This discussion paper was produced by Development Initiatives, in partnership with UNICEF. This is part of a wider project of work being carried out by DI and UNICEF in 2022–23, supporting reform around the issue of overheads for local and national actors. It builds on the previous research into the current practices of UN agencies and INGOs which informed the recently endorsed IASC Guidance on the Provision of Overheads to Local and National Partners.

For more information or to be part of this discussion, please contact Philimon Majwa at UNICEF and Fran Girling-Morris, DI.

Ensuring that local and national actors can access overheads has become a key focus for humanitarian reform efforts over the past year. Locally-led humanitarian response is more effective, more efficient and improves accountability to, and participation of, those most affected by crisis. Overheads – also referred to in this paper as ‘indirect costs’ or indirect cost recovery (ICR) (see Appendix 2: What are ‘indirect costs’ or ‘overheads’?) – are critical for building the organisational capacity, sustainability and preparedness of frontline responders. By not providing overheads, the international aid system – including donors, UN agencies and international non-governmental organisations (INGOs) – is not adequately supporting local actors to meet the growing complexity of humanitarian response, including in situations of protracted crises where communities face intersecting risks.

Many international organisations with an intermediary role^[1] and donors are now in the process of reflecting critically on their own practice amid changing industry standards. To support this reform process, the Inter-Agency Standing Committee (IASC) published Guidance on the Provision of Overheads to Local and National Partners in November 2022.^[2] The Guidance was informed by research carried out by Development Initiatives (DI) with UNICEF and Oxfam, which mapped the current practices of intermediary organisations and identified examples of good practice from the perspective of local actors.^[3] Implementation of the Guidance is being supported by the IASC Task Force 5 on Localisation. Within the Grand Bargain, the caucus on funding for localisation is also addressing the issue of overheads for local actors in early 2023.^[4] This follows the outcome document of the caucus on the role of intermediaries (at the time for writing endorsed by 26 Grand Bargain signatories), which included a commitment from members to allocate overhead costs to local and national actors.^[5]

This paper, produced by DI in partnership with UNICEF, aims to support these ongoing discussions by summarising donors’ current indirect cost policies and perspectives on the issue of overhead allocation to local actors, as well as setting out various opportunities and barriers to change identified by donors. This builds on, and is designed to complement, the previous mapping of intermediary practices and is based on interviews with 12 government donor representatives. To benefit from learning from private philanthropy on this issue, representatives from three private foundations were also interviewed. Interviews took place between October 2022 and January 2023.

Key messages:

• Most donors currently rely on the pass-through policies of their UN and INGO partners and provide no guidance or regulations of their own around how funding (including overheads) should be provided to local and national actors. Their partners’ policies are also not known, asked for or interrogated. Some exceptions to this include Canada, Denmark and FCDO’s INGO funding guidelines.
• Despite this, most donors recognise that this is an oversight, that ensuring local actors have access to overheads is important for more effective and efficient humanitarian programming and they have a role to play in incentivising change. Many are currently in the process of developing positions or policies on this.
• IASC members have endorsed Guidance on the provision of overheads to local and national actors. Donors can change their funding regulations to influence and push their partners to establish and roll-out fairer funding practices.
• UN agencies receive the majority of donor funding – changing UN practices therefore has the potential to make the biggest impact for local actors. INGOs face different challenges and pressures around sharing the existing overhead. Donors could allocate additional funding – which would avoid disincentivising INGOs from partnering with local actors – in different ways: increasing the fixed rate, including an additional budget line specifically for local actor indirect costs, or re-thinking how to fund the role of the ‘intermediary’.
• The immediate priority for donors should be to establish quick (even temporary) fixes with partners that allow local partners to immediately start regularly accessing adequate overhead funding on all new (and current, where relevant) grants.

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This section outlines current donor perspectives and policies around overheads and any requirements around partnership arrangements with local actors. Detailed information on individual donors is in Appendix 1.

Donor perspectives on the issue of overheads

There is general agreement on the importance of overheads for local partners and that donors have a role in incentivising change.

While awareness of the issue was newer for some, all the donors interviewed emphasised that ensuring local actors have access to indirect costs was a matter of both principle and effectiveness. Donors spoke of the necessity of overheads, for example to build up reserves, to support organisational sustainability and to develop more professional systems and administrative capacity, for example HR practices. The majority of donors interviewed do not provide significant amounts of funding directly to local actors – there was therefore an emphasis on supporting equitable partnerships, where local actors receive the same funding conditions as the intermediary. Some donors also emphasised the importance of overheads in supporting local actors to play a more significant and visible role in the system, as this could lead to more direct funding opportunities.

The extent to which the issue of overheads for local actors is a current priority differs between donors. However, ‘localisation’ as a whole was identified as being a top priority along with quality funding. Reflection on this issue had been triggered by the Grand Bargain intermediaries caucus outcome document, awareness of the IASC’s focus on this issue and, in some cases, pressure from INGO partners as well as the general sector-focus on localisation and decolonisation.

Donor policies for UN agencies

DAC government donors provide most humanitarian funding to multilateral organisations – 56% in 2021, compared with 20% to NGOs. This funding is provided in different ways: as core funding, against humanitarian appeals or for specific programmes. Within this, UN agencies receive funding for their own indirect costs and can partner with other implementing organisations, including L/NNGOs, according to their own strategies and policies. UN organisations’ cost recovery policies, which include their indirect cost rates, are approved by the governance body for each agency (e.g. Executive Board or General Assembly) and these rates are generally then applied to donor programme budgets, though in some cases are negotiated with individual donors.^[6]

Donors rely on UN agency policy for local partner overheads

None of the donors interviewed have regulations or guidelines for their UN partners on how overheads should be passed on or provided to downstream partners. Donors therefore rely on the policies of each respective agency regarding the provision of overheads to local actors, though these policies are not generally requested, interrogated, or even known by donors. For those agencies that do provide overheads for local partners, for example UNHCR, these costs are not ‘shared’ from the agency’s overhead. For example, all the funding provided to a local partner, including any indirect costs, might be included in the overall budget under the ‘implementing partner’ line.

In general, UN agencies do not report to donors how much of their specific funding is passed on to local and national partners, or how much overhead is provided. It also seems there is a lack of awareness of the specific policies of each agency around overheads (see our mapping of intermediary policies and practices). There were no examples given of donors incentivising agencies to provide overheads and advocacy around this appeared limited.

Discussion between donors and partners around overheads is less advanced with UN agencies than among INGOs. Several donors reported that they did not feel this was a current priority within multilaterals (in the same way as within INGOs), however clearly donors have also not prioritised tabling overheads as topic for discussion. Dialogue with UN agencies – for example in annual consultations, on Executive Boards and steering committees – are opportunities for donors to advocate on these issues.

Donors interviewed reported that the overheads issue had not been specifically pushed, either due to limited resources, prioritising other issues (e.g., increasing volume of funding to local actors) or lack of awareness. Different donors have varying amounts of leverage with different agencies and smaller donors look to larger donors for leadership on advocacy issues.

Donor policies for INGOs

Donor civil society funding is mainly provided to INGOs. Funding provided directly to L/NNGOs from donors is limited, and in most cases was managed at the country level. Most of the donors interviewed provide a fixed or sliding overhead rate to their INGO partners, ranging from 7–12%. Exceptions include Switzerland, which negotiates a rate with each INGO partner directly; USAID, which allows partners the option of negotiating a variable indirect cost rate based on actual expenditure (the ‘NICRA’) or a 10% flat rate (known as the de minimus – this is available to organisations who are not able to calculate a NICRA, including local and national partners) and FCDO, which has a similar approach, allowing their INGO partners to calculate their own non-project attributable costs (NPAC).

Donors mainly rely on INGO partner policy for local partner overheads

Almost all donors (9 of 12) interviewed did not allow the overheads of the INGO’s local partners to be included in the overall budget and did not have regulations or guidance on how the indirect costs provided to the INGO should be shared or passed on. As with their UN partners, most donors therefore rely on the partnership approach and policies of each INGO, although the approach or policies are not always requested, interrogated or even known by donors.

A small number of donors did softly incentivise their partners to pass on overhead funding to local actors though this was not strictly enforced and most donors did not have data on whether the overhead provided to INGOs is shared with L/NNGOs. Donors reported feeling they have more direct leverage over the behaviour of INGOs, compared to their UN partners, partly as they have more control over how they provide funding. Several donors are currently in active dialogue with their INGO partners about how to provide fairer overheads to local partners, with the aim of negotiating a common position on overhead policy. For example, Sida has developed an overhead pilot with Oxfam GB (see Appendix 1). Others are just at the start of these conversations.

A few donors have changed their funding models to include local partner overheads

• Denmark’s new funding guidelines for 2022–2025 allow Danish civil society organisations (CSOs) to budget up to 7% of partner costs as overheads, in addition to the 7% overhead they are allocated. This is not compulsory, but partners are required to report on the pass-through of funding to local partners, including overheads. The overhead is provided as fully flexible, unaudited funding.
• Since 2021, Canada’s International Humanitarian Assistance Funding Application Guidelines for NGOs has allowed partners to budget up to 7.5% in indirect costs for their own operations and 7.5% for any local and national NGO they work with. While encouraged, this budget line is not compulsory. The overhead is provided as fully flexible, unaudited funding.
• In recent years the UK has also taken steps to allow overhead funding for local actors. The FCDO Humanitarian Response Funding Guidelines allows the lead partner to calculate their own NPAC rate and, in addition, budget Localisation Support and Administrational Costs (LSAC), as overhead for their local partners.^[7] The guidelines stipulate that lead partners must pass on LSAC to local and national downstream partners either at their own NPAC rate or at 10% – whichever is highest. These guidelines were mandatory for the Rapid Response Facility (RRF) and are best practice guidance for other humanitarian grants, but are not yet widely used. The LSAC is designed to be provided as fully flexible funding.

Most donors acknowledge that they have a role to play in incentivising change around overhead practices. However, there was a general consensus that this is a complex issue, requiring input across different internal departments and with partners.

This section outlines different options identified in interviews for how the issue of overheads could be overcome by donors. Learning from interviews with private foundations is included in Appendix 2.

UN agencies

Changing donor regulations to influence pass-through practices

As noted above, the majority of humanitarian funding provided by DAC government donors flows through multilateral agencies (56% in 2021).^[8] Changing UN agency policy and practice therefore has the potential for the greatest gains in terms of access to overheads for local partners.

Donors could make several relatively easy changes to how they provide funding which would influence and incentivise their UN partners to provide overheads for local actors and signal that this is a priority area for them. This could include:

• Requesting organisational policies on the provision of overheads to L/NNGOs.
• Stipulating in funding agreements that all partners in the funding chain must receive funding to meet their overhead costs.
• Requesting that overheads for local partners are included in budgets to donors as a specific budget line.
• Requesting reporting on how overheads will be/have been passed to local partners.
• Requiring written justification in cases where overheads are not provided to downstream partners.
• Ensuring there are regular updates in meetings with UN partners to monitor the roll-out of any new policies.

Examples of donors taking this approach are currently limited to INGO intermediary partners, rather than UN agencies.

Considerations

• Requesting information on how overheads are provided to through intermediaries to local partners as a first step would provide some much-needed transparency for donors and the sector overall. Nearly all donors interviewed did not have the data on how much funding intermediaries pass on to local and national actors, let alone how much overhead funding is provided. This data is either not provided or requested in the reporting mechanisms. Some donors suggested this would need to be done first, before considering any further changes to their indirect cost policies.
• Wider commitments to provide quality funding without burdensome reporting requirements need to be balanced with ensuring donors have information on how the funding they provide is cascaded. Donors and intermediaries need to discuss how this reporting burden can be managed while still ensuring that intermediaries are incentivised to include overheads in grants with local actors. For example, donors could request reporting on how overheads are shared only until organisations develop their own policies.

INGOs

Changing donor regulations to influence pass-through practices

As with UN agencies (see above), donors could also make relatively simple changes to funding regulations with INGO partners to influence and incentives a change in funding practices. There are a few examples of this already happening – Canada’s International Humanitarian Assistance Funding Application Guidelines for NGOs request partners to include a description of how they are working with local partners, including the proportion of the overall budget which will be directly transferred for implementation and overheads. Denmark’s CSO funding guidelines also require partners to report on how much funding they pass on to local organisations, including what proportion is provided as an overhead.

Considerations

• Unlike UN agencies – who are able to provide partner overhead costs outside of their own indirect cost recovery processes – donors need to consider the financial implications of requiring INGO partners to share their existing overhead rate. For some partner organisations there is a sense that current overhead rates ‘just’ cover indirect costs, especially those organisations without alternative income streams, and they cannot afford to ‘share’ overheads and still manage the current compliance and risk management responsibilities placed on them by donors. Sharing overheads would not mean these costs, and their linked liabilities, are proportionately reduced.
• The idea that donors should expect INGO partners to share their existing overhead makes even less sense for donors who allow partners to calculate their own indirect cost rate based on actual expenditure, for example the US’s NICRA and the UK’s NPAC. These are not fixed rates and are designed to cover the costs of the direct recipient. For example, US federal funding rules state that the NICRA is for the use of the recipient only.

Allocating additional funding for local partner indirect costs

Most donors acknowledged the pressure that would be put on the finances of INGO partners if they were asked to share the overhead as it is currently provided. For many intermediaries, existing ICR rates are not based on actual indirect costs incurred. They are also often insufficient and must be complemented with additional income, such as private fundraising. A clear solution is for donors to recognise both the overhead needs of their INGO partners and their local partners by providing adequate funding for both. There are various options for how donors could allocate additional funding to INGOs in order to cover local partner indirect costs:

Option 1: Increasing the overhead rate

None of the donors interviewed had yet increased the fixed overhead rate available to INGOs, though some are considering it. For example, Germany (GFFO) is in the process of adopting new funding regulations which would increase the overhead rate from 7% to 9% for INGOs who partner with local organisations. The US is also exploring increasing the de minimus rate.

Considerations

• In theory, an increase in the overall overhead rate would help INGOs to better cover the indirect costs of both their own organisation and pass on overheads to their local partners. This could be used to incentivise intermediaries to work with local organisations, for example by allowing an increase in overhead only to organisations who pass on a certain proportion of funding to local actors.
• Donors must consider whether an increase in overhead would be accompanied by requirements on how the overhead is split (for example, proportional to the size of each partner’s implementation responsibilities) or whether it would be at the discretion of the INGO grant holder. To be successful, donors may need to set expectations on how they would like this increase to be used.
• Ensuring there is a shared understanding between donors and implementing partners of what costs are classified as direct, shared direct and indirect is important to build support of, and trust in, this type of policy change. The first component of the Money Where It Counts protocol provides a useful list of direct and indirect cost functions.

Option 2: Additional budget line for local partner overheads

Rather than increasing the overall fixed overhead rate, Canada, FCDO and Denmark have allowed an additional budget line under direct costs to be added specifically to cover the overhead costs for local partners. Other donors mentioned that this was also being explored. Donors identified several factors which enabled change in policy. Firstly, in-depth consultation and constant dialogue with partners was critical to build trust and unpick challenges. For example, Denmark instigated monthly meetings with some of their INGO and local partners to act as a sounding board and incorporate feedback throughout the process of developing the new funding guidelines. Secondly, framing this policy issue within a narrative of delivering more effective aid was important, as was reinforcing the message that this funding was going to local organisations rather than to NGO headquarters in Europe. To support this, Denmark’s funding guideline for Danish CSOs also included a new rule that a maximum of 20% of the total programme budget can be spent at headquarters level.

Considerations

• This approach more clearly acknowledges the role that indirect costs play in supporting the institutional strengthening and capacity development of local actors and demonstrates an explicit donor commitment to strengthening locally-led leadership in humanitarian response. This idea is reflected in FCDO naming the budget line ‘Localisation Support and Administrational Costs’ rather than ‘overheads’. It also recognises the legitimate costs and responsibilities of intermediary organisations.
• It is important to ensure that the additional budget line for local partner overheads is subject to the same conditions as the INGO indirect costs, for example unrestricted, flexible and unaudited funding (see ‘What does good practice look like?’). It is these characteristics which give this type of funding value.

Option 3: Re-thinking the role of the ‘intermediary’

Another option discussed was to allow the INGO to budget for some of their intermediary functions in the direct budget, rather than resource them from the overhead, for example security, monitoring and evaluation and headquarters costs. This would allow INGOs to share the existing overhead more easily with local organisations. To explore this, Dutch INGOs with their donor, the Netherlands, have started a cost identification exercise to more clearly understand the costs of localisation. This includes the option of translating costs normally associated with overheads into the direct budget.

Considerations

• This approach more clearly acknowledges and defines the role INGOs play as intermediaries, including the responsibility placed on them as the overall grant holder, while allowing them to share the current overhead more fairly.
• It also opens up a relevant, but much broader, conversation about the changing roles of intermediary organisations within a system orientating toward more locally-led response, the role of the intermediary in this landscape, and whether current funding models are fit for purpose.
• Clearly, another option to recognise the (changing) role of the intermediary is to pay the true costs of each organisation’s overheads by negotiating individual rates based on their actual expenditure. For example, by using a methodology such as FCDO’s NPAC or the US’s NICRA (see Box 2 for how the IKEA Foundation have recently made a similar change). This approach to calculating individual rates (or a sliding scale) – rather than setting a fixed rate – better reflects the reality that organisations have different indirect cost rates based on many variables, including their levels of other unrestricted income streams (for example from charity shops and private fundraising) and type of programming (for example advocacy organisations versus direct implementation). This would also better reflect the different roles INGOs might play, such as those who still directly implement and those who have moved towards a more partnership model.

Common barriers

There are common challenges across these scenarios, not least a lack of appetite from many donors to consider increasing the overall overhead funding available. Donors reported facing difficulty in ‘selling’ these types of policy changes in a context of rising humanitarian needs and a need to demonstrate value for money. One donor also emphasised the importance of having transparency over what is being funded, rather than funding a growing ‘black hole’ of indirect costs.

Donors also face regulatory challenges. For example, some are unable to change the legal framework which governs their humanitarian funding mechanisms, including overhead rates, without parliamentary approval. For one donor, the growing issue of overheads for local actors has led to a wider examination of the limitations of the regulations governing their whole overhead policy which restricts the overhead to be spent within the timeframe of the project duration and on activities connected to the project. Some donor audit requirements also make it difficult for INGOs to share overheads with their local partners – for example when the cost to the local partner of conducting the donor-required dedicated audit far outweighs the volume of overhead funding that would be received.

A small number of donors mentioned the potential fiduciary risk in providing overheads to local partners. There is a concern that L/NNGOs may not have the systems in place to properly manage this type of unrestricted funding – despite that fact that regular access to overhead funding would enable local actors to develop and update these types of financial and risk management systems.

There is broad consensus that local and national partners should be provided with overhead funding. The complexity is in how this should happen, and whether the onus for change is more on the intermediary organisation or the donor. Below we outline actions for donors for short-term improvements as well as for more substantive policy change.

Actions for short-term improvements

The immediate priority for donors should be to establish quick (even temporary) fixes with partners that allow local partners to immediately start regularly accessing adequate overhead funding on all new (and current, where relevant) grants.

Donors should collectively support and push UN agencies to implement the Guidance endorsed by IASC members by establishing and rolling out policies around the provision of overhead funding.

• There are clear steps donors can take to influence UN partners to instigate fairer overhead practices. The issue of overheads should be on the agenda of regular meetings with UN partners who do not currently have a policy on overhead provision. As most donor funding is provided to UN agencies, adjusting UN practices will lead to the widest felt change.
• Donors should require that these policies are shared and request agencies publish data on the funding they provide to local actors, including overheads. Given the different sizes and capacities of donors to engage on this topic among competing priorities, and to reduce the reporting burden on agencies, this could be approached through a common multi-donor position.

Donors must work with INGO partners to find solutions to the issue of indirect cost coverage for local partners.

• This paper sets out various options for donors to allocate additional funding for local partner indirect costs. Moving forward – and making change happen – requires dialogue, partnership and trust (see learning from private foundations in Appendix 2) and donors should start discussions with their partners, including local actors. Many intermediary organisations have existing good practices around overhead provision, and donors should support and reward partners who are working toward more progressive and equitable partnership practices.
• Donors and INGO partners could agree underlying assumptions as a starting point for these discussions (see Box 3)
• This does not need to be a static issue. For example, donors could introduce an additional budget line dedicated for local partner overheads to provide a short-term fix, while also examining longer-term solutions that require more in-depth scoping. This could involve undertaking a true cost identification exercise with their partners, starting the process of changing funding regulations or linking overhead policy to the outcome of broader discussions around the role of the intermediary. Throughout this, donors must commit to ensuring they provide overheads as flexible funding that is not time-bound and not subject to donor audits.
• Donors must be cautious of not inadvertently disincentivising INGOs from partnering with local organisations. This could be the case if donors require INGOs to start sharing overheads without first considering the financial implications. This financial challenge needs to be approached openly. A useful step could be to ask partners to identify the true direct and indirect costs of delivering a discrete humanitarian project, including the costs associated with fulfilling the ‘intermediary’ function and the costs of downstream partners. This could form the basis of a pilot overheads project.
• Relatedly, donors should understand the differences in the funding models of their INGO partners. Several INGOs are actively piloting new approaches to sharing overheads and developing their own policies (see the latest mapping). This can be a difficult and involved process – from changing internal systems and processes to enable and record ICR sharing to grappling with how to cover costs with less income. This challenge presents differently depending on the INGO’s funding model and needs to be considered in partner discussions around overhead sharing.

Peer-to-peer discussion and sharing of good practice and lessons learned should be encouraged.

• There is a lack of awareness – and a clear interest among some donors to know – how others are developing thinking and policy on this issue. Donors have committed to supporting more locally-led humanitarian action and many are signatories to the Grand Bargain, which has specifically stated that overheads must be allocated to local actors.^[9]
• While forums such as the Grand Bargain localisation caucus are an important opportunity to address this issue, they only include a small number of donors and there would be value in this being addressed within other donor groups. For example, the Good Humanitarian Donorship Initiative or donor groups emerging out of the Grand Bargain fora would be useful places to discuss this issue and facilitate learning exchange.

Donors should engage with local and national NGOs directly on this issue.

• Local and national actors have been advocating around the issue of fairer provision of overheads for years. Donors must seek to regularly engage with the local organisations their international partners work with. They should be included in discussions around the development of new funding guidelines around overheads. Donors should also seek to follow up specifically on this issue, to monitor progress in rolling out policies and assess outcomes.

Actions toward substantive policy change

The issue of funding overheads opens up wider questions around both the (changing) role of intermediary organisations and the potentially outdated system of indirect cost recovery. The wider and deeper changes to organisational policy and practice that may be needed to cover the indirect costs of partners may therefore be complex and require a longer-term horizon. This should not, however, delay action and – given the inherent complexity of some of these issues – donors should seek to begin grappling with them as soon as possible.

For real change to be felt, there needs to be a critical mass of donors covering the true costs of humanitarian operations, including those delivered by international and national organisations.

• It is unlikely that donors will agree on one harmonised policy but despite this, collective donor action on the overall approach is important to influence change, especially within multilateral organisations.
• The implications of different donors taking different approaches should also be considered. For example, if some donors increase funding to cover local actor overheads and others do not, what does that mean for burden sharing? Will some donors be compensating for the indirect cost deficits of other donors?

Donors should consider framing their support for local actors’ indirect costs in terms of funding for localisation.

• The evidence clearly shows that overheads are critical for strengthening the institutional capacity of local organisations, yet there are connotations around the language of ‘overheads’ that can be misleading and unhelpful. There needs to be a change in mindset that recognises overheads as essential for safe, effective and efficient programming.
• Some donors and agencies view low overheads as offering better value and greater efficiency, rather than a sign that costs have not been properly identified and allocated or are being subsidised by more flexible sources of funding. Similarly, concerns around risk need to be better unpacked. While there are valid concerns around minimising the risks of financial misuse, projects without overheads budgeted should also be seen as carrying inherent risk. In addition, if local actors are trusted by international organisations and fulfil the required due diligence to partner with them, then should they not also be trusted to manage overheads securely?
• Support for local actors’ overheads should therefore be situated within donor support for more locally-led humanitarian action and the language used could reflect that. A key enabling factor highlighted by donors who have changed policies around overheads was to ensure strong messaging around the use of the funding and to emphasise that it is being used to create better conditions for local and national actors in crisis contexts, rather than increasing funding to the headquarters of international organisations.

Donors should support efforts toward a more harmonised system-wide approach to cost classification.

• A blockage in providing overheads is the lack of common cost classifications. There is not currently a common understanding of what types of costs are defined as overheads, making it difficult to identify where specific costs are carried within budgets. Relevant cost-harmonising initiatives – such as the first component of the Money Where It Counts protocol on cost classification and the Dioptra tool – provide useful high-level models and could be integrated with other cost harmonisation projects such as the UN Finance and Budget Network and the IFR4NPO.
• A harmonised approach to cost classifications and setting out clearly the direct and indirect costs incurred by organisations, is the starting point for more honest conversations about the true cost of quality humanitarian programming and whether the current system is covering these costs sufficiently.

Donors need to reflect on whether the current system of fixed rate indirect costs fully covers the costs of partners and is conducive to effective humanitarian response.

• In the future, donors could consider how to fully cover indirect costs, either through negotiating individual rates based on actual costs or introducing a sliding scale which would reflect the different overhead cost needs of different organisations.

Given that many organisations are dual-mandated, donors could consider ensuring that overhead policies are harmonised across both their humanitarian and development funding streams.

• Some donors, such as Denmark and Spain, have the same funding guidelines for both humanitarian and development funding instruments or have overhead policies which are based on the same legal requirements, while others are contracted and governed separately and therefore have different overhead rates.
• Having one approach would improve cohesiveness and predictability, especially for local organisations for whom the distinction between humanitarian and development funding may be less relevant.

Government donors should be conscious of emerging evidence-based practice from private doors and explore how this challenges existing practice as well as how to incorporate this new thinking.

• There is a trend in private philanthropy toward providing multi-year core operating support rather than grants to organisations (see Appendix 2), with growing evidence to suggest that this approach supports organisations to be more resilient, operate more strategically and ultimately achieve greater impact.
• As the sector aims to move toward a system where donors fund local humanitarian actors directly, and in a context where crises are increasingly predictable and protracted, the value in providing core mission support to local actors, rather than project-based funding, should be investigated. Organisations on the front line of crisis response especially need support to develop their sustainability, resilience and preparedness capacity and receiving unrestricted, multi-year funding which is focused on outcomes rather than outputs is a good basis for future funding models. This would mean the issue of overhead allocation is no longer relevant and could also go some way to overcoming the capacity barriers donors face in increasing direct funding to local actors.

The issue of indirect cost coverage has been an issue in US philanthropy for decades. There have been sweeping changes in the approach to funding non-profit overheads in the last ten years following advocacy and evidence around the pressures that low indirect cost rates have on organisations.

Several influential reports and campaigns have contributed to a change in mindset and approach to indirect cost coverage among some foundations, towards a ‘pay-what-it-takes’ model. These included a 1986 report on the impacts of low indirect cost rates by the Rand Corporation,^[10] the introduction of the concept of the non-profit starvation cycle in 2009 by the Bridgespan group^[11] and the Overhead Myth campaign in 2013. These all highlighted the efficiency and efficacy losses associated with inadequate overhead funding, where grantees are under constant pressure to meet unrealistic donor expectations of the costs of running a non-profit, and challenge the idea that overhead rates are a useful measure of organisational efficiency.

More recently, the Funders for Real Cost, Real Change (FRC) initiative – a collaboration between 2019 and 2021 of 12 large private funders – have developed a series of step-by-step recommendations, tools and templates to equip funders to change their practices and to support non-profits to better identify and communicate their true costs. Research commissioned by FRC also contributed substantial quantitative evidence around the scale and impacts of underfunding of national NGOs in ten countries.^[12]

Examples of progressive policy change

Several foundations have taken progressive steps to address the underfunding of overheads in their grant projects.^[13] Broadly, this has been approached in three different ways:

1: Funding the actual indirect cost rates

• Some foundations have changed their approach by agreeing to fund their grantees’ true costs rather having a fixed minimum or maximum rate. For example, the IKEA Foundation (see Box 2) and the Hewlett Foundation now allow grantees to calculate and propose their own indirect cost rate based on their actual expenditure.^[14]
• This is based on the recognition that many factors affect the costs involved in delivering a project which look different for different organisations. This approach allows grantees to take the lead in determining how best to allocate funding to direct and indirect costs.
• A challenge to this approach is determining what adequate indirect costs actually look like with different definitions and methodologies used across the sector. There is also a risk that the rates proposed are insufficient for what the organisation needs, given that in the past they have been incentivised to underinvest in these costs. In addition, the inherent power differential between donor and grantees makes it challenging for grantees to ask donors to cover their true indirect costs for fear of jeopardising their funding.

2: Increasing the fixed indirect cost rate

• Others have increased the fixed or sliding scale of indirect cost rates on project grants, including the MacArthur Foundation which nearly doubled the allowable overhead from 15% to 29% in 2019.^[15] This was based on analysis into the average minimum indirect cost rate for different groups of non-profits identified as financially healthy.^[16]
• Effective from the start of 2023, the Ford Foundation has also increased their minimum indirect cost rate from 20% to 25% and allows higher rates if the costs can be proved. ^[17] The Casey Foundation adopted a sliding scale of between 15–25% dependent on the size of the grantee.^[18] This was based on analysis of grantee data which found that smaller grantees had higher indirect cost rates than larger organisations suggesting that a one-size-fits-all approach may not be suitable.^[19]

3: Increasing core funding over grants

• There is also a move by some foundations to increase long-term general operating support or core funding and reduce project funding. The Hewlett Foundation now issues more than two thirds of its grants as flexible funding.
• The Ford Foundation has also increased the proportion of its funding being provided as core support to 81% in 2021, and in 2016 launched the Building Institutions and Networks Initiative (BUILD). BUILD provides flexible, multi-year funding to social justice organisations (over half of which are in the Global South) to strengthen their institutions and build organisational and financial resilience in order to improve programming and achieve impact. The first round of grants, from 2016 to 2021, saw US$1 billion dispersed to nearly 350 partners in over 30 countries.^[20] A 2022 evaluation found that 83% of surveyed grantees reported they were more financial resilient and, importantly, contributed to outcomes by enabling them to take opportunities, respond more quickly and implement programmes more effectively.^[21]

Lessons learnt

Philanthropic foundations have different funding models, accountability systems and mandates to government donors. However, there are useful lessons to be learnt from the change in model pursued by some foundations around the issue of overheads. Key findings from interviews include:

• Trust is at the centre of partnerships with grantee organisations. Trust was built through the grantees’ track record, their leadership, effectiveness and compliance. Donors emphasised that they felt they had a responsibility to help undo the ‘starvation cycle’ that their past indirect cost policies had contributed to. They approached this issue from the assumption that their grantees know how to best run their own organisations and the costs involved.
• The exercise of supporting grantees to identify their true costs helped change happen by allowing greater transparency and giving grantees confidence to communicate their costs and leverage this with other donors.
• Mindset change is slow and needs constant work. Foundations interviewed emphasised that they must regularly reinforce this new way of working with their own staff as well as with their grantees who may not be used to budgeting for their true costs.
• Organisations have different business models and their true overhead cost rates naturally differ. Foundations interviewed shared that the smaller local and national organisations they fund tend to have higher overhead costs because they may not have such sophisticated financial systems which can apportion shared project costs in the same way as larger organisations with multiple projects.

Overheads are part of complex strategies developed by humanitarian organisations in which different funding streams are assembled to fully recover all costs. There is not one standard approach to defining, classifying, and calculating overheads. However, broadly, partners have three types of cost:

• Direct itemised costs of project activities.
• Shared administration or support costs incurred as a direct result of the project activities but shared across different projects. These costs are either itemised or provided as a lump sum in some cases, on the proviso that the partner provides a detailed breakdown of planned spending.
• Indirect costs or overheads that cannot be directly attributed to project activities that are often calculated as a proportion of direct project expenditure. These may also be referred to as core or support costs, administration fees and general operating support.

There is no standardised definition of these different types of costs or agreement on what type of cost falls in each category, and donors and international organisations take different approaches. Broadly, overheads are used to refer to expenditure outside of normal programme implementation costs that are necessary for an organisation to deliver its mission.^[22] This could cover central support costs, such as senior management positions; or functions, such as establishing and maintaining overarching organisational policies and systems. Overheads ultimately enable an organisation to deliver programmes effectively, efficiently, and safely.^[23] Two useful definitions of overheads/indirect costs are:

• “A percentage charge applied to an organisation’s expenditure for programme-related costs that are not directly attributable to a specific programme.” (DI, 2008)^[24]
• “The necessary and reasonable costs incurred to manage the organisation as a whole, provide oversight over all its activities and put into place the overarching policies, frameworks and systems that enable it to operate.” (Money Where It Counts protocol, 2019)^[25]