1. What is a social stock exchange?
1.1 Social stock exchanges are dedicated platforms that allow investors to purchase stakes in social enterprises, volunteer groups and welfare organizations. Contrary to most capital market exchanges that allow firms to be listed when they meet certain business criteria (see here for Security and Exchange Board of India’s (“SEBI”) initial public offering guidelines), a social stock exchange generally screens enterprises on the basis of their ‘social impact’ before listing them. It falls under the broad purview of ‘impact investment’- a form of funding that aims to drive measurable social benefits while also generating monetary returns. Arguably, social stock exchanges have to potential to offer innovative solutions that utilize equity investments to create social impacts.
1.2 Indian finance minister Nirmala Sitharaman first floated the idea of social stock exchange for India in her union budget speech for 2019-2020. Under the overarching objective of bolstering ‘inclusive growth’ and ‘financial inclusion’, Sitharaman proposed setting up an ‘electronic fundraising platform’ for organizations working towards social welfare objectives, under SEBI’s regulatory ambit. While the idea has been described as ‘radical’, there are is little clarity on the shape, mechanics, and mandate of this social stock exchange. As of now, following Sitharaman’s budget announcement, SEBI has set up a working group under the chairmanship Ishaat Hussain (Director, State Bank of India Foundation) in September 2019 to examine and make recommendations on the structures and mechanics of a social stock exchange. The following paragraphs attempt to shed some light on potential stock exchange models- their drawbacks and benefits- and the larger discourse surrounding social stock exchanges.
2. Who is saying what?
2.1 The industry perception appears varied. Largely, stakeholders have applauded the decision, as it indicates the government’s willingness to address funding deficits in the social sector. For instance, Piyush Jain, cofounder of ImpactGuru said that the proposed social stock exchange will acknowledge the problems of investment fundraising for social enterprises. Shamika Ravi, research director at Brookings India, echoes this view. Importantly, many stakeholders believe that it will bring greater transparency for non-profits, assisting investors to better evaluate the social enterprises they would like to invest in. More or less, the industry agree that the move is significant and bound to be successful in India.
2.2 On the flipside, Vishal Mehta, co-founder of Lok Capital suggested that establishing a small and medium enterprise (“SME”) exchange is a better and viable alternative to a social stock exchange by arguing that most social enterprises were SMEs. He added that India’s investment sector was not mature enough to sustain the proposed social stock exchange.
3. What are the challenges while building a social stock exchange?
3.1 No legal criteria: It will be difficult to distinguish between a social enterprise and a normal enterprise given that there exists no legal criteria to differentiate between the two. Stakeholders have voiced similar concerns, saying that the government will need to create a legal definition of a ‘social enterprise’. This has remained an issue for most social stock exchanges over the world. For example, social enterprises in Singapore and South Africa need to have a ‘social purpose’ whereas UK based social enterprises are not mandated to have any social purpose as the primary aim of their business. Similarly, Canada uses a widely understood metric ‘B Corporation Standard’ to determine the social enterprises’ social and environmental impact. Similar to traditional crowdsourcing platforms, the Brazilian social stock exchange however directly matches interested social investors with social enterprises without conducting any valuation.
3.2 Scope of participation: It remains unclear if the proposed social stock exchange covers non-profit organisations in addition to social enterprises within its scope. Further, numerous non-profit organisations in India may be unable to comply with the proposed disclosure and listing standards as they not registered and lack the resources to maintain their financial records. In fact, several social enterprises in India operate as charitable trusts, societies, or as limited liability partnership. On the other hand, the social stock exchange could also apply to voluntary organizations such as the BCCI, which is one of the richest sporting bodies.
3.3 Governance structure: Maintaining adequate liquidity in the proposed social stock exchange will be a major hurdle as there is a lack of clarity on how the proposed social stock exchange will allow social enterprises to raise capital. Many people are speculating if it will social enterprises to raise funds through equity or debt, and if these ‘investments’ will be tradeable. The government will need to clarify if the proposed social stock exchange will convert donations made to non-profit organisation into securities and facilitate its trade. On the other hand, the Government may look to the models of social stock exchanges of other countries. For instance, in the United Kingdom, the social stock exchange only connects the public with impact investments. It is not a transactional platform. It only profiles different impact investments. In Canada, the social stock exchange aims to address “social finance market failures by providing social ventures with a low-cost method of gaining access to investors.” Additionally, in Singapore, the exchange concerns itself with listing, trading, clearing and settlement of securities issued by social enterprises across Africa and Asia, making it the only actual public social stock exchange.
3.4 Tax: Since a number of Indian social enterprises follow a non-profit structure by way of tax incentives and subsidies, it will be necessary for the government to address questions pertaining to dividend payouts, return on investments, bond issuance, etc. without running the risk of losing the social enterprises’ tax-exempt status. Overall, there is a need to bring clarity on taxation of social enterprises since tax breaks are given for donations to social initiatives but they are not transferable.
3.5 Impact assessment intermediaries: The proposed social stock exchange may give rise to a new set of intermediaries such as impact assessors responsible to measure the impact of work that social enterprises do. The SEBI may have to come up with regulations to govern their registrations and scope of work. Delays in managing these activities may lead to loss of opportunity.
3.6 Return of investment: Social stock exchanges often find it challenging to determine the return on investments for investors. In case of social enterprise investment, the return on investment will be based on realization of the social welfare objective. There is no established criteria to determine the success of a social welfare objective. Further, investors will be prone to risks such as the “crowding out” effect and mission drift. Appropriate safety measures will need to be built within the system to safeguard the interests of the investors and the listed social enterprises.
4. How do we build an effective social stock exchange for India?
Different countries may have developed their social stock exchanges based on the interests of their stakeholders and though these models might serve as a good reference for Indian policymakers, the proposed Indian social stock exchange will need to be designed keeping in mind the interests of Indian stakeholders. To this end, the following recommendations may help in building a transparent exchange:
4.1 The government should relax compliance and reporting standards to make the social stock exchange inclusive enough for all social entities to reap benefits.
4.2 Corporate social responsibility (“CSR”) funds should be routed to the listed social enterprise through the social stock exchange to reduce the misuse of CSR funds.
4.3 The Government should work with non-profit organisations and social enterprises to prepare them to absorb large funds. Since capital markets work on a large scale, it will be necessary to teach social enterprises to consume the large sum that may be raised through the proposed social stock exchange.
4.4 Since foreign funds play a substantial role in the social sector in India, the regulatory framework should also account for the interests of overseas investors while designing the proposed Indian social stock exchange.
4.5 Appropriate amendments should be introduced to tax laws to allow for the transfer of tax benefits.
4.6 The government should work towards establishing a common understanding of impact metrics and align with international standards of impact assessment to better integrate with international participants.
4.7 Incentives for investors investing in social enterprises through the proposed social stock exchange should be increased by the government to maintain good liquidity over the long term.
The exact nature and functioning of the proposed social stock exchange is yet to be clarified by the government. That being said, the intent behind this move extends beyond the ‘financial inclusion’ and ‘inclusive growth’ objectives voiced by Sitharaman. It has been suggested that the idea of a social stock exchange was introduced to help reduce India’s dependence on foreign aid. Since it came to power in 2014, the ruling government has cracked down on more than 13,000 NGOs by cancelling their licenses for receiving foreign funds. It is not surprising that foreign funding to India plunged 40 percent between 2013 and 2018. Therefore, the proposed exchange could provide new and cheaper sources of funding social welfare projects for an ecosystem that is- somewhat paradoxically-both thriving, and starved of investment.
(Authored by Vihang Jumle, Associate with inputs from Vijayant Singh, Associate at Ikigai Law)