(Authored by Gaurang Mansinghka, Editor)
The novel idea of a social stock exchange (‘SSE’) which underlines the notion of financial inclusion was brought to the fore by the Finance Minister, Nirmala Sitharaman in the Union budget speech for the FY 2019-20. Pursuant to her speech, the Securities and Exchange Board of India (‘SEBI’) had set up a working group which in its report dated June 1, 2020 ("Report") has recommended structures and mechanisms to facilitate fund-raising by social enterprises. This post attempts to highlight and analyse the recommendations made by the working group.
Defining a social enterprise
The Report avoids a one-size-fits-all approach and therefore does not prescribe a set legal definition that an enterprise needs to satisfy to be categorized as a ‘social enterprise’. However, an enterprise has to comply with a minimum reporting standard and specify the impact they wish to create on a self-declaration basis to fall under the garb of a social enterprise.
Differentiating between for-profit and non-profit enterprises
The Report differentiates between a for-profit social enterprise (‘FPE’) and a non-profit social enterprise (‘NPO’) because of the inherent differences in the way these entities operate and their ability to raise funds. It prescribes different methods and approaches for FPEs and NPOs under the aegis of SSE. However, it recommends a common minimum reporting standard for NPOs and FPEs. The reporting standard is expected to usher and become more rigorous and transparent as SSE evolves.
Housing SSE under the existing exchanges
Instead of creating a new exchange altogether, SSE would operate as a separate segment under the existing exchanges. This would, in turn, be beneficial for SSE as it will be able to use the existing infrastructure to its advantage without deploying many resources.
Minimum reporting framework
In the immediate term, the social enterprises need to report the social problem intended to be addressed, target segment, the extent of target segment served, approach to solving the problem, members of the governing body, prior funding history, financials and registrations and pass through the assessment mechanism to be developed by SEBI. The SSE is to ensure that this criterion is met by all social enterprises that wish to use the SSE platform to raise funds. The Report envisions a more rigorous mechanism in the intermediate-term.
A beneficiary centric method of measurement is prescribed which goes beyond mere behavioural reporting by the enterprises. This is done so that impact is viewed from the beneficiary’s lens and overcomes the hurdle of skewed reporting by the reporting entities. A standardized framework can be devised only when one sees how the SSE evolves. Currently, there exists no standard reporting framework for NPOs and as a result, the Report recommends that existing information repositories ("IRs") along with the Institute of Chartered Accountants of India should formulate a set of common standards.
The capacity building unit will be responsible for bringing to together the existing IRs, implementing the reporting standard, operating the capacity building fund and raising awareness about the instruments available on SSE. The Report also provides for creating a capacity-building fund which would assist in organizing the existing IRs, implementing the reporting framework, assisting the NPOs in their reporting obligations and creating awareness.
Owing to the lack of revenue-generating capacity, the prescribed instruments for NPOs focus on unlocking funds from donors, philanthropists and corporate social responsibility (‘CSR’) spenders. Some of the instruments are zero-coupon zero principal bonds, social venture funds devised as grants-in, grants-out, pay for success models or impact bonds and close-ended mutual funds whose returns can be channelled towards a social cause. Even though these instruments do not focus on financial gains yet these are not bereft of the risk factor as they still run the risk of not being able to create an impact. Apart from the instruments prescribed for NPOs, FPEs can also list equity shares on SSE which will be similar to the Innovators Growth Platform.
Developing new institutions:
IRs will be set up to overcome information asymmetry and lack of publically available robust information about the social enterprises and resultantly, act as a ‘feeder’ to SSE. The IRs would help in listing of active NPOs, formulating a standardized reporting framework for NPOs, do information reporting for NPOs and undertake due diligence. SSEs may also maintain a directory of social enterprises. The profession of social auditors will have to be developed and promoted who will evaluate and measure impact. The Report envisions the creation of a regulator for social reporting and overseeing the functioning of social auditors and other related social institutions.
The Report aims to incentivize the use of SSE by recommending numerous policy interventions like-
Permitting funding to NPOs to be counted towards CSR obligations of a company.
Authorizing trading of CSR spends between companies with excess and deficit CSR spends and the SSE can be used as a platform for this purpose.
Contributions towards the capacity building fund of SSE to be counted towards CSR commitments.
Notification of zero-coupon zero principal bonds as a security under the Securities Contract (Regulation) Act, 1956.
Reducing minimum ticket size and minimum corpus requirement for social venture funds.
Exempting trades on SSE from Securities Transaction Tax.
Exempting the payment of Capital Gains Tax on long term capital gains pursuant to the sale of securities on SSE.
Permitting donors to claim 100% tax exemption for donations to NPOs that benefit from SSE and make all investments in securities of NPOs tax-deductible.
Permitting CSR expenditure that goes to SSE as a deduction from taxable income.
Allowing a tax holiday of 5 years to FPEs listed on SSE.
Allowing revenue generated through SSE by stock exchanges to be tax-deductible.
Many countries like Brazil, Canada, Mauritius, Singapore and the UK have SSEs but most of them operate either as a mere directory or as a matchmaking platform for FPEs. But in case of India, the Report envisages a comprehensive framework for both FPEs and NPOs and goes beyond matchmaking by introducing new instruments and structures.
SSE for COVID-19
The concept of SSE couldn’t have been envisioned at a fitter time as SSE has the potential of unlocking large amounts of social capital during these unprecedented times. Social capital along with conventional sources of capital can help counter the economic contagion. A COVID-19 Aid Fund can be set up and ‘pay-for-success’ bonds and blended finance instruments can be used to attract impact CSR donations, impact investors, philanthropists etc.
The Report is a welcome step for the social sector but the success of the platform will depend on the implementation of the recommendations. It will be interesting to see how SEBI, in its final report, would strike a balance between liberalisation and regulatory oversight. However, if SSE is to finance the change it seeks to, it needs to be ensured that benefits are reaped by the actual target segment. All in all, SSE is a much-needed impetus to the social sector in India and has the potential to unlock new avenues of capital to reinvigorate the sector.