring. These foundations (about 150 grant makers in Canada with assets of over $25 million) are beginning to establish targets for impact investing of as much as 10 percent of their portfolios. In my view, we don’t need government to force them into making this change more rapidly; it is better to allow the market to develop and innovate, as it is already doing.

Charitable foundations generally do not have the scale or the expertise that asset managers do to be able to perform due diligence on infrastructure investments and be confident they can generate the mix of financial and social returns that foundations are looking for.

Third, Bill Young suggests that regulation is the best way to get foundations to invest in infrastructure such as affordable housing and renewable energy. It may well be true that more capital would flow into such infrastructure, particularly since many impact investment opportunities can be found in these areas.

But it would be just as easy, and better, if such infrastructure were financed by noncharitable pools of capital managed by asset managers. Indeed, specialized asset managers are becoming more active in the impact-investing market. Asset managers at more than 1,340 organizations account for more than 50 percent of impact investors, responsible for US$502 billion in assets worldwide, according to a recent study by the Global Impact Investing Network.

Charitable foundations generally do not have the scale or the expertise that asset managers do to be able to perform due diligence on infrastructure investments and be confident they can generate the mix of financial and social returns that foundations are looking for.

Is there a public-policy approach that would make more philanthropic capital available to community? Let’s look at how the modernization of the rules in the federal Income Tax Act (ITA) could more successfully optimize the assets of charitable foundations.

These foundations pursue an exclusively public-benefit purpose. They are uniquely suited to advancing capital to create public benefit, in areas such as generating decent work, working toward inclusive local economies, optimizing the opportunities for Indigenous youth, ending youth homelessness and building integrated mental, social and health care services, to list a few instances where long-term, patient and high-risk philanthropic capital is required, whether in the form of grants, loans or sometimes investments.

This capital can spur social innovation to build stronger democratic institutions, enable better outcomes for marginalized citizens and immigrants, or pilot public health and educational interventions and more effective public-benefit journalism, for example.

It’s risky work. Outcomes are tough to measure. Impact investing opportunities are scarce. This kind of public-benefit work does not generate secured financial streams. There is a reason why financial markets and businesses do not pursue public-benefit projects: they do not create the private benefit that drives investors.

But if we want foundations to allocate capital more effectively, it would be more productive for government to change the ITA rules that control charitable activities and strictly segregate charitable and business activities.

There has not been a comprehensive review of the ITA with respect to charities in 50 years. Many of the provisions regarding charities were introduced piecemeal and are inconsistent. This is no way to regulate an important sector that contributes so much to Canada’s economy and society in the 21st century. There are many constraints on capital deployment by private foundations, including the following:

  • Restrictive rules governing financial relations between charities and noncharities, such as social-purpose businesses, including unnecessarily rigid requirements to maintain direction and control over charitable funds;
  • Lack of regulatory clarity about how foundations make loans to charities or non-charities;
  • Tight limits on the investments that private foundations can make in limited partnerships (a frequently used structure for nonprofit corporations and an accepted asset class for private investors);
  • An excessive focus on the activities rather than the purposes of charities.

An overhaul of the provisions in the ITA that limit financial interactions between private foundations and organizations, including other charities, social enterprises and nonprofits, is badly needed. Currently, foundations are essentially confined to a box labelled “grants to qualified donees,” or grants made to other charities. In other words, onerous restrictions and limits in the public-policy regime largely keep private foundations from advancing capital in any form other than grants to designated charities.

While public-policy objectives rightly ensure that charitable capital is not used for private benefit and that it is deployed in pursuit of a charitable purpose, the thicket of rules and policies that has grown up around private foundations severely limits the possibility of deploying more capital creatively for public good.

This is a point on which Bill Young and I can wholeheartedly agree! There is growing charitable-sector pressure and insistence on this sorely needed public-policy intervention, which would lead to real and rapid change for communities. If more charities, nonprofits and social enterprises can get access to capital, because more loans are made, more investments made in limited partnerships and more grants awarded to noncharities, then we will indeed see the foundation sector’s capital being deployed more effectively than through a regulation that forces investment of a whole portfolio for impact.

This article is a response to Foundations ought to be investing in infrastructure, by Bill Young (Policy Options, April 29, 2019).

Photo: Shutterstock by JPL Designs

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Hilary Pearson
Hilary Pearson spent almost two decades as president of Philanthropic Foundations Canada. She writes a regular blog on charities and philanthropy, and is working on a book about the little-known world of Canadian foundations.

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